[Federal Register: May 24, 2002 (Volume 67, Number 101)]
[Rules and Regulations]
[Page 36739-36763]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr24my02-22]
[[Page 36739]]
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Part IV
Commodity Futures Trading Commission
Securities and Exchange Commission
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17 CFR Parts 41 and 240
Cash Settlement and Regulatory Halt Requirements for Security Futures
Products; Final Rule
[[Page 36740]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 41
RIN 3038-AB86
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-45956; File No. S7-15-01]
RIN 3235-AI24
Cash Settlement and Regulatory Halt Requirements for Security
Futures Products
AGENCIES: Commodity Futures Trading Commission and Securities and
Exchange Commission.
ACTION: Joint final rule.
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SUMMARY: The Commodity Futures Trading Commission (``CFTC'') and the
Securities and Exchange Commission (``SEC'') (collectively
``Commissions'') are adopting a new rule generally to require that the
final settlement price for each cash-settled security futures product
fairly reflect the opening price of the underlying security or
securities, and that trading in any security futures product halt when
a regulatory halt is instituted with respect to a security or
securities underlying the security futures product by the national
securities exchange or national securities association listing the
security. The rule adopted today would set forth more specifically how
the exchange's or association's rules can satisfy provisions added to
the Commodity Exchange Act (``CEA'') and the Securities Exchange Act of
1934 (``Exchange Act'') by the Commodity Futures Modernization Act of
2000 (``CFMA''). The Commissions are also issuing an interpretation of
the statutory requirement under the CEA and the Exchange Act that
procedures be put in place for coordinated surveillance among the
markets trading security futures products and any market trading any
security underlying the security futures products or any related
security.
EFFECTIVE DATE: The rules are effective June 24, 2002.
FOR FURTHER INFORMATION CONTACT:
CFTC
Richard A. Shilts, Acting Director, Division of Economic Analysis,
at (202) 418-5275; Thomas M. Leahy, Jr., Financial Instruments Unit
Chief, Division of Economic Analysis, at (202) 418-5278; or Gabrielle
A. Sudik, Attorney, Office of General Counsel, at (202) 418-5120,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, NW, Washington, DC 20581. E-mail: ([email protected]),
([email protected]), or ([email protected]).
SEC
Jerry Carpenter, Assistant Director, at (202) 942-4187; Terri
Evans, Assistant Director, at (202) 942-4162; Alton Harvey, Office
Head, at (202) 942-4167; Michael Gaw, Special Counsel, at (202) 942-
0158; Cyndi Nguyen, Attorney, at (202) 942-4163; and Michael Rae,
Attorney, at (202) 942-0785, Division of Market Regulation, Securities
and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-
1001.
SUPPLEMENTARY INFORMATION: The CFTC is adopting Rule 41.1(j) through
(l), 41.25(a)(2), 41.25(b), and 41.25(d) under the CEA.\1\ The SEC is
adopting Rule 6h-1 under the Exchange Act.\2\
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\1\ Rule 41.1(j)-(l), 17 CFR 41.1, hereinafter referred to as
CFTC Rule 41.1; 41.25(a)(2), 17 CFR 41.25(a)(2), hereinafter
referred to as CFTC Rule 41.25(a)(2); 41.25(b), 17 CFR 41.25(b),
hereinafter referred to as CFTC Rule 41.25(b); and 41.25(d), 17 CFR
41.25(d), hereinafter referred to as CFTC Rule 41.25(d).
\2\ Rule 6h-1, 17 CFR 240.6h-1, hereinafter referred to as SEC
Rule 6h-1.
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Table of Contents
I. Introduction
II. Discussion
A. Settlement Prices for Cash-Settled Security Futures Products
1. Background
2. Proposed Rule for Settlement Prices
3. Final Rule
a. Final Settlement Price for Cash-Settled Security Futures
Products Must Fairly Reflect the Opening Price
i. CFTC Technical Amendment
b. Definitions of ``Opening Price'' and ``Regular Trading
Session''
c. Determining a Final Settlement Price When Opening Price Not
Readily Available
d. New Provision to Resolve Conflict Between Market Rules and
Clearing Agency Rules
e. Exemptions
B. Regulatory Halts
1. Background
2. Proposed Rule for Regulatory Halts
3. Final Rule
a. Trading Halt Coordination in Single-Stock Futures
b. Trading Halt Coordination in Narrow-Based Security Index
Futures
c. Definition of a Regulatory Halt
d. Exemptions
C. Commissions' Interpretation of Statutory Requirements for
Coordinated Surveillance
1. Markets Trading Security Futures
2. Exchanges Trading Securities Other Than Security Futures
III. Paperwork Reduction Act
CFTC:
SEC:
A. Summary of Collection of Information
B. Proposed Use of Information
C. Respondents
D. Total Annual Reporting and Recordkeeping Burden
E. Record Retention Period
F. Collection of Information Is Mandatory
G. Confidentiality
IV. Costs and Benefits of the Final Rule
CFTC:
SEC:
A. Comments
B. Benefits of SEC Rule 6h-1 under the Exchange Act
C. Costs of SEC Rule 6h-1 under the Exchange Act
V. Consideration of the Burden on Competition, and Promotion of
Efficiency, Competition, and Capital Formation
SEC:
A. Effects on Competition
1. Settlement Procedures for Cash-Settled Security Futures
Products
2. Trading Halt Provisions
3. Conclusion
B. Effects on Efficiency and Capital Formation
1. Settlement Procedures for Cash-Settled Security Futures
Products
2. Trading Halt Provisions
VI. Final Regulatory Flexibility Act
CFTC:
SEC:
VII. Statutory Basis and Text of Rule
Appendix A
I. Introduction
The CFMA \3\ authorizes the trading of futures on individual stocks
and narrow-based security indexes (collectively, ``security futures
'').\4\ The CFMA defines security futures products as ``securities''
under the Exchange Act,\5\ the Securities Act of 1933,\6\ the
Investment Company Act of 1940,\7\ and the Investment Advisers Act of
1940,\8\ and as contracts of sale for future delivery of a single
security or of a narrow-based security index or options thereon under
the CEA.\9\ Accordingly, the regulatory framework established by the
CFMA for the markets and intermediaries trading security futures
[[Page 36741]]
products provides the SEC and the CFTC with joint jurisdiction.
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\3\ Pub. L. No. 106-554, Appendix E, 114 Stat. 2763.
\4\ After December 21, 2003, the Commissions may jointly
determine to permit trading of puts, calls, straddles, options, or
privileges on security futures (along with security futures,
collectively referred to as ``security futures products''). See
Section 2(a)(1)(D)(iii) of the CEA, 7 U.S.C. 2(a)(1)(D)(iii);
Section 6(h)(6) of the Exchange Act, 15 U.S.C. 78f(h)(6).
\5\ See Section 3(a)(10) of the Exchange Act, 15 U.S.C.
78c(a)(10).
\6\ See Section 2(a)(1) of the Securities Act of 1933, 15 U.S.C.
77b(a)(1).
\7\ See Section 2(a)(36) of the Investment Company Act of 1940,
15 U.S.C. 80a-2(a)(36).
\8\ See Section 202(a)(18) of the Investment Advisers Act of
1940, 15 U.S.C. 80b-2(a)(18).
\9\ See Section 1a(31) of the CEA, 7 U.S.C. 1a(31).
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Under the Exchange Act, it is unlawful for any person to effect
transactions in security futures products that are not listed on a
national securities exchange \10\ or on a national securities
association registered pursuant to Section 15A(a) of the Exchange
Act.\11\ In addition, Section 6(h)(2) of the Exchange Act \12\ provides
that such an exchange or association may trade only those security
futures products that conform with listing standards filed by the
exchange or association with the SEC under Section 19(b) of the
Exchange Act \13\ and that meet certain criteria specified in Section
2(a)(1)(D)(i) of the CEA \14\ and the standards and conditions
enumerated in Section 6(h)(3) of the Exchange Act.\15\
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\10\ Section 6(g) of the Exchange Act, 15 U.S.C. 78f(g), allows
a designated contract market under Section 5 of the CEA, 7 U.S.C. 7,
or a registered derivatives transaction execution facility under
Section 5a of the CEA, 7 U.S.C. 7a, to register as a national
securities exchange solely for the purpose of trading security
futures products (``Security Futures Product Exchange''). See
Securities Exchange Act Release No. 44692 (August 13, 2001), 66 FR
43721 (August 20, 2001) (adopting, in part, requirements for
designated contract markets and registered derivatives transaction
execution facilities to register as national securities exchanges).
By definition, the phrase ``national securities exchange''
encompasses Security Futures Product Exchanges. For simplicity, the
text of this release refers to national securities exchanges and
national securities associations. The CFTC's rules in Section VII of
this release, however, by their terms, apply to designated contract
markets and registered derivatives transaction execution facilities.
\11\ 15 U.S.C. 78o-3(a).
\12\ 15 U.S.C. 78f(h)(2).
\13\ 15 U.S.C. 78s(b).
\14\ 7 U.S.C. 2(a)(1)(D)(i).
\15\ 15 U.S.C. 78f(h)(3).
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In particular, the CEA and the Exchange Act stipulate that the
listing standards of an exchange or association trading security
futures products shall, among other things, require that trading in the
security futures product not be readily susceptible to manipulation of
the price of such security futures products, nor to causing or being
used in the manipulation of the price of any underlying security or
option thereon.\16\ In addition, listing standards must require that
the market on which the security futures product trades has in place
procedures to coordinate trading halts between such market and any
market on which any security underlying the security futures product is
traded and other markets on which any related security is traded.\17\
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\16\ See Section 2(a)(1)(D)(i)(VII) of the CEA, 7 U.S.C.
2(a)(1)(D)(i)(VII); Section 6(h)(3)(H) of the Exchange Act, 15
U.S.C. 78f(h)(3)(H).
\17\ See Section 2(a)(1)(D)(i)(X) of the CEA, 7 U.S.C.
2(a)(1)(D)(i)(X); Section 6(h)(3)(K) of the Exchange Act, 15 U.S.C.
78f(h)(3)(K). Before a national securities exchange or national
securities association lists or trades security futures products, it
is required to file, pursuant to Section 19(b) of the Exchange Act,
15 U.S.C. 78s(b), a proposed rule change with the SEC establishing
listing standards that comply with Section 6(h)(3) of the Exchange
Act, 15 U.S.C. 78f(h)(3). Generally, a national securities exchange
registered under Section 6(a) of the Exchange Act, 15 U.S.C. 78f(a),
or a national securities association registered under Section 15A(a)
of the Exchange Act, 15 U.S.C. 78o-3(a), must file proposed rule
changes with the SEC pursuant to Section 19(b)(1) of the Exchange
Act, 15 U.S.C. 78s(b)(1), for notice, comment, and SEC approval,
prior to implementation, unless the rule is otherwise permitted to
become effective pursuant to Section 19(b)(3) of the Exchange Act,
15 U.S.C. 78s(b)(3). A Security Futures Product Exchange or a
national securities association registered under Section 15A(k) of
the Exchange Act, 15 U.S.C. 78o-3(k), must generally submit,
pursuant to Section 19(b)(7) of the Exchange Act, 15 U.S.C.
78s(b)(7), proposed rule changes relating to certain enumerated
matters, including listing standards. See 17 CFR 240.19b-7.
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Accordingly, the Commissions proposed amendments to Rule 41.1 and
Rule 41.25 under the CEA, and new Rule 6h-1 under the Exchange Act to
generally provide that (i) the final settlement price for each cash-
settled security futures product fairly reflect the opening price of
the underlying security or securities, and (ii) the listing standards
of national securities exchanges and national securities associations
trading security futures products establish a halt in trading in any
security futures product when the national securities exchange or
national securities association listing the security institutes a
regulatory halt with respect to a security or securities underlying the
security futures product.\18\ In response to the Proposing Release, the
Commissions received eight comment letters.\19\ As discussed further
below, the Commissions are adopting the rule substantially as proposed,
with slight modifications in response to recommendations by commenters.
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\18\ See Securities Exchange Act Release No. 44743 (August 24,
2001), 66 FR 45904 (August 30, 2001) (``Proposing Release'').
\19\ See letters to Jean A. Webb, Secretary, CFTC, and Jonathan
G. Katz, Secretary, SEC, from, or on behalf of: Joanne Moffic-
Silver, General Counsel, Chicago Board Options Exchange, dated
October 1, 2001 (``CBOE Letter''); David J. Vitale, President and
Chief Executive Officer, Chicago Board of Trade, dated October 1,
2001 (``CBOT Letter''); James J. McNulty, President and Chief
Executive Officer, Chicago Mercantile Exchange, Inc., dated October
1, 2001 (``CME Letter''); Jonathon Barton, Chairman, Futures
Industry Association/Securities Industry Association Steering
Committee on Security Futures, dated April 4, 2002 (``FIA/SIA
Steering Committee Letter''); James E. Buck, Senior Vice President
and Secretary, New York Stock Exchange, Inc., dated October 19, 2001
(``NYSE Letter''); William H. Navin, Executive Vice President and
General Counsel, the Options Clearing Corporation, dated October 3,
2001 (``OCC Letter''); Joel Greenberg, Managing Director,
Susquehanna International Group, LLP, dated October 17, 2001 (``SIG
Letter''); and Larry Coury, Silvia Madrid, Laura Murias, Mike
Periera, Vivek Sahota, Benjamin Sparks, Adrian Spirollari, and
Wallace Truesdale, Students at Fordham University School of Law,
dated October 1, 2001 (``Students Letter''). In addition to the
comment letters received on the Proposing Release, the Commissions
reviewed three comment letters received by the CFTC on its separate
proposal regarding full membership in the Intermarket Surveillance
Group. See infra discussion at Section II.C., Commissions'
Interpretation of Statutory Requirements for Coordinated
Surveillance.
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II. Discussion
A. Settlement Prices for Cash-Settled Security Futures Products
1. Background
All currently traded index futures and options are cash-settled.
When stock index futures and options began trading in the mid-1980s,
virtually all of these products used closing-price settlement
procedures. Closing-price settlement procedures in index futures and
options generally base the index settlement price on the execution
prices from the last regular session trades in the underlying
securities. The cash settlement provisions of stock index futures and
options contracts facilitated the growth of sizeable index arbitrage
activities by firms and professional traders and made it relatively
easy for arbitrageurs to buy or sell the underlying stocks at or near
the market close on expiration Fridays \20\ in order to ``unwind''
arbitrage-related positions. These types of unwinding programs at the
close on expiration Fridays often severely strained the liquidity of
the securities markets.
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\20\ The term ``expiration Fridays'' refers to the third Friday
of each month that marks the expiration date for that month's
individual stock options, stock index options, and stock index
futures contracts. On the expiration date, options and futures
contracts cease to exist. Some stock index futures and options
expire on a quarterly basis, with their expiration Friday occurring
on the third Friday of the last month of the quarter (March, June,
September, and December).
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Regulators and self-regulators were concerned that the liquidity
constraints faced by the securities markets to accommodate expiration-
related buy or sell programs at the market close on expiration Fridays
could exacerbate ongoing market swings during an expiration and could
provide opportunities for entities to anticipate these pressures and
enter orders as part of manipulative or abusive trading practices
designed to artificially drive up or down share prices. To reduce such
expiration-related strains on market liquidity, markets trading the
most actively-traded futures contracts and many stock index option
contracts moved to opening-price settlement procedures. As discussed in
the Proposing Release, opening-price settlement procedures offered
several features that enabled the securities
[[Page 36742]]
markets to better handle expiration-related unwinding programs.
2. Proposed Rule for Settlement Prices
In view of the experience gained with settlements in cash-settled
stock index futures and options in the 1980s and in light of the
potential for manipulation of the underlying securities markets, the
Commissions proposed that security futures products that specify cash
settlement in lieu of physical delivery use a final settlement price
that fairly reflected the opening price of the underlying security or
securities as the basis for cash settling positions at contract
expiration.\21\
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\21\ See Proposing Release, supra note 18.
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The Commissions' proposal also required that, if an opening price
for an underlying security or securities was not readily available, the
final settlement price of the overlying cash-settled security futures
product had to fairly reflect the price of the underlying security or
securities during its most recent regular trading session. The
Commissions' proposal provided exchanges and associations with some
discretion to implement this general rule. Finally, the proposal
explicitly permitted the Commissions to grant a national securities
exchange or national securities association an exemption from the above
requirements.
3. Final Rule
a. Final Settlement Price for Cash-Settled Security Futures Products
Must Fairly Reflect the Opening Price
The Commissions are adopting the requirement as proposed that the
final settlement price of a cash-settled security futures product
fairly reflect the opening price of the underlying security or
securities, if the opening price is readily available.\22\
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\22\ CFTC Rule 41.25(b)(1) and SEC Rule 6h-1(b)(1). The CFTC is
adopting one technical change to CFTC Rule 41.25(b). See discussion
infra at II.A.3.a.i., CFTC Technical Amendment.
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Several commenters generally supported this aspect of the
proposal.\23\ One commenter stated that cash-settled security futures
products should be settled based on opening prices of the underlying
securities because cash-settled index options already are required to
settle in the same manner.\24\ A second commenter advocated opening
price settlement because closing-price settlement procedures for
futures and options products in the 1980s ``strained the liquidity of
the securities markets and raised concerns about opportunities for
manipulative or abusive trading practices.'' \25\ This commenter
believed that, with the increased use of opening-price settlement,
specialists are better able to handle expiration-related unwinding
programs because there are well-developed opening procedures to
disseminate price indications in an orderly manner and because
specialists have the remainder of the session to trade out of any
position imbalances acquired at the opening.
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\23\ See CBOE Letter, CBOT Letter, and NYSE Letter.
\24\ See CBOE Letter.
\25\ See NYSE Letter.
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A third commenter noted that the migration in 1987 from closing
price to opening price settlement on its S&P 500 and other futures
contracts ``was largely in response to the fact that Friday afternoon
settlements--which corresponded to existing practices for listed
options expirations--exposed NYSE specialists to large information-less
market-on-close orders without an adequate mechanism to cope.''\26\
Nevertheless, this commenter pointed out potential problems with the
proposed approach. It stated, for example, that the openings of all
securities do not occur simultaneously and, therefore, calculation of
an index must be based on non-synchronous transaction prices. This
commenter also noted that a volume-weighted average transaction price
over a short time interval has evolved into an industry standard for
determining final settlement prices for futures based on securities
trading on decentralized markets, such as Nasdaq. In response to the
foregoing, the Commissions note that the rule being adopted today does
not mandate that a particular methodology be used to derive an opening
price. A national securities exchange or national securities
association is, therefore, free to develop its own methodology for
determining final settlement prices, provided that the result ``fairly
reflects'' the opening price.\27\
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\26\ See CME Letter.
\27\ Any rule change proposed by a national securities exchange
or national securities association to establish listing standards
for security futures products, including methodologies for
determining final settlement prices, would have to be filed with the
SEC pursuant to Section 19 of the Exchange Act, 15 U.S.C. 78s, and
the rules thereunder. See supra note 10 and accompanying text. Rule
changes should also be submitted to the CFTC in accordance with CFTC
Rule 41.24, 17 CFR 41.24.
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The same commenter also stated that the Commissions' proposal could
create a discrepancy between security futures products based on narrow-
based security indexes and other derivative products based on the same
indexes: while the former would be required to settle using opening
prices, the latter are subject to no such requirement.\28\ Another
commenter noted that the option on the S&P 100 index (the ``OEX''
option) still employs closing-price settlement and called upon the
Commissions to bring OEX into line with the opening-price settlement
procedures now being adopted.\29\
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\28\ See CME Letter.
\29\ See NYSE Letter.
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The Commissions do not believe it is necessary or appropriate at
this time to mandate opening settlement procedures for all options and
futures. As the Commissions noted in the Proposing Release, CBOE
believed that the closing price settlement procedures were appropriate
for OEX because these options were used primarily by retail investors
and were not actively used in the types of index arbitrage unwinding
programs that had strained the liquidity of the securities markets at
the close on expiration.\30\ Further, the Commissions note that the
vast majority of options do use opening-price settlement procedures;
\31\ therefore, the rule being adopted today is consistent with that
general practice.\32\
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\30\ For example, the OCC indicated that for the month of
November 2001, the dollar amount of premiums settled in SPX options
was over 12 times larger than that for OEX options. Both indexes are
capitalization-based indexes from Standard & Poor's.
\31\ See Proposing Release, supra note .
\32\ If the circumstances so warrant, the SEC may in the future
consider requiring all cash-settled options to use opening-price
settlement procedures.
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One commenter also did not believe that the decision to employ
opening-rather than closing-price procedures should be based on a
perceived threat of increased manipulative activity, arguing that
improvements in audit trails, record-keeping practices, and inter-
exchange cooperation have greatly increased the ability to detect and
punish manipulative activity.\33\ The Commissions agree that these
enhancements have increased the ability of regulators to detect and
punish manipulative trading activity. Nevertheless, the Commissions
believe that it is appropriate to take steps that reduce not merely the
incentive, but also the ability to manipulate the market. For example,
one commenter described its implementation of special closing
procedures to reduce the scope for end-of-day manipulation, while
stating that the use of opening prices would obviate the need for these
special closing procedures.\34\ This commenter also noted that opening-
price settlement decreases the likelihood of price distortions not
brought about by manipulative intent, such as human
[[Page 36743]]
error, that can significantly affect the closing prices of securities
and their overlying indexes, because the markets have no time before
the closing to correct such errors. The Commissions believe that market
distortions--whether caused by manipulation, human error, or
difficulties in balancing buy- and sell-side interest--are more likely
to occur in an environment in which closing-price settlement of
derivative products is used, and that the potential for these
distortions exists to a far lesser degree at the opening.\35\
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\33\ See CME Letter.
\34\ See NYSE Letter.
\35\ See supra discussion at Section II.A.1., Background.
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i. CFTC Technical Amendment
The CFTC notes one technical change to the text of CFTC Rule
41.25(b). In an earlier rulemaking, the CFTC adopted an introductory
paragraph that required that the cash settlement price of security
futures products must be ``reliable and acceptable, be reflective of
prices in the underlying securities market and be not readily
susceptible to manipulation.'' \36\ The CFTC included this language in
the earlier rulemaking to reflect the CFTC's longstanding policy
regarding the standards for cash-settlement of futures contracts, which
are set forth in the CFTC's Guideline No. 1.\37\ The CFTC also included
this language in the Proposing Release for the present rulemaking.\38\
In the final rules published today, the CFTC has decided to eliminate
this introductory paragraph because the requirements of the paragraph
are embodied in the remainder of the Rule 41.25(b) and in other rules
in Part 41.
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\36\ See 66 FR 55078 (November 1, 2001).
\37\ See 17 CFR Part 40, Appendix A(a)(2)(iii).
\38\ See 66 FR at 45918.
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The requirements that the cash settlement price must be reliable,
acceptable and reflect the prices in the underlying securities markets
are embodied in CFTC Rules 41.25(b)(1) and (2). These rules require
that cash settlement prices be based on the opening price of a security
futures product's underlying security or securities, or, if the opening
price for one or more securities is not readily available, the final
settlement price of the security futures products must fairly reflect
the price of the underlying security or securities during the most
recent regular trading session for such securities or the next
available opening price. Based on prior analyses and for reasons
discussed in the proposing release, the CFTC previously has determined
that opening prices represent reliable indicators of the values of
securities and thus are acceptable for hedging of securities'
positions. In addition, opening prices are established under procedures
designed to ensure that the prices are reflective of prices in the
underlying securities market. Finally, the requirement that the cash
settlement price not be readily susceptible to manipulation is embodied
in CFTC Rule 41.22(f), which states, ``Trading in the security futures
products is not readily susceptible to manipulation of the price of
such security futures product, nor to causing or being used in the
manipulation of the price of any underlying security, option on such
security, or option on a group or index including such securities,
consistent with the conditions for trading of [sect] 41.25[.]'' \39\
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\39\ See 17 CFR 41.22(f); 66 FR at 55084. See also Core
Principle for Contract Markets 3 of the CEA requiring designated
contract markets to list contracts that are not readily susceptible
to manipulation; Core Principle for Contract Markets 4 of the CEA
requiring designated contract markets to monitor trading to prevent
manipulation, price distortion, and disruptions of the delivery or
cash-settlement process; and Core Principle for DTEFs 3 of the CEA
requiring DTEFs to monitor trading to ensure orderly trading.
Sections 5(d)(3), 5(d)(4) and 5a(d)(3) of the CEA; 7 U.S.C. 7(d)(3),
7(d)(4) and 7a(d)(3).
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b. Definitions of ``Opening Price'' and ``Regular Trading Session''
The Commissions are adopting the definition of ``regular trading
session'' as proposed.\40\ However, in response to comments, the
Commissions have modified the definition of ``opening price'' by
clarifying that, if a security is not listed on a national securities
exchange or a national securities association, the opening price shall
be the price at which a security opened for trading, or a price that
fairly reflects the price at which a security opened for trading, on
the primary market for the security.
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\40\ A ``regular trading session'' of a security means the
normal hours for business of a national securities exchange or
national securities association that lists the security. See CFTC
Rule 41.1(k) and SEC Rule 6h-1(a)(2).
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The Commissions proposed to define ``opening price'' as ``the price
at which a security opened for trading, or a price that fairly reflects
the price at which a security opened for trading, during the regular
trading session of the national securities exchange or national
securities association that lists the security.'' \41\ One commenter,
however, observed that security futures products may be based on
securities the primary markets of which are foreign, and that using the
opening price from a U.S. market--if there is one--might not be a
meaningful or practical solution for optimal contract design.\42\
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\41\ See proposed CFTC Rule 41.1(j) and proposed SEC Rule 6h-
1(a)(1).
\42\ See CME Letter.
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The Commissions acknowledge that the proposed definition of
``opening price'' failed to contemplate that the market trading a
security that underlies a security futures product could be a market
other than a national securities exchange or national securities
association, such as a foreign stock exchange. Therefore, the
Commissions have revised the definition to provide that, if the
underlying security is not listed on a national securities exchange or
a national securities association, the opening price is the price at
which the security opened for trading, or a price that fairly reflects
the price at which a security opened for trading, on the primary market
for the security. To the extent that the underlying security is listed
on a national securities exchange or national securities association,
however, as explained further below, the Commissions continue to
believe that it is appropriate to use the opening price from the
listing market.\43\
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\43\ If a security futures product were based on an American
Depository Receipt (``ADR'') traded on a national securities
exchange or national securities association, the opening price for
the ADR would necessarily, under the rule adopted today, be derived
from the national securities exchange or national securities
association that trades it. However, if a security futures product
were based on the foreign security itself, the market listing the
security futures product must exercise its discretion to identify
the primary market of the foreign security for purposes of deriving
its opening price. See Securities Exchange Act Release No. 44725
(August 20, 2001).
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One commenter stated that it may soon become the case that the
listing market is not the primary trading venue for a security and,
thus, not the most liquid market.\44\ The Commissions agree that this
possibility exists, but nevertheless believe that national securities
exchanges and national securities associations are, at the present
time, a significant source of liquidity for those securities that are
permitted to underlie security futures products and, therefore, that
opening prices derived from these listing markets are appropriate to
use as final settlement prices. Moreover, the Commissions believe, at
this time, that a rule requiring, for example, the calculation of
trading volumes to determine the appropriate primary market from which
to derive an opening price for a security listed in the U.S. would
impose unnecessary burdens without furthering the anti-manipulation
goals enshrined in Section 2(a)(1)(D)(i)(VII) of the CEA \45\
[[Page 36744]]
and Section 6(h)(3)(H) of the Exchange Act.\46\
---------------------------------------------------------------------------
\44\ See CME Letter.
\45\ 7 U.S.C. 2(a)(1)(D)(i)(VII).
\46\ 15 U.S.C. 78f(h)(3)(H).
---------------------------------------------------------------------------
c. Determining a Final Settlement Price When Opening Price Not Readily
Available
The Commissions proposed that, if the opening price of an
underlying security were not readily available, the final settlement
price of a cash-settled security futures product overlying that
security must reflect a price of the underlying security taken from its
most recent regular trading session. The proposed rule provided,
however, that national securities exchanges and national securities
associations could request exemptions from the Commissions on a case-
by-case basis.
Although one commenter supported this aspect of the proposal,\47\
four commenters generally opposed the Commissions' exclusive use of a
``look back'' settlement procedure for security futures products when
the opening prices for the underlying securities are unavailable and,
instead, recommended using the next day's opening prices.\48\ These
commenters noted that the existing cash settlement procedures for stock
index options and stock index futures allow ``next opening''
prices.\49\ Further, one commenter, a clearing agency, urged the
Commissions not to require national securities exchanges and national
securities associations to adopt rules addressing the determination of
security futures final settlement prices when opening prices are not
readily available, because of potential conflicts with clearing agency
rules.\50\ Another commenter believed that the establishment of
consistent and commercially appropriate alternative pricing conventions
should be resolved by a collaboration among the exchanges that design
the product and the clearinghouse, with appropriate consultation with
their members and participants.\51\
---------------------------------------------------------------------------
\47\ See CBOT Letter.
\48\ See CBOE Letter, CME Letter, and SIG Letter. See also OCC
Letter (urging the Commissions to withdraw this aspect of the
proposal, or at a minimum, modify it to allow the final settlement
value to be based on the next opening).
\49\ See CBOE Letter, CME Letter, and SIG Letter. Two of these
commenters--the CBOE and the CME--stated that, until May 2000, the
futures and options markets derived alternate settlement prices from
a previous trading session, but changed their procedures after
Hurricane Floyd threatened to close the NYSE on the expiration
Friday of September 17, 1999. See, e.g., Securities Exchange Act
Release No. 42857 (May 30, 2000), 65 FR 36185 (June 7, 2000)
(approving SR-CBOE-00-02, which replaced look-back pricing with next
opening pricing procedures on CBOE in certain situations). See also
FIA/SIA Steering Committee Letter (stating that the Commissions'
proposed requirement is inconsistent with existing market practice
and rules governing a broad range of listed stock index products)
and OCC By-Laws, Article XII, Section 5 (allowing OCC to fix the
final settlement price for security futures products using next
opening prices of the underlying securities, as well as look-back
pricing).
\50\ See OCC Letter.
\51\ See FIA/SIA Steering Committee Letter.
---------------------------------------------------------------------------
In addition, several commenters contended that under the
Commissions' proposed rule hedges could be significantly disrupted.\52\
One commenter specifically noted that market participants holding
hedged or arbitraged positions expect to unwind the positions
simultaneously at stock prices that have equal value in relation to
derivative settlement prices.\53\ According to the commenter, this
equal value is achieved when the prices used to calculate the index
settlement are the same prices that the market participant receives
when unwinding the stock side of the position; when one or more
component stocks cannot be unwound at that price, the settlements
become disjointed and financial exposure occurs. Two commenters
described how such a scenario would have unfolded had September 14,
2001, been an expiration Friday: A security futures product--under the
Commissions'' proposal--would have settled based on the prices of
underlying securities traded on September 10, although prices at the
next opening on September 17 were generally significantly lower.\54\
---------------------------------------------------------------------------
\52\ See CBOE Letter, CME Letter, FIA/SIA Steering Committee
Letter, OCC Letter, and SIG Letter.
\53\ See SIG Letter.
\54\ See OCC Letter and SIG Letter.
---------------------------------------------------------------------------
In response to the comment letters, the final rule adopted by the
Commissions allows for either look-back or next opening prices to be
used as alternate final settlement prices when an opening price is not
readily available.\55\ The Commissions agree with the commenters that
the original proposal could result in an unwanted and unwarranted de-
linking of hedging positions if they mandated look-back pricing
procedures for security futures products. The Commissions also agree
that it would be inadvisable for the Commissions' rule to result in
proposed rule changes by national securities associations and national
securities exchanges that could conflict with the rules of their
registered clearing agency or derivatives clearing organization.\56\
---------------------------------------------------------------------------
\55\ CFTC Rule 41.25(b)(2) and SEC Rule 6h-1(b)(2). The
Commissions' rules do not specify the circumstances in which an
opening price would not be ``readily available.'' National
securities exchanges and national securities associations, however,
would have to establish, as part of their listing standards,
specific rules that apply this term. In addition, national
securities exchanges and national securities associations would have
to file proposed rule changes to delineate which method would be
used in determining final settlement prices and when it would be
applied.
\56\ For a further discussion on this issue, see discussion
infra at II.A.3.d., New Provision to Resolve Conflict Between Market
Rules and Clearing Agency Rules.
---------------------------------------------------------------------------
The Commissions will not, however, prohibit a national securities
exchange or national securities association from employing look-back
pricing if it believed that such course were appropriate. One commenter
stated that situations may arise in which a very small percentage of
the securities of an index fail to trade on an expiration Friday.\57\
In such situations, the commenter believed, it would be reasonable to
allow the overlying derivative on the index to settle by using look-
back prices for those few underlying securities that did not open,
rather than waiting to obtain the next opening price for those few
securities before settlement. The commenter recommended that there be
flexibility to employ look-back pricing if two percent or less of the
weighting of an index did not open for trading on an expiration Friday.
While the Commissions do not believe it is appropriate to set a de
minimis standard for use of look-back pricing, the Commissions agree
with the commenter's general point that situations may arise where the
ability to use look-back pricing will facilitate the fair settlement of
an overlying security futures product. The Commissions further note
that the final rule being adopted today is consistent with OCC rules
that allow for look-back pricing in certain circumstances.\58\
---------------------------------------------------------------------------
\57\ See SIG Letter.
\58\ See OCC By Laws, Article XII, Section 5 (allowing OCC to
fix the final settlement price for security futures products using
next opening prices of the underlying securities, as well as look-
back pricing).
---------------------------------------------------------------------------
d. New Provision To Resolve Conflict Between Market Rules and Clearing
Agency Rules
The rule adopted by the Commissions today allows a national
securities exchange or national securities association to choose
between look-back and next opening pricing procedures for security
futures products; however, it also provides the registered clearing
agency or derivatives clearing organization that is used to clear such
products with the authority to determine the final settlement prices in
certain circumstances.\59\ The Commissions believe that the rule
adopted today is consistent with the current conditions under which OCC
provides clearing services to national securities exchanges and
national
[[Page 36745]]
securities associations. Any national securities exchange or national
securities association wishing to use OCC clearing services for
security futures must enter into a clearing agreement with OCC in which
both parties agree that security futures will be cleared by OCC in
accordance with OCC's by-laws and rules, which currently give OCC the
final authority to determine final settlement prices in certain
circumstances.\60\ The Commissions believe that the rule adopted today
takes into account such arrangements, as well as allows for similar
arrangements between other clearing agencies or derivatives clearing
organizations and national securities exchanges or national securities
associations. The Commissions also believe that the rule adopted today
addresses concerns raised by commenters.
---------------------------------------------------------------------------
\59\ See CFTC Rule 41.25(b)(3) and SEC Rule 6h-1(b)(3).
\60\ See Securities Exchange Act Release No. 44727 (August 20,
2001), 66 FR 45351 (August 28, 2001).
---------------------------------------------------------------------------
Under proposed CFTC Rule 41.25 and SEC Rule 6h-1, a clearing agency
or derivatives clearing organization would not have been entitled to
determine a final settlement price. One clearing agency commenter
pointed out that its rules relating to security futures products
specifically provide that, in the case of a conflict between OCC's
rules and the rules of a national securities exchange or national
securities association, OCC rules control.\61\ OCC expressed the view
that ``the Commissions' rules should not force the exchanges to adopt
rules in this area at all, but rather should permit that function to be
left to the rules of the clearing organization.'' \62\ OCC further
stated that, ``[w]hether or not the exchanges have rules on this
subject, it should remain clear that the rules of the clearing
organization will control in the event of any inconsistency, thus
assuring uniformity of treatment of fungible products that might be
traded on more than one exchange.'' Another commenter endorsed the view
that the clearing agency's rules should control in the event of a
conflict.\63\
---------------------------------------------------------------------------
\61\ See OCC Letter and OCC By-Laws, Article XII, Section 6.
\62\ See also FIA/SIA Steering Committee Letter (urging the
Commissions not to require exchanges and associations to adopt rules
addressing the determination of fallback security futures final
settlement prices when opening prices are not readily available).
\63\ See CBOE Letter.
---------------------------------------------------------------------------
The Commissions disagree with the view that markets trading
security futures products should not address settlement procedures. To
the extent that a clearing agency or derivatives clearing organization
does not have rules in place to address all situations for determining
the settlement price of a cash-settled security futures product, the
national securities exchange or national securities association that
trades such product should have rules in place. However, the
Commissions believe that it is appropriate to expressly provide that,
in the event of a conflict between the rules of a registered clearing
agency or derivatives clearing organization and a market that trades a
security futures product, the clearing agency or derivatives clearing
organization may establish a new final settlement price for a security
futures product if it determines, pursuant to its rules, that the final
settlement price determined by the exchange or association is not
consistent with the protection of investors or customers, as
applicable, and the public interest, taking into account such factors
as fairness to buyers and sellers of the affected security futures
product, the maintenance of a fair and orderly market in such security
futures product, and consistency of interpretation and practice. In the
absence of such a provision, confusion could arise if securities
underlying a security futures product failed to trade on an expiration
Friday and the market trading the security futures product and its
clearing agency or derivatives clearing organization had different
rules for determining a final settlement price. Moreover, this
provision will make security futures products that trade on different
markets more fungible, because a single clearing agency or derivatives
clearing organization will be able in certain circumstances to
harmonize procedures across different markets for determining alternate
settlement prices.
e. Exemptions
In the final rule adopted by the Commissions, the Commissions'
ability to grant exemptions to the rule's requirements has been
expanded slightly from that proposed. The proposal explicitly provided
that any national securities exchange or national securities
association may receive an exemption from the requirements that final
settlement prices of security futures products reflect the opening
prices of the underlying securities or, if opening prices are not
available, look-back pricing procedures. The final rule explicitly
provides that the CFTC may grant an exemption with respect to any
provision of paragraphs (a)(2) and (b) of CFTC Rule 41.25, provided
that the CFTC finds that the exemption is consistent with the public
interest and the protection of customers.\64\ Similarly, the rule
explicitly provides that the SEC may grant an exemption with respect to
any provision of SEC Rule 6h-1, provided that the exemption is
necessary or appropriate in the public interest and consistent with the
protection of investors.\65\ The Commissions are expanding the scope of
the exemption to make it more consistent with the SEC's exemptive
authority under Section 36 of the Exchange Act, which allows the SEC,
by rule, regulation, or order to conditionally or unconditionally
exempt any person, security, or transaction, or any classes thereof,
from any rule or regulation under the Exchange Act, to the extent that
such exemption is necessary or appropriate in the public interest, and
is consistent with the protection of investors.\66\ Because exchanges
and associations are subject to the requirements of both CFTC Rule
41.25(a)(2) and (b) and SEC Rule 6h-1, to be exempt from such
requirements an exchange or association would have to obtain an
exemption from both the CFTC and the SEC.
---------------------------------------------------------------------------
\64\ See CFTC Rule 41.25(d). In the Proposing Release, the CFTC
referred to ``investors'' when discussing the exemptive provision.
The final rule will more closely adhere to the CEA, and refer
instead to ``customers.''
\65\ See SEC Rule 6h-1(d).
\66\ See Section 36 of the Exchange Act, 15 U.S.C. 78mm. See
also Section 8a(5) of the CEA allows the CFTC to make and promulgate
such rules and regulations as, in the judgment of the CFTC, are
reasonably necessary to effectuate any of the provisions or to
accomplish any of the purposes of the CEA. 7 U.S.C. 12a(5). The CFTC
believes that granting an exemption to the use of opening prices for
cash settlement would be consistent with Section 8a(5) of the CEA,
so long as the exemption is consistent with the public interest, the
protection of customers, and otherwise furthers the provisions of
the CEA.
---------------------------------------------------------------------------
B. Regulatory Halts
1. Background
Generally, there are two types of regulatory halts used in the
equity and options markets: News pending halts and circuit breaker
halts. News pending halts are designed to protect the interests of
current and potential shareholders by facilitating the orderly
dissemination of potentially market moving information and the
discovery of fair and reasonable prices for securities based on new
information.\67\ A news pending halt benefits current
[[Page 36746]]
and potential shareholders by halting all trading in the securities
until there has been an opportunity for the information to be
disseminated to the public. It also helps to promote public confidence
in the market and the integrity of the marketplace by giving the public
an opportunity to evaluate information in making investment decisions.
---------------------------------------------------------------------------
\67\ See, e.g., the American Stock Exchange LLC (``Amex''),
Listing Standards, Policies and Requirements, Section 402(b); Boston
Stock Exchange (``BSE'') Rules of the Board of Governors, Supplement
to Chapter XXVII, Section 4; National Association of Securities
Dealers (``NASD'') Rule 4120; and the New York Stock Exchange, Inc.
(``NYSE'') Listed Company Manual, Sections 202.06 and 202.07.
---------------------------------------------------------------------------
Circuit breakers are brief, coordinated cross-market trading halts
used by the stock, options, and index futures markets to mitigate
systemic stress when a severe one-day market drop of historic
proportions prevents the financial markets from operating in an orderly
manner.\68\ The Commissions approved various exchanges' circuit breaker
proposals in response to the October 1987 market break to permit these
brief, coordinated cross-market halts to provide opportunities during a
severe market decline to reestablish an equilibrium between buying and
selling interests in an orderly fashion, and to help to provide market
participants with a reasonable opportunity to become aware of, and
respond to, significant price movements.\69\ The coordinated cross-
market trading halts provided by circuit breaker procedures are
designed to operate only during significant market declines and to
substitute orderly, pre-planned halts for the ad hoc and destabilizing
halts which can occur when market liquidity is exhausted.\70\
Currently, all stock exchanges and the NASD have rules or policies to
implement coordinated circuit breaker halts.\71\ The options markets
also have rules applying circuit breakers.\72\ Finally, the index
futures exchanges have adopted circuit breaker halt procedures in
conjunction with their price limit rules \73\ for index products.\74\
The options markets also have in place rules regarding trading halts on
index options.\75\ Several of the options markets will halt trading
when, for example, a certain fixed percentage of the index halts
trading or when it is appropriate in the interests of a fair and
orderly market and to protect investors.\76\
---------------------------------------------------------------------------
\68\ See Circuit Breaker Report by the Staff of the President's
Working Group on Financial Markets dated August 18, 1998 (``Circuit
Breaker Report'').
\69\ See Securities Exchange Act Release No. 26198 (October 19,
1988), 53 FR 41637 (October 24, 1988) (order approving circuit
breaker rules for the Amex, CBOE, NASD, NYSE). The CFTC approved
circuit breaker price limit and trading halt rule changes after the
publication in the Federal Register of the proposed rule changes and
request for public comment, 53 FR 35539 (September 14, 1988) (CBOT,
CME, Kansas City Board of Trade, New York Futures Exchange).
\70\ See Circuit Breaker Report, supra note 68.
\71\ See Securities Exchange Act Release No. 39846 (April 9,
1998), 63 FR 18477 (April 15, 1998) (order approving proposals by
Amex, BSE, Chicago Stock Exchange (``CHX''), NASD, NYSE, and the
Philadelphia Stock Exchange, Inc. (``Phlx'')). See also Amex Rule
117; BSE, Rules of the Board of Governors, Section 34A; CHX Rule
10A; Cincinnati Stock Exchange (``CSE'') Rule 12.11; NYSE Rule 80B;
the Pacific Exchange, Inc. (``PCX'') Rule 4.22 (a), (b), and (c);
and Phlx Rule 133. CSE Rule 12.11 gives the chairman or the
president of the CSE the power to suspend trading whenever he or she
believes that such suspension would be in the public interest, which
has been interpreted as requiring the CSE, as a matter of policy, to
halt trading in all equities traded on the CSE in conjunction with
halted trading at all other U.S. equity and equity-related markets.
See Securities Exchange Act Release No. 26440 (January 10, 1989), 54
FR 1830 (January 17, 1989). The NASD also recognizes the risks
imposed on any single market that remains open while all other U.S.
markets have halted trading in response to extraordinary price
movements, and maintains a market closing policy to halt, upon SEC
request, all domestic trading in both securities listed on the
Nasdaq Stock Market and all equity and equity-related securities
trading in the over-the-counter market should other major securities
markets initiate market-wide trading halts in response to
extraordinary market conditions. See NASD Rule 4120; NASD IM-4120-4.
The SEC notes that it has a standing request with the NASD to halt
trading as quickly as practicable whenever the NYSE and other equity
markets have suspended trading. See Securities Exchange Act Release
No. 39582 (January 26, 1998), 63 FR 5408 (February 2, 1998).
\72\ See Amex Rule 950 (applying Amex Rule 117, Trading Halts
Due to Extraordinary Market Volatility, to options transactions);
CBOE Rule 6.3B; the International Securities Exchange, LLC (``ISE'')
Rule 703; PCX Rule 4.22 (which applies to options contracts through
Rules 6.1(a) and (e)); and Phlx Rule 133.
\73\ A price limit, in itself, does not halt trading in the
futures, but prohibits trading at prices below the pre-set limit
during a price decline. Intraday price limits are removed at pre-set
times during the trading session, such as ten minutes after the
thresholds are reached or at 3:30 p.m., whichever is earlier. Daily
price limits remain in effect for the entire trading session.
Specific price limits are set for each stock index futures contract.
There are no price limits for U.S. stock index options, equity
options, or stocks.
\74\ See, e.g., CME Rule 4002.I. The CME will implement a
circuit breaker trading halt in SPX Futures if the 10 percent
circuit breaker halt has been imposed in the securities markets and
the futures are ``locked'' at their 10 percent price limit. Trading
will not reopen in SPX Futures until the circuit breaker halt has
been lifted in the securities markets and trading has resumed in
stocks comprising at least 50 percent of the index capitalization.
The CME will implement another circuit breaker trading halt in SPX
Futures if the 20 percent circuit breaker halt has been imposed in
the securities markets and the futures are locked at their 20
percent price limit. Once again, trading will not reopen in SPX
Futures until the circuit breaker halt has been lifted in the
securities markets and trading has resumed in stocks comprising at
least 50 percent of the index capitalization.
\75\ See Amex Rule 918C(b)(3); CBOE Rule 24.7; PCX Rule 7.11;
and Phlx Rule 1047A(c).
\76\ For example, trading on the PCX in any index option is
halted whenever trading in underlying securities whose weighted
value represents more than 20 percent of the value of a broad-based
index or 10 percent of the value of other indices is halted. See PCX
Rule 7.11. Similarly, under Phlx Rule 1047A(c), trading in any index
option may be halted whenever trading on the primary market in
underlying securities representing more than 10 percent of the
current index value is halted or suspended, and there is approval
from two floor officials and the concurrence of a market regulation
officer. See Phlx Rule 1047A(c).
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2. Proposed Rule for Regulatory Halts
As discussed above, Section 2(a)(1)(D)(i)(X) of the CEA \77\ and
Section 6(h)(3)(K) of the Exchange Act \78\ provide that listing
standards for security futures products must include procedures to
coordinate trading halts between the market that trades the security
futures product, any market that trades any underlying security, and
other markets on which any related security is traded. To assure such
coordination of trading halts, the Commissions proposed CFTC Rule
41.25(a)(2) and SEC Rule 6h-1. More specifically, the Commissions
proposed that trading in a future on a single security be halted at all
times that such a news pending regulatory halt or a circuit breaker
regulatory halt has been instituted by the listing market for the
underlying security. The Commissions also proposed that trading be
halted in a future on a narrow-based security index when a news pending
or circuit breaker regulatory halt was instituted for one or more
underlying securities that constitute 30 percent or more of the market
capitalization of the narrow-based security index.\79\
---------------------------------------------------------------------------
\77\ 7 U.S.C. 2(a)(1)(D)(i)(X).
\78\ 15 U.S.C. 78f(h)(3)(K).
\79\ It should be noted that the Commissions have jointly
adopted rules to establish the method of determining the market
capitalization of a narrow-based security index for the limited
purpose of determining whether a security is one of the 750
securities with the largest market capitalization under one of the
exclusions from the definition of narrow-based security index. See
Securities Exchange Act Release No. 44724 (August 20, 2001), 66 FR
44490 (August 23, 2001).
---------------------------------------------------------------------------
3. Final Rule
a. Trading Halt Coordination in Single-Stock Futures
The Commissions are adopting, as proposed, a requirement that the
rules of a national securities exchange or national securities
association that lists or trades security futures products provide that
trading of a future on a single security be halted at all times that a
regulatory halt has been instituted for the underlying security.
Two commenters agreed that trading in a future on a single security
should be halted when trading in the underlying security is subject to
a regulatory halt.\80\ Another commenter, while generally supporting
the proposed trading halt requirements for single-stock futures,
believed that it may be appropriate to trade a single stock futures
product when the listing market has imposed a trading halt, if the
listing
[[Page 36747]]
market is not the principal trading venue for the underlying security
because the prices on that market may not be reflective of current
market conditions.\81\
---------------------------------------------------------------------------
\80\ See CBOT Letter and NYSE Letter.
\81\ See CME Letter. See infra notes 103-104 and accompanying
text.
---------------------------------------------------------------------------
In addition, one commenter believed that the requirement to halt
trading in single-stock futures when trading in the underlying security
is halted was overly broad to satisfy the requirement that procedures
be put in place to coordinate trading halts.\82\ This commenter
believed that this was overly broad and burdensome in its application
to retail investors for whom single-stock futures might serve as the
only available means for managing risk. This commenter recommended
allowing trading halt sessions during which investors with risk
exposure to an underlying equity, which has been halted, might have the
opportunity to enter into single stock futures transactions with
dealers.
---------------------------------------------------------------------------
\82\ See Students Letter.
---------------------------------------------------------------------------
The Commissions understand the concern raised by one commenter
regarding continued trading of a security futures product when the
underlying security has halted trading if the listing market is not the
primary market. However, the Commissions believe that designating the
listing market as the venue for the purpose of applying the rule
provides for ease of use and application, because it does not require
national securities exchanges or national securities associations to
determine the primary market for each underlying security. Further, due
to the contractual relationship between the issuer and the listing
market, the listing market has a direct and ongoing relationship with
the issuer. The Commissions believe, therefore, that the listing market
is in the best position to be informed promptly by the issuer that
pending news would require the imposition of a trading halt. Finally,
the Commissions believe that the listing market represents sufficient
liquidity that imposing a trading halt on a security futures product
when the listing market for the underlying security imposes a trading
halt furthers the purposes of Section 2(a)(1)(D)(i)(X) of the CEA\83\
and Section 6(h)(3)(K) of the Exchange Act.\84\
---------------------------------------------------------------------------
\83\ 7 U.S.C. 2(a)(1)(D)(i)(X).
\84\ 15 U.S.C. 78f(h)(3)(K).
---------------------------------------------------------------------------
With respect to the commenter's concern regarding the potential
impact of such a rule on retail investors, the Commissions note that
one of the purposes of trading halts is to provide for an adequate
opportunity for information about a security to be disseminated to the
public. The Commissions do not believe that it would be consistent with
the protection of investors to permit investors, including retail
investors, to trade a surrogate for a security--i.e., a future on the
security--without the benefit of material information about such
security or the benefit of such other information that was the basis
for the regulatory halt.
Finally, with respect to news pending halts, two commenters
questioned the absolute requirement that trading in a security futures
product must be halted during a news pending halt in the underlying
security.\85\ These commenters recommended providing exchanges with
discretion to impose a trading halt when there is a news pending
trading halt in the underlying security. Specifically, one commenter
believed that this discretion is important because there may be
circumstances when it is necessary to allow trading in a security
futures product when the underlying stock is halted, such as when there
is a need to adjust positions before an expiration.\86\
---------------------------------------------------------------------------
\85\ See CBOE Letter and FIA/SIA Steering Committee Letter.
\86\ See CBOE Letter.
---------------------------------------------------------------------------
Given the rarity of an occurrence when a national securities
exchange or national securities association would feel compelled to
continue trading a security futures product while the trading of
underlying stock is halted, the Commissions do not agree that there
ought to be discretion in imposing regulatory halts for security
futures products. The Commissions note that the underpinning for
imposing news pending regulatory halts is promoting investor protection
and fair and orderly markets. To the extent that there is pending news
that could impact an investor's decision and to the extent that single-
stock futures are surrogates for the underlying security, the
Commissions continue to believe in the need for a provision requiring
that trading in a security futures product be halted at all times that
a regulatory halt has been instituted for the underlying security or
securities, with certain limits for narrow-based security index
futures. Furthermore, in the event that discretion is needed, the
Commissions note that the exemptive authority in CFTC Rule 41.25(d) and
SEC Rule 6h-1(d) allows the Commissions to exempt national securities
exchanges or national securities associations from the regulatory halt
provisions if the CFTC determines that such an exemption is consistent
with the public interest and the protection of customers and the SEC
determines that such exemption is necessary or appropriate in the
public interest and consistent with the protection of investors.
By adopting this rule, the Commissions aim to maintain and preserve
the integrity of this mechanism so that the trading of security futures
products will not be used as a tool to circumvent the institution of
regulatory halts. Moreover, the Commissions believe that the purpose of
halting trading in the underlying security would be frustrated if
market participants could circumvent this halt by trading during the
halt in the related security futures product.\87\
---------------------------------------------------------------------------
\87\ The Commissions' rules do not preclude a market trading
security futures products from halting trading for other appropriate
reasons, such as operational difficulties being experienced by the
market or its automated systems or concerns over clearance and
settlement operations.
---------------------------------------------------------------------------
b. Trading Halt Coordination in Narrow-Based Security Index Futures
The Commissions proposed that national securities exchanges and
national securities associations halt trading in a future on a narrow-
based security index when component securities representing 30 percent
or more of the market capitalization of such index are subject to a
regulatory halt. In response to comments, the final rules modify the
proposal by increasing to 50 percent the market capitalization
represented by the component security or securities in a narrow-based
security index that must be halted before a national securities
exchange or national securities association must halt trading in a
future on such index.
In addition to the comments supporting the Commissions' proposed
trading halt rule,\88\ the Commissions received three comments
specifically addressing the application of regulatory halts to futures
based on narrow-based security indexes.\89\ One commenter neither
specifically supported nor opposed the Commissions' proposed 30 percent
capitalization test, although it suggested a possible alternative such
as allowing narrow-based security index futures based principally on
U.S. listed securities to continue trading until they have become limit
offered at a price limit corresponding to a particular coordinated
circuit breaker level.\90\ Another commenter believed that the
Commissions' proposal to require a trading halt in a narrow-based
security index future when a component security or securities that
constitute 30 percent or more of the market capitalization of
[[Page 36748]]
the index are subject to a trading halt was too low a threshold to
justify the disruption that it would inflict upon the futures
market.\91\ Instead, this commenter recommended that the threshold be
no lower than 50 percent of an index's capitalization to be consistent
with the threshold required for re-opening futures trading on broad-
based indexes following a market-wide halt. This commenter noted that
when trading in futures on a broad-based index is halted as a result of
an exchange-wide halt in the relevant securities market, such futures
trading resumes only when at least 50 percent of the securities
underlying an index, by market capitalization, have reopened for
trading.\92\
---------------------------------------------------------------------------
\88\ See supra notes 80 and 81.
\89\ See CBOE Letter, CBOT Letter, and CME Letter.
\90\ See CME Letter.
\91\ See CBOT Letter.
\92\ See, e.g., CBOT Rule 1008.01 and CME Rule 4002.I., supra
note 74.
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Another commenter recommended providing exchanges with greater
discretion to decide whether to impose or maintain a trading halt.\93\
This commenter stated that by specifying a specific percentage level,
the proposed rule implied that it would be improper for an exchange to
consider trading interruptions in underlying stocks that collectively
represent less than 30 percent of an index. This commenter also
believed that because not all indexes underlying security futures
products may be capitalization weighted, it may be difficult for
exchanges to determine on a real-time basis when securities comprising
30 percent of the market capitalization of a price-weighted or equal
dollar weighted index are halted. Similarly, one of the commenters
expressed a concern that, with respect to corporate news events, it may
be operationally difficult to determine on a real-time basis whether
the threshold of market capitalization has been crossed.\94\ This
commenter hoped the Commissions would recognize the potential
difficulty and accept good faith attempts to comply.
---------------------------------------------------------------------------
\93\ See CBOE Letter.
\94\ See CME Letter.
---------------------------------------------------------------------------
The Commissions do not believe that trading in a narrow-based
security index future should necessarily be halted because a trading
halt has been instituted for only one or several low-weighted component
securities. An inappropriately low threshold could lead to needless and
potentially disruptive trading halts in the narrow-based index future.
However, as noted in the Proposing Release, regulatory halts of narrow-
based-index component securities could affect a sufficiently large
portion of the index to make continued trading of a security futures
product based on that index a means of improperly circumventing
regulatory halts in the underlying component securities. Under these
circumstances, trading halt procedures would not be coordinated, as
required by Section 2(a)(1)(D)(i)(X) of the CEA\95\ and Section
6(h)(3)(K) of the Exchange Act,\96\ since the security futures product
would continue to trade while investors would be precluded from trading
the underlying securities. Moreover, the SEC believes that continued
trading in the security futures product under these circumstances could
undercut key provisions in the securities laws designed to protect
investors and promote the fair and orderly operation of the markets.
---------------------------------------------------------------------------
\95\ 7 U.S.C. 2(a)(1)(D)(i)(X).
\96\ 15 U.S.C. 78f(h)(3)(K).
---------------------------------------------------------------------------
However, in response to the commenter's statement that the 30
percent market capitalization test was too low, and therefore,
potentially too disruptive to the market, and after consideration of
the potential effects of the proposed 30 percent trading halt
threshold, the Commissions are requiring that trading be halted in a
narrow-based security index futures product when component securities
representing 50 percent or more of the market capitalization of that
narrow-based security index are subject to a regulatory halt. The
Commissions believe that one of the major economic benefits that market
participants derive from the trading of futures on narrow-based
security indexes is the ability to hedge positions containing the
securities underlying the indexes, thereby reducing the risk of holding
positions in those securities. For traders using a narrow-based
security index future to hedge a position containing the component
index securities, trading halts in certain of those component
securities necessarily will introduce basis risk because the one-to-one
relationship between the cash portfolio of securities and the narrow-
based index future is disrupted.
The Commissions believe that the proposed 30 percent threshold is
too low because it could unnecessarily disrupt hedge positions
involving futures on narrow-based security indexes that may still be
substantially performing their intended risk-shifting function when
trading is halted in a limited number of the index's component
securities. The Commissions believe that a 50 percent threshold would
better serve the requirement's intended purpose. In adopting a 50
percent threshold, the Commissions sought to balance the utility of
maintaining effective hedge positions with concerns about circumventing
the coordination requirement by allowing trading in narrow-based index
futures to continue when trading in a limited number of the underlying
securities is halted.
The Commissions believe that while it is not possible to eliminate
completely the risk involved in hedging securities with a future on a
narrow-based security index when trading halts are instituted for
certain of those underlying securities, the 50 percent threshold
reduces such risk. Therefore, the Commissions are adopting a 50 percent
threshold because it appears to appropriately balance the goals of
hedging utility with the prevention of improper circumvention of
regulatory halts in the underlying securities. The Commissions also
note that the 50 percent threshold is consistent with existing
thresholds for re-opening trading in broad-based security index futures
following a market-wide trading halt in the trading of the underlying
securities.\97\
---------------------------------------------------------------------------
\97\ See CBOT Rule 1008.01 and CME Rule 4002.I., supra note 74.
---------------------------------------------------------------------------
The Commissions reiterate, however, that their rule is not designed
to preclude a market trading futures on narrow-based security indexes
from halting trading when securities representing less than 50 percent
of the market capitalization of the index are halted or for other
appropriate reasons, such as operational difficulties being experienced
by the market or its automated systems or concerns over clearance and
settlement operations. The Commissions also note that the threshold at
50 percent provides further discretion to national securities exchanges
and national securities associations to establish their thresholds at
lower levels, or to change the thresholds as market conditions or
experience warrant. This provides flexibility to the markets to modify
trading halt thresholds, which would not be possible if the Commissions
set the threshold at a lower level.
With respect to the commenters' concern regarding the potential
difficulty in calculating the market capitalization of an index,
especially for price-weighted or equal dollar weighted indexes, for
purposes of instituting the regulatory halt, the Commissions note that
selecting market capitalization as the method for calculating the
weight of the index is similar to an existing standard used to
calculate trigger points for circuit breaker operations.\98\ The
Commissions chose to apply a similar
[[Page 36749]]
method in implementing regulatory halts to narrow-based security index
futures products. In addition, in specifying market capitalization as
the method for weighing an index, the rule provides clarity and
uniformity for all national securities exchanges and national
securities associations to utilize in implementing regulatory halts in
security futures products based on narrow-based security indexes and
helps prevent the trading of security futures products from becoming a
means of circumventing regulatory halts in the underlying securities.
---------------------------------------------------------------------------
\98\ See, e.g., CME Rule 4002.I., supra note 74.
---------------------------------------------------------------------------
c. Definition of a Regulatory Halt
The Commissions are adopting the definition of regulatory halt as
proposed.\99\ Specifically, a regulatory halt is defined as a delay,
halt, or suspension in the trading of a security by the national
securities exchange or national securities association that lists the
security as a result of a news pending regulatory halt or the operation
of circuit breakers. The definition of regulatory halt does not include
the listing market's halting of trading because of an imbalance of buy
and sell orders in a particular security or when trading is disrupted
due to a problem in its systems or on its trading floor. The definition
of regulatory halt in the rule adopted today incorporates the
definition of news pending regulatory halt contained in the
Consolidated Tape Association Plan (``CTA Plan'').\100\ Under the CTA
Plan, a regulatory halt occurs whenever the primary market for any
eligible security, in the exercise of its regulatory functions, halts
or suspends trading in the security because the primary market has
determined (i) that there are matters relating to the security or
issuer that have not been adequately disclosed to the public, or (ii)
that there are regulatory problems relating to the security which
should be clarified before trading is permitted to continue.\101\ When
a regulatory trading halt is initiated by the primary market for a
security, the regional exchanges and Nasdaq also halt trading in the
security, and the options exchanges halt trading in related options.
The options exchanges also halt trading in an equity option when the
underlying security has ceased trading.\102\
---------------------------------------------------------------------------
\99\ See CFTC Rule 41.1(l) and SEC Rule 6h-1(a)(3).
\100\ See Securities Exchange Act Release No. 41315 (April 20,
1999), 64 FR 23142 (April 29, 1999) (noting that the NYSE follows
the CTA Plan when instituting a regulatory halt); and Securities
Exchange Act Release No. 41877 (September 14, 1999), 64 FR 51566
(September 23, 1999) (noting that Amex follows the CTA Plan when
instituting a regulatory halt); see also CTA Plan (Second
Restatement), Section XI (a). The CTA Plan is a joint industry plan
that governs the consolidated transaction reporting system, and each
of the participants agrees to comply with the provisions of the
plan. Recognizing the importance of disseminating information with
respect to trading halts in certain securities, the CTA Plan imposes
notification obligations upon the primary market whenever a
regulatory halt occurs.
\101\ See CTA Plan (Second Restatement), Section XI (a). For
example, an event that may qualify under this standard and call for
a regulatory halt is when it is unclear whether a security continues
to meet the listing standards of the market on which the security is
listed.
\102\ The rules of the options exchanges generally provide for
halts in options whenever it is appropriate in the interests of a
fair and orderly market and to protect investors. See Amex Rule
918(b); CBOE Rule 6.3(a) and .04 of the Interpretations and Policies
of CBOE Rule 6.3; ISE Rule 702; PCX Rule 6.65(a); and Phlx Rule
1047(b).
---------------------------------------------------------------------------
Although generally supporting the requirement to halt trading in
single-stock futures when trading in the underlying security has been
halted due to a corporate news event, one commenter stated that the
definition of regulatory halt could be refined to address situations
not contemplated by the CFMA, such as where the listing market is not
the primary trading venue for the underlying security or where the
listing market is in a foreign country.\103\
---------------------------------------------------------------------------
\103\ See CME Letter.
---------------------------------------------------------------------------
In response to this comment, the Commissions note that the rule
being adopted today does not preclude national securities exchanges and
national securities associations trading security futures products from
halting trading if they believe it is necessary to the orderly
operation of the market. The rules of a national securities exchange or
national securities association may permit it to halt trading in
situations not covered by the rule being adopted today.\104\ To the
extent that the security or securities underlying a security futures
product is listed on a foreign market, under the rule adopted today,
national securities exchanges and national securities associations have
the flexibility to impose trading halt requirements where the
underlying security is listed solely on a foreign market. Further, the
Commissions believe that it would be unduly burdensome and
administratively difficult to require national securities exchanges and
associations to calculate the primary market for each security
underlying a security futures product. Again, under their rules,
national securities exchanges and associations may also halt trading in
a security futures product if the primary market, but not the listing
market, halted trading in the underlying security or securities, but it
is not mandated by the Commissions' rules.
---------------------------------------------------------------------------
\104\ One commenter believed that the Commissions should expand
on the examples of the reasons why national securities exchanges and
associations could impose additional trading halts to include order
imbalances. See NYSE Letter. As noted above, the rule being adopted
today does not preclude a market trading security futures products
from establishing rules that permit or require it to halt trading
for other appropriate reasons.
---------------------------------------------------------------------------
With respect to the Commissions' proposal to include within the
definition of ``regulatory halt'' trading halts due to circuit breaker
procedures, three commenters generally supported the extension of
market-wide circuit breaker procedures to security futures products in
order to ensure coordinated and consistent circuit breaker procedures
across equity products.\105\ One of the commenters, however, noted a
potential competitive issue over security futures product ``look-
alikes'' that can trade in the unregulated upstairs market and do
currently trade in foreign jurisdictions that may not adhere to the
coordinated circuit breaker procedures.\106\ This commenter recommended
that the Commissions provide exchanges with latitude in implementing
coordinated circuit breaker procedures and flexibility in imposing this
requirement on security futures products where the principal trading
venues for the underlying securities (or for a subset in the case of
narrow-based indexes) are in foreign markets.
---------------------------------------------------------------------------
\105\ See CBOE Letter and FIA/SIA Steering Committee Letter; see
also CME Letter.
\106\ See CME Letter.
---------------------------------------------------------------------------
The Commissions note that the coordinated cross-market trading
halts provided by circuit breaker procedures are designed to operate
only during significant market declines and to substitute orderly, pre-
planned halts for the ad hoc and destabilizing halts that can occur
when market liquidity is exhausted. The circuit breakers also protect
investors and the market by providing opportunities for market and
market participants to assess market conditions and potential systemic
stress during a historic market decline. In approving the original
circuit breakers proposed by the securities market, the SEC noted that
the circuit breakers were an effort by the securities and futures
markets to arrive at a coordinated means to address potentially
destabilizing market volatility of the severity of the October 1987
market break.\107\ Therefore, in the interest of having coordinated
trading halts across the U.S. equity markets, the Commissions do not
agree that the exchanges should have latitude in implementing
coordinated circuit breaker procedures on security futures products
where the underlying
[[Page 36750]]
security is not solely listed in a foreign market. To the extent that
additional latitude is needed, the Commissions have the discretion to
grant separate exemptions in those circumstances if the CFTC determines
that such an exemption is consistent with the public interest and the
protection of customers and the SEC determines that such exemption is
necessary or appropriate in the public interest and consistent with the
protection of investors.
---------------------------------------------------------------------------
\107\ See Securities Exchange Act Release No. 26198 (October 19,
1988), 53 FR 41637 (October 24, 1988).
---------------------------------------------------------------------------
For these reasons, the Commissions believe that it is important to
include within the definition of regulatory halt cross-market circuit
breakers and, therefore, to require the application of cross-market
circuit breaker regulatory halt procedures to security futures
products. Moreover, the Commissions believe that such requirement is
necessary to satisfy the requirements of Section 2(a)(1)(D)(i)(X) of
the CEA\108\ and Section 6(h)(3)(K) of the Exchange Act.\109\ If cross-
market circuit breaker regulatory halt procedures were not applied to
the security futures products, such a failure would undermine the use
of trading halts in the underlying securities markets.
---------------------------------------------------------------------------
\108\ 7 U.S.C. 2(a)(1)(D)(i)(X).
\109\ 15 U.S.C. 78f(h)(3)(K).
---------------------------------------------------------------------------
d. Exemptions
As discussed previously,\110\ the Commissions are expanding the
exemption provisions in CFTC Rule 41.25(d) and SEC Rule 6h-1(d), which
were originally proposed to apply only to the final settlement prices
for security futures products. Under the final rule, the CFTC has the
authority to grant an exemption with respect to any provision of
paragraphs (a)(2) and (b) of CFTC Rule 41.25, provided that the CFTC
finds that the exemption is consistent with the public interest and the
protection of customers.\111\ The SEC has the authority to grant an
exemption with respect to any provision of SEC Rule 6h-1, provided that
the exemption is necessary or appropriate in the public interest and
consistent with the protection of investors.\112\ Because exchanges and
associations are subject to the requirements of both CFTC Rule
41.25(a)(2) and (b) and SEC Rule 6h-1, to be exempt from such
requirements an exchange or association would have to obtain an
exemption from both the CFTC and the SEC.
---------------------------------------------------------------------------
\110\ See supra discussion at II.A.3.e., Exemptions, which
discusses the expansion of the exemption to make it more consistent
with the SEC's exemptive authority under Section 36 of the Exchange
Act.
\111\ See CFTC Rule 41.25(d).
\112\ See SEC Rule 6h-1(d).
---------------------------------------------------------------------------
C. Commissions' Interpretation of Statutory Requirements for
Coordinated Surveillance
1. Markets Trading Security Futures
In amending the CEA and Exchange Act to permit the trading of
futures on single stocks and narrow-based security indexes, Congress
specifically required that exchanges and associations trading these new
products have procedures in place for coordinated surveillance with
other markets on which security futures products trade, any market on
which any security underlying the security futures product is traded,
and other markets on which any related security trades.\113\ Because
security futures products are surrogates for the securities on which
their values are based, such coordinated surveillance is essential to
detection of manipulation and insider trading. As discussed in detail
below, the Commissions interpret the statutory requirement for
coordinated surveillance to mean that if an exchange or association is
a Full Member of the Intermarket Surveillance Group (``ISG'') \114\ or
has the ability to obtain all information that a Full Member of the ISG
is currently able to obtain from both current and former members,
including, among other things, the ability to obtain market
surveillance reports or information, and information relating to
investigations, then that market would meet the statutory requirement
for coordinated surveillance.
---------------------------------------------------------------------------
\113\ Section 2(a)(1)(D)(i)(VIII) of the CEA, 7 U.S.C.
2(a)(1)(D)(i)(VIII); Section 6(h)(3)(I) of the Exchange Act, 15
U.S.C. 78f(h)(3)(I).
\114\ ISG Full Members are Amex, BSE, CBOE, CHX, CSE, ISE, NASD,
NYSE, PCX and Phlx.
---------------------------------------------------------------------------
For an exchange or association to satisfy the statutory requirement
that ``procedures be in place for coordinated surveillance,'' the
Commissions stated in the Proposing Release that they believed it was
``essential that all such exchanges and associations be Full Members of
the ISG.'' \115\ In view of the role that the ISG plays, the
Commissions stated their belief that the ISG should grant full
memberships to all national securities exchanges and national
securities associations registered pursuant to Section 15A(a) of the
Exchange Act \116\ trading securities futures products, including
Security Futures Product Exchanges, upon a good-faith showing that the
entities meet the criteria for full membership.
---------------------------------------------------------------------------
\115\ See Proposing Release, supra note 18.
\116\ 15 U.S.C. 78o-3(a).
---------------------------------------------------------------------------
The CFTC in a separate proposing release also proposed, in part, to
require boards of trade trading security futures products to be Full
Members of ISG.\117\ The CFTC received three comment letters regarding
this aspect of the CFTC Proposal.\118\ All of the commenters raised
concerns regarding mandatory memberships in ISG. As a result, the CFTC
deferred making a decision on requiring membership in ISG to allow the
Commissions together to consider the appropriate means of ensuring that
the coordinated surveillance requirement under the CEA and the Exchange
Act is satisfied.\119\
---------------------------------------------------------------------------
\117\ See 66 FR 37932 (July 20, 2001) (``CFTC Proposal'').
\118\ The CFTC received comment letters from CME, Amex, and ISG.
\119\ See 66 FR 55078 (November 1, 2001).
---------------------------------------------------------------------------
As noted in the Proposing Release, ISG was created under the
auspices of the SEC as a forum to ensure that national securities
exchanges and national securities associations adequately share
surveillance information and coordinate inquiries and investigations
designed to address potential intermarket manipulations and trading
abuses. Full Members routinely share a great deal of surveillance and
investigatory information, and the SEC continues to believe that this
framework has proven to be an effective mechanism to ensure that there
is adequate information sharing and investigatory coordination for
potential intermarket manipulations and trading abuses.
The Commissions continue to believe that any national securities
exchange--including an exchange registered under Section 6(g) of the
Exchange Act--that satisfies the requirements to be a Full Member of
ISG should be admitted as a Full Member of ISG. Nevertheless, in light
of comment letters received on the CFTC Proposal, we do not believe
that an exchange trading security futures products must be a Full
Member of ISG to satisfy the requirement that ``procedures be in place
for coordinated surveillance among the market on which the security
futures product is traded, any market on which any security underlying
the security futures product is traded, and other markets on which any
related security is traded to detect manipulation and insider
trading.'' \120\
---------------------------------------------------------------------------
\120\ Section 2(a)(1)(D)(i)(VIII) of the CEA, 7 U.S.C.
2(a)(1)(D)(i)(VIII); Section 6(h)(3)(I) of the Exchange Act, 15
U.S.C. 78f(h)(3)(I).
---------------------------------------------------------------------------
In particular, the Commissions believe that exchanges and
associations trading security futures products may also satisfy the
CEA's and Exchange Act's coordinated surveillance requirement through
Affiliate Membership in ISG, if the Affiliate Members trading security
futures products also enter into supplemental
[[Page 36751]]
agreements with other Affiliate Members trading security futures
products and with Full Members to share the same information as Full
Members of ISG currently share with each other.\121\ The Commissions,
however, believe that the current information sharing agreement among
Affiliate Members and the agreement between Affiliate and Full Members
(referred to in Appendix A as ``Affiliate Agreement'') is insufficient
to satisfy the obligation of a market trading security futures products
to coordinate surveillance with other markets trading security futures
and with markets trading related products because of certain
limitations on the information that must be shared.\122\ The
Commissions believe, however, that these limitations, discussed below,
can be overcome if Affiliate Members trading security futures products
and Full Members agree to share information beyond what is currently
required by the ISG for Affiliate Members.
---------------------------------------------------------------------------
\121\ An ISG Affiliate Member is a contract market or foreign
self-regulatory organization that has become affiliated with ISG.
See Appendix A for the relevant provisions of the agreement among
Full Members of ISG.
\122\ Futures exchanges and non-U.S. exchanges and associations
are Affiliate Members of ISG. The limitations in an Affiliate
Member's obligations to share information is of less concern when an
Affiliate Member is not trading securities.
---------------------------------------------------------------------------
For example, ISG provides to Full Members market surveillance
reports. It is unclear whether Full Members have access to market
surveillance reports of Affiliate Members or whether Affiliate Members
have access to such information from each other. The Commissions
understand that this information is, as a practical matter, made
available to all ISG members upon request, but believe that the
obligation to provide such information upon request should be explicit.
In addition, Full Members are required to share information and
documents, upon request, about current and former members.\123\
Affiliate Members, however, are only required to share with each other
and with Full Members information and documents relating to current
members.\124\ Similarly, Full Members are only required to share with
Affiliate Members information about current members, not about their
former members.\125\ The Commissions believe that information about
former members is necessary under some circumstances to facilitate
investigations by Full and Affiliate Members.
---------------------------------------------------------------------------
\123\ See Appendix A, Section 2(b).
\124\ See, e.g., Appendix A, Section 2(c).
\125\ See, e.g., Appendix A, Section 2(d).
---------------------------------------------------------------------------
Moreover, the agreement among Full Members allows Full Members to
request information and documents from each other relating to ongoing
investigations.\126\ This information can be very useful in assisting
an exchange performing its own, related investigation. However, the
agreement between Full Members and Affiliate Members (and among
Affiliate Members) does not provide for the sharing of this type of
information. It is the Commissions' understanding that these agreements
did not provide for the sharing of investigatory information due to a
perceived prohibition in the CEA that restricted the sharing of such
information.\127\ The CFTC, however, believes the CEA allows the
sharing of investigatory documents and information, provided that the
futures market providing such information adopts a rule allowing for
the sharing of information pursuant to an information sharing
arrangement.\128\ Therefore, because there is no legal prohibition on
sharing investigatory information, the Commissions believe that such
information may be shared between Affiliate and Full Members and among
Affiliate Members trading security futures products. Without the
sharing of such investigatory information, investigations by an
Affiliate Member into manipulation or trading abuses related to the
trading of security futures could be hindered unnecessarily. In
addition, a Full Member's inability to obtain such information or
documents from an Affiliate Member could hinder the Full Member's
investigation of manipulation or trading abuses in other securities
that were related to manipulation or trading abuses in the trading of
security futures on an Affiliate Member's market.
---------------------------------------------------------------------------
\126\ See Appendix A, Section 2(b).
\127\ See 8c(a)(2) of the CEA, 7 U.S.C. 12c(a)(2).
\128\ See 8a(6) of the CEA, 7 U.S.C. 12a(6).
---------------------------------------------------------------------------
Finally, once information is requested, Affiliate Members are
generally only required to use ``best efforts'' in accordance with
their rules to obtain the information.\129\ In addition, Affiliate
Members only need to provide the information to Full Members to the
extent that it is not inconsistent with its rules or with applicable
law.\130\ Similarly, Full Members are only required to use best efforts
in accordance with their rules to obtain the requested information for
Affiliate Members and to provide such information to the extent that it
is not inconsistent with its rule or applicable law.\131\ Such
limitations are not included as part of the agreement among Full
Members. The Commissions believe that any restrictions on the ability
of Affiliate or Full Members to share information could hinder the
ability of these members to coordinate surveillance.
---------------------------------------------------------------------------
\129\ See, e.g., Appendix A, Section 2(c).
\130\ Id.
\131\ See, e.g., Appendix A, Section 2(d).
---------------------------------------------------------------------------
As discussed above, the Commissions believe that the limitations on
an Affiliate Member's obligations to share information could be easily
addressed through means other than becoming Full Members of ISG. For
example, Affiliate Members trading security futures products and Full
Members could enter into a supplementary agreement to share the
information described above among each other despite the limitations in
the current agreements.\132\ If Full and Affiliate Members enter into
this type of agreement, the Commissions believe that the markets would
meet the statutory requirement for coordinated surveillance.
---------------------------------------------------------------------------
\132\ The Commissions note that this may require exchanges and
associations trading security futures products to implement rules
allowing for the sharing of information. See supra notes 126-128.
---------------------------------------------------------------------------
The Commissions also believe that exchanges trading security
futures products could satisfy the requirement to coordinate
surveillance by entering into bilateral surveillance agreements with
each exchange, association, or market on which any security underlying
the security futures product or related security is traded to detect
manipulation and insider trading. The Commissions, however, believe
that such bilateral agreements would have to contain essentially the
same information sharing obligations that Full Members of ISG currently
have with respect to each other.\133\
---------------------------------------------------------------------------
\133\ See Appendix A, Section 2.
---------------------------------------------------------------------------
Accordingly, if a market trading security futures products becomes
a Full Member of the ISG, becomes an Affiliate Member of the ISG and
enters into a supplemental agreement to share the additional
information described above with Full Members and other Affiliate
Members trading security futures products, or enters into appropriate
bilateral surveillance agreements to detect manipulation and insider
trading with each exchange, association or market on which security
futures products trade, and any market on which any security underlying
the security futures product or related security is traded, the
Commissions believe that the market would satisfy the requirements of
Section 2(a)(1)(D)(i)(VIII) of the CEA and Section 6(h)(3)(I) of the
Exchange Act.\134\
---------------------------------------------------------------------------
\134\ 7 U.S.C. 2(a)(1)(D)(i)(VIII); 15 U.S.C. 78f(h)(3)(I).
---------------------------------------------------------------------------
[[Page 36752]]
2. Exchanges Trading Securities Other Than Security Futures
Sections 6(b)(1) and 15A(b)(2) of the Exchange Act require all
national securities exchanges and national securities associations to
enforce compliance by their members and persons associated with their
members, with the provisions of the Exchange Act and the rules and
regulations thereunder.\135\ Securities exchanges' and associations'
memberships in ISG currently enable them to satisfy this requirement
with respect to enforcement of the proscriptions against insider
trading and the anti-manipulation provisions of the federal securities
laws.\136\ Security futures products are surrogates for their
underlying securities and, therefore, there is the potential that
trading in this new product could be used to manipulate trading in the
underlying security or in other related securities, such as options.
Accordingly, the SEC believes that the introduction of security futures
products means that, to satisfy their obligations under Sections 6 and
15A of the Exchange Act,\137\ exchanges and associations that trade
securities that are related to security futures must have the same
ability to share information and to coordinate surveillance with
markets trading such security futures products as they currently have
through ISG with exchanges and associations trading other securities.
For this reason, the SEC believes that the limitations described above
in the current obligations of Affiliate Members to share information
with Full Members would also unnecessarily hinder or constrain the
ability of national securities exchanges and national securities
associations to enforce compliance with the federal securities laws.
---------------------------------------------------------------------------
\135\ In addition, Sections 6(b)(1) and 15A(b)(2) of the
Exchange Act require all national securities exchanges and national
securities associations to enforce compliance by their members and
persons associated with their members, with the provisions of the
exchanges' or associations' own rules. Section 6(b)(1) of the
Exchange Act, 15 U.S.C. 78f(b)(1); Section 15A(b)(2) of the Exchange
Act, 15 U.S.C. 78o-3(b)(2).
\136\ Sections 9 and 10(b) of the Exchange Act, 15 U.S.C. 78i
and 78j(b).
\137\ 15 U.S.C. 78f and 15 U.S.C. 78o-3.
---------------------------------------------------------------------------
The SEC believes that exchanges and associations could address
these limitations on the obligations of Affiliate Members to share
information by, for example, entering into a supplementary agreement to
share such information among Full and Affiliate Members despite the
limitations in the current agreements. Alternatively, the SEC believes
that exchanges or associations trading securities that are related to
security futures traded by an exchange or association that is not a
Full Member of ISG could satisfy the requirement to coordinate
surveillance by entering into bilateral surveillance agreements with
such exchange or association that is adequate to detect manipulation
and insider trading. The Commissions, however, believe that such
bilateral agreements would have to contain essentially the same
information sharing obligations that Full Members of ISG currently have
with respect to each other.
III. Paperwork Reduction Act
CFTC: This rulemaking contains information collection requirements.
As required by the Paperwork Reduction Act of 1995, 44 U.S.C. 3507(d),
the CFTC submitted a copy of the proposed amendments to its rules to
the Office of Management and Budget (OMB) for its review.
Collection of Information: Part 41, Relating to Security Futures
Products, OMB Control Number 3038-0059.
No comments were received in response to the CFTC's invitation in
the proposed rules to comment on any paperwork burden associated with
these regulations.\138\
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\138\ See Proposing Release, 66 FR at 45912.
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SEC: Certain provisions of the new rule contain ``collection of
information requirements'' within the meaning of the Paperwork
Reduction Act of 1995 (``PRA'').\139\ Accordingly, the Commission
submitted the proposed rule to the Office of Management and Budget
(``OMB'') in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. OMB
approved the new collection and assigned it OMB Control No. 3235-0555.
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.
---------------------------------------------------------------------------
\139\ 44 U.S.C. 3501 et seq.
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In the Proposing Release, the Commissions solicited comments on
these collection of information requirements. The Commissions received
no comments that specifically addressed the PRA portion of the
Proposing Release. Because the new rule is substantially similar to the
proposed rule, the SEC continues to believe that the estimates
published in the Proposing Release regarding the proposed collection of
information burdens associated with the new rule are appropriate.
A. Summary of Collection of Information
As discussed above, the Exchange Act, as amended by the CFMA,
provides that a national securities exchange or national securities
association may trade security futures products only if the listing
standards for such products conform with the requirements set forth in
Section 6(h)(3) of the Exchange Act.\140\ These listing standards must,
among other things, require that: (1) Trading in the security futures
product not be readily susceptible to manipulation of the price of such
security futures product, nor to causing or being used in the
manipulation of the price of any underlying security, option on such
security, or option on a group or index including such securities,\141\
and (2) the market on which the security futures product is traded has
in place procedures to coordinate trading halts between such market and
any market on which any security underlying the security futures
product is traded and other markets on which any related security is
traded.\142\ To further these statutory mandates, the SEC is adopting
SEC Rule 6h-1 to generally provide that: (1) the final settlement price
for each cash-settled security futures product fairly reflect the
opening price of the underlying security or securities; and (2) the
trading in any security futures product halt when a regulatory halt is
instituted with respect to a security or securities underlying the
security futures product by the national securities exchange or
national securities association listing the security. The SEC
anticipates that national securities exchanges and national securities
associations that wish to trade security futures products will file
with the SEC proposed rule changes, pursuant to Section 19(b) of the
Exchange Act,\143\ to establish listing standards that are consistent
with the requirements set forth in Section 6(h)(3) of the Exchange
Act.\144\
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\140\ 15 U.S.C. 78f(h)(3).
\141\ See 15 U.S.C. 78f(h)(3)(H).
\142\ See 15 U.S.C. 78f(h)(3)(K).
\143\ 15 U.S.C. 78s(b).
\144\ 15 U.S.C. 78f(h)(3).
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B. Proposed Use of Information
The SEC will review these proposed rule changes in the manner
prescribed by Section 19(b) of the Exchange Act. In addition, the SEC
will publish these proposed rule changes to afford the public an
opportunity to comment on the listing standards adopted by national
securities exchanges and national securities associations with respect
to security futures products.
[[Page 36753]]
C. Respondents
The SEC estimates that there will be 17 respondents to the proposed
rule: 9 currently registered national securities exchanges, 1 national
securities association (the NASD) that operates a securities market
(Nasdaq), and an estimated 7 futures markets that are expected to
register as Security Futures Product Exchanges.
D. Total Annual Reporting and Recordkeeping Burden
The SEC received no comments on its proposed estimates and has not
revised them. The SEC estimates the paperwork burden for each
respondent to comply with proposed SEC Rule 6h-1 will be 10 hours of
legal work at $128/hour,\145\ for a total cost of $1,280 per
respondent. The SEC estimates that the total burden on all respondents
will be 170 hours (10 hours/response x 17 respondents x 1 response/
respondent), for a total cost of $21,760 ($1,280/response x 17
respondents x 1 response/respondent). The SEC believes that these
burdens will be incurred on a one-time basis and will not recur.
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\145\ The estimated rate of $128 per hour is derived from the
SIA Management and Professional Earnings, Table 107 (Attorney, New
York), and includes a 35 percent differential for bonus, overhead,
and other expenses.
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E. Record Retention Period
As set forth in SEC Rule 17a-1,\146\ a national securities exchange
or national securities association must retain records of the
collection of information for at least five years, the first two years
in an easily accessible place. However, SEC Rule 17a-1 requires a
national securities exchange registered under Section 6(g) of the
Exchange Act to retain only those records relating to persons,
accounts, agreements, contracts, and transactions involving security
futures products.\147\
---------------------------------------------------------------------------
\146\ 17 CFR 240.17a-1.
\147\ See 15 U.S.C. 78q(b)(4)(B).
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F. Collection of Information Is Mandatory
This collection of information is mandatory for any national
securities exchange or national securities association that elects to
list and trade security futures products.
G. Confidentiality
Any information filed with the Commission will be made publicly
available. Information in the files of national securities exchanges or
national securities associations that elect to list and trade security
futures products will be subject to Commission enforcement inquiries or
investigations and trading reconstructions, as well as for inspections
and examinations.
IV. Costs and Benefits of the Final Rule
CFTC: Section 15 of the CEA requires the CFTC to consider the costs
and benefits of its action before issuing a new regulation.\148\ The
CFTC understands that, by its terms, Section 15 does not require the
CFTC to quantify the costs and benefits of a new regulation or to
determine whether the benefits of the proposed regulation outweigh its
costs. Nor does Section 15 require that each proposed rule be analyzed
in isolation when that rule is a component of a larger package of rules
or rule revisions. Rather, Section 15 simply requires the CFTC to
``consider the costs and benefits'' of its action.
---------------------------------------------------------------------------
\148\ 7 U.S.C. 19.
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Section 15 further specifies that costs and benefits shall be
evaluated in light of five broad areas of market and public concern:
protection of market participants and the public; efficiency,
competitiveness, and financial integrity of futures markets; price
discovery; sound risk management practices; and other public interest
considerations. Accordingly, the CFTC could in its discretion give
greater weight to any one of the five enumerated areas of concern and
could in its discretion determine that, notwithstanding its costs, a
particular rule was necessary or appropriate to protect the public
interest or to effectuate any of the provisions or to accomplish any of
the purposes of the Act.
The CFTC considered the costs and benefits of these rules in light
of the specific areas of concern identified in Section 15,\149\ and
concluded that the rules should have no effect, from the standpoint of
imposing costs or creating benefits, on the financial integrity or
price discovery function of the futures and options markets or on the
risk management practices of trading facilities or others. The rules
also should have no material effect on the protection of market
participants and the public and should not impact the efficiency and
competition of the markets.
---------------------------------------------------------------------------
\149\ See Proposing Release, 66 FR at 45914.
---------------------------------------------------------------------------
The CFTC invited public comment on the costs and benefits of the
proposed rules.\150\ The CFTC received no comments. Accordingly, the
CFTC has determined to adopt the rules discussed above.
---------------------------------------------------------------------------
\150\ See Proposing Release, 66 FR at 45914.
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SEC: The CFMA \151\ authorizes the trading of futures on individual
stocks and narrow-based security indexes (``security futures'').\152\
The CFMA provides, among other things, that the listing standards for
security futures products must require that trading in security futures
products not be readily susceptible to manipulation of the price of
such security futures product, nor to causing or being used in the
manipulation of the price of any underlying security, option on such
security, or option on a group or index including such securities.\153\
In addition, listing standards must require that the market on which
the security futures product trades has in place procedures to
coordinate trading halts between such market and any market on which
any security underlying the security futures product is traded and
other markets on which any related security is traded.\154\
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\151\ Pub. L. No. 106-554, Appendix E, 114 Stat. 2763.
\152\ After December 21, 2003, the SEC and the CFTC may jointly
determine to permit trading of puts, calls, straddles, options, or
privileges on security futures (along with security futures,
collectively referred to as ``security futures products''). See
Section 2(a)(1)(D)(iii) of the CEA, 7 U.S.C. 2(a)(1)(D)(iii);
Section 6(h)(6) of the Exchange Act, 15 U.S.C. 78f(h)(6).
\153\ See Section 2(a)(1)(D)(i)(VII) of the CEA, 7 U.S.C.
2(a)(1)(D)(i)(VII); Section 6(h)(3)(H) of the Exchange Act, 15
U.S.C. 78f(h)(3)(H).
\154\ See Section 2(a)(1)(D)(i)(X) of the CEA, 7 U.S.C.
2(a)(1)(D)(i)(X); Section 6(h)(3)(K) of the Exchange Act, 15 U.S.C.
78f(h)(3)(K).
---------------------------------------------------------------------------
Accordingly, the SEC is adopting new SEC Rule 6h-1 under the
Exchange Act generally to require that the final settlement price for
each cash-settled security futures product fairly reflect the opening
price of the underlying security or securities, and that trading in any
security futures product halt when a regulatory halt is instituted with
respect to a security or securities underlying the security futures
product by the national securities exchange or national securities
association listing the security.
Specifically, SEC Rule 6h-1(a) defines the terms ``opening price,''
``regular trading session,'' and ``regulatory halt'' generally as
proposed.\155\ However, the SEC has incorporated a provision into the
definition of ``opening price'' to clarify that if a security is not
listed on a national securities exchange or a national securities
association, the opening price shall be the price at which a security
opened for trading, or a price that fairly reflects the price at which
a security opened for trading, on the primary market for the security.
---------------------------------------------------------------------------
\155\ SEC Rule 6h-1(a).
---------------------------------------------------------------------------
Also like the proposed rule, adopted SEC Rule 6h-1(b)(1) requires
that the final settlement price of a cash-settled security futures
product must fairly reflect the opening price of the
[[Page 36754]]
underlying security or securities.\156\ However, if the opening price
for one or more securities underlying a security futures product is not
readily available,\157\ SEC Rule 6h-1(b)(2) provides that the final
settlement price of the security futures product shall fairly reflect
the price of the underlying security or securities during its most
recent regular trading session or the next available opening price of
the underlying security or securities.\158\ Furthermore,
notwithstanding SEC Rule 6h-1(b)(1) or (b)(2), the SEC amended the
proposed rule to add SEC Rule 6h-1(b)(3), which states that if a
clearing agency to which a final settlement price of a security futures
product is or would be reported determines, pursuant to its rules, that
such final settlement price is not consistent with the protection of
investors and the public interest, the clearing agency has the
authority to determine, under its rules, a final settlement price for
such security futures product. Under SEC Rule 6h-1(b)(3), the clearing
agency must take into account such factors as fairness to buyers and
sellers of the affected security futures product, the maintenance of a
fair and orderly market in such security futures product, and
consistency of interpretation and practice.
---------------------------------------------------------------------------
\156\ SEC Rule 6h-1(b).
\157\ Although SEC Rule 6h-1(b)(2) does not define when an
opening price would not be ``readily available,'' national
securities exchanges and national securities associations would have
to establish, as part of their listing standards, rules that
interpret this term.
\158\ The SEC amended the proposed rule to allow look forward
pricing in response to recommendations by commenters.
---------------------------------------------------------------------------
With respect to regulatory halts for security futures products, the
SEC is generally adopting the provision as proposed requiring that
trading of a security futures product based on a single security be
halted at all times that a regulatory halt has been instituted for the
underlying security.\159\ The trading of security futures product based
on a narrow-based security index must be halted at all times that a
regulatory halt has been instituted for one or more of the underlying
securities that constitute 50 percent or more of the market
capitalization of the narrow-based security index.\160\
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\159\ SEC Rule 6h-1(c)(1).
\160\ In the Proposing Release, the SEC originally proposed
halting trading in a security futures product when 30 percent of the
market capitalization of a narrow-based security index halted
trading in the underlying markets. As discussed further below, this
change was made in response to commenters. See SEC Rule 6h-1(c)(2).
The rule being adopted today does not preclude a market trading
security futures products based on narrow-based security indexes
from halting trading at a threshold of less than 50 percent of the
market capitalization of the index or for other appropriate reasons,
such as operational difficulties being experienced by the market or
its automated systems or concerns over clearance and settlement
operations.
---------------------------------------------------------------------------
Finally, the SEC has expanded the exemption in SEC Rule 6h-1(d) to
permit the SEC to grant a national securities exchange or national
securities association an exemption from any provision of SEC Rule 6h-1
if the SEC determines that such an exemption is necessary or
appropriate in the public interest and consistent with the protection
of investors. The SEC has expanded the scope of the exemption to make
it more consistent with its exemptive authority under Section 36 of the
Exchange Act, which allows the SEC, by rule, regulation, or order to
conditionally or unconditionally exempt any person, security, or
transaction, or any classes thereof, from any rule or regulation under
the Exchange Act, to the extent that such exemption is necessary or
appropriate in the public interest, and is consistent with the
protection of investors.\161\
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\161\ See supra note 66 and accompanying text.
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A. Comments
In the Proposing Release,\162\ the SEC requested comments on all
aspects of the costs and benefits of the adopted rule, including
identification of additional costs and benefits of the changes. In
addition, the SEC encouraged commenters to identify, discuss, analyze,
and supply relevant data regarding the proposed rule. Specifically, the
SEC requested data to quantify the costs and benefits of the proposed
rule. The SEC requested estimates of these costs and benefits, as well
as any costs and benefits not already described, which may result from
the adoption of the proposed rule. Furthermore, the SEC requested
comment on the estimate of the number of respondents that would be
affected by proposed SEC Rule 6h-1 and the costs and benefits
associated with complying with the proposed rule. The SEC specifically
requested comments on the operational and maintenance costs associated
with the proposal and whether these costs would be significant.
Commenters were asked to provide analysis and empirical data to support
their views on the costs and benefits associated with the proposal.
---------------------------------------------------------------------------
\162\ See Proposing Release, supra note 18.
---------------------------------------------------------------------------
Although no comments specifically addressed the Costs and Benefits
analysis in the Proposing Release,\163\ there were comments that may
apply generally to the costs and benefits of the adopted rule. The SEC
anticipates that the rule adopted today will generate the costs and
benefits described below and has incorporated the general comments into
the applicable discussion.
---------------------------------------------------------------------------
\163\ See Proposing Release, supra note 18.
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B. Benefits of SEC Rule 6h-1 Under the Exchange Act
Adopted SEC Rule 6h-1(a) defines the terms ``opening price,''
``regular trading session,'' and ``regulatory halt.'' As a definitional
provision, subparagraph (a) imposes no costs on the respondents.
However, by defining the terms, the SEC believes that adopted SEC Rule
6h-1(a) should benefit respondents by providing legal certainty to
respondents when complying with the rule.
One commenter stated that the definition of ``opening price''
failed to anticipate instances where the market trading a security
underlying a security futures product may be a market other than a
national securities exchange or national securities association, such
as a foreign stock exchange.\164\ Therefore, the SEC has revised the
definition to provide that, if the underlying security is not listed on
a national securities exchange or a national securities association,
the opening price is the price at which the security opened for
trading, or a price that fairly reflects the price at which a security
opened for trading, on the primary market for the security. The SEC
believes that the additional language should provide clear guidance and
clarification of the term ``opening price'' in those instances where
the security futures products may be based on securities that are not
listed in the United States. To the extent that the underlying security
is listed on a national securities exchange or national securities
association, the SEC believes that it is appropriate to use the opening
price from the listing market. Despite the commenter's view that the
listing market may not be the primary trading venue for a security and,
thus, not the most liquid market,\165\ the SEC believes that the
listing market is a significant source of liquidity for a security that
underlies a security futures product and that a rule requiring, for
example, the calculation of trading volumes to determine the
appropriate primary market from which to derive an opening price for a
security listed in the U.S. would impose unnecessary burdens without
significantly furthering anti-manipulation goals.
---------------------------------------------------------------------------
\164\ See CME Letter.
\165\ See CME Letter.
---------------------------------------------------------------------------
Further, this commenter stated that the proposed definition of the
term ``regulatory halt,'' which is being
[[Page 36755]]
adopted as proposed, also does not address situations where the listing
market is not the primary trading venue for the underlying security or
where the listing market is in a foreign country.\166\ The SEC notes
that the rule adopted today is not intended to limit the ability of
national securities exchanges and national securities associations to
impose a trading halt in other circumstances, such as when the
underlying security is listed on a foreign market that has halted
trading. The rule provides national securities exchanges and national
securities associations with the flexibility to submit proposed rule
changes that address situations not covered by the rule being adopted
today.\167\ However, in those instances where the underlying security
is listed in the United States, the SEC believes that by specifically
designating the listing market as the appropriate venue, the rule
allows for ease of application and clear guidance for respondents to
administer and implement the rule. For example, the SEC believes that,
due to the contractual relationship between the issuer and the listing
market, the listing market has a direct and ongoing relationship with
the issuer and, therefore, is in the best position to be informed
promptly by the issuer that pending news would require the imposition
of a trading halt.
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\166\ See CME Letter.
\167\ One commenter believed that the SEC and the CFTC should
expand on the examples of the types of reasons why national
securities exchanges and associations could impose additional
trading halts provided in the footnotes of the Proposing Release to
include order imbalances. See NYSE Letter. As noted above, the rule
being adopted today is not designed to preclude a market trading
security futures products from halting trading for other appropriate
reasons. Therefore, a national securities exchange or national
securities association would be free to impose additional
restrictions on trading that are not required by this rule.
---------------------------------------------------------------------------
Adopted SEC Rule 6h-1(b)(1) requires that the final settlement
price of a cash-settled security futures product must fairly reflect
the opening price of the underlying security or securities. Several
commenters generally supported this aspect of the proposal.\168\ The
SEC believes that the provision for cash-settled security futures
products under adopted SEC Rule 6h-1(b)(1) is necessary to minimize
opportunities for intermarket manipulations and to promote the fair and
orderly operation of the securities markets. In particular, opening-
price settlement procedures appear to be necessary to satisfy Section
6(h)(3)(H) of the Exchange Act \169\ that listing standards for
security futures products must require that trading in a security
futures product not be readily susceptible to manipulation of the price
of such product, nor to causing or being used in the manipulation of
the price of any underlying security, option on such security, or
option on a group or index including such securities.
---------------------------------------------------------------------------
\168\ See CBOE Letter, CBOT Letter, and NYSE Letter.
\169\ 15 U.S.C. 78f(h)(3)(H).
---------------------------------------------------------------------------
The SEC believes that SEC Rule 6h-1(b)(1) should facilitate the
ability of the securities markets to handle expiration-related
unwinding programs and mitigate the liquidity strains that had
previously been experienced in the securities markets on expirations
for stock index futures and options. The SEC further believes that the
liquidity constraints associated with expiration-related buy or sell
programs at the close on expiration Fridays aggravated ongoing market
swings during an expiration and provided opportunities for entities to
anticipate these pressures and enter orders as part of manipulative or
abusive trading practices designed to artificially drive up or down
share prices.\170\
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\170\ The liquidity constraints faced by the securities markets
due to unwinding programs used in closing-price settlement
procedures were discussed by the SEC staff in its report on the
market decline on November 15, 1991. See SEC Division of Market
Regulation, Trading Analysis of November 15, 1991 (October 1992).
---------------------------------------------------------------------------
The SEC notes that the rule adopted today provides national
securities exchanges and national securities associations with
flexibility to implement the requirements of the Exchange Act. The SEC
notes that the rule adopted today does not mandate that a particular
methodology be used to derive an opening price. A national securities
exchange or national securities association would retain the
flexibility to establish the procedures to determine the opening price,
which will be used to determine the settlement price of security
futures products. The SEC believes that this flexibility should provide
respondents with the ability to meet the needs of the market place,
while satisfying their obligations under the Exchange Act.
In those instances where the opening price was not readily
available, the SEC proposed that the final settlement price of a cash-
settled security futures product overlying that security must reflect a
price of the underlying security taken from its most recent regular
trading session. The proposed rule also provided that national
securities exchanges and national securities associations could request
exemptions from the settlement price provisions from the SEC on a case-
by-case basis.
Although one commenter supported this aspect of the proposal,\171\
four commenters generally opposed the SEC's exclusive use of a ``look
back'' settlement procedure for security futures products when the
opening prices for the underlying securities are unavailable and,
instead, recommended using the next day's opening prices.\172\ These
commenters noted that the existing cash settlement procedures for stock
index options and stock index futures allow ``next opening''
prices.\173\ Further, one commenter, a clearing agency, urged the SEC
not to require national securities exchanges and national securities
associations to adopt rules addressing the determination of security
futures final settlement prices when opening prices are not readily
available because of potential conflicts with clearing agency
rules.\174\ Another commenter believed that the establishment of
consistent and commercially appropriate alternative pricing conventions
should be resolved by a collaboration among the exchanges that design
the product and the clearinghouse, with appropriate consultation with
their members and participants.\175\ Furthermore, several commenters
argued that under the SEC's proposed rule hedges could be significantly
disrupted.\176\
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\171\ See CBOT Letter.
\172\ See CBOE Letter, CME Letter, and SIG Letter. See also OCC
Letter (urging the Commissions to withdraw this aspect of the
proposal, or at a minimum, modify it to allow the final settlement
value to be based on the next opening).
\173\ See CBOE Letter, CME Letter, and SIG Letter. See also FIA/
SIA Steering Committee Letter (stating that the Commissions'
proposed requirement is inconsistent with existing market practice
and rules governing a broad range of listed stock index products)
and OCC By-Laws, Article XII, Section 5 (allowing OCC to fix the
final settlement price for security futures products using next
opening prices of the underlying securities, as well as look-back
pricing).
\174\ See OCC Letter.
\175\ See FIA/SIA Steering Committee Letter.
\176\ See CBOE Letter, CME Letter, FIA/SIA Steering Committee
Letter, OCC Letter, and SIG Letter.
---------------------------------------------------------------------------
In response to the commenters, the final rule adopted by the SEC
allows either look-back or look forward opening prices to be used as
alternate final settlement prices when an opening price is not readily
available. Specifically, adopted SEC Rule 6h-1(b)(2) requires that, if
an opening price for one or more securities underlying a security
futures product is not readily available, the final settlement price of
the security futures product shall fairly reflect (i) the price of the
underlying security or securities during the most recent regular
trading session for such security or securities, or (ii) the next
available opening price of the underlying security or securities.
[[Page 36756]]
As discussed earlier, the SEC agrees with the commenters' view that
the proposed rule could have resulted in an unwanted and unwarranted
de-linking of hedging positions if it mandated look-back pricing
procedures for security futures products. The SEC believes that the
adopted rule will provide national securities exchanges and national
securities associations with some discretion to implement this general
rule without dictating how the settlement price is derived for a
security futures product. The SEC further notes that the final rule
adopted today is consistent with OCC rules that allow for look-back
pricing in certain circumstances.
In addition, one commenter indicated that problems could arise if
an exchange or association that trades a security futures product and
the registered clearing agency through which it clears such product had
different rules for the determination of an alternate settlement
price.\177\ For example, a national securities exchange or national
securities association wishing to use OCC clearing services for
security futures must enter into a clearing agreement with OCC in which
both parties agree that security futures will be cleared by OCC in
accordance with OCC's by-laws and rules, which currently give OCC the
final authority to determine final settlement prices in certain
circumstances.\178\ This commenter recommended that the clearing agency
be permitted, under its rules, to determine the final settlement price
of the security futures product.\179\ In light of the comments, the
final rule has been amended. Pursuant to adopted SEC Rule 6h-1(b)(3),
if a clearing agency determines, pursuant to its rules, that such final
settlement price is not consistent with the protection of investors and
the public interest, taking into account such factors as fairness to
buyers and sellers of the affected security futures product, the
maintenance of a fair and orderly market in such security futures
product, and consistency of interpretation and practice, the clearing
agency has the authority to determine, under its rules, a final
settlement price for such security futures product.
---------------------------------------------------------------------------
\177\ See OCC Letter.
\178\ See supra note 60 and accompanying text.
\179\ See OCC Letter; see also CBOE Letter (recommending that
security futures products have the proviso that the clearing
corporation rules have precedence for determining the index value at
expiration during a trading halt in the underlying security); FIA/
SIA Steering Committee Letter (urging the Commissions not to require
exchanges and associations to adopt rules addressing the
determination of fallback security futures final settlement prices
when opening prices are not readily available).
---------------------------------------------------------------------------
The SEC believes that in the absence of such a provision, confusion
could arise if securities underlying a security futures product failed
to trade on an expiration Friday and the market trading the security
futures product and its clearing agency had different rules determining
a final settlement price. Moreover, this provision should make security
futures products that trade on different markets more fungible, because
a single clearing agency will be able to harmonize procedures across
different markets for determining alternate settlement prices.
In addition, adopted SEC Rule 6h-1(c)(1) and (c)(2) requires the
trading on security futures products based on a single security to be
halted at all times that a regulatory halt has been instituted for the
underlying security or, if based on a narrow-based security index, to
be halted at all times that a regulatory halt has been instituted for
one or more underlying securities that constitute 50 percent or more of
the market capitalization of the narrow-based security index. The SEC
believes that the adopted rule should help preserve the investor
protection and market integrity goals of regulatory halt procedures in
the securities markets. The SEC believes that the close relationship
between the underlying security or securities and the pricing of the
overlying security futures product generally justifies a regulatory
halt of the security futures product at all times that a regulatory
halt has been instituted for the underlying security or
securities.\180\
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\180\ The trading halt provision of adopted SEC Rule 6h-1(c)
would not be exclusive. The adopted rule is not designed to preclude
a market trading security futures products from halting trading for
other appropriate reasons, such as operational difficulties being
experienced by the market or its automated systems or concerns over
clearance and settlement operations.
---------------------------------------------------------------------------
With respect to regulatory halts due to pending news, the SEC does
not agree with two commenters who questioned the absolute requirement
that trading in a security futures product must be halted during a news
pending halt in the underlying security.\181\ These commenters
recommended providing exchanges with discretion to impose a trading
halt when there is a news pending trading halt in the underlying
security.\182\ Specifically, one commenter believed that this
discretion is necessary to allow trading in a security futures product
when the underlying stock is halted in certain circumstances, such as
when there is a need to adjust positions before an expiration.\183\
Given the rarity of such situations and that the significant
underpinning for imposing news pending regulatory halts is to promote
investor protection and fair and orderly markets, the SEC believes
that, to the extent that there is pending news that could impact an
investor's decision and to the extent that single-stock futures are
surrogates for the underlying security, there is a need for a provision
requiring that trading in a security futures product be halted at all
times that a regulatory halt has been instituted for the underlying
security or securities, with certain limits for narrow-based security
index futures. SEC Rule 6h-1(c)(1) and (2), which concern regulatory
halts, will benefit current and potential shareholders by providing an
opportunity for material information about the underlying security or
securities to be disseminated to the public. Since pending news may
have a significant effect on trading, the SEC believes that all
investors should have an opportunity to learn of and react to material
information in order to make informed investment judgments.\184\
Accordingly, news pending regulatory halts should foster public
confidence in the market and promote the integrity of the market place.
Furthermore, the SEC believes that requiring an exchange or association
to halt trading on a security futures product at all times that a
regulatory halt has been instituted for the underlying security or
securities should contribute to the maintenance of an efficient market.
---------------------------------------------------------------------------
\181\ See CBOE Letter and FIA/SIA Steering Committee Letter.
\182\ Id.
\183\ See CBOE Letter.
\184\ See Securities Exchange Act Release No. 32890 (September
14, 1993), 58 FR 48916 (September 20, 1993).
---------------------------------------------------------------------------
In addition, the SEC believes that regulatory halts in the trading
of security futures products due to the operation of circuit breakers
should further protect investors and the markets by mitigating
potential systemic stress during a historic market decline and allow
for the reestablishment of an equilibrium between buying and selling
interests in an orderly fashion. The SEC generally believes that pre-
determined, coordinated, cross-market operations of circuit breakers
would effectively address market declines that threaten to result in ad
hoc and potentially destabilizing market closings.
The SEC does not agree with one commenter's recommendation that the
SEC should provide exchanges with latitude in implementing coordinated
circuit breaker procedures and flexibility in imposing this requirement
on security futures products where the
[[Page 36757]]
principal trading venues for the underlying securities (or for a subset
of securities in the case of narrow-based indexes) are in foreign
markets.\185\ The SEC believes that it is important to require the
application of cross-market circuit breaker regulatory halt procedures
to security futures products and that such a requirement is necessary
to satisfy the requirements of Section 6(h)(3)(K) of the Exchange
Act.\186\ If cross-market circuit breaker regulatory halt procedures
were not applied to the security futures products, the lack of such
procedures would undermine the use of trading halts in the underlying
securities. Furthermore, national securities exchanges and national
securities associations do have the flexibility under the rule to
impose trading halt requirements where the underlying security is
listed solely on a foreign market.
---------------------------------------------------------------------------
\185\ See CME Letter.
\186\ 15 U.S.C. 78f(h)(3)(K).
---------------------------------------------------------------------------
In addition, to be effective, circuit breakers have to be
coordinated across stock, stock index futures, and options markets in
order to prevent intermarket problems of the kind experienced in
October 1987.\187\ Since the markets currently coordinate regulatory
halts between the listing market for the underlying security and other
markets that trade the underlying security or any related security in
order to promote investor protection and fair and orderly markets, SEC
Rule 6h-1(c)(1) and (2) should help ensure such coordination and
effectiveness through the use of regulatory halts in the markets
trading security futures products.
---------------------------------------------------------------------------
\187\ In response to the events of October 19, 1987, when the
Dow Jones Industrial Average (``DJIA'') sustained a one-day decline
of 508 points (22.6%), the nation's securities and futures markets
in 1988 adopted rules that provide for coordinated, cross-market
trading halts in all equity and equity-derivative markets following
specified declines in the DJIA. See Circuit Breaker Report, supra
note 68. See also Securities Exchange Act Release No. 38080
(December 23, 1996), 61 FR 69126 (December 31, 1996) (citing the
SEC's desire to have coordinated mechanisms across these markets to
deal with potential volatility that may develop during periods of
extreme downward volatility).
---------------------------------------------------------------------------
Although the SEC understands the concern raised by one commenter
regarding continued trading of a security futures product when the
underlying security has halted trading if the listing market is not the
primary market,\188\ the SEC believes that, due to the contractual
relationship between the issuer and the listing market, the listing
market has a direct and ongoing relationship with the issuer and is,
consequently, in the best position to be informed promptly by the
issuer that pending news would require the imposition of a trading
halt. The SEC also believes that designating the listing market as the
venue for the purpose of applying the rule provides for ease of use and
application and prevents national securities exchanges or national
securities associations from having to determine the primary market for
each underlying security. Further, the SEC believes that the listing
market should represent sufficient liquidity that imposing a trading
halt on a security futures product when the listing market for the
underlying security imposes a trading halt furthers the purposes of
Section 6(h)(3)(K) of the Exchange Act.\189\
---------------------------------------------------------------------------
\188\ See CME Letter.
\189\ 15 U.S.C. 78f(h)(3)(K).
---------------------------------------------------------------------------
With respect to narrow-based security indexes, the SEC believes
that trading should be halted when a trading halt has been instituted
for a sufficiently large portion of an index in order to prevent
continued trading of the security futures product from becoming a means
to improperly circumvent regulatory trading halts in the underlying
securities. If trading in only one component security is halted,
continued trading in a security future based on an index in which such
a security represents a substantial portion of the index value could
also undermine the trading halt in the underlying security. The SEC
believes that trading halt procedures also would not be coordinated, as
contemplated by Section 6(h)(3)(K) of the Exchange Act,\190\ if the
security futures product based on an index continued to trade while
investors were precluded from trading some or all of the underlying
securities. Moreover, the SEC believes that continued trading in the
security futures product under these circumstances could undercut key
provisions in the securities laws designed to protect investors and
promote the fair and orderly operation of the markets.
---------------------------------------------------------------------------
\190\ 15 U.S.C. 78f(h)(3)(K).
---------------------------------------------------------------------------
Accordingly, the SEC believes that a general practice whereby
trading is halted for the security futures product when investors lack
access to current pricing information in the primary market for the
underlying security should contribute to the maintenance of fair and
orderly markets. Moreover, the SEC believes that this coordination of
trading halts by SEC Rule 6h-1(c)(1) and (2) would generally benefit
investors and the market by providing fewer opportunities for abuse and
manipulation. SEC Rule 6h-1(c)(1) and (2) also would further increase
investor confidence in the stability of the markets by assuring
investors and the public that the national securities exchanges and
national securities associations trading security futures product are
reasonably equipped to handle market demand and pending material news.
Furthermore, in the final rule adopted by the SEC, the rule permits
the SEC to grant an exemption with respect to any provision of SEC Rule
6h-1 based on its existing exemptive authority pursuant to Section 36
of the Exchange Act. Any exemption would require a finding that the
action is necessary or appropriate in the public interest and
consistent with the protection of investors. The SEC believes that the
exemption provided for in SEC Rule 6h-1(d)\191\ would benefit national
securities exchanges and national securities associations by providing
them with flexibility in responding to changing market conditions, as
well as provide the SEC with continued oversight over the respondents
by granting an exemption when it is necessary or appropriate in the
public interest and is consistent with the protection of investors.
---------------------------------------------------------------------------
\191\ The SEC may grant an exemption from the rule, either
unconditionally or on specified terms and conditions, if it finds
that such exemption is necessary or appropriate in the public
interest and consistent with the protection of investors. See
Section 36 of the Exchange Act, 15 U.S.C. 78mm.
---------------------------------------------------------------------------
B.Costs of SEC Rule 6h-1 under the Exchange Act
The SEC estimates that there would be 17 respondents to the rule: 9
currently registered national securities exchanges, 1 national
securities association (the NASD) that operates a securities market
(Nasdaq), and an estimated 7 futures markets that are expected to
register as Security Futures Product Exchanges.
National securities exchanges and national securities associations
may file proposed rule changes pursuant to Section 19(b) of the
Exchange Act \192\ to implement SEC Rule 6h-1.\193\ However, the SEC
notes that even in the absence of SEC Rule 6h-1 each of the respondents
would have to file one or more proposed rule changes to adopt listing
standards for security futures products to trade security futures
products pursuant to the Exchange Act, as amended by the CFMA.
---------------------------------------------------------------------------
\192\ 15 U.S.C. 78s(b).
\193\ The SEC has adopted Rule 19b-7, which would direct
Security Futures Product Exchanges to file proposed rule changes on
Form 19b-7. See Securities Exchange Act Release No. 44692, supra
note.
---------------------------------------------------------------------------
Further, under Rule 17a-1 of the Exchange Act,\194\ a national
securities exchange or national securities association is required to
retain records of the collection of information for at
[[Page 36758]]
least 5 years, with the first 2 years in an easily accessible place.
However, Rule 17a-1 requires a Security Futures Product Exchange to
retain only those records relating to persons, accounts, agreements,
contracts, and transactions involving security futures products.\195\
The SEC believes that respondents would not incur any additional
capital or start-up costs beyond the paperwork costs, nor any
additional operational or maintenance costs, to comply with the
collection of information requirements under SEC Rule 6h-1.\196\ As
discussed above, the paperwork burden for each respondent to comply
with the new rule will be $1,280, resulting in a total cost for the 17
respondents of $21,760.
---------------------------------------------------------------------------
\194\ 17 CFR 240.17a-1.
\195\ See 15 U.S.C. 78q(b)(4)(B).
\196\ See Paperwork Reduction Act discussion at Section III.
---------------------------------------------------------------------------
As mentioned earlier, adopted SEC Rule 6h-1(a) defines the terms
``opening price,'' ``regular trading session,'' and ``regulatory
halt.'' The definitions of the relevant terms impose no costs on the
respondents.
SEC Rule 6h-1 also requires respondents that choose to trade
security futures products to develop a system for determining the
settlement price of a cash-settled security futures product to fairly
reflect the opening price of the underlying security. However, because
respondents to the adopted rule currently have systems in place to
determine opening prices, the SEC believes that respondents complying
with the settlement provisions of SEC Rule 6h-1 would only incur
minimal operational or maintenance costs to reconfigure their current
settlement procedures to fairly reflect the opening price of the
underlying security.
In addition, in order to comply with SEC Rule 6h-1(c)(1) and (2),
the SEC believes that national securities exchanges and national
securities associations may incur costs in developing or adapting
existing systems to monitor when listing markets have instituted a
regulatory halt for an underlying security of the security futures
product. Similarly, costs may be incurred for system changes needed to
calculate the market capitalization of an underlying narrow-based
security index and when one or more of the underlying securities that
constitute 50 percent or more of the market capitalization of a narrow-
based security index are subject to a regulatory halt. The commenters
did not provide the SEC with actual estimates of the costs they would
incur to institute such a system. To the extent that systems need to be
developed to determine the market capitalization of narrow-based
security indexes to trigger a regulatory trading halt, the SEC does not
believe that the additional costs that may be incurred will be
substantial. Similarly, with respect to the costs in developing or
adapting existing systems to monitor when listing markets institute
regulatory halts for the security or securities, as applicable,
underlying the security futures product, the SEC believes that these
costs should not be substantial in light of the fact that the majority
of affected markets already have systems in place to monitor regulatory
halts. For instance, the SEC notes that 9 of the estimated 17
respondents are already required to provide notification of regulatory
halts since they are participants of the Consolidated Tape Association
Plan (``CTA Plan'')\197\ and thus, should already have systems in place
to monitor each other of regulatory halts being instituted. The SEC
also believes that each of the remaining respondents will have to
develop a similar system to monitor when regulatory halts have been
instituted for the underlying security. However, any costs that will be
incurred to establish such a system arise from the requirements of the
Exchange Act, as amended by the CFMA, to coordinate trading halts.\198\
The rule adopted today merely clarifies the requirement imposed by the
Exchange Act, as amended by the CFMA.
---------------------------------------------------------------------------
\197\ The CTA Plan is a joint industry plan that governs the
consolidated transaction reporting system. Parties to the CTA Plan
are as follows: the American Stock Exchange LLC, Boston Stock
Exchange, Inc., Chicago Board Options Exchange, Inc., Chicago Stock
Exchange, Inc., Cincinnati Stock Exchange, Inc., National
Association of Securities Dealers, Inc., New York Stock Exchange,
Inc., Pacific Exchange, Inc., and Philadelphia Stock Exchange, Inc.
See CTA Plan (Second Restatement), Section III (a).
\198\ Section 6(h)(3)(K) of the Exchange Act, 15 U.S.C.
78f(h)(3)(K).
---------------------------------------------------------------------------
One commenter believed that the requirement to halt trading in
single-stock futures when trading in the underlying security is halted
was overly broad to satisfy the requirement that procedures be put in
place to coordinate trading halts.\199\ This commenter believed that
this was overly broad and burdensome in its application to retail
investors for whom single-stock futures might serve as the only
available means for managing risk and that the SEC should allow trading
halt sessions during which investors with risk exposure to an
underlying equity, which has been halted, might have the opportunity to
enter into single-stock futures transactions with dealers.
---------------------------------------------------------------------------
\199\ See Students Letter.
---------------------------------------------------------------------------
In response, the SEC notes that the purpose of trading halts is to
ensure that there is an adequate opportunity for information about a
security to be disseminated to the public. The SEC does not believe
that it would be consistent with the protection of investors to permit
investors, including retail investors, to trade a surrogate for a
security when trading is halted in that security. By adopting this
rule, the SEC seeks to maintain and preserve the integrity of this
mechanism so that the trading of security futures products will not be
used as a tool to circumvent the institution of regulatory halts.
Moreover, the SEC believes that the purpose of halting trading in the
underlying security would be frustrated if market participants could
circumvent this halt by trading during the halt in the related security
futures product.\200\
---------------------------------------------------------------------------
\200\ The SEC's rule does not preclude a market trading security
futures products from halting trading for other appropriate reasons,
such as operational difficulties being experienced by the market or
its automated systems or concerns over clearance and settlement
operations.
---------------------------------------------------------------------------
Another commenter believed that the SEC's proposal to require a
trading halt in a narrow-based security index future when a security or
securities that constitute 30 percent or more of the market
capitalization of the index are subject to a trading halt was too low a
threshold to justify the disruption that it would inflict upon the
futures market.\201\ Another commenter recommended providing exchanges
with greater discretion to decide whether to impose or maintain a
trading halt.\202\ This commenter also believed that because not all
indexes underlying security futures products may be capitalization
weighted, it may be difficult for exchanges to determine on a real-time
basis when securities comprising 30 percent of the market
capitalization of a price-weighted or equal dollar weighted index are
halted. Similarly, one of the commenters expressed a concern that, with
respect to corporate news events, it may be operationally difficult to
determine on a real-time basis whether the threshold of market
capitalization has been crossed.\203\
---------------------------------------------------------------------------
\201\ See CBOT Letter.
\202\ See CBOE Letter.
\203\ See CME Letter.
---------------------------------------------------------------------------
In response to the commenter's statement that the 30 percent market
capitalization test was too low and after consideration of the
potential effects of the proposed 30 percent trading halt threshold,
the adopted rule requires trading to be halted in a narrow-based
security index futures product when component securities representing
50 percent or more of the market capitalization of that narrow-based
[[Page 36759]]
security index are subject to a regulatory halt.\204\ The SEC believes
that one of the major economic benefits that market participants derive
from the trading of futures on narrow-based security indexes is the
ability to hedge positions containing the securities underlying the
indexes, thereby reducing the risk of holding positions in those
securities. For traders using a narrow-based security index future to
hedge a position containing the component index securities, trading
halts in certain of those component securities necessarily will
introduce basis risk because the one-to-one relationship between the
cash portfolio of securities and the narrow-based index future is
disrupted.
---------------------------------------------------------------------------
\204\ As with adopted SEC Rule 6h-1(c)(1), the trading halt
provision of adopted SEC Rule 6h-1(c)(2) is not intended to be
exclusive. The adopted rule is not designed to preclude a market
trading security futures products based on narrow-based security
indexes from halting trading at a threshold of less than 50 percent
of the market capitalization of the index or for other appropriate
reasons, such as operational difficulties being experienced by the
market or its automated systems or concerns over clearance and
settlement operations.
---------------------------------------------------------------------------
The SEC believes that the proposed 30 percent threshold is too low
because it could unnecessarily disrupt hedge positions involving
futures on narrow-based security indexes that may still be
substantially performing their intended risk-shifting function when
trading is halted in a limited number of the index's component
securities. The SEC believes that a 50 percent threshold would better
serve the requirement's intended purpose. In adopting a 50 percent
threshold, the SEC sought to balance the utility of maintaining
effective hedge positions with concerns about circumventing the
coordination requirement by allowing trading in narrow-based index
futures to continue when trading in a limited number of the underlying
securities is halted. The SEC believes that while it is not possible to
eliminate completely the risk involved in hedging securities with a
future on a narrow-based security index when trading halts are
instituted for certain of those underlying securities, the 50 percent
threshold reduces such risk. Therefore, the SEC is adopting a 50
percent threshold because it appears to appropriately balance the goals
of hedging utility with prevention of improperly circumventing
regulatory halts in the underlying securities. With respect to the
commenters' concern regarding the potential difficulty in calculating
the market capitalization of an index, especially for price-weighted or
equal dollar weighted indexes, for purposes of instituting the
regulatory halt, the SEC notes that selecting market capitalization as
the method for calculating the weight of the index is similar to an
existing standard used to calculate trigger points for circuit breaker
operations.\205\ Consequently, the SEC chose to apply a similar method
in implementing regulatory halts to narrow-based security index futures
product. Furthermore, in specifying market capitalization as the method
for weighing an index, the rule provides clarity and uniformity for all
respondents to utilize in implementing regulatory halts in security
futures products based on narrow-based security indexes. If the rule
allowed for different methods of weighing an index for purposes of
imposing a regulatory halt in the trading of a security futures
product, the SEC believes that the trading of security futures products
may be more susceptible to becoming a means of circumventing regulatory
halts in the underlying securities.
---------------------------------------------------------------------------
\205\ See, e.g., CME Rule 4002.I., supra note 74.
---------------------------------------------------------------------------
V. Consideration of the Burden on Competition, and Promotion of
Efficiency, Competition, and Capital Formation
SEC: Section 3(f) of the Exchange Act \206\ requires the SEC,
whenever it is engaged in rulemaking and is required to consider or
determine whether an action is necessary or appropriate in the public
interest, to consider whether the action will promote efficiency,
competition, and capital formation. In addition, Section 23(a)(2) of
the Exchange Act \207\ requires the SEC, when promulgating rules under
the Exchange Act, to consider the impact any such rules would have on
competition. Section 23(a)(2) further provides that the SEC may not
adopt a rule that would impose a burden on competition not necessary or
appropriate in furtherance of the purposes of the Exchange Act. In the
Proposing Release, the SEC requested comment on these issues.\208\
---------------------------------------------------------------------------
\206\ 15 U.S.C. 78c(f).
\207\ 15 U.S.C. 78w(a)(2).
\208\ The CFTC is not required to consider its proposed rules
under these standards.
---------------------------------------------------------------------------
A. Effects on Competition
1. Settlement Procedures for Cash-Settled Security Futures Products
SEC Rule 6h-1 provides that the final settlement price for each
cash-settled security futures product fairly reflect the opening price
of the underlying security or securities. In the event that the opening
price of an underlying security is not readily available, SEC Rule 6h-1
permits a national securities exchange or national securities
association that lists and trades an overlying cash-settled security
futures product to use look-back or next opening pricing procedures to
derive a final settlement price for the security futures product.
However, if a clearing agency determines, pursuant to its rules, that
such final settlement price is not consistent with the protection of
investors and the public interest, taking into account such factors as
fairness to buyers and sellers of the affected security futures
product, the maintenance of a fair and orderly market in such security
futures product, and consistency of interpretation and practice, the
clearing agency has the authority to determine, under its rules, a
final settlement price for such security futures product.
The SEC does not believe that these provisions will impose any
burden on competition not necessary or appropriate in furtherance of
the purposes of the Exchange Act. The rule adopted today codifies what
is general industry practice for other cash-settled derivative
products. Thus, even in the absence of the rule, it is likely that the
markets would have opted for opening-price rather than closing-price
procedures for security futures products. In addition, under the final
rule, the market listing the security futures product may use look-back
or next opening prices in instances where the opening price of an
underlying security is not readily available. The SEC believes that
this flexibility will assist national securities exchanges and national
securities associations in responding to market conditions when
creating security futures products. Finally, the provision that allows
a clearing agency to determine a final settlement price in certain
instances will remove an obstacle to the fungibility of security
futures products, which may in time lead to the same security futures
product being multiply traded on more than one national securities
exchange or national securities association. The SEC believes that the
trading of security futures products on multiple markets promote
competition.
The Commissions received one comment on the proposed settlement
procedures that briefly addressed competitive issues. This commenter
stated that exchange-listed security futures products ``will be subject
to intense competition'' and urged the Commissions to avoid rulemaking
that would lead to the sub-optimal design of security futures products
and thereby ``unfairly tilt the competitive landscape.'' \209\ In light
of the revisions
[[Page 36760]]
made to the rule at the suggestion of the various commenters, the SEC
believes that the rule will further the anti-manipulation principles of
Section 6(h)(3)(H) of the Exchange Act \210\ while giving the markets
flexibility to determine the characteristics of the products that they
wish to trade. In addition, the SEC believes that the final rule
promotes competition by providing national securities exchanges and
national securities associations with the ability to structure their
security futures products so as to respond to competitive forces in the
marketplace.
---------------------------------------------------------------------------
\209\ See CME Letter.
\210\ 15 U.S.C. 78f(h)(3)(H).
---------------------------------------------------------------------------
2. Trading Halt Provisions
The Commissions received two comments that address the competitive
aspects of the trading halt provisions of the proposed rule. One
commenter stated that security futures product ``lookalikes'' can trade
in the unregulated upstairs market and in foreign jurisdictions; to the
extent that these other trading venues do not coordinate their trading
halts, ``there is a potential competitive issue.'' \211\ Likewise, the
second commenter stated that sophisticated investors could create a
synthetic future in a halted stock.\212\
---------------------------------------------------------------------------
\211\ See CME Letter.
\212\ See Students Letter.
---------------------------------------------------------------------------
The SEC does not believe that the trading halt provisions will
impose any burden on competition not necessary or appropriate in
furtherance of the purposes of the Exchange Act. These provisions do
restrict competition, in the sense that they restrict the freedom and
ability to trade a security futures product whenever trading is halted
in the underlying security or securities. The SEC believes, however,
that such a requirement is necessary and appropriate to further the
purposes of the Exchange Act, which require that listing standards for
security futures products must include procedures to coordinate trading
halts between the market that trades the security futures product, any
market that trades any underlying security, and other markets on which
any related security is traded. Specifically, in the absence of these
mandatory halts for the security futures product, the purpose of
declaring the halt in the underlying security or securities would be
frustrated, because the market for the overlying security futures
product could serve as a proxy for the underlying market.
Further, the SEC believes that trading halts promote fair
competition by providing an adequate opportunity for information about
a security to be disseminated to the public. The SEC does not believe
that it would be consistent with the protection of investors,
particularly retail investors, to permit trading in a surrogate for a
security when trading is halted in that security. Thus, the SEC
believes it is essential, to ensure fair and orderly markets, to
prevent a national securities exchange or national securities
association from becoming a proxy market by trading an overlying
security futures product when trading is halted in an underlying
security. Furthermore, any potential restraint on competition caused by
the rule's trading halt provisions must be weighed against the
requirement that listing standards, pursuant to Section 6(h)(3)(K) of
the Exchange Act,\213\ include procedures to coordinate trading halts
with the market that trades the underlying security.
---------------------------------------------------------------------------
\213\ 15 U.S.C. 78f(h)(3)(K).
---------------------------------------------------------------------------
3. Conclusion
The SEC finds that SEC Rule 6h-1 will promote competition and will
not impose any burden on competition not necessary or appropriate in
furtherance of the purposes of the Exchange Act.
B. Effects on Efficiency and Capital Formation
1. Settlement Procedures for Cash-Settled Security Futures Products
The SEC believes that the settlement provisions of SEC Rule 6h-1
will improve efficiency and capital formation. Although no commenters
addressed the efficiency and capital formation aspects of the proposed
rule directly, some of the commenters \214\ noted that the proposed
rule could have significant adverse monetary consequences and, by
implication, impact efficiency and capital formation. Under the
proposed rule, a security futures product would have been required to
use look back prices in the event that the opening price of the
underlying security or securities were not readily available. These
commenters noted that situations could arise where, due to some
disruption to the markets, a hedge consisting of a security futures
product and another security was ``mismatched.'' This unhedged exposure
could result in significant market losses. The final rule reduces the
possibility of such losses--and, thus, improves efficiency and capital
formation--by allowing security futures products to settle based on
next opening prices if an opening price for one or more security
futures products is not readily available and by allowing a registered
clearing agency, in certain circumstances, to harmonize inconsistent
settlement practices.
---------------------------------------------------------------------------
\214\ See supra note 52.
---------------------------------------------------------------------------
2. Trading Halt Provisions
The Commissions received no comments directly addressing efficiency
and capital formation aspects of the trading halt provisions of SEC
Rule 6h-1.
Regulatory trading halts provide an opportunity for investors to
learn of, and react to, material information to make informed
investment judgments. In addition, they mitigate potential systematic
stress during severe market declines and allow for the reestablishment
of an equilibrium between buying and selling interests in an orderly
fashion. Accordingly, the SEC believes that the trading halt provisions
of SEC Rule 6h-1, by requiring national securities exchanges and
national securities associations to halt trading in security futures
products when trading is halted in the underlying security or
securities, will ultimately improve efficiency and capital formation by
creating a more fair and orderly marketplace.
VI. Final Regulatory Flexibility Act
CFTC: The Regulatory Flexibility Act (``RFA'') requires federal
agencies, in promulgating rules, to consider the impact of those rules
on small entities.\215\ The rules adopted herein would affect
designated contract markets, registered derivatives transaction
execution facilities and derivatives clearing organizations. The CFTC
has previously established certain definitions of ``small entities'' to
be used in evaluating the impact of its rules on small entities in
accordance with the RFA. In its previous determinations, the CFTC
concluded that contract markets are not small entities for the purpose
of the RFA.\216\ The CFTC recently determined that registered
derivatives transaction execution facilities and derivatives clearing
organizations are not small entities for purposes of the RFA.\217\ The
CFTC invited the public to comment on the Chairman's certification that
these rules would not have a significant economic impact on a
substantial number of small entities.\218\ The CFTC received no
comments on the certification.
---------------------------------------------------------------------------
\215\ 5 U.S.C. 601 et seq.
\216\ See 47 FR 18618, 18619 (April 30, 1982) (discussing
contract markets).
\217\ See 66 FR 14262, 14268 (March 9, 2001) (discussing
registered derivatives transaction execution facilities); 66 FR
45604, 45609 (August 29, 2001) (discussing derivatives clearing
organizations).
\218\ See Proposing Release, 66 FR at 45918.
---------------------------------------------------------------------------
[[Page 36761]]
SEC: Pursuant to Section 605(b) of the Regulatory Flexibility
Act,\219\ the SEC certified that the adopted rule would not have a
significant economic impact on a substantial number of small entities.
This certification, including the reasons therefore, was attached to
the Proposing Release No. 34-44743 (August 24, 2001) as Appendix A. The
SEC solicited comments concerning the impact on small entities and the
Regulatory Flexibility Act certification, but received no comments.
---------------------------------------------------------------------------
\219\ 5 U.S.C. 605(b).
---------------------------------------------------------------------------
VII. Statutory Basis and Text of Rule
List of Subjects
17 CFR Part 41
Security futures products, Trading halts and Settlement provisions.
17 CFR Part 240
Securities.
Commodity Futures Trading Commission
17 CFR Chapter I
The CFTC has the authority to adopt these rules pursuant to
sections 2(a)(1)(D)(i)(VII), 2(a)(1)(D)(i)(X), and 8a(5) of the CEA, 7
U.S.C. 2(a)(1)(D)(i)(VII), 2(a)(1)(D)(i)(X), and 12(a)(5).
For the reasons set out in the joint preamble, Title 17, Chapter I
of the Code of Federal Regulations is amended as follows.
PART 41--SECURITY FUTURES PRODUCTS
1. The authority citation for Part 41 is revised to read as
follows:
Authority: Sections 206, 251 and 252, Pub. L. 106-554, 114 Stat.
2763; 7 U.S.C. 1a, 2, 6f, 6j, 7a-2, 12a; 15 U.S.C. 78(g)(2).
2. Section 41.1 is amended by adding paragraphs (j), (k) and (l) to
read as follows:
[sect] 41.1 Definitions.
For purposes of this part:
* * * * *
(j) Opening price means the price at which a security opened for
trading, or a price that fairly reflects the price at which a security
opened for trading, during the regular trading session of the national
securities exchange or national securities association that lists the
security. If the security is not listed on a national securities
exchange or a national securities association, then opening price shall
mean the price at which a security opened for trading, or a price that
fairly reflects the price at which a security opened for trading, on
the primary market for the security.
(k) Regular trading session of a security means the normal hours
for business of a national securities exchange or national securities
association that lists the security.
(l) Regulatory halt means a delay, halt, or suspension in the
trading of a security, that is instituted by the national securities
exchange or national securities association that lists the security, as
a result of:
(1) A determination that there are matters relating to the security
or issuer that have not been adequately disclosed to the public, or
that there are regulatory problems relating to the security which
should be clarified before trading is permitted to continue; or
(2) The operation of circuit breaker procedures to halt or suspend
trading in all equity securities trading on that national securities
exchange or national securities association.
3. Section 41.25 is amended by adding the text of paragraph (a)(2)
and adding paragraph (d) and by revising paragraph (b) to read as
follows:
[sect] 41.25 Additional conditions for trading for security futures
products.
(a) Common provisions. * * *
(2) Regulatory trading halts. The rules of a designated contract
market or registered derivatives transaction execution facility that
lists or trades one or more security futures products must include the
following provisions:
(i) Trading of a security futures product based on a single
security shall be halted at all times that a regulatory halt has been
instituted for the underlying security; and
(ii) Trading of a security futures product based on a narrow-based
security index shall be halted at all times that a regulatory halt has
been instituted for one or more underlying securities that constitute
50 percent or more of the market capitalization of the narrow-based
security index.
* * * * *
(b) Final settlement prices for security futures products.
(1) The final settlement price of a cash-settled security futures
product must fairly reflect the opening price of the underlying
security or securities;
(2) Notwithstanding paragraph (b)(1) of this section, if an opening
price for one or more securities underlying a security futures product
is not readily available, the final settlement price of the security
futures product shall fairly reflect:
(i) The price of the underlying security or securities during the
most recent regular trading session for such security or securities; or
(ii) The next available opening price of the underlying security or
securities.
(3) Notwithstanding paragraphs (b)(1) or (b)(2) of this section, if
a derivatives clearing organization registered under Section 5b of the
Act or a clearing agency exempt from registration pursuant to Section
5b(a)(2) of the Act, to which the final settlement price of a security
futures product is or would be reported determines, pursuant to its
rules, that such final settlement price is not consistent with the
protection of customers and the public interest, taking into account
such factors as fairness to buyers and sellers of the affected security
futures product, the maintenance of a fair and orderly market in such
security futures product, and consistency of interpretation and
practice, the clearing organization shall have the authority to
determine, under its rules, a final settlement price for such security
futures product.
* * * * *
(d) The Commission may exempt from the provisions of paragraphs
(a)(2) and (b) of this section, either unconditionally or on specified
terms and conditions, any designated contract market or registered
derivatives transaction execution facility, if the Commission
determines that such exemption is consistent with the public interest
and the protection of customers. An exemption granted pursuant to this
paragraph shall not operate as an exemption from any Securities and
Exchange Commission rules. Any exemption that may be required from such
rules must be obtained separately from the Securities and Exchange
Commission.
Issued in Washington, DC on May 17, 2002 by the Commodity
Futures Trading Commission.
Jean A. Webb,
Secretary.
Securities and Exchange Commission
17 CFR Chapter II
The SEC is adopting the rules pursuant to its authority under
Exchange Act Sections 6, 9, 15A, 19, 23(a), and 36, 15 U.S.C. 78f, 78i,
78o-3, 78s, 78w(a), and 78mm.
For the reasons set out in the joint preamble, Title 17, Chapter
II, part 240 of the Code of Federal Regulations is amended as follows.
[[Page 36762]]
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
1. The authority citation for part 240 continues to read, in part,
as follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i,
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5,
78w, 78x, 78ll, 78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-
3, 80b-4 and 80b-11, unless otherwise noted.
* * * * *
2. Section 240.6h-1 is added to read as follows:
[sect] 240.6h-1 Settlement and regulatory halt requirements for
security futures products.
(a) For the purposes of this section:
(1) Opening price means the price at which a security opened for
trading, or a price that fairly reflects the price at which a security
opened for trading, during the regular trading session of the national
securities exchange or national securities association that lists the
security. If the security is not listed on a national securities
exchange or a national securities association, then opening price shall
mean the price at which a security opened for trading, or a price that
fairly reflects the price at which a security opened for trading, on
the primary market for the security.
(2) Regular trading session of a security means the normal hours
for business of a national securities exchange or national securities
association that lists the security.
(3) Regulatory halt means a delay, halt, or suspension in the
trading of a security, that is instituted by the national securities
exchange or national securities association that lists the security, as
a result of:
(i) A determination that there are matters relating to the security
or issuer that have not been adequately disclosed to the public, or
that there are regulatory problems relating to the security which
should be clarified before trading is permitted to continue; or
(ii) The operation of circuit breaker procedures to halt or suspend
trading in all equity securities trading on that national securities
exchange or national securities association.
(b) Final settlement prices for security futures products.
(1) The final settlement price of a cash-settled security futures
product must fairly reflect the opening price of the underlying
security or securities.
(2) Notwithstanding paragraph (b)(1) of this section, if an opening
price for one or more securities underlying a security futures product
is not readily available, the final settlement price of the security
futures product shall fairly reflect:
(i) The price of the underlying security or securities during the
most recent regular trading session for such security or securities; or
(ii) The next available opening price of the underlying security or
securities.
(3) Notwithstanding paragraph (b)(1) or (b)(2) of this section, if
a clearing agency registered under Section 17A of the Act (15 U.S.C.
78q-1), or exempt from registration pursuant to Section 17A(b)(7) of
the Act (15 U.S.C. 78q-1(b)(7)), to which the final settlement price of
a security futures product is or would be reported determines, pursuant
to its rules, that such final settlement price is not consistent with
the protection of investors and the public interest, taking into
account such factors as fairness to buyers and sellers of the affected
security futures product, the maintenance of a fair and orderly market
in such security futures product, and consistency of interpretation and
practice, the clearing agency shall have the authority to determine,
under its rules, a final settlement price for such security futures
product.
(c) Regulatory trading halts. The rules of a national securities
exchange or national securities association registered pursuant to
Section 15A(a) of the Act (15 U.S.C. 78o-3(a)) that lists or trades one
or more security futures products must include the following
provisions:
(1) Trading of a security futures product based on a single
security shall be halted at all times that a regulatory halt has been
instituted for the underlying security; and
(2) Trading of a security futures product based on a narrow-based
security index shall be halted at all times that a regulatory halt has
been instituted for one or more underlying securities that constitute
50 percent or more of the market capitalization of the narrow-based
security index.
(d) The Commission may exempt from the requirements of this
section, either unconditionally or on specified terms and conditions,
any national securities exchange or national securities association, if
the Commission determines that such exemption is necessary or
appropriate in the public interest and consistent with the protection
of investors. An exemption granted pursuant to this paragraph shall not
operate as an exemption from any Commodity Futures Trading Commission
rules. Any exemption that may be required from such rules must be
obtained separately from the Commodity Futures Trading Commission.
By the Securities and Exchange Commission.
Dated: May 17, 2002.
Margaret H. McFarland,
Deputy Secretary.
Note: Appendix A to the preamble will not appear in the Code of
Federal Regulations.
Appendix A
Relevant Provisions of the Agreement Among
American Stock Exchange LLC, Boston Stock Exchange,
Incorporated, Chicago Board Options Exchange, Incorporated, Chicago
Stock Exchange, Incorporated, Cincinnati Stock Exchange,
Incorporated, International Securities Exchange LLC, National
Association of Securities Dealers, Inc., New York Stock Exchange,
Inc., Pacific Exchange, Inc., Philadelphia Stock Exchange, Inc.
(collectively, ``ISG/SROs'') as of [the date of Release].
* * * * *
Section 1. Intermarket Surveillance Group (``ISG'')
(a)(i) The Intermarket Surveillance Group (``ISG'') shall have
as its purposes: (a) the coordination and development of programs
and procedures designed to assist in identifying possible fraudulent
and manipulative acts and practices across markets, particularly,
between markets which trade the same or related securities and
between markets which trade equity securities and options on an
index in which such securities are included, (b) the routine
exchange of Market Surveillance Reports, as that term is defined in
Section 2(e), among ISG/SROs which is appropriate to the performance
of adequate market surveillance, and (c) the exchange of
information, upon request, among ISG/SROs which is appropriate to
the requesting ISG/SRO in the discharge of its regulatory
responsibilities under the Act to enforce compliance by its members
and persons associated with its members with its rules. Each of the
nine ISG/SROs will appoint form time to time one of its executive
officers responsible for market surveillance to serve as its
Principal Representative on the ISG. Each Principal Representative
at any time appointed by an ISG/SRO shall serve as a member of ISG
until such appointing ISG/SRO shall appoint a successor, such
successor appointment to be evidenced by a written notice delivered
by the appointing ISG/SRO to each of the other ISG/SROs.
(a)(ii) An ``ISG affiliate'' is a contract market or foreign
self-regulatory organization which shall have such privileges and
obligations as are set forth herein. A contract market or foreign
self-regulatory organization shall become an ISG Affiliate if: (a)
it is so approved by the unanimous vote of all ISG/SROs in
attendance at a meeting of the ISG, and (b) the principal executive
officer of the contract market or foreign self-regulatory
organization so approved agrees in writing in a form approved by the
ISG/SROs that the organization accepts the privileges and
obligations of an ISG Affiliate. (Such a
[[Page 36763]]
writing is hereinafter referred to as an ``Affiliate Agreement.'')
An ISG Affiliate shall appoint an Affiliate Representative to
the ISG who shall be one of the executive officers of the ISG
Affiliate responsible for market surveillance. The Affiliate
Representative shall select one member form the ISG Affiliate staff
to serve as an alternate for, and under the direction of, the
Affiliate Representative. The alternate shall be generally familiar
with market surveillance techniques and procedures.
* * * * *
Section 2. Sharing of Information and Confidentiality
(a) Attached hereto as Exhibit A is an executed copy of the
Agreement between SIAC (``Information Processor'') and the ISG
Participants, including the Letter Agreement amending the Agreement
(the ``Service Agreement''), providing for the development and
operation of a Central Collection and Reporting System. As provided
in the Service Agreement, each of the ISG/SROs will routinely
receive Market Surveillance Reports relating to securities (as that
term is defined in Section 3(a)(10) of the Act):
(i) Which are traded on such receiving ISG/SRO, and
(ii) That are derived from (e.g., options) or underlie (e.g.,
stocks) securities which are traded on such receiving ISG/SRO.
(b) From time to time, an ISG/SRO (``requesting SRO'') may ask
another ISG/SRO (``requested SRO'') to provide it with information
or documents: (i) relating to a security traded through the
facilities of either ISG/SRO or (ii) relating to a member or a
former member of either ISG/SRO (including, but not limited to
information or documents concerning the identity, trading activity
and positions of the requested ISG/SRO's members, former members or
customers of the requested ISG/SRO's members or former members) for
the purpose of enforcing compliance with the provisions of the Act,
or for other regulatory purposes. Upon receipt of such a request,
the requested ISG/SRO shall obtain such information from its own
records or from its members and former members, and shall provide
any information or documents so gathered to the requesting ISG/SRO.
In addition, an ISG/SRO may ask another ISG/SRO to provide it with
information or documents relating to an investigation or a
disciplinary action by the requested ISG/SRO against any of its
members, member organizations or persons associated with its members
or member organizations. Upon receipt of such a request, the
requested ISG/SRO shall obtain such information or documents
concerning disciplinary actions from its own records and shall
provide such information or documents to the requesting ISG/SRO.
(c) From time to time, an ISG/SRO may ask an ISG Affiliate to
provide it with information or documents: (1) Relating to a
security, an option on a security, a currency option, a futures
contract, an option on a futures contract or any other derivative or
underlying instrument traded through the facilities of the ISG
Affiliate, or (2) relating to a member of an ISG/SRO or the ISG
Affiliate (including, but not limited to, information or documents
concerning the identity, trading activity and positions of the ISG
Affiliate's members or customers of the ISG Affiliate's members). An
ISG Affiliate shall agree in an Affiliate Agreement that, upon
receipt of such a request, it shall use its best efforts in
accordance with its rules to obtain such information from its own
records or from its members, and, to the extent not inconsistent
with its rules or with applicable law, provide any information or
documents so gathered to the requesting ISG/SRO. In addition, an
ISG/SRO may ask an ISG Affiliate to provide it with information or
documents relating to the disposition of a disciplinary action taken
by the ISG Affiliate against any of its members, member
organizations or persons associated with its members or member
organizations. An ISG Affiliate shall agree in an Affiliate
Agreement that, upon receipt of such a request, it shall obtain such
information or documents concerning disciplinary actions from its
own records and, to the extend not inconsistent with its rules or
with applicable law, provide such information or documents to the
requesting ISG/SRO.
(d) From time to time, an ISG Affiliate may ask an ISG/SRO to
provide it with information or documents: (1) Relating to a
security, an option on a security, a currency option or any other
derivative or underlying instrument traded through the facilities of
the ISG/SRO, or (2) relating to a member of an ISG Affiliate or the
ISG/SRO (including, but not limited to, information or documents
concerning the identity, trading activity and positions of the ISG/
SRO's members or customers of the ISG/SRO's members). Upon receipt
of such a request, the ISG/SRO shall use its best efforts in
accordance with its rules to obtain such information from its own
records or from its members, and, to the extent not inconsistent
with its rules or with applicable law, provide any information or
documents so gathered to the requesting ISG Affiliate. In addition,
an ISG Affiliate may ask ISG/SRO to provide it with information or
documents relating to the disposition of a disciplinary action taken
by the ISG/SRO against any of its members, member organizations or
persons associated with its members or member organizations. Upon
receipt of such a request, the ISG/SRO shall obtain such information
or documents concerning disciplinary actions from its own records
and, to the extent not inconsistent with its rules or with
applicable law, provide such information or documents to the
requesting ISG Affiliate.
(e) Market Surveillance Reports as used in this Agreement shall
include:
(i) with respect to securities subject to last sale reporting
pursuant to CTA, CQ, OPRA or NASDAQ Plans: quotations, last sale,
clearing and other trading information available pursuant to, or
collected under, such Plans; and post trade information generated
pursuant to the ITS Plan.
(ii) reports routinely collected by an ISG/SRO relating to
program trading, i.e., the purchase or sale of stocks that are part
of a coordinated trading strategy, or relating to trades by its
members and member organizations which are not reported to the
Consolidated Tape.
(iii) reports relating to positions or exercises of securities.
* * * * *
[FR Doc. 02-12979 Filed 5-23-02; 8:45 am]
BILLING CODE 8010-01-P; 6391-01-P