[Federal Register: May 17, 2001 (Volume 66, Number 96)]
[Proposed Rules]
[Page 27559-27579]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr17my01-20]
[[Page 27559]]
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Part IV
Commodity Futures Trading Commission
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17 CFR Part 41
Securities and Exchange Commission
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17 CFR Part 240
Method for Determining Market Capitalization and Dollar Value of
Average Daily Trading Volume; Application of the Definition of Narrow-
Based Security Index; Proposed Rules
[[Page 27560]]
COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 41
RIN 3038-AB77
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-44288; File No. S7-11-01]
RIN 3235-AI13
Method for Determining Market Capitalization and Dollar Value of
Average Daily Trading Volume; Application of the Definition of Narrow-
Based Security Index
AGENCIES: Commodity Futures Trading Commission and Securities and
Exchange Commission.
ACTION: Joint proposed rules.
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SUMMARY: The Commodity Futures Trading Commission ("CFTC") and the
Securities and Exchange Commission ("SEC") (collectively,
"Commissions") are proposing Rule 41 under the Commodity Exchange Act
("CEA") and Rules 3a55-1 through 3a55-3 under the Securities Exchange
Act of 1934 ("Exchange Act"). These proposed rules would implement
new statutory provisions enacted by the Commodity Futures Modernization
Act of 2000 ("CFMA"). Specifically, the CFMA directs the Commissions
to jointly specify by rule or regulation the method to be used to
determine "dollar value of average daily trading volume" and "market
capitalization" for purposes of the new definition of "narrow-based
security index" in the CEA and the Exchange Act. Proposed Rule 41.11
under the CEA and proposed Rule 3a55-1 under the Exchange Act are
intended to fulfill this statutory directive by specifying such
methods. In addition, these proposed rules define certain terms that
would add clarity to the statutory definition of "narrow-based
security index."
In addition, proposed Rule 41.12 under the CEA and proposed Rule
3a55-2 under the Exchange Act would create an exception to the
definition of narrow-based security index, to permit, subject to
certain conditions, a designated contract market, registered
derivatives transaction execution facility ("DTEF"), or foreign board
of trade to continue trading a contract of sale for future delivery on
a security index that becomes a narrow-based security index during the
first 30 days after the future begins trading. Similarly, proposed Rule
41.14 under the CEA would permit a national securities exchange to
continue trading a contract of sale for future delivery on an index
that ceases to be a narrow-based security index, subject to certain
conditions. These rules are intended to minimize market disruption when
a broad-based security index becomes a narrow-based security index, and
when a narrow-based security index becomes a broad-based security
index.
Finally, proposed Rule 41.13 under the CEA and proposed Rule 3a55-3
under the Exchange Act would provide that when a futures contract on a
security index is traded on or subject to the rules of a foreign board
of trade, that index shall not be considered a narrow-based security
index if it would not be a narrow-based security index pursuant to the
statutory definition of a narrow-based security index or the exclusions
from that definition. These rules would clarify and establish that when
a futures contract on a security index is traded on or subject to the
rules of a foreign board of trade, the index underlying such contract
shall be considered a broad-based security index if it qualifies as
such pursuant to the statutory definition of narrow-based security
index, or pursuant to the exclusions from that definition.
DATES: Comments must be received on or before June 18, 2001.
ADDRESSES: Comments should be sent to both agencies at the addresses
listed below.
CFTC: Comments should be sent to the Commodity Futures Trading
Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington,
DC 20581, Attention: Office of the Secretariat. Comments may be sent by
facsimile transmission to (202) 418-5521, or by e-mail to
[email protected]. Reference should be made to "Narrow-Based Security
Indexes."
SEC: Persons wishing to submit written comments should send three
copies to Jonathan G. Katz, Secretary, Securities and Exchange
Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. Comments
also may be submitted electronically at the following e-mail address:
[email protected]. All comment letters should refer to File No. S7-
11-01; this file number should be included on the subject line if e-
mail is used. Comment letters received will be available for public
inspection and copying in the SEC's Public Reference Room, 450 Fifth
Street, NW., Washington, DC 20549-0102. Electronically submitted
comment letters will be posted on the SEC's Internet web site (http://www.sec.gov). The SEC does not edit personal identifying information,
such as names or e-mail addresses, from electronic submissions. Submit
only the information you wish to make publicly available.
FOR FURTHER INFORMATION CONTACT:
CFTC: Elizabeth L.R. Fox, Acting Deputy General Counsel; Richard A.
Shilts, Acting Director; or Thomas M. Leahy, Jr., Financial Instruments
Unit Chief, Division of Economic Analysis, Commodity Futures Trading
Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington,
DC 20581. Telephone: (202) 418-5000. E-mail: ([email protected]),
([email protected]), or ([email protected]).
SEC: Nancy J. Sanow, Assistant Director, at (202) 942-0771; Ira L.
Brandriss, Special Counsel, at (202) 942-0148; or Sapna C. Patel,
Attorney, at (202) 942-0166, Office of Market Supervision, Division of
Market Regulation, Securities and Exchange Commission, 450 Fifth
Street, NW., Washington, DC 20549-1001.
SUPPLEMENTARY INFORMATION: The Commissions are proposing Subparts A and
B of Rule 41 (Rules 41.1 and 41.2 and Rules 41.10 through 41.14) under
the CEA,\1\ 17 CFR 41, and Rules 3a55-1 through 3a55-3 under the
Exchange Act,\2\ 17 CFR 3a55-1 through 3a55-3.\3\
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\1\ All references to the CEA are to 7 U.S.C. 1 et seq.
\2\ All references to the Exchange Act are to 15 U.S.C. 78a et
seq.
\3\ Subpart A of proposed Rule 41 under the CEA consists of
general provisions for purposes of the rule, including definitions
(Rule 41.1) and recordkeeping requirements (Rule 41.2). Subpart B of
proposed Rule 41, "Narrow-Based Security Indexes," begins with
proposed Rule 41.10 on purpose and scope. Proposed Rules 41.11,
41.12, and 41.13 of Subpart B correspond to proposed Rules 3a55-1,
3a55-2, and 3a55-3 under the Exchange Act, respectively. Proposed
Rule 41.14 of Subpart B parallels provisions incorporated in the CEA
and the Exchange Act by the CFMA.
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Table of Contents
I. Introduction
II. Definition of "Narrow-Based Security Index"
A. Indexes Included within the Definition of a Narrow-Based
Security Index
B. Indexes Excluded from the Definition of a Narrow-Based
Security Index
1. The Index's Component Securities Have High Market
Capitalization and Dollar Value of Average Daily Trading Volume
2. A Futures Contract on a Broad-Based Security Index that
Becomes Narrow-Based
a. Statutory Grace Period
b. Proposed Exclusion from the Definition of Narrow-Based
Security Index During First 30 Days of Trading
3. Proposed Rule for Futures Contracts Traded on or Subject to
the Rules of a Foreign Board of Trade
[[Page 27561]]
III. Method for Determining Market Capitalization and Dollar Value
of Average Daily Trading Volume
A. Determining Market Capitalization
B. Determining Dollar Value of Average Daily Trading Volume
C. Determining Average Daily Trading Volume
D. Determining Average Price
1. Basic Definition
2. Exception Permitting Use of Non-Volume-Weighted Average Price
for Certain Calculations
E. Component Securities of an Index that Trade in Foreign
Markets
F. Determining "the Preceding 6 Full Calendar Months"
G. The Lowest Weighted 25% of an Index
IV. Transitional Exemption for Broad-Based Index Futures
V. Request for Comments
VI. Paperwork Reduction Act
CFTC:
A. Summary of Collection of Information
B. Proposed Use of Information
C. Respondents
D. Total Annual Reporting and Recordkeeping Burden
1. Capital Costs
2. Burden Hours
E. General Information About the Collection of Information
F. Request for Comment
SEC:
A. Summary of Collection of Information
B. Proposed Use of Information
C. Respondents
D. Total Annual Reporting and Recordkeeping Burden
1. Capital Costs
2. Burden Hours
E. General Information About the Collection of Information
F. Request for Comment
VII. Costs and Benefits of the Proposed Rules
CFTC
SEC:
A. Benefits
B. Costs
VIII. Consideration of Burden on Competition, and Promotion of
Efficiency, Competition, and Capital Formation
IX. Regulatory Flexibility Act Certifications
CFTC
SEC
X. Statutory Bases and Text of Proposed Rules
I. Introduction
The CFMA,\4\ which became law on December 21, 2000, lifted the ban
on single stock and narrow-based stock index futures ("security
futures"). In addition, the CFMA established a framework for the joint
regulation of these newly-permissible products by the CFTC and the SEC.
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\4\ Pub. L. No. 106-554, 114 Stat. 2763 (2000).
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Prior to enactment of the CFMA, the Shad-Johnson Accord
("Accord") governed trading in contracts of sale for future delivery
("futures contracts" or "futures") on securities and security
indexes. Negotiated by the Chairmen of the SEC and the CFTC in 1982 and
signed into law in 1983, the Accord permitted futures exchanges to
offer futures contracts on security indexes if the contracts satisfied
certain statutory criteria: (1) the contract had to be cash-settled;
(2) the contract could not be readily susceptible to manipulation; and
(3) the underlying securities had to measure and reflect the entire
market or a substantial segment of the market, i.e., it was a contract
on a "broad-based" security index.\5\ The Accord prohibited any
futures contracts on security indexes that did not meet these criteria.
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\5\ Section 2(a)(1)(B) of the CEA implemented the terms of the
1982 jurisdictional accord between the SEC and the CFTC. Futures
Trading Act of 1982 Section 101, Publ. Law. No. 97-444, 96 Stat 2294
[codified at 7 U.S.C. Section 2(a)], repealed by the Commodity
Futures Modernization Act of 2000, Pub. L. No. 106-554, 114 Stat.
2763 (2000).
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In addition to repealing the prohibition on certain types of
security futures, the CFMA amended the CEA and the Exchange Act by
adding a definition of "narrow-based security index." This definition
establishes an objective test of whether a security index is narrow-
based.\6\ Futures contracts on security indexes that are narrow-based
security indexes will be jointly regulated by the CFTC and the SEC
under the framework established by the CFMA.\7\ Futures contracts on
indexes that are broad-based security indexes,\8\ on the other hand,
are under the sole jurisdiction of the CFTC and, therefore, only
designated contract markets, registered derivatives transaction
execution facilities ("DTEFs"), and foreign boards of trade may trade
these products.
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\6\ See Section 1a(25) of the CEA and Section 3(a)(55) of the
Exchange Act.
\7\ No person may execute or trade a security future product
until the later of December 21, 2001 or such date that a futures
association registered under Section 17 of the CEA meets the
requirements in Section 15A(k)(2) of the Exchange Act, except that
beginning on August 21, 2001, eligible contract participants may
enter into transactions with each other on a principal-to-principal
basis.
\8\ Use of the term "broad-based security index" in this
release means a security index that is not a narrow-based security
index.
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For this reason, it is important that the definition of "narrow-
based security index" in the CEA and the Exchange Act be easily
understood and applied by market participants. As directed by the CFMA,
the rules jointly proposed today by the Commissions specify the method
to be used to determine market capitalization and dollar value of
average daily trading volume for purposes of the new definition of
"narrow-based security index." \9\
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\9\ Section 1a(25)(E) of the CEA and Section 3(a)(55)(F) of the
Exchange Act.
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The proposed rules would also establish provisions governing
certain circumstances when narrow-based security indexes become broad-
based, and when broad-based security indexes become narrow-based.
II. Definition of "Narrow-Based Security Index"
The CFMA amended the definition of "security" in the Exchange
Act,\10\ the Securities Act of 1933 ("Securities Act"),\11\ the
Investment Company Act of 1940 ("Investment Company Act"),\12\ and
the Investment Advisers Act of 1940 ("Investment Advisers Act") \13\
to include a "security future." For purposes of each of those Acts,
as well as the CEA, "security future" is defined, in relevant part,
as "a contract of sale for future delivery of a single security or of
a narrow-based security index." \14\ The definition of "narrow-based
security index" in the CEA and the Exchange Act is the focus of this
release.\15\
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\10\ Section 3(a)(10) of the Exchange Act.
\11\ Section 2(a)(14) of the Securities Act, 15 U.S.C.
77b(a)(14).
\12\ Section 2(a)(36) of the Investment Company Act, 15 U.S.C.
80a-2(a)(36).
\13\ Section 202(a)(18) of the Investment Advisers Act, 15
U.S.C. 80b-2(a)(18).
\14\ The term "security future" is defined in Section
3(a)(55)(A) of the Exchange Act. This definition is incorporated by
reference in Section 2(a)(16) of the Securities Act, 15 U.S.C.
77b(a)(16); Section 2(a)(52) of the Investment Company Act, 15
U.S.C. 80a-2(a)(52); and Section 202(a)(27) of the Investment
Advisers Act, 15 U.S.C. 80b-2(a)(27). "Security future" is also
defined in Section 1a(31) of the CEA.
\15\ See Section 3(a)(55) of the Exchange Act. The definition of
"narrow-based security index" in the Exchange Act is incorporated
by reference in Section 2(a)(16) of the Securities Act, 15 U.S.C.
77b(a)(16); Section 2(a)(52) of the Investment Company Act, 15
U.S.C. 80a-2(a)(52); and Section 202(a)(27) of the Investment
Advisers Act, 15 U.S.C. 80b-2(a)(27). "Narrow-based security
index" is also defined in Section 1a(25) of the CEA.
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A. Indexes Included within the Definition of a Narrow-Based Security
Index
Under the CEA and the Exchange Act, an index is a "narrow-based
security index" if it has any one of the following four
characteristics: (1) it has nine or fewer component securities; (2) any
one of its component securities comprises more than 30% of its
weighting; (3) any group of five of its component securities together
comprise more than 60% of its weighting; or (4) the lowest weighted
component securities comprising, in the aggregate, 25% of the index's
weighting have an aggregate dollar value of average daily trading
volume ("ADTV") of less than $50 million (or in the case of an index
with 15 or more component
[[Page 27562]]
securities, $30 million).\16\ An index that has none of the four
characteristics set forth above is not a "narrow-based security
index." Accordingly, any contract of sale for future delivery on such
an index would not be a security future and thus would be subject to
the sole jurisdiction of the CFTC.\17\
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\16\ Section 1a(25)(A)(i)--(iv) of the CEA and Section
3(a)(55)(B)(i)--(iv) of the Exchange Act.
\17\ See Section 2(a)(1)(C)(ii) of the CEA. A contract of sale
for future delivery on a security index that is not a narrow-based
security index may include component securities that are not
registered under Section 12 of the Exchange Act.
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With regard to the fourth test noted above, i.e., whether an index
is a "narrow-based security index" based on the dollar value of ADTV
of the lowest weighted securities in the index, the CEA and the
Exchange Act require the CFTC and SEC to jointly specify the method of
determining the dollar value of average daily trading volume, and
mandate that this value be calculated as of the "preceding 6 full
calendar months." \18\ The proposed rules discussed below in Part III.
of this release specify such a method and define the terms "preceding
6 full calendar months" and "lowest weighted 25% of the index's
weighting" as those terms are used in the proposed rules.
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\18\ Section 1a(25)(E) of the CEA and Section 3(a)(55)(F) of the
Exchange Act.
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B. Indexes Excluded from the Definition of a Narrow-Based Security
Index
In addition to defining an index as narrow-based if the index has
any of the characteristics described above, the definition of "narrow-
based security index" in the CEA and Exchange Act excludes from its
scope indexes that satisfy certain criteria. Any contract of sale for
future delivery on an index excluded from the definition, as described
below, is not a security futures product under the securities laws, and
thus would be subject solely to the jurisdiction of the CFTC.
1. The Index's Component Securities Have High Market Capitalization and
Dollar Value of Average Daily Trading Volume
Under the CEA and the Exchange Act, an index is not a "narrow-
based security index" if it has all of the following characteristics:
(1) it has at least nine component securities; (2) no component
security comprises more than 30% of its weighting; (3) each of its
component securities is registered under Section 12 of the Exchange
Act; and (4) each component security is one of 750 securities with the
largest market capitalization ("Top 750") and one of 675 securities
with the largest dollar value of ADTV ("Top 675").\19\
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\19\ Section 1a(25)(B)(i) of the CEA and Section 3(a)(55)(C)(i)
of the Exchange Act.
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The CEA and the Exchange Act require the Commissions to jointly
specify the method to be used to determine market capitalization and
dollar value of ADTV for purposes of this exclusion from the definition
of "narrow-based security index." \20\ These values are to be
calculated as of the preceding 6 full calendar months.\21\ The rules
the Commissions are proposing today specify the methods to determine
these values, and are discussed below in Part III.
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\20\ Section 1a(25)(E) of the CEA and Section 3(a)(55)(F) of the
Exchange Act.
\21\ Id.
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To assure that a futures contract on a security index qualifies for
this exclusion, a designated contract market, registered DTEF, or
foreign board of trade trading the futures contract must calculate both
the Top 750 and Top 675 securities based on market capitalization and
dollar value of ADTV, respectively, for the preceding 6 full calendar
months, in addition to assessing compliance with the exclusion's other
criteria.\22\
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\22\ As a general matter, any national securities exchange,
designated contract market, registered DTEF, or foreign board of
trade that trades a futures contract on a security index will be
required to determine whether or not the contract is a security
future to assure that the market is in compliance with the CEA and
the Exchange Act. The Commissions note that national securities
exchanges, designated contract markets, or registered DTEFs that
trade security index futures will need to preserve records of all
their determinations with respect to the daily narrow-based or non-
narrow-based status of security indexes in order to comply with
their recordkeeping requirements under Sections 5(d)(17) and
5a(d)(8) of the CEA and proposed Rule 41.2 under the CEA, and Rule
17a-1 under the Exchange Act, 17 CFR 240.17a-1.
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Q1: The Commissions request comment on whether it would be
difficult for market participants to determine the Top 750 and Top 675
out of all securities registered under Section 12 of the Exchange Act.
Should the Commissions establish, by rule, a subset of Section 12-
registered securities from which market participants would have to
determine the Top 750 and Top 675? If so, what should this subset of
securities be? For example, would it be appropriate to limit the
universe of securities from which market participants determine the Top
750 and Top 675 to the securities traded on the New York Stock
Exchange, the Nasdaq National Market System, and the American Stock
Exchange? Is there another subset that would be more appropriate, such
as the securities comprising the Russell 3000 Index?
Q2: The Commissions also request comment on whether they should
undertake to determine the Top 750 and Top 675. For example, should the
Commissions determine these securities and make these lists publicly
available? If the Commissions do this, how often should the Top 750 and
Top 675 be determined and published? Monthly? Quarterly? More or less
often? If the Commissions do publish such lists, they would have to
establish a rule that any security that appears on both the Top 750 and
Top 675 list would be deemed to be one of the Top 750 and Top 675
securities every day during the period in which these lists were
publicly available. Conversely, any security that did not appear on the
lists would be deemed not to satisfy paragraph (B)(i)(III) of Section
1a(25) of the CEA and paragraph (C)(i)(III) of Section 3(a)(55) of the
Exchange Act. The Commissions solicit commenters' views on the benefits
and drawbacks of this approach and on any preferable methods for the
Commissions to determine the Top 750 and the Top 675.
Q3: Are there any other approaches or issues that the Commissions
should consider with respect to determining the Top 750 and Top 675?
2. A Futures Contract on a Broad-Based Security Index that Becomes
Narrow-Based
a. Statutory Grace Period
If a futures contract were trading on an index that was broad-based
for at least 30 days and subsequently the index became a narrow-based
security index, the index is excluded from the definition of a
"narrow-based security index" if it is narrow-based for 45 or fewer
business days over the course of three consecutive calendar months. If
the index is a "narrow-based security index" for more than 45
business days over three consecutive calendar months, the index is a
"narrow-based security index," but the Exchange Act and the CEA
provide a temporary grace period of three months before the futures
contract becomes a security future.\23\ In contrast, under these
statutory provisions, if the futures contract has been trading for
fewer than 30 days as a contract of sale for future delivery on an
index that is not a "narrow-based security index," the future would
become a security futures product immediately if the index satisfies
any of the criteria set forth in Section 1a(25)(A) of the CEA and
Section 3(a)(55)(B) of the Exchange Act.\24\
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\23\ Section 1a(25)(D) of the CEA and Section 3(a)(55)(E) of the
Exchange Act.
\24\ See supra note 16 and accompanying text.
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[[Page 27563]]
If a security index on which a futures contract is trading became
narrow-based for more than 45 days over three consecutive months, and
thus pursuant to Section 1a(25)(D) of the CEA and Section 3(a)(55)(E)
of the Exchange Act becomes narrow-based, the Commissions believe that
in order for trading to continue to be regulated exclusively by the
CFTC, the designated contract market, registered DTEF, or foreign board
of trade trading the contract would be required, before the temporary
three-month grace period elapses, to change the composition of, or
weightings of securities in, the index so that the index is not a
narrow-based security index. Alternatively, the designated contract
market, registered DTEF, or foreign board of trade trading a futures
contract on such index could comply with the requirements of the
securities laws applicable to security futures products.
Q4: Should the Commissions specify expressly the extent of changes
a designated contract market, registered DTEF, or foreign board of
trade needs to make to an index before the end of the temporary three-
month grace period so that it does not need to comply with the
securities laws applicable to markets trading security futures
products? If so, commenters are asked for their views on what types of
changes should be required.
b. Proposed Exclusion from the Definition of Narrow-Based Security
Index During First 30 Days of Trading
To address the potential dislocation of market participants trading
a future on an index that becomes narrow-based during the first 30 days
of trading, and thus does not qualify for the statutory grace period
under Section 1a(25)(D) of the CEA and Section 3(a)(55)(E) of the
Exchange Act, the Commissions are proposing Rule 41.12 under the CEA
and Rule 3a55-2 under the Exchange Act. These rules are being proposed
pursuant to paragraph (vi) of Section 1a(25)(B) of the CEA and Section
3(a)(55)(C) of the Exchange Act, which permit the Commissions to
establish, by rule, requirements for futures contracts on indexes that,
if met, would provide additional exclusions from the definition of a
"narrow-based security index." \25\
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\25\ Section 1a(25)(B)(vi) of the CEA and Section
3(a)(55)(C)(vi) of the Exchange Act provide that notwithstanding the
definition of narrow-based security index, an index is not a narrow-
based security if a futures contract is "traded on or subject to
the rules of a board of trade and meets such requirements as are
jointly established by rule, regulation, or order by [the
Commissions]."
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Specifically, the proposed rules would provide an exclusion from
the definition of narrow-based security index for a futures contract
that began trading on a security index that was not narrow-based and
became narrow-based during the first 30 days after it began trading, if
the index would not have been a narrow-based index, had it been in
existence, for an uninterrupted period of 6 months prior to the first
day of trading. The Commissions preliminarily believe that this six-
month period is appropriate as an indication that the change in the
index's character during the first 30 days was an anomaly, so that a
temporary exclusion from the definition of a narrow-based security
index is warranted.
The proposed rules provide, however, that an index that is not a
narrow-based security index for the first 30 days of trading, as
discussed above, would become a narrow-based security index if it has
been a narrow-based security index for more than 45 business days over
three consecutive calendar months, and would be a security future, with
the attendant legal obligations, following an additional three-month
grace period.
Q5: The Commissions request commenters to provide their views on
proposed Rule 41.12 under the CEA and proposed Rule 3a55-2 under the
Exchange Act. In particular, the Commissions request comment on their
proposal that an index not be narrow-based for 6 months prior to a
futures contract on such index commencing to trade in order for the
exclusion in these proposed rules to apply. Is 6 months the appropriate
time frame?
3. Proposed Rule for Futures Contracts Traded on or Subject to the
Rules of a Foreign Board of Trade
As noted above, the statutory definition of narrow-based security
index set forth in Section 1a(25)(A) of the CEA and Section 3(a)(55)(B)
of the Exchange Act, and the exclusions from that definition provided
by Section 1a(25)(B) of the CEA and Section 3(a)(55)(C) of the Exchange
Act, in effect also define a broad-based security index. The federal
securities laws do not apply to futures contracts on broad-based
security indexes. Prior to the enactment of the CFMA, futures contracts
on broad-based security indexes were reviewed by both the CFTC and the
SEC to ensure compliance with the provisions of the Shad-Johnson
Accord. Specifically, this review evaluated whether the contract was
cash-settled, not readily susceptible to manipulation, and represented
a broad market segment. The CFMA altered the statutory requirements for
approval of broad-based indexes such that no approval or review is
required by the SEC for these products.
With regard to security index futures traded on or subject to the
rules of foreign boards of trade, the Commissions believe that security
indexes underlying such contracts should be considered broad-based
security indexes if they qualify as such pursuant to the statutory
definition of a narrow-based index, or pursuant to the exclusions from
that definition. The Commissions are proposing Rule 41.13 under the CEA
and Rule 3a55-3 under the Exchange Act to clarify and establish that
when a futures contract on an index is traded on or subject to the
rules of a foreign board of trade, such index would not be a narrow-
based security index (i.e., it would be broad-based) if it would not be
a narrow-based security index if a futures contract on such index were
traded on a designated contract market or registered DTEF.\26\ The
Commissions recognize their obligation to jointly adopt rules or
regulations that set forth the requirements that a futures contract on
a security index traded on or subject to the rules of a foreign board
of trade must meet in order for the index to be excluded from the
definition of narrow-based security index and request comment on how
rules relating to foreign broad-based indexes should address issues
specific to indexes traded on or subject to the rules of a foreign
board of trade.
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\26\ Section 1a(25)(B)(iv) of the CEA and Section
3(a)(55)(C)(iv) of the Exchange Act grant the Commissions joint
authority to exclude an index underlying a futures contract from the
definition of narrow-based security index when that index is traded
on or subject to the rules of a foreign board of trade and meets
such requirements that are established by rule or regulation jointly
by the Commissions.
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Additionally, the Commissions note that Section 1a(25)(B)(v) of the
CEA and Section 3(a)(55)(C)(v) of the Exchange Act create a
"grandfather" provision that permits the offer and sale in the United
States of security index futures traded on or subject to the rules of
foreign boards of trade that were authorized by the CFTC before the
CFMA was enacted.\27\ This "grandfather" provision is in effect for
18 months after the CFMA's enactment, after which such indexes will be
subject
[[Page 27564]]
to the ongoing requirements of the CEA and any new standard in effect
thereafter.
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\27\ Certain such futures contracts are currently offered to
U.S. customers pursuant to no-action letters by the CFTC staff, to
which the SEC did not object. The Commissions note that some of the
index futures trading on or subject to the rules of foreign boards
of trade that are trading pursuant to such no-action letters would
not be considered to be broad-based index futures under Sections
1a(25)(A) or 1a(25)(B)(i) of the CEA and Sections 3(a)(55)(B) or
3(a)(55)(C)(i) of the Exchange Act.
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The Commissions have identified and request comment on the
following issues:
Q6: The Commissions ask for comment on their proposed rules. As
noted above, the Commissions propose that the statutory definition of
narrow-based security index under Section 1a(25)(A) of the CEA and
Section 3(a)(55)(B) of the Exchange Act and the exclusion under Section
1a(25)(B)(i) of the CEA and Section 3(a)(55)(C)(i) of the Exchange Act
would be applicable to futures on indexes traded on or subject to the
rules of a foreign board of trade, including indexes comprised of
domestic securities as well as those that are comprised primarily of
securities traded on foreign markets. Would it be appropriate for the
statutory definition and exclusion to be the sole criteria for index
futures traded on or subject to the rules of a foreign board of trade?
\28\ If not, what issues should be considered in order to develop an
additional exclusion from the statutory definition to describe whether
an index that underlies a future trading on or subject to the rules of
a foreign board of trade is broad-based?
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\28\ The Commissions note that currently some futures contracts
on indexes traded on or subject to the rules of foreign boards of
trade are excluded from the definition of narrow-based security
index solely under the "grandfather" provisions in Section
1a(25)(B)(v) of the CEA and Section 3(a)(55)(C)(v) of the Exchange
Act, which terminate on June 21, 2002.
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Q7: What criteria should be set forth for futures on indexes traded
on or subject to the rules of a foreign board of trade in order for
such indexes to be considered broad-based? For example, commenters are
asked for their views regarding criteria for the depth of the market,
the concentration of the component securities, the permissibility of
any affiliation among the issuers of component securities, the
liquidity of component securities, and any other factors.
Q8: What provisions should be included to assure the accuracy of
the information that is used to determine that the index is broad-
based, in view of the fact that certain key data regarding such foreign
securities is often not required to be disclosed.
Q9: If commenters believe that an additional exclusion is
warranted, what are the unique characteristics of foreign securities
and foreign securities markets that would argue in favor of a different
standard for determining whether an index comprised of such securities
is broad-based? Commenters are also requested to provide their views on
the impact of such a different standard on investor protection. Taking
into account the nature and size of the markets for the securities
underlying the index, is it appropriate to consider indexes comprised
of foreign securities to be broad-based where those indexes are more
concentrated in one or a few securities? Is it appropriate to consider
indexes comprised of foreign securities to be broad-based, considering
the nature and size of the underlying securities markets, if they are
comprised of less liquid securities than would be permitted in a broad-
based index, pursuant to the statutory definition of narrow-based
security index? If so, please indicate why this is appropriate.
Q10: If a rule is adopted providing an additional exclusion from
the definition of narrow-based security index for an index underlying a
futures contract traded on or subject to the rules of a foreign board
of trade, how should the Commissions address any potential competitive
disadvantage to U.S. securities exchanges, alternative trading systems,
designated contract markets, or registered DTEFs that might result from
an additional exclusion?
Q11: How can the Commissions craft rules that avoid potential
uncertainty as to the characterization of an index on an ongoing basis?
How can the Commissions best design criteria that remain sound over
time and do not introduce unforeseeable uncertainties into the
regulatory and trading framework?
Q12: As noted above, certain futures contracts on indexes of
foreign securities that are currently traded on foreign boards of trade
(and in some cases, domestic contract markets) have been permitted to
be offered to U.S. customers under CFTC no-action relief granted under
standards that required such indexes to represent a broad segment of
the cash market; the SEC did not object to such relief. Some of these
indexes may become narrow-based security indexes in the absence of the
"grandfather" provision described above. Would it be appropriate for
the Commissions to use their authority under Section 1a(25)(B)(vi) of
the CEA and Section 3(a)(55)(C)(vi) to jointly establish rules
excluding such indexes or exclude such indexes by order?
Q13: The SEC asks for comment on whether an additional exclusion
from the definition of narrow-based security index for index futures
contracts traded on or subject to the rules of foreign boards of trade
would be consistent with the purposes of the federal securities laws.
III. Method for Determining Market Capitalization and Dollar Value
of Average Daily Trading Volume
A. Determining Market Capitalization
As discussed above, an index is not a "narrow-based security
index" under paragraph (B)(i) of Section 1a(25) of the CEA and
paragraph (C)(i) of Section 3(a)(55) of the Exchange Act if, among
other things, all of its component securities are among the Top 750
securities in terms of market capitalization. The Commissions are
jointly proposing new rules under the CEA and the Exchange Act that
would set forth the method for determining the market capitalization of
a security.\29\
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\29\ The proposed method would apply only to calculating market
capitalization of a security to determine whether it is a Top 750
security. Because the CFMA directs the two Commissions to specify a
method for calculating market capitalization solely for this
purpose, the sponsor or compiler of an index otherwise categorized
as a market capitalization-weighted index would not be required to
use the proposed method to determine the relative weightings of the
index's component securities. See Section 1a(25)(E)(ii) of the CEA
and Section 3(a)(55)(F)(ii) of the Exchange Act.
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Paragraph (a)(1) of proposed Rule 41.11 under the CEA and proposed
Rule 3a55-1 under the Exchange Act would establish that market
capitalization is the product of: (1) the number of outstanding shares
of the security as reported in the most recent quarterly or annual
report of the company \30\--'i.e., Form 10-Q, 10-K, 10-QSB, 10-KSB, or
20-F; \31\ and (2) the average price of the security over the preceding
6 full calendar months. The definitions of "average price" of a
security and "preceding 6 full calendar months" are discussed in
Parts III.D. and III.F. below.\32\
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\30\ To rely on this exclusion from the definition of narrow-
based security index, all the component securities of an index must
be registered pursuant to Section 12 of the Exchange Act. See
Section 1a(25)(B)(i)(III)(aa) of the CEA and Section
3(a)(55)(C)(i)(III)(aa) of the Exchange Act. Therefore, information
regarding the number of outstanding shares will be contained in the
company's annual and periodic reports.
\31\ 17 CFR Sections 249.308a, 249.310, 249.308b, 249.310b, and
249.220f.
\32\ See infra notes 40-41 and 48-49 and accompanying text.
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A national securities exchange, designated contract market,
registered DTEF, or foreign board of trade that trades or proposes to
trade a futures contract on a security index may contract with an
outside party to supply the information and data analysis required to
determine market capitalization. For example, the market trading the
futures contract may have a contract with a data vendor that supplies
transaction information through an electronic medium.
[[Page 27565]]
However, in these circumstances, the market would be responsible for
determining that the calculation by the outside party is consistent
with the Commissions' proposed rules.
Q14: The Commissions solicit comment on their proposed method for
calculating the market capitalization of a security. In particular, are
there other methods of calculating the market capitalization of a
security that would be better for market participants to use? If so,
are these alternatives as appropriate as the method proposed by the
Commissions?
Q15: The Commissions also solicit comment on whether relying on the
information reported by issuers to the SEC is the best way to determine
the number of outstanding shares of a security.
Q16: It is possible that a corporate event affecting the number of
shares outstanding of a security, such as a stock split, stock
dividend, stock buyback, or merger, can occur after the filing by its
issuer of an annual or periodic report. This may be particularly
relevant in the case of foreign issuers that file with the SEC just
once a year. Should the proposed rule specifically address such events,
and, if so, how? For example, should national securities exchanges,
designated contract markets, registered DTEFs, and foreign boards of
trade be permitted to or be required to rely on updated information
contained in any subsequent Form 8-K \33\ filed by the issuer, or on
more current information submitted to the primary market center for the
underlying security? Are there reliable means other than SEC annual,
periodic, and current reports to determine the current number of shares
outstanding of a security in the event of a corporate event that
results in a change in the number of outstanding shares?
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\33\ 17 CFR 249.308.
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Q17: The Commissions solicit comment on whether they should permit
a national securities exchange, designated contract market, registered
DTEF, or foreign board of trade to rely on an independent calculation
of the market capitalization of a security by a third party. Should
there be any conditions imposed when such a third party is used?
Q18: Do third parties, such as data vendors, calculate market
capitalization using a different method than that proposed by the
Commissions? If so, what are these methods? Should the Commissions
incorporate these methods into the proposed rules? What would be the
impact of any variation that may result if the same calculations are
made based on slightly different information?
Q19: If national securities exchanges, designated contract markets,
registered DTEFs, and foreign boards of trade rely on the calculations
of third parties, should those third parties be required to meet
certain qualification standards? For example, should third parties be
qualified only if data dissemination and calculation is part of their
regular business? Should notification to the Commissions be required if
a third party's calculations are used?
B. Determining Dollar Value of Average Daily Trading Volume
Dollar value of ADTV is used in two provisions of the definition of
"narrow-based security index." \34\ As required by the CFMA, the
Commissions are proposing rules that would set forth the method for
determining an individual security's dollar value of ADTV.
Specifically, paragraph (a)(2) of proposed Rule 41.11 under the CEA and
proposed Rule 3a55-1 under the Exchange Act would establish that dollar
value of ADTV is the product of: (1) the average daily trading volume
of the security over the preceding 6 full calendar months; and (2) the
average price of the security over the preceding 6 full calendar
months.
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\34\ Section 1a(25)(A)(iv) and (B)(i) of the CEA and Section
3(a)(55)(B)(iv) and (C)(i) of the Exchange Act.
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The Commissions believe that multiplying a security's average daily
trading volume over the preceding 6 full calendar months by its average
price over the same period is a reasonable and simple method to use to
determine the dollar value of its ADTV. The definitions of "average
price" of a security and "preceding 6 full calendar months," are
discussed in Parts III.D. and III.F. below.
A national securities exchange, designated contract market,
registered DTEF, or foreign board of trade that trades or proposes to
trade a futures contract on a security index may contract with a third
party information provider to calculate, or provide the information
necessary to calculate, the dollar value of ADTV. The market, however,
would be responsible for determining that such calculation is
consistent with the Commissions' proposed rules.
Q20: The Commissions solicit comments on their proposed method of
calculating a security's dollar value of ADTV.
Q21: The Commissions are also interested in commenters' views on
whether alternative ways to calculate this value would be more accurate
or less burdensome to compute. For example, should the dollar value of
ADTV of a security be calculated by multiplying the number of shares in
each transaction by the price at which the transaction took place, then
summing these values for each day in the six-month period, and finally
dividing that sum by the number of trading days in the six-month
period?
Q22: While the security of an issuer that underlies an American
Depository Receipt ("ADR") must be registered under Section 12 of the
Exchange Act, the ADR itself is deemed to be a separate security and is
exempt from registration under Section 12. The Commissions solicit
comments on whether, when determining the ADTV of a security, the ADTV
of ADRs representing shares of such security should be included. The
Commissions also solicit comment on whether, when determining average
price of a security, the average price, on a proportional basis, of
ADRs representing shares of such security should be considered.
Q23. For purposes of the exclusion from the definition of narrow-
based security index in Section 1a(25)(B)(i) of the CEA and Section
3(a)(55)(C)(i) of the Exchange Act, should an ADR be considered
registered pursuant to Section 12 of the Exchange Act if its underlying
security is so registered?
Q24: The Commissions solicit comment on whether they should permit
a national securities exchange, designated contract market, registered
DTEF, or foreign board of trade to rely on an independent calculation
of the dollar value of ADTV of a security by a third party. Should
there be any conditions imposed when such a third party is used?
Q25: Do third parties, such as data vendors, calculate dollar value
of ADTV using a different method than that proposed by the Commissions?
If so, what are those methods? Should the Commissions incorporate these
methods into the proposed rules? What would be the impact of any
variation that may result if the same calculations are made based on
slightly different information?
Q26: If national securities exchanges, designated contract markets,
registered DTEFs, and foreign boards of trade rely on the calculations
of third parties, should those third parties be required to meet
certain qualification standards? For example, should third parties be
qualified only if data dissemination and calculation is part of their
regular business? Should notification to the Commissions be required if
a third party's calculations are used?
[[Page 27566]]
C. Determining Average Daily Trading Volume
Paragraph (b)(1) of Proposed Rule 41.11 under the CEA and proposed
Rule 3a55-1 under the Exchange Act would define the ADTV of a security
as the total number of shares of such security traded on the trading
days of the principal market for the security \35\ during the preceding
6 full calendar months divided by the number of trading days on the
principal market for the security during the same period.\36\ The
inclusion of foreign trading data is discussed in Part III.E.
below.\37\
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\35\ The principal market for a security is proposed to mean the
single market with the largest aggregate reported trading volume for
the security during the preceding 6 full calendar months. See
Paragraph (b)(7) of proposed Rule 41.11 under the CEA and proposed
Rule 3a55-1 under the Exchange Act.
\36\ See below in Part III.E. regarding the proposed limitation
of trading days to "trading days of the principal market for the
security."
\37\ See infra notes 42-47 and accompanying text.
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Q27: The Commissions request comment on the proposed definition of
ADTV.
Are there other, more appropriate ways to determine ADTV?
D. Determining Average Price
1. Basic Definition
The proposed methods for determining market capitalization and
dollar value of ADTV require assessing the average price of a security
over the preceding 6 full calendar month period. Paragraph (b)(2)(i) of
proposed Rule 41.11 under the CEA and proposed Rule 3a55-1 under the
Exchange Act would establish a method that takes into account the
number of shares in each transaction in calculating the average price
of a security. This method, often termed "volume-weighted average
price," would require that there first be established a value for each
transaction, by multiplying the price per share in U.S. dollars of each
transaction by the number of shares traded in that transaction. Then,
the sum of these values for all the transactions in the security during
the 6-month period is divided by the total number of shares traded
during that period. The inclusion of foreign trading data is discussed
in Part III.E. below.\38\
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\38\ Id.
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Q28: The Commissions request commenters' views on the proposed
method for calculating a security's "average price." Are there other
methods that would be more appropriate? For example, another way to
determine "average price" is to use the closing price of the security
for each day of the preceding 6 full calendar months averaged over that
same 6-month period. Should the rules permit the use of the average
closing price of a security to calculate dollar value of ADTV instead
of requiring an overall average price based on transactions throughout
the day?
Q29: Do third parties, such as data vendors, calculate the average
price of a security using a different method than that proposed by the
Commissions? If so, what are those methods? Should the Commissions
incorporate these methods into the proposed rules?
Q30: If national securities exchanges, designated contract markets,
registered DTEFs, and foreign boards of trade rely on the calculations
of third parties, should those third parties be required to meet
certain qualification standards? For example, should third parties be
qualified only if data dissemination and calculation is part of their
regular business? Should notification to the Commissions be required if
a third party's calculations are used?
2. Exception Permitting Use of Non-Volume-Weighted Average Price for
Certain Calculations
Paragraph (b)(2)(ii) of proposed Rule 41.11 under the CEA and
proposed Rule 3a55-1 under the Exchange Act would permit the use of a
non-volume-weighted average price under certain conditions.
Specifically, for purposes of determining whether the dollar value of
ADTV of the lowest weighted 25% of a security index exceeds the
statutory threshold \39\ of $50 million (or $30 million for indexes
with 15 or more component securities), national securities exchanges,
designated contract markets, registered DTEFs, and foreign boards of
trade would be permitted to use an average price for each component
security defined as the average price level at which transactions in
the security took place over the six-month period, irrespective of the
number of shares traded in each transaction.\40\
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\39\ See Section 1a(25)(A)(iv) of the CEA and Section
3(a)(55)(B)(iv) of the Exchange Act.
\40\ Id.
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Such non-volume-weighted average price may be easier to calculate
than a volume-weighted average price, and the Commissions preliminarily
believe that it would be a reasonable alternative for purposes of this
one aspect of the statutory definition of narrow-based security
index.\41\ However, because the method does not take into account the
volume of shares traded at each price, and thus yields only an
approximation of a security's true average price, the Commissions are
proposing to permit its use subject to a limitation.
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\41\ The Commissions do not believe it appropriate to permit the
use of an alternative method to true, volume-weighted average price
for purposes of the other statutory tests that require the use of
average price. If a choice of methods was permitted for these other
tests--which require determining whether a security is one of the
Top 750 and Top 675 securities in terms of market capitalization and
dollar value of ADTV--different markets might arrive at different
lists of the Top 750 and Top 675 securities. As a result, the same
index could be deemed a narrow-based security index in one market
and a broad-based index in another.
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Sometimes, the dollar value of ADTV of the lowest weighted 25% of
an index, when based on the non-volume-weighted average price of each
security comprising it, may exceed the statutory threshold, while the
real dollar value of its ADTV--based on the more exact, volume-weighted
figures for average price of each security--falls short. Accordingly,
paragraphs (a)(2)(iii) and (b)(2)(ii) of proposed Rule 41.11 under the
CEA and proposed Rule 3a55-1 under the Exchange Act would stipulate
that this method may be used only when the dollar value of ADTV of the
lowest weighted 25% of an index based on this method equals or exceeds
$55 million (or $33 million for indexes with 15 or more component
securities)--i.e., it exceeds the statutory thresholds of $50 million
(or $30 million for indexes with 15 or more component securities) by at
least 10%. If it does not, the average price of securities must be
calculated using the volume-weighted average price method in paragraph
(a)(2)(i) of the proposed rules. The Commissions preliminarily believe
that when the dollar value of ADTV of a security index exceeds the $50
million threshold (or the $30 million threshold, as the case may be) by
10% when using the non-volume weighted price, the security index would
most likely exceed those thresholds if the volume-weighted average
price test was used.
Q31: The Commissions request comment on this proposed alternative
method for calculating average price for purposes of determining
whether the dollar value of ADTV of the lowest weighted 25% of an index
equals or exceeds $55 million (or $33 million, for indexes with 15 or
more component securities). Is the 10% threshold appropriate? Should it
be higher or lower?
E. Component Securities of an Index That Trade in Foreign Markets
Security indexes may contain a number of securities that are
registered under Section 12 of the Exchange Act and traded in the
United States and that may also trade in markets outside the United
States.
Paragraphs (b)(1) and (b)(2)(i) and (ii) of proposed Rule 41.11
under the CEA
[[Page 27567]]
and proposed Rule 3a55-1 under the Exchange Act would permit data from
non-U.S. markets to be included in determining the average daily
trading volume and average price of a security, provided that the
information has been reported to a foreign financial regulatory
authority \42\ in the jurisdiction where the security is traded. The
Commissions preliminarily believe that it is reasonable to allow
markets to include such non-U.S. trading volume in determining the
total dollar value of a security's ADTV.\43\ To the extent that trades
that are executed on non-U.S. markets are included in the calculation
of a security's ADTV, the proposed rules would also require those same
trades to be included in calculating the security's average price.\44\
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\42\ "Foreign financial regulatory authority" is defined in
the paragraph (b)(3) of proposed Rule 41.11 under the CEA and
proposed Rule 3a55-1 under the Exchange Act to have the same meaning
as in Section 3(a)(52) of the Exchange Act.
\43\ The use of foreign trading data could also affect average
price for purposes of determining market capitalization, although
the Commissions do not believe that the impact would be significant.
\44\ See paragraph (b)(2)(iv) of proposed Rule 41.11 under the
CEA and proposed Rule 3a55-1 under the Exchange Act.
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In addition, paragraph (b)(2)(ii) and (iii) of proposed Rule 41.11
under the CEA and proposed Rule 3a55-1 under the Exchange Act would
allow price information from non-U.S. markets to be figured into the
average price only when the price for each transaction included in that
calculation is translated into U.S. dollars at the trading date's noon
buying rate in New York City for cable transfers in foreign currencies
as certified for customs purposes by the Federal Reserve Bank of New
York ("noon buying rate").\45\
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\45\ See also 17 CFR 229.301 (Instructions to Item 301, No. 7),
which similarly requires registrants to use the noon buying rate for
purposes of determining the rate of exchange for selected financial
data included in registration statements under the Securities Act
and periodic reports under the Exchange Act.
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Finally, the Commissions recognize that because the trading days in
various countries do not necessarily conform to each other, a uniform
standard would be appropriate. To assure consistency, the proposed
rules would permit price and trading volume data for each security to
be included only for the trading days of the "principal market for the
security." \46\ "Principal market" for a security is defined as the
single market with the largest aggregate reported trading volume for
the security during the preceding 6 full calendar months.\47\
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\46\ See paragraphs (b)(1) and (b)(2)(i) and (ii) of proposed
Rule 41.11 under the CEA and proposed Rule 3a55-1 under the Exchange
Act.
\47\ Paragraph (b)(7) of proposed Rule 41.11 under the CEA and
proposed Rule 3a55-1 under the Exchange Act.
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Q32: Do the proposed rules adequately allow foreign trading volume
to be included? Is information regarding non-U.S. trading volume for
the preceding 6 full calendar months readily available?
Q33: The Commissions solicit comment specifically on the proposed
requirement that the exchange rate used be the noon buying rate. Are
rates readily available for all currencies in which securities may
trade worldwide? How should the rule account for the possibility that
trades occur on days when the noon buying rate is unavailable? For
example, should the rule require that the prior day's rate, or an
average rate over a period of time, be used? Is another exchange rate
method preferable to the noon buying rate, and if so, which exchange
rate method?
Q34: The Commissions also solicit comment specifically on the
proposed limitation on the use of market data to data for the trading
days of the principal market of the security. Is there an alternative
way to take into account the fact that trading calendars in various
countries are not always synchronous? For example, one alternative way
is to calculate the dollar value of ADTV over the preceding 6 full
calendar months separately for each securities market where the
security trades, based on that market's own trading calendar (and
taking into account the appropriate exchange rate), and then to sum the
dollar value of ADTV over the preceding 6 full calendar months for all
the securities markets. What would be the advantages and disadvantages
of such an approach? Commenters are asked to provide specific examples
of how to determine both ADTV and average price if data from various
securities markets for all trading days is to be included.
Q35: Commenters are requested to provide their views regarding
whether any other issues relating to foreign trading data need to be
addressed.
F. Determining "the Preceding 6 Full Calendar Months"
The CEA and Exchange Act specify that the dollar value of ADTV and
market capitalization shall be calculated as of the "preceding 6 full
calendar months." \48\ Paragraph (b)(5) of proposed Rules 41.11 under
the CEA and 3a55-1 under the Exchange Act would define the preceding 6
full calendar months, with respect to a particular day, as the period
of time beginning on the same day of the month 6 months before such
day, and ending on the day prior to such day. For example, for August
16 of a particular year, the preceding 6 full calendar months means the
period beginning February 16 and ending August 15. Similarly, for March
8 of a particular year, the 6-month period begins on September 8 of the
previous year and ends on March 7.
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\48\ Section 1a(25)(E)(i) of the CEA and Section 3(a)(55)(F)(i)
of the Exchange Act.
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The Commissions believe that this "rolling" 6-month approach is
appropriate, particularly in light of issues that would arise if 6 full
calendar months were measured from the first to the last day of each
month on the calendar. If that approach were used, it would be
difficult to apply the CEA and Exchange Act provisions excepting a
security index from the definition of narrow-based security index if,
among other things, it is narrow-based for 45 or fewer business days in
a three-month period.\49\
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\49\ Sections 1a(25)(B)(iii) and (D) of the CEA and Sections
3(a)(55)(C)(iii) and (E) of the Exchange Act.
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For example, if a national securities exchange, designated contract
market, registered DTEF, or foreign board of trade needed to assess the
dollar value of ADTV for the six months preceding July 20, and the
measuring period for which the dollar value of ADTV for the component
securities of an index is determined as the 6-month period from January
1 through June 30, the dollar value of ADTV would be static for each
day in July. In this example, the calculation would not take into
account any transactions that occurred during July. Thus, if this
approach were used to define the 6-month period, the Commissions
believe it would leave meaningless the statutes' provisions concerning
the number of days within a three-month period that a future on an
index that is narrow-based may continue to trade under the regulatory
framework for futures on indexes that are not narrow-based.
Q36: Is there an approach other than the one proposed to determine
the preceding 6 full calendar months? How would such an alternative
work in applying the provision that excludes a non-narrow based index
future that becomes narrow-based from the definition of a narrow-based
security index future if it is narrow-based for 45 or fewer days in a
three month period?
G. The Lowest Weighted 25% of an Index
As discussed in Part II.A. above, one of the factors that may
render a security index narrow-based is if the aggregate dollar value
of the ADTV of the lowest
[[Page 27568]]
weighted 25% of its component securities is less than $50 million (or
$30 million for an index of 15 component securities or more).\50\
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\50\ Section 1a(25)(A)(iv) of the CEA and Section
3(a)(55)(B)(iv) of the Exchange Act.
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The proposed rules would establish that the "lowest weighted 25%
of an index's weighting" is comprised of those component securities
that have the lowest weightings in the index such that, when their
weightings are summed, they equal no more than 25% of the weight of the
index.\51\ To identify these securities, the following method would
apply: (1) all component securities in an index would be ranked from
the lowest to highest weighting; and (2) beginning with the lowest
weighted security and proceeding to the next lowest weighted security
and continuing in this manner, the weightings would be added to each
other until they reach the sum that would come closest to, or equal
25%, but would not exceed 25%. Those securities would then comprise the
lowest weighted 25% of the index.
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\51\ Paragraph (b)(4) of proposed Rule 41.11 under the CEA and
proposed Rule 3a55-1 under the Exchange Act. Paragraph (b)(9) of the
proposed rules, respectively, would clarify that "weighting" of a
component security of an index means the percentage of the index's
value represented or accounted for by that component security.
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In addition, the calculation of ADTV and its dollar value for any
given moment in time must take into account trading volume and price
data for the relevant securities over the preceding 6 months of
trading. Yet the securities that comprise the lowest weighted 25% of an
index may vary from day to day. The proposed rules establish how the
ADTV of the lowest weighted 25% of an index and its dollar value is to
be determined.
Specifically, the proposed rules would establish that, for any
particular day, the ADTV of the lowest weighted 25% of the index is
calculated based on the price and trading data over the preceding 6
months for the securities that comprise the lowest weighted 25% of the
index for that day. The Commissions believe that this method of taking
a "snapshot" of the current lowest weighted 25% and then looking
retroactively to determine the aggregate dollar value of the ADTV over
the preceding 6 months of the securities in the snapshot is a
reasonable approach for the purposes of the statute and would be
considerably less burdensome than the alternative of requiring a
calculation of the data for the lowest weighted 25% of the index for
each day of the preceding 6 full calendar months.
Q37: The Commissions request comment concerning whether the method
for identifying the securities comprising the lowest weighted 25% of an
index's weighting is practicable. Is there any other approach the
Commissions should consider?
IV. Transitional Exemption for Broad-Based Index Futures
As discussed above, the statutory definition of narrow-based
security index provides a temporary exclusion under certain conditions
for a futures contract trading on an index that was not narrow-based
and subsequently became narrow-based for no more than 45 business days
over three consecutive calendar months. If the index becomes narrow-
based for more than 45 days over three consecutive calendar months, the
statute then provides a grace period of three months during which the
index is excluded from the definition of narrow-based security
index.\52\
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\52\ See supra, Part II.B.2.
---------------------------------------------------------------------------
The CFTC is proposing to adopt Rule 41.14 under the CEA to provide
a similar temporary exclusion and transitional grace period for a
security futures product that was trading on a narrow-based security
index that becomes a broad-based index. Paragraph (a) of proposed Rule
41.14 under the CEA would establish a temporary exclusion for a
security future that began trading on an index that was narrow-based
and subsequently became broad-based for no more than 45 days in a
three-month calendar period. In such case the index would continue to
be considered narrow-based. Paragraph (b) of proposed Rule 41.14 would
provide a transition period for an index that was a narrow-based
security index and became broad-based for more than 45 days over three
consecutive calendar months, permitting it to continue to be a narrow-
based security index for the three following calendar months.\53\
---------------------------------------------------------------------------
\53\ Proposed Rule 41.1(a) under the CEA would define "broad-
based security index" as "a group or index of securities that does
not constitute a narrow-based security index."
---------------------------------------------------------------------------
To minimize disruption, paragraph (c) of the proposed CEA rule also
provides that a national securities exchange may, following the
transition period, continue to trade only in those months in which the
contract had open interest on the date the transition period ended and
shall limit trading to liquidating positions. The Commissions note that
a national securities exchange that intends to trade an index following
the end of the transition period, other than as specified in paragraph
(b), would be required to take such action as may be necessary to trade
the index as a broad-based index subject to the sole jurisdiction of
the CFTC.\54\
---------------------------------------------------------------------------
\54\ See Section 2(a)(1)(C)(ii) of the CEA.
---------------------------------------------------------------------------
V. Request for Comments
The Commissions solicit comments on all aspects of proposed Rules
41.1 and 41.2 and Rules 41.10 through 41.14 under the CEA and proposed
Rules 3a55-1 through 3a55-3 under the Exchange Act. In particular, the
Commissions seek comments on whether the proposed methods for
determining the market capitalization and dollar value of ADTV are
appropriate, or whether other calculation methodologies would be more
suitable. In suggesting other methodologies, commenters should provide
specific examples. Commenters are welcome to offer their views on any
other matter raised by the proposed rules.
VI. Paperwork Reduction Act
CFTC
A. Summary of Collection of Information
The Paperwork Reduction Act ("PRA") of 1995 \55\ imposes certain
requirements on federal agencies (including the CFTC) in connection
with their conducting or sponsoring any collection of information as
defined by the PRA.
---------------------------------------------------------------------------
\55\ 44 U.S.C. 3504(h).
---------------------------------------------------------------------------
Futures contracts on security indexes that meet the statutory
definition of narrow-based security index are jointly regulated by the
SEC and CFTC. Futures contracts on indexes that do not meet the
statutory definition of narrow-based remain under the sole jurisdiction
of the CFTC. To implement the definition of a narrow-based security
index, the Commissions are required to jointly specify by rule or
regulation the method for determining market capitalization and dollar
value of ADTV of securities comprising an index.
In addition, the CFMA amended the CEA by requiring national
securities exchanges that deal in security futures products to become
designated contract markets solely for the purpose of trading security
futures products ("notice-registered contract markets").\56\
---------------------------------------------------------------------------
\56\ See Sections 2(a)(1)(D)(ii) and 5f of the CEA.
---------------------------------------------------------------------------
A designated contract market or registered DTEF that trades or
proposes to trade a futures contract on a security index must ascertain
whether or not the security index falls within the definition of
narrow-based security index to determine the jurisdiction under which
trading in such contract falls, and whether the market in which it
trades is
[[Page 27569]]
in compliance with the relevant securities and commodities laws. This
will entail, among other things, a collection of the information
necessary to make the requisite determination under the provisions of
the CEA and the Exchange Act regarding the market capitalization and
dollar value of ADTV of individual securities or groups of securities
comprising the index.
The proposed rules would provide the method by which a market
trading a futures contract on a security index must determine the
market capitalization and dollar value of ADTV of securities comprising
the index in order to assure that it is in compliance with the
applicable requirements of the CEA and the Exchange Act.
Proposed Rule 41.2 requires designated contract markets (including
notice-registered contract markets) and registered DTEFs that trade a
security index or security futures product to maintain, in accordance
with the requirements of Rule 1.31, books and records of all activities
relating to the trading of such products. This proposed rule restates
the existing recordkeeping requirements of the CEA.\57\ The proposed
rule also specifies that, in order to comply with these recordkeeping
requirements, designated contract markets and registered DTEFs that
trade futures contracts on security indexes and security futures
products would be required to preserve records of any calculations used
to determine whether an index is broad-based or narrow-based.
---------------------------------------------------------------------------
\57\ See Sections 5(d)(17) and 5a(d)(8) of the CEA.
---------------------------------------------------------------------------
B. Proposed Use of Information
Designated contract markets and registered DTEFs that wish to trade
futures contracts on a security index would use the methods specified
in the proposed rules to determine market capitalization and dollar
value of ADTV of a security or a group of securities comprising the
index. These determinations would enable these designated contract
markets and registered DTEFs to ascertain whether a security index on
which they propose to trade or are trading a futures contract is
"narrow-based," and thus subject to the joint jurisdiction of the SEC
and the CFTC, or is "broad-based," and thus subject to the exclusive
jurisdiction of the CFTC.
Any market that trades a futures contract on a broad-based or
narrow-based security index would be required to retain records of its
determinations as required by the recordkeeping requirements of the
proposed rules.
C. Respondents
The only entities required under the proposed rules to retain such
records would be designated contract markets (including notice-
registered contract markets) and registered DTEFs that trade futures
contracts on security indexes. The CFTC estimates that potentially 11
designated contract markets (of which four would be notice-registered)
would be required by the proposed rules to comply with these
recordkeeping requirements. No registered DTEFs are currently trading
futures products. The CFTC requests comment on whether any additional
entities would be required to keep these records.
D. Total Annual Reporting and Recordkeeping Burden
1. Capital Costs
Designated contract markets (including notice-registered contract
markets) and registered DTEFs that trade futures contracts on security
indexes would be required to keep on file all records concerning their
determinations that such indexes were either broad-based or narrow-
based for a period of five years, of which the first two years of such
records would be required to be readily accessible. Because these
markets are already required to have recordkeeping systems in place,
the CFTC preliminarily estimates that any additional costs of retaining
and storing the collected information discussed above would be nominal.
The CFTC is soliciting comment on this finding.
2. Burden Hours
Designated contract markets and registered DTEFs that trade futures
contracts on security indexes would be required to retain and store the
determinations of market capitalization and dollar value of ADTV
obtained by applying the methods provided by the proposed rules for
five years; of which the first two years of such records would be
required to be readily accessible. The CFTC estimates that it would
take the 11 respondents one hour each to retain any documents made or
received by it in determining whether an index is narrow-based or
broad-based. The total burden in complying with proposed rule 41.2
would be 11 hours. The CFTC is soliciting comment on this estimate.
E. General Information About the Collection of Information
The collection of information required by the proposed rules is
mandatory and would need to be retained by designated contract markets
and registered DTEFs for five years, and for the first two years the
information must be readily accessible. 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 OMB control number.
F. Request for Comment
The CFTC requests comments: (1) on whether the proposed collection
of information is necessary for the proposed performance of the
functions of the agency, including whether the information shall have
practical utility; (2) to evaluate the accuracy of the CFTC's estimate
of the burden of the proposed collection of information; (3) on whether
the proposed collection of information will enhance the quality,
utility, and clarity of the information to be collected; and (4)
whether the proposed collection of information will minimize the burden
of collection on those who are to respond, including through the use of
electronic or automated collection techniques or other forms of
information technology.
Persons wishing to submit comments on the collection of information
requirements should direct them to the Office of Information and
Regulatory Affairs, OMB, Room 10235, New Executive Office Building,
Washington, DC 20503, Attention: Desk Officer for the CFTC, and to the
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, NW, Washington, DC 20581, Attention: Office of the Secretariat.
Comments may be sent by facsimile transmission to (202) 418-5521 or by
e-mail to [email protected]. Reference should be made to Narrow-Based
Security Indexes.
The CFTC has submitted the proposed collection of information to
OMB for approval. Members of the public should direct any general
comments to both the CFTC and OMB within 30 days. OMB is required to
make a decision concerning the collection of information between 30 and
60 days after publication in the Federal Register, so a comment to OMB
is best assured of having its full effect if OMB receives it within 30
days of publication of this release. Requests for the materials
submitted to OMB by the CFTC with regard to this collection of
information are available from the CFTC Clearance Officer, Three
Lafayette Centre, 1155 21st Street, NW, Washington, DC 20581,
Telephone: (202) 418-5160.
SEC
Certain provisions of the proposed rules contain "collection of
information" requirements within the
[[Page 27570]]
meaning of the Paperwork Reduction Act of 1995 ("PRA"),\58\ and the
SEC has submitted them to the Office of Management and Budget ("OMB")
for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. The
SEC is proposing to amend the collection of information entitled "Rule
17a-1: Recordkeeping rule for national securities exchanges, national
securities associations, registered clearing agencies, and the
Municipal Securities Rulemaking Board" (OMB Control Number 3235-0208).
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 OMB control number.
---------------------------------------------------------------------------
\58\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------
A. Summary of Collection of Information
As noted above, the CFMA lifted the ban on trading single stock and
narrow-based stock index futures and established a framework for the
joint regulation of these products by the SEC and the CFTC. In
addition, the CFMA amended the Exchange Act and CEA by adding a
definition of "narrow-based security index," which establishes an
objective test of whether a security index is narrow-based.\59\ Futures
contracts on security indexes that meet the statutory definition of
narrow-based security index are jointly regulated by the SEC and the
CFTC. Futures contracts on indexes that do not meet the statutory
definition of narrow-based security index remain under the sole
jurisdiction of the CFTC. To implement the definition of a narrow-based
security index, the Commissions are required to specify jointly by rule
or regulation the method for determining market capitalization and
dollar value of ADTV of securities comprising an index.\60\
---------------------------------------------------------------------------
\59\ See Section 1a(25)(A) of the CEA and Section 3(a)(55)(B) of
the Exchange Act.
\60\ Section 3(a)(55)(F) of the Exchange Act and Section 1a
(25)(E) of the CEA.
---------------------------------------------------------------------------
In addition, the CFMA amended the Exchange Act by adding new
Section 6(g), which would require an exchange that is a designated
contract market or a registered DTEF that lists or trades security
futures products to register as a national securities exchange
("notice-registered national securities exchange") solely for the
purpose of trading security futures products.\61\
---------------------------------------------------------------------------
\61\ See Section 6(g) of the Exchange Act, 15 U.S.C. 78f(g).
---------------------------------------------------------------------------
A national securities exchange, designated contract market,
registered DTEF, or foreign board of trade that trades or proposes to
trade a futures contract on a security index must ascertain whether or
not the security index falls within the definition of narrow-based
security index to determine the jurisdiction under which trading in
such contract falls, and whether the market in which it trades is in
compliance with the relevant securities and commodities laws. This will
entail, among other things, a collection of the information necessary
to make the requisite determination under the provisions of the
Exchange Act and the CEA regarding the market capitalization and dollar
value of ADTV of individual securities or groups of securities
comprising the index.
Proposed Rule 3a55-1 under the Exchange Act specifies the method to
determine market capitalization and dollar value of ADTV of index
securities.\62\ Thus, the proposed rule would provide the method by
which a market trading a futures contract on a security index must
determine the market capitalization and dollar value of ADTV of index
securities in order to assure that it is in compliance with the
applicable requirements of the Exchange Act and the CEA.
---------------------------------------------------------------------------
\62\ Proposed Rule 41.11 under the CEA parallels proposed Rule
3a55-1.
---------------------------------------------------------------------------
Rule 17a-1 under the Exchange Act,\63\ among other things, requires
national securities exchanges, which by definition include entities
registered under the new notice registration provisions of the Exchange
Act,\64\ to retain copies of all documents, including all
correspondence, memoranda, papers, books, notices, accounts, and other
records made or received by them in the course of their business and in
the conduct of their self-regulatory activities for a period of not
less than five years, in the first two years in an easily accessible
place. Any exchange that lists or trades a futures contract on a
narrow-based security index product must be registered with the SEC
pursuant to Section 6 of the Exchange Act and, as a registered national
securities exchange, will be subject to the recordkeeping requirements
of Rule 17a-1. Rule 17a-1 thus will apply to any notice-registered
national securities exchange. Accordingly, in order to comply with
these recordkeeping requirements, a national securities exchange,
including a notice-registered national securities exchange, that lists
or trades futures contracts on narrow-based security indexes would be
required to preserve records of any calculations used to determine
whether an index is narrow-based.\65\
---------------------------------------------------------------------------
\63\ 17 CFR 240.17a-1.
\64\ See Section 6 of the Exchange Act, 15 U.S.C. 78f.
\65\ This PRA analysis does not include any collection of
information and recordkeeping requirements that would apply to
designated contract markets, registered DTEFs, and foreign boards of
trade that trade futures contracts on security indexes that are not
narrow-based because the trading of these products is not subject to
the SEC's jurisdiction. Therefore, such information and
recordkeeping would not be subject to Rule 17a-1 under the Exchange
Act.
---------------------------------------------------------------------------
B. Proposed Use of Information
National securities exchanges, designated contract markets,
registered DTEFs, and foreign boards of trade would use the methods
specified in the proposed rules to determine market capitalization and
dollar value of ADTV of a security or a group of securities comprising
the index. These determinations would enable these national securities
exchanges, designated contract markets, registered DTEFs, and foreign
boards of trade to ascertain whether a security index on which they
propose to trade or are trading a futures contract is "narrow-based,"
and thus is subject to the joint jurisdiction of the SEC and CFTC. If
the market determined that the index is not narrow-based under the
proposed rules' methodology, the futures contract would be solely under
the CFTC's jurisdiction.
The SEC will use the collected information to monitor the accuracy
of the determinations made by national securities exchanges, including
notice-registered national securities exchanges, as to whether a
security index is narrow-based.
Any national securities exchange, including any notice-registered
national securities exchange, that trades a futures contract on a
narrow-based security index would be required to retain records of its
determinations pursuant to the recordkeeping requirements of Rule 17a-
1.
C. Respondents
The only entities required under Rule 17a-1 under the Exchange Act
to retain such records would be national securities exchanges
(including designated contract markets and registered DTEFs registered
as national securities exchanges pursuant to Section 6(g) of the
Exchange Act) that trade futures contracts on narrow-based security
indexes. The SEC estimates that potentially 4 national securities
exchanges and 7 notice-registered national securities exchanges
(designated contract markets registered pursuant to Section 6(g) of the
Exchange
[[Page 27571]]
Act)\66\ would be required by the Exchange Act and the rules thereunder
to comply with these recordkeeping requirements. No registered DTEFs
are currently trading futures products. The SEC requests comment on
whether any additional entities would be required to keep these
records.
---------------------------------------------------------------------------
\66\ Notice-registered national securities exchanges are those
entities that register in accordance with Section 6(g) of the
Exchange Act and proposed Rule 6a-4 under the Exchange Act by filing
a proposed Form 1-N. See Securities Exchange Act Release No. 44279
(May 8, 2001).
---------------------------------------------------------------------------
D. Total Annual Reporting and Recordkeeping Burden
1. Capital Costs
Rule 17a-1 under the Exchange Act would require national securities
exchanges, including any notice-registered national securities
exchanges, that trade futures contracts on narrow-based security
indexes to keep on file for a period of no less than five years, the
first two years in an easily accessible place, all records concerning
their determinations that such indexes were narrow-based.\67\ Because
national securities exchanges, including notice-registered national
securities exchanges that have been designated contract markets with
the CFTC, currently are required to have recordkeeping systems in
place,\68\ the SEC preliminarily estimates that any additional costs of
retaining and storing the collected information discussed above would
be nominal. The SEC is soliciting comment on this estimation.
---------------------------------------------------------------------------
\67\ 17 CFR 240.17a-1.
\68\ See Rule 17a-1 under the Exchange Act, 17 CFR 240.17a-1,
and Sections 5(d)(17) and 5a(d)(8) of the CEA.
---------------------------------------------------------------------------
2. Burden Hours
National securities exchanges, including notice-registered national
securities exchanges, that trade futures contacts on security indexes
would be required to comply with the recordkeeping requirements under
Rule 17a-1 under the Exchange Act.\69\ National securities exchanges,
including notice-registered national securities exchanges, would be
required to retain and store any documents related to determinations
made using the definitions in proposed Exchange Act Rule 3a55-1 for no
less than five years, the first two years in an easily accessible
place. The current burden estimate for Rule 17a-1, as of July 20, 1998,
is 50 hours per year for each exchange.\70\ The SEC estimates that it
would take each of the 11 respondents one hour annually to retain any
documents made or received by it in determining whether an index is a
narrow-based security index. The total burden in complying with Rule
17a-1 for each national securities exchange, including notice
registered national securities exchanges, under proposed Rule 3a55-1
would be 11 hours. The SEC is soliciting comment on this estimate.
---------------------------------------------------------------------------
\69\ 17 CFR 240.17a-1.
\70\ See 63 FR 38865 (July 20, 1998) (SEC File No. 270-244, OMB
Control No. 3235-0208) (seeking an extension of OMB approval of
Rule17a-1 under the Exchange Act).
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E. General Information About the Collection of Information
The collection of information required by the proposed rules is
mandatory and would need to be retained by the national securities
exchanges and notice-registered national securities exchanges for no
less than five years, and for the first two years the information must
be in an easily accessible place, as required under Exchange Act Rule
17a-1. Under Rule 17a-1, the information collected pursuant to the
proposed rules would be retained by the national securities exchange or
the notice-registered national securities exchange that is relying on
the proposed rules. The SEC would obtain access to the information upon
request. Any collection of information received by the SEC would not be
made public.
F. Request for Comment
Pursuant to 44 U.S.C. 3506(c)(2)(B), the SEC solicits comments to:
(1) evaluate whether the proposed collection of information is
necessary for the proposed performance of the functions of the agency,
including whether the information shall have practical utility; (2)
evaluate the accuracy of the SEC's estimate of the burden of the
proposed collection of information; (3) enhance the quality, utility,
and the clarity of the information to be collected; and (4) minimize
the burden of collection on those who are to respond, including through
the use of electronic or automated collection techniques or other forms
of information technology.
Persons wishing to submit comments on the collection of information
requirements should direct them to the following persons: (1) Desk
Officer for the Securities and Exchange Commission, Office of
Information and Regulatory Affairs, Office of Management and Budget,
Washington, D.C. 20503; and (2) Jonathan G. Katz, Secretary, Securities
and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C.
20549-0609, with reference to File No. S7-11-01.
The SEC has submitted the proposed collection of information to OMB
for approval. Members of the public should direct any general comments
to both the SEC and OMB within 30 days. OMB is required to make a
decision concerning the collection of information between 30 and 60
days after publication in the Federal Register, so a comment to OMB is
best assured of having its full effect if OMB receives it within 30
days of publication of this release. Requests for the materials
submitted to OMB by the SEC with regard to this collection of
information should be in writing, refer to File No. S7-11-01, and be
submitted to the Securities and Exchange Commission, Records
Management, Office of Filings and Information Services, 450 Fifth
Street, N.W., Washington, D.C. 20549-0609.
VII. Costs and Benefits of the Proposed Rules
CFTC
Section 15(a) of the CEA requires the CFTC to consider the costs
and benefits of its action before issuing a new regulation.\71\ The
CFTC understands that, by its terms, Section 15(a) 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 it 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(a) simply requires the CFTC to
"consider the costs and benefits" of its action.
---------------------------------------------------------------------------
\71\ Section 15(a) of the CEA, 7 U.S.C. 19(a).
---------------------------------------------------------------------------
Section 15(a) 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 proposed rules constitute a package of related rule provisions.
The rules provide guidance to trading facilities in order to facilitate
compliance with governing laws. Furthermore, the rules provide
alternatives that may reduce the costs of compliance.
[[Page 27572]]
The CFTC is considering the costs and benefits of the proposed
rules as a totality, in light of the specific areas of concern
identified in Section 15(a). The proposed 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 proposed 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.
Accordingly, the CFTC has determined to propose the rules discussed
above. The CFTC invites public comment on the application of the cost-
benefit provision of Section 15(a) of the CEA in regard to the proposed
rules. Commenters also are invited to submit any data that they may
have quantifying the costs and benefits of the proposed rules.
SEC
The SEC is proposing new rules, Rules 3a55-1 through 3a55-3, under
the Exchange Act. The proposed rules are in response to the mandate of
the CFMA, which, among other things, requires the CFTC and SEC to
jointly specify by rule or regulation the method to be used to
determine "market capitalization" and "dollar value of average daily
trading volume" with respect to implementing the new provisions of the
CEA and Exchange Act regarding contracts for future delivery on
security indexes.
The CFMA lifted the ban on, and will permit the trading of, single
stock futures and futures on narrow-based security indexes. In addition
to repealing the prohibition on certain types of security index
futures, the CFMA amended the CEA and Exchange Act by adding the
definition of "narrow-based security index." This definition
establishes an objective test of whether a security index is narrow-
based.\72\ Futures contracts on security indexes that are narrow-based
security indexes will be jointly regulated by the CFTC and the SEC
under the framework established by the CFMA. Futures contracts on
indexes that are not narrow-based security indexes, on the other hand,
will be under the sole jurisdiction of the CFTC, and therefore only a
designated contract market, registered derivatives transaction
execution facility ("DTEF"), or foreign board of trade may trade
these products.
---------------------------------------------------------------------------
\72\ See Section 1a(25) of the CEA and Section 3(a)(55) of the
Exchange Act.
---------------------------------------------------------------------------
Proposed Rule 3a55-1 under the Exchange Act would provide methods
of calculating market capitalization and dollar value of average daily
trading volume ("ADTV") for purposes of determining whether a
security index is narrow-based within the meaning of the Exchange Act.
Proposed Rule 3a55-2 under the Exchange Act would exempt from the
definition of narrow-based security index those security indexes on
which futures contracts have traded on a designated contract market, a
registered DTEF, or foreign board of trade for fewer than 30 days,
provided they would not have been narrow-based security indexes for an
uninterrupted 6 full calendar months prior to the first day of trading.
Proposed Rule 3a55-3 under the Exchange Act would establish that when a
futures contract on a security index is traded on or subject to the
rules of a foreign board of trade, that index shall not be considered a
narrow-based security index if it would not be a narrow-based security
index pursuant to the statutory definition of a narrow-based index or
the exclusions from that definition. These proposed rules would provide
methods of calculation and guidance for national securities exchanges,
designated contract markets, registered DTEFs, and foreign boards of
trade in determining whether or not a security index is narrow-based
under the Exchange Act.
The SEC has identified below certain costs and benefits relating to
proposed Rules 3a55-1 through 3a55-3 under the Exchange Act. The SEC
requests comments on all aspects of this cost-benefit analysis,
including identification of any additional costs and/or benefits of the
proposed rules. The SEC encourages commenters to identify and supply
any relevant data, analysis and estimates concerning the costs and/or
benefits of the proposed rules.
A. Benefits
The benefits of proposed Rules 3a55-1 through 3a55-3 under the
Exchange Act are related to the benefits that will accrue as a result
of the enactment of the CFMA. By repealing the ban on single stock
futures and futures on narrow-based security indexes, the CFMA will
enable a greater variety of financial products to be traded that
potentially could facilitate price discovery and the ability to hedge.
Investors will benefit by having a wider choice of financial products
to buy and sell, and markets and market participants will benefit by
having the ability to trade these products. The benefits are likely to
relate to the volume of trading in these new instruments. Because
security futures are a new product, however, the SEC is unable to
quantify these benefits and therefore requests comments, data, and
estimates.
Furthermore, the CFMA clarifies the jurisdiction of the CFTC and
the SEC over futures contracts on security indexes, and alleviates the
regulatory burden of dual CFTC and SEC jurisdiction where it is
appropriate to do so. Under the new provisions of the CEA and Exchange
Act, the CFTC and SEC will jointly regulate futures contracts on
narrow-based security indexes. The trading of futures contracts on
broad-based security indexes will be under the sole jurisdiction of the
CFTC and may be traded only on designated contract markets and by and
through intermediaries registered with the CFTC. The CFMA provides
objective criteria for determining whether or not a security index is
narrow-based, and the proposed rules would provide instruction in
applying those criteria. The SEC requests comments, data, and estimates
regarding the increased regulatory certainty that will result from the
definition of narrow-based security index contained in the Exchange
Act.
Proposed Rule 3a55-1 under the Exchange Act would provide
methodologies for determining market capitalization and the dollar
value of ADTV for purposes of ascertaining whether or not a security
index is narrow-based as defined in the CFMA. The proposed rules would
provide the benefit of clear, objective standards for determining both
market capitalization and the dollar value of ADTV. Market
capitalization would, under the proposed rules, be computed as the
product of the average price of a component security and the number of
outstanding shares of that security. The dollar value of ADTV would,
under the proposed rules, be computed as the product of the average
price of a component security and the ADTV of that security.
To implement these calculations, the proposed rules would define
"average daily trading volume" and, as more fully described below, a
method to calculate "average price." In addition, the proposed rules
would clarify how to calculate the dollar value of ADTV for the lowest
weighted 25% of an index. The SEC requests specific comments regarding
the benefits and efficiency of the proposed methods for determining
market capitalization and the dollar value of ADTV, and invites
comments regarding the benefits of any alternative approaches.
Proposed Rule 3a55-1 under the Exchange Act would provide the
following objective definition for
[[Page 27573]]
"average price" for purposes of calculating market capitalization and
dollar value of ADTV: The total dollar value of all transactions in a
component security on the trading days of the principal market for the
security during the preceding 6 full calendar months divided by the
total number of shares traded in such transactions for the preceding 6
full calendar months, where the dollar value for each transaction is
the price per share in U.S. dollars of that transaction multiplied by
the number of shares in such transaction ("volume-weighted average
price").
For purposes of determining whether the dollar value of the ADTV of
the lowest weighted 25% of an index reaches the statutory threshold of
$50 million (or $30 million), the proposed rules would also permit a
national securities exchange, designated contract market, registered
DTEF, or foreign board of trade to elect a different method of
calculation of average price, under certain conditions,\73\ which may
be more cost-efficient for it to use. Average price according to this
method would be the sum of the price per share in U.S. dollars for each
transaction in a component security during the preceding 6 full
calendar months divided by the total number of such transactions during
the preceding 6 full calendar months ("non-volume-weighted average
price"). This choice provides flexibility in a manner that may lower
implementation costs. The SEC seeks comments as to the benefits and
flexibility of these two methods of calculating "average price" for
purposes of determining whether the dollar value of ADTV of the lowest
weighted 25% of an index meets the statutory threshold under the above-
stated condition.
Proposed Rule 3a55-1 under the Exchange Act would also mandate a
"snapshot" method for determining dollar value of ADTV for the lowest
weighted 25% of an index.\74\ On a particular day, the lowest weighted
component securities comprising, in the aggregate, 25% of an index's
weighting, would be those securities that are the lowest weighted
securities when all the securities in such index are ranked from lowest
to highest based on the index's weighting methodology, and for which
the sum of the weight of such securities is equal to, or less than,
25%.
The SEC believes that taking a "snapshot" of the securities
comprising the lowest weighted 25% of an index for a particular day,
and then using that "snapshot" to determine the dollar value of ADTV
for those securities for the preceding 6 months, is a reasonable method
of calculation that may reduce the computation burden on national
securities exchanges, designated contract markets, registered DTEFs,
and foreign boards of trade. Otherwise, for each day of the preceding 6
full calendar months, the market would have to assess the weighting of
each security, rank the securities by weighting, and then determine the
ADTV for the lowest weighted 25% of the index that day. The SEC seeks
comments as to the benefits of this "snapshot" method of calculating
the lowest weighted 25% of an index.
Under the Exchange Act, market capitalization and the dollar value
of ADTV must be calculated "as of the preceding 6 full calendar
months." The proposed rule would specify a "rolling" 6 month period,
i.e., with respect to a particular day, the "preceding 6 full calendar
months" would mean the period of time beginning on the same calendar
date 6 months before and ending on the day prior to that day. A
national securities exchange, designated contract market, registered
DTEF, or foreign board of trade would benefit from this definition
because a specific and objective time frame for the required
calculations would be provided. The SEC requests comment as to the
benefits of this "preceding 6 full calendar months" criteria and asks
for suggestions and examples of any alternative approach.
The SEC believes proposed Rule 3a55-1 under the Exchange Act would
provide an additional benefit to national securities exchanges,
designated contract markets, registered DTEFs, and foreign boards of
trade by permitting use of foreign trading data for the calculations of
market capitalization and the dollar value of ADTV when component
securities of an index are also traded on markets outside of the United
States. The proposed rule would clarify that such foreign transaction
data may be used only if it has been reported to a foreign financial
regulatory authority in the jurisdiction in which the security is
traded, and that, if the price information is reported in a foreign
currency, it must be converted into U.S. dollars on the basis of the
transaction date's noon buying rate in New York City for cable
transfers in foreign currencies as certified for customs purposes by
the Federal Reserve Bank of New York. The SEC invites comments and
appropriate data regarding the benefits and/or costs associated with
the use of information from transactions outside the United States.
In addition, proposed Rule 3a55-2 under the Exchange Act would
provide a limited exclusion from the definition of "narrow-based
security index" for an index underlying a futures contract that has
traded for less than 30 days, as long as the index would not have been
a narrow-based index for the 6 full calendar months prior to the first
day of trading. This exclusion would be beneficial because it would
allow futures contracts to continue to trade during this 30 day period
without triggering Exchange Act provisions requiring registration by
the market trading the futures. The SEC requests comments on the
benefits of this exemption.
Finally, proposed Rule 3a55-3 under the Exchange Act would
establish that when a futures contract on a security index is traded on
or subject to the rules of a foreign board of trade, that index shall
not be considered a narrow-based security index if it would not be a
narrow-based security index pursuant to the statutory definition of a
narrow-based security index or the exclusions from that definition. The
proposed rule would clarify and establish that when a futures contract
on an index is traded on or subject to the rules of a foreign board of
trade, such index would not be a narrow-based security index if it
would not be a narrow-based security index if a futures contract on
such index were traded on a designated contract market or registered
DTEF. The SEC seeks comments on the benefits of such a rule.
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\73\ The proposed rules specify that the volume-weighted average
price must be used for purposes of determining dollar value of ADTV
of the lowest weighted 25% of an index, if the result is less than
$55,000,000 when using the non-volume-weighted average price
($33,000,000 in the case of an index with 15 or more component
securities).
\74\ For purposes of the Exchange Act, a narrow-based security
index includes an index in which the lowest weighted component
securities comprising in the aggregate 25% of the index's weighting
have an aggregate dollar value of ADTV of less than $50,000,000
($30,000,000 in the case of an index with 15 or more component
securities).
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The SEC welcomes comments as to the benefits and flexibility
provided by the methods of calculation and limited exclusion discussed
above and also seeks comments as to any alternative methodologies that
may be used.
B. Costs
In complying with proposed Rules 3a55-1 through 3a55-3 under the
Exchange Act, a national securities exchange, designated contract
market, registered DTEF, or foreign board of trade would incur certain
costs. Under the CFMA, national securities exchanges, designated
contract markets, registered DTEFs, and foreign boards of trade must
use the methods provided by the proposed rules to determine whether or
not a security index is narrow-based and thus whether the
[[Page 27574]]
futures contract is subject solely to the CFTC's jurisdiction or
subject to joint jurisdiction of the CFTC and SEC. Thus the costs of
complying with the proposed rules primarily are attributable to the
implementation of the new provisions of the Exchange Act pertaining to
the definition of narrow-based security index. National securities
exchanges, designated contract markets, registered DTEFs, and foreign
boards of trade trading these products are responsible for assuring
compliance with the proposed rules and thus would incur various costs
in determining the market capitalization and the dollar value of ADTV
for component securities of a security index. The SEC, however, is
unable at this time to estimate the extent of the costs the proposed
calculation methodologies will engender.
The statutorily-mandated computations contained in the proposed
rules would require national securities exchanges, designated contract
markets, registered DTEFs, and foreign boards of trade to gather
information to ascertain the market capitalization and the dollar value
of ADTV for component securities of an index with respect to each day,
taking into account data for the preceding 6 full calendar months. To
compute market capitalization, the proposed rules require a market to
know the number of outstanding shares of a security as reported on the
issuer's most recent annual or periodic report filed with the SEC and
each security's average price during the preceding 6 full calendar
months. To compute dollar value of ADTV, the rules require a market to
tally the average daily trading volume and the average price for each
component security during the preceding 6 full calendar months. An
additional calculation would be required to determine the lowest
weighted 25% of an index. Alternatively, a market could incur costs if
it contracted with an outside party to perform the calculations. In
addition, a national securities exchange, designated contract market,
registered DTEF, or foreign board of trade may be confronted with costs
associated with obtaining and accessing appropriate data from an
independent third party vendor. For example, national securities
exchanges, designated contract markets, registered DTEFs, and foreign
boards of trade may be required to pay certain fees to such a vendor to
acquire the necessary information. Furthermore, if the market
capitalization and dollar value of ADTV calculations require data that
is not readily available, particularly if foreign data is used,
national securities exchanges, designated contract markets, registered
DTEFs, and foreign boards of trade possibly would incur additional
costs to obtain such data. The SEC requests comments, data, and
estimates on all aspects of the costs associated with the proposed
calculations. Commenters should address the likelihood that certain
market information may not be readily available and the potential costs
associated with obtaining that information.
In addition, an exclusion from the definition of narrow-based
security index is available when all component securities are among
both the Top 750 securities (by market capitalization) and Top 675
securities (by dollar value of ADTV). A designated contract market,
registered DTEF, or foreign board of trade would be charged with
identifying these Top 750 and Top 675 securities to determine whether a
security index qualifies for this exclusion by using the calculations
specified in the proposed rules. Commenters are requested to provide
comments, cost estimates, and any other relevant data with respect to
the costs involved in making such determinations.
The calculations required under the proposed rules for market
capitalization and the dollar value of ADTV may require additional data
storage.\75\ A national securities exchange, designated contract
market, or registered DTEF would need to consider how to store the
data--whether to maintain hard copies or electronic copies of all the
computations. The national securities exchange, designated contract
market, or registered DTEF would also have to take into consideration
the time period for which the data would have to be stored and the
costs associated with such storage and maintenance. The SEC
specifically requests comments on the recordkeeping costs and data
maintenance associated with the proposals and whether these costs would
be significant.
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\75\ Under Rule 17a-1 under the Exchange Act, 17 CFR 240.17a-1,
and Sections 5(d)(17) and 5a(d)(8) of the CEA, and proposed Rule
41.2 under the CEA, respectively, national securities exchanges,
designated contract markets, and registered DTEFs would need to
preserve records of all their determinations with respect to the
narrow-based or non-narrow-based status of security indexes.
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A national securities exchange, designated contract market,
registered DTEF, or foreign board of trade may also incur resource
costs to carry out the computations required under the proposed rules.
Comments are requested as to whether the proposed rules are likely to
result in a need to increase the number of staff, or result in
additional resource burdens, to perform the required calculations.
Commenters should provide cost data to support their views.
Finally, the SEC requests commenters to identify any other costs
associated with the proposals that have not been considered herein, and
what the extent of those costs would be.
VIII. Consideration of Burden on Competition, and Promotion of
Efficiency, Competition, and Capital Formation
SEC
Section 3(f) of the Exchange Act requires the SEC, when engaged in
rulemaking that requires it to consider or determine whether an action
is necessary or appropriate in the public interest, to consider whether
the action would promote efficiency, competition, and capital
formation.\76\ Section 23(a)(2) requires the SEC, in adopting rules
under the Exchange Act, to consider the impact any rule would have on
competition.\77\
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\76\ Section 3(f) of the Exchange Act, 15 U.S.C. 78c(f).
\77\ Section 23(a)(2) of the Exchange Act, 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------
The SEC believes that proposed Rule 3a55-1 would promote efficiency
by setting forth clear methods and guidelines for national securities
exchanges, designated contract markets, registered DTEFs, and foreign
boards of trade in applying the statutory definition of narrow-based
security index. The SEC further believes that proposed Rule 3a55-2
would promote efficiency by providing designated contract markets,
registered DTEFs, and foreign boards of trade a way to ensure that a
futures contract trading solely under the jurisdiction of the CFTC does
not suddenly become a security future within the first 30 days of
trading and subject, as a result, to a new regulatory regime. The SEC
also believes that proposed Rule 3a55-3 would promote efficiency by
clarifying and establishing that when a futures contract on an index is
traded on or subject to the rules of a foreign board of trade, such
index would not be a narrow-based security index if it would not be a
narrow-based security index if a futures contract on such index were
traded on a designated contract market or registered DTEF.
The SEC preliminarily believes that the proposed rules may enhance
capital formation, because the proposed rules would provide clarity
with respect to the method for determining whether a particular
security index is narrow-based or broad-based. In this way, market
participants would have
[[Page 27575]]
certainty as to whether a futures contract on a particular index falls
within the sole jurisdiction of the CFTC or will be under the joint
jurisdiction of the SEC and CFTC. The benefits to the capital formation
process, however, principally flow from the CFMA itself, which lifts
the ban on the trading of single stock futures and narrow-based stock
index futures.
The SEC preliminarily believes that the proposed rules would not
impose any significant burdens on competition. The statutory definition
of narrow-based security index and the exclusions from that definition
contained in Section 1a(25)(A) and (B) of the CEA and Section
3(a)(55)(B) and (C) of the Exchange Act set forth the criteria that a
market trading a futures contract on a stock index must use to
determine whether the SEC and CFTC jointly, or the CFTC alone, would
have regulatory authority over that futures contract. The statutory
definition of a narrow-based security index and the exclusions from
that definition substantively are identical in both the CEA and the
Exchange Act, and the joint CFTC-SEC rules proposed in this release
also are substantively identical.
The CFMA directs the SEC and CFTC to jointly specify methods for
determining market capitalization and the dollar value of ADTV as those
terms are used in the aforementioned statutory definition and
exclusion. The SEC believes that proposed Rule 3a55-1, developed
jointly with the CFTC, sets forth objective methods in fulfillment of
the CFMA directive and further clarifies the application of the
statute. The SEC believes that proposed Rule 3a55-2 is necessary in the
public interest to prevent potential dislocations for market
participants trading a futures contract on an index that becomes
narrow-based during the first 30 days of trading and would impose no
burden on competition. In addition, the SEC believes that proposed Rule
3a55-3 is necessary in the public interest and would impose no burden
on competition because it serves to clarify and establish that when a
futures contract on a security index is traded on or subject to the
rules of a foreign board of trade, that index shall not be considered a
narrow-based security index if it would not be a narrow-based security
index pursuant to the statutory definition of a narrow-based security
index or the exclusions from that definition.
The SEC requests comments on the potential benefits, as well as
adverse consequences, that may result with respect to efficiency,
competition, and capital formation if the proposed rules are adopted.
IX. Regulatory Flexibility Act Certifications
CFTC
The Regulatory Flexibility Act ("RFA") requires federal agencies,
in promulgating rules, to consider the impact of those rules on small
entities.\78\ The rules adopted herein would affect contract markets
and other trading facilities. 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.\79\
In its previous determinations, the CFTC has concluded that contract
markets are not small entities for the purpose of the RFA.\80\ The CFTC
has also recently proposed determining that the other trading
facilities subject to its jurisdiction, for reasons similar to those
applicable to contract markets, would not be small entities for
purposes of the RFA.\81\
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\78\ 5 U.S.C. 601 et seq.
\79\ See 47 FR 18618-21 (April 30, 1982).
\80\ See id. at 18619 (discussing contract markets).
\81\ See 66 FR 14262, 14268 (March 9, 2001).
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Accordingly, the CFTC does not expect the rules, as proposed
herein, to have a significant economic impact on a substantial number
of small entities. Therefore, the Acting Chairman, on behalf of the
CFTC, hereby certifies, pursuant to 5 U.S.C. 605(b), that the proposed
amendments will not have a significant economic impact on a substantial
number of small entities. The CFTC invites the public to comment on
this finding and on its proposed determination that trading facilities
such as registered DTEFs not be small entities for purposes of the RFA.
SEC
Section 603(a) \82\ of the Administrative Procedures Act
("APA"),\83\ as amended by the RFA,\84\ generally requires the SEC to
undertake a regulatory flexibility analysis of all proposed rules, or
proposed rule amendments, to determine the impact of such rulemaking on
"small entities."\85\ Section 605(b) of the RFA specifically exempts
from this requirement any proposed rule, or proposed rule amendment,
which, if adopted, would not "have a significant economic impact on a
substantial number of small entities." Proposed Rule 3a55-1 provides
methods for determining market capitalization and dollar value of ADTV
in addition to other guidelines in applying the definition of narrow-
based security index. Proposed Rule 3a55-2 creates an exemption from
the definition of narrow-based security index for designated contract
markets, registered DTEFs, and foreign boards of trade trading certain
futures contracts. Proposed Rule 3a55-3 under the Exchange Act
establishes that when a futures contract on a security index is traded
on or subject to the rules of a foreign board of trade, that index
shall not be considered a narrow-based security index if it would not
be a narrow-based security index pursuant to the statutory definition
of a narrow-based security index or the exclusions from that
definition. Because only national securities exchanges, designated
contract markets, registered DTEFs, and foreign boards of trade would
be making determinations as to the status of security indexes on which
future contracts are trading, the Acting Chairman of the SEC has
certified that the proposed rules, if adopted, would not have a
significant economic impact on a substantial number of small entities.
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\82\ 5 U.S.C. 603(a).
\83\ 5 U.S.C. 551 et seq.
\84\ 5 U.S.C. 601 et seq.
\85\ Although Section 601(b) of the RFA defines the term "small
entity," the statute permits agencies to formulate their own
definitions. The Commission has adopted definitions of the term
small entity for the purposes of Commission rulemaking in accordance
with the RFA. Those definitions, as relevant to this proposed
rulemaking, are set forth in Rule 0-10, 17 CFR 240.0-10. See
Securities Exchange Act Release No. 18452 (January 28, 1982), 47 FR
5215 (February 4, 1982).
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The SEC invites commenters to address whether the proposed rules
would have a significant economic impact on a substantial number of
small entities, and if so, what would be the nature of any impact on
small entities. The SEC requests that commenters provide empirical data
to support the extent of such impact.
This certification is attached as an Appendix.
X. Statutory Bases and Text of Proposed Rules
List of Subjects
17 CFR Part 41
Security futures products, Reporting and recordkeeping
requirements.
17 CFR Part 240
Securities.
Commodity Futures Trading Commission
17 CFR Chapter I
In accordance with the foregoing, Title 17, chapter I of the Code
of Federal Regulations is proposed to be amended by adding part 41 as
follows:
[[Page 27576]]
PART 41--SECURITY INDEX AND SECURITY FUTURES PRODUCTS
Sec.
Subpart A--General Provisions
41.1 Definitions.
41.2 Required records.
41.3-41.9 [Reserved]
Subpart B--Narrow-Based Security Indexes
41.10 Purpose and scope.
41.11 Method for determining market capitalization and dollar value
of average daily trading volume; application of the definition of
narrow-based security index.
41.12 Indexes underlying futures contracts trading for fewer than
30 days.
41.13 Futures contracts on security indexes trading on or subject
to the rules of a foreign board of trade.
41.14 Transition period for indexes that cease being narrow-based
security indexes.
Authority: 7 U.S.C. 1a(25), 2a and 12a(5).
Subpart A--General Provisions
Sec. 41.1 Definitions.
For purposes of this part:
(a) Broad-based security index means a group or index of securities
that does not constitute a narrow-based security index.
(b) Foreign board of trade means a board of trade located outside
of the United States, its territories or possessions, whether
incorporated or unincorporated, where foreign futures or foreign
options are entered into.
(c) Narrow-based security index has the same meaning as in section
1a(25) of the Commodity Exchange Act.
Sec. 41.2 Required records.
A designated contract market or registered derivatives transaction
execution facility that trades a security index or security futures
product shall maintain in accordance with the requirements of Sec. 1.31
books and records of all activities related to the trading of such
products, including: Records related to any determination under subpart
B of this part whether or not a futures contract on a security index is
a narrow-based security index or a broad-based security index.
Secs. 41.3--41.9 [Reserved]
Subpart B--Narrow-Based Security Indexes
Sec. 41.10 Purpose and scope.
This subpart includes methods to be used by trading facilities for
the purpose of determining whether a futures product is based on an
index of securities subject to the joint jurisdiction of the Commodity
Futures Trading Commission and the Securities and Exchange Commission
or is based on a broad-based security index subject to the exclusive
jurisdiction of the Commodity Futures Trading Commission. The methods
included in this subpart relate to determining market capitalization
and dollar value of average daily trading volume which are terms used,
but not developed, in the statutory definitions of "narrow-based
security product." Consistent with Section 1a(25)(E)(ii) of the
Commodity Exchange Act and Section 3a(55)(F)(ii) of the Securities
Exchange Act of 1934, the methods for determining market capitalization
and dollar value of average daily trading volume set forth in this
subpart have been adopted jointly by the Commodity Futures Trading
Commission and the Securities and Exchange Commission. The subpart also
includes rules that permit, subject to certain conditions, a trading
facility to continue to trade a narrow-based security index or a broad-
based security index, as the case may be, after that index has become a
broad-based security index or a narrow-based security index, as the
case may be. The comparable rules of the Securities and Exchange
Commission may be found at 17 CFR 240.3a55-1 through 240.3a55-3.
Sec. 41.11 Method for determining market capitalization and dollar
value of average daily trading volume; application of the definition of
narrow-based security index.
(a) Determining market capitalization and dollar value of average
daily trading volume ("ADTV"). The method to be used to determine a
security's market capitalization for purposes of Section 1a(25)(B) of
the Act (7 U.S.C. 1a(25)(B)), and dollar value of ADTV for purposes of
Section 1a(25)(A) and (B) of the Act (7 U.S.C. 1a(25)(A) and (B)) shall
be as follows:
(1) Market capitalization. The market capitalization of a security
is the product of:
(i) The average price of such security; and
(ii) The number of outstanding shares of such security.
(2) Dollar value of ADTV. (i) The dollar value of ADTV of a single
security is the product of:
(A) The average price of such security; and
(B) The ADTV of such security.
(ii) The dollar value of ADTV of the lowest weighted 25% of an
index is the sum of the dollar value of ADTV of each of the component
securities comprising the lowest weighted 25% of such index.
(iii) The dollar value of ADTV of the lowest weighted 25% of an
index may be calculated by using average price as defined in paragraph
(b)(2)(ii) of this section, provided that when such average price is
used, the dollar value of ADTV of the lowest weighted 25% of the index
equals or exceeds $55,000,000 (or in the case of an index with 15 or
more component securities, $33,000,000).
(b) Definitions. For purposes of this section:
(1) Average daily trading volume in a security means the total
number of shares of such security traded on the trading days of the
principal market for the security during the preceding 6 full calendar
months (which may include any shares traded on a market outside the
United States, provided such information has been reported to a foreign
financial regulatory authority in the jurisdiction where the security
is traded) divided by the number of trading days of the principal
market for the security during the preceding 6 full calendar months.
(2) Average price. (i) Average price of a security means the total
dollar value of all transactions in such security on the trading days
of the principal market for the security during the preceding 6 full
calendar months (which may include transactions on a market outside the
United States, provided such information has been reported to a foreign
financial regulatory authority in the jurisdiction where the security
is traded) divided by the total number of shares traded in such
transactions, where the dollar value for each transaction is the price
per share in U.S. dollars of such transaction multiplied by the number
of shares in such transaction.
(ii) For purposes of paragraph (a)(2)(iii) of this section only,
average price of a security may be calculated as the sum of the price
per share in U.S. dollars for each transaction in such security on the
trading days of the principal market for the security during the
preceding 6 full calendar months (which may include prices of
transactions on a market outside the United States, provided such
information has been reported to a foreign financial regulatory
authority in the jurisdiction where the security is traded) divided by
the total number of such transactions during the preceding 6 full
calendar months.
(iii) If the price of a transaction is reported in a currency other
than U.S. dollars, such price must be converted into U.S. dollars on
the basis of the transaction date's noon buying rate in New York City
for cable transfers in foreign currencies as certified for customs
purposes by the Federal Reserve Bank of New York.
[[Page 27577]]
(iv) The transactions used to determine average price must be the
same transactions used to determine ADTV.
(3) Foreign financial regulatory authority has the same meaning as
in Section 3(a)(52) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(52)).
(4) Lowest weighted 25% of an index. With respect to any particular
day, the lowest weighted component securities comprising, in the
aggregate, 25% of an index's weighting for purposes of Section 1a(25)
of the Act ("lowest weighted 25% of an index"), means those
securities:
(i) That are the lowest weighted securities when all the securities
in such index are ranked from lowest to highest based on the index's
weighting methodology; and
(ii) For which the sum of the weight of such securities is equal
to, or less than, 25%.
(5) Outstanding shares of a security means the number of
outstanding shares of such security as reported on the most recent
Form10-K, Form10-Q, Form 10-KSB, Form 10-QSB, or Form 20-F (17 CFR
Secs. 249.310, 249.308a, 249.310b, 249.308b, or 249.220f) filed with
the Securities and Exchange Commission by the issuer of such security.
(6) Preceding 6 full calendar months means, with respect to a
particular day, the period of time beginning on the same day of the
month 6 months before and ending on the day prior to such day.
(7) Principal market for a security means the single securities
market with the largest reported trading volume for the security during
the preceding 6 full calendar months.
(8) Trading days of the principal market means all days on which
the principal market for the security is open for trading.
(9) Weighting of a component security of an index means the
percentage of such index's value represented, or accounted for, by such
component security.
Sec. 41.12 Indexes underlying futures contracts trading for fewer than
30 days.
(a) An index on which a contract of sale for future delivery is
trading on a designated contract market, registered derivatives
transaction execution facility, or foreign board of trade is not a
narrow-based security index under Section 1a(25) of the Act (7 U.S.C.
1a(25)) for the first 30 days of trading, if such index would not have
been a narrow-based security index on each day of the preceding 6 full
calendar months prior to the commencement of trading of such contract.
(b) An index that is not a narrow-based security index for the
first 30 days of trading pursuant to paragraph (a) of this section,
shall become a narrow-based security index if such index has been a
narrow-based security index for more than 45 business days over 3
consecutive calendar months.
(c) An index that becomes a narrow-based security index solely
because it was a narrow-based security index for more than 45 business
days over 3 consecutive calendar months pursuant to paragraph (b) of
this section shall not be a narrow-based security index for the
following 3 calendar months.
(d) Preceding 6 full calendar months has the same meaning as in
Sec. 41.11(b)(6).
Sec. 41.13 Futures contracts on security indexes trading on or subject
to the rules of a foreign board of trade.
When a contract of sale for future delivery on a security index is
traded on or subject to the rules of a foreign board of trade, such
index shall not be a narrow-based security index if a futures contract
on such index were traded on a designated contract market or registered
derivatives transaction execution facility.
Sec. 41.14 Transition period for indexes that cease being narrow-based
security indexes.
(a) Forty-five day tolerance provision. An index that is a narrow-
based security index that becomes a broad-based security index for no
more than 45 days over 3 consecutive calendar months shall be a narrow-
based security index.
(b) Transition period for indexes that cease being narrow-based
security indexes for more than forty-five days. An index that is a
narrow-based security index that becomes a broad-based security index
for more than 45 days over 3 consecutive calendar months shall continue
to be a narrow-based security index for the following 3 calendar
months.
(c) Trading in months with open interest following transition
period. After the transition period provided for in paragraph (b) of
this section ends, a national securities exchange may continue to trade
only in those months in the security futures product that had open
interest on the date the transition period ended and shall limit
trading to positions that liquidate previously-established positions.
(d) Definition of calendar month. Calendar month means, with
respect to a particular day, the period of time beginning on a calendar
date and ending during another month on a day prior to such date.
By the Commodity Futures Trading Commission.
Dated: May 10, 2001.
Jean A. Webb,
Secretary.
Securities and Exchange Commission
17 CFR Chapter II
In accordance with the foregoing, Title 17, chapter II, part 240 of
the Code of Federal Regulations is proposed to be amended as follows:
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
1. The 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, 78f, 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. Sections 240.3a55-1 through 240.3a55-3 are added to read as
follows:
Sec. 240.3a55-1 Method for determining market capitalization and
dollar value of average daily trading volume; application of the
definition of narrow-based security index.
(a) Determining market capitalization and dollar value of average
daily trading volume ("ADTV"). The method to be used to determine a
security's market capitalization for purposes of Section 3(a)(55)(C) of
the Act (15 U.S.C. 78c(a)(55)(C)) and dollar value of ADTV for purposes
of Section 3(a)(55)(B) and (C) of the Act (15 U.S.C. 78c(a)(55)(B) and
(C)) shall be as follows:
(1) Market capitalization. The market capitalization of a security
is the product of:
(i) The average price of such security; and
(ii) The number of outstanding shares of such security.
(2) Dollar value of ADTV. (i) The dollar value of ADTV of a single
security is the product of:
(A) The average price of such security; and
(B) The ADTV of such security.
(ii) The dollar value of ADTV of the lowest weighted 25% of an
index is the sum of the dollar value of ADTV of each of the component
securities comprising the lowest weighted 25% of such index.
(iii) The dollar value of ADTV of the lowest weighted 25% of an
index may be calculated by using average price as defined in paragraph
(b)(2)(ii) of this section, provided that when such average price is
used, the dollar value of ADTV of the lowest weighted 25% of
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the index equals or exceeds $55,000,000 (or in the case of an index
with 15 or more component securities, $33,000,000).
(b) Definitions. For purposes of this section:
(1) Average daily trading volume in a security means the total
number of shares of such security traded on the trading days of the
principal market for the security during the preceding 6 full calendar
months (which may include any shares traded on a market outside the
United States, provided such information has been reported to a foreign
financial regulatory authority in the jurisdiction where the security
is traded) divided by the number of trading days of the principal
market for the security during the preceding 6 full calendar months.
(2) Average price. (i) Average price of a security means the total
dollar value of all transactions in such security on the trading days
of the principal market for the security during the preceding 6 full
calendar months (which may include transactions on a market outside the
United States, provided such information has been reported to a foreign
financial regulatory authority in the jurisdiction where the security
is traded) divided by the total number of shares traded in such
transactions, where the dollar value for each transaction is the price
per share in U.S. dollars of such transaction multiplied by the number
of shares in such transaction.
(ii) For purposes of paragraph (a)(2)(iii) of this section only,
average price of a security may be calculated as the sum of the price
per share in U.S. dollars for each transaction in such security on the
trading days of the principal market for the security during the
preceding 6 full calendar months (which may include prices of
transactions on a market outside the United States, provided such
information has been reported to a foreign financial regulatory
authority in the jurisdiction where the security is traded) divided by
the total number of such transactions during the preceding 6 full
calendar months.
(iii) If the price of a transaction is reported in a currency other
than U.S. dollars, such price must be converted into U.S. dollars on
the basis of the transaction date's noon buying rate in New York City
for cable transfers in foreign currencies as certified for customs
purposes by the Federal Reserve Bank of New York.
(iv) The transactions used to determine average price must be the
same transactions used to determine ADTV.
(3) Foreign financial regulatory authority has the same meaning as
in Section 3(a)(52) of the Act (15 U.S.C. 78c(a)(52)).
(4) Lowest weighted 25% of an index. With respect to any particular
day, the lowest weighted component securities comprising, in the
aggregate, 25% of an index's weighting for purposes of Section
3(a)(55)(B)(iv) of the Act (15 U.S.C. 78c(a)(55)(B)(iv)) ("lowest
weighted 25% of an index") means those securities:
(i) That are the lowest weighted securities when all the securities
in such index are ranked from lowest to highest based on the index's
weighting methodology; and
(ii) For which the sum of the weight of such securities is equal
to, or less than, 25%.
(5) Outstanding shares of a security means the number of
outstanding shares of such security as reported on the most recent Form
10-K, Form 10-Q, Form 10-KSB, Form 10-QSB, or Form 20-F (17 CFR
249.310, 249.308a, 249.310b, 249.308b, or 249.220f) filed with the
Commission by the issuer of such security.
(6) Preceding 6 full calendar months means, with respect to a
particular day, the period of time beginning on the same day of the
month 6 months before and ending on the day prior to such day.
(7) Principal market for a security means the single securities
market with the largest reported trading volume for the security during
the preceding 6 full calendar months.
(8) Trading days of the principal market means all days on which
the principal market for the security is open for trading.
(9) Weighting of a component security of an index means the
percentage of such index's value represented, or accounted for, by such
component security.
Sec. 240.3a55-2 Indexes underlying futures contracts trading for fewer
than 30 days.
(a) An index on which a contract of sale for future delivery is
trading on a designated contract market, registered derivatives
transaction execution facility, or foreign board of trade is not a
narrow-based security index under Section 3(a)(55) of the Act (15
U.S.C. 78c(a)(55)) for the first 30 days of trading, if such index
would not have been a narrow-based security index on each day of the
preceding 6 full calendar months prior to the commencement of trading
of such contract.
(b) An index that is not a narrow-based security index for the
first 30 days of trading pursuant to paragraph (a) of this section,
shall become a narrow-based security index if such index has been a
narrow-based security index for more than 45 business days over 3
consecutive calendar months.
(c) An index that becomes a narrow-based security index solely
because it was a narrow-based security index for more than 45 business
days over 3 consecutive calendar months pursuant to paragraph (b) of
this section shall not be a narrow-based security index for the
following 3 calendar months.
(d) Preceding 6 full calendar months has the same meaning as in
Sec. 240.3a55-1.
Sec. 240.3a55-3 Futures contracts on security indexes trading on or
subject to the rules of a foreign board of trade.
When a contract of sale for future delivery on a security index is
traded on or subject to the rules of a foreign board of trade, such
index shall not be a narrow-based security index if it would not be a
narrow-based security index if a futures contract on such index were
traded on a designated contract market or registered derivatives
transaction execution facility.
By the Securities and Exchange Commission.
Dated: May 10, 2001.
Margaret H. McFarland,
Deputy Secretary.
Appendix
Note: This appendix to the preamble will not appear in the Code
of Federal Regulations.
Regulatory Flexibility Act Certification
I, Laura S. Unger, Acting Chairman of the Securities and
Exchange Commission ("SEC"), hereby certify, pursuant to 5 U.S.C.
605(b), that proposed Rules 3a55-1, 3a55-2, and 3a55-3 under the
Securities Exchange Act of 1934 ("Exchange Act") would not, if
adopted, have a significant economic impact on a substantial number
of small entities. Under the Commodity Futures Modernization Act of
2000, the SEC and the Commodity Futures Trading Commission
("CFTC") jointly must specify the method to be used to determine
"market capitalization" and "dollar value of average daily
trading volume" ("ADTV") for purposes of Section 3(a)(55) of the
Exchange Act and Section 1a(25) of the Commodity Exchange Act.
Proposed Rule 3a55-1 would specify the methods for determining the
dollar value of ADTV and market capitalization for purposes of
ascertaining whether a security index is narrow-based under Section
3(a)(55) of the Exchange Act. Proposed Rule 3a55-2 would create an
exemption from the definition of narrow-based security index for
designated contract markets, registered derivatives transaction
execution facilities ("DTEFs"), and foreign boards of trade
trading certain futures contracts. Proposed Rule 3a55-3 under the
Exchange Act would establish that
[[Page 27579]]
when a futures contract on a security index is traded on or subject
to the rules of a foreign board of trade, that index shall not be
considered a narrow-based security index if it would not be a
narrow-based security index pursuant to the definition of a narrow-
based security index, or the exclusions from that definition,
contained in Section 3(a)(55) of the Exchange Act. The proposed
rules would be incorporated into a joint rulemaking with the CFTC.
Only national securities exchanges, designated contract markets,
registered DTEFs, and foreign boards of trade would be involved in
the calculation of ADTV and market capitalization, all of which are
not small entities for purposes of the Regulatory Flexibility Act.
Accordingly, proposed Rules 3a55-1, 3a55-2, and 3a55-3 would not
have a significant economic impact on a substantial number of small
entities.
Dated: May 9, 2001.
Laura S. Unger,
Acting Chairman.
[FR Doc. 01-12278 Filed 5-16-01; 8:45 am]
BILLING CODE 8010-01-P