[Federal Register: August 23, 2001 (Volume 66, Number 164)]
[Rules and Regulations]
[Page 44489-44516]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr23au01-12]
[[Page 44489]]
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Part III
Commodity Futures Trading Commission
Securities and Exchange Commission
17 CFR Parts 41 and 240
Method for Determining Market Capitalization and Dollar Value of
Average Daily Trading Volume; Application of the Definition of Narrow-
Based Security Index; Joint Fi
[[Page 44490]]
nal Rule
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 41
RIN 3038-AB77
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-44724; 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; Joint Final Rule
AGENCIES: Commodity Futures Trading Commission and Securities and
Exchange Commission.
ACTION: Joint Final Rules.
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SUMMARY: The Commodity Futures Trading Commission (``CFTC'') and
Securities and Exchange Commission (``SEC'') (collectively,
``Commissions'') are adopting joint final rules to 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 ``market capitalization'' and ``dollar value of average daily
trading volume'' for purposes of the new definition of ``narrow-based
security index,'' including exclusions from that definition, in the
Commodity Exchange Act (``CEA'') and the Securities Exchange Act of
1934 (``Exchange Act''). The CFMA also directs the Commissions to
jointly adopt rules or regulations that set forth the requirements for
an index underlying a contract of sale for future delivery traded on or
subject to the rules of a foreign board of trade to be excluded from
the definition of ``narrow-based security index.''
EFFECTIVE DATE: August 21, 2001.
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, N.W., Washington,
D.C. 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, N.W., Washington, D.C. 20549-1001.
SUPPLEMENTARY INFORMATION: The CFTC is adopting Subparts A and B of
Part 41 (Rules 41.1 and 41.2, and Rules 41.11 through 41.14) under the
CEA,\1\ 17 CFR 41.\2\ The SEC is adopting Rules 3a55-1 through 3a55-3
under the Exchange Act,\3\ 17 CFR 240.3a55-1 through 3a55-3.
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\1\ All references to the CEA are to 7 U.S.C. 1 et seq.
\2\ Subpart A of Part 41 under the CEA consists of general
provisions for purposes of the rules included in this Part,
including definitions (Rule 41.1) and recordkeeping requirements
(Rule 41.2). Subpart B of Rule 41, ``Narrow-Based Security
Indexes,'' begins with Rule 41.11 on purpose and scope. Rules 41.11,
41.12, and 41.13 of Subpart V correspond to Rules 3a55-1, 3a55-2,
and 3a55-3 under the Exchange Act, respectively. Rule 41.14 of
Subpart B parallels provisions incorporated in the CEA and the
Exchange Act by the CFMA.
\3\ All references to the Exchange Act are to 15 U.S.C. 78a et
seq.
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Table of Contents
I. Background and Overview of New Rules
A. Statutory Provisions
1. Definition of Narrow-Based Security Index
2. Indexes Excluded from Definition of Narrow-Based Security
Index
B. Proposing Release
C. Final Rules--An Overview
II. Discussion of Joint Final Rules
A. CEA Rule 41.11 and Exchange Act Rule 3a55-1: Methods for
Determining Market Capitalization and Dollar Value of Average Daily
Trading Volume
1. Determining the Market Capitalization of a Security
a. Proposed Rules
b. Comment Letters
c. Final Rules
2. Determining Dollar Value of Average Daily Trading Volume of a
Security
a. Proposed Rules
b. Comment Letters
c. Final Rules
i. Dollar Value of ADTV for Purposes of Section 1a(25)(A) of the
CEA and Section 3(a)(55)(B) of the Exchange Act
ii. Dollar Value of ADTV for Purposes of Determining Whether a
Security is One of the Top 675
3. Use of the Top 750 and Top 675 Lists
4. The Lowest Weighted 25% of an Index
5. Determining ``the Preceding 6 Full Calendar Months''
6. Depositary Shares
7. General Guidance in Application of the Rule
B. CEA Rule 41.12 and Exchange Act Rule 3a55-2: A Future on a
Broad-Based Security Index that Becomes Narrow-Based During First 30
Days of Trading
1. The Relevant Statutory Provision
2. Proposed Rules
3. Comment Letters
4. Final Rules
5. Other Issues Concerning a Broad-Based Index that Becomes
Narrow-Based
C. CEA Rule 41.13 and Exchange Act Rule 3a55-3: A Future Traded
on or Subject to the Rules of a Foreign Board of Trade
1. Proposed Rules
2. Comment Letters
3. Final Rules
D. CEA Rule 41.14: A Future on a Narrow-Based Security Index
that Becomes Broad-Based
1. The Relevant Statutory Provision
2. Proposed Rule
3. Comment Letters
4. Final Rule
E. Additional Comments
III. Administrative Procedure Act
CFTC
SEC
IV. Paperwork Reduction Act
CFTC
SEC
A. The Use and Disclosure of the Information Collected
B. Total Annual Reporting and Recordkeeping Burden
1. Capital Costs
2. Burden Hours
V. Costs and Benefits of the Final Rules
CFTC
SEC
A. Comments
B. Benefits
C. Costs
VI. Consideration of Burden on Competition, and Promotion of
Efficiency, Competition, and Capital Formation
SEC
VII. Regulatory Flexibility Act Certification
CFTC
SEC
VIII. Text of Rules
I. Background and Overview of New Rules
A. Statutory Provisions
The CFMA,\4\ which became law on December 21, 2000, establishes a
framework for the joint regulation by the CFTC and SEC of the trading
of futures on single securities and on narrow-based security indexes
(collectively, ``security futures'').\5\ Previously, these products
were statutorily prohibited from trading in the United States. Under
the CFMA, designated contract markets and registered derivatives
transaction execution facilities (``DTEFs'') may trade security futures
if they register with the
[[Page 44491]]
SEC and comply with certain other requirements of the Exchange Act.
Likewise, national securities exchanges and national securities
associations may trade security futures if they register with the CFTC
and comply with certain requirements of the CEA.
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\4\ Pub. L. No. 106-554, 114 Stat. 2763 (2000).
\5\ No person may execute or trade a security futures 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
on the later of August 21, 2001, or such date that a futures
association registered under Sectionn 17 of the CEA meets the
requirements in Section 15A(k)(2) of the Exchange Act, eligible
contract participants may enter into transactions with each other on
a principal-to-principal basis. Section 2(a)(1)(D)(iii)(II) of the
CEA and Section 6(h)(6) of the Exchange Act provide that options on
security futures may not be traded for at least three years after
the enactment of the CFMA.
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To distinguish between security futures on narrow-based security
indexes, which are jointly regulated by the Commissions, and futures on
broad-based security indexes, which are under the exclusive
jurisdiction of the CFTC,\6\ the CFMA also amended the CEA and the
Exchange Act by adding an objective definition of ``narrow-based
security index.''
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\6\ Prior to the enactment of the CFMA, futures on broad-based
indexes were subject to the sole jurisdiction of the CFTCC, with the
SEC having a limited right of review, to ensure compliance with the
provisions of the Shad-Johnson Accord as implemented in former
Section 2(a)(1)(B) of the CEA. This 1982 jurisdictional accord
(signed into law in 1983) permitted futures exchanges to trade
futures on security indexes if they were cash-settled and were not
readily susceptible to manipulation and if the indexes traded
measured and reflected a market segment. See Futures Trading Act of
1982 Section 101, Pub. L. 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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1. Definition of Narrow-Based Security Index
Under the CEA and 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) the five highest weighted 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 (``lowest weighted 25%'') 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 securities, $30
million).\7\
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\7\ Section 1a(25)(A)(i)-(iv) of the CEA and Section
3(a)(55)(B)(i)-(iv) of the Exchange Act.
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Any security index that does not have any of the four
characteristics set forth above is, in effect, a broad-based security
index. Accordingly, any future on such an index would not be a security
future and thus would be subject to the sole jurisdiction of the
CFTC.\8\
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\8\ See Section 2(a)(1)(C)(ii) of the CEA. A future on a
security index that is not a narrow-based security index under this
definition may include component securities that are not registered
under Section 12 of the Exchange Act.
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2. Indexes Excluded from Definition of Narrow-Based Security Index
The definition of narrow-based security index in the CEA and
Exchange Act also excludes from its scope certain security indexes that
satisfy specified criteria. A future on an index that meets the
criteria of any of the six categories of indexes that are so excluded
from the definition is not a security future under the securities laws,
and thus is subject solely to the jurisdiction of the CFTC.
The first and most fundamental exclusion applies to indexes
comprised wholly of U.S.-registered securities that have high market
capitalization and dollar value of ADTV, and meet certain other
criteria. Specifically, a security index is not a narrow-based security
index under this exclusion 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 the index's 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'').\9\
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\9\ Section 1a(25)(B)(i) of the CEA and Section 3(a)(55)(C)(i)
of the Exchange Act.
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The second exclusion provides that a security index is not a
narrow-based security index if a board of trade was designated by the
CFTC as a contract market in a future on the index before the CFMA was
enacted.\10\
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\10\ Section 1a(25)(B)(ii) of the CEA and Section
3(a)(55)(C)(ii) of the Exchange Act.
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The third exclusion provides that if a future was trading on an
index that was not a narrow-based security index for at least 30 days,
the index is excluded from the definition of a ``narrow-based security
index'' as long as it does not assume the characteristics of narrow-
based security index for more than 45 business days over three calendar
months.\11\ This exclusion, in effect, creates a tolerance period that
permits a broad-based security index to retain its broad-based status
if it becomes narrow-based for 45 or fewer business days in the three-
month period.\12\
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\11\ Section 1a(25)(B)(iii) of the CEA and Section
3(a)(55)(C)(ii) of the Exchange Act.
\12\ If the index becomes narrow-based for more than 45 days
over three consecutive calendar months, the statute then provides an
additional grace period of three months during which the index is
excluded from the definition of narrow-based security index. See
Section 1a(25)(D) of the CEA and Section 2(a)(55)(E) of the Exchange
Act.
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The fourth exclusion provides that a security index is not a
narrow-based security index if it is traded on or subject to the rules
of a foreign board of trade and meets such requirements as are jointly
established by rule or regulation by the CFTC and SEC.\13\
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\13\ Section 1a(25)(B)(iv) of the CEA and Section
3(a)(55)(C)(iv) of the Exchange Act.
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The fifth exclusion is essentially a temporary ``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.\14\ Specifically, the exclusion provides that, until June 21,
2002, a security index is not a narrow-based security index if: (1) A
future on the index is traded on or subject to the rules of a foreign
board of trade; (2) the offer and sale of such future in the United
States was authorized before the date of enactment of the CFMA; and (3)
the conditions of such authorization continue to apply.\15\
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\14\ Certain of these futures are currently offered to U.S.
customers pursuant to no-action letters issued by the CFTC staff, to
which the SEC has not objected.
\15\ Section 1a(25)(B)(v) of the CEA and Section 3(a)(55)(C)(v)
of the Exchange Act.
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The sixth exclusion provides that an index is not a narrow-based
security index if a future on the index is traded on or subject to the
rules of a board of trade and meets such requirements as are
established by rule, regulation, or order jointly by the two
Commissions.\16\ This exclusion grants the Commissions authority to
jointly establish further exclusions from the definition of narrow-
based security index.
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\16\ Section 1a(25)(B)(vi) of the CEA and Section
3(a)(55)(C)(vi) of the Exchange Act.
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B. Proposing Release
On May 17, 2001, the CFTC and SEC published for comment three
proposed rules under the CEA and Exchange Act relating to this
statutory definition of narrow-based security index and the exclusions
from that definition.\17\ The proposed rules contained methods for
determining ``market capitalization'' and ``dollar value of average
daily trading volume,'' in fulfillment of the directive of the CFMA
that the Commissions, by rule or regulation, jointly specify the
methods to be used to determine these values.\18\
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\17\ Securities Exchange Act Release No. 44288 (May 9, 2001), 66
FR 27560 (``Proposing Release''). See also Securities Exchange Act
Release No. 44475 (June 26, 2001), 66 FR 34864 (July 2, 2001), which
extended the comment period on the proposed rules.
\18\ See Section 1a(25)(E)(ii) of the CEA and Section
3(a)(55)(F)(ii) of the Exchange Act.
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The proposed rules also set forth an additional exclusion from the
definition of narrow-based security index with respect to the trading
of a future on a
[[Page 44492]]
broad-based index during the first 30 days of trading, and added a
provision concerning security indexes traded on or subject to the rules
of a foreign board of trade. The CFTC also published for comment an
additional, related rule under the CEA to accommodate the trading of
security futures on a narrow-based security index that became a broad-
based index.
The Commissions received 16 comment letters on the proposals, which
are discussed more fully below.\19\ In large part, commenters favored
the proposed rules, but offered various recommendations to refine the
proposals or add new rules.
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\19\ See letters to Jean A. Webb, Secretary, CFTC, and Jonathan
G. Katz, Secretary, SEC, from, or on behalf of: Philip McBride
Johnson, dated May 29, 2001 (``Johnson Letter''); Hong Kong Futures
Exchange Limited, dated June 8, 2001 (``HKFE Letter''); General
Motors Investment Management Corporation, dated June 11, 2001
(``GMIMCo Letter''); American Stock Exchange LLC, dated June 14,
2001 (``Amex Letter''); Bourse de Montreal (The Montreal Exchange,
Inc.), dated June 14, 2001 (``ME Letter''); Chicago Board Options
Exchange, Inc., dated June 18, 2001 (``CBOE Letter''); Chicago
Mercantile Exchange Inc., dated June 18, 2001 (``CME Letter I'');
SFE Corporation Limited, dated June 18, 2001 (``SFE Letter''); The
Board of Trade of the City of Chicago, Inc., dated June 25, 2001
(``CBOT Letter''); Managed Funds Association, dated July 11, 2001
(``MFA Letter''); Barclays Global Investors, N.A., dated July 17,
2001 (``Barclays Letter''); Futures Industry Association, Inc.,
dated July 18, 2001 (``FIA Letter''); The Goldman Sachs Group, Inc.
and its subsidiaries, dated July 18, 2001 (``GS Letter''); U.S.
Securities Markets Coalition, dated July 18, 2001 (``Securities
Markets Coalition Letter''); Chicago Mercantile Exchange Inc., dated
July 30, 2001 (``CME Letter II''); Securities Industry Association,
dated August 3, 2001 (``SIA Letter'').
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C. Final Rules--An Overview
The Commissions have considered the commenters' views and have
modified the proposed rules in some respects to reflect these comments.
A summary of the final rules follows.
Rule 41.11 under the CEA and Rule 3a55-1 under the
Exchange Act
Rules 41.11 under the CEA and 3a55-1 under the Exchange Act
establish a method for determining the dollar value of ADTV of a
security for purposes of the definition of narrow-based security index
under the CEA and Exchange Act. This method requires the inclusion of
reported transactions outside the United States in calculating dollar
value of ADTV for purposes of Section 1a(25)(A) of the CEA and Section
3(a)(55)(B) of the Exchange Act.\20\ It also requires aggregating the
value of trading volume in a depositary share \21\ that represents a
security with trading volume in its underlying security.
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\20\ See supra note 7 and accompanying text.
\21\ Depositary shares are generally evidenced by American
Depositary Receipts, or ``ADRs.''
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In response to comments, the Commissions have incorporated into
their rules a provision that allows for the designation by the
Commissions of a list of the Top 750 securities and Top 675 securities
for purposes of the first exclusion from the definition of narrow-based
security index.\22\ If, however, the Commissions do not designate a
list of such securities, the final rules also establish how national
securities exchanges, designated contract markets, registered DTEFs,
and foreign boards of trade themselves are to calculate the market
capitalization and dollar value of ADTV of securities for purposes of
determining whether a security is one of the Top 750 securities or Top
675 securities. Recognizing concerns about the accessibility of foreign
trading volume data and to assure uniformity among markets, the final
rules establish that only reported transactions in the United States
are to be included in a market's calculations to determine whether a
security is one of the Top 675 securities. The final rules also provide
that the requirement that each component security of an index be
registered under Section 12 of the Exchange Act for purposes of the
first exclusion from the definition of narrow-based security index will
be satisfied with respect to any security that is a depositary share,
if the deposited securities underlying the depositary share are
registered under Section 12, and the depositary shares are registered
under the Securities Act of 1933 on Form F-6.
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\22\ See supra note 9 and accompanying text.
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Finally, the rules define certain terms to add clarity to the
definition of narrow-based security index.
Rule 41.12 under the CEA and Rule 3a55-2 under the
Exchange Act
Rules 41.12 under the CEA and 3a55-2 under the Exchange Act address
the circumstance when a broad-based security index underlying a future
becomes narrow-based during the first 30 days of trading. In such case,
the future does not meet the requirement of having traded for at least
30 days to qualify for the tolerance period granted by Section
1a(25)(B)(iii) of the CEA and Section 3(a)(55)(C)(iii) of the Exchange
Act. The new rules provide that the index will nevertheless be excluded
from the definition of narrow-based security index throughout that
first 30 days if the index would not have been a narrow-based security
index had it been in existence for an uninterrupted period of six
months prior to the first day of trading. In response to comments, the
rules as adopted provide additional criteria by which an index will be
excluded from the definition of a narrow-based security index during
the first 30 days that a future on such index is trading.
Rule 41.13 under the CEA and Rule 3a55-3 under the
Exchange Act
Rule 41.13 under the CEA and Rule 3a55-3 under the Exchange Act
clarify when a security index underlying a future that is traded on or
subject to the rules of a foreign board of trade will be considered a
broad-based security index. Specifically, these rules provide that when
a future on a security index is traded on or subject to the rules of a
foreign board of trade, it will not be considered a narrow-based
security index if it would not be a narrow-based security index if a
future on that same index were traded on a designated contract market
or registered DTEF.
Rule 41.14 under the CEA
Rule 41.14 under the CEA, which is adopted solely by the CFTC,
addresses the circumstance where a future on a narrow-based security
index was trading on a national securities exchange as a security
future and the index subsequently became broad-based by the terms of
the statutory definition--a circumstance not addressed by the statute.
The rule provides that if the index becomes broad-based for no more
than 45 business days over three consecutive calendar months, it will
still be considered a narrow-based security index.
In addition to this 45-day tolerance provision, new Rule 41.14
under the CEA provides that if the index became broad-based for more
than 45 days subsequent to the beginning of trading as a narrow-based
security index, a transition period of three consecutive calendar
months will be granted in which the index will continue to be a narrow-
based security index. After the transition period is over, the exchange
will be permitted to continue trading the product only in those months
in the future that had open interest on the day the transition period
ended.
II. Discussion of Joint Final Rules
A. CEA Rule 41.11 and Exchange Act Rule 3a55-1: Methods for Determining
Market Capitalization and Dollar Value of Average Daily Trading Volume
1. Determining the Market Capitalization of a Security
The market capitalization of a security is relevant only to the
determination of whether a security is one of the 750 securities with
the largest market capitalization, permitting the index of which it is
a component to qualify as broad-based under the first exclusion
[[Page 44493]]
from the definition of narrow-based security index.\23\
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\23\ See supra note 9 and accompanying text.
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a. Proposed Rules
The proposed rules would have defined the market capitalization of
a security for these purposes as 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; and (2) the average price of
the security over the preceding 6 full calendar months.
The proposed rules defined outstanding shares as the number of
outstanding shares as reported in the most recent quarterly or annual
report of the company--i.e., Form 10-Q, 10-K, 10-QSB, 10-KSB, or 20-F
\24\--filed with the SEC by the issuer of the security. The proposed
rules included a method for determining the average price of a security
over time that took into account the number of shares in each
transaction over the 6-month period.\25\
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\24\ 17 CFR 249.310, 249.308a, 249.310b, 249.308b, or 249.220f.
\25\ The proposed method, which involved a calculation of the
security's volume-weighed average price, is discussed below. See
infra Part II.A.2.
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The Commissions requested comment on the use of this method, and
asked whether another method, such as using a security's daily closing
price, would be more appropriate. In addition, the Commissions asked
for comment on whether, in determining the average price of a security,
the price of American Depositary Receipts (``ADRs'') representing
shares of such security should be included proportionally. Comment was
also requested on whether the definition of outstanding shares should
address corporate events that affect the number of shares outstanding
of a security and that occur after the annual or quarterly report of
the issuer, and whether, for example, updated information contained in
any subsequent Form 8-K \26\ filed by the issuer, or more current
information submitted to the primary market center for the underlying
security, should be included.
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\26\ 17 CFR 249.308.
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The Proposing Release also included a request for comment on
whether it would be difficult for market participants to determine the
Top 750 securities, and whether the Commissions should themselves
undertake to compile, on a regular basis, a Top 750 list.
b. Comment Letters
Several commenters objected to the use of average price as a factor
to determine market capitalization.\27\ Most commenters who addressed
the Commissions' questions on this subject favored using the security's
daily closing price in lieu of average price.\28\ This method was seen
as a way to simplify the calculation, to yield more verifiable
results,\29\ and to conform to common methods used in the industry.\30\
Some commenters maintained that generally, in view of the number of
calculations required to determine market capitalization on an ongoing
basis, the least burdensome method should be required.\31\ One
commenter believed that the Commissions should allow flexibility in the
methodologies used to calculate average price and market
capitalization,\32\ while another emphasized the importance of
uniformity.\33\ Several commenters favored the inclusion of transaction
prices in ADRs in calculating the average price of the underlying
security.\34\
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\27\ See CBOE Letter; CBOT Letter; CME Letter I; GS Letter.
\28\ See CBOE Letter; CBOT Letter; GS Letter; SIA Letter. See
also CME Letter I.
\29\ See GS Letter.
\30\ See CBOT Letter.
\31\ See CBOE Letter; CBOT Letter; SIA Letter.
\32\ See CME Letter I.
\33\ See CBOE Letter.
\34\ See CBOE Letter; CBOT Letter; CME Letter I.
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Commenters on the definition of outstanding shares favored a rule
that would permit taking into account corporate events that affect the
number of shares outstanding at the time they become effective.\35\ One
commenter expressed the concern that vendors of market information
routinely adjust the number of shares they use to calculate market
capitalization between regular reporting periods in the case of
corporate events that affect the number of shares outstanding.\36\
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\35\ See, e.g., SIA Letter.
\36\ See CBOT Letter. See also CME Letter I.
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Several commenters indicated that it would indeed be difficult to
constantly determine the Top 750 securities and endorsed the suggestion
that the Commissions publish lists of the Top 750 securities for
purposes of the statutory provision.\37\ One exchange also argued that
a list published by the Commissions was necessary so as to eliminate
uncertainty and assure conformity among markets in determining the
status of various security indexes.\38\
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\37\ See CBOE Letter; CBOT Letter; CME Letter I; SIA Letter.
\38\ See CBOE Letter.
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c. Final Rules
In response to commenters' suggestions, the Commissions are
adopting two alternative methods for markets to determine whether a
security is one of the Top 750 securities. The Commissions expect to be
able at some point in the near future to designate a list of such
securities and have provided in the final rules for this
possibility.\39\ However, because a final determination has not been
made regarding the Commissions' designation of a list, the Commissions
are adopting rules setting forth the method for markets to use to
calculate market capitalization and thereby to determine the securities
that comprise the Top 750.\40\
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\39\ Rule 41.11(a)(1) under the CEA and Rule 3a55-1(a)(1) under
the Exchange Act, 17 CFR 41.11(a)(1) and 17 CFR 240.3a55-1(a)(1).
See also infra notes 83-84 and accompanying text.
\40\ Rule 41.11(a)(2) under the CEA and Rule 3a55-1(a)(2) under
the Exchange Act, 17 CFR 41.11(a)(2) and 17 CFR 240.3a55-1(a)(2).
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Specifically, in the absence of a designated list of these
securities, paragraph (d)(6) of Rule 41.11 under the CEA and Rule 3a55-
1 under the Exchange Act \41\ defines the ``market capitalization,'' on
a particular day, of a security that is not a depositary share as the
product of: (1) The number of outstanding shares of the security on
that day; and (2) the closing price of the security on that day.\42\
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\41\ 17 CFR 41.11(d)(6) and 17 CFR 240.3a55-1(d)(6).
\42\ This definition of market capitalization is for purposes
only of the Commissions' rules for calculating market capitalization
of a security to determine whether it is a Top 750 security. The
sponsor or compiler of an index otherwise categorized as a market
capitalization-weighted index is not required to use this definition
to determine the relative weightings of the index's component
securities.
---------------------------------------------------------------------------
When a component security of an index is an ADR, market
capitalization for a particular day is defined as the product of: (1)
The closing price of the depositary share that day, divided by the
number of deposited securities represented by the depositary share; and
(2) the number of outstanding shares of the security represented by the
depositary share that same day.
The ``closing price'' of a security is defined in paragraph (d)(2)
of the rules \43\ as the price at which the last reported transaction
\44\ in the security
[[Page 44494]]
took place in the regular session of the principal market for the
security \45\ in the United States. This definition applies when
reported transactions have taken place in the U.S. If no reported
transactions in a particular security have taken place in the United
States, but a depositary share in the security trades in the U.S., the
closing price of the security is defined as the closing price of the
depositary share representing the security divided by the number of
shares of the underlying security that the depositary share represents.
---------------------------------------------------------------------------
\43\ 17 CFR 41.11(d)(2) and 17 CFR 240.3a55-1(d)(2).
\44\ As defined in paragraph (d)(10) of the rules, ``reported
transaction'' means:
(i) with respect to securities transactions in the United
States, any transaction for which a transaction report is collected,
processed, and made available pursuant to an effective transaction
reporting plan, or for which a transaction report, last sale data,
or quotation information is disseminated through an automated
quotation system as described in Section 3(a)(51)(A)(ii) of the Act
(15 U.S.C. 78c(a)(51)(A)(ii)); and
(ii) with respect to securities transactions outside the United
States, any transaction that has been reported to a foreign
financial regulatory authority in the jurisdiction where such
transaction has taken place.
17 CFR 41.11(d)(10) and 17 CFR 240.3a55-1(d)(10). ``Foreign
financial regulatory authority'' is defined, as in the proposed
rule, to have the same meaning as in Section 3(a)(52) of the
Exchange Act, 15 U.S.C. 78c(a)(52). 17 CFR 41.11(d)(4) and 17 CFR
240.3a55-1(d)(4).
\45\ The principal market of a security is defined in paragraph
(d)(9) of the rules as the single securities market with the largest
reported trading volume for the security during the preceding 6 full
calendar months. 17 CFR 41.11(d)(9) and 17 CFR 240.3a55-1(d)(9).
---------------------------------------------------------------------------
If no reported transactions in the security or in a depositary
share representing the security have taken place in the United States,
the closing price of the security is defined as the price at which the
last transaction in such security took place in the regular trading
session of the principal market for the security. The price, if
reported in non-U.S. currency, must be converted into U.S. dollars on
the basis of a spot rate of exchange relevant for the time of the
transaction obtained from at least one independent entity that provides
or disseminates foreign exchange quotations in the ordinary course of
its business.\46\
---------------------------------------------------------------------------
\46\ See infra note 76 and accompanying text for a more detailed
discussion of foreign currency conversions under these rules.
---------------------------------------------------------------------------
The Commissions concur with the commenters that use of a security's
closing price, rather than its average price as proposed, is reasonable
in view of the purposes of the rule-determining which securities are
among the 750 securities with the largest market capitalization.
Relying on the closing price will also help assure uniformity among
markets in applying the statutory definition.
For the same reason, the Commissions have defined closing price in
the rules generally as the price of the last transaction in the regular
trading session of the principal market for the security in the United
States.\47\ Although a security that is registered under Section 12 of
the Exchange Act, and thereby eligible for inclusion among the 750
securities with the largest market capitalization, may trade on markets
outside of the United States, the Commissions believe that, in this
context, the interests of uniformity are served by defining the closing
price in U.S. dollars as based on the last transaction for the security
in the regular trading session of the principal U.S. market. When a
foreign security that is registered under Section 12 trades in the
United States only in the form of a depositary share, the rule
establishes that the closing price of such share must be adjusted to
reflect the ratio of shares represented by the depositary share to the
number of outstanding shares in the underlying security. This is
because the formula for market capitalization of the underlying
security uses the number of outstanding shares in the underlying
security as the multiplier with closing price.
---------------------------------------------------------------------------
\47\ See CBOE Letter and GS Letter, suggesting a similar
definition.
---------------------------------------------------------------------------
In addition, following the suggestion of commenters, the
Commissions have modified the definition of outstanding shares from
that proposed to include updated information on changes in the number
of shares outstanding reflecting corporate events that occur after the
annual or quarterly report, as contained in any Form 8-K filed by the
issuer.\48\
---------------------------------------------------------------------------
\48\ See 17 CFR 41.11(d)(7) and 17 CFR 240.3a55-1(d)(7). The
definition does not include, however, information submitted by the
issuer to the primary market center for the underlying security, but
not filed on a Form 8-K. The Commissions believe that a requirement
to include such information could impose an unreasonable burden on
markets in terms of monitoring for such changes and could lead to a
lack of uniformity in the data used by different markets.
---------------------------------------------------------------------------
The final rules provide that, once the market capitalization of a
security is calculated for each day of the preceding 6 full calendar
months, market capitalization of such security as of the preceding 6
full calendar months must be determined.\49\ This determination
requires: (1) Summing the values of the market capitalization for each
trading day in the U.S. during the preceding 6 full calendar months;
\50\ and (2) dividing this sum by the total number of such trading
days.\51\
---------------------------------------------------------------------------
\49\ Rule 41.11(a)(2)(i) under the CEA and Rule 3a55-1(a)(2)(i)
under the Exchange Act.
\50\ The definition of ``preceding 6 full calendar months'' is
in paragraph (d)(8) of CEA Rule 41.11 and Exchange Act Rule 3a55-1
and is discussed, infra notes 88-92 and accompanying text.
\51\ Some commenters suggested that the market capitalization of
a security over the preceding 6 full calendar months be determined
by first calculating the security's average closing price for the
entire 6-month period, and then multiplying such average closing
price by the number of outstanding shares of such security for each
day in the 6-month period. See, e.g., CBOT Letter. The method
adopted by the Commissions, however, requires calculating the market
capitalization of a security for each day in the 6-month period, and
then averaging those daily market capitalization values over the 6-
month period. This method takes into account any change in the
number of outstanding shares of the security that may have occurred
during the 6-month period.
---------------------------------------------------------------------------
Finally, paragraph (a)(2)(ii) of these rules \52\ provides that the
750 securities with the largest market capitalization shall be
identified from the universe of all reported securities as defined in
Rule 11Ac1-1 under the Exchange Act \53\ that are common stock or
depositary shares. The Commissions believe that this provision will
ease the burden on markets in identifying the Top 750, by limiting the
universe from which these securities must be identified to securities
listed on a national securities exchange, the trades of which are
reported to the Consolidated Tape Association (``CTA''), and securities
that are Nasdaq National Market System (``Nasdaq NMS'') securities.
---------------------------------------------------------------------------
\52\ 17 CFR 41.11(a)(2)(ii) and 17 CFR 3a55-1(a)(2)(ii).
\53\ A reported security is a security for which transaction
reports are collected, processed, and made available pursuant to an
effective transaction reporting plan. See 17 CFR 240.11Ac1-1(a)(20).
---------------------------------------------------------------------------
2. Determining Dollar Value of Average Daily Trading Volume of a
Security
The dollar value of ADTV of a security is relevant for purposes of:
(1) determining whether an index is a narrow-based security index under
the statutory definition, which requires an assessment of whether the
dollar value of the ADTV of the lowest weighted 25% of the index is
less than $50 million (or $30 million for indexes with 15 or more
component securities); \54\ and (2) determining whether a security is
among the 675 securities with the largest dollar value of ADTV,
permitting the index of which it is a component to qualify as broad-
based under the first exclusion from the definition of narrow-based
security index.\55\
---------------------------------------------------------------------------
\54\ See supra note 7 and accompanying text.
\55\ See supra note 9 and accompanying text.
---------------------------------------------------------------------------
a. Proposed Rules
The proposed rules would have defined the dollar value of ADTV of a
security for the purpose of the definition of narrow-based security
index as 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.
The definition of average price of a security over the preceding 6
full calendar months in the proposed rules took into account the number
of shares
[[Page 44495]]
in each transaction during the period. This method, often termed
``volume-weighted average price,'' or ``VWAP,'' would require a person
calculating the average to first establish a value for each transaction
by multiplying the price per share in U.S. dollars of the 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 would be divided by the total number of shares traded
during that period.
The proposed rules provided an alternative method for determining
the dollar value of ADTV of a security using 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 exceeded the statutory thresholds of $50 million
(or $30 million), national securities exchanges, designated contract
markets, registered DTEFs, and foreign boards of trade would have been
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.
In addition, the proposed rules permitted data from non-U.S.
markets to be included in determining the ADTV and average price of a
security, provided that the information was reported to a foreign
financial regulatory authority in the jurisdiction where the security
is traded. To the extent that trades executed on non-U.S. markets were
included in the calculation of ADTV, the proposed rules required the
same trades to be included in calculating average price. The proposed
rules also required that for non-U.S. transactions to be included in
the calculation of average price, the price of each transaction would
need to be translated into U.S. dollars at the trading date's noon
buying rate in New York City as certified for customs purposes by the
Federal Reserve Bank of New York (``noon buying rate''). Price and
trading volume data for each security were to be included only for the
trading days of the principal market for the security.
The Commissions requested comment on the use of the proposed method
for determining dollar value of ADTV, and inquired whether another
method, such as using an average of a security's daily closing price,
would be more appropriate. In addition, the Proposing Release solicited
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. The Proposing Release also included
a request for comment on whether it would be difficult for market
participants to determine the Top 675 securities, and whether the
Commissions should themselves undertake to compile, on a regular basis,
a Top 675 list.
b. Comment Letters
Several commenters objected to the use of VWAP as a multiplier in
determining dollar value of ADTV.\56\ The commenters asserted that the
calculations required by this method would be too numerous,
complicated, and overly burdensome in light of the purposes of the
statute and would not increase the reliability of the results.
Moreover, they pointed out that, because the methodologies of
calculating VWAP differ among market data vendors, the results would
not be as consistent as using a method based on closing price.
---------------------------------------------------------------------------
\56\ See CBOE Letter; CME Letter 1; GS Letter. See also CBOT
Letter.
---------------------------------------------------------------------------
There was a divergence of views, however, with respect to an
appropriate alternative. One commenter believed that the Commissions
should allow flexibility in the methodologies used to calculate average
price and dollar value of ADTV.\57\ Some commenters favored the use of
the average daily closing price of a security as the multiplier to be
used with the security's ADTV to determine dollar value of ADTV.\58\
Another commenter maintained that while closing price is the standard
multiplier used (with the number of outstanding shares) in calculating
market capitalization, using an average closing price to determine
dollar value of ADTV would be an ``unconventional and less accurate
measure of average value traded'' than using VWAP as the multiplier,
which, it argued, is ``standard and intuitive.''\59\ This commenter
pointed out, however, that the same result reached by using the
proposed method could be reached by using a method that had been
suggested as an alternative in the Proposing Release. This method
involves calculating the actual dollar value of all transactions in a
security for each trading day during the 6-month period, and then
arriving at an average for the period by summing the values for each
trading day and dividing the result by the number of such trading days.
---------------------------------------------------------------------------
\57\ See CME Letter I.
\58\ See CBOE Letter; GS Letter, See also CME Letter I.
\59\ See CBOT Letter.
---------------------------------------------------------------------------
Several commenters favored including the trading in ADRs in
calculating the average price of their underlying securities.\60\ With
respect to the proposed rule permitting the limited use of a non-
volume-weighted average price for purposes of determining whether the
daily trading value of the lowest weighted 25% of an index exceeded the
statutory thresholds, two commenters did not believe that it was likely
to be helpful and one commenter did not favor the conditions imposed
for use of this alternative.\61\
---------------------------------------------------------------------------
\60\ See CBOE Letter; CBOT Letter; CME Letter I; SIA Letter.
\61\ See CBOT CME Letter I; SIA Letter.
---------------------------------------------------------------------------
Three commenters expressed views on the proposed rules with respect
to the inclusion of foreign trading data. One commenter generally
agreed with the proposed rules,\62\ while another believed that, for
ADTV, only the volume reported on the principal listing exchange in the
United States should be included.\63\ A third commenter questioned the
restriction limiting the use of foreign data to data reported to a
foreign financial regulatory authority, suggesting, instead, that the
rules permit the use of trading data derived from trading on foreign
markets subject to surveillance by an appropriate foreign regulatory
authority.\64\ This commenter also sought clarification as to whether
the inclusion of data from non-U.S. exchanges is optional or mandatory,
noting that if the use of foreign data is merely optional, this could
lead to inconsistent determinations as to whether an index is broad-
based or narrow-based.\65\
---------------------------------------------------------------------------
\62\ See CME Letter I.
\63\ See CBOE LEtter.
\64\ See SIA Letter. The SIA stated that it was not clear that
all relevant jurisdictions require reporting to a financial
regulatory authority.
\65\ Id.
---------------------------------------------------------------------------
Finally, several commenters indicated that it would indeed be
difficult to constantly determine the Top 675 securities, and endorsed
the suggestion that the Commissions should publish lists of the Top 675
securities for purposes of the statutory provision.\66\ One exchange
also argued that a list published by the Commissions was necessary to
eliminate uncertainty and assure conformity among markets in
determining the status of various security indexes.\67\
---------------------------------------------------------------------------
\66\ See CBOE Letter; CBOT Letter; CME Letter I; SIA Letter.
\67\ See CBOE Letter.
---------------------------------------------------------------------------
c. Final Rules
The rules, as adopted, establish different methods to be used to
determine the dollar value of a security's ADTV for purposes of the two
provisions where this value is relevant,
[[Page 44496]]
as noted above: the statutory definition of narrow-based security index
(Section 1a(25)(A) of the CEA and Section 3(a)(55)(B) of the Exchange
Act); and the first exclusion from that definition (Section
1a(25)(B)(i) of the CEA and Section 3(a)(55)(C)(i) of the Exchange
Act).
As discussed further below, the final rules provide for the
possibility that the Commissions will designate the Top 675 for
purposes of the exclusion. The Commissions are actively investigating
the possibility of designating this list with routine periodic updates.
To the extent feasible, the Commissions are committed to include
foreign volume data. The Commissions welcome suggestions at any time
from interested parties regarding this matter.
In the event that no such list is designated by the Commissions,
the rules provide a method for markets themselves to determine the Top
675 securities for this purpose. The Commissions agree with the view
expressed by some commenters that it is important in such case that all
markets use the same data. Accordingly, it is critical that the
information used to determine these 675 securities is easily obtained
by all markets and is identical. Because of limitations in the
accessibility and uniformity of trading data from foreign markets, the
Commissions have determined that, for purposes only of determining the
Top 675 securities, only U.S. market volume data should be used. At
this time, the Commissions believe that this simplification will not
make a significant impact on the final list drawn from the intersection
of the Top 750 and Top 675.
For purposes of determining whether the dollar value of the lowest
weighted 25% of a particular index exceeds the $50 million (or $30
million) threshold established by the definition of narrow-based
security index, the Commissions believe that small variations in the
derived ADTV for component securities are not critical. Therefore, the
Commissions have determined to require the inclusion of foreign market
trading data in the calculation of a security's dollar value of ADTV.
The Commissions are adopting different methodologies for
calculating the value of ADTV for purposes of the two provisions where
the value is relevant, i.e., requiring the use of foreign volume data
for the definition but not for the first exclusion, for a practical
reason. The Commissions believe that it is important to have a single
list of the Top 675 securities for ascertaining compliance with the
first exclusion to enhance certainty regarding eligible securities. In
contrast, the Commissions believe that small variations in the derived
ADTV that may result from the use of foreign volume data for component
securities under the definition would be acceptable and would not
undermine the statutory requirement that the lowest weighted 25% of an
index exceed minimum volume thresholds to be a broad-based index.
i. Dollar Value of ADTV for Purposes of Section 1a(25)(A) of the CEA
and Section 3(a)(55)(B) of the Exchange Act
First, paragraph (b)(1)(i)(A) of Rule 41.11 under the CEA and Rule
3a55-1 under the Exchange Act \68\ provides the method to determine the
dollar value of ADTV of a security for purposes of assessing whether
the dollar value of ADTV of the lowest weighted 25% of a security index
exceeds $50 million (or $30 million). The method entails calculating
the dollar value of ADTV of a security separately for each jurisdiction
in which it trades, and then summing the values for all
jurisdictions.\69\ Once the dollar value of ADTV of each component
security comprising the lowest weighted 25% of an index \70\ is
calculated, those values are summed to determine the aggregate dollar
value of ADTV of the lowest weighted 25% of an index.\71\
---------------------------------------------------------------------------
\68\ 17 CFR 41.11(b)(1)(i)(A) and 17 CFR 240.3a55-1(b)(1)(i)(A).
\69\ A separate calculation is required for each jurisdiction
because the value of foreign trading, which is reported in local
currency, must be converted into U.S. dollars each day on the basis
of a spot exchange rate valid for that particular day, see infra
note 76, and then averaged over the 6-month period. Under the rule
as proposed, the overall VWAP in U.S. dollars for all markets could
have been calculated together, but that calculation, too, required
the value of each day's transactions in each foreign market to have
been originally translated from the local currency into U.S. dollars
on the basis of a rate valid for that particular day.
\70\ See infra notes 85-86 and accompanying text for a
discussion of the definition of ``lowest weighted 25% of an index.''
\71\ 17 CFR 41.11(b)(1)(iv) and 17 CFR 240.3a55-1(b)(1)(iv).
---------------------------------------------------------------------------
For trading in a security in the United States, paragraph
(b)(1)(ii) of Rule 41.11 under the CEA and Rule 3a55-1\72\ under the
Exchange Act provides that the dollar value of ADTV of a security is
the sum of the value of all reported transactions in the security for
each U.S. trading day during the preceding 6 full calendar months,
divided by the total number of trading days. For trading in a security
in a jurisdiction other than the United States, paragraph
(b)(1)(iii)\73\ sets forth the same method for determining the dollar
value of ADTV of a security in each jurisdiction in which it traded,
but stipulates that the value of each day's trading must be translated
into U.S. dollars on the basis of that day's exchange rate, as
discussed further below.
---------------------------------------------------------------------------
\72\ 17 CFR 41.11(b)(1)(ii) and 17 CFR 240.3a55-1(b)(1)(ii).
\73\ 73 17 CFR 41.11(b)(1)(iii) and 17 CFR 240.3a55-
1(b)(1)(iii).
---------------------------------------------------------------------------
Calculating a security's VWAP will not be necessary.\74\ In
response to the concerns raised by commenters, the method adopted for
determining dollar value of ADTV requires a market to first compute the
dollar value of a security's trading each day, and then to average the
result over the 6-month period. This calculation yields the same result
as proposed, without requiring the calculation of a security's
VWAP.\75\
---------------------------------------------------------------------------
\74\ Both the volume-weighted average price and non-volume-
weighted average price definitions of ``average price'' in the
proposed rules have thus been eliminated.
\75\ This method also does not require the separate calculation
of ADTV. Thus, the proposed definition of ADTV is not being adopted.
---------------------------------------------------------------------------
The rule allows flexibility in the choice of an exchange rate.\76\
The proposed rule would have required the use of the noon buying rate
to assure conformity in the determination of whether a security is one
of the 675 securities with the largest dollar value of ADTV. However,
because the Commissions are adopting a different methodology for
determining dollar value of ADTV of the lowest weighted 25% of an index
than the methodology for determining whether a security is among the
Top 675, the Commissions believe that permitting markets some
flexibility in applying an exchange rate is acceptable, as long as the
exchange rate used is a spot rate of exchange obtained from an
independent entity that provides or disseminates foreign exchange
quotations in the ordinary course of its business. Such entity must be
active in the foreign currency markets as a source that quotes rates
for the purpose of buying and selling foreign currencies. The Federal
Reserve Bank, as in the proposed rules, would be an acceptable source.
---------------------------------------------------------------------------
\76\ See paragraph (b)(1)(iii)(B) of the rules, 17 CFR
41.11(b)(1)(iii)(B) and 17 CFR 3a55-1(b)(1)(iii)(B) .
---------------------------------------------------------------------------
As supported by commenters who favored the inclusion of ADR data,
the rules also establish that the dollar value of ADTV of a security
includes the value of all reported transactions in any depositary share
that represents such security; and that the dollar value of ADTV of a
depositary share includes the value of all reported transactions in its
underlying security.\77\
---------------------------------------------------------------------------
\77\ See paragraph 41.11(b)(1)(i)(B)-(C) of the rules, 17 CFR
41.11(b)(1)(i)(B)-(C) and 17 CFR 240.3a55-1(b)(1)(i)(B)-(C).
---------------------------------------------------------------------------
The Commissions note that the inclusion of information from non-
U.S.
[[Page 44497]]
markets is mandatory in determining whether the lowest weighted 25% of
an index is more than $50 million (or $30 million). The final rule
retains the restriction of the proposed rules limiting data from non-
U.S. markets to transactions reported to a foreign financial regulatory
authority.\78\ The Commissions believe that there is no way to assure
that information on transactions that are not so reported is reliable
or accurate.
---------------------------------------------------------------------------
\78\ See supra note 44.
---------------------------------------------------------------------------
ii. Dollar Value of ADTV for Purposes of Determining Whether a Security
is One of the Top 675
Second, in response to commenters, the Commissions are adopting two
alternative methods for markets to determine whether a security is one
of the 675 securities with the largest dollar value of ADTV. The
Commissions expect to be able at some point in the near future to
designate a list of such securities and have provided in the final
rules for such possible designation.\79\ However, because a final
determination regarding the Commissions' designation of such list has
not yet been made, the Commissions are adopting rules setting forth the
method for markets themselves to use to calculate dollar value of ADTV
and thereby to determine which securities are among the Top 675.
---------------------------------------------------------------------------
\79\ See infra notes 83-84 and accompanying text.
---------------------------------------------------------------------------
Specifically, in the absence of a designated list of such
securities, paragraph (b)(2)(ii)(A) of CEA Rule 41.11 and Exchange Act
Rule 3a55-1 \80\ defines the dollar value of ADTV of a security as of
the preceding 6 full calendar months as the sum of the value of all
reported transactions in such security in the United States for each
trading day during the preceding 6 full calendar months, divided by
total number of such trading days.
---------------------------------------------------------------------------
\80\ 17 CFR 41.11(b)(2)(ii)(A) and 17 CFR 240.3a55-
1(b)(2)(ii)(A).
---------------------------------------------------------------------------
In considering a method for markets to use in compiling their own
lists individually, the Commissions faced a concern about the
variability in the way trading information from foreign markets
currently may be accessed and compiled. After careful deliberation, the
Commissions concluded that for the purposes of certainty and
conformity, while the averaging method for determining dollar value of
ADTV should remain the same, it is appropriate at this time to limit
the data that is to be used by markets in identifying the Top 675 to
U.S. trading information. The Commissions believe that this will help
ensure that the Top 675 lists compiled individually by various markets,
which is one of the bases for determining whether a security index is
broad-based, will be uniform and verifiable.
Finally, paragraph (b)(2)(ii)(B) of these rules \81\ provides that
the 675 securities with the largest dollar value of ADTV shall be
identified from the universe of all reported securities as defined in
Rule 11Ac1-1 under the Exchange Act \82\ that are common stock or
depositary shares. The Commissions believe that this provision will
ease the burden on markets in identifying the Top 675, by limiting the
universe from which these securities must be identified to securities
listed on a national securities exchange, the trades of which are
reported to the CTA, and securities that are Nasdaq NMS securities.
---------------------------------------------------------------------------
\81\ 17 CFR 41.11(b)(2)(ii)(B) and 17 CFR 3a55-1(b)(2)(ii)(B).
\82\ A reported security is a security for which transaction
reports are collected, processed, and made available pursuant to an
effective transaction reporting plan. See 17 CFR 240.11Ac1-1(a)(20).
---------------------------------------------------------------------------
3. Use of the Top 750 and Top 675 Lists
As noted above, commenters indicated that it would be difficult to
constantly determine the Top 750 and Top 675 securities, and endorsed
the idea that the Commissions publish a list of the Top 750 and Top 675
securities. The final rules accommodate the possibility of the
Commissions designating a list of the Top 750 and of the Top 675
securities. The Commissions may either generate lists of such
securities themselves, or designate lists compiled by a third party.
Such designated lists would alleviate the burden on markets of
calculating the lists, and help ensure uniformity in, and verifiability
of, the information used by markets to determine that a security index
is broad-based.
Specifically, paragraph (a)(1) of Rule 41.11 under the CEA and Rule
3a55-1 under the Exchange Act provides that a security will be one of
750 securities with the largest market capitalization on any particular
day when it is included on a list of such securities designated by the
SEC and CFTC.\83\ Similarly, paragraph (b)(2)(i) of these rules
provides that a security will be one of the 675 securities with the
largest dollar value of ADTV on any particular day when it is included
on a list of such securities designated by the SEC and CFTC.\84\
---------------------------------------------------------------------------
\83\ 17 CFR 41.11(a)(1) and 17 CFR 240.3a55-1(a)(1).
\84\ 17 CFR 41.11(b)(2)(i) and 17 CFR 240.3a55-1(b)(2)(i).
---------------------------------------------------------------------------
The rules contemplate that the Commissions will prepare a list of
the Top 750 and a list of the Top 675 that will be the sole source by
which a market participant may determine whether a component security
of an index fulfills the statutory requirements. The provision also
allows for the possibility that the Commissions may choose to designate
Top 750 and Top 675 lists that have been prepared by a third party.
The rule providing for the designation of lists is also intended to
address another issue raised by the Commissions in the Proposing
Release and remarked on by several commenters: How often must the Top
750 and Top 675 securities be identified in order to verify that
component securities of an index still would be included on such lists?
The final rules provide that a security will be one of 750 securities
with the largest market capitalization and one of 675 securities with
the largest dollar value of ADTV on any particular day when it is
included on a list of such eligible securities designated by the
Commissions as applicable for that day. Any security on such list
designated by the Commissions would remain an eligible security until
the next list is released.
In addition to easing the burden on exchanges, the Commissions note
that this provision also has ramifications for the statutory tolerance
period, which permits a broad-based security index to retain its broad-
based status as long as it does not assume the characteristics of a
narrow-based security index for more than 45 business days over three
calendar months. The rule adopts a principle suggested in the
discussion of the possibility of officially-designated lists in the
Proposing Release. Any security that appears on both lists will be
deemed to be one of the Top 750 and Top 675 securities every day during
the period in which those lists are designated as applicable.
Conversely, any security that does not appear on the lists will be
deemed not to satisfy the statutory requirements every day those lists
are designated as applicable.
4. The Lowest Weighted 25% of an Index
As discussed 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 weighted 25% of its component securities is less than $50
million (or $30 million for an index of 15 component securities or
more).
The Commissions are adopting as proposed a provision that addresses
the situation when no group of the lowest weighted securities in an
index equals exactly 25% of the index's weighting.
[[Page 44498]]
Paragraph (d)(5) of CEA Rule 41.11 and Exchange Act Rule 3a55-1
establishes that the ``lowest weighted 25% of an index'' 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.\85\
---------------------------------------------------------------------------
\85\ 17 CFR 41.11(d)(5) and 17 CFR 240.3a55-1(d)(5). See also
paragraph (d)(12) of the rule, which clarifies 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.
---------------------------------------------------------------------------
To identify these securities, the following method applies: (1) All
component securities in an index are 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 are added to each other until they reach the sum
that comes closest to, or equals 25%, but does not exceed 25%. Those
securities comprise the lowest weighted 25% of the index.
One commenter acknowledged that any application of the statute must
account for the situation where no group of securities comprise exactly
25% of the index's weighting, but argued that the solution includes a
paradoxical element: in some cases, when a new component security is
added to an index--theoretically broadening the index--the result can
be that the number of securities in the ``lowest weighted 25%'' is
decreased, making it more difficult to clear the $50 million (or $30
million) hurdle.\86\
---------------------------------------------------------------------------
\86\ See CME Letter I. For further explanation, see id., at
pages 4-5.
---------------------------------------------------------------------------
The Commissions believe that the provision as proposed is
consistent with the intent of Congress in fashioning the ``lowest
weighted 25%'' test. The commenter's alternative solution is to prorate
the dollar value of ADTV of the security that puts the lowest weighted
group of securities ``over the top'' of the 25% line. In the
Commissions'' view, a pro rata approach does not accord with the
concept implicit in the statute that the lowest weighted 25% comprises
a whole number of component securities.
Paragraph (d)(5)(ii) of CEA Rule 41.11 and Exchange Act Rule 3a55-
1, which is adopted today as proposed, addresses another issue in the
calculation of dollar value of ADTV of the lowest weighted 25% of a
security index. As explained in the Proposing Release, the calculation
of dollar value of ADTV 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 rule
provides instruction as to how the dollar value of ADTV of the lowest
weighted 25% of an index is to be determined on a particular day.
Paragraph (d)(5)(ii) of CEA Rule 41.11 and Exchange Act Rule 3a55-1
establishes 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 will 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.\87\
---------------------------------------------------------------------------
\87\ See also SIA Letter endorsing this approach.
---------------------------------------------------------------------------
5. Determining ``the Preceding 6 Full Calendar Months''
As already noted, the CEA and Exchange Act specify that the dollar
value of ADTV and market capitalization are to be calculated as of the
``preceding 6 full calendar months.''\88\
---------------------------------------------------------------------------
\88\ Section 1a(25)(E)(i) of the CEA and Section 3(a)(55)(F)(i)
of the Exchange Act.
---------------------------------------------------------------------------
Paragraph (d)(8) of CEA Rule 41.11 and Exchange Act Rule 3a55-1,
being adopted today as proposed, defines ``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.\89\ 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 preceding 6 full calendar months begins on
September 8 of the previous year and ends on March 7.
---------------------------------------------------------------------------
\89\ 17 CFR 41.11(d)(8) and 17 CFR 240.3a55-1(d)(8).
---------------------------------------------------------------------------
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 third exclusion from the definition of narrow-
based security index in the CEA and Exchange Act, which excepts a
broad-based security index from the definition of narrow-based security
index if it has assumed narrow-based characteristics for 45 or fewer
business days in a three-month period.\90\
---------------------------------------------------------------------------
\90\ Sections 1a(25)(B)(iii) and (D) of the CEA and Sections
2(a)(55)(C)(iii) and (E) of the Exchange Act. See supra notes 11-12
and accompanying text.
---------------------------------------------------------------------------
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 of a security for the six months preceding July
20, and the measuring period were the 6-month period from January 1
through June 30, the dollar value of ADTV of such security would be
static for each day in July. In this example, the calculation would not
take into account any transactions that occurred during July. The
Commissions believe that the tolerance provision of the third
exclusion, which specifies 45 days of tolerance within a three-month
period in which dollar value of ADTV levels may drop below the
threshold, indicates that a ``rolling month'' approach is most
appropriate.
One commenter agreed with this approach.\91\ Another commenter,
however, took issue, maintaining that Congress likely intended
``calendar months'' to mean the month-long periods referred to as
January, February, etc., and that it is possible to read the statute's
tolerance provisions compatibly with this interpretation.\92\ This
commenter's main contention in this connection, however, appeared to be
that it would be advantageous to keep market capitalization values and
dollar values of ADTV static for a month at a time. According to this
commenter, a month-by-month compilation of the Top 750 and Top 675
lists--rather than a required daily compilation--would, among other
things, ``dramatically reduce the data gathering calculation, and
paperwork burden on exchanges.''
---------------------------------------------------------------------------
\91\ See CBOE Letter.
\92\ See CME Letter I.
---------------------------------------------------------------------------
The Commissions note that in view of the new facet of the final
rule providing for the designation of Top 750 and 675 lists that may be
applicable for periods of some duration, this latter concern may to a
large extent be alleviated. The Commissions also believe that a month-
long, static dollar value of ADTV would not comport with the purposes
of the statute's $50 million (or $30 million) hurdle for the lowest
weighted 25% of an index to achieve broad-based status. Thus, the
Commissions have adopted the proposed definition of ``preceding 6 full
calendar months'' in the final rules.
[[Page 44499]]
6. Depositary Shares
In the Proposing Release, the Commissions requested comment on
whether an ADR should be considered registered pursuant to Section 12
of the Exchange Act for purposes of the first exclusion from the
definition of narrow-based security index, which is available for an
index comprised solely of Top 750 and Top 675 securities registered
under Section 12.\93\
---------------------------------------------------------------------------
\93\ As explained in the Proposing Release, while the security
of an issuer that underlies an ADR must be registered pursuant to
Section 12, the ADR itself is deemed to be a separate security and
is exempt from Section 12 registration.
---------------------------------------------------------------------------
Commenters responded favorably on this issue.\94\ Because a
depositary share is a security that represents a common stock, the
Commissions believe that an instance where a depositary share is a
component security of an index is fundamentally equivalent to the
instance where the common stock is the component security. The
Commissions, therefore, have provided in the final rules \95\ that the
requirement that each component security of an index be registered
under Section 12 of the Exchange Act for purposes of the first
exclusion will be satisfied with respect to any security that is a
depositary share if the deposited securities underlying the depositary
share is registered under Section 12. This allowance is granted on
condition that the depositary share is registered under the Securities
Act of 1933 on Form F-6.\96\
---------------------------------------------------------------------------
\94\ See CBOE Letter; CBOT Letter; CME Letter I; SIA Letter.
\95\ See paragraph (c) of CEA Rule 41-11 and Exchange Act Rule
3a55-1, 17 CFR 41.11(c) and 17 CFR 240.3a55-1(c).
\96\ 17 CFR 239.36.
---------------------------------------------------------------------------
7. General Guidance in Application of the Rule
As a general matter, the Commissions note that any national
securities exchange, designated contract market, registered DTEF, or
foreign board of trade that trades a future on a security index will be
required to determine whether or not the future is a security future to
assure that the market is in compliance with the CEA and the Exchange
Act.\97\
---------------------------------------------------------------------------
\97\ The Commissions further 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 whether a security index is
narrow-based or broad-based to comply with their recordkeeping
requirements under Sections 5(d)(17) and 5a(d)(8) of the CEA and new
Rule 41.2 under the CEA, 17 CFR 41.2, and Rule 17a-1 under the
Exchange Act, 17 CFR 240.17a-1.
---------------------------------------------------------------------------
The Proposing Release asked for comment on whether the Commissions
should permit a national securities exchange, designated contract
market, registered DTEF, or foreign board of trade to rely on
independent calculations by a third party to determine market
capitalization and dollar value of ADTV for purposes of these rules,
and if so, whether any conditions should be imposed when a third party
is used and whether the third party should be required to meet certain
qualification standards.
Several commenters believed that markets should be permitted to
rely on third parties,\98\ and one added that no conditions should be
imposed and third parties should not be required to meet qualification
standards.\99\ One commenter believed, however, that the Commissions
should create or designate one official source for any data used for
purposes of determining market capitalization and dollar value of ADTV,
not only for the Top 750 and Top 675, but for all securities registered
under Section 12.@\
---------------------------------------------------------------------------
\98\ See CBOT Letter; CME Letter I; SIA Letter.
\99\ See CME Letter I. See also SIA Letter, maintaining that
notification to the CFTC or SEC on the use of third-party data
should not be required.
@\ See CBOE Letter. With respect to components of a security
index that are not registered under Section 12, the CBOE believed
that it is the responsibility of the self-regulatory organization on
which the index is listed to determine and monitor dollar value of
ADTV.
---------------------------------------------------------------------------
Upon careful consideration of the question, the Commissions have
determined not to adopt any rules at this time that prohibit or place
conditions on the use of third parties or impose qualifications
standards on such third parties.
As such, a national securities exchange, designated contract
market, registered DTEF, or foreign board of trade may contract with an
outside party to supply the information and data analysis required to
determine, for example, whether the dollar value of ADTV of the lowest
weighted 25% of a security index exceeds the $50 million (or $30
million) threshold, thus demonstrating that the index falls outside the
basic definition of narrow-based security index; or whether the market
capitalization and dollar value of ADTV of all the component securities
in an index are among the Top 750 and Top 675 securities for purposes
of the first exclusion from that definition. For example, the market
trading the future may have a contract with a data vendor that supplies
transaction information through an electronic medium. However, in all
circumstances the market will be responsible for assuring that the
calculation by the outside party is consistent with the final rules.
One commenter maintained that an exchange ``should be able to apply
logical relationships to minimize the calculation burden.''\101\ The
commenter supplied an example where the lowest traded price of a
security over the 6-month period, multiplied by the ADTV of the
security over the same period, yielded a value of more than $50
million. Because the dollar value of ADTV based on actual prices would
necessarily be more than $50 million, the commenter argued, no further
calculations should be necessary. Based on this example, the commenter
recommended that flexibility be granted so that an exchange will have
the ability to choose the least burdensome way of satisfying the
statutory criteria.
---------------------------------------------------------------------------
A\ CME Letter I.
---------------------------------------------------------------------------
The Commissions note the rules establish the methods by which
market capitalization and dollar value of ADTV are determined. Any way
that a market can minimize its calculations, yet still demonstrate with
mathematical certainty that the statutory thresholds have been met, is
acceptable.
One commenter believed that the rules should require only an annual
determination as to whether an index is narrow-based or broad-based,
and that if it is determined that an index has changed in status, a
future on the index should be permitted to continue trading for an
additional one-year grace period.B\ As the commenter recognized,
this approach differs from the grace periods specified in the CEA and
Exchange Act. At this time the Commissions do not believe such a
substantial change from the statutory definition is appropriate.
---------------------------------------------------------------------------
B\ See SIA Letter.
---------------------------------------------------------------------------
B. CEA Rule 41.12 and Exchange Act Rule 3a55-2: A Future on a Broad-
Based Security Index that Becomes Narrow-Based During First 30 Days of
Trading
1. The Relevant Statutory Provision
As discussed above, the CEA and Exchange Act include a tolerance
provision that allows, under certain conditions, a future on a security
index to continue to trade as a broad-based index future--even when the
index temporarily assumes characteristics that would render it a
narrow-based security index under the statutory definition. An index
qualifies for this tolerance and therefore is not a narrow-based
security index if: (i) A future on the index traded for at least 30
days as an instrument that was not a security future before the index
assumed the characteristics of a narrow-based security index; and (ii)
the index does not retain the characteristics of a narrow-based
security index for
[[Page 44500]]
more than 45 business days over three consecutive calendar months.C\
---------------------------------------------------------------------------
C\ Section 1a(25)(B)(iii) of the CEA and Section
3(a)(55)(C)(iii) of the Exchange Act.
---------------------------------------------------------------------------
Under these statutory provisions, if a future began trading on a
security index that was broad-based, and, within fewer than 30 days,
the index assumed the characteristics of a narrow-based security index,
the future would become a security future immediately. A designated
contract market, registered DTEF, or foreign board of trade that is not
registered with the SEC would not be permitted to allow trading in the
instrument to continue on its market, unless it were in compliance with
relevant provisions of the Exchange Act.
2. Proposed Rules
To avert any dislocations that could potentially be created by such
a sudden change in a product's status, the Commissions proposed new
rules under the CEA and Exchange Act to create a temporary exclusion
from the definition of narrow-based security index.D\ As proposed,
that exclusion would have permitted a future on a broad-based index to
continue to trade as such even if the index assumed narrow-based
characteristics during the first 30 days of trading, provided that the
index would not have been a narrow-based security index, had it been in
existence, for an uninterrupted period of six months prior to the first
day of trading. Put in other terms, if a future on an index would not
have been deemed a security future, had the index been in existence,
for six months prior to the beginning of trading, it could continue
trading as a broad-based future even if, during the first 30 days, the
index temporarily assumed the characteristics of a narrow-based index
(so long as it did not retain those characteristics for more than 45
business days in three consecutive calendar months).
---------------------------------------------------------------------------
D\ As discussed supra note 16 and accompanying text, Section
1a(25)(B)(vi) of the CEA and Section 3(a)(55)(C)(vi) of the Exchange
Act grant the Commissions authority to create additional exclusions
from the statutory definition of narrow-based security index for
indexes underlying futures that meet such requirements that they may
establish.
---------------------------------------------------------------------------
3. Comment Letters
The two commenters who addressed this subject generally favored the
aim of the proposed rules, but were concerned about the six months of
calculations that would be required to satisfy the condition for the
temporary exclusion.E\ One of these commenters noted, in particular,
that to determine that an index was not a narrow-based security index
as of a date six months before trading begins, as required by the
proposed rules, a market would actually be required to look at trading
data from yet another six months prior to that date.F\ This is
because the definition of narrow-based security index requires an
assessment of dollar value of ADTV ``as of the preceding 6 full
calendar months.'' This commenter supported an approach that would
require dollar value of ADTV of the lowest weighted 25% of an index to
meet the $50 million (or $30 million) hurdle separately for each day of
the six months prior to the beginning of trading to qualify for the
exclusion.
---------------------------------------------------------------------------
E\ See CBOT Letter; CME Letter I. Another comment letter,
relating to the tax ramifications of these proposed rules, is
discussed infra note 139 and accompanying text.
F\ See CME Letter I.
---------------------------------------------------------------------------
The other commenter expressed the additional concern that under the
rules as proposed, an exchange with plans to begin trading a future on
a broad-based index would have no assurance, until the eve of the
launch date, that in fact the index had been broad-based for every day
during the preceding 6 months.G\ This commenter suggested that an
exclusion instead should be granted if the index simply was narrow-
based no more than 45 days over three months looking retroactively from
the launch date.
---------------------------------------------------------------------------
G\ See CBOT Letter.
---------------------------------------------------------------------------
4. Final Rules
After careful consideration of the comments, the Commissions have
determined to adopt the temporary exclusion with slight modifications
from the proposal. The final rules exclude from the definition of
narrow-based security index an index that satisfies one of three
alternative requirements. In addition, under the final rules, an index
may qualify for the exclusion on the basis of data compiled as of a
date up to a month prior to the beginning of trading of a future on the
index. This provides exchanges with some certainty about the regulatory
framework under which a product will trade.
Specifically, Rule 41.12 under the CEA and Rule 3a55-2 under the
Exchange Act \108\ provide that an index is not a narrow-based security
index during the first 30 days of trading if:
---------------------------------------------------------------------------
\108\ 17 CFR 41.12 and 17 CFR 3a55-2.
---------------------------------------------------------------------------
The index would not have been a narrow-based security
index on each trading day of the six-month period \109\ preceding a
date up to 30 days prior to the launch of trading of a future on the
index. This alternative requires that the index would have been a
broad-based security index for an uninterrupted six months prior to
trading to qualify for the exclusion for the first 30 days, as in the
proposed rules.
---------------------------------------------------------------------------
\109\ The rules identify this six-month period as the
``preceding 6 full calendar months with respect to a date no earlier
than 30 days prior to the commencement of trading'' of a future on
the index. Id.
---------------------------------------------------------------------------
On each trading day of the six-month period preceding a
date up to 30 days prior to the launch of trading of a future on the
index, (i) the index had more than 9 component securities; (ii) no
component security in the index comprised more than 30% of the index's
weighting; (iii) the 5 highest weighted component securities in the
index did not comprise, in the aggregate, more than 60% of the index's
weighting; and (iv) the dollar value of the trading volume of the
lowest weighted 25% of such index was not less than $50 million (or in
the case of an index with 15 or more component securities, $30
million). This alternative requires an index not to be a narrow-based
security index under Section 1a(25)(A) of the CEA and Section
3(a)(55)(B) of the Exchange Act, but permits a market to determine the
dollar value of a security's trading volume on a daily basis without
calculating an average using six months of data for each day.\110\
---------------------------------------------------------------------------
\110\ The second and third alternative may ease the burden on
markets, as suggested by one of the commenters, by allowing a market
to calculate the relevant values for each day separately, without
averaging in data for the previous 6 full calendar months.
---------------------------------------------------------------------------
On each trading day of the six-month period preceding a
date up to 30 days prior to the launch of trading of a future on the
index, (i) the index had at least 9 component securities; (ii) no
component security in the index comprised more than 30% of the index's
weighting; and (iii) each component security in such index was
registered pursuant to Section 12 of the Act and was one of the Top 750
and Top 675 securities that day. This alternative requires an index to
meet the requirements for the exclusion from the definition of narrow-
based security index under Section 1a(25)(B) of the CEA and Section
3(a)(55)(C) of the Exchange Act, but permits a market to determine
whether a component security is one of the Top 750 and one of the Top
675 on a daily basis without calculating an average using six months of
data for each day.
The Commissions note that the statute by its own terms requires 30
days of trading as a broad-based index before changes in an index's
characteristics may be tolerated. The Commissions believe that an index
that is broad-based for six uninterrupted months, subject to the
additional allowances permitted
[[Page 44501]]
under the second and third alternatives noted above, is sufficient
enough of an indication that a subsequent change in the index's
character within the first 30 days of actual trading would be an
anomaly and would warrant a temporary exclusion from the definition of
narrow-based security index. On the other hand, the Commissions do not
believe that it is reasonable, as suggested by one commenter, to
provide an exclusion for an index that was still fluctuating from
broad-based to narrow-based status (albeit for fewer than 46 days over
three months) in the months immediately prior to trading.
Finally, the rules as adopted provide, as in their proposed
version, that if an index that has qualified under the temporary
exclusion subsequently assumes narrow-based characteristics for more
than 45 business days over three consecutive calendar months, it
becomes a narrow-based security index, and thus the future on it
becomes a security future following an additional three-month grace
period.
5. Other Issues Concerning a Broad-Based Index That Becomes Narrow-
Based
If a security index on which a future 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 future on
such index could comply with the requirements of the securities laws
applicable to security futures.
The Proposing Release requested comment on whether the Commissions
should expressly specify the extent of changes that would need to be
made to the index in the event that the market does not wish to comply
with the requirements of the securities laws. The three commenters who
addressed this question generally responded in the negative.\111\ The
Commissions have determined not to undertake the adoption of specific
rules for this situation at this time.
---------------------------------------------------------------------------
\111\ See CBOE Letter; CBOT Letter; CME Letter I.
---------------------------------------------------------------------------
One commenter suggested that even after the grace period has
elapsed for a broad-based index that has become a narrow-based security
index, liquidating trades in the future should still be permitted in
months with open interest.\112\ The Commissions note that the statute
did not make allowances for such trades. In view of the fact that a
three-month grace period already exists for such futures, in addition
to the three-month tolerance period, the Commissions are not adopting
any additional allowance at this time.
---------------------------------------------------------------------------
\112\ See CBOT Letter.
---------------------------------------------------------------------------
C. CEA Rule 41.13 and Exchange Act Rule 3a55-3: A Future Traded on or
Subject to the Rules of a Foreign Board of Trade
1. Proposed Rules
In the Proposing Release, the Commissions expressed the belief that
security indexes underlying futures that are traded on or subject to
the rules of foreign boards of trade should be considered broad-based
security indexes if they qualify as such in light of the statutory
definition of a narrow-based index, or the exclusions from that
definition. The Commissions thus proposed Rule 41.13 under the CEA and
Rule 3a55-3 under the Exchange Act to clarify and establish that when a
future on an index is traded on or subject to the rules of a foreign
board of trade, that index would not be a narrow-based security index
if it would not be a narrow-based security index if a future on the
same index were traded on a designated contract market or registered
DTEF.\113\ The Proposing Release also requested comment on how rules
relating to foreign security indexes should address issues specific to
indexes traded on or subject to the rules of a foreign board of trade.
---------------------------------------------------------------------------
\113\ 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.
---------------------------------------------------------------------------
2. Comment Letters
Most of the commenters who addressed the subject of indexes traded
on or subject to the rules of a foreign board of trade did not appear
to object to the proposed rule, but focused their comments on the
question of an additional rule to create different standards for
indexes traded on or subject to the rules of a foreign board of trade
that would expand the types of indexes that would be considered broad-
based indexes.\114\ One commenter maintained that the public interest
requires the Commissions to move forward and grant relief with respect
to foreign security index contracts promptly.\115\
---------------------------------------------------------------------------
\114\ See Barclays Letter; CBOE Letter; CBOT Letter; CME Letter
I; FIA Letter; GMIMCo Letter; GS Letter; HFKE Letter; Johnson
Letter; ME Letter; MFA Letter; SFE Letter; SIA Letter.
\115\ See FIA Letter. On the other hand, the CME Letter
suggested that, in view of the controversy surrounding standards for
foreign indexes, proposed rules in this area be separated from the
rest of the proposed rules so as not to disrupt and prolong the
rulemaking process.
---------------------------------------------------------------------------
Commenters in favor of a different and more expansive standard for
when a security index future traded on or subject to the rules of a
foreign board of trade is broad-based made a number of arguments in
support of their view. For example, commenters contended that Congress
intended that different criteria be created for such indexes,\116\ and
that American investors, particularly institutional investors, need to
be able to trade in futures on foreign indexes for risk management,
asset allocation, ``view-driven'' strategies, and other purposes, and
would suffer substantial adverse impact and competitive disadvantage
with respect to non-U.S. investors if they could not trade such
futures.\117\
---------------------------------------------------------------------------
\116\ See Barclays Letter; FIA Letter; GMIMCo Letter; GS Letter.
\117\ See Barclays Letter; FIA Letter; GMIMCo Letter; GS Letter;
ME Letter.
---------------------------------------------------------------------------
In addition, commenters stated that the standards embodied in the
statutory definition of narrow-based security index are of little value
in evaluating foreign indexes because they were designed with U.S.
markets in mind,\118\ that standards for foreign-based indexes should
be flexible and consistent with the realities of the local stock market
and economy,\119\ and that futures on foreign-based indexes are
normally traded only among sophisticated investors and therefore need
little or no regulation.\120\
---------------------------------------------------------------------------
\118\ See FIA Letter.
\119\ See FIA Letter; GS Letter; HKFE Letter; ME Letter; SIA
Letter.
\120\ See GMIMCo Letter.
---------------------------------------------------------------------------
Other arguments from commenters supporting a different standard for
indexes underlying futures traded on foreign markets were that many
foreign boards of trade operate under regulatory regimes comparable to
that in the United States, that principles of international regulatory
comity support reliance on such regimes, and that local stock market
regulation should be sufficient to minimize the risk that a foreign
index future or its underlying
[[Page 44502]]
securities will be manipulated.\121\ Finally, some commenters claimed
that U.S. interest in the integrity of foreign securities trading is
less than U.S. interest in the integrity of trading in U.S.
securities.\122\
---------------------------------------------------------------------------
\121\ See HKFE Letter; ME Letter; SFE Letter; SIA Letter.
\122\ See GMIMCo Letter.
---------------------------------------------------------------------------
Some of these commenters proposed their own, or endorsed an
alternative set of, criteria for indexes traded on or subject to the
rules of a foreign board of trade.\123\ Others, while not as specific,
set forth the general principles by which they believed the Commissions
should formulate rules for foreign-based indexes.\124\
---------------------------------------------------------------------------
\123\ See Barclays Letter; FIA Letter; GMIMCo Letter; GS Letter;
SIA Letter.
\124\ See HKFE Letter; ME Letter; SFE Letter.
---------------------------------------------------------------------------
Two commenters, on the other hand, believed that indexes traded on
or subject to the rules of foreign boards of trade should be held to
the same standards as indexes traded on U.S. markets.\125\ In
particular, one commenter argued, the susceptibility of the component
securities of an index to manipulation-with a view to the depth of the
market in those component securities, their liquidity, and their
concentration in the index-should continue to guide the Commissions in
determining the status of foreign-based indexes.\126\ Another commenter
argued that a rule that would create a distinction between an index
future traded on or subject to the rules of a foreign board of trade
would unfairly place domestic boards of trade at a competitive
disadvantage and would contradict Congress's explicit intentions in
enacting the CFMA.\127\
---------------------------------------------------------------------------
\125\ See CBOE Letter; CME Letter I.
\126\ See CBOE Letter.
\127\ See CME Letter II.
---------------------------------------------------------------------------
In connection with foreign-based indexes, some commenters also
raised concerns relating to current statutory provisions that govern
the trading of futures by ``eligible contract participants,'' or
``ECPs.'' \128\ These commenters observed that ECPs may trade futures
on securities--including futures on narrow-based security indexes and
any type of foreign-based security index--in the over-the-counter
market with little regulatory supervision either by the SEC or CFTC,
and contended that futures exchanges are disadvantaged as a result.
---------------------------------------------------------------------------
\128\ See HKFE Letter.
---------------------------------------------------------------------------
Several of these commenters therefore advocated the adoption of a
rule that would permit the trading of futures on such indexes on
futures exchanges at least by ECPs, in the absence of a separately
crafted standard for foreign based security indexes to qualify as
broad-based indexes.\129\ Otherwise, they argued, the trading of such
futures would migrate to an unregulated arena.\130\ Two commenters
observed, on the other hand, that trading over-the-counter is more
difficult and substantially more expensive than on an exchange, and
cited this fact as an argument to permit trading in such indexes on a
futures exchange.\131\
---------------------------------------------------------------------------
\129\ See GS Letter; HKFE Letter; ME Letter; MFA Letter.
\130\ See CBOT Letter; GMIMCo Letter.
\131\ See FIA Letter; GS Letter. The FIA, however, did not
suggest limiting the trading of futures on foreign indexes to ECPs.
---------------------------------------------------------------------------
3. Final Rules
The Commissions are adopting Rule 41.13 under the CEA and Rule
3a55-3 under the Exchange Act \132\ as proposed. These rules provide
that when a future on an index is traded on or subject to the rules of
a foreign board of trade, such index is not a narrow-based security
index if it would not be a narrow-based security index if a future on
the same index were traded on a designated contract market or
registered DTEF. The rules clarify and establish that an index
underlying a future traded on or subject to the rules of a foreign
board of trade will be considered broad-based if it qualifies as such
pursuant to the statutory definition of narrow-based security index.
---------------------------------------------------------------------------
\132\17 CFR 41.13 and 17 CFR 240.3a55-3.
---------------------------------------------------------------------------
Because of the strong interest in the Commissions' adopting rules
implementing the definition of narrow-based security index, as they are
today doing, the Commissions believe that at this time it is prudent to
adopt Rule 41.13 under the CEA and Rule 3a55-3 under the Exchange Act
as proposed. Nevertheless, the Commissions recognize the need to
address those foreign index futures that are currently trading as
broad-based index futures under the exclusive jurisdiction of the CFTC
and that would be considered narrow-based index futures under the rules
being adopted today.\133\ The Commissions recognize their obligation
jointly to adopt rules or regulations that set forth the requirements
that a future 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. The
Commissions also acknowledge the requests of commenters that further
rulemaking should be considered by the Commissions to address what
commenters characterize as the unique nature of foreign stocks, foreign
stock indexes and foreign markets. The Commissions jointly will
consider further amendments to the rules regarding index futures
trading on or subject to the rules of a foreign board of trade pursuant
to their joint statutory rulemaking authority. As part of their
considerations, the Commissions will weigh the competitive implications
of treating a future on an index as a broad-based index future when
traded on or subject to the rules of a foreign board of trade, but
treating a future on the same index as a security future when it trades
on a U.S. market.
---------------------------------------------------------------------------
\133\ See supra note 15 and accompanying text.
---------------------------------------------------------------------------
The Commissions note at the same time that the CEA and Exchange Act
grant them joint authority to exclude any security index from the
definition of narrow-based security index by rule or by order that
meets such requirements that they jointly establish. Because of ongoing
business activities, the Commissions will consider using this authority
in the case of foreign-based security indexes that are currently
offered to U.S. investors pursuant to CFTC no-action letters, and may
also consider using this authority as to foreign-based security indexes
that may be developed in the future.
D. CEA Rule 41.14: A Future on a Narrow-Based Security Index That
Becomes Broad-Based
1. The Relevant Statutory Provision
As discussed above, the statutory definition of narrow-based
security index provides a temporary exclusion under certain conditions
for a future 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.\134\
---------------------------------------------------------------------------
\134\ See supra note 12 and accompanying text.
---------------------------------------------------------------------------
The statute provides no such tolerance and grace period for a
narrow-based security index that subsequently becomes broad-based.
2. Proposed Rule
Rule 41.14 under the CEA was proposed to fill this gap by providing
a 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 the rule was proposed to
establish a temporary exclusion for a security
[[Page 44503]]
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
treated for an interim grace period of three months as a narrow-based
contract.
Paragraph (b) of the rule was proposed to 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.\135\
---------------------------------------------------------------------------
\135\ Rule 41.1(a) as proposed defined ``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 rule also was proposed
to provide 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.
3. Comment Letters
Two commenters addressed proposed Rule 41.14. One of these
commenters believed the rule was appropriate, but in regard to a
narrow-based index that becomes a broad-based index, suggested that a
designated contract market or registered DTEF be allowed to immediately
treat the index as a broad-based security index, rather than wait
through the three-month grace period, and be subject to the sole
jurisdiction of the CFTC.\136\ This would give the listing market the
freedom to choose the course that is less disruptive to market
participants.
---------------------------------------------------------------------------
\136\ See CME Letter I.
---------------------------------------------------------------------------
The other commenter suggested that if the underlying index had been
narrow-based for at least six consecutive months prior to the initial
trading of the security index futures contract, but later became a
broad-based index, there should be a presumption that the contract was
offered as a narrow-based contract in good faith.\137\ As such, the
rule should allow a grace period of nine months, instead of three, for
purposes of unwinding the contract, or the rule should allow the
listing market to seek qualification as a designated contract market in
order to continue trading the contract. This commenter also suggested
that the CFTC should have the flexibility to extend the grace period or
eliminate the ``liquidating only'' limitation, in order to foster
liquidity and avoid harming traders.
---------------------------------------------------------------------------
\137\ See Amex Letter.
---------------------------------------------------------------------------
4. Final Rule
After careful consideration of the comments, the CFTC has
determined to adopt the rules in large measure as they were proposed,
with one change resulting from the suggestion of a commenter.
The CFTC has decided not to allow a designated contract market or
registered DTEF to immediately treat an index that has switched from
narrow-based to broad-based as a broad-based index. Instead, all
markets must continue to treat former narrow-based indexes as narrow-
based indexes during the three-month grace period provided for in
41.14(b). The CFTC notes that indexes that switch from being narrow-
based to broad-based may still be in a transitioning period. The three-
month grace period, which will continue to treat an index as a narrow-
based index, will provide certainty to the market and investors that
the index has indeed become broad-based, and is not in the midst of
more fluctuation.
Furthermore, when an index underlying a security index futures
contract switches from being narrow-based to broad-based and does not
return to narrow-based status during the grace period, the customers
who trade that contract would need to switch regulatory regimes. A
three-month grace period will prevent those who trade in such contracts
from being taken by surprise by the switch in regulatory oversight.
Regarding the comments of the second commenter, the CFTC agrees
that only allowing liquidating trades as proposed under Rule 41.14(c)
will reduce liquidity and may harm traders. As such, markets may
continue trading security index futures contracts on narrow-based
indexes that have become broad-based, without limiting trading to
liquidating trades only. However, the CFTC has decided to keep the
three-month grace period in Rule 41.14(b), instead of allowing a nine-
month grace period or other extended grace period. The three-month
grace period mirrors the time frame established by the CFMA governing
broad-based indexes that become narrow-based. Comparable treatment for
narrow-based indexes that become broad-based is equitable. Moreover,
allowing flexible extended grace periods for certain contracts would
create uncertainty in the market and for traders regarding the status
of the product and their obligations. Further, allowing for an
extension of the grace period on a case-by-case basis may be a lengthy
process, leaving traders uncertain as to when trading in the particular
contract may come to an end or when the new regulatory scheme becomes
applicable.
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), will 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.\138\ The CFTC has
determined to adopt a ``no-action'' position with respect to a national
securities exchange trading a contract based on a narrow-based security
index that becomes a broad-based security index, so long as the
national securities exchange administers the contract in accordance
with Rule 41.14. Accordingly, the CFTC will not institute any
enforcement action for violations of the CEA when a national securities
exchange is in the midst of the 45-day tolerance provision of paragraph
(a), the three-month grace period of paragraph (b), or the unwinding
period of paragraph (c).
---------------------------------------------------------------------------
\138\ See Section 2(a)(1)(C)(ii) of the CEA.
---------------------------------------------------------------------------
E. Additional Comments
One comment letter, submitted by the U.S. Securities Markets
Coalition (``Coalition''),\139\ raised concerns over certain tax
implications that these markets believe result from the definition of
narrow-based security index and the rules as proposed. Under new tax
provisions that were enacted contemporaneously with the CFMA, futures
and options on broad-based security indexes receive certain favorable
treatment that futures and options on narrow-based security indexes do
not. As to the determination of which indexes qualify as broad-based
and which are treated as narrow-based, the tax laws incorporate by
reference the definition of narrow-based security index in the Exchange
Act.
---------------------------------------------------------------------------
\139\ Securities Markets Coalition Letter.
---------------------------------------------------------------------------
As discussed above, under the definition of narrow-based security
index in the Exchange Act and the proposed rules, when a broad-based
index suddenly becomes narrow-based, the status of the index as broad-
based is preserved unless the index becomes narrow-based for more than
45 days over a three-month period. When this tolerance is exceeded, the
index remains broad-based for another three months. These tolerance and
grace period provisions by their own terms apply, however, only when a
future is already trading on the index. As a result, if only an option
(and not a future) is trading on a broad-based index, and the index
[[Page 44504]]
suddenly becomes narrow-based, the option would be considered an option
on a narrow-based security index immediately. The option would thus
immediately lose its favorable tax treatment.
The Coalition further noted that, as a result of this statutory
framework, if only an option, and not a future, is trading on a
particular security index, that index may fluctuate back and forth in
tax status from day to day. This result, the Coalition believes, will
create uncertainty and confusion for investors, with a resulting
disruption of the markets. The Coalition recommended that the
Commissions modify their rules to the extent possible to address this
issue.
Specifically, the Coalition observed that Rule 41.14 under the CEA,
which creates tolerance and grace periods for a narrow-based security
index that becomes broad-based, defines an index's status without
regard to whether a future is trading on the index. The Coalition
recommended, first, that the equivalent of CEA Rule 41.14 be adopted as
a rule under the Exchange Act, so that it will be incorporated by
reference by the tax laws. The Coalition further recommended that Rule
41.12 under the CEA and Rule 3a55-2 under the Exchange Act, which
provide an exclusion for a broad-based security index that became
narrow-based during the first 30 days of trading, be worded similarly
to define such an index's status without regard to whether a future
traded on the index.
The Commissions note, in consideration of these comments, that the
CFMA itself, as incorporated in the CEA and Exchange Act, ties its
tolerance and grace period provisions to indexes upon which a future
has traded. The Commissions cannot alter these statutory provisions,
and believe that their rules providing an additional temporary
exclusion for a broad-based index that became narrow-based must conform
to the statutory contours. In addition, the SEC believes that it is not
empowered to adopt the equivalent of CEA Rule 41.14 under the Exchange
Act, which provides relief for futures on indexes that become broad-
based, because the SEC has no jurisdiction over broad-based security
index futures.
Two commenters raised issues concerning the treatment of futures on
Exchange Traded Funds.\140\ The Commissions believe that these issues
fall outside the scope of the current rulemaking and will not address
them in this context. The Commissions expect to receive in the coming
months questions about futures on other types of security products, as
well, and for the foreseeable future will evaluate the status of such
futures on a case-by-case basis.
---------------------------------------------------------------------------
\140\ See Amex Letter; CBOT Letter.
---------------------------------------------------------------------------
III. Administrative Procedure Act
CFTC
The Administrative Procedure Act (the ``APA'') generally requires
that rules promulgated by an agency not be made effective less than
thirty days after publication, except for, among other things,
instances where the agency finds good cause to make a rule effective
sooner, and has published that finding together with the rule.\141\
Pursuant to the CFMA, beginning on August 21, 2001, eligible contract
participants may trade security futures products on a principal-to-
principal basis. The rules being published today directly affect the
products that eligible contract participants may trade. The CFTC
believes good cause exists for the rules to become effective on August
21, 2001, so that eligible contract participants may begin trading the
new products as contemplated by the CFMA.
---------------------------------------------------------------------------
\141\ 5 U.S.C. 553(d)(3).
---------------------------------------------------------------------------
SEC
Section 553(d) of the Administrative Procedure Act\142\ generally
provides that, unless an exception applies, a substantive rule may not
be made effective less than 30 days after notice of the rule has been
published in the Federal Register. One exception to the 30-day
requirement is an agency's finding of good cause for providing a
shorter effective date.
---------------------------------------------------------------------------
\142\ 5 U.S.C. 553(d).
---------------------------------------------------------------------------
The CFMA provides that principal-to-principal transactions between
certain eligible contract participants in security futures products may
commence on August 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.\143\ The CFMA lifted the ban on,
and permits the trading of, futures contracts on single securities and
on narrow-based security indexes. Furthermore, the CFMA amended the CEA
and Exchange Act by adding an objective definition of ``narrow-based
security index'' to provide guidance for markets to determine whether a
security index is narrow-based.\144\ 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 DTEF, or foreign board of trade may trade these
products.
---------------------------------------------------------------------------
\143\ See Section 6(g)(5)(B)(ii) of the Exchange Act, 15 U.S.C.
78f(g)(5)(B)(ii).
\144\ See Section 1a(25) of the CEA and Section 3(a)(55) of the
Exchange Act.
---------------------------------------------------------------------------
The CFMA became law on December 21, 2000. Since the passage of the
CFMA, the SEC has moved quickly to propose and adopt rules that would
provide markets with the method for determining market capitalization
and dollar value of ADTV for purposes of ascertaining whether a
security index is narrow-based. The SEC proposed these rules on May 17,
2001. The initial comment period for the rules expired on June 18,
2001. The comment period, however, was extended by the CFTC and the SEC
until July 11, 2001. After reviewing and considering the comments
received, the SEC is adopting the rules, which provide the methods for
markets to determine whether a security index is narrow-based or broad-
based as required by the Exchange Act, as amended by the CFMA. By
allowing principal-to-principal transactions between certain eligible
contract participants in security futures products to commence on
August 21, 2001, Congress effectively established a statutory deadline
for the adoption of these rules. If the effective date is delayed for
30 days, the SEC will not have rules in place for markets to determine
market capitalization and dollar value of ADTV. Therefore, eligible
contract participants will be unable to trade futures on security
indexes on a principal-to-principal basis.
The primary purpose of the 30-day delayed effectiveness requirement
is to give affected parties a reasonable period of time to adjust to
the new rules. Here, the parties that must comply with the rules would
not be harmed by immediate effectiveness of the rules. The affected
entities are familiar with the proposed rules, which were published for
comment, and the adopted rules are substantially similar to those
proposed rules. Moreover, the 30-day delay in effectiveness could
interfere with the goals established by Congress in adopting the CFMA.
For these reasons, the SEC finds that good cause exists for the rules
to be immediately effective upon publication.
IV. Paperwork Reduction Act
CFTC
This rulemaking contains information collection requirements. As
required by the Paperwork Reduction Act of 1995
[[Page 44505]]
(44 U.S.C. 3501 et seq.), the CFTC submitted a copy of these rules to
the Office of Management and Budget for its review. See 44 U.S.C.
3507(d)(1).
Collection of Information: Part 41, Relating to Security Futures
Products, OMB Control Number 3038-0059.
The information collection requirements of this rulemaking will
impact designated contract markets (including notice-registered
contract markets) and registered DTEFs that wish to trade a futures
contract on a security index. Designated contract markets and
registered DTEFs that wish to trade futures contracts on a security
index would use the methods specified in these 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.
Furthermore, Rule 41.2 requires designated contract markets and
registered DTEFs that trade a futures contract on a security index 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 rule restates the existing recordkeeping requirements of the
CEA.\145\ The 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 are required to
preserve records of any calculations used to determine whether an index
is narrow-based or broad-based.
---------------------------------------------------------------------------
\145\ See Sections 5(d)(17) and 5a(d)(8) of the CEA.
---------------------------------------------------------------------------
The CFTC may not conduct or sponsor, and a person is not required
to respond to an information collection unless it displays a currently
valid OMB control number. No comments were received in response to the
CFTC's invitation in the notice of proposed rulemaking to comment on
any potential paperwork burden associated with these rules. See 44
U.S.C. 3507(d)(2).
SEC
Certain provisions of Rules 3a55-1 through 3a55-3 contain
``collection of information'' requirements within the meaning of the
Paperwork Reduction Act of 1995 (``PRA''),\146\ and the SEC 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 proposed,
and OMB approved, an amendment to 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.
---------------------------------------------------------------------------
\146\ 44 U.S.C 3501 et seq.
---------------------------------------------------------------------------
The Proposing Release solicited comments on this collection of
information requirement.\147\ Two comments were received implicitly
addressing the PRA section of the Proposing Release. One commenter
stated that it would be a heavy administrative burden to preserve the
records documenting daily calculations of market capitalization and
dollar value of ADTV of a security or group of securities comprising an
index.\148\ The same commenter, however, stated that the CFMA's
statutory framework provides a ``clear implication'' that these
calculations must be made daily.\149\ The other commenter on PRA issues
stated that Congress' intention when adopting the CFMA was to require
monthly, rather than daily, calculations for purposes of the
determining whether a security index is narrow-based.\150\ According to
the commenter, if monthly calculations were intended and required by
the statute, the paperwork burden on the exchanges, as well as the
paperwork and review burden on the Commissions, would be reduced.\151\
---------------------------------------------------------------------------
\147\ See Proposing Release, supra note 17.
\148\ See CBOT Letter.
\149\ Id.
\150\ See CME Letter I.
\151\ Id.
---------------------------------------------------------------------------
Because the final rules are substantially similar to the proposed
rules, the SEC continues to believe that the estimates published in the
Proposing Release regarding the proposed collection of information with
respect to recordkeeping burdens associated with the final rules, as
discussed below, are appropriate. The Commissions, however, have
amended the proposed rules to establish methods for determining the
market capitalization and dollar value of ADTV for purposes of
ascertaining whether a security-index is narrow-based that are
responsive to commenters' suggestions. In this regard, the Commissions
have incorporated revisions to the proposed rules to reflect what
commenters view as simpler methods of calculating these values. These
modifications to the rules change somewhat the methodology used to
determine whether a security index is narrow-based or broad-based but
do not, in any way, alter the recordkeeping burden associated with the
preservation of the records of these calculations, i.e., the collection
of information required pursuant to Rule 17a-1 under the Exchange
Act.\152\
---------------------------------------------------------------------------
\152\ 17 CFR 240.17a-1
---------------------------------------------------------------------------
Any collection of information pursuant to the new rules is
mandatory and will need to be retained by the national securities
exchanges, including national securities exchanges registered pursuant
to Section 6(g) of the Exchange Act (``notice-registered national
securities exchanges''), for no less than five years; for the first two
years, the information must be kept in an easily accessible place, as
required under Exchange Act Rule 17a-1.
A. The Use and Disclosure of the Information Collected
The information collected to comply with the methods to determine
market capitalization and dollar value of ADTV that are set forth in
the final rules is required by the CFMA. The CFMA lifted the ban on the
trading of futures on single securities and on narrow-based security
indexes and established a framework for the joint regulation of these
products by the CFTC and the SEC. In addition, the CFMA amended the CEA
and the Exchange Act by adding a definition of ``narrow-based security
index,'' which establishes an objective test of whether a security
index is narrow-based.\153\ Futures on security indexes that meet the
statutory definition of narrow-based security index are jointly
regulated by the CFTC and the SEC. Futures 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 jointly
specify by rule or regulation the method to determine market
capitalization and dollar value of ADTV of securities comprising an
index.\154\ The rules adopted in this release fulfill this statutory
directive.
---------------------------------------------------------------------------
\153\ See Section 1a(25)(A) of the CEA and Section 3(a)(55)(B)
of the Exchange Act.
\154\ See Section 1a(25)(E) of the CEA and Section 3(a)(55)(F)
of the Exchange Act.
---------------------------------------------------------------------------
In addition, the CFMA amended the Exchange Act by adding new
Section
[[Page 44506]]
6(g), which requires 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-by filing written notice
with the SEC-solely for the purpose of trading security futures
products.\155\
A national securities exchange, designated contract market,
registered DTEF, or foreign board of trade that trades or proposes to
trade futures on a security index must ascertain whether the security
index falls within or outside of the definition of narrow-based
security index to determine if the futures contract is jointly
regulated by the CFTC and SEC or solely by the CFTC. This is necessary
because, to comply with the applicable laws and carry out their
regulatory functions, the markets must know which set or sets of
statutes and rules apply to a particular futures contract. This process
entails, among other things, a collection of the information necessary
to make the requisite determination under the provisions of the CEA and
Exchange Act regarding the market capitalization and dollar value of
ADTV of component securities comprising a security index.
---------------------------------------------------------------------------
\155\ See Section 6(g) of the Exchange Act, 15 U.S.C. 78f(g).
---------------------------------------------------------------------------
Rule 3a55-1 under the Exchange Act specifies the method to
determine market capitalization and dollar value of ADTV with respect
to the definition of narrow-based security index. \156\ Thus, the final
rule provides the methods by which a market trading a futures contract
on a security index must determine the market capitalization and dollar
value of ADTV to ascertain whether a security index on which it
proposes to trade, or is trading, a futures contract is narrow-based,
and thus is subject to the joint jurisdiction of the CFTC and the SEC.
If the security index is determined to be broad-based, the trading of
futures on that index is subject to the sole jurisdiction of the CFTC.
---------------------------------------------------------------------------
\156\ Rule 41.11 under the CEA parallels Rule 3a55-1.
---------------------------------------------------------------------------
The SEC will use the collected information to monitor whether the
calculations are being made in compliance with the rules. The SEC will
obtain access to the information upon request. Any collection of
information received by the SEC will not be made public.
Rule 17a-1, among other things, requires national securities
exchanges, which by definition include entities registered under the
new notice registration provisions of the Exchange Act, \157\ 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; for the
first two years, these documents must be kept in an easily accessible
place. Any exchange that lists or trades a futures contract on a
narrow-based security index 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 applies to any notice-registered national
securities exchange. Accordingly, 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 will be required to preserve
records of any calculations used to determine whether an index is
narrow-based.\158\
---------------------------------------------------------------------------
\157\ See Section 6 of the Exchange Act, 15 U.S.C. 78f.
\158\ This PRA analysis does not include any collection of
information and recordkeeping requirements that will 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 will not be subject to Rule 17a-1 under the Exchange
Act. The CFTC has adopted Rule 41.2, which contains recordkeeping
requirements for designated contract markets and registered DTEFs.
---------------------------------------------------------------------------
B. Total Annual Reporting and Recordkeeping Burden
1. Capital Costs
Rule 17a-1 under the Exchange Act requires a national securities
exchange, including any notice-registered national securities exchange,
that trades futures contracts on a narrow-based security index 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. In the Proposing Release, the SEC
estimated that any additional costs of retaining and storing the
collected information discussed above would be nominal because national
securities exchanges, including notice-registered national securities
exchanges that have been designated as contract markets by, or
registered as DTEFs with, the CFTC, are currently required to have
recordkeeping systems in place.\159\
---------------------------------------------------------------------------
\159\ 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.
---------------------------------------------------------------------------
The SEC received no direct comments on the costs of data retention
and storage. Based on information provided by an industry source, the
SEC anticipates that retaining and storing the determinations made
under the new rules may require the use of one or two compact discs on
a daily basis or setting up servers to preserve the information. The
SEC believes, however, that because exchanges already have data storage
facilities in place, it will not be burdensome or costly for exchanges
to modify their existing recordkeeping systems to accommodate the
storage of the records of calculations made pursuant to the new rules.
In addition, it should be noted that the new rules simply provide the
methodologies for determining market capitalization and dollar value of
ADTV, as mandated by the CFMA. The CFMA requires that the
determinations as to market capitalization and dollar value of ADTV,
and thus the status of a securities index as narrow-based or broad-
based, be made, while Exchange Act Rule 17a-1 simply requires that such
determinations be retained.
2. Burden Hours
National securities exchanges, including notice-registered national
securities exchanges, that trade futures contacts on security indexes
will be required to comply with the recordkeeping requirements under
Rule 17a-1. National securities exchanges, including notice-registered
national securities exchanges, will be required to retain and store any
documents related to determinations made using the definitions in
Exchange Act Rule 3a55-1 for no less than five years, the first two
years in an easily accessible place. The current burden hour estimate
for Rule 17a-1, as of July 20, 1998, is 50 hours per year for each
exchange.\160\ In the Proposing Release, the SEC estimated that it
would take each of the 11 national securities exchanges, including
notice-registered national securities exchanges, expected to trade
futures contracts on security indexes one hour annually to retain any
documents made or received by it in determining whether an index is a
narrow-based security index. No comments were received on this
particular estimate. The total burden in complying with Rule 17a-1
[[Page 44507]]
for each national securities exchange, including notice registered
national securities exchanges, under new Rule 3a55-1 is therefore
estimated to be 11 hours.
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\160\ See 63 FR 38865 (July 20, 1998) (SEC File No. 270-244, OMB
Control No. 3235-0208) (seeking an extension of OMB approval of Rule
17a-1 under the Exchange Act.
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V. Costs and Benefits of the Final Rules
CFTC
Section 15 of the CEA, as amended by section 119 of the CFMA,
requires the CFTC to consider the costs and benefits of its action
before issuing a new regulation under the CEA. The CFTC understands
that, by its terms, section 15 does not require the CFTC to quantify
the costs and benefits of a new regulation or to determine whether the
benefits of the proposed regulation outweigh its costs.
Section 15 further specifies that costs and benefits shall be
evaluated in light of five broad areas of market and public concern:
(1) Protection of market participants and the public; (2) efficiency,
competitiveness, and financial integrity of futures markets; (3) price
discovery; (4) sound risk management practices; and (5) other public
interest considerations. Accordingly, the CFTC could in its discretion
give greater weight to any one of the five enumerated areas of concern
and could in its discretion determine that, notwithstanding its costs,
a particular rule was necessary or appropriate to protect the public
interest or to effectuate any of the provisions or to accomplish any of
the purposes of the Act.
The CFTC considered the costs and benefits of this rule package in
light of the specific areas of concern identified in section 15 of the
CEA,\161\ and concluded that these rules would have no effect on the
financial integrity or price discovery function of the markets, or on
the risk management practices of trading facilities. The CFTC also
concluded that these rules would have no material effect on the
protection of market participants and the public, and should not impact
the efficiency and competition of the markets. The CFTC solicited
comments about its consideration of these costs and benefits.\162\ The
CFTC received no comments.
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\161\ 66 FR 27559, 27572 (May 17, 2001).
\162\ 66 FR at 27571.
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The CFTC further notes that the CFMA specifically mandates that the
CFTC and the SEC jointly adopt rules or regulations specifying the
method to be used to determine market capitalization and dollar value
of average daily trading volume.\163\ Accordingly, the CFTC has
determined to adopt the regulations discussed above.
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\163\ Section 1a(25)(E)(ii) of the CEA; 7 U.S.C. 1a(25)(E)(ii).
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SEC
New Rule 3a55-1 under the Exchange Act provides the methods of
determining market capitalization and dollar value of ADTV,
respectively, for purposes of ascertaining whether a security index is
narrow-based within the meaning of the Exchange Act. New Rule 3a55-2
under the Exchange Act excludes 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 and become narrow-based, provided
that they meet certain criteria. New 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 will
not be considered a narrow-based security index if a futures contract
on such index were traded on a designated contract market or registered
DTEF. These rules provide methods of calculation and guidance for
national securities exchanges, designated contract markets, registered
DTEFs, and foreign boards of trade in determining whether a security
index is narrow-based under the Exchange Act.
A. Comments
In the Proposing Release, the SEC requested comments on all aspects
of the costs and benefits of the proposed rules, including
identification of additional costs and benefits of the proposals. None
of the commenters provided dollar-based estimates regarding the overall
costs and benefits of the proposed rules. However, several commenters
discussed certain aspects of the joint CFTC-SEC proposal that addressed
the costs and benefits of the proposed rules, and one commenter
provided an estimate regarding staffing needs to comply with the
proposed rules.\164\
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\164\ One commenter raised concerns about certain implications
that it believed could result from the statutory definition of
narrow-based security index and certain proposed rules. See
Securities Markets Coalition Letter. The commenter pointed to the
differing tax treatment that may result if an option (not a future)
is traded on a broad-based security index that becomes narrow-based.
In addition, the commenter suggested that the proposed rules under
the CEA creating tolerance and grace periods for a narrow-based
security index that becomes broad-based also be adopted under the
Exchange Act. The SEC notes that this commenter's concerns result
from the provisions of the CFMA itself, which the Congress, and not
the Commissions, is empowered to change. Accordingly, the SEC has
not incorporated this comment letter into its analysis of the costs
and benefits of the final rules.
---------------------------------------------------------------------------
In particular, two commenters stated that the rules as proposed
would impose a heavy administrative burden and that performing lengthy
calculations to determine the status of a security index on a daily
basis would be cumbersome and resource intensive.\165\ One of these
commenters also stated that calculations would be pointless for indexes
that were not ``close calls.'' \166\ Both commenters suggested that, to
ease the computational burden imposed by the proposed rules, markets
trading these products should be permitted to use and rely on third-
party vendors for information and calculations.\167\
---------------------------------------------------------------------------
\165\ See CBOT Letter and CME Letter I.
\166\ See CME Letter I.
\167\ See CBOT Letter and CME Letter I.
---------------------------------------------------------------------------
Another commenter specifically remarked about the consistency and
accuracy of data available through third-party vendors.\168\ The
commenter stated that there should be one official source that compiles
the lists of Top 750 and Top 675 securities.\169\ The commenter
suggested that having an official source for such lists will reduce the
overall costs to all markets otherwise required to make these
calculations. This commenter noted that a single compiler of the lists
will result in consistent treatment of futures on security indexes.
Furthermore, this commenter indicated that it will need to hire two
additional staff personnel to calculate market capitalization and
dollar value of ADTV for securities comprising an index on which future
contracts trade.
---------------------------------------------------------------------------
\168\ See CBOE Letter.
\169\ See Section II.A.3. above for a description of Top 750 and
Top 675 securities.
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The SEC also received several comments regarding potential costs
that might be incurred unless different criteria for the definition of
narrow-based security index are adopted to accommodate indexes
comprised of foreign securities.\170\ The SEC notes that the
Commissions have adopted Rules 41.13 under the CEA and 3a55-3 under
[[Page 44508]]
the Exchange Act, which 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 will not be considered 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 Commissions will continue to consider the views
and suggestions of the commenters regarding futures contracts on
security indexes comprised of foreign securities.
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\170\ Several commenters supported the adoption of different
standards for security indexes underlying futures traded on or
subject to the rules of a foreign board of trade. See ME Letter,
HKFE Letter, and SFE Letter. Two commenters, however, stated that
security indexes underlying futures traded on or subject to the
rules of a foreign board of trade should be held to the same
standards as security indexes underlying futures traded in U.S.
markets. See CBOE Letter, CME Letter II. Some of the commenters
favoring separate criteria for the indexes comprised of foreign
securities mentioned the perceived costs that could be incurred by
investors, unless separate standards are adopted. See ME Letter,
HKFE Letter; SFE Letter. The SEC points out that the definition of
narrow-based security index as contained in the CEA and Exchange
Act, and not the rules adopted in this release, set forth the
criteria regarding whether a security index is narrow-based.
Consequently, the perceived costs result from the statute's
provisions and not the final rules.
---------------------------------------------------------------------------
In response to the commenters' concerns and suggestions, the SEC
has amended the proposed rules with respect to the methods for
determining market capitalization and dollar value of ADTV to assess
whether a security index is narrow-based or broad-based. Where
possible, estimated costs and benefits are provided below, as well as
the SEC's response to these comments.
B. Benefits
In the Proposing Release, the SEC noted that the benefits of 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 the trading of futures on single securities and on
narrow-based security indexes, the CFMA enables 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 security futures.
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
registered DTEFs. The CFMA provides objective criteria for determining
whether or not a security index is narrow-based, and the newly-adopted
rules provide assistance in applying those criteria.
New Rule 3a55-1 under the Exchange Act provides methodologies for
determining market capitalization and dollar value of ADTV for purposes
of ascertaining whether or not a security index is narrow-based as
defined in the Section 3(a)(55) of the Exchange Act. The adopted rule
provides the benefit of clear, objective standards for determining both
market capitalization and dollar value of ADTV. In the Proposing
Release, the proposed rules used ``average price'' to compute market
capitalization and dollar value of ADTV. Based on the suggestions of
commenters, the Commissions have amended the methods to determine
market capitalization and dollar value of ADTV. In particular, the new
rule uses the ``closing price'' for a security for a particular day for
purposes of determining its market capitalization. Also, unlike the
proposed rule, Rule 3a55-1 does not mandate using a volume-weighted
average price to determine dollar value of ADTV.
Under the Rule 3a55-1, market capitalization of a security on a
particular day is defined as the product of the closing price of such
security on that same day and the number of outstanding shares of such
security on that same day. Rule 3a55-1 provides an objective definition
for the ``closing price'' of a security based on whether reported
transactions in the security have taken place in the United States or
only in other jurisdictions for purposes of calculating market
capitalization. Market capitalization is relevant in determining
whether an index qualifies for an exclusion from the definition of
narrow-based security index. If each component security is one of 750
securities with the largest market capitalization and one of 675
securities with the largest dollar value of ADTV, among other criteria,
the index is broad-based.
Market capitalization of a security for purposes of Rule 3a55-1 can
be determined in the following manner. If, on a particular day, each
component security of an index is on the list of the Top 750 securities
with the largest market capitalization that is designated by the CFTC
and SEC as applicable for that day, then the market capitalization
criterion is satisfied. If the CFTC and SEC have not designated such a
list, the method to be used to determine market capitalization for a
security as of the preceding 6 full calendar months is to sum the
values of the market capitalization of such security for each U.S.
trading day of the preceding 6 full calendar months, and then divide
that sum by the total number of such trading days.
New Rule 3a55-1 also provides two separate methods for determining
dollar value of ADTV. For purposes of Section 3(a)(55)(B) of the
Exchange Act,\171\ dollar value of ADTV of a security is the sum of
dollar value of ADTV of all reported transactions in such security, in
each jurisdiction where the security trades, including transactions in
the United States and transactions in jurisdictions other than the
United States. In addition, Rule 3a55-1 sets forth the method to
determine dollar value of ADTV for trading in a security in the United
States and in jurisdictions other than the United States over a period
of the preceding 6 full calendar months. The new rule also establishes
how to calculate dollar value of ADTV for the lowest weighted 25% of an
index and clarifies that all reported transactions for any depositary
share that represents a security be included in the calculation of
dollar value of ADTV of the underlying security, and that all reported
transactions for a security underlying a depository share be included
in the calculation of dollar value of ADTV of the depository share.
---------------------------------------------------------------------------
\171\ 15 U.S.C. 78c(a)(55)(B).
---------------------------------------------------------------------------
For purposes of Section 3(a)(55)(C)(i)(III)(cc) of the Exchange
Act,\172\ if a component security of the index is on the list of Top
675 securities with the largest dollar value of ADTV by the SEC and the
CFTC as applicable for that day, the dollar value of ADTV criterion is
satisfied. If the Commissions do not designate such a list, then the
method to be used to determine dollar value of ADTV for a single
security as of the preceding 6 full calendar months is to sum the value
of all reported transactions in such security in the United States for
each U.S. trading day during the preceding 6 full calendar months, and
then divide the sum by the total number of such trading days.
---------------------------------------------------------------------------
\172\ 15 U.S.C. 78c(a)(55)(C)(i)(III)(cc).
---------------------------------------------------------------------------
Under the statutory definition of narrow-based security index, the
market capitalization and dollar value of ADTV must be calculated ``as
of the preceding 6 full calendar months.'' Rule 3a55-1 specifies a
``rolling'' 6 month period, i.e., with respect to a particular day, the
``preceding 6 full calendar months'' will mean the period of time
beginning on the same calendar date 6 months before and ending on the
day prior to that day.
The SEC believes new Rule 3a55-1 under the Exchange Act provides 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 calculation of dollar
value of ADTV for the lowest weighted 25% of the index when component
securities of an index are also traded on markets outside of the United
States.
[[Page 44509]]
The new rule clarifies 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 a rate of exchange
for that day obtained from at least one independent entity that
provides or disseminates foreign exchange quotations in the ordinary
course of its business.
In addition, the SEC adopted Rule 3a55-2 under the Exchange Act.
The new rule provides 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
meets certain specified criteria. This exclusion is beneficial because
it will 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.
Finally, new 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 will not be
considered 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. This rule is
beneficial because it aids markets in assessing whether a futures
contract trading on a security index comprised of foreign securities
will be subject to sole CFTC jurisdiction or joint CFTC-SEC
jurisdiction.
C. Costs
In complying with new Rules 3a55-1 through 3a55-3 under the
Exchange Act, a national securities exchange, designated contract
market, registered DTEF, or foreign board of trade will 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 new rules to determine whether or not a
security index is narrow-based and thus whether the futures contract is
subject solely to the CFTC's jurisdiction or subject to the joint
jurisdiction of the CFTC and SEC. Thus, the costs of complying with the
new 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 their own compliance with
the newly-adopted rules and thus will incur various costs in
determining the market capitalization and dollar value of ADTV for
component securities of a security index.
The new rules require national securities exchanges, designated
contract markets, registered DTEFs, and foreign boards of trade to
gather information to ascertain the market capitalization and dollar
value of ADTV for component securities of an index with respect to each
day, in certain cases taking into account data for the preceding 6 full
calendar months. To compute dollar value of ADTV for a single security
that is a component of an index, Rule 3a55-1 requires a market in
certain circumstances to tally the sum of dollar value of ADTV of all
reported transactions in such security in each jurisdiction where the
security trades for the preceding 6 full calendar months, using the
method described in the rule. An additional calculation will be
required to determine dollar value of ADTV of the lowest weighted 25%
of an index.
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). To compute market capitalization
in the event the Commissions do not designate a list of the Top 750
securities, the final rules require a market to determine the number of
outstanding shares of a security on a particular day as reported on the
issuer's most recent annual or periodic report filed with the SEC and
each security's closing price for that same day for a period comprising
the preceding 6 full calendar months. A designated contract market,
registered DTEF, or foreign board of trade will 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 new rules. Rule 3a55-1, however, allows the CFTC and
the SEC to designate lists providing the Top 750 securities with
respect to market capitalization and the Top 675 securities with
respect to dollar value of ADTV.
A market may incur costs if it contracts 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 incur the 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 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 will incur additional costs
to obtain such data.
The commenters did not provide the SEC with actual estimates of the
costs that they would incur to compile the data and make the
computations with respect to market capitalization and dollar value of
ADTV. The SEC therefore contacted several exchanges regarding cost
assessments; however, these exchanges did not provide dollar-based
estimates. Consequently, the SEC is using estimates provided by third-
party vendors in assessing the start-up and maintenance costs to
perform and retain the calculations required by the new rules. The SEC
estimates the cost of obtaining a third-party vendor's terminal to be
$1,650 per month for the first terminal and $1,300 per month per
terminal if two or more terminals are used. The SEC estimates a cost of
$500 per month to maintain communication lines to obtain the data feed.
In addition, it is anticipated that there will be a one-time
installation fee of $300 per terminal. The total cost for each of the
11 exchanges expected to trade futures on security indexes to install
and maintain one terminal for the first year is estimated to be
$26,100, which includes the one-time installation fee. The total cost
for each of the 11 exchanges to maintain one terminal on an annual
basis thereafter is estimated to be $25,800. The total cost for all of
the 11 exchanges to install and maintain one terminal for the first
year is estimated to be $287,100, which includes the one-time
installation fee. The total cost for all of the 11 exchanges to
maintain one terminal on an annual basis thereafter is estimated to be
$283,800. The SEC notes, however, that for those exchanges that already
have such third-party vendor terminals in place, there should be no
additional costs associated with obtaining the required data to comply
with the new rules.
The calculations required under the new rules for market
capitalization and dollar value of ADTV may require
[[Page 44510]]
additional data storage.\173\ A national securities exchange,
designated contract market, or registered DTEF will 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 will also have to take
into consideration the time period for which the data will have to be
stored and the costs associated with such storage and maintenance.
Taking into account that exchanges already have recordkeeping systems
in place, the SEC believes that any new or additional data storage
costs will be minimal. In addition, the SEC understands that data
storage may be minimized if markets rely on third-party vendors as a
source for data because those vendors' terminals generally are linked
to PC terminals that can readily store the information.
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\173\ 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 new Rule 41.2
under CEA, respectively, national securities exchanges, designated
contract markets, and registered DTEFs will need to preserve records
of all their determinations with respect to the narrow-based or non-
narrow-based status of security indexes.
---------------------------------------------------------------------------
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 new rules. As
noted above, one commenter indicated that it would need two additional
staff personnel to comply with the new rules.\174\ While not
necessarily agreeing with that estimate, using the assessment that two
full-time staff persons would be required, the SEC estimates that the
total annual cost of employing a staff person in a clerical position to
perform the computations based on the new rules will be approximately
$42,520 plus 35% for overhead costs (i.e., costs of supervision, space
and administrative support), for a total of approximately $57,600 ($32
per hour per market).\175\ The SEC estimates that the total annual cost
of employing a staff person in a supervisory position to oversee the
clerical staff person will be approximately $135,001 plus 35% for
overhead costs, for a total of approximately $180,000 ($100 per hour
per market).\176\ Therefore, the SEC estimates the total cost that each
of the 11 exchanges expected to trade futures on security indexes will
incur in engaging staff to make the required computations to be
$237,600 annually. The total cost that all of the 11 exchanges will
incur in engaging staff to comply with the final rules is estimated to
be $2,613,600 annually.
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\174\ See CBOE Letter.
\175\ See Report on Office Salaries In The Securities Industry
2000, prepared by the Securities Industry Association (September
2000).
\176\ See Report on Management & Professional Earnings In The
Securities Industry 2000, prepared by the Securities Industry
Association (September 2000).
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The SEC therefore anticipates that the total cost that will be
incurred by each of the 11 exchanges expected to trade futures on
security indexes to comply with the new rules will be $263,700 for the
first year with the one-time installation fee. The SEC anticipates that
the total cost that will be incurred by each of the 11 exchanges
thereafter will be $263,400 annually. The total cost anticipated for
all 11 exchanges will therefore be $2,900,700 for the first year and
$2,897,400 annually thereafter. The SEC anticipates that, in fact, the
actual costs that will be incurred by the 11 markets expected to trade
futures on security indexes will be significantly less than this total
estimated cost because most of these markets currently have access to
the requisite data. Additionally, costs will be reduced if the
Commissions disseminate the lists of Top 750 securities (by market
capitalization) and Top 675 securities (by dollar value of ADTV).
VI. 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.\177\ Section 23(a)(2) requires the SEC, in adopting rules
under the Exchange Act, to consider the impact any rule would have on
competition.\178\ In the Proposing Release, the SEC requested comments
on these statutory considerations.
---------------------------------------------------------------------------
\177\ Section 3(f) of the Exchange Act, 15 U.S.C. 78c(f).
\178\ Section 23(a)(2) of the Exchange Act, 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------
The SEC believes that new Rule 3a55-1 under the Exchange Act will
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 new Rule
3a55-2 under the Exchange Act will 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 new Rule 3a55-3 under the
Exchange Act will 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 will 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 believes that the final rules may enhance capital
formation, because the new rules will 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 will have
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 futures on single securities and narrow-based
security indexes.
The SEC believes that the adopted rules will 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, will 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 adopted in this release also are substantively identical.
Several commenters addressed the issue of competition with respect
to the proposed rules. In particular, the SEC received a few comments
stating that exchanges will face unregulated competition because
eligible contract participants trading futures over-the-counter will
not be subject to these new rules.\179\ The SEC points out that the
[[Page 44511]]
Congress, in adopting the CFMA, provided for a differing scheme of
regulation for eligible contract participants. The SEC also received
several comments stating that foreign boards of trade should be subject
to different criteria with respect to the definition of narrow-based
security index.\180\ Two other commenters, however, stated that foreign
boards of trade should be held to the same standards as national
securities exchanges, designated contract markets, and registered
DTEFs.\181\ The SEC notes that the new rules are even-handed in their
application with respect to domestic and foreign markets that propose
to trade futures on a particular security index and thus should not
impose any burden on competition with respect to how particular
security indexes are treated under the final rules.
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\179\ See HKFE Letter; SFE Letter; ME Letter.
\180\ See FIA Letter; GMIMCo Letter; Barclays Letter; ME Letter;
HKFE Letter; SFE Letter; MFA Letter.
\181\ See CBOE Letter; CME Letter II.
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The CFMA directed the SEC and CFTC to jointly specify the methods
for determining market capitalization and dollar value of ADTV, as
those terms are used in the aforementioned statutory definition and
exclusion. The SEC believes that new 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 statutory
provisions. The SEC believes that new 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 should impose no
burden on competition. This rule is important because, to qualify for
the statutory tolerance period of 45 days over 3 consecutive calendar
months, a future on a security index must have been traded on a
designated contract market or a registered DTEF for at least 30 days.
In addition, the SEC believes that new Rule 3a55-3 is necessary in the
public interest and should 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 if a futures
contract on such index were traded on a designated contract market or
registered DTEF. This means that a foreign board of trade can look to
the same criteria to determine whether a security index is broad-based
as a designated contract market or registered DTEF.
VII. Regulatory Flexibility Act Certification
CFTC
The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601 et seq.,
requires federal agencies, in promulgating rules, to consider the
impact of those rules on small entities. The rules adopted herein would
affect contract markets and registered DTEFs. The CFTC previously
established certain definitions of ``small entities'' to be used by the
CFTC in evaluating the impact of its rules on small entities in
accordance with the RFA.\182\ In its previous determinations, the CFTC
concluded that contract markets are not small entities for the purpose
of the RFA.\183\ The CFTC recently determined that registered DTEFS are
also not small entities for the purposes of the RFA.\184\ The CFTC
invited the public to comment on its proposed determination that
registered DTEFs would not be small entities for purposes of the RFA
and on the Chairman's certification that these rules would not have a
significant economic impact on a substantial number of small
entities.\185\ The CFTC received no comments on its proposed
determination or on its certification.
---------------------------------------------------------------------------
\182\ 47 FR 18618-21 (April 30, 1982).
\183\ 47 FR 18618, 18619 (discussing contract markets).
\184\ 66 FR 42256, 42268 (August 10, 2001).
\185\ See 5 U.S.C. 605(b).
---------------------------------------------------------------------------
SEC
Pursuant to section 605(b) of the Regulatory Flexibility Act,\186\
the Acting Chairman of the SEC certified that the rules would not have
a significant economic impact on a substantial number of small
entities. This certification was attached to the Proposing Release as
an Appendix.\187\ The SEC solicited comments concerning the impact on
small entities and the Regulatory Flexibility Act Certification, but
received no comments.
---------------------------------------------------------------------------
\186\ See 5 U.S.C. 605(b).
\187\ See Proposing Release, supra note 17.
---------------------------------------------------------------------------
VIII. Text of Rules
List of Subjects
17 CFR Part 41
Security futures products, Reporting and recordkeeping
requirements.
17 CFR Part 240
Securities.
Chapter I--Commodity Futures Trading Commission
In accordance with the foregoing, Title 17, chapter I of the Code
of Federal Regulations is amended by adding part 41 to read as follows:
PART 41--SECURITY FUTURES
Sec.
Subpart A--General Provisions
41.1 Definitions.
41.2 Required records.
41.3-41.9 [Reserved]
Subpart B--Narrow-Based Security Indexes
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, 2, 6j, 7a-2, 12a.
Subpart A--General Provisions
Sec. 41.1 Definitions.
For purposes of this part:
* * * * *
(a)-(b) [Reserved]
(c) Broad-based security index means a group or index of securities
that does not constitute a narrow-based security index.
(d) 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.
(e) 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.
[[Page 44512]]
Secs. 41.3--41.9 [Reserved]
Subpart B--Narrow-Based Security Indexes
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) Market capitalization. For purposes of Section 1a(25)(B) of the
Act (7 U.S.C. 1a(25)(B)):
(1) On a particular day, a security shall be 1 of 750 securities
with the largest market capitalization as of the preceding 6 full
calendar months when it is included on a list of such securities
designated by the Commission and the SEC as applicable for that day.
(2) In the event that the Commission and the SEC have not
designated a list under paragraph (a)(1) of this section:
(i) The method to be used to determine market capitalization of a
security as of the preceding 6 full calendar months is to sum the
values of the market capitalization of such security for each U.S.
trading day of the preceding 6 full calendar months, and to divide this
sum by the total number of such trading days.
(ii) The 750 securities with the largest market capitalization
shall be identified from the universe of all reported securities, as
defined in Sec. 240.11Ac1-1, that are common stock or depositary
shares.
(b) Dollar value of ADTV.
(1) For purposes of Section 1a(25)(A) and (B) of the Act (7 U.S.C.
1a(25)(A) and (B)):
(i) (A) The method to be used to determine the dollar value of ADTV
of a security is to sum the dollar value of ADTV of all reported
transactions in such security in each jurisdiction as calculated
pursuant to paragraphs (b)(1)(ii) and (iii) of this section.
(B) The dollar value of ADTV of a security shall include the value
of all reported transactions for such security and for any depositary
share that represents such security.
(C) The dollar value of ADTV of a depositary share shall include
the value of all reported transactions for such depositary share and
for the security that is represented by such depositary share.
(ii) For trading in a security in the United States, the method to
be used to determine the dollar value of ADTV as of the preceding 6
full calendar months is to sum the value of all reported transactions
in such security for each U.S. trading day during the preceding 6 full
calendar months, and to divide this sum by the total number of such
trading days.
(iii) (A) For trading in a security in a jurisdiction other than
the United States, the method to be used to determine the dollar value
of ADTV as of the preceding 6 full calendar months is to sum the value
in U.S. dollars of all reported transactions in such security in such
jurisdiction for each trading day during the preceding 6 full calendar
months, and to divide this sum by the total number of trading days in
such jurisdiction during the preceding 6 full calendar months.
(B) If the value of reported transactions used in calculating the
ADTV of securities under paragraph (b)(1)(iii)(A) is reported in a
currency other than U.S. dollars, the total value of each day's
transactions in such currency shall be converted into U.S. dollars on
the basis of a spot rate of exchange for that day obtained from at
least one independent entity that provides or disseminates foreign
exchange quotations in the ordinary course of its business.
(iv) 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.
(2) For purposes of Section 1a(25)(B)(III)(cc) of the Act (7 U.S.C.
1a(25)(B)(III)(cc)):
(i) On a particular day, a security shall be 1 of 675 securities
with the largest dollar value of ADTV as of the preceding 6 full
calendar months when it is included on a list of such securities
designated by the Commission and the SEC as applicable for that day.
(ii) In the event that the Commission and the SEC have not
designated a list under paragraph (b)(2)(i) of this section:
(A) The method to be used to determine the dollar value of ADTV of
a security as of the preceding 6 full calendar months is to sum the
value of all reported transactions in such security in the United
States for each U.S. trading day during the preceding 6 full calendar
months, and to divide this sum by the total number of such trading
days.
(B) The 675 securities with the largest dollar value of ADTV shall
be identified from the universe of all reported securities as defined
in Sec. 240.11Ac1-1 that are common stock or depositary shares.
(c) Depositary Shares and Section 12 Registration. For purposes of
Section 1a(25)(B)(III)(aa) of the Act (7 U.S.C. 1a(25)(B)(III)(aa)),
the requirement that each component security of an index be registered
pursuant to Section 12 of the Securities Exchange Act of 1934 (15
U.S.C. 78l) shall be satisfied with respect to any security that is a
depositary share if the deposited securities underlying the depositary
share are registered pursuant to Section 12 of the Securities Exchange
Act of 1934 and the depositary share is registered under the Securities
Act of 1933 (15 U.S.C. 77a et seq.) on Form F-6 (17 CFR 239.36).
(d) Definitions. For purposes of this section:
(1) SEC means the Securities and Exchange Commission.
(2) Closing price of a security means:
(i) If reported transactions in the security have taken place in
the United States, the price at which the last transaction in such
security took place in the regular trading session of the principal
market for the security in the United States.
(ii) If no reported transactions in a security have taken place in
the United States, the closing price of such security shall be the
closing price of any depositary share representing such security
divided by the number of shares represented by such depositary share.
(iii) If no reported transactions in a security or in a depositary
share representing such security have taken place in the United States,
the closing price of such security shall be the price at which the last
transaction in such security took place in the regular trading session
of the principal market for the security. If such price is reported in
a currency other than U.S. dollars, such price shall be converted into
U.S. dollars on the basis of a spot rate of exchange relevant for the
time of the transaction obtained from at least one independent entity
that provides or disseminates foreign exchange quotations in the
ordinary course of its business.
(3) Depositary share has the same meaning as in Sec. 240.12b-2.
(4) 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)).
(5) 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)(A)(iv) of the Act (7 U.S.C. 1a(25)(A)(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% of the index's total weighting.
[[Page 44513]]
(6) Market capitalization of a security on a particular day:
(i) If the security is not a depositary share, is the product of:
(A) The closing price of such security on that same day; and
(B) The number of outstanding shares of such security on that same
day.
(ii) If the security is a depositary share, is the product of:
(A) The closing price of the depositary share on that same day
divided by the number of deposited securities represented by such
depositary share; and
(B) The number of outstanding shares of the security represented by
the depositary share on that same day.
(7) 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
Securities and Exchange Commission by the issuer of such security,
including any change to such number of outstanding shares subsequently
reported by the issuer on a Form 8-K (17 CFR 249.308).
(8) 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.
(9) 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.
(10) Reported transaction means:
(i) With respect to securities transactions in the United States,
any transaction for which a transaction report is collected, processed,
and made available pursuant to an effective transaction reporting plan,
or for which a transaction report, last sale data, or quotation
information is disseminated through an automated quotation system as
described in Section 3(a)(51)(A)(ii) of the Securities Exchange Act of
1934 (15 U.S.C. 78c(a)(51)(A)(ii)); and
(ii) With respect to securities transactions outside the United
States, any transaction that has been reported to a foreign financial
regulatory authority in the jurisdiction where such transaction has
taken place.
(11) U.S. trading day means any day on which a national securities
exchange is open for trading.
(12) 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:
(1) Such index would not have been a narrow-based security index on
each trading day of the preceding 6 full calendar months with respect
to a date no earlier than 30 days prior to the commencement of trading
of such contract;
(2) On each trading day of the preceding 6 full calendar months
with respect to a date no earlier than 30 days prior to the
commencement of trading such contract:
(i) Such index had more than 9 component securities;
(ii) No component security in such index comprised more than 30
percent of the index's weighting;
(iii) The 5 highest weighted component securities in such index did
not comprise, in the aggregate, more than 60 percent of the index's
weighting; and
(iv) The dollar value of the trading volume of the lowest weighted
25% of such index was not less than $50 million (or in the case of an
index with 15 or more component securities, $30 million); or
(3) On each trading day of the 6 full calendar months preceding a
date no earlier than 30 days prior to the commencement of trading such
contract:
(i) Such index had at least 9 component securities;
(ii) No component security in such index comprised more than 30
percent of the index's weighting; and
(iii) Each component security in such index was:
(A) Registered pursuant to Section 12 of the Securities Exchange
Act of 1934 (15 U.S.C. 78) or was a depositary share representing a
security registered pursuant to Section 12 of the Securities Exchange
Act of 1934;
(B) 1 of 750 securities with the largest market capitalization that
day; and
(C) 1 of 675 securities with the largest dollar value of trading
volume that day.
(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) Definitions. For purposes of this section:
(1) Market capitalization has the same meaning as in
Sec. 41.11(d)(6) of this chapter.
(2) Dollar value of trading volume of a security on a particular
day is the value in U.S. dollars of all reported transactions in such
security on that day. If the value of reported transactions used in
calculating dollar value of trading volume is reported in a currency
other than U.S. dollars, the total value of each day's transactions
shall be converted into U.S. dollars on the basis of a spot rate of
exchange for that day obtained from at least one independent entity
that provides or disseminates foreign exchange quotations in the
ordinary course of its business.
(3) Lowest weighted 25% of an index has the same meaning as in
Sec. 41.11(d)(5) of this chapter.
(4) Preceding 6 full calendar months has the same meaning as in
Sec. 41.11(d)(8) of this chapter.
(5) Reported transaction has the same meaning as in
Sec. 41.11(d)(10) of this chapter.
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 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.
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 business 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 business days over 3 consecutive calendar months shall
continue to be a narrow-
[[Page 44514]]
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.
(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.
Chapter II--Securities and Exchange Commission
Authority
The Commission is adopting the rules pursuant to its authority
under Exchange Act Sections 3(a), 3(b), 6, 15A, 17(a), 17(b), 19,
23(a).
In accordance with the foregoing, Title 17, chapter II, part 240 of
the Code of Federal Regulations is 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) Market capitalization. For purposes of Section
3(a)(55)(C)(i)(III)(bb) of the Act (15 U.S.C.
78c(a)(55)(C)(i)(III)(bb)):
(1) On a particular day, a security shall be 1 of 750 securities
with the largest market capitalization as of the preceding 6 full
calendar months when it is included on a list of such securities
designated by the Commission and the CFTC as applicable for that day.
(2) In the event that the Commission and the CFTC have not
designated a list under paragraph (a)(1) of this section:
(i) The method to be used to determine market capitalization of a
security as of the preceding 6 full calendar months is to sum the
values of the market capitalization of such security for each U.S.
trading day of the preceding 6 full calendar months, and to divide this
sum by the total number of such trading days.
(ii) The 750 securities with the largest market capitalization
shall be identified from the universe of all reported securities, as
defined in Sec. 240.11Ac1-1, that are common stock or depositary
shares.
(b) Dollar value of ADTV.
(1) For purposes of Section 3(a)(55)(B) of the Act (15 U.S.C.
78c(a)(55)(B)):
(i) (A) The method to be used to determine the dollar value of ADTV
of a security is to sum the dollar value of ADTV of all reported
transactions in such security in each jurisdiction as calculated
pursuant to paragraphs (b)(1)(ii) and (iii).
(B) The dollar value of ADTV of a security shall include the value
of all reported transactions for such security and for any depositary
share that represents such security.
(C) The dollar value of ADTV of a depositary share shall include
the value of all reported transactions for such depositary share and
for the security that is represented by such depositary share.
(ii) For trading in a security in the United States, the method to
be used to determine the dollar value of ADTV as of the preceding 6
full calendar months is to sum the value of all reported transactions
in such security for each U.S. trading day during the preceding 6 full
calendar months, and to divide this sum by the total number of such
trading days.
(iii) (A) For trading in a security in a jurisdiction other than
the United States, the method to be used to determine the dollar value
of ADTV as of the preceding 6 full calendar months is to sum the value
in U.S. dollars of all reported transactions in such security in such
jurisdiction for each trading day during the preceding 6 full calendar
months, and to divide this sum by the total number of trading days in
such jurisdiction during the preceding 6 full calendar months.
(B) If the value of reported transactions used in calculating the
ADTV of securities under paragraph (b)(1)(iii)(A) is reported in a
currency other than U.S. dollars, the total value of each day's
transactions in such currency shall be converted into U.S. dollars on
the basis of a spot rate of exchange for that day obtained from at
least one independent entity that provides or disseminates foreign
exchange quotations in the ordinary course of its business.
(iv) 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.
(2) For purposes of Section 3(a)(55)(C)(i)(III)(cc) of the Act (15
U.S.C. 78c(a)(55)(C)(i)(III)(cc)):
(i) On a particular day, a security shall be 1 of 675 securities
with the largest dollar value of ADTV as of the preceding 6 full
calendar months when it is included on a list of such securities
designated by the Commission and the CFTC as applicable for that day.
(ii) In the event that the Commission and the CFTC have not
designated a list under paragraph (b)(2) of this section:
(A) The method to be used to determine the dollar value of ADTV of
a security as of the preceding 6 full calendar months is to sum the
value of all reported transactions in such security in the United
States for each U.S. trading day during the preceding 6 full calendar
months, and to divide this sum by the total number of such trading
days.
(B) The 675 securities with the largest dollar value of ADTV shall
be identified from the universe of all reported securities as defined
in Sec. 240.11Ac1-1 that are common stock or depositary shares.
(c) Depositary Shares and Section 12 Registration. For purposes of
Section 3(a)(55)(C) of the Act (15 U.S.C. 78c(a)(55)(C)), the
requirement that each component security of an index be registered
pursuant to Section 12 of the Act (15 U.S.C. 78l) shall be satisfied
with respect to any security that is a depositary share if the
deposited securities underlying the depositary share are registered
pursuant to Section 12 of the Act and the depositary share is
registered under the Securities Act of 1933 (15 U.S.C. 77a et seq.) on
Form F-6 (17 CFR 239.36).
(d) Definitions. For purposes of this section:
(1) CFTC means Commodity Futures Trading Commission.
(2) Closing price of a security means:
(i) If reported transactions in the security have taken place in
the United States, the price at which the last transaction in such
security took place in the regular trading session of the principal
market for the security in the United States.
(ii) If no reported transactions in a security have taken place in
the United States, the closing price of such security shall be the
closing price of any depositary share representing such security
divided by the number of shares represented by such depositary share.
[[Page 44515]]
(iii) If no reported transactions in a security or in a depositary
share representing such security have taken place in the United States,
the closing price of such security shall be the price at which the last
transaction in such security took place in the regular trading session
of the principal market for the security. If such price is reported in
a currency other than U.S. dollars, such price shall be converted into
U.S. dollars on the basis of a spot rate of exchange relevant for the
time of the transaction obtained from at least one independent entity
that provides or disseminates foreign exchange quotations in the
ordinary course of its business.
(3) Depositary share has the same meaning as in Sec. 240.12b-2.
(4) Foreign financial regulatory authority has the same meaning as
in Section 3(a)(52) of the Act (15 U.S.C. 78c(a)(52)).
(5) 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% of the index's total weighting.
(6) Market capitalization of a security on a particular day:
(i) If the security is not a depositary share, is the product of:
(A) The closing price of such security on that same day; and
(B) The number of outstanding shares of such security on that same
day.
(ii) If the security is a depositary share, is the product of:
(A) The closing price of the depositary share on that same day
divided by the number of deposited securities represented by such
depositary share; and
(B) The number of outstanding shares of the security represented by
the depositary share on that same day.
(7) 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, including any change to such
number of outstanding shares subsequently reported by the issuer on a
Form 8-K (17 CFR 249.308).
(8) 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.
(9) 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.
(10) Reported transaction means:
(i) With respect to securities transactions in the United States,
any transaction for which a transaction report is collected, processed,
and made available pursuant to an effective transaction reporting plan,
or for which a transaction report, last sale data, or quotation
information is disseminated through an automated quotation system as
described in Section 3(a)(51)(A)(ii) of the Act (15 U.S.C.
78c(a)(51)(A)(ii); and
(ii) With respect to securities transactions outside the United
States, any transaction that has been reported to a foreign financial
regulatory authority in the jurisdiction where such transaction has
taken place.
(11) U.S. trading day means any day on which a national securities
exchange is open for trading.
(12) 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:
(1) Such index would not have been a narrow-based security index on
each trading day of the preceding 6 full calendar months with respect
to a date no earlier than 30 days prior to the commencement of trading
of such contract;
(2) On each trading day of the preceding 6 full calendar months
with respect to a date no earlier than 30 days prior to the
commencement of trading such contract:
(i) Such index had more than 9 component securities;
(ii) No component security in such index comprised more than 30
percent of the index's weighting;
(iii) The 5 highest weighted component securities in such index did
not comprise, in the aggregate, more than 60 percent of the index's
weighting; and
(iv) The dollar value of the trading volume of the lowest weighted
25% of such index was not less than $50 million (or in the case of an
index with 15 or more component securities, $30 million); or
(3) On each trading day of the preceding 6 full calendar months,
with respect to a date no earlier than 30 days prior to the
commencement of trading such contract:
(i) Such index had at least 9 component securities;
(ii) No component security in such index comprised more than 30
percent of the index's weighting; and
(iii) Each component security in such index was:
(A) Registered pursuant to Section 12 of the Act (15 U.S.C. 78) or
was a depositary share representing a security registered pursuant to
Section 12 of the Act;
(B) 1 of 750 securities with the largest market capitalization that
day; and
(C) 1 of 675 securities with the largest dollar value of trading
volume that day.
(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) Definitions. For purposes of this section:
(1) Market capitalization has the same meaning as in Sec. 240.3a55-
1(d)(6).
(2) Dollar value of trading volume of a security on a particular
day is the value in U.S. dollars of all reported transactions in such
security on that day. If the value of reported transactions used in
calculating dollar value of trading volume is reported in a currency
other than U.S. dollars, the total value of each day's transactions
shall be converted into U.S. dollars on the basis of a spot rate of
exchange for that day obtained from at least one independent entity
that provides or disseminates foreign exchange quotations in the
ordinary course of its business.
(3) Lowest weighted 25% of an index has the same meaning as in
Sec. 240.3a55-1(d)(5).
[[Page 44516]]
(4) Preceding 6 full calendar months has the same meaning as in
Sec. 240.3a55-1(d)(8).
(5) Reported transaction has the same meaning as in Sec. 240.3a55-
1(d)(10).
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 Commodity Futures Trading Commission.
Dated: August 20, 2001.
Catherine D. Dixon,
Assistant Secretary.
By the Securities and Exchange Commission.\188\
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\188\ Chairman Pitt did not participate in this matter.
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Dated: August 20, 2001.
Jonathan G. Katz,
Secretary.
[FR Doc. 01-21391 Filed 8-21-01; 8:45 am]
BILLING CODE 8010-01-P