Self-Regulatory Organizations; National Association of Securities Dealers, Inc; Order Approving Proposed Rule Change Relating to Option Position and Exercise Limits and Position Reporting Obligations; and Notice of Filing and Order Granting Accelerated Approval to Amendment No. 1 Thereto, 67675-67678 [E6-19732]

Download as PDF Federal Register / Vol. 71, No. 225 / Wednesday, November 22, 2006 / Notices Specifically, the Commission believes that the proposal is consistent with Section 15A(b)(6) of the Act 13 in that it is designed to promote just and equitable principles of trade, to perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest. The Commission also believes that the proposal is consistent with Section 15A(b)(9) of the Act 14 in that it does not impose any burden on competition not necessary or appropriate in furtherance of the purposes of the Act. Any trade in unregistered corporate debt securities on NYSE will automatically be captured by NYSE’s systems. The Commission understands that NYSE will provide data on such trades to NASD for surveillance purposes. Therefore, NASD should be able to obtain necessary surveillance data without subjecting joint NYSE/ NASD members to a duplicative reporting requirement. The Commission concludes that it is reasonable and consistent with the Act for NASD to eliminate from its rules the requirement that a trade executed on NYSE also be reported to TRACE.15 Pursuant to Section 19(b)(2) of the Act,16 the Commission finds good cause for approving the proposed rule change, as amended, before the thirtieth day after the date of publication of notice of filing thereof. Accelerating approval of this proposed rule change will immediately eliminate double-reporting of certain bond trades and thereby eliminate an unnecessary burden on NYSE members trading corporate bonds pursuant to the terms of an exemption being granted in a related action today by the Commission.17 The Commission believes that NASD’s rule change raises no issues of regulatory concern, because NASD should have access to sufficient regulatory information relating to the exempted bond trades through the information-sharing agreement it will enter with NYSE. Therefore, the Commission does not believe it is necessary or appropriate to delay approval and implementation of this proposal pending a notice-and-comment period. 13 15 U.S.C. 78o–3(b)(6). U.S.C. 78o–3(b)(9). 15 The Commission will continue to monitor the growth of intermarket competition in the corporate bond markets and, in the event market fragmentation becomes a concern, will consider appropriate means to address the consolidation of market information for corporate bonds. 16 15 U.S.C. 78s(b)(2). 17 See Securities Exchange Act Release No. 54766 (November 16, 2006) (File No. S7–06–05). pwalker on PROD1PC61 with NOTICES 14 15 VerDate Aug<31>2005 22:25 Nov 21, 2006 Jkt 211001 V. Conclusion It is therefore ordered, pursuant to Section 19(b)(2) of the Act,18 that the proposed rule change (SR–NASD–2006– 110), as amended, is hereby approved on an accelerated basis. For the Commission, by the Division of Market Regulation, pursuant to delegated authority.19 Nancy M. Morris, Secretary. [FR Doc. E6–19728 Filed 11–21–06; 8:45 am] BILLING CODE 8011–01–P [Release No. 34–54755; File No. SR–NASD– 2006–007] Self-Regulatory Organizations; National Association of Securities Dealers, Inc; Order Approving Proposed Rule Change Relating to Option Position and Exercise Limits and Position Reporting Obligations; and Notice of Filing and Order Granting Accelerated Approval to Amendment No. 1 Thereto November 15, 2006. I. Introduction On January 23, 2006, the National Association of Securities Dealers, Inc. (‘‘NASD’’) filed with the Securities and Exchange Commission (‘‘Commission’’), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Exchange Act’’) 1 and Rule 19b–4 thereunder,2 a proposed rule change to amend NASD Rule 2860, which relates to position and exercise limits and position reporting obligations for members that hold positions in index and equity options or that represent customers holding such positions. The proposed rule change was published for comment in the Federal Register on February 6, 2006.3 The Commission received one comment on the proposal.4 In its comment letter, the Securities Industry Association (‘‘SIA’’) ‘‘endorse[d] the adoption of clear and objective criteria for identifying those index options that would be exempt from NASD option position and exercise limits.’’ 5 However, the SIA also 18 15 U.S.C. 78s(b)(2). CFR 200.30–3(a)(12). 1 15 U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 3 See Securities Exchange Act Release No. 53189 (January 30, 2006), 71 FR 6117. 4 See letter from John R. Vitha, Esq., Chairman, Securities Industry Association Derivative Product Committee, to Nancy M. Morris, Secretary, Commission, dated May 23, 2006 (‘‘SIA Letter’’). 5 Id. at 1. 19 17 Frm 00135 Fmt 4703 recommended ‘‘streamlining the relevant standards and easing the operational steps necessary for NASD member firms to verify compliance with the Proposed Rule Change.’’ 6 In response to this comment, NASD filed Amendment No. 1 to the proposed rule change on September 20, 2006.7 This notice and order solicits comments from interested persons on Amendment No. 1 and approves the proposal, as amended by Amendment No. 1, on an accelerated basis. II. Description of the Proposal SECURITIES AND EXCHANGE COMMISSION PO 00000 67675 Sfmt 4703 A. Position Limits for OTC Index Options NASD currently prohibits its members, for their proprietary or agency accounts, from holding positions in over-the-counter (‘‘OTC’’) equity options 8 that exceed certain position limits.9 NASD also imposes exercise limits on a member that holds OTC equity options; the member may not exercise, within a period of five consecutive business days, a number of option contracts that exceeds the same number established for the position limit.10 The position limits that NASD imposes on its members for OTC equity options are based on similar standards established by the option exchanges for ‘‘standardized’’ equity options.11 In contrast, NASD rules impose no position limits on OTC index options, but do not clarify what constitutes an OTC index option for this purpose. NASD believes that some indexes underlying OTC options might have economic characteristics more closely resembling single securities than broadbased indexes. This could be the case, for example, where the index consisted of only a small number of securities or if one or a few securities represented a significant percentage of the index’s weighting. In its initial filing, NASD proposed 11 criteria an index would have to meet to be sufficiently broadbased for an option on that index to be 6 Id. 7 The text of Amendment No. 1 is available on the NASD’s Web site (https://www.nasd.com), at NASD’s principal office, and at the Commission’s Public Reference Room. 8 An ‘‘OTC option’’ for the purposes of this approval order means any option contract not issued or subject to issuance by the Options Clearing Corporation (‘‘OCC’’). 9 These position limits vary depending on the characteristics of the security underlying the OTC option. See NASD Rule 2860(b)(3)(A)(viii). 10 See NASD Rule 2860(b)(4). NASD’s proposal will impact its exercise limits in the same way as it will change its position limits. 11 The term ‘‘standardized equity option’’ means any equity options contract issued, or subject to issuance by, The Options Clearing Corporation that is not a FLEX Equity Option. See NASD Rule 2860(b)(2)(UU). E:\FR\FM\22NON1.SGM 22NON1 67676 Federal Register / Vol. 71, No. 225 / Wednesday, November 22, 2006 / Notices pwalker on PROD1PC61 with NOTICES deemed a ‘‘conventional index option’’ under proposed NASD Rule 2860(b)(2)(N).12 A position in a ‘‘conventional index option’’ would continue to be free from any position limits imposed by NASD rules. In addition, a position in an OTC option overlying the same index as an exchange-traded option would not be subject to position limits. A position in an OTC index option that did not either qualify as a ‘‘conventional index option’’ or overlie the same index as an exchange-traded option would in effect be deconstructed into separate equity option components, and NASD position limits would apply with respect to each component.13 In response to the SIA Comment Letter, NASD in Amendment No. 1 replaced the 11 originally proposed criteria for a ‘‘conventional index option’’ with the following criteria: • An index must contain nine or more equity securities. • No equity security may comprise more than 30% of the equity security component of the index’s weighting. • Each equity security in the index is either: 1. A component security of the Russell 3000 Index or the FTSE AllWorld Index Series; or 2. Characterized by a minimum market capitalization and minimum trading volume.14 12 The 11 criteria originally proposed by NASD to define a ‘‘conventional index option’’ were as follows: a) The option must be A.M.-settled; b) The index must be weighted pursuant to one of a number of widely recognized methodologies; c) The index must consist of ten or more component securities; d) Each component security must be characterized by a minimum market capitalization; e) Each component security must be characterized by a minimum trading volume; f) The most highly weighted components of the index must be characterized by heightened trading volume, as compared to the remaining components; g) No single component security or group of five securities may represent more than a maximum concentration of the index; h) All component securities are ‘‘NMS securities’’ as defined in Regulation NMS; i) Certain non-U.S. component securities may not, in the aggregate, represent more than a maximum weight of the index; j) An equal dollar-weighted index will be rebalanced once every quarter; and k) If an underlying index is maintained by a broker-dealer, the index must be calculated by a third party that has implemented appropriate information barriers around its personnel who have access to information about changes to the index. 13 See NASD Rule 2860(b)(2)(JJ). 14 Specifically, each equity security in the index must: (A) Have a market capitalization of at least $75 million, or, in the case of the lowest weighted component securities in the basket or index in the aggregate account for no more than 10% of the weight of the index $50 million; and (B) have a trading volume for each of the preceding six months VerDate Aug<31>2005 22:25 Nov 21, 2006 Jkt 211001 The SIA recommended basing the definition of a ‘‘conventional index option,’’ in part, on the definition under the Exchange Act of what is not a ‘‘narrow-based security index.’’ 15 As provided in that definition, the SIA recommended replacing the requirement that a qualifying index be comprised of ten or more securities with a requirement that an index be comprised of nine or more securities. Similarly, the SIA also recommended that the NASD amend its proposal to conform with the criterion under the Exchange Act definition described above, to provide that no equity security in the index represent more than 30% of the equity security component of the index. NASD adopted both of these recommendations. In its original filing, NASD required that the components of an index underlying a ‘‘conventional index option’’ be characterized by certain minimum market capitalization and liquidity standards.16 The SIA suggested that NASD treat components of the Russell 3000 Index and the FTSE AllWorld Index Series as meeting such quantitative standards without measuring the actual market capitalization and trading volume of such components.17 In Amendment No. 1, NASD retained the quantitative standards for market capitalization and trading volume, but allowed that condition to be met if an equity security is included in the Russell 3000 Index or the FTSE All-World Index Series. NASD believes that these indexes are reasonable surrogates for the quantitative measurements, and that these alternative criteria would reduce the compliance burden for members to monitor capitalization and trading volume of the index components. NASD believes that the criteria it proposed in Amendment No. 1 to replace the original 11 criteria impose sufficient parameters on the components of the index to ensure that a qualifying index would not be so narrowly constructed as to have the economic characteristics of a single security or small group of securities. Accordingly, NASD in Amendment No. 1 eliminated the remaining criteria proposed in the original filing. of at least one million shares or, in the case of each of the lowest weighted component securities in the basket or index that in the aggregate account for no more than 10% of the weight of the index, 500,000 shares. 15 See 15 U.S.C. 78c(a)(55)(C). 16 See supra note 14 17 See SIA Letter at 3. PO 00000 Frm 00136 Fmt 4703 Sfmt 4703 B. Large Options Position Reporting Under existing NASD Rule 2860(b)(5)(A)(i)(a), an NASD member must report a position of 200 contracts or more in any OTC option covering an ‘‘underlying security or index.’’ 18 On June 30, 2006, the Commission approved an NASD rule change that, among other things, eliminated the term ‘‘underlying index,’’ which was defined to mean ‘‘an index upon which a Nasdaq index option contract is based.’’ 19 Accordingly, NASD rules currently provide no standard for the types of OTC index options for which members must report large positions. NASD’s initial proposal would have clarified this situation by requiring a member to report a position of 200 or more contracts in: (1) An OTC option on an index underlying an exchange-traded option, or (2) a ‘‘conventional index option,’’ as defined in proposed NASD Rule 2860(b)(2)(N). In its comment letter, the SIA suggested that a position in an OTC index option should be exempt from any position reporting requirements unless the OTC option overlies the same index as an exchange-traded option. NASD generally agrees with the SIA’s approach and is proposing to revise its Rule 2860(b)(5) to provide that a member must report a position in a ‘‘conventional index option’’ only when such option is based on an index that underlies, or is substantially similar to an index that underlies, an exchangetraded option. This approach would enable NASD Market Regulation staff to analyze the exchange-traded and OTC markets in aggregate for options on the same or substantially similar indexes.20 NASD believes that position reporting for other conventional index options would be of little regulatory interest and represents that, to the extent it requires information about a position in a conventional index option on a specially negotiated index or group of underlying securities, it can obtain such information from a member pursuant to 18 When a member conducts a business in standardized (i.e., exchange-traded) options but is not a member of the exchange on which the option is traded (i.e. is an ‘‘access firm’’), the member also must report to NASD a position of 200 contracts or more in a standardized option. See NASD Rule 2860(b)(5)(A)(i)(b). Nothing in this proposal affects an access firm’s obligation to report positions in standardized options. 19 The proposed rule change amended various NASD rules in anticipation of the Nasdaq Stock Market’s separation from NASD. See Securities Exchange Act Release No. 54084 (June 30, 2006), 71 FR 38935 (July 10, 2006) (SR–NASD–2005–087). 20 Telephone conversation among Gary Goldsholle, Associate General Counsel, NASD, Kathryn Moore, Assistant General Counsel, NASD, and Tim Fox, Special Counsel, Commission, on October 31, 2006. E:\FR\FM\22NON1.SGM 22NON1 Federal Register / Vol. 71, No. 225 / Wednesday, November 22, 2006 / Notices a request under NASD Rule 8210.21 Thus, NASD believes that eliminating this position reporting requirement would not prevent it from accessing information relating to a conventional index option position as needed to carry out its market oversight and enforcement responsibilities. Finally, the SIA urged NASD to revisit the threshold at which position reporting applies, for the OTC options where position reporting is required.22 The SIA suggested raising the threshold from the current 200 contracts to 10,000 contracts. NASD stated in Amendment No. 1 that it does not believe such a change is appropriate or necessary at this time. However, NASD stated that it will consider this issue and subject it to further review and discussion with the other self-regulatory organizations. pwalker on PROD1PC61 with NOTICES C. Position Limits for Options on Foreign Equity Securities Under existing NASD Rule 2860(b)(3)(A)(viii), the position limits for conventional equity options parallel the limits for the standardized options on the same security. Therefore, if a standardized equity option is subject to a higher tier of position limits because of the relatively liquid and deep nature of the market for the underlying security, then a conventional option on the same security would be subject to a higher tier as well. On the other hand, with respect to an OTC option on an equally liquid foreign security, for which no exchange-traded equivalent exists, a member is required to limit its holdings (or its customer’s holdings) to the lowest tier of position limits, absent prior approval of NASD staff. To alleviate this disparate treatment of OTC options on foreign equities, NASD proposed in the original filing to allow the higher tiers of position limits for OTC options overlying equity components of the FTSE All-World Index Series 23 meeting the volume and float criteria established by the options exchanges for standardized options on domestic equity securities.24 21 However, a position in an OTC index option that did not qualify as a ‘‘conventional index option’’ would in effect be deconstructed into separate equity option components, and the position reporting obligation would apply with respect to each component. See NASD Rule 2860(b)(2)(JJ). 22 See SIA Letter at 4. 23 NASD has represented that, if it designates another index in addition to or instead of the FTSE All-World Index Series, NASD would publish the designation of the new index in a Notice to Members and provide members at least 30 days’ written notice of the change. 24 See Commentary .07 to American Stock Exchange Rule 904, Section 7(c) of Chapter III of the Boston Options Exchange Rules, Interpretation .02 to Chicago Board Options Exchange (‘‘CBOE’’) Rule VerDate Aug<31>2005 22:25 Nov 21, 2006 Jkt 211001 Under the proposed rule change, a member would file a post-trade notice— within one business day—with NASD staff providing the necessary trade volume data and/or current float data to support the member’s position limit calculation. NASD staff would review the member’s notice, and, if the staff determined that a member incorrectly assigned a position limit, a staff member would instruct the firm to reduce its position below the appropriate limits determined by NASD staff. The Commission received no comments on this aspect of the proposal. D. Miscellaneous Issues The SIA also suggested revising the definition of ‘‘conventional index option’’ to permit the inclusion of financial assets other than equity securities.25 NASD believes that the originally proposed definition of ‘‘conventional index option’’ permits the inclusion of non-equity assets and is not proposing any change to the rule text to accommodate SIA’s suggestion. According to NASD, financial assets other than equity securities could be part of an index and the option thereon could still qualify as a ‘‘conventional index option’’ if the equity security components of the index together met the criteria in the definition. In addition to changes in response to the SIA Letter, NASD in Amendment No. 1 proposed to clarify the date on which an OTC index option would or would not qualify as a ‘‘conventional index option.’’ The revised rules clarify that the definition’s requirements apply as of the date the option position is created.26 NASD designed this approach to clarify that subsequent events that might impact an index’s components would not change how an option on that index is treated for purposes of NASD’s position limits and position reporting rules. III. Discussion The Commission finds that the proposed rule change, as amended, is consistent with the requirements of the Exchange Act and the rules and regulations thereunder applicable to a national securities association and, in particular, the requirements of Section 15A(b)(6) of the Exchange Act,27 which requires that the rules of the NASD be 4.11; International Securities Exchange Rule 412(d); Commentary .06 to NYSE Arca Rule 6.8; Commentary .05 to Philadelphia Stock Exchange Rule 1001. 25 See SIA Letter at 4. 26 Telephone conversation between Gary Goldsholle, Associate GeneralCounsel, NASD, and Tim Fox, Division of Market Regulation, Commission on October 19, 2006. 27 15 U.S.C. 78o–3(b)(6). PO 00000 Frm 00137 Fmt 4703 Sfmt 4703 67677 designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to facilitate transactions in securities, and to remove impediments to and perfect the mechanism of a free and open market and, in general, to protect investors and the public interest.28 The Commission believes the proposed rule change is reasonably designed to enhance the NASD’s ability to monitor the options positions of members and their customers and to clarify applicable position limits. In particular, the Commission believes that the NASD rules it is approving today reasonably differentiate between broadbased indexes and indexes whose economic characteristics more closely approximate those of a single security or a small number of securities. The Commission believes that the proposal is designed to balance between allowing the NASD to obtain information for surveilling the market in OTC index options and limiting the burdens on NASD members that hold positions in such options. The Commission finds good cause for approving the proposal, as amended by Amendment No. 1, prior to the thirtieth day after the amended proposal is published for comment in the Federal Register pursuant to Section 19(b)(2) of the Exchange Act.29 The Commission believes that Amendment No. 1 does not make any changes to the proposal that would adversely impact investor protection or the public interest. The Commission notes that it received only one comment letter in response to NASD’s original proposal.30 Amendment No. 1 is generally responsive to the commenter’s concerns and does not materially alter the proposal. The Commission notes that accelerating approval will enable NASD to implement the proposed rule changes without further delay. IV. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning Amendment No. 1, including whether Amendment No. 1 is consistent with the Exchange Act. Comments may be submitted by any of the following methods: Electronic comments • Use the Commission’s Internet comment form (https://www.sec.gov/ rules/sro.shtml); or 28 In approving the proposal, the Commission has considered the rule’s impact on efficiency, competition, and capital formation. See 15 U.S.C. 78c(f). 29 15 U.S.C. 78s(b)(2). 30 See SIA Letter, supra note 4. E:\FR\FM\22NON1.SGM 22NON1 67678 Federal Register / Vol. 71, No. 225 / Wednesday, November 22, 2006 / Notices • Send an e-mail to rulecomments@sec.gov. Please include File Number SR–NASD–2006–007 on the subject line. Paper comments • Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, Station Place, 100 F Street, NE., Washington, DC 20549–1090. All submissions should refer to Amendment No. 1 to File Number SR– NASD–2006–007. This file number should be included on the subject line if e-mail is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s Internet Web site (https://www.sec.gov/ rules/sro.shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission’s Public Reference Section, Station Place, 100 F Street, NE., Washington, DC 20549. Copies of such filing also will be available for inspection and copying at the principal office of NASD. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to Amendment No. 1 to File Number SR–NASD–2006–007 and should be submitted on or before December 13, 2006. pwalker on PROD1PC61 with NOTICES V. Conclusion It is therefore ordered, pursuant to Section 19(b)(2) of the Exchange Act,31 that the proposed rule change (SR– NASD–2006–007) be, and hereby is approved, and that Amendment No. 1 is approved on an accelerated basis. For the Commission, by the Division of Market Regulation, pursuant to delegated authority.32 Nancy M. Morris, Secretary. [FR Doc. E6–19732 Filed 11–21–06; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–54753; File No. SR–NSX– 2006–14] Self-Regulatory Organizations; National Stock Exchange, Inc.; Notice of Filing and Immediate Effectiveness of a Proposed Rule Change and Amendment No. 1 Thereto To Implement a Fee Schedule Under NSX Rule 16.1(a) and 16.1(c) for Transactions Executed Through NSTS and To Modify a Fee Schedule for ITS Transactions November 14, 2006. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Act’’) 1 and Rule 19b–4 thereunder,2 notice is hereby given that on October 31, 2006, the National Stock Exchange, Inc. (‘‘NSX’’ or ‘‘Exchange’’) filed with the Securities and Exchange Commission (‘‘Commission’’) the proposed rule change as described in Items I, II, and III below, which Items have been substantially prepared by the Exchange. On November 13, 2006, NSX submitted Amendment No. 1 to the proposed rule change. The Exchange has designated this proposal as one establishing or changing a due, fee, or other charge applicable only to a member imposed by the Exchange under Section 19(b)(3)(A)(ii) of the Act 3 and Rule 19b–4(f)(2) thereunder,4 which renders the proposal effective upon filing with the Commission. The Commission is publishing this notice to solicit comments on the proposed rule change, as amended, from interested persons. I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change The Exchange proposes to implement a new Fee Schedule to supplement Exchange Rule 11.10 for transactions executed through the Exchange’s National Securities Trading System (‘‘NSTS’’), and to amend the Fee Schedule applicable to transactions under the Intermarket Trading System Plan and/or the Plan for the Purpose of Creating and Operating an Intermarket Communications Linkage (‘‘ITS Plans’’), both to provide for an execution fee and a rebate for executions in Exchange Traded Funds (‘‘ETFs’’) classified as Tape B securities. The other fees for executions through NSTS during the phase-in period of Exchange’s new 1 15 U.S.C. 78s(b)(1). CFR 240.19b–4. 3 15 U.S.C. 78s(b)(3)(A)(ii). 4 17 CFR 240.19b–4(f)(2). 2 17 31 Id. 32 17 CFR 200.30–3(a)(12). VerDate Aug<31>2005 22:25 Nov 21, 2006 Jkt 211001 PO 00000 Frm 00138 Fmt 4703 Sfmt 4703 trading system, NSX BLADE, will remain the fees contained in NSX Rule 11.10. The text of the proposed rule change, as amended, is available on the Exchange’s Web site at https:// www.nsx.com, at the principal office of NSX, and at the Commission’s Public Reference Room. II. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, the Exchange included statements concerning the purpose of and basis for the proposed rule change, as amended, and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set forth in Sections A, B, and C below, of the most significant aspects of such statements. A. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change 1. Purpose The Exchange proposes to (i) Provide for a rebate of $0.0027 per share executed for adding liquidity in NSTS for ETFs that are classified as Tape B securities and (ii) charge a liquidity taker fee of $0.0030 per share for transactions in ETFs that are classified as Tape B securities via NSTS, including transactions executed through the auspices of the ITS Plans. Background The Exchange has created a new state of the art trading platform, known as NSX BLADE, that utilizes a strict price/ time priority system as the ultimate replacement for NSTS. In connection with the new trading platform, the Exchange filed a proposed rule change to accommodate the new trading platform, which was approved on August 31, 2006.5 As part of that rule filing, the Exchange stated that NSX BLADE will be phased in gradually—first with a small group of Tape C securities over several weeks until all Tape C securities have been transitioned to the new system. Once all Tape C securities have been transitioned to NSX BLADE, the Exchange will then transition all Tape A and Tape B securities.6 5 See Securities Exchange Act Release No. 54391 (August 31, 2006), 71 FR 52836 (September 7, 2006) (order approving SR–NSX–2006–08). 6 The Exchange commenced the gradual phase-in of NSXBLADE on October 23, 2006 with the E:\FR\FM\22NON1.SGM 22NON1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 71, Number 225 (Wednesday, November 22, 2006)]
[Notices]
[Pages 67675-67678]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E6-19732]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54755; File No. SR-NASD-2006-007]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc; Order Approving Proposed Rule Change Relating to Option 
Position and Exercise Limits and Position Reporting Obligations; and 
Notice of Filing and Order Granting Accelerated Approval to Amendment 
No. 1 Thereto

 November 15, 2006.

I. Introduction

    On January 23, 2006, the National Association of Securities 
Dealers, Inc. (``NASD'') filed with the Securities and Exchange 
Commission (``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Exchange Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to amend NASD Rule 2860, which 
relates to position and exercise limits and position reporting 
obligations for members that hold positions in index and equity options 
or that represent customers holding such positions. The proposed rule 
change was published for comment in the Federal Register on February 6, 
2006.\3\ The Commission received one comment on the proposal.\4\ In its 
comment letter, the Securities Industry Association (``SIA'') 
``endorse[d] the adoption of clear and objective criteria for 
identifying those index options that would be exempt from NASD option 
position and exercise limits.'' \5\ However, the SIA also recommended 
``streamlining the relevant standards and easing the operational steps 
necessary for NASD member firms to verify compliance with the Proposed 
Rule Change.'' \6\ In response to this comment, NASD filed Amendment 
No. 1 to the proposed rule change on September 20, 2006.\7\ This notice 
and order solicits comments from interested persons on Amendment No. 1 
and approves the proposal, as amended by Amendment No. 1, on an 
accelerated basis.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 53189 (January 30, 
2006), 71 FR 6117.
    \4\ See letter from John R. Vitha, Esq., Chairman, Securities 
Industry Association Derivative Product Committee, to Nancy M. 
Morris, Secretary, Commission, dated May 23, 2006 (``SIA Letter'').
    \5\ Id. at 1.
    \6\ Id.
    \7\ The text of Amendment No. 1 is available on the NASD's Web 
site (https://www.nasd.com), at NASD's principal office, and at the 
Commission's Public Reference Room.
---------------------------------------------------------------------------

II. Description of the Proposal

A. Position Limits for OTC Index Options

    NASD currently prohibits its members, for their proprietary or 
agency accounts, from holding positions in over-the-counter (``OTC'') 
equity options \8\ that exceed certain position limits.\9\ NASD also 
imposes exercise limits on a member that holds OTC equity options; the 
member may not exercise, within a period of five consecutive business 
days, a number of option contracts that exceeds the same number 
established for the position limit.\10\ The position limits that NASD 
imposes on its members for OTC equity options are based on similar 
standards established by the option exchanges for ``standardized'' 
equity options.\11\ In contrast, NASD rules impose no position limits 
on OTC index options, but do not clarify what constitutes an OTC index 
option for this purpose.
---------------------------------------------------------------------------

    \8\ An ``OTC option'' for the purposes of this approval order 
means any option contract not issued or subject to issuance by the 
Options Clearing Corporation (``OCC'').
    \9\ These position limits vary depending on the characteristics 
of the security underlying the OTC option. See NASD Rule 
2860(b)(3)(A)(viii).
    \10\ See NASD Rule 2860(b)(4). NASD's proposal will impact its 
exercise limits in the same way as it will change its position 
limits.
    \11\ The term ``standardized equity option'' means any equity 
options contract issued, or subject to issuance by, The Options 
Clearing Corporation that is not a FLEX Equity Option. See NASD Rule 
2860(b)(2)(UU).
---------------------------------------------------------------------------

    NASD believes that some indexes underlying OTC options might have 
economic characteristics more closely resembling single securities than 
broad-based indexes. This could be the case, for example, where the 
index consisted of only a small number of securities or if one or a few 
securities represented a significant percentage of the index's 
weighting. In its initial filing, NASD proposed 11 criteria an index 
would have to meet to be sufficiently broad-based for an option on that 
index to be

[[Page 67676]]

deemed a ``conventional index option'' under proposed NASD Rule 
2860(b)(2)(N).\12\ A position in a ``conventional index option'' would 
continue to be free from any position limits imposed by NASD rules. In 
addition, a position in an OTC option overlying the same index as an 
exchange-traded option would not be subject to position limits. A 
position in an OTC index option that did not either qualify as a 
``conventional index option'' or overlie the same index as an exchange-
traded option would in effect be deconstructed into separate equity 
option components, and NASD position limits would apply with respect to 
each component.\13\
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    \12\ The 11 criteria originally proposed by NASD to define a 
``conventional index option'' were as follows:
    a) The option must be A.M.-settled;
    b) The index must be weighted pursuant to one of a number of 
widely recognized methodologies;
    c) The index must consist of ten or more component securities;
    d) Each component security must be characterized by a minimum 
market capitalization;
    e) Each component security must be characterized by a minimum 
trading volume;
    f) The most highly weighted components of the index must be 
characterized by heightened trading volume, as compared to the 
remaining components;
    g) No single component security or group of five securities may 
represent more than a maximum concentration of the index;
    h) All component securities are ``NMS securities'' as defined in 
Regulation NMS;
    i) Certain non-U.S. component securities may not, in the 
aggregate, represent more than a maximum weight of the index;
    j) An equal dollar-weighted index will be rebalanced once every 
quarter; and
    k) If an underlying index is maintained by a broker-dealer, the 
index must be calculated by a third party that has implemented 
appropriate information barriers around its personnel who have 
access to information about changes to the index.
    \13\ See NASD Rule 2860(b)(2)(JJ).
---------------------------------------------------------------------------

    In response to the SIA Comment Letter, NASD in Amendment No. 1 
replaced the 11 originally proposed criteria for a ``conventional index 
option'' with the following criteria:
     An index must contain nine or more equity securities.
     No equity security may comprise more than 30% of the 
equity security component of the index's weighting.
     Each equity security in the index is either:
    1. A component security of the Russell 3000 Index or the FTSE All-
World Index Series; or
    2. Characterized by a minimum market capitalization and minimum 
trading volume.\14\
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    \14\ Specifically, each equity security in the index must: (A) 
Have a market capitalization of at least $75 million, or, in the 
case of the lowest weighted component securities in the basket or 
index in the aggregate account for no more than 10% of the weight of 
the index $50 million; and (B) have a trading volume for each of the 
preceding six months of at least one million shares or, in the case 
of each of the lowest weighted component securities in the basket or 
index that in the aggregate account for no more than 10% of the 
weight of the index, 500,000 shares.
---------------------------------------------------------------------------

    The SIA recommended basing the definition of a ``conventional index 
option,'' in part, on the definition under the Exchange Act of what is 
not a ``narrow-based security index.'' \15\ As provided in that 
definition, the SIA recommended replacing the requirement that a 
qualifying index be comprised of ten or more securities with a 
requirement that an index be comprised of nine or more securities. 
Similarly, the SIA also recommended that the NASD amend its proposal to 
conform with the criterion under the Exchange Act definition described 
above, to provide that no equity security in the index represent more 
than 30% of the equity security component of the index. NASD adopted 
both of these recommendations.
---------------------------------------------------------------------------

    \15\ See 15 U.S.C. 78c(a)(55)(C).
---------------------------------------------------------------------------

    In its original filing, NASD required that the components of an 
index underlying a ``conventional index option'' be characterized by 
certain minimum market capitalization and liquidity standards.\16\ The 
SIA suggested that NASD treat components of the Russell 3000 Index and 
the FTSE All-World Index Series as meeting such quantitative standards 
without measuring the actual market capitalization and trading volume 
of such components.\17\ In Amendment No. 1, NASD retained the 
quantitative standards for market capitalization and trading volume, 
but allowed that condition to be met if an equity security is included 
in the Russell 3000 Index or the FTSE All-World Index Series. NASD 
believes that these indexes are reasonable surrogates for the 
quantitative measurements, and that these alternative criteria would 
reduce the compliance burden for members to monitor capitalization and 
trading volume of the index components.
---------------------------------------------------------------------------

    \16\ See supra note 14
    \17\ See SIA Letter at 3.
---------------------------------------------------------------------------

    NASD believes that the criteria it proposed in Amendment No. 1 to 
replace the original 11 criteria impose sufficient parameters on the 
components of the index to ensure that a qualifying index would not be 
so narrowly constructed as to have the economic characteristics of a 
single security or small group of securities. Accordingly, NASD in 
Amendment No. 1 eliminated the remaining criteria proposed in the 
original filing.

B. Large Options Position Reporting

    Under existing NASD Rule 2860(b)(5)(A)(i)(a), an NASD member must 
report a position of 200 contracts or more in any OTC option covering 
an ``underlying security or index.'' \18\ On June 30, 2006, the 
Commission approved an NASD rule change that, among other things, 
eliminated the term ``underlying index,'' which was defined to mean 
``an index upon which a Nasdaq index option contract is based.'' \19\ 
Accordingly, NASD rules currently provide no standard for the types of 
OTC index options for which members must report large positions. NASD's 
initial proposal would have clarified this situation by requiring a 
member to report a position of 200 or more contracts in: (1) An OTC 
option on an index underlying an exchange-traded option, or (2) a 
``conventional index option,'' as defined in proposed NASD Rule 
2860(b)(2)(N).
---------------------------------------------------------------------------

    \18\ When a member conducts a business in standardized (i.e., 
exchange-traded) options but is not a member of the exchange on 
which the option is traded (i.e. is an ``access firm''), the member 
also must report to NASD a position of 200 contracts or more in a 
standardized option. See NASD Rule 2860(b)(5)(A)(i)(b). Nothing in 
this proposal affects an access firm's obligation to report 
positions in standardized options.
    \19\ The proposed rule change amended various NASD rules in 
anticipation of the Nasdaq Stock Market's separation from NASD. See 
Securities Exchange Act Release No. 54084 (June 30, 2006), 71 FR 
38935 (July 10, 2006) (SR-NASD-2005-087).
---------------------------------------------------------------------------

    In its comment letter, the SIA suggested that a position in an OTC 
index option should be exempt from any position reporting requirements 
unless the OTC option overlies the same index as an exchange-traded 
option. NASD generally agrees with the SIA's approach and is proposing 
to revise its Rule 2860(b)(5) to provide that a member must report a 
position in a ``conventional index option'' only when such option is 
based on an index that underlies, or is substantially similar to an 
index that underlies, an exchange-traded option. This approach would 
enable NASD Market Regulation staff to analyze the exchange-traded and 
OTC markets in aggregate for options on the same or substantially 
similar indexes.\20\ NASD believes that position reporting for other 
conventional index options would be of little regulatory interest and 
represents that, to the extent it requires information about a position 
in a conventional index option on a specially negotiated index or group 
of underlying securities, it can obtain such information from a member 
pursuant to

[[Page 67677]]

a request under NASD Rule 8210.\21\ Thus, NASD believes that 
eliminating this position reporting requirement would not prevent it 
from accessing information relating to a conventional index option 
position as needed to carry out its market oversight and enforcement 
responsibilities.
---------------------------------------------------------------------------

    \20\ Telephone conversation among Gary Goldsholle, Associate 
General Counsel, NASD, Kathryn Moore, Assistant General Counsel, 
NASD, and Tim Fox, Special Counsel, Commission, on October 31, 2006.
    \21\ However, a position in an OTC index option that did not 
qualify as a ``conventional index option'' would in effect be 
deconstructed into separate equity option components, and the 
position reporting obligation would apply with respect to each 
component. See NASD Rule 2860(b)(2)(JJ).
---------------------------------------------------------------------------

    Finally, the SIA urged NASD to revisit the threshold at which 
position reporting applies, for the OTC options where position 
reporting is required.\22\ The SIA suggested raising the threshold from 
the current 200 contracts to 10,000 contracts. NASD stated in Amendment 
No. 1 that it does not believe such a change is appropriate or 
necessary at this time. However, NASD stated that it will consider this 
issue and subject it to further review and discussion with the other 
self-regulatory organizations.
---------------------------------------------------------------------------

    \22\ See SIA Letter at 4.
---------------------------------------------------------------------------

C. Position Limits for Options on Foreign Equity Securities

    Under existing NASD Rule 2860(b)(3)(A)(viii), the position limits 
for conventional equity options parallel the limits for the 
standardized options on the same security. Therefore, if a standardized 
equity option is subject to a higher tier of position limits because of 
the relatively liquid and deep nature of the market for the underlying 
security, then a conventional option on the same security would be 
subject to a higher tier as well. On the other hand, with respect to an 
OTC option on an equally liquid foreign security, for which no 
exchange-traded equivalent exists, a member is required to limit its 
holdings (or its customer's holdings) to the lowest tier of position 
limits, absent prior approval of NASD staff. To alleviate this 
disparate treatment of OTC options on foreign equities, NASD proposed 
in the original filing to allow the higher tiers of position limits for 
OTC options overlying equity components of the FTSE All-World Index 
Series \23\ meeting the volume and float criteria established by the 
options exchanges for standardized options on domestic equity 
securities.\24\
---------------------------------------------------------------------------

    \23\ NASD has represented that, if it designates another index 
in addition to or instead of the FTSE All-World Index Series, NASD 
would publish the designation of the new index in a Notice to 
Members and provide members at least 30 days' written notice of the 
change.
    \24\ See Commentary .07 to American Stock Exchange Rule 904, 
Section 7(c) of Chapter III of the Boston Options Exchange Rules, 
Interpretation .02 to Chicago Board Options Exchange (``CBOE'') Rule 
4.11; International Securities Exchange Rule 412(d); Commentary .06 
to NYSE Arca Rule 6.8; Commentary .05 to Philadelphia Stock Exchange 
Rule 1001.
---------------------------------------------------------------------------

    Under the proposed rule change, a member would file a post-trade 
notice--within one business day--with NASD staff providing the 
necessary trade volume data and/or current float data to support the 
member's position limit calculation. NASD staff would review the 
member's notice, and, if the staff determined that a member incorrectly 
assigned a position limit, a staff member would instruct the firm to 
reduce its position below the appropriate limits determined by NASD 
staff. The Commission received no comments on this aspect of the 
proposal.

D. Miscellaneous Issues

    The SIA also suggested revising the definition of ``conventional 
index option'' to permit the inclusion of financial assets other than 
equity securities.\25\ NASD believes that the originally proposed 
definition of ``conventional index option'' permits the inclusion of 
non-equity assets and is not proposing any change to the rule text to 
accommodate SIA's suggestion. According to NASD, financial assets other 
than equity securities could be part of an index and the option thereon 
could still qualify as a ``conventional index option'' if the equity 
security components of the index together met the criteria in the 
definition.
---------------------------------------------------------------------------

    \25\ See SIA Letter at 4.
---------------------------------------------------------------------------

    In addition to changes in response to the SIA Letter, NASD in 
Amendment No. 1 proposed to clarify the date on which an OTC index 
option would or would not qualify as a ``conventional index option.'' 
The revised rules clarify that the definition's requirements apply as 
of the date the option position is created.\26\ NASD designed this 
approach to clarify that subsequent events that might impact an index's 
components would not change how an option on that index is treated for 
purposes of NASD's position limits and position reporting rules.
---------------------------------------------------------------------------

    \26\ Telephone conversation between Gary Goldsholle, Associate 
GeneralCounsel, NASD, and Tim Fox, Division of Market Regulation, 
Commission on October 19, 2006.
---------------------------------------------------------------------------

III. Discussion

    The Commission finds that the proposed rule change, as amended, is 
consistent with the requirements of the Exchange Act and the rules and 
regulations thereunder applicable to a national securities association 
and, in particular, the requirements of Section 15A(b)(6) of the 
Exchange Act,\27\ which requires that the rules of the NASD be designed 
to prevent fraudulent and manipulative acts and practices, to promote 
just and equitable principles of trade, to facilitate transactions in 
securities, and to remove impediments to and perfect the mechanism of a 
free and open market and, in general, to protect investors and the 
public interest.\28\ The Commission believes the proposed rule change 
is reasonably designed to enhance the NASD's ability to monitor the 
options positions of members and their customers and to clarify 
applicable position limits. In particular, the Commission believes that 
the NASD rules it is approving today reasonably differentiate between 
broad-based indexes and indexes whose economic characteristics more 
closely approximate those of a single security or a small number of 
securities. The Commission believes that the proposal is designed to 
balance between allowing the NASD to obtain information for surveilling 
the market in OTC index options and limiting the burdens on NASD 
members that hold positions in such options.
---------------------------------------------------------------------------

    \27\ 15 U.S.C. 78o-3(b)(6).
    \28\ In approving the proposal, the Commission has considered 
the rule's impact on efficiency, competition, and capital formation. 
See 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    The Commission finds good cause for approving the proposal, as 
amended by Amendment No. 1, prior to the thirtieth day after the 
amended proposal is published for comment in the Federal Register 
pursuant to Section 19(b)(2) of the Exchange Act.\29\ The Commission 
believes that Amendment No. 1 does not make any changes to the proposal 
that would adversely impact investor protection or the public interest. 
The Commission notes that it received only one comment letter in 
response to NASD's original proposal.\30\ Amendment No. 1 is generally 
responsive to the commenter's concerns and does not materially alter 
the proposal. The Commission notes that accelerating approval will 
enable NASD to implement the proposed rule changes without further 
delay.
---------------------------------------------------------------------------

    \29\ 15 U.S.C. 78s(b)(2).
    \30\ See SIA Letter, supra note 4.
---------------------------------------------------------------------------

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 1, including whether Amendment No. 1 
is consistent with the Exchange Act. Comments may be submitted by any 
of the following methods:

Electronic comments

     Use the Commission's Internet comment form (https://
www.sec.gov/rules/sro.shtml); or

[[Page 67678]]

     Send an e-mail to rule-comments@sec.gov. Please include 
File Number SR-NASD-2006-007 on the subject line.

Paper comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, Station Place, 100 F 
Street, NE., Washington, DC 20549-1090.

All submissions should refer to Amendment No. 1 to File Number SR-NASD-
2006-007. This file number should be included on the subject line if e-
mail is used. To help the Commission process and review your comments 
more efficiently, please use only one method. The Commission will post 
all comments on the Commission's Internet Web site (https://www.sec.gov/
rules/sro.shtml). Copies of the submission, all subsequent amendments, 
all written statements with respect to the proposed rule change that 
are filed with the Commission, and all written communications relating 
to the proposed rule change between the Commission and any person, 
other than those that may be withheld from the public in accordance 
with the provisions of 5 U.S.C. 552, will be available for inspection 
and copying in the Commission's Public Reference Section, Station 
Place, 100 F Street, NE., Washington, DC 20549. Copies of such filing 
also will be available for inspection and copying at the principal 
office of NASD. All comments received will be posted without change; 
the Commission does not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
available publicly. All submissions should refer to Amendment No. 1 to 
File Number SR-NASD-2006-007 and should be submitted on or before 
December 13, 2006.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Exchange Act,\31\ that the proposed rule change (SR-NASD-2006-007) be, 
and hereby is approved, and that Amendment No. 1 is approved on an 
accelerated basis.
---------------------------------------------------------------------------

    \31\ Id.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\32\
---------------------------------------------------------------------------

    \32\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Nancy M. Morris,
Secretary.
 [FR Doc. E6-19732 Filed 11-21-06; 8:45 am]
BILLING CODE 8011-01-P

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