Self-Regulatory Organizations; Filing of Proposed Rule Change by the New York Stock Exchange, Inc. Relating to Option Exercise Cut-Off Procedures

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-34050; File No. SR-NYSE-94-12]

Self-Regulatory Organizations; Filing of Proposed Rule Change by

the New York Stock Exchange, Inc. Relating to Option Exercise Cut-Off

Procedures

May 12, 1994.

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934

(``Act'').\1\ notice is hereby given that on March 23, 1994, the New

York Stock Exchange, Inc. (``NYSE'' 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 prepared by the self-regulatory organization. The Commission is

publishing this notice to solicit comments on the proposed rule change

from interested persons.

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

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I. Self-Regulatory Organization's Statement of the Terms of Substance

of the Proposed Rule Change

The NYSE proposes to amend Exchange Rule 780 (Exercise of Option

Contracts) to establish new exercise cut-off procedures in respect to

expiring equity options.

The proposed procedures would continue to require clearing members

to notify The Options Clearing Corporation (``OCC'') of exercises of

equity options and would establish a procedure requiring a member or

member organization to indicate an option holder's final exercise

decision to the Exchange. The member or member organization could do

this in one of two ways: either it could submit a Contrary Exercise

Advice to the Exchange or it could take no action and thereby rely on

OCC's exercise-by-exeption procedures pursuant to OCC Rule 805.\2\ The

``Contrary Exercise Advice'' form instructs the Exchange that the

options holder has decided not to exercise an equity option that

application of OCC's exercise-by-exception procedures would otherwise

automatically exercise or to exercise an equity option that OCC's

exercise-by-exception procedures would not otherwise exercise.

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\2\The OCC's exercise-by-exception procedures make automatic

exercise decisions. They allow (i) the exercise of an in-the-money

option at expiration without the submission of an input entry into

OCC if the option is at or above a predetermined threshold and (ii)

the non-exercise of an option at expiration if the option is not at

or above the predetermined threshold.

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The proposal requires final equity option exercise decisions to be

made at 5:30 p.m. New York time on the business day immediately

preceding the expiration date (the ``exercise cut-off time'') and

allows a member or member organization to submit a Contrary Exercise

Advice subsequent to the exercise cut-off time in the event of a good-

faith error, a failure to reconcile an unmatched option transaction, or

an exceptional circumstance that precludes communication of the

Contrary Exercise Advice.

Under the proposal, a member or member organization may submit the

Contrary Exercise Advice to any place that the Exchange or any other

national options exchange of which it is a member directs, so long as

the option is listed on the directing exchange. Alternatively, the

member or member organization may submit the advice to the Exchange via

OCC.

Where OCC has waived the exercise-by-exception procedures, a member

or member organization must still submit the Contrary Exercise Advice

to the Exchange when the member or member organization wishes to

exercise in a manner that would have been contrary to the automatic

exercise or non-exercise procedure had OCC not waived the exercise-by-

exception procedure. In determining whether the exercise would have

been contrary to the OCC exercise-by-exception procedure had OCC not

waived it, the price of the underlying security would normally be the

last sale price in the primary market on the business day immediately

prior to the expiration date.

Proposed paragraph (d) of Rule 780 requires members and member

organizations to assume responsibility for ensuring that the final

exercise decisions for proprietary and customer accounts are indicated

to the Exchange. The proposed procedures further require each member

organization to establish a cut-off time after which it will not longer

accept final exercise decisions.

Proposed paragraph (f) of Rule 780 requires member organizations to

prepare memoranda of every final exercise decision that requires a

contrary exercise advice, including the time when the decision was made

or received. If a final exercise decision is made after the exercise

cut-off time, the member or member organization must prepare a

memorandum describing the circumstances. The member or member

organization must file a copy of that memorandum with the Exchange's

Market Surveillance Department by no later than 12 p.m. on the first

business day following expiration. All memoranda must be kept in

accordance with Rule 17a-4 under the Act.\3\

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\3\17 CFR 240.17a-4 (1993).

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II. Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

It its filing with the Commission, the self-regulatory organization

included statements concerning the purpose of and basis for the

proposed rule change 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 self-regulatory organization

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

Under the proposed rule change, the 5:30 p.m. exercise cut-off time

for equity options as well as the actual exercise procedures, including

the submission of exercise notices to OCC, remain unchanged and subject

to OCC rules.

While retaining the 5:30 p.m. time limit for equity options, the

proposed rule change removes the 6:30 p.m. cut-off time for the receipt

of exercise instructions for index stock group options, thereby

removing index stock group options from the applicability of Rule 780.

Instead, the existing requirements of Supplementary Material .10 to

Rule 780 would govern the exercise of index stock group options. The

Exchange feels that removing the explicit exercise cut-off time in the

context of index stock group options is warranted because those options

are cash settled, thereby making it unlikely that an exercise will

affect the market for the securities underlying the index option, and

because the requirements of Supplementary Material .10 provide

sufficient notice to the Exchange of the exercise of index stock group

options.

The Exchange feels that replacing the existing equity option

exercise cut-off procedures with the proposed procedures will

strengthen member and member organization audit trail capabilities. The

exercise decision indication and the Contrary Exercise Advices will

allow the Exchange to better track activity surrounding the exercise

the equity options. Furthermore, the proposed procedures will provide a

more convenient method for members to indicate exercise intentions to

the Exchange.

In addition, the Exchange believes that the proposed procedures

provide it with a better audit trail. For example, the proposed

procedures would permit a member or member organization to submit a

Contract Exercise Advices directly to the Exchange, rather than to the

clearing firm. This means that responsibility for the timely and proper

submission of Contrary Exercise Advices shifts from the clearing firm

to the option holder himself and his member organization.

Alternatively, the proposed procedures allow a member to continue

to submit final exercise decisions (in the form of Contrary Exercise

Advices) to its clearing member. That would cause the clearing member

to remain responsible for submitting the Contrary Exercise Advice to

the Exchange. In either case, a member may submit the Contrary Exercise

Advice directly to the Exchange at a place that the Exchange shall

designate, or to the Exchange indirectly through OCC via OCC's Clearing

Management and Control System. In both cases, the proposed procedures

will create an efficient audit trail that will allow the Exchange to

identify late submissions.

Under current procedures, members and member organizations need not

make submissions to the Exchange or OCC. Rather, a member or member

organization must time stamp the receipt of an exercise instruction and

maintain that time-stamped instruction in its files. The member or

member organization, and not the Exchange or OCC, controls the records

of options exercises.

Furthermore, the proposed procedures strengthen the requirements

regarding the preparation and maintenance of memoranda, thereby further

strengthening the options exercise audit trail. Members and member

organizations must maintain detailed descriptions of non-automatic

exercises an late exercises. This should facilitate the Exchange's

surveillance of violations of exercise procedures.

The statutory basis for the proposed rule change is the requirement

under Section 6(b)(5) that an exchange have rules that are designed to

prevent fraudulent and manipulative acts and practices, to promote just

and equitable principles of trade, to remove impediments to and perfect

the mechanism of a free and open market and a national market system,

and, in general, to protect investors and the public interest.

(B) Self-Regulatory Organization's Statement on Burden on Competition

The NYSE believes that the proposed rule change will not impose any

burden on competition that is not necessary or appropriate in

furtherance of the purposes of the Act.

(C) Self-Regulatory Organization's Statement on Comments on the

Proposed Rule Change Received From Members, Participants, or Others

The Exchange has not solicited, and does not intend to solicit

comments on the proposed rule change. The Exchange has not received any

unsolicited written comments from members or other interested parties.

III. Date of Effectiveness of the Proposed Rule Change and Timing for

Commission Action

Within 35 days of the date of publication of this notice in the

Federal Register or within such longer period (i) as the Commission may

designate up to 90 days of such date if it finds such longer period to

be appropriate and publishes its reasons for so finding or (ii) as to

which the self-regulatory organization consents, the Commission will:

(a) By order approve such proposed rule change, or

(b) Institute proceedings to determine whether the proposed rule

change should be disapproved.

IV. Solicitation of Comments

Interested persons are invited to submit written data, views and

arguments concerning the foregoing. Persons making written submissions

should file six copies thereof with the Secretary, Securities and

Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549.

Copies of the submission, all subsequent amendments, all written

statements with respect to the proposed rule change that are 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, 450 Fifth Street, NW.,

Washington, DC. Copies of such filing will also be available for

inspection and copying at the principal office of the above-mentioned

self-regulatory organization. All submissions should refer to File No.

SR-NYSE-94-12 and should be submitted by June 8, 1994.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\4\

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\4\17 CFR 200.30-3(a)(12) (1993).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 94-12040 Filed 5-17-94; 8:45 am]

BILLING CODE 8010-01-M