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Notice

Self-Regulatory Organizations; Notice of Filing and Order Granting Accelerated Approval of Proposed Rule Changes by the Pacific Exchange, Inc. and the American Stock Exchange LLC Relating to Exercise Price Intervals and Exercise Prices for FLEX Equity Options

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Start Preamble February 7, 2000.

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 January 11, and January 27, 2000, the Pacific Exchange, Inc. (“PCX”) and the American Stock Exchange LLC (“Amex”) (collectively the “Exchanges”), respectively, filed with the Securities and Exchange Commission (“Commission”) the proposed rule changes as described in Items I and II below, which Items have been prepared by the Exchanges. The Commission is publishing this notice and order to solicit comments on the proposed rule changes from interested persons and to approve the proposals on an accelerated basis.

I. Self-Regulatory Organizations' Statements of the Terms of Substance of the Proposed Rule Changes

The Amex proposes to remove paragraph (c)(3) from Exchange Rule 903G. Paragraph (c)(3) limits exercise Start Printed Page 8225price intervals and exercise prices for FLEX Equity call options to those that apply to Non-FLEX Equity call options. In addition, PCX proposes to delete Commentary .01 to PCX Rule 8.102, which is similar to the paragraph Amex proposes to remove.[3]

II. Self-Regulatory Organizations' Statements of the Purpose of, and Statutory Basis for, the Proposed Rule Changes

In their filings with the Commission, the Exchange included statements concerning the purpose of and basis for the proposed rule changes and discussed any comments they received on the proposed rule changes. The text of these statements may be examined at the places specified in Item III below. The Exchanges have prepared summaries, set forth in Sections A, B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organizations' Statements of the Purpose of, and Statutory Basis for, the Proposed Rule Changes

1. Purpose

The Exchanges propose to eliminate their rules that limit the exercise price intervals and exercise prices available for FLEX Equity call options to those intervals and prices that are available for Non-FLEX Equity call options. This policy was intended to eliminate uncertainty concerning what constitutes a “qualified” covered call for certain purposes under the Internal Revenue Code pending clarification of this tax issue.

Currently, under Section 1092(c)(4)(B) of the Internal Revenue Code, certain covered short positions in call options qualify for advantageous tax treatment if the options are not in the money by more than a specified amount at the time they are written. One measure used to determine whether a call option is qualified is whether its exercise or “strike” price is not lower than the “lowest qualified benchmark price,” which is generally the highest strike price available for trading that is less than the current price of the underlying stock. Since the exercise prices of FLEX Equity Options are not subject to the same intervals that apply to Non-FLEX Equity Options, this has raised the question whether the existence of a series of FLEX Equity Options with a strike price of, for example, 58 when the price of the underlying stock is 59 would disqualify a Non-FLEX call option with a strike price of 55, which would otherwise be the highest strike price available that is less than the price of the stock.

The Internal Revenue Service (“IRS”) reviewed this issue and proposed regulations that would not require that strike prices established by equity options with flexible terms be taken into account in determining whether standard term equity options are too deep in the money to receive qualified covered call treatment. [4] These regulations became effective on January 25, 2000. [5] The effect of the IRS regulations and the Exchanges' proposed withdrawal of the limitations on the exercise price of Equity FLEX call options is that certain taxpayers, particularly institutional and other large investors, can engage in transactions in Equity FLEX call options with a wider range of exercise prices (as was originally intended) without affecting the applicability of Section 1092 of the Internal Revenue Code for qualified covered call options involving equity options with standard terms.

The Exchanges believe that the proposed rule changes, by eliminating a restriction on Equity FLEX call options which has restricted their usefulness as a risk managing mechanism, will remove impediments to and perfect the mechanisms of a free and open market in FLEX Equity Options, and thus are consistent with the objectives of Section 6(b)(5) [6] of the Act.

2. Statutory Basis

The Exchanges believe that the proposed rule changes are consistent with and further the objectives of Section 6(b)(5) [7] of the Act in that the changes are designed to remove impediments to a free and open market and to protect investors and the public interest.

B. Self-Regulatory Organizations' Statements on Burden on Competition

The Exchanges do not believe that the proposed rule changes will impose any burden on competition.

C. Self-Regulatory Organizations' Statements on Comments on the Proposed Rule Changes Received From Members, Participants, or Others

No written comments were solicited or received with respect to the proposed rule changes.

III. Solicitation of Comments

Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rules are consistent with the Act. Persons making written submissions should file six copies thereof with the Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC20549-0609. Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule changes that are filed with the Commission, and all written communications relating to the proposed rule changes 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 Room. Copies of such filings will also be available for inspection and copying at the principal offices of the PCX and Amex. All submissions should refer to File Nos. SR-PCX-00-01 and SR-Amex-00-02 and should be submitted by March 9, 2000.

IV. Commission's Findings and Order Granting Accelerated Approval of Proposed Rule Changes

After careful review, the Commission finds that the proposals are consistent with the requirements of the Act.[8] In particular, the Commission finds that the proposals are consistent with Section 6(b)(5) [9] of the Act. Section 6(b)(5) requires, among other things, that the rules of an exchange be designed to remove impediments to a free and open market and to protect investors and the public interest.

The Commission believes that the proposals allow sophisticated, high net-worth investors to take full advantage of FLEX options. In part, FLEX options were created to allow these investors to manage their risks by having the ability to negotiate strike prices, contract terms for exercise style (i.e., American, European, or capped), and expiration dates. However, because of the potential adverse tax effect on qualified covered calls, the Exchanges limited FLEX call strike prices and exercise intervals to those available for standardized equity calls. Now that the tax issue has been clarified, this limitation is being removed. With the removal of this Start Printed Page 8226limitation, the Commission believes that sophisticated, high net-worth investors will have a better opportunity to take advantage of the risk-management mechanisms provided by FLEX options.[10]

The Commission finds good cause for approving the proposed rule changes prior to the thirtieth day after the date of publication of notice thereof in the Federal Register. The Commission recently approved a virtually identical Chicago Board Options Exchange, Inc., proposal SR-CBOE-99-63,[11] which had been published as SR-CBOE-98-39.[12] The Commission received no comment letters on this filing. Additionally, Amex filed a very similar proposal, SR-Amex-98-43, which it later withdrew because the IRS had not yet acted on its proposed rulemaking.[13] The current proposals mirror the changes that were approved in SR-CBOE-99-63. In addition, the proposals allow FLEX options to be used as they were originally intended to be used. The Commission believes, therefore, that granting accelerated approval to the proposed rule changes is appropriate and consistent with Section 6 of the Act.[14]

It Is Therefore Ordered, pursuant to Section 19(b)(2) of the Act,[15] that the proposed rule change (SR-PCX-00-01 and SR-Amex-00-02) are hereby approved on an accelerated basis.

Start Signature

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.[16]

Margaret H. McFarland,

Deputy Secretary.

End Signature End Preamble

Footnotes

3.  The Commission approved these rule changes in a single approval order in 1996. See Release No. 34-37726 (September 25, 1996), 61 FR 51474 (October 2, 1996).

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4.  Department of the Treasury, IRS REG-104641-97, 63 FR 34616 (June 25, 1998).

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5.  Department of the Treasury, IRS REG-104641-97, 65 FR 3812 (January 2000).

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8.  In addition, pursuant to Section 3(f) of the Act, the Commission has considered the proposed rules' impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f).

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10.  The Commission expects that the Options Disclosure Document (“ODD”) will promptly be amended to reflect the removal of the strike price limitation for FLEX equity call options. See October 1996 Supplement to the ODD.

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11.  See Release No. 34-42371 (January 31, 2000) (order approving SR-CBOE-99-63.)

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12.  See Release No. 34-40584 (October 21, 1998), 63 FR 58080 (October 29, 1998) (notice of filing of SR-CBOE-98-39.)

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13.  See Release No. 34-40795 (December 15, 1998), 63 FR 71321 (December 24, 1998) (notice of filing SR-Amex-98-43.)

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[FR Doc. 00-3749 Filed 2-16-00; 8:45 am]

BILLING CODE 8010-01-M