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Notice

Self-Regulatory Organizations; Notice of Filing and Order Granting Accelerated Approval of Proposed Rule Change by the Philadelphia Stock Exchange, Inc. Relating to Modified Capitalization Weighting Methodology for Index Options

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Start Preamble July 16, 2002.

Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 (the “Act”),[1] and Rule 19b-4 thereunder,[2] notice is hereby given that on March 1, 2002, the Philadelphia Stock Exchange, Inc. (“Phlx” or “Exchange”) filed with the Securities and Exchange Commission (“Commission” or “SEC”) the proposed rule change as described in Items I and II below, which Items have been prepared by the Exchange. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons and approving the proposed rule change on an accelerated basis.

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

The Exchange proposes to amend Phlx Rule 1009A(b), Designation of the Index, to delete, and then to repropose, modified capitalization weighting as an approved weighting methodology for index options so that there is no change to the actual present language of Rule 1009A(b). The following is the text of the proposed rule change. Language that is currently in the text of the rule, which is proposed to be deleted and immediately reinserted, is underlined.

Designation of the Index

Rule 1009A.

(a) No change.

(b)-(b)(1) No change.

(b)(2) The index is capitalization-weighted, price-weighted , modified capitalization-weighted or equal dollar-weighted, and consists of ten or more component securities;

(b)(3)-b(10) No change.

(b)(11) An equal dollar-weighted index will be rebalanced at least once every calendar quarter ; and a modified capitalization-weighted index will be rebalanced at least twice annually;

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 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

1. Purpose

The purpose of the proposed rule change is to first delete, and immediately to reinsert pursuant to Commission approval, language in Rule 1009A(b) relating to modified capitalization weighting as a permissible weighting methodology for narrow-based index options listed and traded pursuant to Rule 1009A(b). The language is currently in effect, inasmuch as it became immediately effective on March 1, 2002, pursuant an Exchange filing made pursuant to section Start Printed Page 4787519(b)(3)(A) of the Act [3] and Rule 19b-4(f)(6) thereunder.[4]

In 1998 the Commission adopted new Rule 19b-4(e),[5] eliminating the requirement that a self-regulatory organization (“SRO”) file a proposal under Section 19(b)(3)(A) [6] to list and trade options on a narrow-based index, provided that the SRO has generic listing criteria approved by the Commission and meets certain other requirements. The Exchange is now seeking Commission approval, under section 19(b)(2) of the Act,[7] of the addition of modified capitalization weighting as a permissible methodology in order to ensure the applicability of Rule 19b-4(e) [8] to products which the Exchange may list and trade pursuant to Rule 1009A(b).[9] With the affirmative Commission approval of the proposed rule change, Phlx will have greater assurance that it will be permitted under Rule 19b-4(e) to introduce new options that are based on narrow-based stock indexes using modified capitalization weighting, but without the Exchange having to file a proposal under Section 19(b)(3)(A) of the Act.[10]

As discussed in the Exchange's original filing made pursuant to section 19(b)(3)(A) of the Act,[11] the purpose of the language adding modified capitalization weighting as a permitted weighting methodology is to increase and diversify the number and types of securities products the Exchange may offer to the investing public. The reasons for the original proposal are set forth below and serve as the basis of the Exchange's current request for Commission approval under section 19(b)(2) of the Act.[12]

Increasingly, the Exchange receives requests to trade new indexes using the modified capitalization weighting methodology. Accordingly, in order to accommodate those requests in a timely manner and respond to market demand, the Exchange seeks to permit this calculation methodology for narrow-based indexes. The Exchange wishes to accommodate these requests and proposes to add this methodology to the existing narrow based criteria set forth in Phlx Rule 1009A(b), which permits the listing of options on stock index groups pursuant to Rule 19b-4(e) under the Act.[13] Use of the modified capitalization weighted methodology (in addition to the capitalization-weighted, price-weighted, or equal dollar-weighted methodologies) should allow the Exchange greater flexibility in developing indexes and facilitate the listing of options on stock industry index groups that more accurately reflect the industry represented by the index.

When determining the value using capitalization weighting methodology, the following calculation applies: multiply the primary exchange regular-way last sale price of each component security by the number of shares outstanding, add the result for each product and divide the sum by the current index divisor. The index value for a modified capitalization-weighted index is calculated in a similar manner. However, instead of using the actual number of shares outstanding, an adjusted number of shares outstanding are used in the calculation. (Thus, the following calculation applies: multiply the primary exchange regular-way last sale price of each component security by an adjusted number of shares outstanding, add the results for each product, and then divide the sum by the current index divisor). The adjusted number of shares is determined by a proprietary algorithm. When using the modified capitalization weighting, the Exchange will use a calculation methodology that will be clearly defined and will consist of objective standards in accordance with the generic criteria set forth in Phlx Rule 1009A. In addition, the terms of the index will be defined in the marketing materials describing a new index and in the circulars that the Exchange distributes to its members upon the launch of a new index option.

The modified capitalization weighting methodology uses an adjusted number of shares outstanding to prevent component companies with a relatively high market capitalization from representing an inordinately large portion of an index's value. For example, inclusion of a company that is highly capitalized, in relation to the other smaller capitalized companies in the index, may result in the higher capitalized company's representation in the index exceeding 25% of the index's value. Thus, options on these indexes could not be listed on the Phlx. However, because use of the modified capitalization methodology permits a reduction in the higher capitalized company's representation in the index to an amount less than 25% of the index's value, the listing criteria of Phlx Rule 1009A(b)(6) are satisfied. Therefore, modifying the capitalization amounts of the securities underlying an index can prevent an individual stock from inappropriately skewing the performance of an entire index, thus market accuracy and transparency should be correspondently enhanced by use of the modified capitalization methodology. Currently, indexes such as the Nasdaq 100 [14] and Fortune e-50 [15] utilize modified capitalization weighting. Thus, it is an established calculation methodology that the Exchange seeks to capture in its listing standards.

Additionally, the Exchange will review the component weightings of indexes employing the modified capitalization weighting methodology at least semi-annually (or pursuant to then-existing standards), and if necessary, adjust them to ensure that the index continues to meet the weighting guidelines. Also, adjustments will be made on an intra-semi-annual basis, as necessary, to reflect corporate actions such as, share issuances, repurchases and other events of significance.

2. Statutory Basis

For these reasons, the Exchange believes that its proposal is consistent with section 6(b) [16] of the Act in general, and furthers the objectives of section 6(b)(5),[17] in that it is designed to promote just and equitable principles of trade, and to remove impediments to and perfect the mechanism of a free and open market and a national market system, and protect the investors and the public interest, by encouraging and adding flexibility to the development of new indexes, thereby, increasing the amount of new products available to the investing public, consistent with the purposes of option listing standards. Specifically, the Exchange seeks to list Start Printed Page 47876new index options based on this calculation methodology pursuant to Rule 1009A(b), the Exchange's generic narrow-based index option rule. The Exchange believes that it will have greater assurance that such options are eligible for listing pursuant to Rule 19b-4(e) [18] if the language regarding modified capitalization weighting as a permitted index weighting methodology is added to the text of Rule 1009A(b) pursuant to Commission approval.

B. Self-Regulatory Organization's Statement on Burden on Competition

The Exchange does not believe that the proposed rule change will impose any inappropriate burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed Rule Change Received From Members, Participants or Others

No written comments were neither solicited nor received.

III. Solicitation of Comments

Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is 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, DC 20549-0609. 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 at the Commission's Public Reference Room. Copies of such filing will also be available for inspection and copying at the principal office of the Exchange. All submissions should refer to File No. SR-PHLX -2002-42 and should be submitted by August 12, 2002.

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

After careful review, the Commission finds good cause for approving the proposed rule change prior to the thirtieth day after the date of publication of notice thereof in the Federal Register pursuant to section 19(b)(2) of the Act.[19] The proposed rule change will enable the Exchange to provide investors access to certain narrow-based index options based upon modified capitalization weighted indexes more quickly than would be possible if the Exchange were required to a file proposed rule change for each such option. Acceleration of the Commission's approval order will permit the Exchange to begin eligibility of modified capitalization weighted indexes for narrow based index option trading, with the assurance that such indexes may underlie options to which Commission Rule 19b-4(e) applies. The Commission notes that the proposed rule change is significantly similar to the rules of another self-regulatory organization already approved by the Commission pursuant to section 19(b)(2) of the Act and does not raise novel regulatory issues.[20] Accordingly, the Commission finds that there is good cause, consistent with section 6(b)(5) of the Act,[21] to approve the proposal on an accelerated basis.

Start Signature

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.[22]

Margaret H. McFarland,

Deputy Secretary.

End Signature End Preamble

Footnotes

4.  17 CFR 240.19b-4(f)(6). See Securities Exchange Act Release No. 45622 (March 21, 2002), 67 FR 15269 (March 29, 2002).

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5.  17 CFR 240.19b-4(e). See Securities Exchange Act Release No. 40761 (December 8, 1998), 63 FR 70952 (December 22, 1998).

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9.  Rule 19b-4(e) provides in relevant part that “[t]he listing and trading of a new derivative securities product by a self-regulatory organization shall not be deemed a proposed rule change * * * if the Commission has approved, pursuant to section 19(b) of the Act (15 U.S.C. 78s(b)), the self-regulatory organization's trading rules, procedures and listing standards for the product class that would include the new derivative securities product and the self-regulatory organization has a surveillance program for the product class (emphasis added).”

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12.  15 U.S.C. 78s(b)(2). To date, the Exchange has not listed and traded any modified capitalization weighted index options pursuant to Rule 1009A(b).

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14.  The Nasdaq-100®, Nasdaq-100 Index®, and Nasdaq® are trade or service marks of The Nasdaq Stock Market, Inc.

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15.  The Fortune e-50® is a trade or service mark of the American Stock Exchange LLC.

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20.  See Securities Exchange Act Release No. 41557 (June 24, 1999), 64 FR 36055 (July 2, 1999) (Order approving File No. SR-Amex-99-09 to allow modified equal-dollar and modified capitalization weighting calculation methodologies for narrow based index options on the American Stock Exchange LLC).

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[FR Doc. 02-18402 Filed 7-19-02; 8:45 am]

BILLING CODE 8010-01-P