

[Federal Register: October 4, 2006 (Volume 71, Number 192)]
[Notices]               
[Page 58656-58658]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr04oc06-103]                         

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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54514; File No. SR-OCC-2006-05]

 
Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Granting Approval of a Proposed Rule Change Relating to 
Expiration Date Exercise Procedures

September 26, 2006.

I. Introduction

    On April 6, 2006, The Options Clearing Corporation (``OCC'') filed 
with the Securities and Exchange Commission (``Commission'') proposed 
rule change SR-OCC-2006-05 pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'').\1\ Notice

[[Page 58657]]

of the proposal was published in the Federal Register on August 18, 
2006.\2\ No comment letters were received. For the reasons discussed 
below, the Commission is granting approval of the proposed rule change.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 54306, (August 11, 
2006), 71 FR 47853.
---------------------------------------------------------------------------

II. Description

    The proposed rule change will amend OCC Rule 805, Expiration Date 
Exercise Procedure, to reduce the threshold amounts used to determine 
which equity options are in the money for purposes of ``exercise by 
exception'' processing. A conforming change would also be made to OCC 
Rule 1106, Open Positions, which concerns the treatment of open 
positions following the suspension of a clearing member.
    OCC has for years maintained an ``exercise by exception'' 
procedure. Under that procedure, options that are in the money at 
expiration by more than a specified threshold amount are exercised 
automatically unless the clearing member carrying the position 
instructs OCC otherwise. Equity options are determined to be in the 
money or not in the money based on the difference between the exercise 
price and the closing price of the underlying equity interest on the 
last trading day before expiration. In September 2004, in order to 
streamline expiration processing, OCC reduced the threshold amounts 
from $.75 to $.25 for equity options in a clearing member's customers' 
account and from $.25 to $.15 for equity options in any other account 
(i.e., firm and market makers' accounts).\3\ The September 2004 change, 
which was implemented at the request of the OCC Roundtable,\4\ 
immediately yielded significant benefits to both OCC and clearing 
members as evidenced by the fact that the time for submitting exercise 
instructions was reduced by one to three hours on an average expiration 
weekend.
---------------------------------------------------------------------------

    \3\ Securities Exchange Act Release No. 50178 (August 10, 2004), 
69 FR 51343 (August 18, 2004) [File No. SR-OCC-2004-04].
    \4\ The OCC Roundtable is an OCC sponsored advisory group 
comprised of representatives from OCC's participant exchanges, OCC, 
a cross-section of OCC clearing members, and industry service 
bureaus. The OCC Roundtable considers operational improvements that 
may be made to increase efficiencies and lower costs in the options 
industry.
---------------------------------------------------------------------------

    Increasing options volumes in 2004 and 2005 prompted the OCC 
Roundtable to review the threshold amounts used for equity options in 
an effort to further reduce operational risks and improve expiration 
processing. Initially, the OCC Roundtable proposed that the threshold 
amount for all account types be set at $.01, but an OCC survey of 
clearing members found that while 65% of responding clearing members 
supported such a change, 35% were against it. A second OCC survey 
determined that 75% of responding clearing members were in favor of and 
25% were opposed to changing the threshold amount change to $.05 for 
all account types. The OCC Roundtable then requested that OCC establish 
$.05 as the threshold amount applicable to equity options exercises for 
all account types.
    In response to this request, OCC analyzed equity options exercise 
information from the June 2004 through December 2005 expirations. OCC 
analysis determined from its members that 70% of equity option 
contracts carried in clearing members' customers' accounts that were in 
the money by amounts of $.05 to $.24 (i.e., the proposed change to the 
``in-the-money'' amount represented by the proposed threshold change) 
were exercised. OCC analysis also determined from its members that 
exercise activity in other account types supported the proposed 
threshold amount change.
    OCC surveyed all clearing members to obtain their views and 
comments on the proposed change to $.05 as the threshold amount for 
equity options for all account types. Survey results demonstrated 
strong support across the membership for the change. Eighty-seven 
clearing members responded to the survey with sixty-five clearing 
members (75%) being in favor of the threshold change and 22 clearing 
members (25%) being opposed.\5\ Clearing members supporting the change 
confirmed the OCC Roundtable's view that such a change would 
significantly reduce the number of instructions clearing members are 
currently required to submit at expiration and thereby would shorten 
the time frame for completing their instructions to OCC.
---------------------------------------------------------------------------

    \5\ OCC contacted clearing members that did not respond to its 
survey. These firms expressed no opinion on the matter.
---------------------------------------------------------------------------

    OCC contacted each firm that expressed opposition to the $.05 
threshold amount change. These firms are generally midsize to small 
retail clearing members. Their opposition to the change reflected their 
principal concern that they would have to submit more ``do not 
exercise'' instructions. Some indicated concerns about the need to 
educate customers and about the possibility that commission costs could 
make an exercise unprofitable.\6\ However, all of these firms indicated 
that they could adapt to a $.05 threshold amount if it was supported by 
the majority of clearing members. OCC further reviewed the positions 
carried by these firms and determined that, on average, they generally 
carry positions in fewer than 10 expiring series per expiration that 
are below the current threshold amount of $.25. This review led OCC to 
conclude that the threshold amount change to $.05 would result in only 
a slight increase in processing time for these firms and that they 
would not be unduly burdened by its implementation.
---------------------------------------------------------------------------

    \6\ As noted, clearing members are able to instruct OCC not to 
exercise an expiring equity option.
---------------------------------------------------------------------------

    OCC's survey of clearing members also asked firms to provide an 
estimate of the time they would need to accommodate the threshold 
change based upon supplied time frames (e.g., 0-3 months or 4-6 
months). The majority of firms indicated that they could complete the 
necessary systems development and customer notifications within six 
months. OCC contacted every firm that commented on the proposed time 
frames, and all expressed the view that their efforts would be 
completed in the six month time period.
    The OCC Roundtable has recommended that this change be implemented 
for the October 2006 expiration. Therefore, OCC requests that the 
Commission approve the proposed rule change with an effective date of 
October 1, 2006, and that the Commission authorize OCC to implement the 
threshold change thereafter based upon its assessment of clearing 
member readiness. OCC would provide at least ten days advance notice to 
clearing members of the effective date for the new threshold amounts by 
information memoranda and by other forms of electronic notice such as 
e-mail. Additionally, OCC would allow clearing members additional time 
to complete preparations for the threshold change if necessary.

III. Discussion

    Section 17A(b)(3)(F) of the Act requires, among other things, that 
the rules of a clearing agency be designed to promote the prompt and 
accurate clearance and settlement of securities transactions.\7\ OCC 
Rule 805 is based on the assumption that when an option is in-the-money 
by at least a minimum fixed threshold level, most OCC members and their 
customers would choose to exercise the option. The rule has the effect, 
therefore, of reducing the number of exercise instructions that must be 
submitted to and processed by OCC. As OCC notes in its description of 
the proposed rule change, if a threshold

[[Page 58658]]

amount is set too low, the result could be that some members would have 
to submit a greater number of ``do not exercise'' instructions than 
they would have to submit if the threshold amount was set at a higher 
amount. However, the Commission is satisfied that by consulting with an 
industry advisory group, by surveying its clearing members, and by its 
analysis, OCC has made a reasoned determination in deciding to set the 
threshold amount for equity options in all account types at $.05. 
Furthermore, we note that OCC consulted with its clearing members to 
ensure that even those that did not actively support the proposed rule 
change would not be adversely affected in a significant manner by the 
new threshold amount. Accordingly, because the proposed rule change is 
designed to reduce the amount of processing required for in-the-money 
equity options, we find that it is designed to promote the prompt and 
accurate clearance and settlement of securities transactions.
---------------------------------------------------------------------------

    \7\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

IV. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act and 
in particular Section 17A of the Act and the rules and regulations 
thereunder.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-OCC-2006-05) be and hereby 
is approved.
---------------------------------------------------------------------------

    \8\ 17 CFR 200.30-3(a)(12).

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\8\
Nancy M. Morris,
Secretary.
[FR Doc. E6-16332 Filed 10-3-06; 8:45 am]

BILLING CODE 8010-01-P
