Self-Regulatory Organizations; Notice of Filing and Immediate Effectiveness of Proposed Rule Change by the Philadelphia Stock Exchange, Inc. Eliminating the Restriction on Exercise Prices for FLEX Equity Call Options to Those Prices That Apply to Standardized Equity Call Options

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”), and Rule 19b-4 thereunder, notice is hereby given that on March 15, 2000, the Philadelphia Stock Exchange, Inc. (“Phlx” or “Exchange”) filed with the Securities and Exchange Commission (“SEC” or “Commission”) 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.

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

The Phlx proposes to delete the provision in Exchange Rule 1079(a)(3) that limits exercise prices for FLEX equity call options to those that apply to standardized equity call options.

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 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 amend Phlx Rule 1079(a)(3) to eliminate the limitation of the exercise prices available for FLEX equity call options to those prices that are available for standardized equity call options. Under Phlx Rule 1079, FLEX call options allow certain terms to be customized, such as the underlying security, the type of option, the exercise price, the exercise style, and the expiration date. The Exchange, however, restricted the strike prices for FLEX equity call options to those prices that are available for standardized equity call options because of a concern that the flexible strike price feature could result in an available standardized equity call option that would not be classified as a “qualified” covered call under the Internal Revenue Code (“Code”). The Exchange represents that this would jeopardize the modest tax treatment enjoyed by writers of standardized equity call options.

Currently under Section 1092(c)(4)(B) of the Code, writers of such qualified covered short positions in equity call options receive advantageous tax treatment if the options are exchange-traded and not “deep-in-the-money.” An option is “deep-in-the-money” if the strike price of the option is lower than the lowest qualified benchmark price for stock. The Code defines this benchmark price as generally the highest strike price available for trading that is less than the current price of the underlying stock.

The Exchange implemented Phlx Rule 1079(a)(3) to remove uncertainty concerning what constitutes a qualified covered call under Section 1092(c)(4) of the Code. If the exercise prices of FLEX equity call options were not subject to the same prices and intervals that apply to standardized equity call options, this could raise the question of whether the existence of a series of FLEX equity call options with a strike price of, for example, $58 when the price of the underlying stock is $59, would disqualify a standardized equity call option with a strike price of $55, which would otherwise be the lowest qualified benchmark price, i.e., the highest strike price available for trading that is less than the price of the stock. The Exchange represents that it was concerned that the Internal Revenue Service (“IRS”) may interpret the short covered standardized call equity option with a $55 strike price as deep-in-the-money and not grant it qualified covered call treatment under Section 1092(c)(4) of the Code.

On January 25, 2000, the IRS resolved this question by issuing a final rule which states that strike prices established by the equity options with flexible terms will not be taken into account when determining whether standardized equity call options are deep-in-the-money and therefore do not receive qualified covered call treatment. Therefore, the Exchange now proposes to modify Phlx Rule 1079(a)(3)(B) to lift the restriction on exercise prices for FLEX equity call options. The Exchange represents that the effect of the IRS regulations and the Exchange's proposal is to permit certain taxpayers, particularly institutional and other large Exchange's proposal is to permit certain taxpayers, particularly institutional and other large investors, to engage in transactions in FLEX equity call options with a wider range of exercise prices (as was originally intended) without affecting the applicability of Section 1092 of the Code for qualified covered call options involving equity call options with standard terms.

2. Statutory Basis

The Exchange believes that the proposed rule change is consistent with Section 6(b)(5) of the Act in general, and furthers the objectives of Section 6(b)(6)(5) in particular, in that it is designed to facilitate transactions in securities, to remove impediments to and perfect the mechanism of a free and open market and a national market system, as well as to protect investors and the public interest by eliminating the restriction on FLEX equity call options that has limited their usefulness as a risk management tool.

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

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

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

The Exchange has neither solicited nor received comments on the proposed rule change.

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

The proposed rule change has become effective pursuant to Section 19(b)(3)(A) of the Act and Rule 19b-4(f)(6) thereunder because the foregoing proposed rule change: (1) Does not significantly affect the protection of investors or the public interest; (2) does not impose any significant burden on competition; and (3) does not become operative for 30 days after the date of filing or such shorter time as the Commission may designate if consistent with the protection of investors and the public interest; provided that the Exchange has given the Commission written notice of its intent to file the proposed rule change at least five business days prior to the filing date of the proposed rule change, or such shorter time as designated by the Commission. The Exchange has requested that the Commission accelerate the operative date of the proposed rule change so that the Exchange may implement this proposal as quickly as possible and allow FLEX options to be used as they were originally intended.

The Commission finds that it is appropriate to designate the proposal to become operative upon filing, because the immediate implementation of the proposed rule change is consistent with the protection of investors and the public interest. Specifically, the Commission previously approved virtually identical proposals by three other exchanges. The Commission notes that the proposed rule change concerns issues that have previously been the subject of a full comment period pursuant to Section 19(b) of the Act. The Commission does not believe that the proposed rule change raises any new regulatory issues.

The Commission also believes that immediate implementation of the proposed rule change is beneficial to investors. The Commission believes that the proposal allows 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 exercise prices, contact terms for exercise style (i.e., American, European, or capped), and expiration dates. However, because of the adverse tax effect on qualified covered calls, the Exchange limited FLEX equity call options exercise prices to those prices available for standardized equity call options. Now that the tax issue has been clarified, the Exchange is removing this restriction. With the removal of this limitation, the Commission believes that sophisticated, high net-worth investors will better be able to take advantage of the risk-management mechanisms provided by FLEX equity call options.

At any time within 60 days of the filing of such proposed rule change, the Commission may summarily abrogate such rule change if it appears to the Commission that such action is necessary or appropriate in the public interests, for the protection of investors or otherwise in furtherance of the purposes of the Act.

IV. 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-00-25 and should be submitted by May 8, 2000.