[Federal Register: November 4, 2009 (Volume 74, Number 212)]
[Rules and Regulations]
[Page 57062-57070]
[DOCID:fr04no09-5]

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 211

[Release No. SAB 113]

Staff Accounting Bulletin No. 113

AGENCY: Securities and Exchange Commission.

ACTION: Publication of staff accounting bulletin.

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

SUMMARY: This Staff Accounting Bulletin (SAB) revises or rescinds
portions of the interpretive guidance included in the section of the
Staff Accounting Bulletin Series titled ``Topic 12: Oil and Gas
Producing Activities'' (Topic 12) and revises a technical reference in
``Topic 3: Senior Securities'' (Topic 3). This update is intended to
make the relevant interpretive guidance consistent with

current authoritative accounting and auditing guidance and Commission
rules and regulations. The principal changes involve revision or
removal of material due to recent Commission rulemaking. Specifically,
the staff is updating the Series in order to bring existing guidance
into conformity with the contents of Financial Reporting Release No. 78
(Release No. 33-8995), Modernization of Oil and Gas Reporting, issued
December 31, 2008 (FR-78), and, in the case of the technical amendment
to SAB Topic 3, Financial Reporting Release No. 79 (Release Nos. 33-
9026; 34-59775), Technical Amendments to Rules, Forms, Schedules and
Codification of Financial Reporting Policies (FR-79), issued April 15,
2009. This SAB also updates related interpretive responses and examples
in Topic 12. The staff expects registrants to apply the updated
guidance in this SAB related to Topic 12 on a prospective basis in
conjunction with the application of FR-78 and retroactively for the
technical amendment to Topic 3 in conjunction with the effective date
of FR-79. FR-78 is effective for registration statements filed on or
after January 1, 2010, and for annual reports on Forms 10-K and 20-F
for fiscal years ending on or after December 31, 2009. FR-79 is
effective as of April 23, 2009.

DATES: Effective Date: November 4, 2009.

FOR FURTHER INFORMATION CONTACT: Jonathan W. Duersch, Assistant Chief
Accountant, Office of the Chief Accountant, at<PHONE_NUMBER>, Doug
Parker, Professional Accounting Fellow, Office of the Chief Accountant,
at<PHONE_NUMBER> or Leslie A. Overton, Associate Chief Accountant,
Division of Corporation Finance, at<PHONE_NUMBER>, Securities and
Exchange Commission, 100 F Street, NE., Washington, DC 20549.

SUPPLEMENTARY INFORMATION: The statements in staff accounting bulletins
are not rules or interpretations of the Commission, nor are they
published as bearing the Commission's official approval. They represent
interpretations and practices followed by the Division of Corporation
Finance and the Office of the Chief Accountant in administering the
disclosure requirements of the Federal securities laws.

    Dated: October 29, 2009.
Elizabeth M. Murphy,
Secretary.

PART 211--[AMENDED]

0
Accordingly, Part 211 of Title 17 of the Code of Federal Regulations is
amended by adding Staff Accounting Bulletin No. 113 to the table found
in Subpart B.

Staff Accounting Bulletin No. 113

    This staff accounting bulletin revises or rescinds portions of the
interpretive guidance in Topic 12, ``Oil and Gas Producing
Activities,'' included in the Staff Accounting Bulletin Series, in
order to make the relevant interpretive guidance consistent with
current authoritative accounting and auditing guidance and Financial
Reporting Release No. 78 (Release No. 33-8995), Modernization of Oil
and Gas Reporting, issued December 31, 2008 (2008 Oil & Gas Release).
This SAB also updates related interpretive responses and examples. This
SAB also includes an amendment to Topic 3 ``Senior Securities,'' for a
technical reference revision to conform to Financial Reporting Release
No. 79 (Release Nos. 33-9026; 34-59775), Technical Amendments to Rules,
Forms, Schedules and Codification of Financial Reporting Policies,
issued April 15, 2009.
    The following describes the changes made to the Staff Accounting
Bulletin Series that are presented at the end of this release:

Topic 3: Senior Securities

    Topic 3.C, the introductory facts are amended to replace the
reference ``Rule 5-02.28 of Regulation S-X'' with ``Rule 5-02.27 of
Regulation S-X'' to conform to paragraph numbering amendments made by
FR-79.

Topic 12: Oil and Gas Producing Activities

    a. Topic 12 is amended to update authoritative accounting
literature references to the FASB's Accounting Standards Codification
(FASB ASC) throughout.
    b. Topic 12.A.1, the introductory facts have been amended, and
questions 1, 2, and 3 are removed, leaving question 4 in place (without
a numerical designation). Questions 1 and 2 are no longer applicable to
the amended definition of ``reliable technology'' in Rule 4-10 of
Regulation S-X. Question 3 is removed to conform to Instruction 1 of
Item 1204 of Regulation S-K, which no longer addresses reserves
attributable to production from processing plant ownership as
previously included in Instruction B of Item 3 of former Industry Guide
2.
    c. Topic 12.A.2, the facts and the interpretive response to
question 1 are amended to conform to changes made by the 2008 Oil & Gas
Release by replacing the use of a year-end price when determining
reserve quantities with the use of the average price during the 12-
month period prior to the ending date of the period covered by the
balance sheet, determined as the unweighted arithmetic average of the
first-day-of-the-month market price within such period for that oil and
gas (the average price). Questions 2 and 3 are removed because the
average price is applied in all cases where contractual prices do not
exist as specified under Rule 4-10(a)(22) of Regulation S-X.
    d. Topic 12.A.3.b is removed to conform to the 2008 Oil & Gas
Release which permits the disclosure of probable and possible reserve
quantities but does not provide a basis to present estimated values
attributed to those reserve quantities.
    e. Topic 12.A.3.c, the facts are amended to remove references to
Industry Guide 2, which has been replaced by amendments to Regulation
S-K and to remove unnecessary references to Regulation S-X and
Financial Accounting Standards Board (FASB) Statement No. 69. The
interpretive response is amended to replace the term ``merger'' with
the term ``business combination'' and replace the term ``combined''
with the term ``consolidated or combined''.
    f. Topic 12.A.3.d is removed to conform to the Commission's rules
and regulations which do not require (and the Division of Corporation
Finance no longer requests) a balance sheet of the general partner to
be included in a registration statement for an offering of limited
partnership interests.
    g. Topic 12.C.1, the facts are amended to remove a reference to
FASB Statement No. 25, which is not included in the FASB ASC. In
addition, non-substantive editorial changes are made to Topic 12.C.2.
    h. Topic 12.D.1, non-substantive editorial changes are made to
question 1 and question 2 is amended to simplify the illustrative
example in the interpretive response and thereby promote a clearer
understanding of the calculation using the ``shortcut'' method for
determining the tax effects in computing the full cost ceiling
limitation and the resulting gross write-off attributed to the full
cost pool.
    i. Topic 12.D.3.b is amended to conform to changes made by the 2008
Oil & Gas Release by replacing the use of a year-end spot price when
determining reserve quantities with the use of the average price during
the 12-month period prior to the ending date of the period covered by
the balance sheet, determined as the unweighted arithmetic average of
the first-day-of-the-month market price within such period for that oil
and gas. Additionally,

the interpretive response is amended to remove unnecessary references
to guidance in FASB Statements 52 and 80, which is now provided in FASB
ASC Topic 815, Derivatives and Hedging, and to add a reference to
Financial Reporting Release No. 72 (Release Nos. 33-8350; 34-48960),
Commission Guidance Regarding Management's Discussion and Analysis of
Financial Condition and Results of Operations, which is more recent
guidance pertinent to Management's Discussion and Analysis disclosures.
    j. Topic 12.D.3.c is amended to conform to changes made by the 2008
Oil & Gas Release by removing the provision to apply a recovery of oil
and gas prices subsequent to period-end, when assessing whether a
write-off computed under the full cost ceiling limitation should be
recognized. As stated in the 2008 Oil & Gas Release, this guidance is
no longer necessary because use of the average price would effectively
eliminate anomalies caused by the single-day period-end price.
    k. Topic 12.D.4, Footnote 1 is removed to eliminate unnecessary
references specifically related to the adoption of FASB Statement 143,
which is now referenced to FASB ASC Subtopic 410-20, Asset Retirement
and Environmental Obligations--Asset Retirement Obligations. Footnotes
previously numbered 2, 3 and 4 are renumbered 1, 2 and 3, respectively.
    l. Topic 12.D.4.a, question 1 and the facts and interpretive
response related to question 1 are amended and question 2 is removed to
eliminate unnecessary references and guidance specifically related to
the adoption of FASB Statement 143.
    m. Topic 12.D.4.b, the facts, question and interpretive response
are amended to eliminate unnecessary references and guidance
specifically related to the adoption of FASB Statement 143.
    n. Topic 12.D.4.c is removed to eliminate unnecessary transition
guidance specifically related to the adoption of FASB Statement 143.
    o. Topic 12.F, Footnote 4 is added to reference the definition of
current prices used in Rule 4-10(c) of Regulation S-X, which was
amended to conform to the 2008 Oil & Gas Release. As amended, Rule 4-
10(c)(8) of Regulation S-X defines current price as the average price
during the 12-month period prior to the ending date of the period
covered by the report, determined as an unweighted arithmetic average
of the first-day-of-the-month price for each month within such period,
unless prices are defined by contractual arrangements, excluding
escalations based upon future conditions.
    p. Topic 12.G and Footnotes 5 and 6 are removed to conform to
changes made by the 2008 Oil & Gas Release. This conforming change
reflects the fact that, under amended Rule 4-10(a)(16) the definition
of ``oil and gas producing activities'' includes the extraction of
natural gas from coal beds.

    Note:  The text of SAB 113 will not appear in the Code of
Federal Regulations.

* * * * *

TOPIC 3: SENIOR SECURITIES

* * * * *

C. Redeemable Preferred Stock

    Facts: Rule 5-02.27 of Regulation S-X states that redeemable
preferred stocks are not to be included in amounts reported as
stockholders' equity, and that their redemption amounts are to be shown
on the face of the balance sheet. However, the Commission's rules and
regulations do not address the carrying amount at which redeemable
preferred stock should be reported, or how changes in its carrying
amount should be treated in calculations of earnings per share and the
ratio of earnings to combined fixed charges and preferred stock
dividends.
* * * * *

TOPIC 12: OIL AND GAS PRODUCING ACTIVITIES

A. Accounting Series Release 257--Requirements for Financial Accounting
and Reporting Practices for Oil and Gas Producing Activities

1. Estimates of Reserve Quantities
    Facts: Rule 4-10 of Regulation S-X contains definitions of possible
reserves, probable reserves, and proved and developed oil and gas
reserves to be used in determining quantities of oil and gas reserves
to be reported in filings with the Commission.
    Question: What pressure base should be used for reporting gas and
production, 14.73 psia or the pressure base specified by the state?
    Interpretive Response: The reporting instructions to the Department
of Energy's Form EIA-28 specify that natural gas reserves are to be
reported at 14.73 psia and 60 degrees F. There is no pressure base
specified in Regulation S-X or S-K. At the present time staff will not
object to natural gas reserves and production data calculated at other
pressure bases, if such pressure bases are identified in the filing.
2. Estimates of Future Net Revenues
    Facts: U.S. GAAP requires the disclosure of the standardized
measure of discounted future net cash flows from production of proved
oil and gas reserves.
    Question: For purposes of determining reserves and estimated future
net revenues, what price should be used for oil and gas which will be
produced after an existing contract expires or after the
redetermination date in a contract?
    Interpretive Response: The price to be used for oil and gas which
will be produced after a contract expires or has a redetermination is
the average price during the 12-month period prior to the ending date
of the period covered by the balance sheet, determined as an unweighted
arithmetic average of the first-day-of-the-month price for each month
within such period for that oil and gas. This average price, which
should be based on the first-day-of-the-month market prices, may be
increased thereafter only for additional fixed and determinable
escalations, as appropriate. A fixed and determinable escalation is one
which is specified in amount and is not based on future events such as
rates of inflation.
3. Disclosure of Reserve Information
a. Removed by SAB 103
b. Removed by SAB 113
c. Limited Partnership 10-K Reports
    Facts: Item 1201(a) of Regulation S-K contains an exemption from
the requirements to disclose certain information relating to oil and
gas operations for ``limited partnerships or joint ventures that
conduct, operate, manage, or report upon oil and gas drilling income
programs that acquire properties either for drilling and production, or
for production of oil, gas, or geothermal steam. * * *
    Limited partnership agreements often contain buy-out provisions
under which the general partner agrees to purchase limited partnership
interests that are offered for sale, based upon a specified valuation
formula. Because of these arrangements, the requirements for disclosure
of reserve value information may be of little significance to the
limited partners.
    Question: Must the financial statements of limited partnerships
included in reports on Form 10-K contain the disclosures of estimated
future net revenues, present values and changes therein, and
supplemental summary of oil and gas activities specified in paragraphs
23 through 36 of FASB Accounting Standards Codification (FASB ASC)
Section 932-235-50, Extractive Activities--Oil and Gas--Notes to
Financial Statements--Disclosure?

    Interpretive Response: The staff will not take exception to the
omission of these disclosures in a limited partnership Form 10-K if
reserve value information is available to the limited partners pursuant
to the partnership agreement (even though the valuations may be
computed differently and may be as of a date other than year end).
However, the staff will require all of the information listed in
paragraphs 23 through 36 of FASB ASC Section 932-235-50 for
partnerships which are the subject of a business combination or
exchange offer under which various limited partnerships are to be
consolidated or combined into a single entity.
d. Removed by SAB 113
e. Rate Regulated Companies
    Question: If a company has cost-of-service oil and gas producing
properties, how should they be treated in the supplemental disclosures
of reserve quantities and related future net revenues provided pursuant
to paragraphs 29 through 36 of FASB ASC Section 932-235-50, Extractive
Activities--Oil and Gas--Notes to Financial Statements--Disclosure?
    Interpretive Response: Rule 4-10 provides that registrants may give
effect to differences arising from the ratemaking process for cost-of-
service oil and gas properties. Accordingly, in these circumstances,
the staff believes that the company's supplemental reserve quantity
disclosures should indicate separately the quantities associated with
properties subject to cost-of-service ratemaking, and that it is
appropriate to exclude those quantities from the future net revenue
disclosures. The company should also disclose the nature and impact of
its cost-of-service ratemaking, including the unamortized cost included
in the balance sheet.
4. Removed by SAB 103

B. Removed by SAB 103

C. Methods of Accounting by Oil and Gas Producers

1. First-Time Registrants
    Facts: In ASR 300, the Commission announced that it would allow
registrants to change methods of accounting for oil and gas producing
activities so long as such changes were in accordance with GAAP.
Accordingly, the Commission stated that changes from the full cost
method to the successful efforts method would not require a
preferability letter. Changes to full cost, however, would require
justification by the company making the change and filing of a
preferability letter from the company's independent accountants.
    Question: How does this policy apply to a nonpublic company which
changes its accounting method in connection with a forthcoming public
offering or initial registration under either the 1933 Act or 1934 Act?
    Interpretive Response: The Commission's policy that first-time
registrants may change their previous accounting methods without filing
a preferability letter is applicable. Therefore, such a company may
change to the full cost method without filing a preferability letter.
2. Consistent Use of Accounting Methods Within a Consolidated Entity
    Facts: Rule 4-10(c) of Regulation S-X states in part that ``[a]
reporting entity that follows the full cost method shall apply that
method to all of its operations and to the operations of its
subsidiaries * * *''
    Question 1: May a subsidiary of the parent use the full cost method
if the parent company uses the successful efforts method of accounting
for oil and gas producing activities?
    Interpretive Response: No. The use of different methods of
accounting in the consolidated financial statements by a parent company
and its subsidiary would be inconsistent with the full cost requirement
that a parent and its subsidiaries all use the same method of
accounting.
    The staff's general policy is that an enterprise should account for
all its like operations in the same manner. However, Rule 4-10 of
Regulation S-X provides that oil and gas companies with cost-of-service
oil and gas properties may give effect to any differences resulting
from the ratemaking process, including regulatory requirements that a
certain accounting method be used for the cost-of-service properties.
    Question 2: Must the method of accounting (full cost or successful
efforts) followed by a registrant for its oil and gas producing
activities also be followed by any fifty percent or less owned
companies in which the registrant carries its investment on the equity
method (equity investees)?
    Interpretive Response: No. Conformity of accounting methods between
a registrant and its equity investees, although desirable, may not be
practicable and thus is not required. However, if a registrant
proportionately consolidates its equity investees, it will be necessary
to present them all on the same basis of accounting.

D. Application of Full Cost Method of Accounting

1. Treatment of Income Tax Effects in the Computation of the Limitation
on Capitalized Costs
    Facts: Item (D) in Rule 4-10(c)(4)(i) of Regulation S-X provides
that the income tax effects related to the properties involved should
be deducted in computing the full cost ceiling.
    Question 1: What specific types of income tax effects should be
considered in computing the income tax effects to be deducted from
estimated future net revenues?
    Interpretive Response: The rule refers to income tax effects
generally. Thus, the computation should take into account (i) the tax
basis of oil and gas properties, (ii) net operating loss carryforwards,
(iii) foreign tax credit carryforwards, (iv) investment tax credits,
(v) alternative minimum taxes on tax preference items, and (vi) the
impact of statutory (percentage) depletion.
    It may often be difficult to allocate a net operating loss (NOL)
carryforward between oil and gas assets and other assets. However, to
the extent that the NOL is clearly attributable to oil and gas
operations and is expected to be realized within the carryforward
period, it should be added to tax basis.
    Similarly, to the extent that investment tax credit (ITC)
carryforwards and foreign tax credit carryforwards are attributable to
oil and gas operations and are expected to be realized within the
carryforward period, they should be considered as a deduction from the
tax effect otherwise computed. Consideration of NOL and ITC or foreign
tax credit carryforwards should not, of course, reduce the total tax
effect below zero.
    Question 2: How should the tax effect be computed considering the
various factors discussed above?
    Interpretive Response: Theoretically, taxable income and tax could
be determined on a year-by-year basis and the present value of the
related tax computed. However, the ``shortcut'' method illustrated
below is also acceptable.

ASSUMPTIONS:
    Cost of proved properties being amortized................  ...............        $396,000   ...............
    Lower of cost or estimated fair value of unproved          ...............          49,000   ...............
     properties to be amortized..............................

    Cost of properties not being amortized...................  ...............          55,000   ...............
                                                                               -----------------
    Capitalized costs of oil and gas assets..................  ...............         500,000   ...............
    Accumulated DD&A.........................................  ...............        (100,000)  ...............
                                                                               -----------------
        Book basis of oil and gas assets.....................  ...............  ...............        $400,000
    Excess of book basis over tax basis ($270,000) of oil and  ...............       $(130,000)  ...............
     gas assets..............................................
    NOL carryforward*........................................  ...............          20,000   ...............
                                                                               -----------------
                                                               ...............        (110,000)  ...............
                                                                               -----------------
    Statutory tax rate (percent).............................  ...............           x 46%   ...............
                                                                               -----------------
                                                               ...............         (50,600)  ...............
    Foreign tax credit carryforward*.........................  ...............           1,000   ...............
    ITC carryforward*........................................  ...............           2,000   ...............
                                                                               -----------------
    Related net deferred income tax liability................  ...............  ...............         (47,600)
                                                                                ----------------
        Net book basis to be recovered.......................  ...............  ...............        $352,400
                                                                                ----------------
Other Assumptions:
    Present value of ITC relating to future development costs  ...............          $1,500   ...............
    Present value of statutory depletion attributable to       ...............         $10,000   ...............
     future deductions.......................................
    Estimated preference (minimum) tax on percentage           ...............            $500   ...............
     depletion in excess of cost depletion...................
    Present value of future net revenue from proved oil and    ...............        $272,000   ...............
     gas reserves............................................
CALCULATION:
    Present value of future net revenue......................  ...............        $272,000   ...............
    Cost of properties not being amortized...................  ...............          55,000   ...............
    Lower of cost or estimated fair value of unproved          ...............          49,000   ...............
     properties included in costs being amortized............
                                                                               -----------------
        Total ceiling limitation before tax effects..........  ...............  ...............        $376,000
Tax Effects:
    Total ceiling limitation before tax effects..............  ...............        $376,000   ...............
    Less: Tax basis of properties............................       $(270,000)  ...............  ...............
        Statutory depletion..................................         (10,000)  ...............  ...............
                                                              -----------------
        NOL carryforward.....................................         (20,000)  ...............  ...............
                                                              -----------------
                                                               ...............        (300,000)  ...............
                                                                               -----------------
    Future taxable income....................................  ...............          76,000   ...............
    Tax rate (percent).......................................  ...............           x 46%   ...............
                                                                               -----------------
    Tax at statutory rate....................................  ...............         (34,960)  ...............
    ITC (future development costs and carryforward)..........  ...............           3,500   ...............
    Foreign tax credit carryforward..........................  ...............           1,000   ...............
    Estimated preference tax.................................  ...............            (500)  ...............
                                                                               -----------------
        Net tax effects......................................  ...............  ...............         (30,960)
                                                                                ----------------
        Cost Center Ceiling..................................  ...............  ...............        $345,040
    Less: Net book basis to be recovered.....................  ...............  ...............         352,400
                                                                                ----------------
    REQUIRED WRITE-OFF, net of tax**.........................  ...............  ...............         $(7,360)

*All carryforward amounts in this example represent amounts which are available for tax purposes and which
  relate to oil and gas operations.
**For accounting purposes, the gross write-off should be recorded to adjust both the oil and gas properties
  account and the related deferred income taxes.

CALCULATION OF GROSS PRE-TAX WRITE-OFF:
    Required write-off, net of tax.............................  ..............  ..............         $(7,360)
                                                                                ----------------
    Divided by (100% minus the statutory rate of 46%)..........  ..............  ..............             54%
                                                                                ----------------
        Gross pre-tax write-off................................  ..............  ..............        $(13,630)
                                                                                ----------------
                    Related Journal Entries                            DR              CR        ...............
Full cost ceiling impairment...................................         $13,630  ..............  ...............
Oil and gas assets.............................................  ..............         $13,630  ...............
Deferred income tax liability..................................          $6,270  ..............  ...............
Deferred income tax benefit....................................  ..............          $6,270  ...............

2. Exclusion of Costs From Amortization
    Facts: Rule 4-10(c)(3)(ii) indicates that the costs of acquiring
and evaluating unproved properties may be excluded from capitalized
costs to be amortized if the costs are unusually significant in
relation to aggregate costs to be amortized. Costs of major development
projects may also be incurred prior to ascertaining the quantities of
proved reserves attributable to such properties.
    Question: At what point should amortization of previously excluded
costs commence--when proved reserves have been established or when
those reserves become marketable? For instance, a determination of
proved reserves may be made before completion of an extraction plant
necessary to process sour crude or a pipeline necessary to market the
reserves. May the costs continue to be excluded from amortization until
the plant or pipeline is in service?
    Interpretive Response: No. The proved reserves and the costs
allocable to such reserves should be transferred into the amortization
base on an ongoing (well-by-well or property-by-property) basis as the
project is evaluated and proved reserves are established.
    Once the determination of proved reserves has been made, there is
no justification for continued exclusion from the full cost pool,
regardless of whether other factors prevent immediate marketing.
Moreover, at the same time that the costs are transferred into the
amortization base, it is also necessary in accordance with FASB ASC
Subtopic 932-835, Extractive Activities--Oil and Gas--Interest and FASB
ASC Subtopic 835-20, Interest--Capitalization of Interest, to terminate
capitalization of interest on such properties.
    In this regard, registrants are reminded of their responsibilities
not to delay recognizing reserves as proved once they have met the
engineering standards.
3. Full Cost Ceiling Limitation
a. Exemptions for Purchased Properties
    Facts: During 20x1, a registrant purchases proved oil and gas
reserves in place (``the purchased reserves'') in an arm's-length
transaction for the sum of $9.8 million. Primarily because the
registrant expects oil and gas prices to escalate, it paid $1.2 million
more for the purchased reserves than the ``Present Value of Estimated
Future Net Revenues'' computed as defined in Rule 4-10(c)(4)(i)(A) of
Regulation S-X. An analysis of the registrant's full cost center in
which the purchased reserves are located at December 31, 20x1 is as
follows:

                                             [Amounts in thousands]
----------------------------------------------------------------------------------------------------------------
                                                                     Purchased     Other proved      Unproved
                                                       Total         reserves       properties      properties
----------------------------------------------------------------------------------------------------------------
Present value of estimated future net revenues..         $14,100           8,600           5,500  ..............
Cost, net of amortization.......................          16,300           9,800           5,500           1,000
Related deferred taxes..........................           2,300  ..............           2,000             300
Income tax effects related to properties........           2,500  ..............           2,500  ..............
----------------------------------------------------------------------------------------------------------------
Comparison of capitalized costs with limitation                      Including       Excluding    ..............
 on capitalized costs at December 31, 20x1:                          purchased       purchased
                                                                     reserves        reserves
----------------------------------------------------------------------------------------------------------------
Capitalized costs, net of amortization..........  ..............         $16,300          $6,500  ..............
Related deferred taxes..........................  ..............         (2,300)         (2,300)  ..............
¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤¤
Net book cost...................................  ..............          14,000           4,200  ..............
-------------------------------------------------
Lower of cost or market of unproved properties..  ..............           1,000           1,000  ..............
                                                                 --------------------------------
Income tax effects related to properties........  ..............         (2,500)         (2,500)  ..............
                                                                 --------------------------------
Limitation on capitalized costs.................  ..............          12,600           4,000  ..............
Excess of capitalized costs over limitation on    ..............           1,400             200  ..............
 capitalized costs, net of tax*.................
----------------------------------------------------------------------------------------------------------------
* For accounting purposes, the gross write-off should be recorded to adjust both the oil and gas properties
  account and the related deferred income taxes.

    Question: Is it necessary for the registrant to write down the
carrying value of its full cost center at December 31, 20x1 by
$1,400,000?
    Interpretive Response: Although the net carrying value of the full
cost center exceeds the cost center's limitation on capitalized costs,
the text of ASR 258 provides that a registrant may request an exemption
from the rule if as a result of a major purchase of proved properties,
a write down would be required even though the registrant believes the
fair value of the properties in a cost center clearly exceeds the
unamortized costs.
    Therefore, to the extent that the excess carrying value relates to
the purchased reserves, the registrant may seek a temporary waiver of
the full-cost ceiling limitation from the staff of the Commission.
Registrants requesting a waiver should be prepared to demonstrate that
the additional value exists beyond reasonable doubt.
    To the extent that the excess costs relate to properties other than
the purchased reserves, however, a write-off should be recorded in the
current period. In order to determine the portion of the total excess
carrying value which is attributable to properties other than the
purchased reserves, it is necessary to perform the ceiling computation
on a ``with and without'' basis as shown in the example above. Thus in
this case, the registrant must record a write-down of $200,000
applicable to other reserves. An additional $1,200,000 write-down would
be necessary unless a waiver was obtained.
b. Use of Cash Flow Hedges in the Computation of the Limitation on
Capitalized Costs
    Facts: Rule 4-10(c)(4) of Regulation S-X provides, in pertinent
part, that

capitalized costs, net of accumulated depreciation and amortization,
and deferred income taxes, should not exceed an amount equal to the sum
of components that include the present value of estimated future net
revenues computed by applying current prices of oil and gas reserves
(with consideration of price changes only to the extent provided by
contractual arrangements) to estimated future production of proved oil
and gas reserves as of the date of the latest balance sheet presented.
    As of the reported balance sheet date, capitalized costs of an oil
and gas producing company exceed the full cost limitation calculated
under the above-described rule based on current prices, as defined in
Rule 4-10(c)(8) of Regulation S-X, for oil and natural gas. However,
prior to the balance sheet date, the company entered into certain
hedging arrangements for a portion of its future natural gas and oil
production, thereby enabling the company to receive future cash flows
that are higher or lower than the estimated future cash flows indicated
by use of the average price during the 12-month period prior to the
balance sheet date, determined as an unweighted arithmetic average of
the first-day-of-the-month price for each month within such period.
These arrangements qualify as cash flow hedges under the provisions of
FASB ASC Topic 815, Derivatives and Hedging, and are documented,
designated, and accounted for as such under the criteria of that
standard.
    Question: Under these circumstances, must the company use the
higher or lower prices to be received after taking into account the
hedging arrangements (``hedge-adjusted prices'') in calculating the
estimated cash flows from future production of oil and gas reserves
covered by the hedges as of the reported balance sheet date?
    Interpretive Response: Yes. Derivative contracts that qualify as a
hedging instrument in a cash flow hedge and are accounted for as such
pursuant to FASB ASC Topic 815 represent the type of contractual
arrangements for which consideration of price changes should be given
under the existing rule. While the SEC staff has objected to previous
proposals to consider various hedging techniques as being equivalent to
the contractual arrangements permitted under the existing rules, the
staff's objection was based on concerns that the lack of clear,
consistent guidance in the accounting literature would lead to
inconsistent application in practice. However, the staff believes that
FASB ASC Topic 815 and related guidance (including a more systematic
approach to documentation) provides sufficient guidance so that
comparable financial reporting in comparable factual circumstances
should result.
    This interpretive response reflects the SEC staff's view that,
assuming compliance with the prerequisite accounting requirements,
hedge-adjusted prices represent the best measure of estimated cash
flows from future production of the affected oil and gas reserves to
use in calculating the ceiling limitation. Nonetheless, the staff
expects that oil and gas producing companies subject to the full cost
rules will clearly indicate the effects of using cash flow hedges in
calculating ceiling limitations within their financial statement
footnotes. The staff further expects that disclosures will indicate the
portion of future oil and gas production being hedged. The dollar
amount that would have been charged to income had the effects of the
cash flow hedges not been considered in calculating the ceiling
limitation also should be disclosed.
    The use of hedge-adjusted prices should be consistently applied in
all reporting periods, including periods in which the hedge-adjusted
price is more or less than the average price during the 12-month period
prior to the balance sheet date, determined as an unweighted arithmetic
average of the first-day-of-the-month price for each month within such
period. Oil and gas producers whose computation of the ceiling
limitation includes hedge-adjusted prices because of the use of cash
flow hedges also should consider the disclosure requirements under FASB
ASC Section 275-10-50, Risks and Uncertainties--Overall-Disclosure.
Paragraph 9 of FASB ASC Section 275-10-50 calls for disclosure when it
is at least reasonably possible that the effects of cash flow hedges on
capitalized costs on the reported balance sheet date will change in the
near term due to one or more confirming events, such as potential
future changes in commodity prices.
    In addition, the use of cash flow hedges in calculating the ceiling
limitation may represent a type of critical accounting policy that oil
and gas producers should consider disclosing consistent with the
cautionary advice provided in Financial Reporting Release No. 60
(Release Nos. 33-8040; 34-45149), Cautionary Advice Regarding
Disclosure about Critical Accounting Policies (December 12, 2001), and
Financial Reporting Release No. 72 (Release Nos. 33-8350; 34-48960),
Commission Guidance Regarding Management's Discussion and Analysis of
Financial Condition and Results of Operations (December 29, 2003).
Through these releases, the Commission has encouraged companies to
include, within their MD&A disclosures, full explanations, in plain
English, of the judgments and uncertainties affecting the application
of critical accounting policies, and the likelihood that materially
different amounts would be reported under different conditions or using
different assumptions.
    The staff's guidance on this issue would apply to calculations of
ceiling limitations both in interim and annual reporting periods.

c. Effect of Subsequent Events on the Computation of the Limitation on
Capitalized Costs

    Facts: Rule 4-10(c)(4)(ii) of Regulation S-X provides that an
excess of unamortized capitalized costs within a cost center over the
related cost ceiling shall be charged to expense in the period the
excess occurs.
    Question: Assume that at the date of the company's fiscal year-end,
its capitalized costs of oil and gas producing properties exceed the
limitation prescribed by Rule 4-10(c)(4) of Regulation S-X. Thus, a
write-down is indicated. Subsequent to year-end but before the date of
the auditor's report on the company's financial statements, assume that
additional reserves are proved up (excluding the effect of increased
oil and gas prices subsequent to year-end) on properties owned at year-
end. The present value of future net revenues from the additional
reserves is sufficiently large that if the full cost ceiling limitation
were recomputed giving effect to those factors as of year-end, the
ceiling would more than cover the costs. Is it necessary to record a
write-down?
    Interpretive Response: No. In this case, the proving up of
additional reserves on properties owned at year-end indicates that the
capitalized costs were not in fact impaired at year-end. However, for
purposes of the revised computation of the ``ceiling,'' the net book
costs capitalized as of year-end should be increased by the amount of
any additional costs incurred subsequent to year-end to prove the
additional reserves or by any related costs previously excluded from
amortization.
    While the fact pattern described herein relates to annual periods,
the guidance on the effects of subsequent events applies equally to
interim period calculations of the ceiling limitation.
    The registrant's financial statements should disclose that
capitalized costs exceeded the limitation thereon at year-

end and should explain why the excess was not charged against earnings.
In addition, the registrant's supplemental disclosures of estimated
proved reserve quantities and related future net revenues and costs
should not give effect to the reserves proved up or the cost incurred
after year-end. However, such quantities may be disclosed separately,
with appropriate explanations.
    Registrants should be aware that oil and gas reserves related to
properties acquired after year-end would not justify avoiding a write-
off indicated as of year-end. Similarly, the effects of cash flow
hedging arrangements entered into after year-end cannot be factored
into the calculation of the ceiling limitation at year-end. Such
acquisitions and financial arrangements do not confirm situations
existing at year-end.
4. Interaction of FASB ASC Subtopic 410-20 Asset Retirement and
Environmental Obligations--Asset Retirement Obligations--and the Full
Cost Rules
    a. Impact of FASB ASC Subtopic 410-20 on the Full Cost Ceiling Test
    Facts: A company following the full cost method of accounting under
Rule 4-10(c) of Regulation S-X must periodically calculate a limitation
on capitalized costs, i.e., the full cost ceiling. Under FASB ASC
Subtopic 410-20, Asset Retirement and Environmental Obligations--Asset
Retirement Obligations, a company must recognize a liability for an
asset retirement obligation (ARO) at fair value in the period in which
the obligation is incurred, if a reasonable estimate of fair value can
be made. The company also must initially capitalize the associated
asset retirement costs by increasing long-lived oil and gas assets by
the same amount as the liability. Any asset retirement costs
capitalized pursuant to FASB ASC Subtopic 410-20 are subject to the
full cost ceiling limitation under Rule 4-10(c)(4) of Regulation S-X.
If a company were to calculate the full cost ceiling by reducing
expected future net revenues by the cash flows required to settle the
ARO, then the effect would be to ``double-count'' such costs in the
ceiling test. The assets that must be recovered would be increased
while the future net revenues available to recover the assets continue
to be reduced by the amount of the ARO settlement cash flows.
    Question: How should a company compute the full cost ceiling to
avoid double-counting the expected future cash outflows associated with
asset retirement costs?
    Interpretive Response: The future cash outflows associated with
settling AROs that have been accrued on the balance sheet should be
excluded from the computation of the present value of estimated future
net revenues for purposes of the full cost ceiling
calculation.1 2
---------------------------------------------------------------------------

    \1\ If an obligation for expected asset retirement costs has not
been accrued under FASB ASC Subtopic 410-20 for certain asset
retirement costs required to be included in the full cost ceiling
calculation under Rule 4-10(c)(4) of Regulation S-X, such costs
should continue to be included in the full cost ceiling calculation.
    \2\ This approach is consistent with the guidance in FASB ASC
Subtopic 410-20 on testing for impairment under FASB ASC Section
360-10-35 Property, Plant, and Equipment--Overall--Subsequent
Measurement. Under that guidance, the asset tested should include
capitalized asset retirement costs. The estimated cash flows related
to the associated ARO that has been recognized in the financial
statements are to be excluded from both the undiscounted cash flows
used to test for recoverability and the discounted cash flows used
to measure the asset's fair value.
---------------------------------------------------------------------------

    b. Impact of FASB ASC Subtopic 410-20 on the Calculation of
Depreciation, Depletion, and Amortization
    Facts: Regarding the base for depreciation, depletion, and
amortization (DD&A) of proved reserves, Rule 4-10(c)(3)(i) of
Regulation S-X states that ``[c]osts to be amortized shall include (A)
all capitalized costs, less accumulated amortization, other than the
cost of properties described in paragraph (ii) below; \3\ (B) the
estimated future expenditures (based on current costs) to be incurred
in developing proved reserves; and (C) estimated dismantlement and
abandonment costs, net of estimated salvage values.'' FASB ASC Subtopic
410-20 requires that upon initial recognition of an ARO, the associated
asset retirement costs be included in the capitalized costs of the
company. Therefore, the estimated dismantlement and abandonment costs
described in (C) above may be included in the capitalized costs
described in (A) above, at least to the extent that an ARO has been
incurred as a result of acquisition, exploration and development
activities to date. Future development activities on proved reserves
may result in additional asset retirement obligations when such
activities are performed and the associated asset retirement costs will
be capitalized at that time.
---------------------------------------------------------------------------

    \3\ The reference to ``cost of properties described in paragraph
(ii) below'' relates to the costs of investments in unproved
properties and major development projects, as defined.
---------------------------------------------------------------------------

    Question: Should the costs to be amortized under Rule 4-10(c)(3) of
Regulation S-X include an amount for estimated dismantlement and
abandonment costs, net of estimated salvage values, that are expected
to result from future development activities?
    Interpretive Response: Yes. Companies should estimate the amount of
dismantlement and abandonment costs that will be incurred as a result
of future development activities on proved reserves and include those
amounts in the costs to be amortized.
c. Removed by SAB 113

E. Financial Statements of Royalty Trusts

    Facts: Several oil and gas exploration and production companies
have created ``royalty trusts.'' Typically, the creating company
conveys a net profits interest in certain of its oil and gas properties
to the newly created trust and then distributes units in the trust to
its shareholders. The trust is a passive entity which is prohibited
from entering into or engaging in any business or commercial activity
of any kind and from acquiring any oil and gas lease, royalty or other
mineral interest. The function of the trust is to serve as an agent to
distribute the income from the net profits interest. The amount to be
periodically distributed to the unitholders is defined in the trust
agreement and is typically determined based on the cash received from
the net profits interest less expenses of the trustee. Royalty trusts
have typically reported their earnings on the basis of cash
distributions to unitholders. The net profits interest paid to the
trust for any month is based on production from a preceding month;
therefore, the method of accounting followed by the trust for the net
profits interest income is different from the creating company's method
of accounting for the related revenue.
    Question: Will the staff accept a statement of distributable income
which reflects the amounts to be distributed for the period in question
under the terms of the trust agreement in lieu of a statement of income
prepared under GAAP?
    Interpretive Response: Yes. Although financial statements filed
with the Commission are normally required to be prepared in accordance
with GAAP, the Commission's rules provide that other presentations may
be acceptable in unusual situations. Since the operations of a royalty
trust are limited to the distribution of income from the net profits
interests contributed to it, the staff believes that the item of
primary importance to the reader of the financial statements of the
royalty trust is the amount of the cash distributions to the
unitholders for the period reported. Should there be any change in the

nature of the trust's operations due to revisions in the tax laws or
other factors, the staff's interpretation would be reexamined.
    A note to the financial statements should disclose the method used
in determining distributable income and should also describe how
distributable income as reported differs from income determined on the
basis of GAAP.

F. Gross Revenue Method of Amortizing Capitalized Costs

    Facts: Rule 4-10(c)(3)(iii) of Regulation S-X states in part:
``Amortization shall be computed on the basis of physical units, with
oil and gas converted to a common unit of measure on the basis of their
approximate relative energy content, unless economic circumstances
(related to the effects of regulated prices) indicate that use of units
of revenue is a more appropriate basis of computing amortization. In
the latter case, amortization shall be computed on the basis of current
gross revenues (excluding royalty payments and net profits
disbursements) from production in relation to future gross revenues
based on current prices (including consideration of changes in existing
prices provided only by contractual arrangements), from estimated
production of proved oil and gas reserves.'' \4\
---------------------------------------------------------------------------

    \4\ Rule 4-10(c)(8) of Regulation S-X defines current price as
the average price during the 12-month period prior to the ending
date of the period covered by the report, determined as an
unweighted arithmetic average of the first-day-of-the-month price
for each month within such period, unless prices are defined by
contractual arrangements, excluding escalations based upon future
conditions.
---------------------------------------------------------------------------

    Question: May entities using the full cost method of accounting for
oil and gas producing activities compute amortization based on the
gross revenue method described in the above rule when substantial
production is not subject to pricing regulation?
    Interpretive Response: Yes. Under the existing rules for cost
amortization adopted in ASR 258, the use of the gross revenue method of
amortization was permitted in those circumstances where, because of the
effect of existing pricing regulations, the use of the units of
production method would result in an amortization provision that would
be inconsistent with the current sales prices being received. While the
effect of regulation on gas prices has lessened, factors other than
price regulation (such as changes in typical contract lengths and
methods of marketing natural gas) have caused oil and gas prices to be
disproportionate to their relative energy content. The staff therefore
believes that it may be more appropriate for registrants to compute
amortization based on the gross revenue method whenever oil and gas
sales prices are disproportionate to their relative energy content to
the extent that the use of the units of production method would result
in an improper matching of the costs of oil and gas production against
the related revenue received. The method should be consistently applied
and appropriately disclosed within the financial statements.

G. Removed by SAB 113

[FR Doc. E9-26525 Filed 11-3-09; 8:45 am]

BILLING CODE 8011-01-P


[Federal Register: April 4, 2008 (Volume 73, Number 66)]
[Notices]
[Page 18589-18592]
[DOCID:fr04ap08-117]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-57583; File No. SR-Phlx-2008-23]

Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.;
Notice of Filing and Immediate Effectiveness of Proposed Rule Change as
Modified by Amendment No. 1 Thereto To Amend the Quarterly Options
Series Pilot Program To Permit the Listing of Additional Series

March 31, 2008.
    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 March 27, 2008, the Philadelphia Stock Exchange, Inc. (``Exchange''
or ``Phlx'') filed with the Securities and Exchange Commission
(``Commission'') the proposed rule change as described in Items I and
II below, which Items have been substantially prepared by the Exchange.
On March 28, 2008, the Exchange submitted Amendment No. 1 to the
proposed rule change. The Exchange has designated this proposal as non-
controversial under section 19(b)(3)(A)(iii) of the Act \3\ and Rule
19b-4(f)(6) thereunder,\4\ which renders the proposed rule change
effective upon filing with the Commission. The Commission is publishing
this notice to solicit comments on the proposed rule change, as
amended, from interested persons.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ 15 U.S.C. 78s(b)(3)(A)(iii).
    \4\ 17 CFR 240.19b-4(f)(6).
---------------------------------------------------------------------------

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

    The Exchange proposes to amend Phlx Rule 1012, Series of Options
Open for Trading, to expand the number of series of exchange traded
fund (``ETF'') options that may be listed pursuant to Phlx's Quarterly
Option Series (``QOS'') pilot program (the ``Pilot Program'') \5\ and
to establish a delisting program in connection with the Pilot
Program.\6\
---------------------------------------------------------------------------

    \5\ Phlx's Pilot Program was established in 2007 and
subsequently extended through July 10, 2008. See Securities Exchange
Act Release Nos. 55301 (February 15, 2007), 72 FR 8238 (February 23,
2007) (SR-Phlx-2007-08) (``Pilot Program Release'') and 56030 (July
9, 2007), 72 FR 38645 (July 13, 2007) (SR-Phlx-2007-42). The
American Stock Exchange, the Chicago Board Options Exchange
(``CBOE''), the International Stock Exchange, and NYSEArca (the
``pilot program exchanges'') have similar pilot programs that
likewise continue through July 10, 2008.
    \6\ The Phlx proposal is substantially identical to a proposal
by CBOE. See Securities Exchange Act Release No. 57410 (March 3,
2008), 73 FR 12483 (March 7, 2008) (SR-CBOE-2007-96). See also
Securities Exchange Act Release No. 57425 (March 4, 2008), 73 FR
12783 (March 10, 2008) (SR-ISE-2008-19) (notice of filing and
immediate effectiveness of a similar proposed rule change by the
International Securities Exchange).
---------------------------------------------------------------------------

    The text of the proposed rule change is available on the Exchange's
Web site (http://www.phlx.com), at the Exchange's principal office, and
at the Commission's Public Reference Room.

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 purpose of the proposed rule change is to amend the Exchange's
Rule 1012, Series of Options Open for Trading, to permit the Exchange
to list strike prices for QOS in ETF options that fall within a
percentage range (30%) above and below the price of the underlying ETF.
The proposed rule change will allow the Exchange, upon demonstrated
customer interest, to open additional strike prices of QOS in ETF
options that are more than 30% above or below the current price of the
underlying ETF. The proposal will permit the Exchange to list up to
sixty (60) additional series per expiration month for each QOS in ETF
options. Additionally, the proposal will establish a delisting program
for delisting QOS within certain parameters.
    The Pilot Program in Phlx Rule 1012 allows the Exchange to list and
trade QOS on ETFs that satisfy the applicable listing criteria under
Phlx rules.\7\ Under the Pilot Program, the Exchange may list QOS in up
to five currently listed option classes that are either options on ETFs
or indexes. The Exchange is also permitted to list QOS in any options
class that is selected by the other pilot program exchanges. QOS trade
based on calendar quarters that end in March, June, September and
December. The

Exchange lists QOS that expire at the end of the next consecutive four
calendar quarters, as well as the fourth quarter of the next calendar
year. For example, if the Exchange were trading QOS in iShares Russell
2000 Index Fund (``IWM'') in the month of April 2008, it would list
series that expire at the end of the second quarter 2008 (June), third
quarter 2008 (September), fourth quarter 2008 (December), first quarter
2009 (March), and fourth quarter 2009 (December).
---------------------------------------------------------------------------

    \7\ Phlx Rule 1101A establishes the Pilot Program for index
options.
---------------------------------------------------------------------------

    Phlx now lists QOS in five ETF options: (1) Nasdaq-100 Index
Tracking Stock (``QQQQ''); (2) IWM; (3) DIAMONDS Trust, Series 1
(``DIA''); (4) Standard and Poor's Depositary Receipts/SPDRs (``SPY'');
and (5) Energy Select SPDR (``XLE'').\8\ The average trading volume and
total volume for QOS in IWM options, QQQQ options, and SPY options
exceed the volume for QOS in the other ETF options (DIA and XLE) that
are listed and traded on the Exchange. The chart below provides trading
volume figures for the fourth quarter in 2007, demonstrating that, in
all but the month of November, QOS in IWM, along with QOS in QQQQ and
SPY, were some of the more popular and heavily traded QOS on the
Exchange.
---------------------------------------------------------------------------

    \8\ These are the same options that are listed by the other
pilot program exchanges.

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                   October 2007                    November 2007                   December 2007
                           QOS                           -----------------------------------------------------------------------------------------------
                                                                ADV          Total Vol          ADV          Total Vol          ADV          Total Vol
--------------------------------------------------------------------------------------------------------------------------------------------------------
IWM.....................................................           2,090          48,066           3,998          83,952           9,325         177,172
QQQQ....................................................           3,900          89,692           8,043         168,904          15,859         301,320
SPY.....................................................           3,919          90,134           4,697          98,646           5,064          96,210
DIA.....................................................             412           9,478             669          14,042           1,816          34,496
XLE.....................................................             653          15,008           8,967         188,316           3,357          63,776
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Over time, some of the pilot program exchanges have received
requests from market participants to add additional strike prices for
QOS in IWM options that would be outside of the price range for setting
strikes as provided for under Rule 5.5(e)(3) (hereinafter ``+/-$5
range'').\9\ Moreover, investors and other market participants have
advised such exchanges that they are buying and selling QOS in IWM
options to trade volatility. In order to adequately replicate the
desired volatility exposure, these market participants need to trade
several IWM option series, many having strike prices that fall outside
of the +/-$5 range currently allowed under the QOS rules.
---------------------------------------------------------------------------

    \9\ Commentary .08(d) to Phlx Rule 1012 provides that the
Exchange shall list strike prices for a QOS that are within $5 from
the closing price of the underlying on the preceding day.
---------------------------------------------------------------------------

    Market participants have also advised pilot program exchanges that
their investment strategies involve trading options tied to a
particular option ``delta,''\10\ rather than a particular level of the
underlying security or index. At issue is the fact that delta depends
on both the relative difference between the level of the underlying
security or index and the option strike price and time to expiration.
For example, with IWM trading at $85 per share, the strike price
corresponding to a ``25-delta'' IWM call (i.e., a call option with a
delta of 25) with one month to expiration would be 89. However, the
strike price corresponding to a ``25-delta'' IWM call with 3 months to
expiration would be 93, and the strike price of a ``25-delta'' call
with 1 year to expiration would be 106. In short, the +/-$5 range for
QOS in IWM options is insufficient to satisfy customer demand.
---------------------------------------------------------------------------

    \10\ ``Delta'' is a measure of how an option price will change
in response to a $1 price change in the underlying security or
index. For example, an ABC option with a delta of ``50'' can be
expected to change by $0.50 in response to a $1 change in the price
of ABC.
---------------------------------------------------------------------------

    In order to meet such customer demand, the Exchange proposes to
amend Commentary .08 to Phlx Rule 1012, which governs the Quarterly
Option Series Pilot Program. Specifically, the Exchange proposes to
revise Commentary .08 to allow the Exchange to open additional strike
prices of QOS in ETF options that are within thirty percent (30%) above
or below the closing price of the underlying on the preceding business
day. The Exchange also will be permitted to open additional strike
prices of QOS in ETF options that are more than 30% above or below the
current price of the underlying ETF, provided that demonstrated
customer interest exists for such series, as expressed by
institutional, corporate, or individual customers or their brokers.
Market-Makers trading for their own account will not be considered when
determining customer interest under this proposed provision. The
Exchange will be permitted to list up to sixty (60) additional series
per expiration month for each QOS in ETF options.
    The Exchange also is proposing to add new paragraph (g) to
Commentary .08 to Phlx Rule 1012, which will set forth a delisting
policy. Specifically, with respect to QOS in ETF options, the Exchange
will, on a monthly basis, review series that are outside a range of
five strikes above and five strikes below the current price of the
underlying ETF, and delist series with no open interest in both the put
and the call series having a strike price that is: (i) Higher than the
highest strike price with open interest in the put and/or call series
for a given expiration month; or (ii) lower than the lowest strike
price with open interest in the put and/or call series for a given
expiration month.
    To illustrate how the proposed delisting program will work, assume
that IWM closed at $70 on the day the Exchange conducts the monthly
review of QOS in ETF options. Series having strike prices above $75 and
below $65 would be reviewed by the Exchange for possible delisting.
Assume that the Exchange lists the following QOS in IWM options that
expire in June 2008:

------------------------------------------------------------------------
         Calls--June 08 Exp                    Puts--June 08 Exp
------------------------------------------------------------------------
     Strike         Open  Interest?        Strike       Open  Interest?
------------------------------------------------------------------------
       62                 No                 62                No
       63                 No                 63               Yes
       64                 Yes                64               Yes
        *                  *                 *                 *
       76                 Yes                76               Yes
       77                 Yes                77               Yes
       78                 Yes                78               Yes
       79                 Yes                79               Yes
       80                 Yes                80               Yes
       81                 Yes                81               Yes
       82                 Yes                82               Yes
       83                 No                 83                No
       84                 No                 84                No
       85                 No                 85               Yes
       86                 Yes                86                No
       87                 Yes                87               Yes
       88                 Yes                88               Yes
       89                 Yes                89                No
       90                 Yes                90                No
       91                 No                 91                No
       92                 No                 92                No
       93                 No                 93                No
------------------------------------------------------------------------

    The Exchange would delist the first series listed above, as well as
the last three: $62, $91, $92, and $93. The Exchange would not delist
the $83 and $84 series because there are series having open interest
with strike prices higher than these two series. In addition, the
Exchange would not delist the $63 call series because there is open
interest in the $63 put series.
    Notwithstanding the proposed delisting policy, customer requests to
add strikes and/or maintain strikes in QOS in ETF options in series
eligible for delisting shall be granted.
    Further, in connection with the proposed delisting policy, if the
Exchange identifies series for delisting, the Exchange shall notify
other options exchanges with similar delisting policies regarding
eligible series for listing, and shall work with such other exchanges
to develop a uniform list of series to be delisted, so as to ensure
uniform series delisting of multiply listed QOS in ETF options. The
Exchange expects that the proposed delisting policy for QOS in ETF
options would be adopted by other options exchanges that have adopted
the QOS Pilot Program.
    The Exchange represents that it has the necessary systems capacity
to support new options series that will result from this proposal.
Further, as proposed, the Exchange notes that this rule change would
become part of the Pilot Program and, going forward, would be
considered by the Commission when the Exchange seeks to renew or make
permanent the Pilot Program in the future.\11\
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    \11\ To the extent the Commission views the proposed rule change
as an expansion of the Pilot Program, thus triggering the
requirement under the terms of the Pilot Program Approval Order that
the Exchange submit a Pilot Program report, the Exchange notes that
it submitted a report on or about June 26, 2007, in connection with
its filing to extend the Pilot Program through July 10, 2008. See
Securities Exchange Act Release No. 56030 (July 9, 2007), 72 FR
38645 (July 13, 2007) (SR-Phlx-2007-42).
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2. Statutory Basis
    The Exchange believes that because the additional new series can be
added without presenting capacity problems and because the Exchange has
proposed a delisting policy with respect to QOS in ETF options, the
rule proposal is consistent with section 6(b) of the Act \12\ in
general, and furthers the objectives of section 6(b)(5) of the Act \13\
in particular, in that it is designed 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 to protect
investors and the public interest.
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    \12\ 15 U.S.C. 78f(b).
    \13\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

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

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

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

    The Exchange has designated the proposed rule change as one that:
(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 from the
date of filing, or such shorter time as the Commission may designate if
consistent with the protection of investors and the public interest.
Therefore, the foregoing rule change has become effective pursuant to
section 19(b)(3)(A) of the Act \14\ and subparagraph (f)(6) of Rule
19b-4 thereunder.\15\ The Exchange has asked the Commission to waive
the 30-day operative delay to permit the Exchange to immediately
compete with the other options exchanges that have similarly amended
their quarterly options series pilot programs.
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    \14\ 15 U.S.C. 78s(b)(3)(A).
    \15\ 17 CFR 240.19b-4(f)(6). In addition, Rule 19b-4(f)(6)(iii)
requires a self-regulatory organization to provide the Commission
with written notice of its intent to file the proposed rule change,
along with a brief description and text of the proposed rule change,
at least five business days prior to the date of filing of the
proposed rule change, or such shorter time as designated by the
Commission. The Exchange has fulfilled this requirement.
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    The Commission notes that this proposal is substantially similar to
a proposed rule change submitted by CBOE, which was approved by the
Commission following publication for notice and comment, and does not
raise any new regulatory issues.\16\ Waiving the 30-day operative delay
will promote, without undue delay, further competition in the options
market.\17\ For these reasons, the Commission believes that waiving the
30-day operative delay is consistent with the protection of investors
and the public interest and designates the proposal operative upon
filing.
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    \16\ See Securities Exchange Act Release No. 57410, supra note
6. See also Securities Exchange Act Release No. 57425, supra note 6.
    \17\ For purposes only of waiving the 30-day operative delay,
the Commission has considered the proposed rule's impact on
efficiency, competition, and capital formation. See 15 U.S.C.
78c(f).
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    The Commission notes that this rule change will become part of the
Pilot Program and, going forward, its effects will be considered by the
Commission in the event that the Exchange seeks to renew or make
permanent the Pilot Program.\18\ Thus, in the Exchange's future reports
on the Pilot Program, the Exchange should include analysis of (1) the
impact of the additional series on the Exchange's market and quote
capacity, and (2) the implementation and effects of the delisting
policy, including the number of series eligible for delisting during
the period covered by the report, the number of series actually
delisted during that period (pursuant to the delisting policy or
otherwise), and documentation of any customer requests to maintain QOS
strikes that were otherwise eligible for delisting.
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    \18\ As set forth in the Pilot Program Release, if the Exchange
were to propose an extension, expansion, or permanent approval of
the Pilot Program, the Exchange must submit, along with any filing
proposing such amendments to the program, a report that provides an
analysis of the Pilot Program covering the entire period during
which the Pilot Program was in effect. See Pilot Program Release,
supra note 5. The Pilot Program Release requires the Exchange to
include in its report, at a minimum: (1) Data and written analysis
on the open interest and trading volume in the classes for which QOS
were opened; (2) an assessment of the appropriateness of the option
classes selected for the Pilot Program; (3) an assessment of the
impact of the Pilot Program on the capacity of the Exchange, OPRA,
and market data vendors (to the extent data from market data vendors
is available); (4) any capacity problems or other problems that
arose during the operation of the Pilot Program and how the Exchange
addressed such problems; (5) any complaints that the Exchange
received during the operation of the Pilot Program and how the
Exchange addressed them; and (6) any additional information that
would assist in assessing the operation of the Pilot Program.
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    At any time within 60 days of the filing of the proposed rule
change, the Commission may summarily abrogate the rule change if it
appears to the Commission that such action is necessary or appropriate
in the public interest, for the protection of investors, or otherwise
in furtherance of the purposes of the Act.\19\
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    \19\ For purposes of calculating the 60-day period within which
the Commission may summarily abrogate the proposed rule change, the
Commission considers the period to commence on March 28, 2007, the
date on which the Exchange filed Amendment No. 1.
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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.
Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to<EMAIL_ADDRESS>Please include
File No. SR-Phlx-2008-23 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number SR-Phlx-2008-23. This file
number should be included on the subject line if e-mail is used. To
help the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's Internet Web site (http://www.sec.gov/rules/
sro.shtml). 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 Room, 100 F Street, NE.,
Washington, DC 20549, on official business days between the hours of 10
a.m. and 3 p.m. Copies of such filing also will be available for
inspection and copying at the principal office of the Exchange. All
comments received will be posted without change; the Commission does
not edit personal identifying information from submissions. You should
submit only information that you wish to make available publicly. All
submissions should refer to File Number SR-Phlx-2008-23 and should be
submitted on or before April 25, 2008.

    For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\20\
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    \20\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E8-6961 Filed 4-3-08; 8:45 am]

BILLING CODE 8011-01-P