[Federal Register Volume 59, Number 14 (Friday, January 21, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-1430]


[[Page Unknown]]

[Federal Register: January 21, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33468; File No. SR-NYSE-93-39]

 

Self-Regulatory Organizations; Order Approving and Notice of 
Filing and Order Granting Accelerated Approval of Amendment No. 1 to a 
Proposed Rule Change by the New York Stock Exchange, Inc., Relating to 
the Listing and Trading of Equity Linked Debt Securities

January 13, 1994.

I. Introduction

    On October 22, 1993, the New York Stock Exchange, Inc. (``NYSE'' or 
``Exchange''), pursuant to section 19(b)(1) of the Securities Exchange 
Act of 1934 (``Act'')\1\ and rule 19b-4 thereunder,\2\ filed with the 
Securities and Exchange Commission (``SEC'' or ``Commission'') a 
proposed rule change to list and trade Equity Linked Debt Securities 
(``ELDS''), hybrid instruments whose value will be linked to the 
performance of a highly capitalized, actively traded common stock or 
other individual equity security. Notice of the proposal appeared in 
the Federal Register on November 8, 1993.\3\ No comment letters were 
received on the proposed rule change. On December 23, 1993, the NYSE 
filed Amendment No. 1 to the proposed rule change.\4\ This order 
approves the proposal.
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    \1\15 U.S.C. 78s(b)(1) (1988).
    \2\17 CFR 240.19b-4 (1992).
    \3\See Securities Exchange Act Release No. 33118 (October 29, 
1993), 58 FR 59285.
    \4\In Amendment No. 1, the NYSE proposes to require (1) that the 
user of the security underlying the ELDS will be a U.S. reporting 
company under the Act; (2) that ELDS will be intermediate-term 
securities (i.e., 2-7 years); and (3) that the linked security will 
be limited to either common stock or non-convertible preferred 
stock. See Letter from James Buck, Senior Vice President and 
Secretary, NYSE, to Richard Zack, Branch Chief, Office of 
Derivatives Regulation, Division of Market Regulation, Commission, 
dated December 23, 1993 (``Amendment No. 1'').
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    Under section 703 of the Exchange's Listed Company Manual 
(``Manual''), the NYSE may approve for listing securities which can not 
be readily categorized under the listing criteria for common and 
preferred stocks, bonds, debentures, and warrants. The NYSE is now 
proposing to (1) amend Section 703 to provide additional criteria 
governing the listing of ELDS, which are intermediate-term (i.e., 2-7 
years), non-convertible hybrid instruments whose value will be linked 
to the performance of a highly-capitalized, actively traded common 
stock or convertible preferred stock; and (2) adopt Paragraph 904.07 of 
the Manual, to provide a form of membership circular describing ELDS. 
The Commission has previously approved listing and trading rules for 
similar products: (1) Generic rules for Equity Linked Notes (``ELNs'') 
listed on the American Stock Exchange, Inc. (``Amex'');\5\ and (2) 
product specific rules for Debt Exchangeable for Common Stock 
(``DECS'') listed on the exchange.\6\
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    \5\See Securities Exchange Act Release No. 32343 (May 20, 1993), 
58 FR 30833 (``Exchange Act Release No. 32343'').
    \6\DECS are hybrid instruments, issued by American Express 
Corporation, paying fixed quarterly interest payments, with 
principal appreciation linked to the common stock of First Data 
Corporation. See Securities Exchange Act Release No. 32950 
(September 23, 1993), 58 FR 50985.
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    As with ELNs, an issuer of ELDS may provide for periodic interest 
payments to holders, whether based on a fixed or floating rate.\7\ 
Furthermore, as with ELNs, a particular issuance of ELDS may also be 
subject to a ``cap'' on the maximum principal amount to be repaid to 
holders upon maturity of the ELDS, and, additionally, may feature a 
``floor'' on the minimum principal amount to be repaid to holders upon 
maturity of the ELDS. The Exchange believes that the listing 
flexibility available to an issuer of ELDS will permit the creation of 
securities which will offer investors the opportunity to more precisely 
focus on a specific investment strategy.
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    \7\The Exchange agrees to notify the Commission if an issuer of 
ELDS provides for periodic interest payments to holders based on a 
floating rate. See Amendment No. 1, supra note based on a floating 
rate. See Amendment No. 1, supra note 4.
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    ELDS will conform to the listing guidelines under Section 703.19 of 
the Manual, which provide that issues must have (1) a minimum public 
float of one million trading units; (2) a minimum of 400 unit holders; 
(3) a minimum life of one year; and (4) an aggregate market value of at 
least $4 million.\8\ Additionally, ELDS will be treated as equity 
instruments for, among other purposes, margin requirements.\9\
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    \8\The hybrid listing standards in section 703.18 of the Manual 
are intended to accommodate listed companies in good standing, their 
subsidiaries and affiliates, and non-listed equities which meet the 
Exchange's original listing standards.
    \9\Telephone conversation between Vincent Patten, Assistant Vice 
president of New Products, NYSE, and Brad Ritter, Attorney, Office 
of Derivatives Regulation, Division of Market Regulation, 
Commission, on January 6, 1994.
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    An issuer of a series of ELDS must also satisfy certain of the 
Exchange's listing criteria. If the issuer is an NYSE-listed company, 
the issuer must be a company in good standing (i.e., above the 
Exchange's continued listing criteria);\10\ if the issuer is an 
affiliate of an NYSE-listed company, the NYSE-listed company must be in 
good standing; and if otherwise, the issuer must satisfy the Exchange's 
initial listing criteria.\11\ Additionally, the issuer must have a 
minimum tangible net worth of $150 million. Finally, the original issue 
price of a series of ELDS, when combined with all of the issuer's other 
ELDS listed on a national securities exchange or otherwise publicly 
traded in the United States, may not be greater than 25% of the 
issuer's net worth at the time of issuance.
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    \10\The continued listing criteria for capital or common stock 
requires that: (1) The number of holders of 100 shares or more is 
equal to or greater than 1,200; (2) the number of publicly-held 
shares is equal to or greater than 600,000; (3) the aggregate market 
value of publicly-held shares is equal to or greater than $5 
million; (4) the aggregate market value of shares outstanding 
(excluding treasury stock) is equal to or greater than $8 million 
and average net income after taxes for the past three years is equal 
to or greater than $600,000; and (5) net tangible assets available 
to common stock are equal to or greater than $8 million and average 
net income after taxes for the past three years is equal to or 
greater than $600,000. See section 802 of the manual.
    \11\Specifically, the minimum original listing criteria requires 
that issuers have: (1) At least 2,000 holders holding 100 shares or 
more or have at least 2,200 holders with a minimum average monthly 
trading volume of 100,000 shares (for the most recent 6-month 
period); (2) a public float of at least 1.1 million shares; (3) an 
aggregate market value of publicly-held shares of at least $18 
million or total net tangible assets of at least $18 million; and 
(4) earnings before taxes of at least $2.5 million in the latest 
fiscal year and earnings before taxes of $2 million in each of the 
preceding two fiscal years, or earnings before taxes of $6.5 million 
in the aggregate for the last three fiscal years with a $4.5 million 
minimum in the most recent fiscal year (all three years are required 
to be profitable). See sections 102.01-102.03 and 103.01-103.05 of 
the Manual. The Exchange will evaluate Sovereign issuers on a case-
by-case basis.
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    Although the Exchange does not believe that ELDS will have any 
discernible impact on the trading market for the underlying linked 
stock, it nevertheless proposes that each equity security on which the 
value of the ELDS is based must (1) have a market capitalization of at 
least $3 billion; (2) have a trading volume of at least 2.5 million 
shares in the one-year period preceding the listing of the ELDS; (3) be 
issued by a U.S. reporting company under the Act which is listed on a 
national securities exchange or traded through the facilities of a 
national securities system;\12\ and (4) be subject to last sale 
reporting. Additionally, under only very limited circumstances, the 
issuance of ELDS relating to any underlying equity security may not 
exceed five percent of the total outstanding shares of such underlying 
equity security.\13\
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    \12\This requirement precludes the issuance of ELDS overlying 
American Depositary Receipts (``ADRs''), whether sponsored or 
unsponsored, and the need for surveillance sharing agreements 
between the relevant foreign and domestic exchanges. The Commission, 
however, would be willing to reexamine this issue at a later date if 
justified by the subsequent trading experience in ELDS and if 
sufficient safeguards were in place to ensure pricing integrity in 
both the ELDS and the underlying linked ADR.
    \13\The only exceptions to this restriction are where either (1) 
the issuer of the ELDS and the issuer of the underlying security are 
affiliated; or (2) the issuer of the ELDS holds an amount of the 
underlying security at least equal to the amount of the underlying 
security represented by the ELDS. In either case, the maximum 
percentage of ELDS that may be issued will be evaluated by the 
Exchange on a case-by-case basis in consultation with the staff of 
the Commission.
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    Because ELDS are linked to another security, the Exchange has 
proposed safeguards that are designed to meet the investor protection 
concerns raised by the trading of ELDS. First, pursuant to NYSE rule 
405, the Exchange will impose a duty of due diligence on its members 
and member firms to learn the essential facts relating to every 
customer prior to trading ELDS. Second, consistent with NYSE rule 405, 
the Exchange will further require that a member or member firm 
specifically approve a customer's account for trading ELDS prior to, or 
promptly after, the completion of the transaction. Third, in accordance 
with the proposed amendment to adopt Paragraph 904.07 of the Manual, 
the Exchange will distribute a circular to its membership providing 
guidance regarding member firm compliance responsibilities (including 
suitability recommendations and account approval) when handling 
transactions in ELDS.\14\
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    \14\The Commission notes that the ELDS are subject to the equity 
margin rules of the Exchange.
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    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities exchange, and, in 
particular, the requirements of section 6(b)(5).\15\ Specifically, the 
Commission believes that providing for the exchange-trading of ELDS 
will offer a new and innovative means of participating in the 
securities markets. In particular, the Commission believes that the 
availability of ELDS will permit investors to more closely approximate 
their desired investment objectives through, for example, shifting some 
of the opportunity for upside gain in return for additional income.\16\ 
Accordingly, for these reasons, as well as the reasons stated in the 
Commission's ELNs approval order,\17\ the Commission finds that the 
NYSE standards for the listing and trading of ELDS are consistent with 
the Act and that the listing and trading of ELDS is in the public 
interest.
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    \15\15 U.S.C. 78f(b)(5) (1988).
    \16\Pursuant to section 6(b)(5) of the Act the Commission must 
predicate approval of exchange trading for new products upon a 
finding that the introduction of the product is in the public 
interest. Such a finding would be difficult with respect to a 
product that served no investment, hedging, or other economic 
function, because any benefits that might be derived by market 
participants would likely be outweighed by the potential for 
manipulation, diminished public confidence in the integrity of the 
markets, and other valid regulatory concerns.
    \17\See Exchange Act Release No. 32343, supra note 5.
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    As with ELNs, ELDS are not leveraged instruments, however, their 
price will still be derived and based upon the underlying linked 
security. Accordingly, the level of risk involved in the purchase or 
sale of an ELDS is similar to the risk involved in the purchase or sale 
of traditional common stock. Nonetheless, in considering the Amex's 
proposal to list and trade ELNs, the Commission had several specific 
concerns with this type of product (i.e., (1) Investor protection 
concerns, (2) dependence on the credit of the issuer of the instrument, 
(3) systemic concerns regarding position exposure of issuers with 
partially hedged positions or dynamically hedged positions, and (4) the 
impact on the market for the underlying linked security).\18\ The 
Commission concluded, however that the Amex proposal adequately 
addressed each of these issues such that the Commission's regulatory 
concerns were adequately minimized.\19\ Similarly, in this proposal, 
the NYSE has proposed safeguards which the Commission finds to be 
equivalent to those approved for the trading of ELNs. Finally the 
proposal was published for the full 21-day comment period and no 
comments were received by the Commission. As a result, the Commission 
finds that the proposed rule change is consistent with the requirements 
of the Act and the rules and regulations thereunder applicable to a 
national securities exchange, and, in particular, the requirements of 
section 6(b)(5).\20\
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    \18\Id.
    \19\Id.
    \20\15 U.S.C. Sec. 78f(b)(5) (1988).
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    The Commission finds good cause for approving Amendment No. 1 to 
the proposed rule change prior to the thirtieth day after the date of 
publication of notice thereof in the Federal Register. The Commission 
finds that Amendment No. 1 more closely conforms the Exchange's 
proposal to the proposal already approved by the Commission with 
respect to the listing and trading of ELNs on the Amex.\21\ 
Specifically, Amendment No. 1 provides for additional listing standards 
that are specifically tailored to ELDS. The Commission believes that 
these additional listing standards strengthen the integrity of the 
security and will promote stability in the marketplace. Additionally, 
the Commission has not received any comments on this proposal. 
Therefore, the Commission believes it is consistent with sections 
6(b)(5)\22\ and 19(b)(2)\23\ of the Act to approve Amendment No. 1 to 
the proposal on an accelerated basis.
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    \21\See Exchange Act Release No. 32343, supra note 5.
    \22\15 U.S.C. Sec. 78f(b)(5) (1988).
    \23\15 U.S.C. Sec. 78s(b)(2) (1988).
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    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 1 to the proposed rule change. 
Persons making written submissions should file six copies thereof with 
the Secretary, Securities and Exchange Commission, 450 Fifth Street, 
NW., Washington, DC 20549. 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 Section, 450 Fifth Street, NW., Washington, DC. Copies of 
such filing will also be available for inspection and copying at the 
principal office of the NYSE. All submissions should refer to File No. 
SR-NYSE-93-39 and should be submitted by February 11, 1994.
    It is therefore ordered, Pursuant to section 19(b)(2) of the 
Act,\24\ that the proposed rule change (File No. SR-NYSE-93-39) is 
approved.
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    \24\15 U.S.C. 78s(b)(2) (1988).

    For the Commission, by the Division of Market Regulation, 
Pursuant to delegated authority.\25\
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    \25\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-1430 Filed 1-19-94; 4:15 pm]
BILLING CODE 8010-01-M