[Federal Register Volume 59, Number 180 (Monday, September 19, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-23049]


[[Page Unknown]]

[Federal Register: September 19, 1994]


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

SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34655; File No. SR-NYSE-94-28]

 

Self-Regulatory Organizations; Order Approving and Notice of 
Filing and Order Granting Accelerated Approval of Amendment No. 1 to 
the Proposed Rule Change by the New York Stock Exchange, Inc. Relating 
to Real Estate Investment Trusts Market Index Target-Term Securities

September 12, 1994.

I. Introduction

    On July 15, 1994, 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 Market Index Target-Term 
Securities (``MITTS''),\3\ the return on which is based upon a 
portfolio of securities (``REIT Portfolio'') of U.S. real estate 
investment trusts (``REITs''). Notice of the proposal appeared in the 
Federal Register on August 11, 1994.\4\ The Exchange filed Amendment 
No. 1 to the proposed rule change on August 25, 1994.\5\ No comment 
letters were received on the proposed rule change. This order approves 
the proposal, as amended.
---------------------------------------------------------------------------

    \1\15 U.S.C. 78s(b)(1) (1988).
    \2\17 CFR 240.19b-4 (1992).
    \3\``MITTS'' is a registered service mark and ``Market Index 
Target-Term Securities'' is a service mark of Merrill Lynch & Co., 
Inc. (``Merrill Lynch'').
    \4\See Securities Exchange Act Release No. 34492 (August 5, 
1994), 59 FR 60227 (August 11, 1994).
    \5\In Amendment No. 1, the Exchange proposes to: (1) Provide 
that dividends paid on a component security will be included in 
calculating both the daily values of the REIT Portfolio and the 
Total Return Portfolio Value (as defined herein), regardless of any 
subsequent corporate event (such as insolvency) that would effect 
the value of the common stock of that component REIT; and (2) amend 
the formula for determining the weightings of the portfolio 
components in the Original Portfolio Value (as defined herein) to 
provide that no component may represent more than 10 percent of the 
Original Portfolio Value. See Letter from James Buck, Senior Vice 
President and Secretary, NYSE, to Sharon Lawson, Assistant Director, 
Office of Market Supervision, Division of Market Regulation, 
Commission, dated August 25, 1994 (``Amendment No. 1'').
---------------------------------------------------------------------------

II. Description of the Proposal

    Under Section 703.19 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.\6\ The NYSE is now 
proposing under Section 703.19 of the Manual to list for trading MITTS 
based on the REIT Portfolio (``REIT Portfolio MITTS'').\7\
---------------------------------------------------------------------------

    \6\See Securities Exchange Act Release Nos. 29229 (May 23, 
1991), 56 FR 24852 (May 31, 1991); and 28217 (July 18, 1990), 55 FR 
30056 (July 24, 1990'') (``Hybrid Approval Orders'').
    \7\The Commission has previously approved the listing and 
trading on the Exchange of a MITTS based upon a global portfolio of 
securities representing telecommunications companies and one based 
on a portfolio of securities representing European companies. See 
Securities Exchange Act Release Nos. 32840 (September 2, 1993), 58 
FR 47485 (September 9, 1993), and 33368 (December 22, 1993), 58 FR 
68975 (December 29, 1993)) (collectively, ``MITTS Approval 
Orders'').
---------------------------------------------------------------------------

    As with other MITTS products, the REIT Portfolio MITTS will conform 
to the listing guidelines under Section 703.19 of the Manual, which 
provides that: (1) Issues must have a minimum public distribution of 
one million securities; (2) a minimum of 400 shareholders; (3) a 
minimum duration of one year; (4) a market value of at least $4 
million; and (5) otherwise comply with the NYSE's initial listing 
criteria.\8\ In addition, the Exchange will monitor the REIT Portfolio 
MITTS to verify compliance with the Exchange's continued listing 
criteria.\9\ MITTS are non-callable senior hybrid debt securities of 
Merrill Lynch that provide for a single payment at maturity, and will 
bear no periodic payments of interest. At maturity, holders of REIT 
Portfolio MITTS will be entitled to receive an amount in cash based 
upon the ``Total Return Portfolio Value;'' provided, however, that the 
amount payable at maturity will not be less than $9 for each $10 
principal amount of the REIT Portfolio MITTS. The ``Total Return 
Portfolio Value'' will be an amount based upon the change in the 
``Original Portfolio Value'' and the value of the REIT Portfolio at 
maturity, plus the aggregate dollar amount of dividends paid on the 
components of the REIT Portfolio during the term of the REIT Portfolio 
MITTS. The ``Original Portfolio Value'' will equal $10, i.e., the value 
of the REIT Portfolio on the date the REIT Portfolio MITTS are priced 
by the issuer for initial offering to the public. The value of the REIT 
Portfolio at maturity will be based on the average of the closing 
prices of the components of the REIT Portfolio for a specified number 
of days immediately prior to the maturity date of the REIT Portfolio 
MITTS.\10\ REIT Portfolio MITTS are cash-settled in that they do not 
give the holder any right to receive a portfolio security or any other 
ownership right or interest in the portfolio securities, although the 
return on the investment is based, in part, on the aggregate portfolio 
value of the REIT Portfolio securities.
---------------------------------------------------------------------------

    \8\The hybrid listing standards in Section 703.19 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. Domestic issuers must also 
meet the earnings and net tangible assets criteria set forth in 
Sections 102.01 and 102.02 of the Manual. Specifically, the minimum 
original listing criteria requires that issuers have: (1) 2,000 
holders holding 100 shares or more or have 2,200 holders with an 
average monthly trading volume of 100,000 shares; (2) a public float 
of 1.1 million shares; (3) an aggregate public market value of $18 
million or total net tangible assets of $18 million; and (4) 
earnings before taxes of $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).
    \9\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. In addition, the continued listing standards 
for bonds require that outstanding publicly-held bonds have an 
aggregate market value or principal amount equal to or greater than 
$1 million. See Section 802 of the Manual.
    \10\In particular, the Total Return Portfolio Value will be 
based on the average closing prices of the REIT Portfolio component 
securities for the first 45 NYSE trading days of the ``Calculation 
Period.'' The Calculation Period is defined as the period from and 
including the 90th scheduled NYSE trading day prior to the maturity 
date to and including the fourth scheduled NYSE trading date prior 
to the maturity date.
---------------------------------------------------------------------------

    According to the NYSE, REIT Portfolio MITTS will allow investors to 
combine the protection of a portion of the principal amount of the 
MITTS with potential additional payments based upon the performance of 
a portfolio of securities representing 20 highly capitalized REITs. In 
particular, the proposed REIT Portfolio MITTS will provide 90% 
principal protection of the original issue price at maturity with the 
opportunity to participate in the dividend stream related to the REIT 
Portfolio components plus any upside appreciation of the underlying 
REIT Portfolio. REIT Portfolio MITTS will mature in August 2000.
    As of June 6, 1994, the REIT Portfolio consisted of the common 
stock of 20 REITs that have significantly different levels of market 
capitalization, ranging from a high of approximately $2.3 billion 
(Simon Property Group, Inc.) to a low of approximately $216 million 
(Excel Realty Trust, Inc.). Also as of June 6, 1994, the exchange 
market prices of the components of the REIT Portfolio ranged from a 
high of $40.25 to a low of $11.25. The average daily trading volume for 
the components of the REIT Portfolio for the period from January 16, 
1994, through July 14, 1994, ranged from a high of approximately 
145,318 shares to a low of approximately 22,030 shares.
    The common stocks of 19 of the 20 component REITs are listed on the 
Exchange and the common stock of the other component REIT is traded on 
the American Stock Exchange (``Amex''). The initial weightings of the 
components of the REIT Portfolio will be based upon each stock's 
relative liquidity (i.e., relative trading volume in dollars) in the 
Untied States; provided, however, that no component may represent more 
than 10% of the Original Portfolio Value.\11\
---------------------------------------------------------------------------

    \11\See Amendment No. 1, supra note 5. For purposes of this 
calculation, the weight of any component that would otherwise exceed 
10% of the Original Portfolio Value will be reduced to 10%. The 
remainder of the Original Portfolio Value will then be allocated 
among the remaining components of the REIT Portfolio based on 
relative liquidity.
---------------------------------------------------------------------------

    To determine relative liquidity, Merrill Lynch will compare the 
average daily consolidated dollar volume of a stock over the 90-day 
period immediately preceding the date on which the REIT Portfolio MITTS 
are priced for issuance to the average daily consolidated dollar volume 
for all of the stocks in the REIT Portfolio for that 90-day period. As 
of June 6, 1994, the highest weighting for any stock in the REIT 
Portfolio was 10.00%\12\ and the weighting for the five components with 
the highest relative liquidity was 42.50%. Also as of that date, the 
lowest weighting for any stock in the REIT Portfolio was 1.58% and the 
weighting for the five components with the lowest relative liquidity 
was 10.24%. For the six-month period from January 16, 1994, through 
July 14, 1994, the average dollar daily trading volume of the 
components ranged from a high of $2,468,375 (Simon Property Group, 
Inc.) to a low of $345,618 (Western Investment Real Estate Trust).
---------------------------------------------------------------------------

    \12\The weight of this component (Simon Property Group, Inc.) 
was reduced from 10.22% to 10% as a result of the modified weighting 
system described herein. Id.
---------------------------------------------------------------------------

    Except for certain multiplier adjustments discussed below, once the 
initial weightings have been determined, the multipliers will remain 
constant throughout the term of the REIT Portfolio MITTS. The value of 
the REIT Portfolio MITTS at any point in time will equal the aggregate 
for the components of the price of each component times the multiplier 
for that component plus the cumulative dividends paid on each component 
since the issue date for the REIT Portfolio MITTS. The multipliers 
assigned to the component REITs will be adjusted for certain events 
such as stock splits, reverse stock splits, or stock dividends, and the 
value of the common stock of the component REITs will also be adjusted 
for certain events including a liquidation, bankruptcy, insolvency, 
merger, or consolidation involving the issuer of the underlying shares. 
For example, if the issuer of the shares underlying a component REIT 
has been subject to a merger or a consolidation and is not the 
surviving entity, then the value for such common stock will be 
determined at the time such issuer is merged or consolidated and will 
equal the last available exchange market price for such common stock 
plus the cumulative dividends paid on that stock from the date of 
issuance of the REIT Portfolio MITTS through that date.\13\ That value 
will then be constant for the remaining term of the REIT Portfolio 
MITTS. In addition, no adjustments of any multiplier of a portfolio 
security will be made unless such adjustment would require a change of 
at least 1% in the multiplier then in effect.
---------------------------------------------------------------------------

    \13\Id.
---------------------------------------------------------------------------

    If the issuer of a portfolio security is in the process of 
liquidation or subject to a bankruptcy proceeding, insolvency, or other 
similar adjudication, such security will continue to be included in the 
REIT Portfolio so long as an exchange market price for such security is 
available. If an exchange market price is no longer available for a 
portfolio security, including, but not limited to, liquidation, 
bankruptcy, insolvency, or any other similar proceeding, then the value 
of that portfolio security used in calculating both the daily value of 
the REIT Portfolio and the Total Return Portfolio Value, will be equal 
to the cumulative dividends paid on that stock from the date of 
issuance of the REIT Portfolio MITTS through that date.\14\ This value 
will be used as long as no exchange market price exists for that 
security.\15\
---------------------------------------------------------------------------

    \14\Id.
    \15\Merrill Lynch will not attempt to find a replacement stock 
or to compensate for the extinction of a security due to bankruptcy 
or a similar event.
---------------------------------------------------------------------------

    Based upon the exchange reported prices of the common stock of the 
component REITs, an independent third party will calculate and 
disseminate the value of the REIT Portfolio no less frequently than 
once every minute during the trading day.\16\
---------------------------------------------------------------------------

    \16\If for any reason during the term of the REIT Portfolio 
MITTS the issuer is unable to obtain an independent third party to 
calculate the value of the REIT Portfolio, the issuer and the 
Exchange shall immediately notify the Commission to discuss the 
implementation of adequate procedures to protect investors and 
minimize any potential for manipulation.
---------------------------------------------------------------------------

    Like the other MITTS products that are listed on the NYSE, REIT 
Portfolio MITTS may not be redeemed prior to maturity and are not 
callable by the issuer. Holders of REIT Portfolio MITTS will be able to 
cash-out of their investment by selling the security on the NYSE. The 
Exchange anticipates that the trading value of the security in this 
secondary trading market will depend in large part on the value of the 
securities comprising the REIT Portfolio and also on such other factors 
as the level of interest rates, the volatility of the value of the REIT 
Portfolio, the time remaining to maturity, dividend rates, and the 
creditworthiness of the issuer, Merrill Lynch.\17\
---------------------------------------------------------------------------

    \17\Merrill Lynch will deposit registered global securities 
representing REIT Portfolio MITTS with its depository, The 
Depository Trust Company (``DTC''), so as to permit book-entry 
settlement of transactions by participants in DTC.
---------------------------------------------------------------------------

    Because REIT Portfolio MITTS are linked to a portfolio of equity 
securities, the NYSE's existing equity floor trading rules will apply 
to the trading of REIT Portfolio MITTS. 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 REIT Portfolio MITTS.\18\ 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 REIT 
Portfolio MITTS prior to, or promptly after, the completion of the 
transaction. Third, REIT Portfolio MITTS will be subject to the equity 
margin rules of the Exchange. Fourth, in accordance with the NYSE's 
Hybrid Approval Orders, the Exchange will, prior to trading REIT 
Portfolio MITTS, distribute a circular to the membership providing 
guidance with regard to member firm compliance responsibilities 
(including suitability recommendations) when handling transactions in 
REIT Portfolio MITTS and highlighting the special risks and 
characteristics of the REIT Portfolio MITTS.\19\
---------------------------------------------------------------------------

    \18\NYSE Rule 405 requires that every member, member firm or 
member corporation use due diligence to learn the essential facts 
relative to every customer and to every order or account accepted.
    \19\See Hybrid Approval Orders, supra note 6.
---------------------------------------------------------------------------

III. Commission Findings and Conclusions

    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). Specifically, the 
Commission believes that providing for exchange-trading of REIT 
Portfolio MITTS will offer a new and innovative means of participating 
in the market for REITs. In particular, the Commission believes that 
REIT Portfolio MITTS will permit investors to gain equity exposure to 
REITs, while at the same time, limiting the downside risk of the 
original investment. For the reasons discussed in the MITTS Approval 
Orders, the Commission finds that the listing and trading of REIT 
Portfolio MITTS is in the public interest.\20\
---------------------------------------------------------------------------

    \20\See MITTS Approval Orders, supra note 7.
---------------------------------------------------------------------------

    As with the other MITTS products approved by the Commission, REIT 
Portfolio MITTS are not leveraged instruments; however, their price 
will still be derived and based upon the underlying linked securities. 
Accordingly, the level of risk involved in the purchase or sale of REIT 
Portfolio MITTS is similar to the risk involved in the purchase or sale 
of traditional common stock. Nonetheless, as with the other MITTS 
products, the Commission has several specific concerns regarding the 
trading of this type of product.
    The Commission notes that the Exchange's rules and procedures that 
address the special concerns attendant to the trading of hybrid 
securities will be applicable to REIT Portfolio MITTS. In particular, 
by imposing the hybrid listing standards, suitability, disclosure, and 
compliance requirements noted above, the Commission believes the 
Exchange has addressed adequately the potential problems that could 
arise from the hybrid nature of REIT Portfolio MITTS. Moreover, the 
Exchange will distribute a circular to its membership calling attention 
to the specific risks associated with REIT Portfolio MITTS.
    The Commission realized that REIT Portfolio MITTS are dependent 
upon the individual credit of the issuer, Merrill Lynch. To some extent 
this credit risk is minimized by the Exchange's continued listing 
standards which require issuers to maintain an aggregate market value 
of $5 million for its publicly-held shares.\21\ In addition, the 
Exchange's hybrid listing standards further require that REIT Portfolio 
MITTS have at least $4 million in market value. In any event, financial 
information regarding Merrill Lynch, in addition to the information 
regarding Merrill Lynch, in addition to the information on the issuers 
of the underlying securities comprising the REIT Portfolio, will be 
publicly available.\22\
---------------------------------------------------------------------------

    \21\See supra note 9.
    \22\All of the securities contained in the REIT Portfolio have 
been issued by companies that are subject to reporting requirements 
under the Act.
---------------------------------------------------------------------------

    The Commission also has a systemic concern, however, that a broker-
dealer, such as Merrill Lynch, or a subsidiary providing a hedge for 
the issuer will incur position exposure. As discussed in the MITTS 
Approval Orders, the Commission believes this concern is minimal given 
the size of REIT Portfolio MITTS issuance in relation to the net worth 
of Merrill Lynch.\23\
---------------------------------------------------------------------------

    \23\See MITTS Approval Orders, supra note 6.
---------------------------------------------------------------------------

    The Commission believes that the listing and trading of REIT 
Portfolio MITTS should not unduly impact the market for the individual 
securities contained in the REIT Portfolio. First, as discussed above, 
the components of the REIT Portfolio are highly capitalized, liquid 
stocks. Second, as discussed above, because of the restriction that no 
component may account for more than 10% of the initial weight of the 
REIT Portfolio, no single component or group of components dominates 
the REIT Portfolio. Third, the issuers of the securities contained in 
the REIT Portfolio are subject to reporting requirements under the Act, 
and all of the portfolio securities are listed and traded on U.S. 
securities exchanges. Finally, the Intermarket Surveillance Group 
Agreement, dated July 14, 1983, as amended on January 29, 1990, will be 
applicable to the trading of REIT Portfolio MITTS and of the underlying 
component securities.\24\ This, in addition to the NYSE's surveillance 
procedures, will serve to deter as well as detect any potential 
manipulation.
---------------------------------------------------------------------------

    \24\The Intermarket Surveillance Group (``ISG'') was formed on 
July 14, 1983 to, among other things, coordinate more effectively 
surveillance and investigative information sharing arrangements in 
the stock and options markets. See Intermarket Surveillance Group 
Agreement, July 14, 1983. The most recent amendment to the ISG 
Agreement, which incorporates the original agreement and all 
amendments made thereafter, was signed by ISG members on January 29, 
1990. See Second Amendment to the Intermarket Surveillance Group 
Agreement, January 29, 1990. The members of the ISG are: the Amex; 
the Boston Stock Exchange, Inc.; the Chicago Board Options Exchange, 
Inc.; the Chicago Stock Exchange, Inc.; the National Association of 
Securities Dealers, Inc.; the NYSE; the Pacific Stock Exchange, 
Inc.; and the Philadelphia Stock Exchange, Inc. Because of potential 
opportunities for trading abuses involving stock index futures, 
stock options, and the underlying stock and the need for greater 
sharing of surveillance information for these potential intermarket 
trading abuses, the major stock index futures exchanges (e.g., the 
Chicago Mercantile Exchange and the Chicago Board of Trade) joined 
the ISG as affiliate members in 1990.
---------------------------------------------------------------------------

    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 of filing thereof in the Federal Register in 
order to allow the Exchange to list without delay REIT Portfolio MITTS 
as described herein. Specifically, in Amendment No. 1 to the proposal, 
the Exchange proposes to provide that all dividends paid on any 
component REIT after the date of issuance of the REIT Portfolio MITTS 
and prior to a corporate event which would effect the value of that 
component security shall be used in calculating both the daily values 
of the REIT Portfolio and the Total Return Portfolio Value. The 
Commission believes this is appropriate because it is consistent with 
the risks involved in the direct ownership of the individual component 
securities, i.e., the owner of a security generally will not be 
required to return dividends paid by the issuer prior to the insolvency 
of the issuer.
    The Exchange also proposes a modified weighting system in Amendment 
No. 1 whereby no component of the REIT Portfolio may account for more 
than 10% of the Original Portfolio Value. The effect of the weighting 
method in this case is merely to reduce the weight of one component 
from 10.22% to 10.00% and to raise the initial weights of the remaining 
components only marginally.\25\ Additionally, for the full six-year 
term of the MITTS, the weights of the component REITS may move freely 
above the 10% level based on subsequent price changes among the 
components. As a result, the Commission believes that this weighting 
method has an immaterial effect on the valuation of the REIT Portfolio 
during the term of the MITTS and on the amount that holders of the REIT 
Portfolio MITTS will ultimately receive upon maturity of the MITTS.
---------------------------------------------------------------------------

    \25\See supra note 12 and accompanying text.
---------------------------------------------------------------------------

    For the reasons stated above, the Commission believes that good 
cause exists for approving Amendment No. 1 to the proposed rule change 
on an accelerated basis.
    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\26\ that the proposed rule change (File No. SR-NYSE-94-28), as 
amended, is approved.
---------------------------------------------------------------------------

    \26\15 U.S.C. 78s(b)(2) (1988).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\27\
---------------------------------------------------------------------------

    \27\17 CFR 200.30-3(a)(12) (1992).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-23049 Filed 9-16-94; 8:45 am]
BILLING CODE 8010-01-M