[Federal Register Volume 59, Number 186 (Tuesday, September 27, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-23793]


[[Page Unknown]]

[Federal Register: September 27, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34691; File No. SR-NYSE-94-14]

 

Self-Regulatory Organizations; Order Approving a Proposed Rule 
Change 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 Health Care Portfolio Market Index Target-
Term Securities (``MITTS'').

I. Introduction

September 20, 1994.
    On April 12, 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 of health care companies (``Health Care 
Portfolio'').\4\ Notice of the proposal appeared in the Federal 
Register on April 28, 1994.\5\ No comment letters were received on the 
proposed rule change. On August 9, 1994, the NYSE filed Amendment No. 1 
to the proposed rule change.\6\ This order approves the proposal, as 
amended.
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    \1\15 U.S.C. 78s(b)(1) (1988).
    \2\17 CFR 240.19b-4 (1992).
    \3\``MITTS'' and ``Market Index Target-Term Securities'' are 
service marks of Merrill Lynch & Co., Inc. (``Merrill Lynch'').
    \4\The Health Care Portfolio is a static portfolio consisting of 
22 equity securities listed as common shares in the United States. 
The components of the portfolio represent companies that offer a 
variety of goods and services in the health care industry.
    \5\See Securities Exchange Act Release No. 33933 (April 20, 
1994), 59 FR 22030 (April 28, 1994).
    \6\Amendment No. 1 to the proposed rule change provides that the 
value of the Health Care Portfolio will be calculated continuously 
and disseminated to the Options Price Reporting Authority (``OPRA'') 
no less frequently than once every minute throughout the trading 
day. 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 9, 1994 (``Amendment No. 1'').
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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.\7\ The NYSE is now 
proposing under Section 703.19 of the Manual to list for trading MITTS 
based on the Health Care Portfolio (``Health Care Portfolio 
MITTS'').\8\
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    \7\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'').
    \8\The Commission recently approved the listing and trading on 
the Exchange of MITTS based upon (1) a global portfolio of 
securities representing telecommunications companies, and (2) a 
portfolio of 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) (``MITTS 
Approval Orders'').
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    As with the other MITTS products, the Health Care 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.\9\ In addition, the Exchange will monitor the Health 
Care Portfolio MITTS to verify compliance with the Exchange's continued 
listing criteria.\10\ 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. Health Care 
Portfolio MITTS will entitle the owner at maturity to receive an amount 
based upon the percentage change between the ``Original Portfolio 
Value'' and the ``Ending Average Portfolio Value,'' subject to a 
minimum repayment amount. The ``Original Portfolio Value'' is the value 
of the Health Care Portfolio on the date on which the issuer prices the 
Health Care Portfolio MITTS issue for the initial offering to the 
public. The ``Ending Average Portfolio Value'' is the average of the 
values of the Health Care Portfolio at the end of the five calendar 
quarters preceding the expiration of the Health Care Portfolio MITTS on 
December 31, 1999.\11\ The Ending Average Portfolio Value will be used 
in calculating the amount owners will receive upon maturity.\12\
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    \9\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).
    \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. 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.
    \11\Specifically, the Ending Average Portfolio Value will equal 
average of the quarterly values of the Health Care Portfolio 
beginning in the calendar quarter ending December 31, 1998. The 
quarterly value for each of the first four of the final five 
calendar quarters shall be the Health Care Portfolio value on the 
last scheduled Exchange trading day on which there is no market 
disruption event. The quarterly value for the final calendar quarter 
shall be the Health Care Portfolio Value on the seventh scheduled 
Exchange trading day preceding maturity of the Health Care MITTS 
unless there is a market disruption event in which case the sixth 
trading day preceding maturity shall be used.
    \12\The Health Care Portfolio MITTS will entitle a holder at 
maturity to receive for each $10 principal amount of MITTS an amount 
equal to the Ending Average Portfolio Value of the Health Care 
Portfolio divided by 10, but in any event no less than $9 per each 
$10 principal amount of Health Care Portfolio MITTS.
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    If the market value of the portfolio has declined, the owner will 
receive not less than a specified percentage of the principal amount of 
the security. (For instance, if the market value of the portfolio used 
to calculate the amount payable at maturity has declined more than 10%, 
the owners of the Health Care Portfolio MITTS will receive 90% of the 
principal amount of the securities.) The payment at maturity is based 
on changes in the value of the portfolio, but does not reflect the 
payment of dividends on the securities that comprise the portfolio. 
Health Care 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 on the aggregate portfolio value of 
the Health Care Portfolio securities.
    According to the NYSE, Health Care Portfolio MITTS will allow 
investors to combine the protection of a portion of the principal 
amount of the MITTS with a potential additional payment based upon the 
performance of a portfolio of securities representing 22 highly 
capitalized health care companies. Health Care Portfolio MITTS will 
mature on December 31, 1999.
    The Health Care Portfolio consists of securities of 22 health care 
companies that have significantly different levels of market 
capitalization, ranging from a high of approximately $28.0 billion 
(Bristol Meyers Squibb Co.) to a low of approximately $311 million 
(Living Centers of America, Inc.).\13\ Nineteen of the securities in 
the Health Care Portfolio are traded on the NYSE and the remainder are 
National Market securities traded through NASDAQ. The average daily 
trading volume for the components of the Health Care Portfolio for the 
period from November 5, 1992, through March 7, 1994, ranged from a high 
of approximately 1.03 million shares (Abbott Laboratories), to a low of 
approximately 20,335 shares (Living Centers of America, Inc.).
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    \13\These values are as of March 7, 1994.
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    At the outset, each of the securities in the Health Care Portfolio 
will have equal representation. Specifically, each security included in 
the portfolio will be assigned a multiplier on the date of issuance so 
that the security represents an equal percentage of the value of the 
entire portfolio on the date of issuance. The multiplier indicates the 
number of shares (or fraction of one share) of a security, given its 
market price on an exchange or through NASDAQ, to be included in the 
calculation of the portfolio. Accordingly, each of the 22 companies 
included in the Health Care Portfolio will represent approximately 4.54 
percent of the total portfolio at the time of issuance.
    The multiplier for each security in the Health Care Portfolio will 
generally remain unchanged except for limited adjustments that may be 
necessary as a result of stock splits or stock dividends.\14\ There 
will be no adjustments to the multipliers to reflect cash dividends 
paid with respect to a portfolio security. 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.
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    \14\Merrill Lynch will adjust the multiplier of any portfolio 
security if the security is subject to a stock split or reverse 
split to equal the product of the number of shares issued with 
respect to one share of the portfolio security and the prior 
multiplier. In the case of a stock dividend, the multiplier will be 
adjusted so that the new multiplier will equal the former multiplier 
plus the product of the number of shares of such portfolio security 
issued with respect to one share of the portfolio security and the 
prior multiplier.
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    If the issuer of a security included in the Health Care Portfolio 
no longer exists, whether for reason of a merger, acquisition or 
similar type of corporate control transaction, then Merrill Lynch will 
assign to that security a value equal to the security's final value for 
the purposes of calculating portfolio values. For example, if a company 
included in the portfolio is acquired by another company, Merrill Lynch 
shall thereafter assign a value to the shares of the acquired company's 
securities equal to the value per share at which time the acquisition 
takes place.
    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 
Health Care Portfolio so long as a market price on an exchange or 
through NASDAQ for such security is available. If such a 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 the portfolio security will be assigned a 
value of zero in connection with calculating the daily portfolio value 
and the closing portfolio value of the Health Care Portfolio, for so 
long as no such market price exists for that security.\15\
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    \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.
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    The value of the Health Care Portfolio will be calculated by an 
independent third party and will be disseminated through OPRA at least 
one each minute throughout the trading day.\16\ The portfolio value 
will equal the sum of the products of the most recently available 
market prices and the applicable multipliers for the portfolio 
securities.
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    \16\See Amendment No. 1, supra note 6.
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    Like other issues of MITTS listed on the NYSE, Health Care 
Portfolio MITTS may not be redeemed prior to maturity and are not 
callable by the issuer. Holders of Health Care 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 Health Care Portfolio and also on such 
other factors as the level of interest rates, the volatility of the 
value of the Health Care Portfolio, the time remaining to maturity, 
dividend rates, and the credit worthiness of the issuer, Merrill 
Lynch.\17\
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    \17\Merrill Lynch will deposit registered securities 
representing Health Care Portfolio MITTS with its depository, the 
Depository Trust Company (``DTC''), so as to permit book-entry 
settlement of transactions by participants in DTC.
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    Because Health Care Portfolio MITTS are linked to a portfolio of 
equity securities, the NYSE'S existing equity floor trading rules will 
apply to the trading of Health Care 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 Health Care 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 Health Care Portfolio MITTS prior to, or promptly after, the 
completion of the transaction. Third, Health Care 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 Health Care Portfolio MITTS, distribute a circular to 
the membership providing guidance with regard to member firm compliance 
responsibilities (including suitability recommendations) when handling 
transactions in Health Care Portfolio MITTS and highlighting the 
special risks and characteristics of the Health Care Portfolio 
MITTS.\19\
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    \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 7.
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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 Health Care 
Portfolio MITTS will offer a new and innovative means of participating 
in the market for health care securities. In particular, the Commission 
believes that Health Care Portfolio MITTS will permit investors to gain 
equity exposure in health care companies, 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 Health Care Portfolio MITTS is consistent with 
the Act.\20\
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    \20\See MITTS Approval Orders, supra note 8.
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    As with other MITTS products, Health Care Portfolio MITTS 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 a Health Care Portfolio MITTS 
is similar to the risk involved in the purchase or sale of traditional 
common stock. Nonetheless, because the final rate of return of a MITTS 
is derivatively priced, based on the performance of a portfolio of 
securities, 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 Health Care 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 Health Care Portfolio MITTS. 
Moreover, the Exchange will distribute a circular to its membership 
calling attention to the specific risks associated with Health Care 
Portfolio MITTS.
    The Commission realizes that Health Care 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 Health Care 
Portfolio MITTS have at least $4 million in market value. In any event, 
financial information regarding Merrill Lynch, in addition to the 
information on the issuers of the underlying securities comprising the 
Health Care Portfolio, will be publicly available.\22\
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    \21\See supra note 10.
    \22\The companies that comprise the Health Care Portfolio are 
reporting companies under the Act.
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    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 Health Care Portfolio MITTS issuance in relation to the net 
worth of Merrill Lynch.\23\
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    \23\See MITTS Approval Orders, supra note 8.
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    The Commission also believes that the listing and trading of Health 
Care Portfolio MITTS should not unduly impact the market for the 
underlying securities comprising the Health Care Portfolio. First, as 
discussed above, the underlying securities comprising the portfolio are 
well-capitalized, highly liquid stocks. Second, because all of the 
components of the Health Care Portfolio will initially be equally 
weighed, no single stock or group of stocks dominates the Health Care 
Portfolio. Finally, the issuers of the underlying securities comprising 
the Health Care Portfolio, are subject to reporting requirements under 
the Act, and all of the portfolio securities are either listed or 
traded on, or traded through the facilities of U.S. securities 
markets.\24\ Additionally, the NYSE's surveillance procedures will 
serve to deter as well as detect any potential manipulation.
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    \24\The Commission notes that 19 of the component securities are 
traded on the NYSE and the remainder are National Market securities 
traded through Nasdaq.
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    Finally, the Commission notes that the value of the Health Care 
Portfolio will be disseminated at least once every minute throughout 
the trading day. The Commission believes that this result is 
appropriate because, unlike previously approved MITTS products which 
contain foreign components, the Health Care Portfolio is comprised 
solely of securities traded in the U.S. for which real-time price 
information is available. The Commission believes that providing access 
to the value of the Health Care Portfolio at least once every minute 
throughout the trading day is extremely important and will provide 
benefits to investors in the product.\25\
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    \25\In this regard, the Commission believes that it is useful 
and beneficial for all investors and market participants to have 
access to the value of the Health Care Portfolio as frequently as 
possible and encourages the NYSE and Merrill Lynch to further 
explore the possibilities in this area, i.e., calculating and 
disseminating the value of the portfolio at least once every 15 
seconds as is done with other derivative products.
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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. As discussed 
above, the Commission believes that investors and market participants 
will benefit from having the value of the Health Care Portfolio 
calculated and disseminated as frequently as possible throughout the 
trading day. The Commission believes that Amendment No. 1 provides this 
benefit without unduly burdening either the Exchange or the issuer of 
the Health Care Portfolio MITTS. Additionally, the Commission notes 
that Amendment No. 1 provides for significantly greater access by 
investors and market participants to current values of the Health Care 
Portfolio than did the original proposal which was noticed for the full 
21-day comment period without any comments being received by the 
Commission. Accordingly, the Commission believes it is consistent with 
Section 6(b)(5) of the Act to approve Amendment No. 1 to the proposed 
rule change on an accelerated basis.
    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-94-14 and should be submitted by October 18, 1994.
    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\26\ that the proposed rule change (File No. SR-NYSE-94-14), as 
amended, is approved.
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    \26\15 U.S.C. 78s(b)(2) (1988).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\27\
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    \27\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-23793 Filed 9-26-94; 8:45 am]
BILLING CODE 8010-01-M