[Federal Register Volume 59, Number 200 (Tuesday, October 18, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-25726]


[[Page Unknown]]

[Federal Register: October 18, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34821; International Series Release No. 729; File No. 
SR-Amex-94-24]

 

Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval of 
Amendment No. 1 to Proposed Rule Change by the American Stock Exchange, 
Inc. Relating to the Listing and Trading of Warrants on the Nikkei 
Stock Index 300

October 11, 1994.

I. Introduction

    On June 17, 1994, the American Stock Exchange, Inc. (``Amex'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4 thereunder,\2\ a 
proposed rule change to list and trade warrants on the Nikkei Stock 
Index 300 (``Nikkei 300 Index'' or ``Index''). On September 7, 1994, 
the Exchange filed Amendment No. 1 to the proposed rule change.\3\
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    \1\15 U.S.C. 78s(b)(1) (1982).
    \2\17 CFR 240.19b-4 (1993).
    \3\In Amendment No. 1, the Amex represented that (1) the Amex 
will advise its member firms that Index warrants may only be sold to 
investors whose accounts have been approved for options trading 
pursuant to Amex Rule 921; (2) Index warrants will, for margin 
purposes, be treated as if they were option contracts subject to 
Amex Rule 462(d); (3) the Amex will use the same surveillance 
procedures that it currently has in place for index warrants listed 
and traded on the Exchange to surveil trading in warrants on the 
Index; and (4) the Exchange is currently negotiating with the Tokyo 
Stock Exchange to obtain a surveillance sharing agreement and 
expects to have such an agreement in place prior to the listing and 
trading of Index warrants. See Letter from Claire P. McGrath, 
Managing Director and Special Counsel, Derivative Securities, Amex, 
to Michael Walinskas, Branch Chief, Derivatives Regulation, Division 
of Market Regulation, Commission, dated September 7, 1994.
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    Notice of the proposed rule change appeared in the Federal Register 
on July 20, 1994.\4\ No comments were received on the proposed rule 
change. This order approves the proposed rule change and Amendments No. 
1 thereto.
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    \4\See Securities Exchange Act Release No. 34365 (July 13, 
1994), 59 FR 37106 (July 20, 1994).
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II. Description of the Proposal

    The Amex proposes to list index warrants based on the Nikkei 300 
Index, and index comprised of 300 representative stocks of the first 
section\5\ of the Tokyo Stock Exchange (``TSE''). On August 11, 1994, 
the Commission approved a proposal by the Exchange to list and trade 
options and full-value and reduced-value long-term options on the 
Index.\6\
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    \5\First section stocks are distinguished from second section 
stocks by more stringent listing standards.
    \6\See Securities Exchange Act Release No. 34526 (August 11, 
1994), 59 FR 42610 (August 18, 1994).
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A. Composition and Maintenance of the Index

    The Nikkei 300 Index was designed by Nihon Keizai Shimbun, Inc. 
(``NKS''). The Amex represents that Index component stocks were 
selected by NKS for their high market capitalizations, and their high 
degree of liquidity, and are representative of the relative 
distribution of industries within the broader Japanese equity market.
    As of July 8, 1994, the total capitalization of the Index was 
approximately US$2.47 trillion.\7\ Market capitalization of the 
individual stocks in the Index ranged from a high of US$83.8 billion to 
a low of US$1.03 billion, with a median of US$3.56 billion and a mean 
of US$8.25 billion. In addition, the average daily trading volume of 
the stocks in the Index, for the six-month period ending June 30, 1994, 
ranged from a high of 4,740,000 shares to a low of 6,000 shares, with a 
mean and median of approximately 676,000 and 417,000 shares, 
respectively. The highest weighted component stock in the Index 
accounts for 3.39 percent of the Index. The five largest Index 
components account for approximately 14.9 percent of the Index's value. 
The lowest weighted component stock comprises 0.042 percent of the 
Index, and the five smallest Index components account for approximately 
0.25 percent of the Index's value.
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    \7\Based on the July 8, 1994 exchange rate of Y98.2 per US$1.00.
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    The Index is maintained by NKS. To maintain the continuity of the 
Index, NKS will adjust the Index divisor to reflect certain events 
relating to the component stocks. These events include, but are not 
limited to, changes in the number of shares outstanding, spin-offs, 
certain rights issuances, and mergers and acquisitions. The Amex 
represents that NKS reviews the composition of the Index periodically.

B. Calculation of the Index

    The Nikkei 300 Index is capitalization-weighted and reflects 
changes in the prices of the Index component securities relative to the 
base date of the Index (October 1, 1982). The value of the Index is 
calculated by multiplying the price of each component security by the 
number of shares outstanding of each such security, adding the 
products, and dividing by the current Index divisor. The Index divisor 
is adjusted to reflect certain events relating to the component 
stocks.\8\ The Index had a closing value of 299.47 on July 13, 1994.
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    \8\See supra Section II.A. The Index divisor was set to give the 
Index a value of 100 on its base date.
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    Because trading does not occur on the TSE during the Amex's trading 
hours, the daily dissemination of the Index value is calculated by the 
Amex once each day based on the most recent official closing price of 
each Index component security as reported by the TSE. This closing 
value is disseminated throughout the trading day on the Amex.

C. Warrant Listing Standards and Customer Safeguards

    The Exchange proposes to trade Nikkei 300 Index warrants pursaunt 
to Section 106 of the Amex Company Guide (``Section 106''). Under 
Section 106, the Amex may approve for listing warrants on established 
foreign and domestic market indexes. The Commission has previously 
approved the listing and trading on the Amex of certain foreign index 
warrants based on the Nikkei Stock Average,\9\ the FT-SE 100 Index,\10\ 
the CAC-40 Index,\11\ and the Hong Kong 30 Index,\12\ all listed in 
accordance with Section 106.
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    \9\See Securities Exchange Act Release No. 27565 (December 22, 
1989), 55 FR 376 (January 4, 1990).
    \10\See Securities Exchange Act Release No. 27769 (March 6, 
1990), 55 FR 9380.
    \11\See Securities Exchange Act Release No. 28544 (October 17, 
1990), 55 FR 42792 (October 23, 1990).
    \12\See Securities Exchange Act Release No. 33036 (October 8, 
1993), 58 FR 53588 (October 15, 1993).
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    The Amex represents that the Index warrant issues will conform to 
the index warrant listing guidelines contained in Section 106. 
Specifically, the listing guidelines of the Amex will require that (1) 
the issuer thereof shall have assets in excess of $100,000,000 and 
otherwise substantially exceed the size and earnings requirements of 
Amex Company Guide Section 101(a);\13\ the term of warrants shall be 
for a period ranging from one to five years from the date of issuance; 
and (3) the minimum public distribution of such issues shall be 
1,000,000 warrants, together with a minimum of 400 public holders, and 
a minimum aggregate market value of $4,000,000.
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    \13\Section 101(a) requires the issuer to have stockholders' 
equity of at least $4,000,000 and pre-tax income of at least 
$750,000 in its last fiscal year, or in two of its last three fiscal 
years.
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    The Amex has proposed applying the same margin treatment as it 
requires for Amex-listed options, as wet forth in Amex Rule 462(d), to 
the purchase of Index warrants.\14\
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    \14\See Amendment No. 1, supra note 3.
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    The Amex also proposes that Nikkei 300 Index warrants will be 
direct obligations of their issuer, subject to cash settlement in U.S. 
dollars, and either exercisable throughout their life (i.e., American 
style) or exercisable only on their expiration date (i.e., European 
style). Upon exercise, or at the warrant expiration date (if not 
exercisable prior to such date), the holder of a warrant structured as 
a ``put'' would receive payment in U.S. dollars to the extent that the 
Index has declined below a pre-stated cash settlement value. 
Conversely, holders of a warrant structured as a ``call'' would, upon 
exercise or at expiration, receive payment in U.S. dollars to the 
extent that the Index has increased above the pre-stated cash 
settlement value. If ``out-of-the-money'' at the time of expiration, 
the warrants would expire worthless.
    Because warrants are derivative in nature and closely resemble 
index options, the Amex has proposed safeguards that are designed to 
meet the investor protection concerns raised by the trading of index 
options. First, the Exchange represents that it will require that Index 
warrants only be sold to investors whose accounts have been approved 
for options trading pursuant to Amex Rule 921.\15\ Second, pursuant to 
Amex rule 411, Commentary .02, the Exchange's options suitability 
standards contained in Amex Rule 923 shall apply to recommendations in 
Index warrants. Third, pursuant to Amex Rule 421, Commentary .02, 
discretionary orders in Index warrants must be approved and initialled 
on the day entered by a Senior Registered Options Principal or a 
Registered Options Principal. Finally, the Amex, prior to commencement 
of trading in Index warrants, will distribute a circular to its 
membership to call attention to the specific risks associated with 
Index warrants.
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    \15\See Amendment No. 1, supra note 3.
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D. Surveillance

    The Exchange will use the same surveillance procedures currently 
utilized for each of the Exchange's other index warrants to monitor 
trading in Index warrants. The Exchange represents that it is currently 
negotiating with the TSE to obtain a surveillance sharing agreement and 
expects to have such an agreement in place prior to the listing and 
trading of Index warrants.\16\
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    \16\See Amendment No. 1, supra note 3.
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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) of the Act.\17\ 
Specifically, the Commission finds that the trading of warrants based 
on the Nikkei 300 Index will serve to protect investors, promote the 
public interest, and help to remove impediments to a free and open 
securities market by providing investors with a means to hedge exposure 
to market risk associated with the Japanese equity market and provide a 
surrogate instrument for trading in the Japanese securities market.\18\ 
The trading of warrants based on the Nikkei 300 Index should provide 
investors with a valuable hedging vehicle that should reflect 
accurately the overall movement of the Japanese equity market.
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    \17\15 U.S.C. Sec. 78f(b)(5) (1988).
    \18\Pursuant to Section 6(b)(5) of the Act, the Commission must 
predicate approval of any new securities product upon a finding that 
the introduction of such product is in the public interest. Such a 
finding would be difficult with respect to a warrant that served no 
hedging or other economic function, because any benefits that might 
be derived by market participants likely would be outweighed by the 
potential for manipulation, diminished public confidence in the 
integrity of the markets,and other valid regulatory concerns.
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    In addition, the Commission believes, for the reasons discussed 
below, that the Amex has adequately addressed issues related to 
customer protection, index design, surveillance, and market impact of 
Nikkei 300 Index warrants.

A. Customer Protection

    Due to the derivative nature of index warrants, the Commission 
believes that Nikkei 300 Index warrants should only be sold to 
investors capable of evaluating and bearing the risks associated with 
trading in such instruments and that adequate risk disclosure be made 
to investors. In this regard, the Commission notes that the rules and 
procedures of the Exchange that address the special concerns attendant 
to the secondary market trading of index warrants will be applicable to 
the Nikkei 300 Index warrants. In particular, by imposing the special 
suitability, account approval, disclosure, and compliance requirements 
noted above, the Amex has adequately addressed potential public 
customer problems that could arise from the derivative nature of Nikkei 
300 Index warrants. Moreover, the Amex plans to distribute a circular 
to its members identifying the specific risks associated with warrants 
on the Nikkei 300 Index and, pursuant to the Amex's listing guidelines, 
only substantial companies capable of meeting their warrant obligations 
will be eligible to issue Nikkei 300 Index warrants.

B. Index Design and Structure

    The Commission finds, as it did in approving Nikkei 300 Index 
options, that it is appropriate and consistent with the Act to classify 
the Index as a broad-based index. Specifically, the Commission believes 
the Index is broad-based because it reflects a substantial segment of 
the Japanese equity market, and, among other things, contains a large 
number of stocks that trade in that market. First, the Index consists 
of 300 actively-traded stocks traded on the first section of the TSE, 
representing 36 different industry groups in Japan. Second, the market 
capitalizations of the stocks comprising the Index are very large. 
Specifically, the total capitalization of the Index, as of July 8, 
1994, was US$2.47 trillion, with the market capitalizations of the 
individual stocks in the Index ranging from a high of US$83.8 billion 
to a low of US$1.03 billion, with a medium value of US$3.56 billion and 
a mean of US$8.25 billion. Third, no one particular stock or group of 
stocks dominates the Index. Specifically, no single stock comprises 
more than 3.39 percent of the Index's total value, and the percentage 
weighting of the five largest issues in the Index accounts for 14.9 
percent of the Index's value. Accordingly, the Commission believes it 
is appropriate to classify the Index as broad-based.

C. Surveillance

    As a general matter, the Commission believes that comprehensive 
surveillance sharing agreements between the relevant foreign and 
domestic exchanges are important where an index product comprised of 
foreign securities is to be traded in the United States. In most cases, 
in the absence of such a comprehensive surveillance sharing agreement, 
the Commission believes that it would not be possible to conclude that 
a derivative product, such as a Nikkei 300 Index warrant, was not 
readily susceptible to manipulation.
    Although the Amex and the TSE do not yet have a written 
comprehensive surveillance sharing agreement that covers the trading of 
Nikkei 300 Index warrants,\19\ a number of factors support approval of 
the proposal at this time. First, while the size of an underlying 
market is not determinative of whether a particular derivative product 
based on that market is readily susceptible to manipulation, the size 
of the market for the securities underlying the Nikkei 300 Index makes 
it less likely that the proposed Index warrants are readily suceptible 
to manipulation.\20\ In addition, the Commission notes that the TSE is 
under the regulatory oversight of the Japanese Ministry of Finance 
(``MOF''). The MOF has responsibility for both the Japanese securities 
and derivatives markets. Accordingly, the Commission believes that the 
ongoing oversight of the trading activity on the TSE by the MOF will 
help to ensure that the trading of Nikkei 300 Index warrants will be 
carefully monitored with a view toward preventing unnecessary market 
disruptions.
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    \19\The Amex and the TSE, however, currently have a surveillance 
sharing agreement in place that covers other derivative products 
traded on the Amex. That agreement has been previously amended by 
the Amex and the TSE to include new products, such as the trading of 
Japan Index options. The Exchange represents that it currently is 
pursuing a comprehensive surveillance sharing agreement with the TSE 
with respect to Nikkei 300 Index Warrants.
    \20\In evaluating the manipulative potential of a proposed index 
derivative product, as it relates to the securities that comprise 
the index and the index product itself, the Commission has 
considered several factors, including (1) the number of securities 
comprising the index or group; (2) the capitalizations of those 
securities; (3) the depth and liquidity of the group or index; (4) 
the diversification of the group or index; (5) the manner in which 
the index or group is weighted; and (6) the ability to conduct 
surveillance on the product. See Securities Exchange Act Release No. 
31016 (August 11, 1992), 57 FR 37012 (August 17, 1992).
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    Finally, the Commission and the MOF have concluded a Memorandum of 
Understanding (``MOU'') that provides a framework for mutual assistance 
in investigatory and regulatory matters.\21\ Morever, the Commission 
also has a longstanding working relationship with the MOF on these 
matters. Based on the longstanding relationship between the Commission 
and the MOF and the existence of the MOU, the Commission is confident 
that it and the MOF could acquire information from one another similar 
to that which would be available in the event that a comprehensive 
surveillance sharing agreement were executed between the Amex and the 
TSE with respect to transactions in TSE-traded stocks related to Nikkei 
300 Index warrant transactions on the Amex.\22\
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    \21\See Memorandum of United States Securities and Exchange 
Commission and the Securities Bureau of the Japanese Ministry of 
Finance on the Sharing of Information, dated May 23, 1986.
    \22\It is the Commission's expectation that this information 
would include transaction, clearing, and customer information 
necessary to conduct an investigation.
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    Nevertheless, the Commission continues to believe strongly that a 
comprehensive surveillance sharing agreement between the TSE and the 
Amex covering Nikkei 300 Index warrants would be an important measure 
to deter and detect potential manipulations or other improper or 
illegal trading involving Nikkei 300 Index warrants. Accordingly, the 
Commission believes it is critical that the TSE and the Amex continue 
to work together to consummate a formal comprehensive surveillance 
sharing agreement to cover Nikkei 300 Index warrants and the component 
securities as soon as practicable.\23\
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    \23\See supra note 19.
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D. Market Impact

    The Commission believes that the listing and trading of Nikkei 300 
Index warrants on the Amex will not adversely impact the securities 
markets in the United States or in Japan. First, the existing index 
warrant surveillance procedures of the Amex will apply to warrants on 
the Index. In addition, the Commission notes that the Index is broad-
based on diversified and includes highly capitalized securities that 
are actively traded on the TSE.

IV. Accelerated Approval of Amendment No. 1

    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 on notice of filing thereof in the Federal Register. 
Amendment No. 1 is consistent with Section 6(b)(5), in that it contains 
representations by the Exchange, concerning margin, options approved 
accounts, and surveillance, which serve to protect investors and the 
public interest, promote just and equitable principles of trade, and 
prevent fraudulent and manipulative acts and practices. Further, these 
representations are consistent with those which were made in connection 
with the Amex's proposal to list warrants on the Hong kong 30 
Index.\24\ That proposal was published for the full 21-day comment 
period, and no comments were received. Therefore, the Commission finds 
that no new regulatory issues are raised by Amendment No. 1. 
Accordingly, the Commission believes it is consistent with Sections 
19(b)(2) and 6(b)(5) of the Act to approve Amendment No. 1 on an 
accelerated basis.
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    \24\See supra note 12.
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V. Solicitation of Comments

    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, 
N.W., Washington, D.C. 20549. Copies of the submission, all subsequent 
amendments, all written statements with respect to the foregoing that 
are filed with the Commission, and all written communications relating 
to the foregoing 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. Sec. 552, will be available for inspection and 
copying in the Commission's Public Reference Section, 450 Fifth Street, 
N.W. Washington, D.C. Copies of such filings also will be available for 
inspection and copying at the principal office of the above-mentioned 
self-regulatory organization. All submissions should refer to File No. 
SR-Amex-94-24, and should be submitted by November 8, 1994.
    It is therefore ordered, Pursuant to Section 19(b)(2) of the 
Act,\25\ that the proposed rule change (SR-Amex-94-24), as amended, is 
hereby approved.
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    \25\15 U.S.C. 78s(b)(2) (1988).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\26\
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    \26\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-25726 Filed 10-17-94; 8:45 am]
BILLING CODE 8010-01-M