[Federal Register Volume 59, Number 203 (Friday, October 21, 1994)]
[Unknown Section]
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From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-26169]


[[Page Unknown]]

[Federal Register: October 21, 1994]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-34848; File No. SR-Amex-94-39]

 

Self-Regulatory Organizations; Order Granting Accelerated 
Approval of a Proposed Rule Change and Notice of Filing and Order 
Granting Accelerated Approval of Amendment No. 1 to the Proposed Rule 
Change by the American Stock Exchange, Inc. Relating to the Listing and 
Trading of Banking Industry Portfolio Indexed Term Notes

October 17, 1994.

I. Introduction

    On September 22, 1994, the American Stock Exchange, Inc. (``Amex'' 
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 Indexed Term Notes 
(``Notes''), the return on which is based upon a static portfolio of 
banking industry securities (``Banking Industry Portfolio''). Notice of 
the proposal appeared in the Federal Register on October 4, 1994.\3\ No 
comment letters were received on the proposed rule change. The Exchange 
filed Amendment No. 1 to the proposal on October 11, 1994.\4\ 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\See Securities Exchange Act Release No. 34723 (September 27, 
1994), 59 FR 50631 (October 4, 1994).
    \4\In Amendment No. 1 to the proposed rule change, the Exchange 
proposes to remove Crestar Financial Corp from the Banking Industry 
Portfolio and replace it with Citizens Bancorp (Md.). See Letter 
from Claire McGrath, Managing Director and Special Counsel, Amex, to 
Michael Walinskas, Branch Chief, Office of Market Supervision 
(``OMS''), Division of Market Regulation (``Division''), Commission, 
dated October 11, 1994.
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II. Description of the Proposal

    Under Section 107 of the Amex Company Guide (``Guide''), the 
Exchange may approve for listing and trading securities which cannot be 
readily categorized under the listing criteria for common and preferred 
stocks, bonds, debentures, or warrants.\5\ The Amex now proposes to 
list for trading, under Section 107A of the Guide, Notes whose value is 
based in whole or in part on a static index composed of twenty 
actively-traded bank stocks.\6\
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    \5\See Securities Exchange Act Release No. 27753 (March 1, 
1990), 55 FR 8626 (March 8, 1990).
    \6\The specific components of the Banking Industry Portfolio 
are: Bancorp Hawaii, Inc.; Barnett Banks, Inc.; Baybanks, Inc.; 
Citizens Bancorp (Md.); City National Corp.; Corestates Financial; 
First American Corp.; First Chicago Corp.; Hibernia Corp.; 
Mercantile Bancorp; Michigan National; Midlantic Corp.; North Fork 
Bancorp; Provident Bankshares; Summit Bancorp; U.S. Bancorp; UJB 
Financial Corp.; Union Planters Corp.; UST Corp.; and Vermont 
Financial Services.
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    The Notes are non-convertible debt securities of Lehman Brothers, 
Inc. (``Lehman Brothers'') and will conform to the listing guidelines 
under Section 107A of the Guide.\7\ Although the specific maturity date 
will not be established until immediately prior to the time of the 
offering, the Notes will provide for maturity within a period of not 
less than one nor more than seven years from the date of issue. The 
Notes provide for a single payment at maturity, and will bear no 
periodic payments of interest. Banking Industry Portfolio Notes 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;'' provided, however, that: (1) the 
amount payable at maturity will not be less than 90% of the principal 
amount of the Notes; and (2) the issuer may place a cap on the amount 
to be paid on the Notes at maturity.\8\ The ``Original Portfolio 
Value'' is the value of the Banking Industry Portfolio on the date on 
which the issuer prices the Notes for the initial offering to the 
public. The ``Ending Average Portfolio Value'' is the average of the 
closing prices of the Banking Industry Portfolio securities for a 
specified number of days prior to maturity of the Notes.\9\ The Ending 
Average Portfolio Value will be used in calculating the amount owners 
will receive upon maturity.\10\
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    \7\Specifically, the Notes must have: (1) a minimum public 
distribution of one million trading units; (2) a minimum of 400 
holders; (3) an aggregate market value of at least $4 million; and 
(4) a term of at least one year. Additionally, the issuer of the 
Notes (i.e., Lehman Brothers) must have assets of at least $100 
million, stockholders' equity of at least $10 million, and pre-tax 
income of at least $750,000 in the last fiscal year or in two of the 
three prior fiscal years. As an alternative to these financial 
criteria, the issuer must have either: (1) assets in excess of $200 
million and stockholders' equity in excess of $10 million; or (2) 
assets in excess of $100 million and stockholders' equity in excess 
of $20 million.
    \8\For example, Lehman Brothers could place a cap on the amount 
to be received at maturity as a stated percentage of the issuance 
price, e.g., 150% of the issuance price. Alternatively, a cap could 
be in the form of a participation rate whereby a holder of the Notes 
would participate in a stated percentage of the total percentage 
change between the Ending Portfolio Value and the Original Portfolio 
Value, e.g., 80% of the total appreciation of the Banking Industry 
Portfolio during the term of the Notes. The Commission notes that 
these examples are by way of illustration, not of limitation, as to 
how a cap on the amount to be paid to holders of the Notes at 
maturity could be constructed by Lehman Brothers.
    \9\Specifically, the Ending Average Portfolio Value will equal 
the average of the closing prices for the Banking Industry Portfolio 
securities for the first 10 of the last 20 trading days prior to 
maturity of the Notes. Telephone conversation between Benjamin 
Krause, Senior Vice President, Capital Markets Group, Amex, and Brad 
Ritter, Senior Counsel, OMS, Division, Commission, on October 11, 
1994.
    \10\The Banking Industry Portfolio Notes will entitle a holder 
at maturity to receive not less than 90% of the original issue price 
for the Notes. Additionally, holders of the Notes may not receive 
the full amount of the change between the Ending Portfolio Value and 
the Original Portfolio Value.
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    If market value of the Banking Industry Portfolio has declined, the 
owners of the Banking Industry Portfolio Notes will receive at least 
90% of the principal amount of the Notes. The payment at maturity is 
based on charges in the value of the Banking Industry Portfolio, 
subject to any cap on appreciation that may be included by the issuer, 
but does not reflect the payment of dividends on the securities that 
comprise the portfolio. Banking Industry Portfolio Notes are cash-
settled in that they do not give 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 value of the Banking Industry Portfolio securities.
    According to the Amex, Banking Industry Portfolio Notes will allow 
investors to combine the protection of a portion of the principal 
amount of the Notes with a potential additional payment based upon the 
performance of a portfolio of 20 highly capitalized banking industry 
stocks. In particular, the proposed Banking Industry Portfolio Notes 
will provide at least 90% principal protection with the opportunity to 
participate in any upside appreciation of the underlying Banking 
Industry Portfolio, subject to any cap on appreciation that may be 
included by the issuer.
    The Banking Industry Portfolio consists of securities of 20 
companies that collectively, at the time of issuance,\11\ will satisfy 
the generic listing requirements approved by the Commission for the 
listing and trading of options on newly established narrow-based 
indexes.\12\ Specifically, the component securities of the Banking 
Industry Portfolio satisfy the following criteria: (1) a minimum market 
capitalization of $75 million, except that up to 10% of the component 
securities may have a market capitalization of not less than $50 
million; (2) trading volume in each of the six months prior to the 
offering of the Notes of not less than one million shares, except that 
up to 10% of the component securities may have a trading volume in each 
of the six months prior to the offering of the Notes of not less than 
500,000 shares; (3) at least 90% of the component securities will meet 
the then current criteria for standardized options trading set forth in 
Exchange Rule 915; (4) all components of the Banking Industry Portfolio 
will be listed on the Amex or the New York Stock Exchange, or will be 
National Market securities traded through Nasdaq; (5) all components of 
the Banking Industry Portfolio will be subject to last sale reporting 
pursuant to Rule 11Aa3-1 of the Act; and (6) no more than 20% of the 
weight of the Banking Industry Portfolio shall be represented by 
foreign securities or ADRs for which the Exchange does not have in 
place a comprehensive surveillance sharing agreement with the 
appropriate regulatory organization(s) in such country(ies).\13\
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    \11\The Commission notes that because the Banking Industry 
Portfolio is a static portfolio, the Amex will not make adjustments 
subsequent to issuance of the Notes for purposes of maintaining 
compliance with these standards.
    \12\See Securities Exchange Act Release No. 34157 (June 3, 
1994), 59 FR 30062 (June 10, 1994).
    \13\The exchange has represented that Lehman Brothers may 
conclude prior to issuance of the Notes, based on changes in its 
market research and investment strategy, that the composition of the 
Banking Industry Portfolio should be altered. In such an event, 
Lehman Brothers would be allowed, with the concurrence of the staff 
of the Commission, to replace component securities accounting for up 
to 10% of the number of components of the Banking Industry Portfolio 
(i.e., two components) provided that with the replacement 
components, the Banking Industry Portfolio still satisfies the 
requirements for the listing and trading of options on newly 
established narrow-based indexes. Id. If Lehman Brothers determines 
to make any changes to the Banking Industry Portfolio that do not 
satisfy these conditions, the Exchange would be required to obtain 
approval from the Commission pursuant to Section 19(b) of the Act 
before listing Notes based on the altered Banking Industry 
Portfolio.
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    At the outset, each of the securities in the Banking Industry 
Portfolio will have equal representation. Specifically, each security 
included in the Banking Industry 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 20 companies included in the Banking Industry 
Portfolio will represent approximately 5.0% of the total portfolio at 
the time of issuance.
    The multiplier for each security in the Banking Industry 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\Lehman Brothers 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 Banking Industry 
Portfolio no longer exists, whether for reason of a merger, acquisition 
or similar type of corporate control transaction, then Lehman Brothers 
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, 
Lehman Brothers shall thereafter assign a value to the shares of the 
acquired company's securities equal to the value per share at the time 
that the acquisition takes place.
    If the issuer of a Banking Industry 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 Banking Industry 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 Banking 
Industry Portfolio, for so long as no such market price exists for that 
security.\15\
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    \15\Lehman Brothers 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 Banking Industry Portfolio will be calculated 
continuously by the Amex and will be disseminated every 15 seconds over 
the Consolidated Tape Association's Network B. 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.
    The Notes may not be redeemed prior to maturity and are not 
callable by the issuer. Holders of Banking Industry Portfolio Notes 
will be able to cash-out of their investment by selling the security on 
the Amex. 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 Banking Industry Portfolio 
and also on such other factors as the level of interest rates, the 
volatility of the value of the Banking Industry Portfolio, the time 
remaining to maturity, dividend rates, and the creditworthiness of the 
issuer, Lehman Brothers.
    Because Banking Industry Portfolio Notes are linked to a portfolio 
of equity securities, the Amex's existing equity floor trading rules 
will apply to the trading of Banking Industry Portfolio Notes. First, 
pursuant to Amex Rule 411, 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 Banking Industry Portfolio 
Notes.\16\ Second, consistent with Amex Rule 411, the Exchange will 
further require that a member or member firm specifically approve a 
customer's account for trading Banking Industry Portfolio Notes prior 
to, or promptly after, the completion of the transaction. Third, 
Banking Industry Portfolio Notes will be subject to the equity margin 
rules of the Exchange. Fourth, the Exchange will, prior to trading 
Banking Industry Portfolio Notes, distribute a circular to the 
membership providing guidance with regard to member firm compliance 
responsibilities (including suitability recommendations) when handling 
transactions in Banking Industry Portfolio Notes and highlighting the 
special risks and characteristics of the Banking Industry Portfolio 
Notes.\17\
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    \16\Amex Rule 411 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.
    \17\The circular shall also highlight any cap on appreciation, 
if any, that the issuer includes in the Notes.
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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.\18\ 
Specifically, the Commission believes that providing for exchange-
trading of Banking Industry Portfolio Notes will offer a new and 
innovative means of participating in the market for banking industry 
securities.\19\ In particular, the Commission believes that Banking 
Industry Portfolio Notes will permit investors to gain equity exposure 
in such companies, while at the same time, limiting the downside risk 
of the original investment. For the reasons discussed in the 
Commission's order approving the listing of Basic Industry Portfolio 
Notes,\20\ the Commission finds that the listing and trading of Banking 
Industry Portfolio Notes is consistent with the Act.
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    \18\15 U.S.C. 78f(b)(5) (1988).
    \19\The Commission Notes that the Banking Industry Portfolio 
Notes are very similar in structure to Basic Industry Portfolio 
Notes recently approved for listing on the Amex. See Securities 
Exchange Act Release No. 34820 (October 11, 1994) (``Exchange Act 
Release No. 34820'').
    \20\Id.
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    As with the Basic Industry Portfolio Notes, Banking Industry 
Portfolio Notes are not leveraged instruments. Their price, however, 
will still be derived and based upon the underlying linked securities. 
Accordingly, the level of risk involved in the purchase or sale of 
Banking Industry Portfolio Notes is similar to the risk involved in the 
purchase or sale of traditional common stock. Nonetheless, the 
Commission has several specific concerns with this type of product 
because the final rate or return of the Notes is derivatively priced, 
based on the performance of the underlying securities. The concerns 
include: (1) investor protection concerns, (2) dependence on the credit 
of the issuer of the security, (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 securities.\21\ The Commission believes the Amex has adequately 
addressed each of these issues such that the Commission's regulatory 
concerns are adequately minimized.\22\ In particular, by imposing the 
listing standards, suitability, disclosure, and compliance requirements 
noted above, the Amex has adequately addressed the potential public 
customer concerns that could arise from the hybrid nature of the 
Notes.\23\ Further, the Commission believes that the listing standards 
and issuance restrictions should help to reduce the likelihood of any 
adverse market impact on the securities comprising the Banking Industry 
Portfolio.
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    \21\Id.
    \22\Id.
    \23\The Exchange will also distribute a circular to its 
membership, in a form approved by the Commission, calling attention 
to the specific risks associated with Banking Industry Portfolio 
Notes.
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    The Commission realizes that Banking Industry Portfolio Notes are 
dependent upon the individual credit of the issuer, Lehman Brothers. 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 $1 million for its publicly-held shares.\24\ In addition, the 
Exchange's hybrid listing standards further require that Banking 
Industry Portfolio Notes have at least $4 million in market value.\25\ 
In any event, financial information regarding Lehman Brothers, in 
addition to the information on the issuers of the underlying securities 
comprising the Banking Industry Portfolio, will be publicly 
available.\26\
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    \24\See Amex Company Guide Sec. 1003(b).
    \25\See Amex Company Guide Sec. 107A.
    \26\The companies that comprise the Banking Industry Portfolio 
are reporting companies under the Act.
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    The Commission finds good cause for approving the proposed rule 
change and Amendment No. 1 to the proposal prior to the thirtieth day 
after the date of publication of notice of filing thereof in the 
Federal Register. Specifically, the Commission believes that the 
proposal, as amended, does not raise any regulatory issues that were 
not addressed by the Amex in its proposal to list and trade Basic 
Industry Portfolio Notes.\27\ Additionally, the Exchange's proposal to 
list and trade Basic Industry Portfolio Notes was noticed for the full 
comment period without any comments being received by the Commission. 
Accordingly, the Commission believes that it is consistent with Section 
6(b)(5) of the Act to approve the proposed rule change and Amendment 
No. 1 thereto on an accelerated basis.
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    \27\See Exchange Act Release No. 34820, supra note 19.
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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 submissions, 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 at the Commission's Public 
Reference Section, 450 Fifth Street, NW., Washington, DC 20549. Copies 
of such filings will also be available for inspection and copying at 
the principal office of the Amex. All submissions should refer to File 
No. SR-Amex-94-39 and should be submitted by November 14, 1994.
    It is Therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\28\ that the proposed rule change (File No. SR-Amex-94-39), as 
amended, is approved.

    \28\15 U.S.C. 78s(b)(2) (1988).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\29\
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    \29\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-26169 Filed 10-20-94; 8:45 am]
BILLING CODE 8010-01-M