[Federal Register Volume 60, Number 173 (Thursday, September 7, 1995)]
[Notices]
[Pages 46653-46660]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-22109]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36165; File No. SR-NYSE-94-41]


Self-Regulatory Organizations; New York Stock Exchange, Inc.; 
Order Approving Proposed Rule Change and Notice of Filing and Order 
Granting Accelerated Approval of Amendment No. 1 to Proposed Rule 
Change Relating to the Establishment of Uniform Listing and Trading 
Guidelines for Stock Index, Currency and Currency Index Warrants

August 29, 1995.

I. Introduction

    On November 9, 1994, the New York Stock Exchange, Inc. (``NYSE'' or 
``Exchange'') submitted to the Securities and Exchange Commission 
(``SEC'' or ``Commission''), pursuant to Section 19(b) (``Section 
19(b)'') of the Securities Exchange Act of 1934 (``Act''),\1\ and Rule 
19b-4 thereunder,\2\ a proposed rule change to establish uniform rules 
for the listing and trading of stock index (``index'' or ``stock 
index''), currency (``currency'') and currency index (``currency 
index'') warrants (collectively ``warrants''). Notice of the proposed 
rule change appeared in the Federal Register on December 20, 1994.\3\ 
One comment letter was received in response to the proposal.\4\

    \1\ 15 U.S.C. 78s(b)(1) (1988 & Supp. V 1993).
    \2\ 17 CFR Sec. 240.19b-4 (1994).
    \3\ See Securities Exchange Act Release No. 35095 (Dec. 12, 
1994), 59 FR 65552.
    \4\ See Letter from Paul M. Gottlieb, Seward & Kissell, to 
Jonathan G. Katz, Secretary, Commission, dated January 10, 1995 
(``Comment Letter'' or ``Seward & Kissell Letter'').
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    The Exchange subsequently filed Amendment No. 1 (``Amendment No. 
1'') to the proposal on August 25, 1995. Amendment No. 1 proposes to 
amend the filing in order to respond to the Comment Letter, the 
Commission's comments and to conform certain of the Exchange's proposed 
rules and policies to those filed by other securities markets. This 
order approves the proposal, as amended.

II. Description of the Proposal

    The NYSE proposes to establish uniform rules for the listing and 
trading of stock index, currency and currency index warrants.\5\ 
Paragraphs 703.15 (Foreign Currency Warrants and Currency Index 
Warrants) and 703.17 (Stock Index Warrants Listing Standards) of the 
Listed Company Manual would be amended to provide uniform listing 
criteria for index, 

[[Page 46654]]
currency and currency index warrants. First, warrant issuers would be 
expected to exceed minimum issuer listing standards. In particular, the 
Exchange proposes that issuers be required to have a minimum tangible 
net worth in excess of $250 million or, in the alternative, have a 
minimum tangible net worth in excess of $150 million, provided that the 
issuer does not have (including as a result of the proposed issuance) 
issued outstanding warrants where the aggregate original issue price of 
all such warrant offerings (combined with offerings by its affiliates) 
listed on a national securities exchange or that are National Market 
securities traded through NASDAQ exceeds 25% of the issuer's net 
worth.\6\

    \5\ The proposed rules would apply to both American-style 
warrants (which may be exercised at any time prior to expiration) 
and European-style warrants (which may only be exercised during a 
specified period before expiration).
    \6\ See Amendment No. 1. The Exchange amended this provision in 
response to the Seward & Kissell Letter.
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    Second, the proposal requires that each unexercised in-the-money 
warrant be automatically exercised on either the delisting date (if the 
issue is not listed upon another organized securities market) or upon 
expiration. Third, the proposal provides that for warrant offerings 
where U.S. stocks constitute 25% or more of the index value (``domestic 
index''), issuers shall use opening prices (``a.m. settlement'') for 
U.S. stocks to determine index warrant settlement values at expiration 
of the warrants, as well as the two business days preceding 
expiration.\7\ Fourth, a new paragraph has been added to Para. 703.17 
of the Listed Company Manual to prohibit ``non-U.S. component 
securities'' from constituting more than 20 percent of the weighted 
value of an index stock group that underlies a stock index warrant. For 
purposes of this provision, the term ``non-U.S. component security'' 
means, the stock, or an American Depositary Receipt on the stock, of a 
company that is organized outside of the United States, where more than 
50 percent of the dollar value of the global trading volume of the 
security occurs outside of the United States and that are not subject 
to a comprehensive surveillance agreement with the primary foreign 
market.\8\ Finally, the Exchange proposes to add Rule 414(n), which is 
designed to assist in the surveillance of index warrant trading. 
Specifically, the Exchange will require issuers of stock index warrants 
to notify the Exchange of any early exercises. For domestic index 
warrants, this notice must occur by 4:30 p.m. (New York time) on the 
day that the settlement value for the warrants is determined.\9\

    \7\ See Amendment No. 1. The Exchange amended its proposal in 
response to the Seward & Kissell Letter and will require the use of 
opening prices in calculating index warrant settlement values during 
the 48 hours prior to expiration. Before then, an issuer may use 
either opening or closing prices.
    \8\ See infra note 37 and accompanying text.
    \9\ See Amendment No. 3.
    Rule 431 (``Rule 431''), the NYSE margin rule, is being amended to 
apply the current customer margin requirements for broad based stock 
index and currency options to stock index, currency and currency index 
warrants. Thus, all purchases of warrants will require payment in full, 
and short sales of stock index warrants will require initial margin of: 
(i) 100 percent of the current value of the warrant plus (ii) 15 
percent of the current value of the underlying broad stock index less 
the amount by which the warrant is out of the money, but to a minimum 
of ten percent of the index value. Short sales of currency warrants 
will follow the margin requirements currently applicable to listed 
currency options. Specifically, the Exchange proposes that short sales 
of warrants on the German Mark, French Franc, Swiss Franc, Japanese 
Yen, British Pound, Australian Dollar and European Currency Unit shall 
each be subject to a margin level of 100% of the current market value 
of each such warrant plus a four percent ``add-on.'' \10\ The margin 
required on currency index warrants would be an amount as determined by 
the Exchange and approved by the Commission.\11\ The Exchange also 
proposes that its stock index, currency and currency index warrant 
margin requirements be permitted offset treatment for spread and 
straddle positions. In this regard, the Exchange proposes that index, 
currency and currency index warrants may be offset with either warrants 
or Options Clearing Corporation (``OCC'') issued options on the same 
index, currency or currency index, respectively. Furthermore, the 
Exchange has proposed that subsections (f)(2)(F)(i), (f)(2)(G)(ii) and 
(f)(2)(G)(iii) of Rule 431, to the extent that such rules concern 
spread and straddle positions in warrants, be subject to a one year 
pilot basis.\12\

    \10\ See Amendment No. 2. Consistent with the treatment of 
options on foreign currencies, warrants on the Canadian Dollar will 
be subject to a one percent ``add-on.'' The margin required on any 
other foreign currency would be subject to approval by the 
Commission. See infra note 26.
    \11\ See infra note 26.
    \12\ Three months prior to the expiration of the pilot program, 
the Exchange will submit a report to SEC staff analyzing the price 
relationship between listed warrants and options on similar stock 
indexes. See Amendment No. 1. The Exchange has also requested no-
action relief from the Commission in order to permit certain short 
positions in stock index call and put warrants to be treated as 
covered for margin purposes.
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    Paragraph (f)(2)(H)(iv) of Rule 431 would be amended to permit the 
carrying of ``short'' option positions against the use of letters of 
guarantee or (in the case of a call) ``escrow receipts,'' without the 
need for margin. The amendment proposes to expand that provision to 
include stock index warrants as well as options. The use of ``escrow 
receipts'' to offset a short call option or warrant position would be 
new to the Exchange's margin rules, which currently only allow the use 
of letters of guarantee. However, the margin rules of other U.S. 
options exchanges provide that no margin is required on a short call 
option where a customer has delivered to the firm carrying the 
customer's account a satisfactory escrow receipt. Amendment No. 1 would 
add the escrow receipt concept to the Exchange's margin rules in 
respect of margin on options, as well as on stock index warrants, and 
would do so in a way that generally parallels the permissible use of 
letters of guarantee under the Exchange's margin rules.
    Proposed Rule 414(f) states that no member or member organization 
shall accept an order from a customer for the purchase or sale of 
warrants unless the customer's account has been approved for options 
trading pursuant to Exchange Rule 721. Furthermore, proposed Rules 
414(g)-(k) require that the option rules pertaining to supervision of 
accounts, suitability, discretionary account trading, customer 
complaints and communications to customers be applied to transactions 
in warrants. Finally, prior to trading index, currency or currency 
index warrants, the Exchange will distribute circulars to its 
membership providing guidance regarding member firm compliance 
responsibilities (including suitability recommendations) when handling 
transactions in warrants.
    Proposed Rule 414(c) provides that position limits for stock index 
warrants on the same index with original issue prices of ten dollars or 
less will be fifteen million warrants covering all such issues.\13\ The 
rule provides that warrants with an original issue price of greater 
than ten dollars will be weighted more heavily than warrants with an 
original issue price of ten dollars or less in calculating position 
limits.\14\ The rule also gives the Exchange the authority to require 
the liquidation of a position in stock index warrants that is in excess 
of 

[[Page 46655]]
the position limits set forth in the rule, and Commentary to the rule 
establishes procedures for allowing limited exceptions to the position 
limits.

    \13\ See infra note 39.
    \14\ For example, if an investor held 100,000 warrants based 
upon the Standard & Poor's 500 Index offered originally at $20 per 
warrant, the size of this position for the purpose of calculating 
position limits would be 200,000.
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    Proposed Rule 414(d) provides for exercise limits on stock index 
warrants analogous to those found in stock index options and states 
that such limits are distinct from any exercise limits that may be 
imposed by the issuers of stock index warrants. Accordingly, no member 
may exercise a long position in warrants over a five consecutive day 
period in excess of the permissible position limit.
    In order to facilitate its review of compliance with position and 
exercise limits, the Exchange has proposed Rule 414(c)(v) which 
establishes reporting requirements for large warrant positions. Under 
the terms of the rule, members will be required to file a report with 
the Exchange whenever any account in which the member has an interest 
has established an aggregate position of 100,000 warrants overlying the 
same index, currency or currency index. For purposes of this rule, the 
Exchange proposes that long positions in puts be combined with short 
positions in call warrants, and that short positions in puts be 
combined with long positions in call warrants.\15\ Finally, proposed 
Rule 414(e) requires that the trading halt provisions of Rule 717 shall 
be applied to the trading of stock index warrants.

    \15\ See Amendment No. 1.
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    Upon Commission approval of the foregoing rule amendments, the 
Exchange proposes that it will only file rule changes for specific 
stock index warrant issuances where there is no corresponding option or 
warrant on the same underlying stock index already listed on a national 
securities exchange or included for quotation on NASDAQ. Accordingly, 
when a listed option overlies a particular broad based index, the 
Exchange proposes it be allowed to list warrants on that index without 
further Commission review and approval pursuant to Section 19(b) of the 
Act, as long as the listing complies with the warrant listing standards 
as approved in this Order.\16\

    \16\ See infra note 26.
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III. Comments Received

    The Commission received one letter in response to its request for 
comments on the NYSE proposal.\17\ The Comment Letter was generally 
supportive of the NYSE's proposal, however, it recommended several 
changes in the proposed regulatory structure applicable to stock index, 
currency and currency index warrants. The Comment Letter was submitted 
on behalf of the Firms, all of whom are represented to be major 
participants in the issuance, underwriting and trading of warrants. 
Because the proposed regulatory regime applicable to warrants will, to 
some extent, be based upon the rules governing standardized options, 
the Comment Letter states that the Firms' comments are driven, in part, 
by the fact that fundamental differences exist between warrants and 
standardized options which necessitate disparate regulatory treatment 
in certain situations.\18\

    \17\ See supra note 4. The Seward & Kissel Letter was submitted 
on behalf of PaineWebber Inc., Bear, Stearns & Co. Inc., Lehman 
Brothers Inc., Smith Barney Inc., Salomon Brothers Inc., Morgan 
Stanley & Co. Inc., and Hambrecht & Quist Inc. (correctively the 
``Firms'').
    \18\ The Comment Letter lists several differences which it 
perceives exist between warrants and standardized options. Chief 
among these are: (1) warrants are separately registered, unsecured 
obligations of their issuer while options are issued and guaranteed 
by the Options Clearing Corp. (``OCC''); (2) during the prospectus 
delivery period, warrant purchasers receive a product-specific 
prospectus while options customers receive an options disclosure 
document (``ODD'') at the time the account is opened; (3) each 
warrant creates a fixed number of outstanding warrants while there 
is theoretically no limit to the number of options that may be 
issued by OCC; and (4) warrants are traded on an exchange in a 
manner similar to stocks which, therefore, translates into superior 
price transparency than for listed options.
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    First, the Comment Letter suggested amending the Issuer Listing 
Standards to eliminate the 25% test or, in the alternative, to adopt 
hedging and/or netting standards designed to more accurately reflect 
issuer-specific risk.\19\ Because warrants are sold by means of a 
registration statement, the Firms believe that adequate disclosure of 
the amount of an issuer's outstanding securities could be included in 
the prospectus. Furthermore, the Comment Letter points out that issuers 
of warrants are traditionally subject to outside evaluation by certain 
credit rating agencies, which should assist investors in determining 
undue issuer credit risk. Finally, the Firms do not believe the 25% 
test bears any resemblance to an issuer's risk exposure since exposure 
fluctuates with market changes at any given time and also because the 
proposal provides no recognition for offsetting hedges or for warrants 
subject to netting.

    \19\ As originally proposed, an issuer would have been required 
to have a tangible net worth of at least $150 million and the 
aggregate original issue price of all of a particular issuer's 
warrant offerings (combined with such offerings by its affiliates) 
that are listed on a national securities exchange or that are 
national market securities traded through NASDAQ were not to exceed 
25% of the issuer's net worth (``25% test).
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    In response to the Seward & Kissel Letter's comments respecting 
issuer listings standards, the NYSE amended the filing to add an 
alternative issuer qualification criteria.\20\ Under the new criteria, 
an issuer will be required to either: (a) have a minimum tangible net 
worth of $250 million; or (b) meet the existing criteria (i.e., 
tangible net worth of $150 million and meet the 25% test).

    \20\ See Amendment No. 1.
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    The Comment Letter also recommended allowing the use of p.m. 
settlement for all American-style warrants exercised anytime except 48 
hours prior to expiration, at which time a.m. settlement would be 
required. According to the Comment Letter, unlike with listed options 
(where OCC is the issuer and runs a balanced book), a warrant issuer 
must hedge its exposure to maintain offsetting positions. Upon early 
exercise of the warrants, the issuer that has hedged its exposure will 
have to take action to ``unwind'' the portion of its hedge relating to 
the exercised warrants. The Firms believe that requiring a.m. 
settlement on the first day after an investor exercises the warrant 
will place additional market risk upon them due to the difficulty in 
managing the hedge. This increased hedging cost, the Firm's argue, 
could result in a higher issuance price for the warrant or could 
require that the warrant settlement value date be postponed an 
additional day, with warrant holders bearing additional market risk 
during this period.
    In response to the Comment Letter, the NYSE amended its filing to 
include a provision permitting p.m. settlement for stock index warrants 
except for a short period before expiration.\21\ Under the terms of the 
amendment, stock index warrants for which 25% or more of the value of 
the underlying index is represented by securities that are traded 
primarily in the U.S. shall, by their terms, provide that, on valuation 
date, as well as for the two business days prior to valuation date, the 
value of the stocks traded primarily in the U.S. which underlie such 
warrants shall be determined be reference to the opening prices of such 
underlying U.S. securities. For example, if the valuation date for an 
issuance of index warrants occurs on a Friday, a.m. settlement must be 
utilized for warrants that are valued on the preceding Wednesday or 
Thursday, as well as on the valuation date.

    \21\ See Amendment No. 1.
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    Third, the Comment Letter recommended creating a special category 
of ``warrant eligible'' customers (separate and distinct from options 
eligibility criteria), who are authorized to trade warrants even if not 
approved 

[[Page 46656]]
to trade options. The Firms believe it is inappropriate to apply an 
options regulatory regime to warrants and that doing so may prevent 
institutional customers who are not permitted to purchase options 
products, yet who nevertheless meet all of the options eligibility 
criteria, from purchasing warrants. In this regard, the Firms propose 
to create a ``warrant eligible'' category with standards mimicking 
those currently required for options approved accounts. As such, 
``warrant-approved'' accounts could purchase warrants, however, they 
could not purchase options or other products requiring options account 
approval. The NYSE did not amend its filing in response to this 
comment.
    Fourth, the Comment Letter urges the adoption of a rule permitting 
firms to approve for warrant trading those accounts managed by an 
investment adviser (``IA'') based upon the IA's representation 
concerning the eligibility status of its customers to engage in warrant 
trading, even if the underlying documentation relating to the managed 
accounts is not provided to the brokerage firms. The NYSE has amended 
its proposal to allow member firms to accept the representation of an 
investment adviser registered under the Investment Advisers Act of 1940 
concerning the eligibility status of its customers to engage in warrant 
trading, even if the underlying documentation relating to the managed 
account is not provided to the member firm, where the managed account 
is for an institutional customer or the investment advisor represents 
the collective investment of a number of persons. The NYSE states that 
this will conform the handling of warrant accounts to the current 
practice with respect to listed options accounts.\22\

    \22\ See Amendment No. 1.
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    Finally, the Comment Letter Addressed the proposed position limits 
applicable to warrants. Specifically, the Comment Letter noted that 
position limits for warrants would be set at levels that are 
approximately 75% of that allowed for similar broad-based indexes. The 
Comment Letter recommended establishing position limits for warrants 
that were equivalent to those established for listed options, allowing 
a hedge exemptions similar to listed option procedures and providing a 
mechanism for specific waivers or exemptions of warrant position limits 
for hedgers, market-makers and broker-dealers comparable to the 
procedures in place for listed options. The NYSE did not amend its 
filing in response to this comment.

IV. Discussion

    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).\23\ Specifically, the 
Commission finds that the Exchange's proposal to establish uniform 
listing standards for broad-based stock index, currency and currency 
index warrants strikes a reasonable balance between the Commission's 
mandates under Section 6(b)(5) to remove impediments to and perfect the 
mechanism of a free and open market and a national market system, while 
protecting investors and the public interest. In addition, the NYSE's 
proposed listing standards for warrants are consistent with the Section 
6(b)(5) requirements that rules of an exchange be designed to prevent 
fraudulent and manipulative acts, to promote just and equitable 
principles of trade, and are not designed to permit unfair 
discrimination among issuers.

    \23\ 15 U.S.C. 78f(b)(5) (1982).
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    The NYSE's proposed generic listing standards for broad-based stock 
index warrants, currency and currency indexes set forth a regulatory 
framework for the listing of such products.\24\ Generally, listing 
standards serve as a means for an exchange to screen issuers and to 
provide listed status only to bona fide issuances that will have 
sufficient public float, investor base, and trading interest to ensure 
that the market has the depth and liquidity necessary to maintain fair 
and orderly markets. Adequate standards are especially important for 
warrant issuances given the leveraged and contingent liability they 
represent. Once a security has been approved for initial listing, 
maintenance criteria allow an exchange to monitor the status and 
trading characteristics of that issue to ensure that it continues to 
meet the exchange's standards for market depth and liquidity so that 
fair and orderly markets can be maintained.

    \24\ The Commission notes that warrants issued prior to this 
approval order will continue to be governed by the rules applicable 
to them at the time of their listing.
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    In reviewing listing standards for derivative-based products, the 
Commission also must ensure that the regulatory requirements provide 
for adequate trading rules, sales practice requirements, margin 
requirements, position and exercise limits and surveillance procedures. 
These rules minimize the potential for manipulation and help to ensure 
that derivatively-priced products will not have a negative market 
impact. In addition, these standards should address the special risks 
to customers arising from the derivative products.\25\ For the reasons 
discussed below, the Commission believes the NYSE's proposal will 
provide it with significant flexibility to list index, currency and 
currency index warrants, without compromising the effectiveness of the 
Exchange's listing standards or regulatory program for such 
products.\26\

    \25\ Pursuant to Section 6(b)(5) of the Act, the Commission is 
required to find, among other things, that trading in warrants will 
serve to protect investors and contribute to the maintenance of fair 
and orderly markets. In this regard, the Commission must predicate 
approval of any new derivative product upon a finding that the 
introduction of such derivative instrument is in the public 
interest. Such a finding would be difficult for a derivative 
instrument 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. As discussed below, the Commission 
believes warrants will serve an economic purpose by providing an 
alternative product that will allow investors to participate in the 
price movements of the underlying securities in addition to allowing 
investors holding positions in some or all of such securities to 
hedge the risks associated with their portfolios.
    \26\ Issuances of warrants overlying a single currency may 
currently be listed for trading without a rule filing provided that 
the underlying currency is one of the original seven foreign 
currencies approved for options trading: the Australian Dollar, 
British Pound, Canadian Dollar, French Franc, German Mark, Japanese 
Yen, Swiss Franc and the European Currency Unit. Issuances of 
currency warrants overlying any other foreign currency would require 
a rule filing pursuant to Section 19(b) of the Act. The Commission 
notes that currency index warrants may only be established without a 
further rule filing upon an index that has been previously approved 
by the Commission pursuant to a Section 19(b) filing. To date, the 
only currency index approved pursuant to Section 19(b) is an equal-
weighted index comprised of the British Pound, Japanese Yen and 
German Deutsche Mark. See Securities Exchange Act Release No. 31627 
(Dec. 21, 1992), 57 FR 62399 (Dec. 30, 1992). Accordingly, any other 
currency index (as well as a broad-based stock index) not previously 
approved by the Commission would require approval pursuant to 
Section 19(b).
A. Issuer Listing Standards and Product Design

    As a general matter, the Commission believes that the trading of 
warrants on a stock index, currency or currency index permits investors 
to participate in the price movements of the underlying assets, and 
allows investors holding positions in some or all of such assets to 
hedge the risks associated with their portfolios. The Commission 
further believes that trading warrants on a stock index, currency or 
currency index provides investors with an important trading and hedging 
mechanism that is designed to reflect accurately the overall movement 
of the component securities.

[[Page 46657]]

    Warrants, unlike standardized options, however, do not have a 
clearinghouse guarantee but are instead dependent upon the individual 
credit of the issuer. This heightens the possibility that an exerciser 
of warrants may not be able to receive full cash settlement upon 
exercise. This additional credit risk, to some extent, is reduced by 
the Exchange's issuer listing standards that require an issuer to have 
either; (a) a minimum tangible net worth of $250 million; or (b) a 
minimum tangible net worth of $150 million, provided that the issuer 
does not have (including as a result of the proposed issuance) issued 
outstanding warrants where the aggregate original issue price of all 
such stock index, currency and currency index warrant offerings (or 
affiliates) that are listed on a national securities exchange or traded 
through the facilities of NASDAQ is in excess of 25% of the warrant 
issuer's net worth. Furthermore, financial information regarding the 
issuers of warrants will be disclosed or incorporated in the prospectus 
accompanying the offering of the warrants. Moreover, the alternative 
test addresses the Comment Letter's concerns on the 25% standard.
    The NYSE's proposal will provide issuers flexibility by allowing 
them to utilize either a.m. or p.m. settlement, provided, however, 
domestic index warrants (i.e., warrants based on indexes for which 25% 
or more of the index value is represented by securities traded 
primarily in the U.S.) (``domestic index warrants'') are required to 
utilize a.m. settlement for expiring warrants as well as during the 
last two business days prior to valuation date.\27\ The Commission 
continues to believe that a.m. settlement significantly improves the 
ability of the market to alleviate and accommodate large and 
potentially destabilizing order imbalances associated with the 
unwinding of index-related positions. Nevertheless, in accordance with 
the Comment Letter's suggestions, the use of p.m. settlement except 
during the last two business days prior to a domestic index warrant's 
valuation date, as well as the valuation date, strikes a reasonable 
balance between ameliorating the price effects associated with 
expirations of derivative index products and providing issuers with 
flexibility in designing their products.\28\ In this context, the 
Commission notes that unlike standardized index options whose 
settlement times are relatively uniform, index warrants are issuer-
based products, whose terms are individually set by the issuer. In 
addition, while options may have unlimited open interest, the number of 
warrants on a given index is fixed at the time of issuance. 
Accordingly, it is not certain that there will be a significant number 
of warrants in indexes with similar components expiring on the same 
day. This may reduce the pressure from liquidation of warrant hedges at 
settlement. Nevertheless, the Commission expects the Exchange to 
monitor this issue and, should significant market effects occur as a 
result of early exercises from p.m. settled index warrants, would 
expect it to make appropriate changes including potentially limiting 
the number of index warrants with p.m. settlement.

    \27\ Currency and currency index warrants are not limited to 
a.m. or p.m. settlement.
    \28\ Foreign stock market based index warrants may utilize p.m. 
settlement throughout their duration.
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B. Customer Protection

    Due to their derivative and leveraged nature, and the fact that 
they are a wasting asset, many of the risks of trading in warrants are 
similar to the risks of trading standardized options. Accordingly, the 
NYSE has proposed to apply its options customer protection rules to 
warrants. In particular, the Commission notes that warrants may only be 
sold to options approved accounts capable of evaluating and bearing the 
risks associated with the trading in these instruments, in accordance 
with NYSE Rule 721, and that adequate disclosure of the risks of these 
products must be made to investors.\29\ In addition, the NYSE will 
apply the options rules for suitability, discretionary accounts, 
supervision of accounts and customer complaints to transactions in 
warrants. By imposing the special suitability and disclosure 
requirements noted above, the Commission believes the NYSE had 
addressed adequately several of the potential customer protection 
concerns that could arise from the options-like nature of warrants.

    \29\ Pursuant to NYSE Rule 726, all options approved accounts 
must receive an ODD, which discusses the characteristic and risks of 
standardized options.
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    The ODD, which all options approved accounts must receive, 
generally explains the characteristics and risks of standardized 
options products. Although many of the risks to the holder of an index 
warrant and option are substantially similar, however, because warrants 
are issuer-based products, some of the risks, such as the lack of a 
clearinghouse guarantee and certain terms for index warrants, are 
different. The NYSE had adequately addressed this issue by proposing to 
distribute a circular to its members that will call attention to the 
specific risks associated with stock index, currency and currency index 
warrants that should be highlighted to potential investors. In 
addition, the issuer listing guidelines described above will ensure 
that only substantial companies capable of meeting their warrant 
obligations will be eligible to issue warrants. These requirements will 
help to address, to a certain extent, the lack of a clearinghouse 
guarantee for index warrants. Finally, warrant purchasers will receive 
a prospectus during the prospectus delivery period. The Commission 
believes that this will ensure that certain information about the 
particular issuance and issuer is publicly available.
    As noted above, the Comment Letter indicates that applying the 
options disclosure framework to warrants is inappropriate. However, the 
Commission believes that the combined approach of making available 
general derivative product information (the ODD), product specific 
information (the Exchange circular), and issuer specific information 
(the prospectus) should provide an effective disclosure mechanism for 
these products.
    At this time, the Commission does not agree with the proposal 
contained in the Comment Letter to create a special ``warrant 
eligible'' classification of purchasers. As noted above, index, 
currency and currency index warrants are very similar to standardized 
options. They are so similar that a customer precluded from trading 
options should not avoid the restriction indirectly by being designated 
by Exchange rules as eligible for stock index, currency or currency 
index warrants. Nevertheless, as the range of exchange-traded 
derivative products increases, the SROs might consider in the future as 
to whether a new derivatives eligibility classification is appropriate.

C. Surveillance
    In evaluating proposed rule changes to list derivative instruments, 
the Commission considers the degree to which the market listing the 
derivative product has the ability to conduct adequate surveillance. In 
this regard the Commission notes that the Exchange has developed 
adequate surveillance procedures for the trading of index and currency 
warrants. First, new issues of currency warrants will be subject to the 
NYSE's existing surveillance procedures applicable to foreign currency 
warrants, which the Commission previously has found to be adequate to 
surveil for manipulation and other abuses 

[[Page 46658]]
involving the warrant market and the underlying foreign currencies.\30\

    \30\ See Securities Exchange Act Release No. 24555 (June 5, 
1987), 52 FR 22570 (June 12, 1987), and Securities Act Release No. 
26152 (Oct. 3, 1988), 53 FR 39832 (Oct. 12, 1988). The Commission 
notes that these surveillance procedures only apply to the issuance 
of warrants overlying one of the approved foreign currencies. See 
supra note 26. The issuance of warrants upon any other foreign 
currency would necessitate a Section 19(b) rule filing which, among 
other things, details applicable surveillance procedures.
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    Second, the Exchange has developed enhanced surveillance procedures 
to apply to domestic stock index warrants which the Commission believes 
are adequate to surveil for manipulation and other abuses involving the 
warrant market and component securities.\31\ Among these enhanced 
surveillance procedures, the Commission notes that issuers will be 
required to report to the Exchange on settlement date the number and 
value of domestic index warrants subject to early exercise the previous 
day. The Commission believes that this information will aid the NYSE in 
its surveillance capacity and help it to detect and deter market 
manipulation and other trading abuses.

    \31\ In addition, the Commission notes that issuers will be 
required to report to the Exchange all trades to unwind a warrant 
hedge that are effected as a result of the early exercise of 
domestic index warrants. This will enable the Exchange to monitor 
the unwinding activity to determine if it was effected in a manner 
that violates Exchange or Commission rules.
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    Third, the Exchange has developed adequate surveillance procedures 
to apply to foreign stock index warrants (i.e., less than 25% of the 
index value is derived from stocks traded primarily in the U.S.).\32\ 
The Commission believes that the ability to obtain information 
regarding trading in the stocks underlying an index warrant is 
important to detect and deter market manipulation and other trading 
abuses. Accordingly, the Commission generally requires that there be a 
surveillance sharing agreement \33\ in place between an exchange 
listing or trading a derivative product and the exchange(s) trading the 
stocks underlying the derivative contract that specifically enables the 
relevant markets to surveil trading in the derivative product and its 
underlying stocks.\34\ Such agreements provide a necessary deterrent to 
manipulation because they facilitate the availability of information 
needed to fully investigate a potential manipulation if it were to 
occur.\35\ In this regard, the NYSE will require that no more than 20% 
of an Index's weight may be comprised (upon issuance and thereafter) of 
foreign securities (or ADRs thereon) that do not satisfy one of the 
following tests: (1) The Exchange has in place an effective 
surveillance agreement \36\ with the primary exchange in the home 
country in which the security underlying the ADR is traded; or (2) 
meets an existing alternative standard available for standardized 
options trading (e.g., satisfy the 50% U.S. trading volume test).\37\ 
The Commission believes that this standard will ensure that index 
warrants are not listed upon foreign indexes whose underlying 
securities trade on exchanges with whom the NYSE has no surveillance 
sharing agreement.

    \32\ Each prior issuance of a foreign stock market based index 
warrant is subject to specific surveillance procedures. These 
procedures are generally tailored to the individual warrant issuance 
and are based upon several factors involving the primary foreign 
market, including the existence of surveillance or information 
sharing agreements.
    \33\ The Commission believes that a surveillance sharing 
agreement should provide the parties with the ability to obtain 
information necessary to detect and deter market manipulation and 
other trading abuses. Consequently, the Commission generally 
requires that a surveillance sharing agreement require that the 
parties to the agreement provide each other, upon request, 
information about market trading activity, clearing activity, and 
the identity of the ultimate purchasers for securities. See e.g., 
Securities Exchange Act Release No. 31529 (Nov. 27, 1992).
    \34\ The ability to obtain relevant surveillance information, 
including, among other things, the identity of the ultimate 
purchasers and sellers of securities, is an essential and necessary 
component of a comprehensive surveillance sharing agreement.
    \35\ In the context of domestic index warrants, the Commission 
notes that the U.S. exchanges are members of the Intermarket 
Surveillance Group (``ISG''), which was formed 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 the amendments made thereafter, was 
signed by ISG members on January 29, 1990. See Second Amendment to 
the ISG Agreement.
    \36\ See supra note 33.
    \37\ See Securities Exchange Act Release Nos. 31529, 57 FR 57248 
(Dec. 3, 1992) and 33555, 59 FR 5619 (Feb. 7, 1994).
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D. Market Impact

    The Commission believes that the listing and trading of index 
warrants, currency warrants and currency index warrants will not 
adversely affect the U.S. securities markets or foreign currency 
markets. First, with respect to currency and currency index warrants, 
the Commission notes that the interbank foreign currency spot market is 
an extremely large, diverse market comprised of banks and other 
financial institutions worldwide. That market is supplemented by 
equally deep and liquid markets for standardized options and futures on 
foreign currencies and option on those futures. An active over-the-
counter market also exists in options, forwards and swaps for foreign 
currencies. This minimizes the possibility that Exchange listed 
warrants would be used to manipulate the spot currency markets. In 
addition, the surveillance procedures for these products would allow 
the Exchange to detect and deter potential manipulation involving 
currency warrants and currency index warrants.
    Second, with respect to index warrants, the Commission notes that 
warrants may only be established upon indexes the Commission has 
previously determined to be broad-based in the context of index options 
or warrant trading. As part of its review of a proposal to list an 
index derivative product, the Commission must find that the trading of 
index options or warrants will serve to protect investors, promote the 
public interest, and contribute to the maintenance of fair and orderly 
markets. Accordingly, the Commission does not believe that the issuance 
of index warrants upon previously approved broad based stock index 
options or warrants will adversely impact the underlying component 
securities. In addition, because index warrants are issued by various 
individual issuers who set their own terms, it is likely that 
expirations among similar index products will be varied, thereby 
reducing the likelihood that unwinding hedge activities would adversely 
affect the underlying cash market. Finally, as discussed above, the 
Commission believes that NYSE's enhanced surveillance procedures 
applicable to stock index warrants are adequate to surveil for 
manipulation and other abuses involving the warrant market, component 
securities and issuer hedge unwinding transactions.
    Third, the Exchange has proposed margin levels for stock index and 
currency warrants equivalent to those in place for stock index and 
currency options. The Commission believes these requirements will 
provide adequate customer margin levels sufficient to account for the 
potential volatility of these products. In addition, options margin 
treatment is appropriate given the options-like market risk posed by 
warrants. The Commission notes that the customer spread margin 
treatment applicable to warrants is subject to a one year pilot 
program. This will allow the Exchange to analyze the pricing 
relationships between listed options and warrants on the same index in 
order to determine whether to revise or approve on a permanent basis 
the proposed spread margin rules.\38\

    \38\ The Commission notes that the margin levels for currency 
index warrants will be set at a level determined by the Exchange and 
approved by the SEC. See Amendment No. 1. Issuances of warrants 
listed prior to the approval of this order will continue to apply 
the margin level applicable to them at the time of their listing.

[[Page 46659]]

    Fourth, the NYSE has established reasonable position and exercise 
limits for stock index warrants, which will serve to minimize potential 
manipulation and other market impact concerns.\39\ Contrary to the 
views expressed in the Comment Letter, the Commission believes that in 
the absence of trading experience with domestic index warrants, it 
would be imprudent to establish position limits for positions greater 
than those currently applicable to domestic stock index options on the 
same index.\40\

    \39\ The Commission notes that there are no position or exercise 
limits applicable to currency or currency index warrants, although 
reporting requirements do apply. Nevertheless, the Commission may 
review the need to establish foreign currency position limits if the 
size of the currency or currency index warrant market increases 
significantly.
    \40\ With respect to the Comment Letter's suggestion that a 
hedge exemption rule be established in order to allow participants 
to readily acquire exemptions from the Exchange as needed, the 
Commission does not believe that such an approach is appropriate at 
this time. The hedge exemption for index options was adopted after 
several years experience with index options trading. Until the SROs 
gain some experience with domestic index warrant trading, it is 
difficult to determine the need for a hedge exemption (i.e., that 
speculative limits are insufficient to meet hedging needs).
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V. Conclusion

    The Commission believes that the adoption of these uniform listing 
and trading standards covering index, currency and currency index 
warrants will provide an appropriate regulatory framework for these 
products. These standards will also benefit the Exchange by providing 
them with greater flexibility in structuring warrant issuances and a 
more expedient process for listing warrants without further Commission 
review pursuant to Section 19(b) of the Act. As noted above, additional 
Commission review of specific warrant issuances will generally only be 
required for warrants overlying any non-approved broad-based index or a 
non-approved currency or currency index. If Commission review of a 
particular warrant issuance is required, the Commission expects that, 
to the extent that the warrant issuance complies with the uniform 
criteria adopted herein, its review should generally be limited to 
issues concerning the newly proposed index. This should help ensure 
that such additional Commission review could be completed in a prompt 
manner without causing any unnecessary delay in listing new warrant 
products.
    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 for the 
following reasons. As discussed below, the changes are either (1) minor 
and technical in nature; (2) responsive to the Comment Letter; (3) 
designed to conform to warrant proposals from other markets; or (4) 
modifications to Exchange surveillance procedures. Accordingly, the 
amendments do not raise new significant regulatory issues or are 
responsive to prior comments. In order to enable the Exchange to list 
new index, currency or currency index warrants as soon as possible, the 
Commission believes it is necessary and appropriate to approve the 
amendment on an accelerated basis.
    Amendment No. 1 proposes to make the following changes to the Index 
Warrant Filing:

Changes to Trading Rules

     A definition of ``cross currency'' would be added to Rule 
414(a)(ii).
     The position limit rule (Rule 414(c)(i)) would be amended 
to provide that, in determining compliance with position limits, 
``aggregate stock index warrant position'' refers to warrants ``on the 
same side of the market''.
     A new paragraph 414(c)(v) (``Reports of Index Warrant 
Positions'') would be added to require members and member organizations 
to report aggregate positions in excess of 100,000 warrants.
     The Index Warrant Filing prescribes the use of opening 
prices in determining settlement values for all settlement dates. This 
Amendment No. 1 would amend Paragraph 414(l) (``Settlement Values'') to 
require the use of opening prices in respect of the calculation of 
settlement values on the day of expiration or on the two business days 
prior to expiration. Before then, an issuer may use either opening or 
closing prices in calculating settlement values.
     A new paragraph 414(n) would be added to require the 
reporting of changes in the number of outstanding warrants due to early 
warrant exercises.

Changes to Margin Rules

     A new paragraph would be added to Paragraph (f)(2)(C) of 
Rule 431 (``Margin Requirements'') in order to define ``call'' and 
``put'' in the currency, currency index and stock index warrant 
context.
     A new element would be added to the definition of ``index 
group value'' (see Paragraph (f)(2)(C) of Rule 431): In calculating the 
index group value, one must multiply by the index value (as in the 
Index Warrant Filing), and divide by any applicable divisor for which 
the warrant's prospectus may provide (a new addition).
     Paragraph (f)(2)(D)(i) of Rule 431 contains a chart of 
initial, maintenance and minimum margin requirements. The currency 
warrant section of that chart would be amended so as to list the margin 
requirements for specific currencies. The currency index warrant 
section would be amended to provide that the Exchange will determine 
currency index warrant margin requirements on a case-by-case basis.
     The Index Warrant Filing proposes to provide margin 
advantages to certain option and warrant positions (i.e., certain 
spread and straddle positions) by adding second and third paragraphs to 
Paragraph (f)(2)(F)(1). This Amendment No. 1 would revise the 
permissible offset positions and restate those paragraphs to make them 
easier to read.
     Two paragraphs would be deleted from Paragraph (f)(2)(H). 
The Index Warrant Filing proposes those paragraphs for the purpose of 
addressing margin on ``short'' stock index warrant positions where the 
holder of the position has hedged by replicating the underlying index 
with appropriate positions in the component securities. The paragraphs 
would be replaced by the ``letter of guarantee'' and ``escrow receipt'' 
provisions discussed in the next three bullets.
     Paragraph (f)(2)(H)(iv) (which the Index Warrant Filing 
proposes to renumber as (f)(2)(H)(v)) of Rule 431) would be amended 
(although it was not amended in the Index Warrant Filing). That 
paragraph permits the carrying of ``short'' option positions against 
the use of letters of guarantee or (in the case of a call) escrow 
receipts, without the need for margin. The amendment proposes to expand 
that provision to include stock index warrants as well as options.
     The use of ``escrow receipts'' to offset a position 
carried short would be new to the Exchange's margin rules, which 
currently only allow the use of letters of guarantee. However, the 
margin rules of other United States options exchanges provide that no 
margin is required on a call option where a customer has delivered to 
the firm carrying the customer's account a satisfactory escrow receipt. 
Amendment No. 1 would add the escrow receipt concept to the Exchange's 
margin rules in respect of margin on options, as well as on stock index 
warrants, and would do so in a way that generally parallels the 
permissible use of letters of 

[[Page 46660]]
guarantee under the Exchange's margin rules.
     The definition of two terms that are found in existing 
paragraph (f)(2)(H)(iv) of Rule 431 would be amended. The changed 
definitions would apply in the ``letter of guarantee'' context, as well 
as in the ``escrow receipt'' context.
     The definition of ``qualified security'' would change to 
``a security listed on a national securities exchange'', rather than 
``a security that meets the listing criteria of the Exchange or of the 
American Stock Exchange''.
     The definition of ``cash equivalents'' would change to 
``securities issued or guaranteed by the United States and having a 
maturity of two years or less'', rather than ``those instruments 
referred to in section 220.8(a)(3)(ii) of Regulation T''.
    The changes to both definitions follow similar changes that the 
American Stock Exchange has heretofore effected.
     Paragraph (f)(2)(K) of Rule 431 would be amended to 
specify that the Exchange may specify higher margin for ``warrants'' 
(stated generically) if the Exchange deems circumstances to warrant 
higher margin.
     New Supplementary Material .20 would be added to Rule 431 
to specify that the Exchange will subject the spread and straddle 
margin rules that the Index Warrant Filing proposes to add to 
paragraphs (f)(2)(F)(i), (f)(2)(G)(ii) and (f)(2)(G)(iii) of Rule 431 
to a one-year pilot program. The Exchange would submit to the 
Commission three months prior to the expiration of the pilot programs a 
report analyzing the price relationship between listed warrants and 
options on similar stock indexes.

Changes to Listing Standards

     The ``net worth''/``asset'' test applicable to issuers of 
currency, currency index or stock index warrants would be amended. (See 
paragraph (a) of Para. 703.15 of the Listed Company Manual in respect 
of currency and currency index warrants and paragraph (a) of Para. 
703.17 of the Listed Company Manual in respect of stock index 
warrants.) Under the new test, an issuer may satisfy the test if it has 
minimum tangible net worth in excess of $250 million. Alternatively, as 
in the Index Warrant Filing, the issuer may have minimum tangible net 
worth in excess of $150 million if its total currency, currency index 
and stock index warrants do not exceed 25 percent of its net worth.
     Para. 703.15 and Para. 703.17 of the Listed Company Manual 
would limit the term of currency, currency index and stock index 
warrants to between one and five years.
     A new paragraph would be added to Para. 703.17 of the 
Listed Company Manual to prohibit ``non-United States component 
securities'' that are not subject to comprehensive surveillance 
agreements from constituting more than 20 percent of the weighted value 
of an index stock group that underlies a stock index warrant.
    Finally, the Index Warrant Filing proposes to introduce Rule 414(h) 
(``Suitability''), which would limit trading by customers in currency, 
currency index or stock index warrants to options-approved accounts. In 
the case of an institutional account or an investment club or other 
collective account, the Exchange would allow a member organization to 
accept the representation of a registered investment adviser as to the 
eligibility of the institution or collective investment group, even if 
the managed account is lacking the underlying documentation.
    As mentioned above, because the changes are either (1) minor and 
technical in nature; (2) responsive to the Comment Letter; (3) designed 
to conform to warrant proposals from other markets; or (4) 
modifications to Exchange surveillance procedures, the Commission 
believes it is appropriate to approve Amendment No. 1 on an accelerated 
basis.
    Therefore, the Commission believes it is consistent with Sections 
6(b)(5) and 19(b)(2) of the Act to approve Amendment No. 1 to the 
NYSE's proposal on an accelerated basis.

VI. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 1. 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 above-mentioned 
self-regulatory organization. All submissions should refer to the file 
number in the caption above and should be submitted by September 28, 
1995.
    It therefore is ordered, pursuant to Section 19(b)(2) of the 
Act,\41\ that the proposed rule change (SR-NYSE-94-41) is approved, as 
amended, with the portion of the rule change relating to spread margin 
treatment being approved on a one year pilot program basis, ending 
August 29, 1996.

    \41\ 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.\42\

    \42\ 17 CFR Sec. 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-22109 Filed 9-6-95; 8:45 am]
BILLING CODE 8010-01-M