[Federal Register Volume 61, Number 96 (Thursday, May 16, 1996)]
[Notices]
[Pages 24846-24849]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-12235]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37188; International Series Release No. 976: File No.
SR-NYSE-96-08]
Self-Regulatory Organizations; New York Stock Exchange, Inc.;
Notice of Filing and Order Granting Accelerated Approval of Proposed
Rule Change Relating to Commodity Indexed Preferred Securities
May 9, 1996.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on April 8,
1996, the New York Stock Exchange, Inc. (``NYSE'' or ``Exchange'')
filed with the Securities and Exchange Commission (``Commission'' or
``SEC'') the proposed rule change as described in Items I and II below,
which Items have been prepared by the NYSE. This Order approves the
proposed rule change on an accelerated basis and also solicits comments
on the proposed rule change from interested persons.
I. Self-Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change
The Exchange proposes to list under Paragraph 703.19 of the Listed
Company Manual (``Manual'') Commodity Futures Index Preferred
Securities (``Securities''). The Securities are intermediate term
securities whose value will be linked, in part, to changes in the 11
individual commodities (or the futures contracts overlying such
commodities) that comprise the J.P. Morgan Commodity Index or its
subindices.
The Securities either will be linked: (1) directly to the price of
a futures contract on the commodity, (2) to an ``Excess Return Index''
of the commodity, or (3) to a ``Total Return Index'' of the commodity.
An Excess Return Index represents the cumulative returns of investing
in unleveraged positions in nearby commodity futures contracts and
constantly rolling the position forward to the next designated contract
as the contract nears expiration. The Total Return Index consists of
the Excess Return Index plus the return on three-month Treasury Bills.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the NYSE included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. NYSE has prepared summaries, set forth in Sections
(A),(B), and (C) below, of the most significant aspects of such
statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
The Exchange proposes to list the Securities pursuant to Para.
703.19 of the Manual. Under Para. 703.19, the issuer will be either a
listed company, an affiliate of a listed company or a company that
meets NYSE listing criteria. It currently is anticipated that the
issuer will be a financing subsidiary of a listed company.
The Securities. The Securities will be preferred securities or debt
securities with a term of two to ten years listed pursuant to Para.
703.19 of the Manual. The redemption price of the Securities will be
based, in part, on the 10-day average level of the value of the
underlying individual commodity (or futures contract) during the 20
days prior to maturity of the Securities. At redemption, holders will
receive par value times a percentage calculated by dividing the ending
value of the underlying commodity (or futures contract) by the
beginning value of the underlying commodity (or futures contract). Such
percentage may be greater or less than 100 percent and, therefore, at
redemption, the holder could receive less than the original issue
amount of the Securities.\1\ The following chart describes the linked
contracts:
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\1\ The underwriter of the Securities has advised the NYSE that
the Securities will comply with the ``hybrid exemption'' of the
Commodity Futures Trading Commission (``CFTC''), 17 CFR part 34. The
underwriter has further advised the Exchange that it has presented a
description of the structure and sample term sheet of the Securities
to the staff of the CFTC, who have not raised any objections.
[[Page 24847]]
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Official
No. commodity name Exchange Units per Contract used
and units contract
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1.. Aluminum $/MT LME............ 25 tons........ Third Wednesday
(Metric Tons). of Mar, Jun,
Sep and Dec.
2.. Copper $/MT..... LME............ 25 tons........ Third Wednesday
of Mar, Jun,
Sep and Dec.
3.. Nickel $/MT..... LME............ 6 tons......... Third Wednesday
of Mar, Jun,
Sep and Dec.
4.. Zinc $/MT....... LME............ 25 tons........ Third Wednesday
of Mar, Jun,
Sep and Dec.
5.. Heating Oil #2 $/ NYMEX.......... 42,000 gal..... Every month.
gal.
6.. Natural Gas $/MM NYMEX.......... 10,000 MM BTU.. Every month.
BTU.
7.. Unleaded Gas $/ NYMEX.......... 42,000 gal..... Every month.
gal.
8.. WTI Light Sweet NYMEX.......... 1,000 bb1...... Every month.
Crude $/BBL.
9.. Platinum $/troy NYMEX.......... 50 troy oz..... Jan, Apr, Jul,
oz. Oct.
10. Gold............ COMEX.......... 100 troy oz.... Feb, Apr, Jun,
Aug and Dec.
11. Silver.......... COMEX.......... 5,000 troy oz.. Mar, May, Jul,
Sep and Dec.
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The Securities will meet the listing criteria of Para. 703.19.
Thus, if the Securities are listed and traded as equity securities:
there will be at least one million Securities outstanding; the
Securities will have a market value of at least $4 million; and there
will be at least 400 holders of the Securities. If the Securities are
listed and traded as debt securities, there will be a minimum public
market value of at least $4 million. Equity margin will apply to all
Securities, whether listed as debt or equity.
The Indices. Securities linked to an Excess Return Index will pay
dividends or interest (collectively, ``Distributions'') at a specified
rate. The value of the Securities will be calculated with reference to
the prices of nearby futures contracts on the applicable commodity. An
independent calculation agent will calculate and disseminate the value
of the Securities every 60 seconds during the trading day. The daily
change in value is derived exclusively from the daily profit or loss on
such futures positions. Over time, the elements of this change can be
described as having two components: the change in price in the nearby
contract (``price return'') and the cost of carry imbedded in the
futures contract forward curve (``roll return'').\2\
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\2\ These are accounting terms used to describe the elements
comprising the return associated with the Index. Changes in the
value of the Securities actually result solely from the cumulative
profit and loss on the futures position overlying the applicable
commodity.
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The price return is the change in price on the nearby futures
contracts. The roll return is the yield that is potentially available
as a result of the difference between the prices for shorter-term
futures positions and longer-term futures positions. These prices could
differ depending on a variety of factors, including market expectation
of price trends and general supply and demand. Historically, many
commodity markets have been in ``backwardation'' for extended periods.
That creates an opportunity to increase return by creating longer-dated
positions and ``rolling'' positions forward as they expire. However,
there is no guarantee that such a strategy will produce a positive
return. If prices for shorter-dated positions are less than the prices
for longer-dated positions (a situation known as ``contango''), there
would be a negative return to the roll over time.
If the Securities are linked to a Total Return Index, in addition
to price return and roll return, the concept of ``collateral return''
will be included when determining the value of the Securities.
Collateral Return incorporates the component of returns on U.S.
Treasury Bills that would arise if the face amount of the investment is
fully collateralized by Treasury Bills. While commodities investors are
not obligated to collateralize their positions fully, this return is
included to facilitate accurate comparison of the performance of an
investment in commodities relative to an investment in financial assets
such as a stock or bond portfolio. Under the Total Return methodology,
the Securities would either not have a separate Distribution or the
Distribution would be substantially less than if the Excess Return
methodology were used.
If the Securities are linked directly to the price of the
commodity, there will be no element of roll return, collateral return
or total return in the pricing. Rather, the holders of the Securities
will receive Distributions on the face value of their Securities. The
frequency and rates of such Distributions will vary from issue to issue
depending upon prevailing interest rates and other factors, including
the price of the linked commodity.
The design, composition and calculation of a Total Return or Excess
Return Index is expected to remain unchanged during the term of the
Securities. If market developments require changes to these aspects of
the product, decisions regarding such changes will be made by the JPMCI
Policy Committee, a neutral business committee. This committee consists
of senior employees in the commodities and research areas of J.P.
Morgan, as well as independent industry and academic experts. Personnel
from J.P. Morgan's commodities group serve only in an advisory, non-
voting role on the committee. J.P. Morgan immediately will notify the
Exchange and vendors of financial information if there is a change in
the design, composition or calculation of the Securities.
If it becomes necessary to choose a replacement price source for
the Securities, the new price source will meet the following criteria:
(i) it will be priced in U.S. dollars, or if priced in a non-U.S.
currency, the exchange on which the contract is traded must publish an
official exchange rate for conversion of the price into U.S. dollars
and such currency must be freely convertible into U.S. currency; (ii)
it will be traded on a regulated futures exchange in an OECD country\3\
or in Singapore; and (iii) it will have a minimum annual volume of
300,000 contracts or US $500 million. The issuer will notify the
Exchange and vendors of financial information immediately if there is a
change to the Securities.\4\
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\3\ The OECD--the Organization of Economic Cooperation and
Development--consists of the United States, Japan, Germany, France,
Italy, the United Kingdom, Canada, Australia, Austria, Belgium,
Denmark, Finland, Greece, Iceland, Ireland, Luxembourg, Mexico,
Netherlands, New Zealand, Norway, Portugal, Spain, Sweden,
Switzerland and Turkey.
\4\ See Memorandum from David Seaman, JPMorgan, to Vincent
Patten, NYSE, dated May 6, 1996.
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Members of the JPMCI Policy Committee and employees of the
calculation agent that are involved in the calculation of, or data
collection for, the Securities are prohibited from trading the
underlying futures positions or the Securities. In addition, the
calculation agent has adopted such reasonable and appropriate
procedures to ensure that it, its agents, affiliates and
[[Page 24848]]
employees do not take advantage of, or communicate to any other person,
any knowledge concerning changes in the value of an Index.
Surveillance. The Exchange will be able to obtain market
surveillance information, including customer identity information, with
respect to transactions occurring on the applicable futures exchange
pursuant to its information sharing agreement with such exchange. The
Exchange will not trade any security unless it has a surveillance
agreement with the market trading the underlying futures contract. In
the extremely unlikely event that the securities are no longer based on
an exchange-traded futures contract (if, for example, that exchange no
longer trades a particular futures contract), the J.P. Morgan Policy
Committee will seek to substitute a similar futures contract. In that
situation, in addition to the conditions listed above, the Exchange
would continue to trade the Securities only if the new futures contract
underlying the Securities trade on an exchange that has a comprehensive
information sharing agreement with the NYSE or if the Commission staff
otherwise concurs in the continuation of such trading.\5\
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\5\ The NYSE has comprehensive surveillance sharing agreements
with all of the exchanges upon which the futures contracts relating
to a particular Securities trade. Specifically, NYSE is able to
obtain market surveillance information, including customer identity
information, for transactions occurring on NYMEX and Comex.
Furthermore, under the ISG information sharing agreement, SFA will
be able to provide, upon NYSE request, surveillance information with
respect to trades effected on the LME, including client identity
information. Finally, if the underlying commodity for an issuance of
Securities changes or if a different market is utilized for purposes
of calculating the value of a designated futures contract, the NYSE
will ensure that it has entered into a surveillance sharing
agreement with respect to the new relevant market.
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Sales Practices. Because there is an element of derivative pricing
regarding the Securities, the Exchange will require members, member
organizations and their employees to make a determination with respect
to customers whose accounts have not previously been approved to trade
futures or options that a transaction in the Securities is suitable for
such customer. In addition, members, member organizations and their
employees recommending a transaction in the Securities will be
required: (i) to determine that the recommend transaction is suitable
for the customer; and (ii) to have a reasonable basis for believing
that the customer can evaluate the special characteristics of, and is
able to bear the financial risks of, the recommended transaction.
The Exchange also will distribute a circular to its membership
prior to the commencement of trading in the Securities. That circular
will provide guidance with respect to member firm compliance
responsibilities (including suitability recommendations) when handling
transactions in the Securities and highlighting the special risks and
characteristics thereof.
Basis--The basis under the Securities Exchange Act of 1934 (``1934
Act'') for this propose rule change is the requirement under Section
6(b)(5) that an exchange have rules that are designed to prevent
fraudulent and manipulative acts and practices, to promote just and
equitable principles of trade, to remove impediments to and perfect the
mechanism of a free and open market and a national market system, and,
in general, to protect investors and the public interest.
B. Self-Regulatory Organization's Statement on Burden on Competition
The Exchange believes that the proposed rule change will not result
in any burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
Comments were neither solicited nor received.
III. 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). In particular, the
Commission believes that the availability of exchange-traded Securities
will provide an instrument for investors to achieve desired investment
objectives (e.g., commodity exposure and portfolio diversification)
through the purchase of an exchange-traded securities product linked to
one of the single commodities noted above.\6\ For the reasons discussed
below, the Commission has concluded that the NYSE listing standards
applicable to Securities are consistent with the Act.
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\6\ Pursuant to Section 6(b)(5) of the Act the Commission must
predicate approval of exchange trading for new products upon a
finding that the introduction of the product is in the public
interest. Such a finding would be difficult with respect to a
product that served no investment, hedging or other economic
function, because any benefits that might be derived by market
participants would likely 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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The Securities are similar in structure to a previous American
Stock Exchange (``Amex'') product, Commodity Indexed Preferred
Securities (``ComPS''), which the Commission approved in February
1996.\7\ ComPS were listed pursuant to Section 107 of the Amex Company
Guide, Other Securities, and, like the NYSE Securities, the principal
value of ComPS is derived from the performance of futures contracts
overlying certain selected physical commodities.
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\7\ See Securities Exchange Act Release No. 36885 (February 26,
1996).
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The value of the Securities will be affected partially by certain
risks that are associate with the purchase and sale of exchange-traded
futures contracts. Furthermore, the Commission notes that the prices of
commodities, including the eleven individual commodities which may
underlie a particular Securities issuance, may be subject to volatile
price movements caused by numerous factors.\8\ Accordingly, an
investment in Securities may also be subject to volatile price
movements due to price changes in the underlying commodities and
related futures contracts. In addition, Securities possess many complex
features, such as the incorporation of roll return and collateral
return into their pricing methodologies.
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\8\ Such factors include, but are not limited to, international
economic, social and political conditions and levels of supply and
demand for the individual commodities.
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In order to address the complex and risky nature of Securities, the
NYSE has proposed special suitability, disclosure, and compliance
requirements. First, the Exchange will require members to make a
determination with respect to customers whose accounts have not
previously been approved to trade futures or options that a transaction
in the proposed securities is suitable for such customer.\9\ This is
important given the embedded derivative component of Securities.
Second, the NYSE will require that members who make recommendations in
Securities determine that the transaction recommended is suitable for
the customer and have a reasonable basis for believing that the
customer can evaluate the special characteristics of, and is able to
bear the financial risks of, the recommended transaction. Third,
because Securities are cash-settled, holders will not receive, nor be
required to liquidate, the underlying physical commodities or overlying
futures
[[Page 24849]]
contracts. The Commission notes that this provision will effectively
terminate a Securities investor's exposure to commodity market risk at
the security's maturity and limit an investor's loss to the amount of
his initial investment. Finally, the Exchange plans to distribute a
circular to its membership calling attention to the specific risks
associated with Securities.\10\ This will assist members in determining
the customers eligible to trade Securities, formulating recommendations
in Securities, and in monitoring customer and firm transactions in
Securities.
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\9\ Such a requirement is more than the duty to know and approve
customers, and entails an obligation to make a determination that
the transaction is suitable for the customer.
\10\ The NYSE circular will be submitted to the Commission for
its review and should include, among other things, a discussion of
those risks which may cause commodities to experience volatile price
movements in addition to details on the pricing methodology to be
used for that particular issuance.
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The Commission also believes that several factors significantly
minimize the potential for manipulation of Securities. First, each of
the futures contracts overlying the commodities is relatively actively
traded, and has considerable open interest. Second, the majority of
futures contracts overlying the component commodities trade on
exchanges that impose position limits on speculative trading activity,
which are designed, and serve, to minimize potential manipulation and
other market impact concerns. Third, as discussed below, the NYSE has
entered into certain surveillance sharing agreements with each of the
futures exchanges upon which the underlying designated futures
contracts trade. These agreements should help to ensure the
availability of information necessary to detect and deter potential
manipulations and other trading abuses, thereby making Securities less
readily susceptible to manipulation. Fourth, the price of Securities
(with respect to those commodities traded in the U.S.) will be
calculated every 60 seconds and disseminated to vendors of electronic
financial information. Fifth, adequate procedures are in place to
prevent the misuse of information by members of the policy committee
responsible for replacements with respect to the underlying
contract.\11\ Accordingly, for the reasons discussed above, the
Commission believes that Securities are not readily susceptible to
manipulation and that in any event, the surveillance procedures in
place are sufficient to detect and deter potential manipulation.
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\11\ As discussed above, members of the policy committee are
expressly prohibited from trading Securities and from communicating
any knowledge concerning changes in the value of the underlying
commodities. The NYSE has advised that it has surveillance
procedures in place to periodically review activity in the
Securities, including the ability to monitor any activity in the
Securities by members of the JPMCI. Telephone conversation between
Vincent Patten, NYSE, and Stephen M. Youhn, SEC, on May 7, 1996.
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The Commission notes that Securities, unlike standardized options,
do not contain a clearinghouse guarantee but are instead dependent upon
the individual credit of the issuer. This heightens the possibility
that a purchaser of Securities may not be able to receive any cash
payment due upon maturity. To some extent this credit risk is minimized
by the Exchange's listing guidelines requiring Securities issuers to
comply with the listing requirements of Para. 703.19(1).\12\ In
addition, financial information regarding the issuer will be disclosed
or incorporated in the prospectus accompanying the offering of
Securities.
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\12\ Paragraph 703.19(1) of the Manual states that if the issuer
is a NYSE-listed company, the issuer must be a company in good
standing (i.e., above Continued Listing Criteria): if an affiliate
of an NYSE-listed company, the NYSE-listed company must be a company
in good standing; if not listed, the issuer must meet NYSE specific
original listing standards. These standards, among other things, set
forth minimum requirements for net tangible assets, net income, and
aggregate market value of publicly held shares.
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Based on the above, the Commission finds that the proposal to trade
the Securities is consistent with the Act, and, in particular, the
requirements of Section 6(b)(5).\13\
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\13\ The Commission notes that a Rule 19b-4 filing might be
required in order to list any other derivative product based upon a
commodity interest that differs from the proposed Securities.
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The Commission finds good cause for approving the proposed rule
change prior to the thirtieth day after the date of publication of
notice thereof in the Federal Register in order to allow NYSE to list
the Securities without delay. The proposal will provide the Exchange
with increased flexibility in the listing of commodity linked products
without compromising investor protection concerns. In addition, the
NYSE proposal is nearly identical to the Amex ComPS proposal, with the
securities being based on the same commodities underlying the futures
contracts, and subject to the same valuation methods used for ComPS.
The Amex proposal was subject to the full notice and comment period and
the Commission notes that no comment letters were received.
Accordingly, the Commission does not believe the NYSE proposal raises
any new or unique regulatory issues. For these reasons, the Commission
believes there is good cause, consistent with Sections 6(b)(5) and
19(b)(2) of the Act, to approve the proposed rule change on an
accelerated basis.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street NW., Washington, D.C. 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, N.W.,
Washington, D.C. 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 June 6, 1996.
It therefore is ordered, pursuant to Section 19(b)(2) of the
Act,\14\ that the proposed rule change (SR-NYSE-96-08) is approved.
\14\ 15U.S.C. 78s(b)(2) (1988).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\15\
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\15\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-12235 Filed 5-15-96; 8:45 am]
BILLING CODE 8010-01-M