[Federal Register Volume 63, Number 74 (Friday, April 17, 1998)]
[Notices]
[Pages 19280-19282]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-10184]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39853; File No. SR-Amex-97-48]


Self-Regulatory Organizations; American Stock Exchange, Inc.; 
Order Granting Approval To Proposed Rule Change Relating to Listing and 
Trading of Index Warrants on the Merrill Lynch 1998 Equity Focus Index

April 13, 1998.

I. Introduction

    On December 22, 1997, the American Stock Exchange, Inc. (``Amex'' 
or ``Exchange'') submitted to the Securities and Exchange Commission 
(``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 thereunder,\2\ a 
proposed rule change to approve for listing and trading index warrants 
based on the Merrill Lynch 1998 Equity Focus Index (``Index'').
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    The proposed rule change was published for comment in the Federal 
Register on February 3, 1998.\3\ No comments were received on the 
proposal. This order approves the proposed rule change.
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    \3\ See Securities Exchange Act Release No. 39580 (January 26, 
1998) 63 FR 5577.
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II. Description of the Proposal

    The purpose of the proposed rule change is to permit the Exchange 
to list and trade cash-settled index warrants based on the Index, an 
equal-dollar weighted index developed by Merrill Lynch, Pierce, Fenner 
& Smith, Inc. The Exchange has represented that the listing and trading 
of warrants based on the Index will comply in all respects with Amex 
Rules 1100 through 1110 and Section 106 of the Amex Company Guide.

Design of the Index

    The Exchange has represented that the Index is narrow-based \4\ and 
composed of the stocks (or American Depositary Receipts (``ADRs'') 
thereon) of 17 companies \5\ representing various industries that are 
traded on the New York Stock Exchange (``NYSE'') or through the 
facilities of the National Association of Securities Dealers Automated 
Quotation system (``Nasdaq''). The Index is equal-dollar weighted and 
is, therefore, designed to ensure that each of the component securities 
is initially represented in an approximately ``equal'' dollar amount in 
the Index. Accordingly, each of the 17 companies included in the Index 
will represent approximately 5.882 percent of the weight of the Index 
at the time of issuance of the warrant. The Index multipliers will be 
determined to yield an Index value of 100.00 on the date the warrant is 
priced for initial offering to the public.
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    \4\ Telephone conversation between Claire McGrath, Vice 
President and Special Counsel, Amex, and Deborah Flynn, Division of 
Market Regulation (``Division''), Commission, on January 22, 1998.
    \5\ The component securities of the Index are as follows: Bank 
of New York Co., Inc.; Chubb Corp.; Comcast Corporation; Cracker 
Barrel Old Country Stores; Delta Airlines, Inc.; DST Systems, Inc.; 
Federal National Mortgage Association; Guidant Corporation; Masco 
Corp.; Office Depot, Inc.; Pfizer, Inc.; Protective Life Corp.; 
Questar Corp.; Tenet Healthcare Corp.; Telecom Italia SpA; KLM Royal 
Dutch Airlines; and Toyota Motor Corporation.
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    According to the Amex, the total market capitalization of the Index 
totaled $380 billion on December 10, 1997. The median capitalization of 
the companies in the Index on that date was $9.4 billion and the 
average market capitalization of these companies was $22 billion. The 
individual market capitalization of the companies ranged from $1.7 
billion to $106 billion. In addition, minimum monthly trading volume in 
the Index stocks ranged from approximately 330,000 shares to 54.4 
million shares during the six month period from June through November 
1997.
    According to the Exchange, 15 of the Index's 17 component 
securities meet the current criteria for standardized options trading 
set forth in Rule 915. Only two component securities, Telecom Italia 
SpA and Toyota Motor Corporation, are represented by ADRs and according 
to the Amex, in both instances, comprehensive surveillance sharing 
arrangements are in place with the appropriate regulatory authorities 
in each relevant country. The Amex represents that no component 
security represents more than 25% of the weight of the index and the 
five highest weighted securities do not account for more that 50% of 
the weight of the Index.
    Amex contemplates listing a single issuance of warrants based on 
the Index,\6\ with a term ranging from one to three years. If the Amex 
seeks to list and trade other products based on the Index, including 
other issuances of Index warrants, the Exchange will advise the 
Commission to determine whether an additional filing pursuant to Rule 
19b-4 \7\ is necessary. In addition, if the term of the warrants 
exceeds one year, the Exchange will monitor the options eligibility of 
the underlying securities. If less that 75% of the weight of the Index 
is composed of securities that are options eligible, the Amex will 
notify the Commission.\8\
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    \6\ Telephone conversation between Claire McGrath, Vice 
President and Special Counsel, Amex, and Deborah Flynn, Division, 
Commission, on January 22, 1998.
    \7\ 17 CFR 240.19b-4.
    \8\ Telephone conversation between Claire McGrath, Vice 
President and Special Counsel, Amex, and Deborah Flynn, Division, 
Commission, on April 8, 1998.
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Maintenance of the Index

    Shares of a component stock may be replaced (or supplemented) with 
other securities under certain circumstances, such as the conversion of 
a component stock into another class of security, the

[[Page 19281]]

termination of a depositary receipt program or the spin-off of a 
subsidiary. If the stock remains in the Index, the multiplier of that 
security in the portfolio may be adjusted to maintain the component's 
relative weight in the Index at the level immediately prior to the 
corporate action. In the event that a security in the Index is removed 
due to a corporate consolidation and the holders of such security 
receive cash, the cash value of such security will be included in the 
Index and will accrue interest at LIBOR to term, compounded daily.

Trading of the Index Warrants

    The Index warrants will be direct obligations of their issuer 
subject to cash-settlement during their term, and either exercisable 
throughout their life (i.e., American style) or exercisable only on 
their expiration date (i.e., European style). Upon exercise, or at the 
warrant expiration date (if not exercisable prior to such date), the 
holder of a warrant structured as a ``put'' would receive payment in 
U.S. dollars to the extent that the Index has declined below a pre-
stated index level. Conversely, holders of a warrant structured as a 
``call'' would, upon exercise or at expiration, receive payment in U.S. 
dollars to the extent that the Index has increased above the pre-stated 
index level. If ``out-of-the-money'' at the time of expiration, the 
warrants would expire worthless.

Calculation and Dissemination of the Value of the Index

    Similar to other stock index values published by the Exchange, the 
value of the proposed Index will be calculated continuously and 
disseminated every 15 seconds over the Consolidated Tape Association's 
Network B.
    The multiplier of each of the 17 component stocks in the Index 
portfolio will remain fixed except in the event of certain types of 
corporate actions. Such corporate action includes the payment of a 
dividend other than an ordinary cash dividend, stock distribution, 
stock split, reverse stock split, rights offering, distribution, 
reorganization, recapitalization, or similar event. The multiplier of 
each component stock may also be adjusted, if necessary, in the event 
of a merger, consolidation, dissolution or liquidation of an issuer or 
in certain other events such as the distribution of property by an 
issuer to shareholders, the expropriation or nationalization of an 
issuer or the imposition of certain foreign taxes on shareholders of a 
foreign issuer.

Listing and Trading of the Index Warrants

    As stated above, the listing and trading of the proposed warrants 
on the Index will comply in all respects with Amex Rules 1100 through 
1110 and Section 106 of the Amex Company Guide. These provisions will 
govern all aspects of the listing and trading of the Index warrants, 
including issuer eligibility,\9\ position and exercise limits,\10\ 
reportable positions,\11\ and trading halts and suspensions.\12\
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    \9\ See Section 106 of the Amex Company Guide.
    \10\ See Amex Rules 1107 and 1108.
    \11\ See Amex Rule 1110.
    \12\ See Amex Rule 1109.
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    In addition, these warrants will be sold only to accounts approved 
for the trading of standardized options \13\ and the Exchange's options 
suitability standards will apply to recommendations regarding Index 
warrants.\14\ Finally, the Amex will distribute a circular to its 
membership, prior to the commencement of trading, calling attention to 
specific risks associated with warrants on the Index.
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    \13\ See Amex Rule 1101.
    \14\ See Amex Rule 1102.
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III. Discussion

    The Commission finds that the proposed rule change, as amended, is 
consistent with the requirements of Section 6 of the Act \15\ and the 
rules and regulations thereunder applicable to a national securities 
exchange.\16\ Specifically, the Commission believes that the proposed 
rule change is consistent with and furthers the objectives of Section 
6(b)(5) of the Act \17\ in that the trading of warrants based on the 
Index will serve to protect the public interest and will help to remove 
impediments to a free and open market by providing investors holding 
positions in some or all of the securities underlying the Index with a 
means to hedge exposure to the market risk associated with their 
portfolios.\18\
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    \15\ 15 U.S.C. 78f.
    \16\ In approving this rule, the Commission notes that it has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \17\ 15 U.S.C. 78f(b)(5).
    \18\ Pursuant to Section 6(b)(5) of the Act, the Commission must 
predicate approval of any new securities product upon a finding that 
the introduction of such product is in the public interest. Such a 
finding would be difficult with respect to a warrant that served no 
hedging or other economic function, because any benefits that might 
be derived by market participants likely would be outweighed by the 
potential for manipulation, diminished public confidence in the 
integrity of the markets, and other valid regulatory concerns.
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    Nevertheless, the trading of warrants on the Index raises several 
concerns relating to the design and maintenance of the Index, customer 
protection, surveillance, and market impact. The Commission believes 
however, for the reasons discussed below, that the Amex has adequately 
addressed these concerns.
    The Commission finds that it is appropriate and consistent with the 
Act for the Amex to designate the Index as narrow-based for warrant 
trading as the Index is composed of a limited number of stocks. The 
Commission believes that the liquid markets, large capitalizations and 
relative weightings of the Index's component stocks significantly 
minimizes the potential for manipulation of the Index. First, the 17 
stocks that comprise the Index, of which 14 trade on the NYSE and 3 
trade on Nasdaq, are actively-traded. During the six month period from 
June 1997 through November 1997, minimum monthly trading in the Index 
stocks ranged from approximately 330,000 shares to 54.4 million shares. 
Second, the market capitalization of the stocks comprising the Index is 
very large. Specifically, the total capitalization of the Index, as of 
December 10, 1997, was approximately $22 billion, with the market 
capitalization of the individual stocks in the Index ranging from $1.7 
billion to $106 billion. In addition, the median capitalization of the 
companies in the Index on that date was $9.4 billion, and the average 
market capitalization of these companies was $22 billion. Third, no one 
particular stock dominates the Index. Specifically, no single stock 
accounts for more than approximately 5.882 percent of the Index's 
value.
    The Commission notes that with respect to the maintenance of the 
Index, shares of a component stock will only be replaced or 
supplemented under certain limited circumstances, such as the 
conversion of a component stock into another class of security, the 
termination of a depositary receipt program or the spin-off of a 
subsidiary. Accordingly, all replacement or supplemental Index 
component securities will be related to the original component 
stock.\19\
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    \19\ In addition, as noted above, in the event that a security 
in the Index is removed due to a corporate consolidation and the 
holders of such security receive cash, the cash value of such 
security will be included in the Index and will accrue interest at 
LIBOR to term.
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    Although the Index, as currently composed, contains highly 
capitalized and actively-traded issues reflected in an equal-weighted 
manner, the Amex has not proposed Index maintenance criteria that 
ensures the Index will remain this way. The Commission understands that 
the Index is designed

[[Page 19282]]

to reflect a static portfolio of stocks and the active Index 
maintenance (i.e., including replacing Index components) generally is 
inconsistent with such approach. In order to address the possibility 
that the quality of the stocks in the Index could deteriorate or one or 
several stocks could dominate the Index, the Amex has represented that 
it is seeking only to list and trade a single issuance of warrants on 
the Index with a limited duration of one to three years. The Commission 
notes that if the Exchange proposes to list and trade other products 
based on Index, including other index warrants, the Exchange will 
advise the Commission in order to determine whether a rule filing 
pursuant to Section 19(b) of the Act \20\ will be necessary. In 
addition, the Commission notes that if the term of the warrants exceeds 
one year, the Exchange will monitor the options eligibility of the 
underlying securities. If less than 75% of the weight of the Index is 
composed of securities that are options eligible, the Amex will notify 
the Commission. Given the high quality of the component stocks, as well 
as the other factors noted above, the Commission believes that the 
absence of active Index maintenance criteria is not fatal to the 
Commission's approval of the listing and trading of a single issuance 
of warrants on the Index.
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    \20\ 15 U.S.C. 78s(b).
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    The Commission further notes that the rules and procedures of the 
Exchange adequately address the special concerns attendant to the 
trading of Index warrants. Specifically, the applicable suitability, 
account approval, disclosure, and compliance requirements of the 
applicable Amex provisions satisfactorily address potential public 
customer concerns. Moreover, the Amex plans to distribute a circular to 
its membership calling attention to specific risks associated with 
warrants on the Index. Finally, pursuant to the Exchange's listing 
guidelines, only companies capable of meeting the Amex's index warrant 
issuer standards will be eligible to issue Index warrants.\21\
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    \21\ See Section 106 of the Amex Company Guide which requires, 
among other things, that the issuer have tangible net worth in 
excess of $250 million and otherwise substantially exceed size and 
earnings requirements in Section 101(A) of the Company Guide or meet 
the alternative guideline set forth in paragraph (a).
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    The Commission believes that the listing and trading of warrants on 
the Index will not adversely impact the underlying securities because 
the Index is comprised of highly-capitalized securities that are 
actively-traded. In addition, the Amex has established reasonable 
position and exercise limits for narrow-based stock index warrants,\22\ 
which will serve to minimize potential manipulation and other stock 
market concerns.
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    \22\ The Commission notes that position limits for narrow-based 
stock index warrants are set at a level roughly equivalent to 75 
percent of narrow-based index options. As a result, position limits 
for warrants based on the Index will be nine million.
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    Finally, the Amex represents \23\ that its existing surveillance 
procedures will allow the Exchange to detect and deter potential 
manipulations and other trading abuses in the derivatives and 
underlying securities markets. The Exchange further represents that 
comprehensive surveillance sharing agreements are in place with the 
appropriate regulatory authorities in the countries that oversee the 
primary markets for the two securities in the Index that are 
represented by ADRs. Accordingly, the Commission believes that the Amex 
should have available to it the regulatory tools necessary to properly 
surveil for abuses in the trading of warrants on the Index.
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    \23\ Telephone conversation between Claire McGrath, Vice 
President and Special Counsel, Amex, and Deborah Flynn, Division, 
Commission, on March 16, 1998.
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V. Conclusion

    For the foregoing reasons, the Commission finds that the Amex's 
proposal to list and trade warrants based on the Index is consistent 
with the requirements of the Act and the rules and regulations 
thereunder.
    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\24\ that the proposed rule change (SR-Amex-97-48) is approved.

    \24\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\25\
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    \25\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-10184 Filed 4-16-98; 8:45 am]
BILLING CODE 8010-01-M