[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
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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