[Federal Register Volume 63, Number 239 (Monday, December 14, 1998)]
[Notices]
[Pages 68811-68814]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-33072]



[[Page 68811]]

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SECURITIES AND EXCHANGE COMMISSION

(Release No. 34-40754; File No. SR-Amex-98-25)


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval to 
Amendment No. 2 to the Proposed Rule Change by the American Stock 
Exchange, Inc. Relating to Listing and Trading Stock Upside Note 
Securities on the Lehman Brothers European Stock Basket

December 7, 1998.

I. Introduction

    On July 1, 1998, the American Stock Exchange, Inc. (``Amex'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``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 list and trade Stock Upside 
Note Securities on the Lehman Brothers European Stock Basket. On July 
31, 1998, and October 9, 1998, respectively, the Exchange submitted 
Amendments Nos. 1 \3\ and 2 \4\ to the proposed rule change to the 
Commission.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Claire P. McGrath, Vice President and 
Special Counsel, Dervatives Legal Counsel, Amex, to Richard 
Strasser, Assistant Director, Division of Market Regulation 
(``Division''), SEC dated July 30, 1998 (``Amendment No. 1'').
    \4\ See letter from Claire P. McGrath, Vice President and 
Special Counsel, Derivatives Legal Counsel, Amex, to Richard 
Strasser, Assistant Director, Division, SEC, dated October 8, 1998 
(``Amendment No. 2'').
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    The proposed rule change, including Amendment No. 1, was published 
for comment in the Federal Register on August 26, 1998.\5\ No comments 
were received on the proposal. This order approves the proposal as 
amended.
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    \5\ Securities Exchange Act Release No. 40338 (August 19, 1998), 
63 FR 45539.
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II. Description of the Proposal

    The Amex proposes to trade Stock Upside Note Securities (``SUNS'') 
on the Lehman Brothers European Stock Basket (``Basket''), a new basket 
of stocks developed by Lehman Brothers Holdings, Inc. (``Lehman 
Brothers'') based entirely on the shares of European companies. SUNS on 
the Basket are designed to allow investors to combine the protection of 
a portion of the principal amount of the SUNS with a potential 
additional payment based upon the performance of a portfolio of highly 
captalized European stocks. In particular, the proposed SUNS will 
provide at least 90% principal protection with the opportunity to 
participate in any upside appreciation of the Basket, subject to any 
cap on appreciation that may be included by the issuer.

Criteria Under Section 107A of the Amex Company Guide

    Under section 107A of the Amex Company Guide, the Exchange may 
approve for listing and trading securities that can not be readily 
categorized under the listing criteria for common and preferred stocks, 
bonds, debentures or warrants.\6\ SUNS issues on the Basket will 
conform to the listing guidelines under Section 107A of the Amex 
Company Guide, which provide, among other things, that the issuer shall 
satisfy the earnings criteria set forth in Section 101 \7\ of the Amex 
Company Guide and have assets in excess of $100 million and 
stockholders' equity of at least $10 million. Where the issuer does not 
satisfy the earnings criteria set forth in Section 101 of the Amex 
Company Guide, the issuer must have assets in excess of $200 million 
and stockholders' equity of at least $10 million; or have assets in 
excess of $100 million and stockholders' equity of at least $20 
million. Further, SUNS will have a minimum public distribution of 
1,000,000 units with a minimum of 400 public shareholders, except, if 
traded in thousand dollar denominations, then no minimum number of 
holders will be required. SUNS will have a principal amount/aggregate 
market value of not less than $4 million. In addition, Amex will apply 
the continued listing guidelines for the proposed SUNS as set forth in 
Sections 1001 through 1003 of the Amex Company Guide. In particular, 
Section 1003(b)(iii) regarding suspensions and delistings with respect 
to limited distribution and reduced market value bonds will apply to 
the SUNS.
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    \6\ The Commission has previously approved the listing and 
trading of hybrid securities similar to SUNS based upon portfolios 
of securities or stock indices. See e.g., Securities Exchange Act 
Release Nos. 32840 (September 2, 1993), 58 FR 47485 (September 9, 
1993); 33368 (December 22, 1993), 58 FR 68975 (December 29, 1993); 
33495 (January 19, 1994), 59 FR 3883 (January 27, 1994); 34692 
(September 20, 1994), 59 FR 49267 (September 27, 1994); 37533 
(August 7, 1996), 61 FR 42075 (August 13, 1996); and 37744 
(September 27, 1996), 61 FR 52480 (October 7, 1996) (``Term Notes 
Approval Orders'').
    \7\ Section 101 of the Amex Company Guide requires issuers to 
have pre-tax earnings of at least $750,000 in the last fiscal year 
of two of the last three fiscal years.
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    The SUNS are non-convertible debt securities of Lehman Brothers and 
will conform to the above listing standards. Although the specific 
maturity date will not be established until immediately prior to the 
time of the offering, the SUNS will provide for maturity within a 
period of not less than two years and not more than seven years from 
the date of issue. The SUNS will provide for a single payment at 
maturity, and will bear no periodic payments of interest. The European 
Stock Basket SUNS will be denominated in U.S. dollars and will entitle 
the owner at maturity to receive an amount based on the percentage 
change between the ``Original Portfolio Value'' and the ``Ending 
Average Portfolio Value,'' provided: (1) the amount payable at maturity 
will not be less than 90% of the principal amount of the SUNS; and (2) 
the issuer may place a cap on the maximum amount of be paid on the SUNS 
at maturity. Thus, holders of the SUNS may not receive the full amount 
of the appreciation of the Ending Average Portfolio Value over the 
Original Portfolio Value. For example, Lehman Brothers may place a cap 
on the amount to be received at maturity as a stated percentage of the 
issuance price, e.g., 150% of the issuance price. Alternatively, a cap 
could be in the form of a participation rate whereby a holder of the 
SUNS would participate in a stated percentage of the total percentage 
change between the Ending Portfolio Value and the Original Portfolio 
Value, e.g., 80% of the total appreciation of the European Stock Basket 
during the term of the SUNS. The Original Portfolio Value is the value 
of the European Stock Basket on the date on which the issuer prices the 
SUNS for the initial offering to the public. The Ending Average 
Portfolio Value is the average of the closing prices of the European 
Stock Basket securities for a ten-day period beginning on the twelfth 
trading day prior to maturity of the SUNS. The European Stock Basket 
SUNS will be cash-settled and will not give holders any right to 
receive any Basket security or any other ownership right or interest in 
such security even though the return on the investment is based on the 
value of the Basket.

The SUNS Basket and Components

    The European Stock Basket will consist of not less than ten nor 
more than thirty stocks of highly capitalized European companies.\8\ 
Each stock included in the Basket will meet the following criteria: (1) 
a market capitalization in excess of $75 million;

[[Page 68812]]

alternatively, the lowest weighted securities in the Basket that do not 
account for more than 10% of the weight of the Basket, may have a 
market capitalization of $50 million or greater; (2) the trading volume 
of each component in the Basket will be at least one million shares 
during each of the six months preceding the listing of the SUNS; 
alternatively, the lowest weighted securities in the Basket that do not 
account for more than 10% of the weight of the Basket, may have a 
volume of at least 500,000 shares during each of the six months 
preceding the listing of the SUNS; (3) the market price for each 
component stock used for the calculation of the Basket will be obtained 
from the stock's primary market; and (4) the market price for each 
component will be at least $5 for the majority of business days during 
the three calendar months preceding the listing of the SUNS.
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    \8\ The Exchange represents that once a determination is made by 
Lehman Brothers as to which securities will be included in the 
Basket, the Exchange will provide a list of those securities to the 
Commission. This list will be provided prior to the commencement of 
trading of the SUNS on the Basket. See Amendment No. 2, supra note 
4.
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Basket Calculation

    The Basket will be calculated using the modified equal-dollar 
weighting methodology. Thus, prior to the issuance of the SUNS, Lehman 
Brothers will establish a weighting for each of the securities in the 
Basket. Specifically, each security included in the Basket will be 
assigned a multiplier so that the security represents the established 
percentage of the value of the entire Basket on the date of issuance. 
The multiplier indicates the number of shares (or fraction of one 
share) of a security, given its market price, to be included in the 
calculation of the Basket. The weightings established for each security 
will assure that: (1) no single stock will represent more than 25% of 
the weight of the Basket; (2) the five highest weighted stocks will 
represent no more than 50% of the weight of the Basket; (3) foreign 
country securities that are not subject to comprehensive surveillance 
agreements will not in the aggregate represent more than 40% of the 
weight of the Basket; (4) stocks for which the primary market is in any 
one country that is not subject to a comprehensive surveillance 
agreement do not represent 20% or more of the weight of the Basket; and 
(5) stocks for which the primary market is in any two countries that 
are not subject to the comprehensive surveillance agreements do not 
represent 33% or more of the weight of the Basket.
    The multiplier of each security of the Basket will generally remain 
unchanged except for adjustments that may be necessary as a result of 
stock splits or stock dividends.\9\ There will be no adjustments to the 
multipliers to reflect cash dividends paid with respect to a portfolio 
security. In addition, no adjustments of any multiplier of a portfolio 
security will be made unless such adjustment would require a change of 
at least 1% in the multiplier then in effect. If the issuer of a 
security included in the Basket no longer exists, whether for reason of 
a merger, acquisition or similar type of corporate control transaction, 
Lehman Brothers will assign to that security a value equal to the 
security's final value for the purposes of calculating portfolio 
values.
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    \9\ The Exchange represents that the independent calculation 
agent will be responsible for making any changes to the multiplier 
that become necessary due to a stock split or dividend. See 
Amendment No. 2, supra note 4.
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    If the issuer of a European Stock Basket security is in the process 
of liquidation or subject to a bankruptcy proceeding, insolvency, or 
other similar adjudication, such security will continue to be included 
in the Basket so long as a market price for such security is available. 
If such a market price is no longer available for a Basket security due 
to a liquidation, bankruptcy, insolvency, or any other similar 
proceeding, then the value of the security will be zero in connection 
with calculating the daily Basket value and the Ending Average 
Portfolio Value, for so long as no such market price exists for that 
security. Lehman Brothers will not attempt to find a replacement stock, 
or to compensate in a manner other than what is set forth above, for 
the extinction of a security due to a bankruptcy or similar event.
    The value of the Basket will be disseminated every 15 seconds from 
9:30 a.m. until 4:00 p.m. each trading day by the Exchange. Such 
disseminated value will be calculated by the Amex or by an independent 
calculation agent appointed by Lehman Brothers. The Basket value will 
be calculated based on real-time prices during the hours the European 
markets overlap trading hours with the Exchange. After the close of the 
European markets, the Basket value will be calculated based on the last 
sale price of the component security. The Basket will be calculated 
using the last sale value for each component security from its primary 
market place. The exchange rate for each currency represented in the 
Basket will be from one of two sources: (i) the WM/Reuter closing value 
reported in London at about 12:00 (New York time) each trading day or 
(ii) the best bid and offer price posted by two or more contributing 
banks as provided by Bridge/Telesphere.\10\ If the market place for any 
one of the securities constituting the European Stock Basket has not 
opened for trading on any given business day, the previous closing 
value will be used in the calculation. The Basket value, for any day, 
will equal the sum of the products of the most recently available 
market prices, expressed in U.S. dollars and the applicable multipliers 
for the Basket securities. Lehman Brothers will undertake to implement 
certain surveillance and compliance procedures with respect to the 
dissemination of the Basket value, requiring that the Basket value be 
announced only through public dissemination and restricting the access 
of the Lehman Brothers trading desk to the Basket value determined by 
the calculation agent until after public dissemination of that value.
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    \10\ See Amendment No. 2, supra note 4.
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Exchange Rules Applicable to SUNS

    The Exchange's equity trading rules will apply to the trading of 
SUNS linked to the European Stock Basket. Those rules include Rule 411, 
which requires members to use due diligence to learn the essential 
facts relative to every customer and to every order or account 
accepted; and Rule 462 which requires the application of equity margin 
rules to the trading of indexed term notes. The Exchange will, prior to 
trading the proposed SUNS, distribute an Information Circular to the 
membership: (1) highlighting the essential features of the SUNS product 
including, but not limited to, if applicable, the less than 100% 
principal protection feature and the fact that the issuer has placed a 
cap on the amount to be paid on the SUNS at maturity; and (2) providing 
guidance with regard to member firm compliance responsibilities 
(including suitability recommendations) when handling transactions in 
the SUNS and highlighting their special risks and characteristics. The 
circular will state that before a member, member organization, or 
employee of such member organization undertakes to recommend a 
transaction in the security, such member or member organization should 
make a determination that the security is suitable for such customer 
and the person making the recommendation should have a reasonable basis 
for believing at the time of making the recommendation, that the 
customer has such knowledge and experience in financial matters that 
they may be capable of evaluating the risks and the special 
characteristics of the recommended transaction, including

[[Page 68813]]

those highlighted, and is financially able to bear the risks of the 
recommended transaction.

III. Discussion

    The Commission finds that the proposed rule change is consistent 
with the Act and the rules and regulations thereunder applicable to a 
national securities exchange, and, in particular, with the requirements 
of Section 6(b)(5) of the Act.\11\ Specifically, the Commission 
believes that providing for exchange-trading of SUNS on the Basket \12\ 
will offer a new and innovative means of participating in the market 
for highly capitalized European stocks. In particular, the Commission 
believes that SUNS on the Basket will permit investors to gain equity 
exposure in such companies, while, at the same time, limiting the 
downside risk of the original investment due to the principle guarantee 
feature.\13\ Accordingly, for the same reasons as discussed in the Term 
Notes Approval Orders,\14\ the Commission finds that the listing and 
trading of SUNS on the Basket is consistent with the Act.\15\
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    \11\ 15 U.S.C. 78f(b)(5).
    \12\ The Commission notes that this approval order is limited to 
the SUNS product; separate Commission approval may be required for 
the Exchange to list and trade any other derivative product based on 
the Lehman Brothers European Stock Basket.
    \13\ Pursuant to Section 6(b)(5) of the Act, the Commission must 
predicate approval of exchange trading of new products upon a 
finding that the introduction of such new 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.
    \14\ See Term Notes Approval Orders, supra note 6.
    \15\ In approving this rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
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    As with other derivative products similar to SUNS, SUNS on the 
Basket are not leveraged instruments; however, their price will still 
be derived from and based upon the underlying linked security. 
Accordingly, the level of risk involved in the purchase or sale of SUNS 
on the Basket is similar to the risk involved in the purchase or sale 
of traditional common stock. Nonetheless, because the final rate of 
return of SUNS is derivatively priced, based on the performance of a 
portfolio of securities, there are several issues regarding the trading 
of this type of product.
    The Commission believes that the Exchange has adequately addressed 
these issues for several reasons. First, the Commission notes that the 
Exchange's rules and procedures that address the special concerns 
attendant to the trading of hybrid securities will be applicable to 
SUNS on the Basket. In particular, by imposing the hybrid listing 
standards, and the suitability, disclosure, and compliance requirements 
noted above, the Commission believes the Exchange has addressed 
adequately the potential problems that could arise from the hybrid 
nature of SUNS on the Basket. Moreover, the Exchange will distribute a 
circular to its membership calling attention to the specific risks 
associated with SUNS on the Basket. In particular, the circular will 
highlight, among other things, that the SUNS on the Basket allow 
investors to participate in appreciation only to the extent that the 
Basket outperforms the initial Basket value based on the average of the 
closing prices of the European Stock Basket securities for a ten-day 
period beginning on the twelfth trading day prior to maturity of the 
SUNS and any cap on appreciation.
    Second, SUNS on the Basket remain a non-leveraged product with the 
issuer guaranteeing no less than 90 percent of principal return.\16\ 
The Commission realizes that the final payout on the SUNS on the Basket 
is dependent in part upon the individual credit of the issuer. To some 
extent this credit risk is minimized by the Exchange's listing 
standards in Section 107A of the Amex Company Guide which provides that 
only issuers satisfying substantial asset and equity requirements may 
issue securities such as SUNS.\17\ In addition, the Exchange's hybrid 
listing standards further require that the proposed indexed term notes 
have at least $4 million in market value.\18\ In any event, financial 
information regarding the issuer, in addition to information on the 
underlying securities, will be publicly available to investors.
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    \16\ The Commission notes that the Amex may not list for trading 
SUNS with less than a 90% principal guarantee without first 
consulting with the Commission. For example, the Commission may 
determine that SUNS with less than a 90% principal guarantee should 
only be sold to customers meeting certain heightened account 
approval and suitability requirements.
    \17\ See supra note 7 and accompanying text.
    \18\ See Amex Company Guide Sec. 107A.
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    Third, the component securities in the Basket are highly-
capitalized, actively-traded European stocks. In addition, the 
components are all publicly traded on the home country's primary 
market. Accordingly, both the history and performance of these 
securities, as well as current pricing trends, should be readily 
available though a variety of public sources.
    Further, the Commission notes that the value of the Basket will be 
disseminated on a real time basis at least once every 15 seconds 
throughout the trading day. As noted above, to the extent that European 
and U.S. market hours overlap, last sale prices on the primary market 
will be used to calculate the value of the Basket. The Commission 
believes that this information will be extremely useful and beneficial 
for investors in SUNS on the Basket.
    Although the SUNS are denominated in U.S. dollars, as noted above, 
the Basket value will be derived from converting the value of each 
security from its home currency into U.S. dollars. The Exchange 
represents that the calculation agent will determine, prior to the 
listing of the SUNS on the Basket, which source it will use.\19\ The 
currency conversion of the Basket will have a significant effect on 
both the intraday value of the Basket as well as the ultimate payout at 
settlement. Accordingly, the currency conversion methodology must be 
fair and accurate and applied in a consistent manner. In this regard, 
the Commission expects the Amex to carefully monitor and surveil the 
currency conversion method, as well as the prices of the foreign 
securities used in the conversion, to ensure the fairness and accuracy 
of valuing the Basket, especially at settlement.
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    \19\ As noted above, the currency conversion will be from one of 
two sources: (i) the WM/Reuter closing value reported in London at 
about 12:00 (New York time) each trading day or (ii) the best bid 
and offer price posted by two or more contributing banks as provided 
by Bridge/Telesphere. The Commission expects that, once chosen, the 
calculation agent will not change the source it uses to convert 
currency values during the life of the SUNS on the Basket.
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    Fourth, while the Commission has a systematic concern that a 
broker-dealer or a subsidiary providing a hedge for the issuer will 
incur position exposure, the Commission believes this concern is 
minimal given the size of the proposed SUNS issuance in relation to the 
net worth of the issuer.\20\
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    \20\ See Term Notes Approval Orders, supra note 6.
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    Finally, the Exchange's surveillance procedures will serve to deter 
as well as detect any potential manipulation. As discussed above, Amex 
represents that: (1) foreign country securities that are not subject to 
comprehensive surveillance agreements will not in the aggregate 
represent more than 40% of the weight of the Basket; (2) stocks for 
which the primary market is in any one country that is not subject to a 
comprehensive surveillance agreement do not represent 20% or more of 
the weight of the Basket; and (3) stocks for which the primary market 
is in any two

[[Page 68814]]

countries that are not subject to the comprehensive surveillance 
agreements do not represent 33% or more of the weight of the Basket. 
Further, if the surveillance coverage should fall below certain levels, 
as discussed above, no new SUNS will be listed. The Commission believes 
that this should help to ensure that adequate surveillance mechanisms 
exist in the future.
    The Commission finds good cause for approving Amendment No. 2 to 
the proposed rule change prior to the thirtieth day after the date of 
publication of notice thereof in the Federal Register. In Amendment No. 
2, the Exchange indicates that: (1) either the Amex or an independent 
calculation agent will calculate the value of the Basket; (2) the 
calculation agent will, if necessary, determine the changes in the 
multipliers of the securities in the Basket; (3) the calculation agent 
will only use the Bridge/Telesphere source for currency conversion 
rates if it is able to obtain the bid and offer prices from two or more 
contributing banks for each currency; and (4) the Exchange will notify 
the Commission once Lehman Brothers determines which securities will be 
included in the Basket. The Commission does not believe that Amendment 
No. 2 raises any regulatory issues that were not addressed by the Term 
Notes Approval Orders. In addition, to the extent that the Basket has 
certain characteristics that differ from the previous Term Notes 
Approval Orders, the Commission believes that the Amex has adequately 
addressed those issues. In this regard, as to the use of Bridge/
Telesphere for currency conversion rates, the Amendment will help to 
ensure that such source will only be used when there are a minimum 
number of bids and offers available. The Commission notes that this 
proposal was published for the full notice and comment period during 
which no comments were received. Accordingly, the Commission believes 
that good cause exists, consistent with Section 6(b)(5) \21\ and 
Section 19(b)(2) \22\ of the Act, to grant accelerated approval to the 
proposed rule change.
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    \21\ 15 U.S.C. 78f(b)(5).
    \22\ 15 U.S.C. 78s(b)(2).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 2, including whether Amendment No. 2 
is consistent with the Act. Persons making written submissions should 
file six copies thereof with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street, N.W., 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 at the Commission's 
Public Reference Room. 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 File No. 
SR-Amex-98-25 and should be submitted by January 4, 1999.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\23\ that the proposed rule change (SR-Amex-98-25) is approved on 
an accelerated basis.

    \23\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\24\
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    \24\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-33072 Filed 12-11-98; 8:45 am]
BILLING CODE 8010-01-M