[Federal Register Volume 64, Number 85 (Tuesday, May 4, 1999)]
[Notices]
[Pages 23883-23885]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-11145]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41334; File No. SR-AMEX-99-03]


Self-Regulatory Organizations; American Stock Exchange LLC; Order 
Granting Approval to Proposed Rule Change Relating to Bond Indexed Term 
Notes

April 27, 1999.

I. Introduction

    On January 12, 1999, the American Stock Exchange LLC (``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

[[Page 23884]]

thereunder,\2\ a proposal to approve for listing and trading under 
Section 107A of the Amex Company Guide seven bond index-linked term 
notes. The proposed rule change and Amendment No. 1 \3\ to the proposal 
were published for comment in the Federal Register on March 11, 
1999.\4\ the Commission received no comments on the proposal. This 
order approves the proposed rule change, as amended.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Letter from Scott G. Van Hatten, Legal Counsel, Amex, to 
Richard Strasser, Assistant Director, Division of Market Regulation 
(``Division''), Commission, dated February 16, 1999 (``Amendment No. 
1''). Amendment No. 1 provided additional details regarding the 
securities, including the principal factors that will affect the 
rate of return on the securities and the formula for determining the 
value of the securities at settlement.
    \4\ Securities Exchange Act Release No. 41135 (March 3, 1999), 
64 FR 12194 (File No. SR-AMEX-99-03).
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II. Description of the Proposal

    The Amex proposes to list for trading under Section 107A of the 
Company Guide \5\ seven term notes, each linked to a different bond 
index (``Bond Index Notes''). The issuers of these securities will be 
qualified under Section 107A(a),\6\ and each issue will meet the size 
and distribution requirements of Section 107A(b).\7\
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    \5\ Under Section 107A of the Company Guide, the Exchange may 
approve for listing and trading securities which cannot be readily 
categorized under the listing criteria for common and preferred 
stocks, bonds, debentures, or warrants. See Securities Exchange Act 
Release No. 27753 (March 1, 1990), 55 FR 8626 (March 8, 1990).
    \6\ Pursuant to Section 107A(a) of the Company Guide, the issuer 
generally must have assets of $100 million and stockholders' equity 
of $10 million.
    \7\ Pursuant to Section 107A(b) of the Company Guide, there must 
be a minimum public distribution of one million trading units with a 
minimum of 400 holders. When trading is expected to occur in larger 
than average trading units (e.g., a $1,000 principal amount or 
more), however, no minimum number of holders will be required. The 
aggregate market value of issues listed under Section 107A must be 
at least $4 million.
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    Holders of the Bond Index Notes generally will receive interest on 
the face value of their securities in an amount to be determined at the 
time of issuance of the securities and disclosed to investors. The 
frequency and rate of the interest payment will vary from issue to 
issue based upon prevailing interest rates and other factors, such as a 
discount factor and interest payments made on the underlying bonds and 
credit spreads.\8\
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    \8\ See Amendment No. 1. The discount factor may reflect 
prevailing interest rates, commissions and such other amounts as 
will be disclosed in the prospectus provided to investors.
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    In addition, investors will receive at maturity an amount based on 
the value of the linked bond index at maturity of the securities, which 
may be more or less than the original principal amount thereof. The 
Bond Index Notes will be valued at settlement based upon the following 
formula: principal amount x (ending index value/beginning index value) 
less a discount factor, which may reflect interest rates, commissions 
and other such amounts as will be disclosed in the prospectus provided 
to investors.\9\ Returns to investors in the Bond Index Notes are 
unleveraged with neither a cap nor a floor.
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    \9\ See Amendment No. 1.
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    Bond index values for the purpose of determining the payment to 
holders at maturity will be determined by reference to prices for the 
linked index on a business day shortly prior to maturity. The Bond 
Index Notes will provide for maturity within a period of not less than 
one nor more than ten years from the date of issue, will not be 
callable or redeemable prior to maturity, and will be cash settled in 
U.S. currency.\10\ Holders of the securities will have no claim to the 
bonds included in the indices.
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    \10\ Id.
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    Prior to the commencement of trading the Bond Index Notes, the 
Exchange will distribute a circular to its membership providing 
guidance about member firm compliance responsibilities, including 
suitability recommendations, and highlighting the special risks and 
characteristics of the proposed securities. In particular, the Exchange 
will require members, member organizations and employees thereof 
recommending a transaction in the Bond Index Notes: (1) to determine 
that such transaction is suitable for the customer, and (2) 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, 
such transaction.
    The securities will be subject to the Exchange's margin rules.\11\ 
The Bond Index Notes are subject to the equity trading rules of the 
Exchange except that, where the securities are traded in thousand 
dollar denominations as debt, they will be traded subject to the 
Exchange's debt trading rules.
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    \11\ See Amex Rule 462.
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    The Exchange anticipates that the issuer will link distinct issues 
of such securities to the following seven bond indices sponsored and 
calculated by Merrill Lynch, Pierce, Fenner & Smith Incorporated 
(``MLPF&S''): the U.S. Domestic Master, Mortgage Master, U.S. 
Corporate/Government Master, U.S. Corporate Master, U.S. Treasury/
Agency Master, U.S. Treasury Master and U.S. Agency Master Indices. 
Each index is intended to track a different sector of the fixed income 
securities market.
    The Exchange represents that each of the bond indices are broad 
based \12\ and are adjusted pursuant to objective, publicly 
disseminated rules.\13\ For a bond to qualify for inclusion in an 
index, it must meet the pre-established and defined list of objective 
criteria. The bonds included in each of the seven indices also meet or 
exceed the Exchange's Bond and Debenture Listing Standards set forth in 
Section 104 of the Amex Company Guide.\14\ Each index is rebalanced on 
the last calendar day of the month. Bonds meeting the index's inclusion 
criteria on the last calendar day of the month are included in the 
index for the following month. Issues that no longer meet the criteria 
during the course of the month remain in the index until the next 
month-end rebalancing, at which point they are dropped from the index. 
Bonds included in the indices are held constant throughout the month 
until the following monthly rebalancing. Bond

[[Page 23885]]

weightings for each of the indices are based on a bond's total 
outstanding capitalization (total face value currently outstanding 
times price plus accrued interest). Returns and weighted average 
characteristics are published daily.
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    \12\ The U.S. Domestic Master Index, established in 1975, is an 
indicator of the performance of the investment grade U.S. domestic 
bond market. The index has over 7,000 issues and a market value of 
over $5 trillion. The U.S. Treasury Master Index was established in 
1977, and has approximately 160 issues with a market value of $2.2 
trillion. The U.S. Agency Master Index, established in 1977, has 
1,675 issues with a market value of approximately $450 billion. The 
U.S. Corporate Master Index was established in 1972, and has 
approximately 4,700 issues with a market value of $1.2 trillion. The 
U.S. Corporate/Government Master Index, established in 1972, has 
6,574 issues with approximate market value of $3.8 trillion. The 
U.S. Treasury/Agency Index is a combination of the U.S. Treasury 
Master and U.S. Agency Master Indices, and contains approximately 
1,800 issues with market value of 6.2 trillion. A further 
description of each of the seven indices is set forth in detail in 
the notice release. See supra, note 4.
    \13\ Information as to how the indices are calculated, including 
the inclusion rules, are published on Bloomberg and the Merrill 
Lynch public web site. Changes in any rules are generally published 
approximately 30 days in advance of any change.
    \14\ The Exchange's Bond and Debenture Listing Standards provide 
for the listing of individual bond or debenture issuances provided 
the issue has an aggregate market value or principal amount of at 
least $5 million and either: the issuer of the debt security has 
equity securities listed on the Exchange (or on the New York Stock 
Exchange); an issuer of equity securities listed on the Exchange (or 
on the New York Stock Exchange) directly or indirectly owns a 
majority interest in, or is under common control with, the issuer of 
the debt security; an issuer of equity securities listed on the 
Exchange (or on the New York Stock Exchange) has guaranteed the debt 
security; a nationally recognized statistical rating organization 
(an ``NRSRO'') has assigned a current rating to the debt security 
that is no lower than an S&P Corporation ``B'' rating or equivalent 
rating by another NRSRO; or if no NRSRO has assigned a rating to the 
issue, an NRSRO has currently assigned; (i) an investment grade 
rating to an immediately senior issue; or (ii) a rating that is no 
lower than an S&P Corporation ``B'' rating, or an equivalent rating 
by another NRSRO, to a pari passu or junior issue.
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    Each of the above indices are calculated by the Merrill Lynch 
Research Portfolio Strategy Group based on the prices of the underlying 
bonds determined each business day. The vast majority of the prices of 
the underlying securities comprising the indices are determined by the 
Merrill Lynch Pricing Services Group. These prices are determined in 
accordance with all applicable statutory rules, self-regulatory 
organization rules and generally accepted accounting principles 
regarding valuation of security positions. When a security price is not 
available from the Pricing Services Group, the Portfolio Strategy Group 
will use a security price from a third party vendor that, in its best 
judgment, will provide the most accurate market price thereof. The 
resulting index values are then disseminated to, and published by, 
Bloomberg L.P. and Reuters at the end of each business day. MLPF&S, in 
its role as calculation agent for the Bond Index Notes, will use the 
index values as published on Bloomberg L.P. In conjunction with the 
issuance of the Bond Index Notes, the Exchange intends to publish the 
index value associated with the previous day's close.

III. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to national securities exchange and, in 
particular, with the requirements of Section 6(b)(5) under the Act \15\ 
that the rules of an exchange be designed to prevent fraudulent and 
manipulative acts and practices, to facilitate transactions in 
securities, and to protect investors and the public interest.\16\
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    \15\ 15 U.S.C. 78f(b)(5).
    \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).
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    The Commission notes that the proposed Bond Index Notes have a 
certain level of risk because they are derivatively priced and the 
final rate of return to investors is unleveraged with neither a cap nor 
a floor. Accordingly, the Commission has specific concerns regarding 
this type of product. For the reasons discussed below, the Commission 
believes that Amex's proposal adequately addresses these concerns.
    First, the Commission notes that the protections of Section 107A of 
the Amex Company Guide were designed to address the concerns attendant 
to the trading of hybrid securities like the proposed Bond Index 
Notes.\17\ In particular, by imposing the hybrid listing standards, 
heightened suitability for recommendations, and compliance 
requirements, noted above, the Commission believes that the Exchange 
has adequately addressed the potential problems that could arise from 
the hybrid nature of the proposed Bond Index Notes. In addition, Amex 
will distribute a circular to its membership calling attention to the 
specific risks associated with the Bond Index Notes. Distribution of 
the circular should help ensure that only customers with an 
understanding of the risk attendant to the trading of the Bond Index 
Notes will trade these securities on their broker's recommendations.
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    \17\ See Securities Exchange Act Release No. 27753 (March 1, 
1990), 55 FR 8623 (March 8, 1990).
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    Second, the Commission notes that the final rate of return on the 
Bond Index Notes depends, 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 Company Guide, which provides 
that only issuers satisfying substantial asset and equity requirements 
may issue these types of hybrid securities. In addition, the Exchange's 
hybrid listing standards further require that the proposed indexed term 
notes have at least $4 million in market value. Further information, 
including specific financial data, regarding the issuer and the 
underlying indices will be publicly available to investors through the 
prospectus.
    Finally, the Commission believes that the listing and trading of 
the proposed Bond Index Notes should not unduly impact the market for 
the securities underlying the indices or raise manipulative concerns. 
The Commission notes that all of the indices are well-established and 
broad-based. Both the history and performance of these indices, as well 
as the objective calculation rules for the indices, should be readily 
available through a variety of public sources. Due to the indices' 
issue size, market value, and representative nature of different 
sectors of the fixed income securities market, the Commission believes 
that the indices are not readily susceptible to manipulation.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\18\ that the proposed rule change (SR-AMEX-99-03) is approved.
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    \18\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\19\
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    \19\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-11145 Filed 5-3-99; 8:45 am]
BILLING CODE 8010-01-M