[Federal Register Volume 66, Number 219 (Tuesday, November 13, 2001)]
[Notices]
[Pages 56872-56875]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-28275]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45024; File No. SR-NASD-2001-79]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of a Proposed Rule Change by the National 
Association of Securities Dealers, Inc. Relating to Enhanced Return 
Notes Linked to the Nasdaq 100-Index

November 5, 2001.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on October 31, 2001, the National Association of Securities Dealers, 
Inc. (``NASD'' or ``Association'') through its subsidiary, The Nasdaq 
Stock Market, Inc. (``Nasdaq''), 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 
Nasdaq. The Commission is publishing this notice to solicit comments on 
the proposed rule change from interested persons and to approve the 
proposal on an accelerated basis.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    Nasdaq proposes to list and trade Enhanced Return Notes Linked to 
the Nasdaq-100 Index (the ``Notes'') issued by Merrill Lynch & Co., 
Inc. (``Merrill Lynch'').

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, Nasdaq 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 III below. Nasdaq 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

(1) Purpose
    Under NASD Rule 4420(f), ``Other Securities,'' Nasdaq may approve 
for listing and trading innovative securities that cannot be 
categorized readily under traditional listing guidelines.\3\ Nasdaq 
proposes to list for trading the Notes, as described below, under NASD 
Rule 4420(f).
---------------------------------------------------------------------------

    \3\ See Securities Exchange Act Release No. 32988 (September 29, 
1993), 58 FR 52124 (October 6, 1993) (order approving File No. SR-
NASD-93-15) (``1993 Order'').
---------------------------------------------------------------------------

Description of the Notes

    The Notes \4\ are a series of senior debt securities that will be 
issued by Merrill Lynch and will not be secured by collateral. The 
Notes will be issued in denominations of whole units (``Units''), with 
each Unit representing a single Note. The original public offering 
price will be $10 per Unit. The Notes will not pay interest and are not 
subject to redemption by Merrill Lynch or at the option of any 
beneficial owner before maturity in February 2003.\5\
---------------------------------------------------------------------------

    \4\ For a detailed description of the Notes, including the risks 
associated with investing in the Notes, see the registration 
statement Merrill Lynch filed with the Commission (File No. 333-
52822).
    \5\ The maturity date will be determined on the day the Notes 
are priced. After Nasdaq filed its proposal, Merrill Lynch revised 
the terms of the Notes to establish a maturity date of February 
2003, rather than January 2003, and to provide for a maximum payment 
on the Notes of $14.00 per Unit. Telephone conversation between John 
Nachmann, Senior Attorney, Nasdaq, and Yvonne Fraticelli, Special 
Counsel, Office of Market Supervision, Division of Market 
Regulation, Commission, on November 5, 2001.
---------------------------------------------------------------------------

    At maturity, if the value of the Nasdaq-100 Index (``Index'') \6\ 
has increased, a beneficial owner will be entitled to receive a payment 
on the Notes based on twice the amount of that percentage increase, not 
to exceed a maximum payment of $14.00 per Unit (the ``Capped 
Value'').\7\ Thus, the Notes provide investors with an opportunity to 
obtain leveraged returns based on the Index. Unlike ordinary debt 
securities, the Notes do not guarantee any return of principal at 
maturity. Therefore, if the value of the Index has declined at 
maturity, a beneficial owner will receive less, and possibly 
significantly less, than the original public offering price of $10 per 
Unit.
---------------------------------------------------------------------------

    \6\ The Index is a modified capitalization-weighted index of 100 
of the largest non-financial companies listed on The Nasdaq National 
Market tier of Nasdaq. The Index constitutes a broadly diversified 
segment of the largest and most actively traded securities listed on 
Nasdaq and includes companies across a variety of major industry 
groups. To limit domination of the Index by a few large stocks, the 
Index is calculated under a ``modified capitalization-weighted'' 
methodology. This capitalization weight distribution is evaluated on 
a quarterly basis and is rebalanced if either one or both of the 
following two weight distribution requirements are not met: (1) The 
current weight of the single largest market capitalization security 
must be less than or equal to 24.0%, and (2) the ``collective 
weight'' of those Index component securities whose individual 
current weights are in excess of 4.5%, when added together, must be 
less than or equal to 48.0%. Index securities are ranked by market 
value and are evaluated annually to determine which securities will 
be included in the Index. Moreover, if at any time during the year 
an Index security is no longer trading on Nasdaq, or is otherwise 
determined by Nasdaq to become ineligible for continued inclusion in 
the Index, the security will be replaced with the largest market 
capitalization security not currently in the Index that meets the 
Index eligibility criteria. For a detailed description of the Index, 
see the registration statement filed by Merrill Lynch with the 
Commission (File No. 333-52822).
    \7\ The final Capped Value will be determined on the day the 
Notes are priced.
---------------------------------------------------------------------------

    The payment that a beneficial owner will be entitled to receive 
(the ``Redemption Amount'') depends entirely on the relation of the 
average of the values of the Index at the close of the market on five 
business days shortly before the maturity of the Notes (the ``Ending 
Value'') and the closing value of the Index on the date the Notes are 
priced for initial sale to the public (the ``Starting Value'').

[[Page 56873]]

    If the Ending Value is less than or equal to the Starting Value, 
the Redemption Amount per Unit will equal:
[GRAPHIC] [TIFF OMITTED] TN13NO01.000

    If the Ending Value is greater than the Starting Value, the 
Redemption Amount per Unit will equal:
[GRAPHIC] [TIFF OMITTED] TN13NO01.001

not to exceed the Capped Value of $14.00 per Unit.

Criteria for Initial and Continued Listing

    The Notes will be subject to Nasdaq's initial listing criteria for 
other securities under NASD Rule 4420(f). Specifically, under NASD Rule 
4420(f)(1):
    (A) The issuer shall have assets in excess of $100 million and 
stockholders' equity of at least $10 million. In the case of an issuer 
which is unable to satisfy the income criteria set forth in paragraph 
(a)(1), Nasdaq generally will require the issuer to have the following: 
(i) Assets in excess of $200 million and stockholders' equity of at 
least $10 million; or (ii) assets in excess of $100 million and 
stockholders' equity of at least $20 million;
    (B) There must be a minimum of 400 holders of the security, 
provided, however, that if the instrument is traded in $1,000 
denominations, there must be a minimum of 100 holders.
    (C) For equity securities designated pursuant to this paragraph, 
there must be a minimum public distribution of 1,000,000 trading units;
    (D) The aggregate market value/principal amount of the security 
will be at least $4 million.
    In addition, Nasdaq notes that Merrill Lynch satisfies the listed 
marketplace requirement set forth in NASD Rule 4420(f)(2).\8\ Lastly, 
pursuant to NASD Rule 4420(f)(3), prior to the commencement of trading 
of the Notes, Nasdaq will distribute a circular to the membership 
providing guidance regarding member firm compliance responsibilities 
and requirements, including suitability recommendations, and 
highlighting the special risks and characteristics of the Notes. In 
particular, Nasdaq will advise members, member organizations and 
employees thereof recommending a transaction in the Notes to: (1) 
Determine that such transaction is suitable for the customer; and (2) 
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.
---------------------------------------------------------------------------

    \8\ NASD Rule 4420(f)(2) generally requires that issuers of 
securities designated pursuant to NASD Rule 4420(e) be listed on 
Nasdaq or the New York Stock Exchange, Inc. (``NYSE'') or be an 
affiliate of a company listed on Nasdaq or the NYSE.
---------------------------------------------------------------------------

    The Notes will be subject to Nasdaq's continued listing criteria 
for other securities in NASD Rule 4450(c), which requires that the 
aggregate market value or principal amount of publicly-held units must 
be at least $1 million. Furthermore, the Notes must have at least two 
registered and active market makers as required by NASD Rule 4450(e).
    The Notes will be registered under section 12 of the Act.

Rules Applicable To the Trading of the Notes

    Because the Notes will be deemed equity securities for the purpose 
of NASD Rule 4420(f), the NASD and Nasdaq's existing equity trading 
rules will apply to the Notes. First, pursuant to NASD Rule 2310, 
``Recommendations to Customers (Suitability),'' and IM-2310-2, ``Fair 
Dealing with Customers,'' NASD members must have reasonable grounds for 
believing that a recommendation to a customer regarding the purchase, 
sale or exchange of any security is suitable for such customer upon the 
basis of the facts, if any, disclosed by such customer as to his other 
security holdings and as to his financial situation and needs.\9\ In 
addition, as previously mentioned, Nasdaq will distribute a circular to 
advise members, member organizations and employees thereof recommending 
a transaction in the Notes to, among other things, 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. Second, the Notes will be subject to the equity margin 
rules. Third, the regular equity trading hours of 9:30 a.m. to 4 p.m. 
will apply to transactions in the Notes. Lastly, NASD Regulation's 
surveillance procedures for the Notes will be the same as the current 
surveillance procedures governing equity securities, and will include 
additional monitoring on key pricing dates.
---------------------------------------------------------------------------

    \9\ NASD Rule 2310(b) requires members to make reasonable 
efforts to obtain information concerning a customer's financial 
status, a customer's tax status, a customer's investment objectives, 
and such other information used or considered to be reasonable by 
such member or registered representative in making recommendations 
to the customer.
---------------------------------------------------------------------------

Disclosure and Dissemination of Information

    Merrill Lynch will deliver a prospectus in connection with the 
initial purchase of the Notes. The procedure for the delivery of a 
prospectus will be the same as Merrill Lynch's current procedure 
involving primary offerings. In addition, Nasdaq will issue a circular 
to NASD members explaining the unique characteristics and risks of the 
Notes.
(2) Basis
    Nasdaq believes that the proposed rule change is consistent with 
section 15A of the Act, in general, and furthers the objectives of 
section 15A(b)(6), in particular, in that it is 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, in general, to protect 
investors and the public interest.

B. Self-Regulatory Organization's Statement on Burden on Competition

    Nasdaq does not believe that the proposed rule change will 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

    Written comments were neither solicited nor received.

III. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing,

[[Page 56874]]

including whether the proposed rule change is consistent with the Act. 
Persons making written submissions should file six copies thereof with 
the Secretary, Securities and Exchange Commission, 450 Fifth Street, 
NW., Washington, DC 20549-0609. 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 Room. Copies of such filing will also be available for 
inspection and copying at the principal office of the NASD. All 
submissions should refer to file number SR-NASD-2001-79 and should be 
submitted by December 4, 2001.

IV. Commission Findings and Order Granting Accelerated Approval of 
the Proposed Rule Change

    Nasdaq has asked the Commission to approve the proposal on an 
accelerated basis to accommodate the timetable for listing the Notes.
    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 association and, in 
particular, with the requirements of section 15A(b)(6) of the Act \10\ 
in that it is designed to promote just and equitable principles of 
trade, to remove impediments to and perfect the mechanism of a free and 
open market, and, in general, to protect investors and the public 
interest.\11\ The Commission believes that the Notes will provide 
investors with a means to participate in any percentage increase in the 
Index that exists at the maturity of the Notes, subject to the Capped 
Value. Specifically, as described more fully above, a beneficial owner 
will be entitled to receive at maturity a payment on the Notes based on 
twice the amount of any percentage increase in the Index, not to exceed 
the Capped Value.
---------------------------------------------------------------------------

    \10\ 15 U.S.C. 78o-3(b)(6).
    \11\ In approving the proposed rule, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    The Notes are leveraged debt instruments whose price will be 
derived from and based upon the value of the Index. In addition, as 
discussed more fully above, the Notes do not guarantee any return of 
principal at maturity. Thus, if the Index has declined at maturity, a 
beneficial owner may receive significantly less than the original 
public offering price of the Notes. Accordingly, the level of risk 
involved in the purchase or sale of the Notes is similar to the risk 
involved in the purchase or sale of traditional common stock. Because 
the final rate of return on the Notes is derivatively priced and based 
upon the performance of an index of securities, because the Notes are 
debt instruments that do not guarantee a return of principal, and 
because investors' potential return is limited by the Capped Value, 
there are several issues regarding trading of this type of product. For 
the reasons discussed below, the Commission believes that Nasdaq's 
proposal adequately addresses the concerns raised by this type of 
product.
    First, the Commission notes that the protections of NASD Rule 
4420(f) were designed to address the concerns attendant to the trading 
of hybrid securities like the Notes.\12\ In particular, by imposing the 
hybrid listing standards, heightened suitability for 
recommendations,\13\ and compliance requirements, noted above, the 
Commission believes that Nasdaq has adequately addressed the potential 
problems that could arise from the hybrid nature of the Notes. The 
Commission notes that Nasdaq will distribute a circular to its 
membership that provides guidance regarding member firm compliance 
responsibilities and requirements, including suitability 
recommendations, and highlights the special risks and characteristics 
associated with the Notes. Specifically, among other things, the 
circular will indicate that the Notes do not guarantee any return of 
principal at maturity, that the maximum return on the Notes is limited 
to $14.00 per unit, that the Notes will not pay interest, and that the 
Notes will provide full exposure to any downside movement in the Index. 
Distribution of the circular should help to ensure that only customers 
with an understanding of the risks attendant to the trading of the 
Notes and who are able to bear the financial risks associated with 
transactions in the Notes will trade the Notes. In addition, the 
Commission notes that Merrill Lynch will deliver a prospectus in 
connection with the initial purchase of the Notes.
---------------------------------------------------------------------------

    \12\ See 1993 Order, supra note 3.
    \13\ As discussed above, Nasdaq will advise members, member 
organizations, and employees thereof recommending a transaction in 
the Notes to: (1) Determine that the transaction is suitable for the 
customer; and (2) 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 transaction.
---------------------------------------------------------------------------

    Second, the Commission notes that the final rate of return on the 
Notes depends, in part, upon the individual credit of the issuer, 
Merrill Lynch. To some extent this credit risk is minimized by the 
NASD's listing standards in NASD Rule 4420(f), which provide that only 
issuers satisfying substantial asset and equity requirements may issue 
these types of hybrid securities. In addition, the NASD's hybrid 
listing standards further require that the Notes have at least $4 
million in market value. Financial information regarding Merrill Lynch, 
in addition to information concerning the issuers of the securities 
comprising the Index, will be publicly available.\14\
---------------------------------------------------------------------------

    \14\ The companies comprising the Index are reporting companies 
under the Act.
---------------------------------------------------------------------------

    Third, the Notes will be registered under section 12 of the Act. As 
noted above, the NASD's and Nasdaq's existing equity trading rules will 
apply to the Notes, which will be subject to equity margin rules and 
will trade during the regular equity trading hours of 9:30 a.m. to 4 
p.m. NASD Regulation's surveillance procedures for the Notes will be 
the same as its current surveillance procedures for equity securities, 
and will include additional monitoring on key pricing dates.
    Fourth, the Commission has a systemic concern that a broker-dealer, 
such as Merrill Lynch, or a subsidiary providing a hedge for the issuer 
will incur position exposure. However, as the Commission has concluded 
in previous approval orders for other hybrid instruments issued by 
broker-dealers,\15\ the Commission believes that this concern is 
minimal given the size of the Notes issuance in relation to the net 
worth of Merrill Lynch.
---------------------------------------------------------------------------

    \15\ See, e.g., Securities Exchange Act Release Nos. 44913 
(October 9, 2001), 66 FR 52469 (October 15, 2001) (order approving 
File No. SR-NASD-2001-73) (approving the listing and trading of 
notes issued by Morgan Stanley Dean Witter & Co. whose return is 
based on the performance of the Index); 44483 (June 27, 2001), 66 FR 
35677 (July 6, 2001) (order approving File No. SR-Amex-2001-40) 
(approving the listing and trading of notes issued by Merrill Lynch 
whose return is based on a portfolio of 20 securities selected from 
the Amex Institutional Index); and 37744 (September 27, 1996), 61 FR 
52480 (October 7, 1996) (order approving File No. SR-Amex-96-27) 
(approving the listing and trading of notes issued by Merrill Lynch 
whose return is based on a weighted portfolio of healthcare/
biotechnology industry securities).
---------------------------------------------------------------------------

    Finally, the Commission believes that the listing and trading of 
the proposed Notes should not unduly impact the market for the 
securities underlying the Index or raise manipulative concerns. The 
Commission notes that the Index is

[[Page 56875]]

well-established and broad-based. In addition, the Commission continues 
to believe, as it has concluded previously, that the large 
capitalizations, liquid markets, and relative weighings of the Index's 
component stocks significantly minimize the potential for manipulation 
of the Index.\16\ The Commission also believes that the weighting 
methodology for the Index should ensure that no one stock or groups of 
stocks dominates the Index, and reduces the potential influence of any 
one stock on the movement of the Index.\17\ In addition, Nasdaq's 
surveillance procedures should serve to deter as well as detect any 
potential manipulation.
---------------------------------------------------------------------------

    \16\ See Securities Exchange Act Release No. 33428 (January 5, 
1994), 59 FR 1576 (January 11, 1994) (order approving File No. SR-
CBOE-93-42) (approving the listing and trading of Index options on 
the Chicago Board Options Exchange).
    \17\ See Securities Exchange Act Release No. 40642 (November 5, 
1998) 63 FR 63759 (November 16, 1998) (order approving File No. SR-
CBOE-98-43).
---------------------------------------------------------------------------

    The Commission finds good cause for approving the proposed rule 
change prior to the thirtieth day after the date of publication of 
notice of filing thereof in the Federal Register. The Commission 
believes that the Notes will provide investors with an additional 
investment choice and that accelerated approval of the proposal will 
allow investors to begin trading the Notes promptly. Accordingly, the 
Commission believes that there is good cause, consistent with sections 
15A(b)(6) and 19(b)(2) of the Act,\18\ to approve the proposal on an 
accelerated basis.
---------------------------------------------------------------------------

    \18\ 15 U.S.C. 78o-3(b)(6) and 78s(b)(2).
---------------------------------------------------------------------------

    The Commission is approving Nasdaq's proposed listing standards for 
the Notes. The Commission specifically notes that, notwithstanding 
approval of the listing standards for the Notes, other similarly 
structured products will require review by the Commission prior to 
being traded on Nasdaq.
    It is therefore ordered, pursuant to section 19(b)(2) of the Act, 
that the proposed rule change (SR-NASD-2001-79) is approved.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\19\
---------------------------------------------------------------------------

    \19\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-28275 Filed 11-9-01; 8:45 am]
BILLING CODE 8010-01-M