[Federal Register Volume 66, Number 228 (Tuesday, November 27, 2001)]
[Notices]
[Pages 59282-59288]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-29399]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45082; File No. SR-Phlx-2001-92]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change and Amendments 
Nos. 1 and 2 by the Philadelphia Stock Exchange, Inc. Relating to the 
Listing and Trading of Index-Linked Exchangeable Notes

November 19, 2001.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'' or ``Exchange Act''),\1\ and Rule 19b-4 thereunder,\2\ notice 
is hereby given that on October 4, 2001, the Philadelphia Stock 
Exchange, Inc. (``Phlx'' or ``Exchange'') filed with the Securities and 
Exchange Commission (``SEC'' or ``Commission'') the proposed rule 
change as described in Items I and II below, which Items have been 
prepared by the Exchange. Amendment No. 1 was filed on November 2, 
2001.\3\ Amendment No. 2 was filed on November 19, 2001.\4\ The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons and to grant accelerated 
approval to the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from John Dayton, Assistant Secretary and 
Counsel, Phlx, to Nancy Sanow, Assistant Director, Division of 
Market Regulation (``Division''), Commission, dated November 1, 2001 
(``Amendment No. 1''). In Amendment No. 1, the Phlx stated that it 
would highlight in its circular to members concerning the proposed 
new product, index-linked exchangeable notes, the various call and 
redemption features that makes this product different from other 
products listed on the Exchange. The Phlx also stated that rules 
applying to members trading for their own account, specialists, odd-
lot brokers, and the handling of orders and reports would also apply 
to the trading of these products.
    \4\ See letter from John Dayton, Assistant Secretary and 
Counsel, Phlx, to Nancy Sanow, Assistant Director, Division of 
Market Regulation (``Division''), Commission, dated November 16, 
2001 (``Amendment No. 2''). In Amendment No. 2, the Phlx amended 
subsection (ii) in proposed rule 803(m)(4)(ii) to add the 
requirement that in addition to the standards stated there, such 
index qualifying under that subsection will also meet the 
requirements of Phlx Rule 1009A(b)(12). In addition, the Exchange 
represents that with respect to any future rules adopted by the 
Exchange pursuant to Rule 19b-4(e), the Exchange commits, in its 
Section 19(b)(2) filings to adopt such new rules, to state and 
discuss whether or not it proposes to apply the new rule standards 
to index-linked exchangeable notes.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Exchange proposes to adopt listing standards for a new product 
to be known as index-linked exchangeable notes. The text of the 
proposed rule change, as amended, follows. Additions are in italics.
* * * * *
    Rule 803(a)-(1) No Change.
    (m) Index-Linked Exchangeable Notes
    Index-linked exchangeable notes which are exchangeable debt 
securities that are exchangeable at the option of the holder (subject 
to the requirement that the holder in most circumstances exchange a 
specified minimum amount of notes), on call by the issuer or at 
maturity for a cash amount (the ``Cash Value Amount'') based on the 
reported market prices of the Underlying Stocks of an Underlying Index 
will be considered for listing and trading on the Exchange pursuant to 
Rule 19b-4(e) under the Securities Exchange Act of 1934, provided:
    (1) Both the issue and the issuer of such security meet the 
criteria set forth in Rule 803(f)1-4, except that the minimum public 
distribution shall be 150,000 notes with a minimum of 400 public note-
holders, except, if traded in thousand dollar denominations, then no 
minimum number of holders.
    (2) The issue has a minimum term of one year.
    (3) The issuer will be expected to have a minimum tangible net 
worth in excess of $250,000,000, and to otherwise substantially exceed 
the earnings requirements set forth in Rule 803(f). In the alternative, 
the issuer will be expected:
    (i) to have a minimum tangible net worth of $150,000,000 and to 
otherwise substantially exceed the earnings requirements set forth in 
Rule 803(f); and
    (ii) not to have issued index-linked exchangeable notes where the 
original issue price of all the issuer's other index-linked 
exchangeable note offerings (combined with other index-linked 
exchangeable note offerings of the issuer's affiliates) listed on a 
national securities exchange or traded through the facilities of Nasdaq 
exceeds 25% of the issuer's net worth.
    (4) The Index to which an exchangeable-note is linked shall either 
be (i) indices that have been created by a third party and been 
reviewed and

[[Page 59283]]

have been approved for the trading of options or other derivative 
securities (each, a ``Third-Party Index'' either by the Commission 
under Section 19(b)(2) of the Securities Exchange Act of 1934, as 
amended (the ``Exchange Act'') and rules thereunder or by the Exchange 
under rules adopted pursuant to Rule 19b-4(e); in addition, the Third-
Party Index's underlying securities shall meet Rule 803(h)(3)(B) and 
the Third-Party Index shall comply with Rule 1009A(b)(12); or (ii) 
indices which the issuer has created and for which an exchange will 
have obtained approval from either the Commission pursuant to Section 
19(b)(2) and rules thereunder or from the Exchange under rules adopted 
pursuant to Rule 19b-4(e) (each, an ``Issuer Index''). The Issuer 
Indices and their underlying securities must meet one of the following:
    (i) the procedures and criteria set forth in Rule 1009A(b)-(c); or
    (ii) the criteria set forth in Rule 803(h)(3)(A)(i)-(iii), 
(h)(3)(B)-(D), (h)(4) and Rule 1009A(b)(12) and the index concentration 
limits set forth in Rule 1009A(b)(6) and in Rule 1009A(c)(1) insofar as 
it relates to Rule 1009A(b)(6).
    (5) Index-linked Exchangeable Notes will be treated as equity 
instruments.
    (6) Beginning twelve months after the initial issuance of a series 
of index-linked exchangeable notes, the Exchange will consider the 
suspension of trading in or removal from listing of that series of 
index-linked exchangeable notes under any of the following 
circumstances:
    (i) If the series has fewer than 50,000 notes issued and 
outstanding;
    (ii) if the market value of all index-linked exchangeable notes of 
that series issued and outstanding is less than $1,000,000; or
    (iii) if such other event shall occur or such other condition 
exists which in the opinion of the Exchange makes further dealings on 
the Exchange inadvisable.
* * * * *

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

    In its filing with the Commission, the Exchange 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. The Exchange 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
    The purpose of this proposed rule change is to enact listing 
standards for index-linked exchangeable notes. Under Exchange Rule 
803(f), 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. The 
Exchange now proposes to list for trading, under new Exchange Rule 
803(m), index-linked exchangeable notes that are intended to allow 
investors to hold a single, exchange-listed note exchangeable for the 
cash value of the underlying stocks index (``Underlying Stocks'') of an 
index (``Underlying Index,'' ``Index,'' ``Underlying Indices,'' and 
``Indices''), and thereby to acquire--in a single security and a single 
trade--exposure to a specific index of equity securities.
    Each Underlying Index must be:
     an index that has been created by a third party and 
approved for the trading of options or other derivative securities 
(each, a ``Third-Party Index'') by the Commission under Section 
19(b)(2) of the Act,\5\ and the rules thereunder, or by the Exchange 
under rules adopted pursuant to Rule 19b-4(e) \6\; or
     an index which the issuer has created and for which an 
Exchange will have obtained approval from the Commission pursuant to 
Section 19(b)(2) \7\ and the rules thereunder, or from the Exchange 
under rules adopted pursuant to Rule 19b-4(e) \8\ (each, and ``Issuer 
Index'').
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    \5\ 15 U.S.C. 78s(b)(2).
    \6\ 17 CFR 240.19b-4(e).
    \7\ 15 U.S.C. 78s(b)(2).
    \8\ 17 CFR 240.19b-4(e).
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    In addition, each Underlying Stock will meet the following 
criteria:
     each issuer of an Underlying Stock shall be an Exchange 
Act reporting company which is listed on a national securities exchange 
or is traded through the facilities of a national securities 
association and is subject to last sale reporting;
     each Underlying Stock of a Third-Party Index will meet the 
standards set forth in the Commission's Section 19(b)(2) order 
approving the index, or the Exchange rules under which it was approved, 
as the case may be; and
     each Underlying Stock of an Issuer Index will meet (with 
minor modifications set forth below) the criteria in Phlx Rules 
1009A(b)-(c), or (with minor modifications set forth below) the 
criteria for underlying securities in Phlx Rule 803(h)(3)(A)(i)-(iii), 
(h)(3)(B)-(D), and (h)(4) and Phlx Rule 1009A(b)(12) and the index 
concentration limits in Phlx Rule 1009A(b)(6) and in Rule 1009A(c)(1) 
insofar as it relates to Rule 1009A(b)(6).

Description of Index-Linked Exchangeable Notes

    Index-linked exchangeable notes are exchangeable debt securities 
that are exchangeable at the option of the holder (subject to the 
requirement that the holder in most circumstances exchange a specified 
minimum amount of notes), on call by the issuer or at maturity for a 
cash amount (the ``Cash Value Amount'') based on the reported market 
prices of the Underlying Stocks of an Underlying Index. Each index-
linked exchangeable note is intended to provide investors with an 
instrument that closely tracks the Underlying Index. Notwithstanding 
that the notes are linked to an index, they will trade as a single 
security. The linkage is on a 1-to-1 basis so that a holder of notes is 
fully exposed to depreciation and appreciation of the Underlying 
Stocks. The Exchange will disseminate, on a real time basis for each 
series of index-linked exchangeable notes, an estimate, updated every 
15 seconds, of the value of a note of that series.\9\ This will be 
based, for example, upon current information regarding the value of the 
Underlying Index. The value for any newly created index shall be 
disseminated by the Exchange on a real time basis and updated every 15 
seconds.
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    \9\ In cases where the Issuer of the index-linked exchangeable 
note disseminates the estimate of the value of the note through 
another exchange, the Phlx will ensure that such value is being 
disseminated by such other exchange on a real-time basis and updated 
every 15 seconds. Telephone conversation between John Dayton, 
Assistant Secretary and Counsel, Phlx, and Christopher Solgan, Law 
Clerk, Division, Commission, on November 19, 2001.
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    Index-linked exchangeable notes are expected to trade at a lower 
cost than the cost of trading each of the Underlying Stocks separately 
(because of reduced commission and custody costs), and also to give 
investors the ability to maintain index exposure without any management 
or administrative fees and ongoing expenses. The initial offering price 
for an index-linked exchangeable note will be established on the date 
the note is priced for sale to the public. In addition, unlike many 
hybrid products, index-linked exchangeable notes will not include 
embedded options or leverage. Because index-linked exchangeable notes 
are debt securities, holders will

[[Page 59284]]

not be recognized by issuers of the Underlying Stocks as the owner of 
those stocks and will have no rights as a stockholder with respect to 
those stocks.
    Additional issuances of a series of index-linked exchangeable notes 
may be made subsequent to the initial issuance of that series (and 
prior to the maturity of that series) for purposes of providing market 
liquidity. Each series of index-linked exchangeable notes may or may 
not provide for quarterly interest coupons based on dividends or other 
cash distributions paid on the Underlying Stocks during a prescribed 
period and an annual supplemental coupon based on the value of the 
Underlying Index during a prescribed period. Index-linked exchangeable 
notes will generally be acquired, held, or transferred only in round-
lot amounts (or round-lot multiples) of 100 notes, although odd-lot 
orders are permissible.
    Beginning on a specified date and up to a specified date prior to 
the maturity date or any call date, the holder of an index-linked 
exchangeable note may exchange some or all of its index-linked 
exchangeable notes for their Cash Value Amount, plus any accrued but 
unpaid quarterly interest coupons. Holders will generally be required 
to exchange a certain specified minimum amount of index-linked 
exchangeable notes, although this minimum requirement may be waived 
following a downgrade in the issuer's credit rating below specified 
thresholds or the occurrence of other specified events.
    Index-linked exchangeable notes may be subject to call by the 
issuer on specified dates or during specified periods, upon at least 
30, but not more than 60, days notice to holders. The call price would 
be equal to the Cash Value Amount, plus any accrued but unpaid 
quarterly interest coupons.
    At maturity, the holder of an index-linked exchangeable note will 
receive a cash amount equal to the Cash Value Amount, plus any 
accumulated but unpaid quarterly and annual supplemental interest 
coupons. Although a specific maturity date will not be established 
until the time of the initial offering of a series of index-linked 
exchangeable notes, the index-linked exchangeable notes will provide 
for maturity within a period of not less than one nor more than thirty 
years from the date of issue.
    In connection with the initial listing of each series of index-
linked exchangeable notes, the Exchange has established that a minimum 
of 150,000 notes held by at least 400 holders be required to be 
outstanding when trading begins. Beginning twelve months after the 
initial issuance of a series of index-linked exchangeable notes, the 
Exchange will consider the suspension of trading in or removal from 
listing of that series of index-linked exchangeable notes under any of 
the following circumstances: (i) If the series has fewer than 50,000 
notes issues and outstanding; (ii) if the market value of all index-
linked exchangeable notes of that series issued and outstanding is less 
than $1 million; or (iii) if such other event shall occur or such other 
condition exists which in the opinion of the Exchange makes further 
dealings on the Exchange inadvisable.

Eligibility Standards for Issuers

    The following standards shall apply to each issuer of index-linked 
exchangeable notes:
    (A) Assets/Equity--The issuer shall have assets in excess of $100 
million and stockholders' equity of at least $10 million. In the case 
of an issuer that is unable to satisfy the earnings criteria set forth 
in the first sentence of Phlx Rule 803(f)2, the Exchange 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) Distribution--Minimum public distribution of 150,000 notes with 
a minimum of 400 public noteholders, except, if traded in thousand 
dollar denominations, then no minimum number of holders.
    (C) Principal Amount/Aggregate Market Value--Not less than $4 
million.
    (D) Tangible Net Worth--The issuer will be expected to have a 
minimum tangible net worth in excess of $250 million, and to otherwise 
substantially exceed the earnings requirements set forth in the first 
sentence of Phlx Rule 803(f)2. In the alternative, the issuer will be 
expected: (i) To have a minimum tangible net worth of $150 million, and 
to otherwise substantially exceed the earnings requirements set forth 
in the first sentence Phlx Rule 803(f)2; and (ii) not to have issued 
index-linked exchangeable notes where the original issue price of all 
the issuer's other index-linked exchangeable note offerings (combined 
with other index-linked exchangeable note offerings of the issuer's 
affiliates) listed on a national securities exchange or traded through 
the facilities of Nasdaq exceeds 25% of the issuer's net worth.

Description of the Underlying Indices

    Underlying Indices will either be: (i) Indices that have been 
created by a third party and have been reviewed and approved for the 
trading of options or other derivative securities (each, a ``Third-
Party Index'') either by the Commission under Section 19(b)(2) of the 
Act,\10\ and the rules thereunder, or by the Exchange under rules 
adopted pursuant to Rule 19b-4(e),\11\ or (ii) indices which the issuer 
has created and for which an Exchange will have obtained approval 
either from the Commission pursuant to Section 19(b)(2) of the Act \12\ 
and rules thereunder or from the Exchange under rules adopted pursuant 
to Rule 19b-4(e) \13\ (each, an ``Issuer Index'').
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    \10\ 15 U.S.C. 78s(b).
    \11\ 17 U.S.C. 240.19b-4(e).
    \12\ 15 U.S.C. 78s(b).
    \13\ 17 CFR 240.19b-4(e).
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    All changes to an Underlying Index, including the deletion and 
addition of Underlying Stocks, index rebalancing, and changes to the 
calculation of the index, will be made in accordance with the 
Commission's Section 19(b)(2) order or the Exchange rules under which 
that index was approved, as the case may be.
    The Underlying Index will be calculated based on either the market 
capitalization, modified market capitalization, price, equal-dollar, or 
modified equal-dollar weighting methodology. If the issuer or a broker-
dealer is responsible for maintaining (or has a role in maintaining) 
the Underlying Index, it would be required to erect and maintain a 
``Fire Wall,'' in a form satisfactory to the Exchange, to prevent the 
flow of information regarding the Underlying Index from the index 
production personnel to the sales and trading personnel, and the index 
must be calculated by a third party who is not a broker-dealer.

Eligibility Standards for Underlying Stocks

    The following standards shall apply to each Underlying Stock:
    (A) General Criteria--Each issuer of an Underlying Stock shall be 
an Exchange Act reporting company that is listed on a national 
securities exchange or is traded through the facilities of a national 
securities association and is subject to last sale reporting.
    (B) Criteria Applicable to Underlying Stocks of Third-Party 
Indices--In addition to meeting the ``General Criteria'' set forth 
under clause (A) above, each Underlying Stock of a Third-Party Index 
shall also meet the criteria specified for Underlying Stocks of that 
index in the Commission's Section 19(b)(2) order approving that index 
or the Exchange rules under which it was approved.
    (C) Criteria Applicable to Underlying Stocks of Issuer Indices--In 
addition to

[[Page 59285]]

meeting the ``General Criteria'' set forth under clause (A) above, each 
Underlying Stock of an Issuer Index shall also meet the criteria 
specified in (1) or (2) below:
    (1) Each Underlying Stock of an Issuer Index shall meet each of the 
following criteria:
    (a) A minimum market value of at least $75 million, except that for 
each of the lowest weighted Underlying Stocks in the index that in the 
aggregate account for no more than 10% of the weight of the index, the 
market value can be at least $50 million;
    (b) trading volume in each of the last six months of not less than 
1 million shares, except that for each of the lowest weighted 
Underlying Stocks in the index that in the aggregate account for no 
more than 10% of the weight of the index, the trading volume shall be 
at least 500,000 shares in each of the last six months;
    (c) in a capitalization-weighted index, the lesser of the five 
highest weighted Underlying Stocks in the index or the highest weighted 
Underlying Stocks in the index that in the aggregate represent at least 
30% of the total number of Underlying Stocks in the index, each have an 
average monthly trading volume of at least 2 million shares over the 
previous six months;
    (d) 90% of the index's numerical index value and at least 80% of 
the total number of Underlying Stocks will meet the then current 
criteria for standardized option trading set forth in Exchange Rule 
1009;
    (e) American Depositary Receipts (``ADRs'') that are not subject to 
comprehensive surveillance agreements do not in the aggregate represent 
more than 20% of the weight of the index;
    (f) all component stocks or ADRs will either be listed on the 
American Stock Exchange or the New York Stock Exchange or traded 
through the facilities of the National Association of Securities 
Dealers Automated Quotation System and reported National Market System 
securities; and
    (g) no Underlying Stock will represent more than 25% of the weight 
of the index, and the five highest weighted Underlying Stocks in the 
index will not in the aggregate account for more than 50% of the weight 
of the index (60% for an index consisting of fewer than 25 Underlying 
Stocks).
    The standards set forth in clauses (a) to (g) above must be 
continuously maintained, except that:
    (a) The criteria that no single Underlying Stock represent more 
than 25% of the weight of the index and the five highest weighted 
Underlying Stocks in the index cannot represent more than 50% (or 60% 
of indices with less than 25 Underlying Stocks) of the weight of the 
index, need only be satisfied for capitalization-weighted and price-
weighted indices as of the first day of January and July in each year;
    (b) the total number of Underlying Stocks in the index may not 
increase or decrease by more than 33\1/3\% from the number of 
Underlying Stocks in the index at the time of its initial listing, and 
in no event may be fewer than nine Underlying Stocks;
    (c) the trading volume of each Underlying Stock in the index must 
be at least 500,000 shares for each of the last six months, except that 
for each of the lowest weighted Underlying Stocks in the index that in 
the aggregate account for no more than 10% of the weight of the index 
trading volume must be at least 400,000 shares for each of the last six 
months; and
    (d) in a capitalization-weighted index, the lesser of the five 
highest weighted Underlying Stocks in the index or the highest weighted 
Underlying Stocks in the index that in the aggregate represent at least 
30% of the total number of stocks in the index have had an average 
monthly trading volume of at least 1 million shares over the previous 
six months.
    (2) In the alternative, each Underlying Stock of an Issuer Index 
shall meet each of the following criteria:
    (a)(i) a minimum market capitalization of $3 billion and during the 
12 months preceding listing is shown to have traded at least 2.5 
million shares; (ii) a minimum market capitalization of $1.5 billion 
and during the 12 months preceding listing is shown to have traded at 
least 10 million shares; or (iii) a minimum market capitalization of 
$500 million and during the 12 months preceding listing is shown to 
have traded at least 15 million shares;
    (b) no Underlying Stock will represent more than 25% of the weight 
of the index, and the five highest weighted component securities in the 
index do not in the aggregate account for more than 50% of the weight 
of the index (60% for an index consisting of fewer than 25 component 
securities), except that for capitalization-weighted and price-weighted 
indices these standards need be satisfied only as of the first day of 
January and July in each year;
    (c) if any Underlying Stock is the stock of a non-U.S. company that 
is traded in the U.S. market as sponsored American Depositary Shares 
(``ADS'') or ADRs then for each such security the Exchange shall 
either;
    (i) have in place a comprehensive surveillance sharing agreement 
with the primary exchange on which each security underlying the ADS or 
ADR is traded;
    (ii) the combined trading volume of each non-U.S. security and 
other related non-U.S. securities occurring in the U.S. market or in 
markets with which the Exchange has in place a comprehensive 
surveillance sharing agreement represents (on a share equivalent basis 
for any ADSs) at least 50% of the combined worldwide trading volume in 
each non-U.S. security, other related non-U.S. securities, and other 
classes of common stock related to each non-U.S. security over the six-
month period preceding the date of listing of the related index-linked 
exchangeable note; or
    (iii)(A) the combined trading volume of each non-U.S. security and 
other related non-U.S. securities occurring in the U.S. market 
represents (on a share equivalent basis) at least 20% of the combined 
world-wide trading volume in each non-U.S. security and in other 
related non-U.S. securities over the six-month period preceding the 
date of listing of the related index-linked exchangeable note; (B) the 
average daily trading volume for each non-U.S. security in the U.S. 
markets over the six months preceding the date of listing of the 
related index-linked exchangeable note is 100,000 or more shares; and 
(C) the trading volume is at least 60,000 shares per day in the U.S. 
markets on a majority of the trading days for the six months preceding 
the date of listing of the related index-linked exchangeable note.
    (d) An Underlying Stock may not exceed 5% of the total outstanding 
common shares of the issuer of that Underlying Stock, however, if any 
Underlying Stock is a non-U.S. security represented by ADSs, common 
shares, or otherwise, then for each such index-linked exchangeable note 
the instrument may not exceed:
    (i) 2% of the total shares outstanding worldwide provided at least 
20% of the worldwide trading volume in each non-U.S. security and 
related non-U.S. security during the six-month period preceding the 
date of listing occurs in the U.S. market;
    (ii) 3% of the total worldwide shares outstanding provided at least 
50% of the worldwide trading volume in each non-U.S. security and 
related non-U.S. security during the six-month period preceding the 
date of listing occurs in the U.S. market; and
    (iii) 5% of the total shares outstanding worldwide provided at 
least 70% of the worldwide trading volume in each non-U.S. security and 
related non-U.S. security during the six-month period

[[Page 59286]]

preceding the date of listing occurs in the U.S. market.
    (e) if any non-U.S. security and related securities has less than 
30% of the worldwide trading volume occurring in the U.S. market during 
the six-month period preceding the date of listing, then the instrument 
may not be linked to that non-U.S. security.
    If an issuer proposes to list an index-linked exchangeable note 
that relates to more than the allowable percentages set forth above, 
the Exchange, with the concurrence of the staff of the Division, will 
evaluate the maximum percentage of index-linked exchangeable note that 
may be issued on a case-by-case basis.
    If an Underlying Stock to which an index-linked exchangeable note 
is to be linked is the stock of a non-U.S. company which is traded in 
the U.S. market as a sponsored ADS, ordinary shares or otherwise, then 
the minimum number of holders of such Underlying Stock shall be 2,000.

Exchange Rules Applicable to Index-Linked Exchangeable Notes

    Index-linked exchangeable notes will be treated as equity 
instruments. Index-linked exchangeable notes will be subject to all 
Exchange rules governing the trading of equity securities, including, 
among others, rules governing priority, parity and precedence of 
orders, market volatility related trading halt provisions pursuant to 
Phlx Rule 133, and responsibilities of specialists. Exchange equity 
margin rules and the regular equity trading hours of 9:30 am to 4 pm 
will apply to transactions in index-linked exchangeable notes.
    In addition, consistent with other structured products, the 
Exchange will distribute a circular to its membership, prior to the 
commencement of trading, providing guidance with respect to, among 
other things, the fact that the notes are subject to call by the 
issuer, and the member firm responsibilities under Exchange Rules 746 
and 747. Lastly, as with other structured products, the Exchange will 
closely monitor activity in index-linked exchangeable notes to identify 
and deter any potential improper trading activity in the index-linked 
exchangeable notes.
2. Statutory Basis
    The proposed rule change, as amended, is consistent with Section 
6(b) of the Act \14\ in general and furthers the objectives of Section 
6(b)(5) \15\ in particular in that it is designed to prevent fraudulent 
and manipulative acts and practices, to promote just and equitable 
principles of trade, and to remove impediments to and perfect the 
mechanism of a free and open market and a national market system, and, 
in general, to protect investors and the public interest.
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    \14\ 15 U.S.C. 78f(b).
    \15\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    No written comments were solicited or received with respect to the 
proposed rule change.

III. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, 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 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 Exchange. All submissions should refer to File 
No. SR-Phlx-2001-92 and should be submitted by December 18, 2001.

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

    The Commission finds that the proposed rule change and Amendment 
No. 1 and 2 are consistent with the requirements of Section 6(b)(5) of 
the Act \16\ and the rules and regulations thereunder applicable to a 
national securities exchange. In particular, the Commission believes 
the Exchange's proposal to list and trade index-linked exchangeable 
notes will provide an instrument for investors to achieve desired 
investment objectives through the purchase of debt securities--index-
inked exchangeable notes--exchangeable for the cash value of the 
Underlying Stocks of an Underlying Index.\17\ Accordingly, the 
Commission finds that the Exchange's proposal will facilitate 
transactions in securities, remove impediments to and perfect the 
mechanism of a free and open market and a national market system, and, 
in general, protect investors and the public interest, and is not 
designed to permit unfair discrimination between customers, issuers, 
brokers, or dealers.\18\
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    \16\ 15 U.S.C. 78f(b)(5). 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\ Index-linked exchangeable notes will generally be acquired, 
held or transferred only in round-lot amounts (or round-lot 
multiples) of 100 notes although odd-lot orders are permissible. 
Although these notes will have features similar to other index 
related products, they differ from other products with respect to 
their exchangeability feature. The Commission notes that the holder 
of the note may exchange the notes at his or her option, on call by 
the issuer, or at maturity for the cash value based upon the 
reported market prices of the Underlying Stocks of an Underlying 
Index. Holders, however, will generally be required to exchange a 
certain specified minimum amount of index-linked exchangeable notes, 
although this minimum requirement may be waived following a 
downgrade in the issuer's credit rating below specified thresholds 
or the occurrence of other specified events.
    \18\ Pursuant to Section 6(b)(5) of the Act, the Commission must 
predicate approval of exchange trading for new products upon a 
finding that the introduction of the product is in the public 
interest. Such a finding would be difficult with respect to a 
product that served no investment, hedging or other economic 
functions, because any benefits that might be derived by market 
participants would likely 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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    The Commission notes that the initial offering price of an index-
linked exchangeable note will be determined on the date that the note 
is priced for sale to the public. The Commission believes that index-
linked exchangeable notes will be attractive to investors because they 
are expected to trade at lower cost than the cost of trading each of 
the Underlying Stocks separately. The Commission also notes that the 
Exchange will disseminate an estimate of the value of a note for each 
series of index-linked exchangeable notes, on a real time basis, every 
15 seconds. The value of any Underlying Index will also be publicly 
available to investors on a real time basis. The Phlx, for example, has 
stated that to the extent there is an existing Index, it will ensure 
its value is publicly available, and if it is a new Index, that the 
Phlx would publish the value itself on a real time basis. This will 
ensure investors receive up-to-date information on the value of the 
note and the Underlying Index. Accordingly,

[[Page 59287]]

index-linked exchangeable notes should allow investors to: (i) Respond 
quickly to market changes through intra-day trading opportunities; (ii) 
engage in hedging strategies not currently available to retail 
investors; and (iii) reduce transaction costs for trading a group or 
index of securities.
    Although the value of index-linked exchangeable notes will be based 
on the value of the Underlying Stocks in an Underlying Index, index-
linked exchangeable notes are not leveraged instruments.\19\ In 
essence, index-linked exchangeable notes are debt securities based on 
the Underlying Stocks of an Underlying Index; the holders of such notes 
will not be considered owners of the Underlying Stocks and will not 
have the rights of a stockholder in those stocks. However, index-linked 
exchangeable notes will be regulated as equity instruments and will be 
subject to all of the Exchange's rules governing the trading of equity 
securities. Nevertheless, the Commission believes that the unique 
nature of index-linked exchangeable notes, related to, among other 
things, the exchangeability feature,\20\ raise certain product design, 
disclosure, trading, and other issues that must be addressed.
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    \19\ In contrast, proposals to list exchange-traded derivative 
products that contain a built-in leverage feature or component raise 
additional regulatory issues, including heightened concerns 
regarding manipulation, market impact, and customer suitability. 
See, e.g., Securities Exchange Act Release No. 36165 (August 29, 
1995), 60 FR 46653 (September 7, 1995) (relating to the 
establishment of uniform listing and trading guidelines for stock 
index, currency, and currency index warrants).
    \20\ See supra note 15.
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A. Index-Linked Exchangeable Notes Generally

    The Commission believes that the proposed index-linked exchangeable 
notes are reasonably designed to provide investors with an investment 
vehicle that substantially reflects the value of the Underlying Stocks 
of an Underlying Index. Index-linked exchangeable notes will be treated 
as equity instruments subject to Phlx rules governing the trading of 
equity securities. As such, the Commission finds that adequate rules 
and procedures exist to govern the trading of index-linked exchangeable 
notes. In this regard, the Commission notes that the Exchange will 
impose specific criteria in the selection of issuers, the Underlying 
Stocks, and the Underlying Indices.
    As noted above, the Phlx rules for index-linked exchangeable notes 
contain specific criteria for issuers. For example, the issuer must 
have a minimum tangible net worth in excess of $250 million and 
substantially exceed the earnings requirements in the first sentence of 
Phlx Rule 803(f)2; or a minimum tangible value of $150 million, 
substantially exceed the earnings requirements in the first sentence of 
Phlx Rule 803(f)2, and not to have issued index-linked exchangeable 
notes where the original issue price of all the issuer's other index-
linked exchangeable note offerings (combined with other index-linked 
exchangeable note offerings of the issuer's affiliates) listed on a 
national securities exchange or traded through the facilities of Nasdaq 
exceeds 25% of the issuer's net worth. These criteria are in part 
intended to ensure that the issuer has enough assets to meet its 
obligations under the terms of the note and should help to reduce 
systematic risk.
    The minimum issue requirements for the issue of index-linked 
exchangeable notes should also serve to establish a minimum level of 
liquidity for the product. These issue requirements include: (i) A 
minimum public distribution of 150,000 notes with a minimum of 400 
public noteholders (no minimum number of holders if traded in one 
thousand dollar denominations), and (ii) market value of $4 million.
    The Phlx rules applicable to the index-linked exchangeable notes 
also contain minimum requirements for the Indices the note can be 
linked to and the underlying components of those Indices. For example, 
because all components of an Underlying Index must be a U.S. reporting 
company, there will be information of available Index component stocks. 
Further, the Phlx's proposed rules for the Indices underlying index-
lined exchangeable notes are linked to other approved criteria for 
index related products. Accordingly, any Underlying Index would have to 
follow the criteria adopted by the Commission for that Index, including 
the criteria for component stocks already in Phlx's rules. These 
requirements will generally contain, among other things, minimum market 
capitalization, trading volume, and concentration requirements that are 
designed to reduce manipulation concerns and ensure a minimum level of 
liquidity for component securities.
    In summary, the rules for selecting components of Indices are 
intended to make the Underlying Stocks and the Underlying Indices 
representatives of the market they are intended to reflect as well as 
to reduce manipulation concerns by setting forth minimum liquidity 
standards for Underlying Stocks. Accordingly, the Commission believes 
that these criteria should serve to ensure that the Underlying Stocks 
of Underlying Indices are well capitalized and actively traded.

B. Disclosure

    The Commission believes that the Exchange's proposal should ensure 
that investors have information that will allow them to be adequately 
apprised of the terms, characteristics, and risks of trading index-
lined exchangeable notes. The Commission notes that upon the initial 
listing of any class of index-linked exchangeable notes, the Exchange 
will issue a circular to its members explaining the unique 
characteristics and risk of this type of security.\21\ The circular 
will also note Exchange members' responsible under Exchange Rules 746 
and 747 regarding transactions in index-linked exchangeable notes. 
Exchange Rule 746 generally requires that members use due diligence to 
learn the essential facts relative to every customer, every order or 
account accepted.\22\ Exchange Rule 747 generally requires that members 
be personally informed of the essential facts of each customer prior to 
giving the required written approval for the opening of that customer 
account.\23\
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    \21\ The Exchange represents that it will highlight the 
exchangeability feature of index-linked exchangeable notes in its 
circular to members. Amendment No. 1, supra note 3.
    \22\ Phlx Rule 746.
    \23\ Phlx Rule 747.
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C. Trading of Index-Linked Exchangeable Notes

    The Commission finds that adequate rules and procedures exist to 
govern the trading of index-linked exchangeable notes. Index-linked 
exchangeable notes will be treated as equity instruments subject to all 
Phlx rules governing the trading of equity securities. These rules 
include; rules governing priority, parity and precedence of orders, 
market volatility related trading halt provisions pursuant to Exchange 
Rule 133, responsibilities of specialists, members dealing for their 
own accounts, odd-lot brokers, and registered traders, and handling of 
orders and reports.\24\ In addition, the Exchange's equity margin rules 
and regular equity trading hours of 9:30 am to 4 pm will apply to 
transactions in index-linked exchangeable notes.
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    \24\ Amendment No. 1, supra note 3.
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    The Commission is satisfied with Phlx's development of specific 
listing and delisting criteria for index-linked exchangeable notes. For 
example, in connection with the initial listing of each series of 
index-linked exchangeable notes, the Exchange has established that a 
minimum of 150,000

[[Page 59288]]

notes held by at least 400 holders be required to be outstanding when 
trading begins. These criteria should help ensure that a minimum level 
of liquidity will exist in each series of index-linked exchangeable 
notes to allow for maintenance of fair and orderly markets. The 
delisting criteria also allows the Exchange of consider suspension of 
trading and the delisting of a series of index-linked exchangeable 
notes if an event were to occur that made further dealings in such 
series inadvisable. This will give the Phlx flexibility to delist 
index-linked exchangeable notes if circumstances warrant such action. 
Further, Phlx rules have specific criteria that allow them to delist if 
there is fewer than 50,000 notes issued and outstanding, of if the 
market value of the index-exchangeable notes is less than $100,000. 
This should ensure a minimum level of liquidity for these products. 
Accordingly, the Commission believes that the rules governing the 
trading of index-linked exchangeable notes, consistent with Section 
6(b)(5) of the Act,\25\ provide adequate safeguards to protect 
investors and the public interest. While the index-linked exchangeable 
notes have certain call and redemption features that make them 
different from other products, the Phlx has addressed any concerns by 
adopting the existing criteria used in other index related products. In 
addition, the Phlx will highlight these different features in the 
circular to members.
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    \25\ 15 U.S.C. 78f(6)(5).
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D. Dissemination of Information

    The Commission believes that the value of index-linked exchangeable 
notes that the Exchange proposes to disseminate will provide investors 
with timely and useful information concerning the value of the index-
linked exchangeable notes based on current information regarding the 
value of the Underlying Index. The value of the Underlying Index will 
also be publicly disseminated. This information will be disseminated 
and updated every 15 seconds during regular Phlx trading hours of 9:30 
am to 4:00 pm, Philadelphia time.

E. Surveillance

    The Commission believes that the surveillance procedures developed 
by the Phlx for index-linked exchangeable notes should be adequate to 
address concerns associated with the listing and trading of such notes. 
In this regard, the Phlx has developed procedures to monitor activity 
in index-linked exchangeable notes to identify and deter improper 
trading activity.
    The Commission also notes that concerns are raised when a broker-
dealer is involved in the development and maintenance of an Underlying 
Index upon which a product, such as index-linked exchangeable notes is 
based, in that case, the broker-dealer and its affiliate should have 
procedures designed specifically to address the improper sharing of 
information. The Commission notes that the Exchange requires the 
implementation of procedures that are satisfactory to the Exchange to 
prevent the misuse of material, non-public information regarding 
changes to Underlying Stocks of an Underlying Index in a particular 
series of index-linked exchangeable notes. In addition, the Commission 
notes that if a broker-dealer is involved in developing or maintaining 
an Underlying Index, the Index must be calculated by a third party who 
is not a broker-dealer.\26\ The Commission believes that such 
information barrier procedures will address the unauthorized transfer 
and misuse of material, non-public information.
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    \26\ See Phlx Rule 1009A(b)(12).
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F. Scope of the Commission's Order

    The Commission is approving the Exchange's proposed listing and 
trading standards for the index-linked exchangeable notes as discussed 
herein. Index-linked exchangeable notes addressed in this order can be 
listed pursuant to Rule 19b-4(e) \27\ if they meet the standards 
discussed above in the Phlx rules. The Commission notes that with 
respect to any future rules adopted by the Exchange pursuant to Rule 
19b-4(e),\28\ the Exchange has indicated that in its Section 19(b)(2) 
filings to adopt such new rules, it will state and discuss whether or 
not it proposes to apply the new rule standards to index-linked 
exchangeable notes.\29\
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    \27\ 17 CFR 240.19b-4(e).
    \28\ Id.
    \29\ See Amendment No. 2, supra note 4.
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G. Accelerated Approval

    The Commission finds good cause for approving the proposal prior to 
the thirtieth day after the date of the publication of notice of filing 
thereof in the Federal Register. The proposal establishes listing and 
trading standards for a new product, index-linked exchangeable notes. 
Granting accelerated approval will allow the Exchange to immediately 
begin listing and trading series of index-linked exchangeable notes 
under these new standards. While the structure of the product is 
different from those previously reviewed by the Commission, the Phlx 
proposes to apply existing criteria used for other index related 
products. Accordingly, the Commission believes that there is good 
cause, consistent with Sections 6(b)(5) and 19(b) of the Act,\30\ to 
approve the proposal on an accelerated basis.
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    \30\ 15 U.S.C. 78f(b)(5) and 78s(b).
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\31\ that the proposed rule change and Amendments No. 1 and 2 (SR-
Phlx-2001-92) is hereby approved on an accelerated basis.
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    \31\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\32\
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    \32\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-29399 Filed 11-26-01; 8:45 am]
BILLING CODE 8010-01-M