[Federal Register Volume 69, Number 71 (Tuesday, April 13, 2004)]
[Notices]
[Pages 19593-19600]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-8265]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49532; File No. SR-PCX-2004-01]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of a Proposed Rule Change and Amendment 
Nos. 1 and 2 Thereto by the Pacific Exchange, Inc. To Trade, Either By 
Listing or Pursuant to Unlisted Trading Privileges, Index-Linked 
Exchangeable Notes

April 7, 2004.
    Pursuant to section 19(b)(1) of the Securities Exchange Commission 
Act of 1934 (``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is 
hereby given that on February 6, 2004, the Pacific Exchange, Inc. 
(``PCX'' or ``Exchange''), through its wholly owned subsidiary PCX 
Equities, Inc. (``PCXE''), filed with the Securities Exchange 
Commission (``Commission'' or ``SEC'') the proposed rule change as 
described in Items I and II below, which Items have been prepared by 
the Exchange. On March 3, 2004, the Exchange submitted Amendment No. 1 
to the proposed rule change.\3\ On March 22, 2004, the Exchange 
submitted Amendment No. 2 to the proposed rule change.\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\ CFR 240.19b-4.
    \3\ On March 3, 2004, the Exchange filed a Form 19b-4, which 
replaced the original filing in its entirety (``Amendment No. 1'').
    \4\ See letter to Nancy J. Sanow, Assistant Director, Division 
of Market Regulation, Commission, from Tania J.C. Blanford, Staff 
Attorney, Regulatory Policy, PCX, dated March 19, 2004 (``Amendment 
No. 2''). In Amendment No. 2, the Exchange made a change to the 
proposed rule text to the conform it to those previously approved by 
both the American Stock Exchange LLC (``Amex''), Philadelphia Stock 
Exchange, Inc. (''Phlx''), and the Chicago Board Options Exchange, 
Inc. (``CBOE''). See Securities Exchange Act Release Nos. 46370 
(August 16, 2002), 67 FR 54509 (August 22, 2002) (Order granting 
accelerated approval to SR-CBOE-2002-29); 45082 (November 19, 2001), 
66 FR 59282 (November 27, 2001) (Order granting accelerated approval 
to SR-Phlx-2001-92); and 44621 (July 30, 2001), 66 FR 41064 (August 
6, 2001) (Order granting accelerated approval to SR-Amex-2001-29).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to amend its rules governing the Archipelago 
Exchange (``ArcaEx''), the equities trading facility of PCXE. The 
Exchange proposed to adopt listing standards for index-linked 
exchangeable notes. With this filing, PCX proposes to add PCXE Rule 
5.2(j)(4) to permit for listing or pursuant to unlisted trading 
privileges (``UTPs''), index-linked exchangeable notes. The text of the 
proposed rule change appears below. Proposed new language is in 
italics.
* * * * *
    Rule 5.2(a)-(i)--No change. (j)(1)-(3)--No change.

Index-Linked Exchangeable Notes

    (4) 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 by the

[[Page 19594]]

Corporation pursuant to Rule 19b-4(e) under the Securities Exchange Act 
of 1934, provided:
    (a) Both the issue and the issuer of such security meet the 
criteria set forth above in ``Other Securities'' (PCXE Rule 5.2(j)(1)), 
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.
    (b) The issue has a minimum term of one year.
    (c) 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 PCXE Rule 5.2(j)(1). 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 PCXE Rule 5.2(j)(1); 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.
    (d) 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 have been approved for the trading of options or other 
derivatives 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 
Corporation under rules adopted pursuant to Rule 19b-4(e); or (ii) 
indices which the issuer has created and for which the Corporation will 
have obtained approval from either the Commission pursuant to Section 
19(b)(2) and rules thereunder or from the Corporation 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 PCX Rule 7.3(b)-(c); or
    (ii) The criteria set forth in subsection (C) and (D) of PCXE Rule 
5.2(j)(2), the index concentration limits set forth in PCX Rule 
7.3(b)(6), and PCX Rule 7.3(b)(12) in so far as it relates to PCX Rule 
7.3(b)(6).
    (e) Index-linked Exchangeable Notes will be treated as equity 
instruments;
    (f) Beginning twelve months after the initial issuance of a series 
of index-linked exchangeable notes, the Corporation 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 Corporation makes further dealings 
on the Corporation inadvisable.
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed 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 had 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 PCXE Rule 
5.2(j)(1), 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, whether by listing or 
pursuant to UTPs, under new PCXE Rule 5.2(j)(4), 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 (``Underlying Stocks'') of an index (''Underlying 
Index,'' ``Index,'' ``Underlying Indices,'' or ``Indices''), and 
thereby acquire--in a single security and 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) of the Act; \6\ or
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    \5\ 15 U.S.C. 78s(b)(2).
    \6\ 17 CFR 240.19b-4(e).
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     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) of the Act \7\ and the rules thereunder, 
or from the Exchange under rules adopted pursuant to Rule 19b-4(e) of 
the Act \8\ (each, an ``Issuer Index'').
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    \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 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;
     Each Underlying Stock of a Third-Party Index 
will meet the standards set forth in the Commission's Section 19(b)(2) 
of the Act 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 PCX 
Rule 7.3(b)-(c); or (with minor modifications set forth below) the 
criteria for underlying securities in PCXE Rule 5.2(j)(1) and the index 
concentration limits in PCX Rule 7.3(b)(6) and PCX Rule 7.3(b)(12) in 
so far as it relates to PCX Rule 7.3(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,

[[Page 19595]]

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 note through another exchange, 
the PCX will ensure that such value is being disseminated by such 
other exchange on a real-time basis and updated every 15 seconds.
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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 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, index-linked 
exchangeable notes will not include embedded options or leverage. 
Because index-linked exchangeable notes are debt securities, holders 
will 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 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 issued 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 PCXE Rule 5.2(j)(1)(C), 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 PCXE Rule 
5.2(j)(1)(C). 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 PCXE Rule 
5.2(j)(1)(C); 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 CFR 240.19b-4(e).
    \12\ 15 U.S.C. 78s(b)(2).
    \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) of the Act \14\ order or the Exchange 
rules under which that index was approved, as the case may be.
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    \14\ 15 U.S.C. 78s(b)(2).
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    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

[[Page 19596]]

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.\15\
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    \15\ See PCX Rule 7.3(b)(12).
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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 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 
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 PCX Rule 3.6;
    (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 Amex 
or the New York Stock Exchange, Inc. (``NYSE'') or traded through the 
facilities of the National Association of Securities Dealers Automated 
Quotation System (``Nasdaq'') 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

[[Page 19597]]

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 preceding the 
date of listing occurs in the U.S. market.
    (e) If any non-U.S. security and related securities have less than 
20% 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 Market 
Regulation Division (``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,\16\ 
including provisions of PCXE Rule 7.56 (trade-through rule), which 
prohibits ETP Holders and Sponsored Participants (hereinafter 
``Users'') from initiating trade-throughs for ITS securities, as well 
as Exchange rules governing priority, parity and precedence of orders, 
market volatility related trading halt provisions, and responsibilities 
of Market Makers.\17\ Exchange equity margin rules and the three 
trading sessions \18\ of the Exchange will apply to trading in index-
linked exchangeable notes.
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    \16\ See PCXE Rule 7 et seq. for a discussion of the rules 
governing equity trading.
    \17\ However, the Exchange represents that if Index-linked 
exchangeable notes are traded only in round lots (or round-lot 
multiples), the Exchange rules relating to odd-lot executions will 
not apply.
    \18\ The Exchange operates three trading sessions each day it is 
open. The three trading sessions are (1) the Opening Session; (2) 
the Core Trading Session; and (3) the Late Trading Session. See PCXE 
Rule 7.34(a).
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    Prior to the commencement of trading in index-linked exchangeable 
notes, the Exchange will distribute a circular to its Users 
highlighting the characteristics of index-linked exchangeable notes, 
including, but no limited to: that the notes are subject to call by the 
issuer; that Users must adhere to the procedures established under PCXE 
Rules 9.2(a) and 9.2(b); that the Exchange may consider factors such as 
those set forth in PCX Rule 7.10(b) in exercising its discretion to 
halt or suspend trading; and that trading will be halted in the event 
that market volatility parameters set forth in PCXE Rule 7.12 have been 
reached.
    In addition, pursuant to Rule 10A-3 of the Act \19\ and section 3 
of the Sarbanes-Oxley Act of 2002,\20\ the Exchange will prohibit the 
initial or continued listing of any security of an issuer that is not 
in compliance with the requirements set forth therein.
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    \19\ 17 CFR 240.10A-3.
    \20\ See Section 3 of Pub. L. 107-204, 116 Stat. 745 (2002).
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    Lastly, the Exchange's surveillance procedures for index-linked 
exchangeable notes will be similar to the procedures used for equity-
linked term notes, index portfolio receipts trust issued receipts, and 
other equity non-option products traded on the Exchange and will 
incorporate and rely upon existing Exchange surveillance systems. 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,\21\ in general, and furthers the objectives of section 
6(b)(5),\22\ 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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    \21\ 15 U.S.C. 78f(b).
    \22\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

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

    Written comments on the proposed rule change were neither solicited 
nor received.

III. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposal 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. Comments 
may also be submitted electronically at the following e-mail address: 
[email protected]. All comment letters should refer to File No. SR-
PCX-2004-01. The file number should be included on the subject line if 
e-mail is used. To help the Commission process and review your comments 
more efficiently, comments should be sent in hardcopy or by e-mail but 
not by both methods. 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 Exchange. All

[[Page 19598]]

submissions should refer to the File No. SR-PCX-2004-01 and should be 
submitted by May 4, 2004.

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

    The Commission finds that the proposed rule change, as amended, is 
consistent with the requirements of section 6(b)(5) of the Act \23\ and 
the rules and regulations thereunder applicable to a national 
securities exchange. In particular, the Commission believes the 
Exchange's proposal to list to trade, whether by listing or unlisted 
trading privileges,\24\ index-linked exchangeable notes will provide an 
instrument for investors to achieve desired investment objectives 
through the purchase of debt securities--index-linked exchangeable 
notes--exchangeable for the cash value of the Underlying Stocks of an 
Underlying Index.\25\ 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 system, and, in general, protect investors and the public 
interest, and is not designed to permit unfair discrimination between 
customers, issuers, brokers, or dealers.\26\ Furthermore, the 
Commission has approved the trading of identical products on the Amex, 
Phlx, and CBOE.\27\
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    \23\ 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).
    \24\ The Commission notes that, pursuant to Rule 12f-5 under the 
Act, prior to trading a particular class or type of security 
pursuant to unlisted trading privileges, the Exchange must have 
listing standards comparable to those of the primary market on which 
the security is listed. 17 CFR 240.15f-5. The Commission finds that 
adequate rules and procedures exist to govern the trading of index-
linked exchangeable notes on the Exchange, pursuant to unlisted 
trading privileges.
    \25\ 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.
    \26\ 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 pubic confidence in the integrity of the 
markets, and other valid regulatory concerns.
    \27\ See Securities Exchange Act Release Nos. 46370 (August 16, 
2002), 67 FR 54509 (August 22, 2002) (Order granting accelerated 
approval to SR-CBOE-2002-29); 45082 (November 19, 2001), 66 FR 59282 
(November 27, 2001) (Order granting accelerated approval to SR-Phlx-
2001-92); and 44621 (July 30, 2001), 66 FR 41064 (August 6, 2001) 
(Order granting accelerated approval to SR-Amex-2001-29).
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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 Exchange, 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 Exchange 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, 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.\28\ 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,\29\ raise certain product design, 
disclosure, trading, and other issues that must be addressed.
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    \28\ In contrast, proposals to list exchange-trade 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), 65 FR 46653 (September 7, 1995) (relating to the 
establishment of uniform listing and trading guidelines for stock 
index, currency, and currency index warrants).
    \29\ See supra note 25.
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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 Exchange 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 Exchange 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 PCXE Rule 
5.2(j)(1)(C); or a minimum tangible value of $150 million, 
substantially exceed the earnings requirements in PCXE Rule 
5.2(j)(1)(C), 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 issues 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

[[Page 19599]]

one thousand dollar denominations), and (ii) market value of $4 
million.
    The Exchange 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 Exchange's proposed rules for the Indices underlying 
index-linked 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 Exchange'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 
representative 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-
linked 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 Users explaining the unique 
characteristics and risks of this type of security.\30\ The circular 
will also note Exchange User's responsibilities under PCXE Rules 9.2(a) 
and 9.2(b) regarding transactions in index-linked exchangeable notes. 
PCXE Rule 9.2(a) generally requires that Users use due diligence to 
learn the essential facts relative to every customer, every order or 
account accepted.\31\ Exchange Rule 9.2 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.\32\
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    \30\ The Exchange represents that it will highlight the 
exchangeability feature of index-linked exchangeable notes in its 
circular to Users.
    \31\ See PCXE Rule 9.2(a).
    \32\ Id. See also PCXE Rule 9.2(b).
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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 
Exchange 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 PCXE Rule 
7.12, Responsibilities of Specialists, Users dealing for their own 
accounts, specialists, odd-lot brokers, and registered traders, and 
handling of orders and reports. In addition, the Exchange's equity 
margin rules and the three trading sessions \33\ of the Exchange will 
apply to transactions in index-linked exchangeable notes.
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    \33\ The Exchange operates three trading sessions each day it is 
open. The three trading sessions are (1) the Opening Session; (2) 
the Core Trading Session; and (3) the Late Trading Session. See PCXE 
Rule 7.34(a).
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    The Commission is satisfied with the Exchange'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 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 to 
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 Exchange 
flexibility to delist index-linked exchangeable notes if circumstances 
warrant such action. Further, Exchange rules have specific criteria 
that allow them to delist if there is fewer than 50,000 notes issued 
and outstanding, or 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,\34\ 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 Exchange has addressed any 
concerns by adopting the existing criteria used in other index related 
products. In addition, the Exchange will highlight these different 
features in the circular to members.
---------------------------------------------------------------------------

    \34\ 15 U.S.C. 78(f)(6)(5).
---------------------------------------------------------------------------

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 New York trading hours of 
9:30 a.m. to 4 p.m.

E. Surveillance

    The Commission believes that the surveillance procedures developed 
by the Exchange for index-linked exchangeable notes should be adequate 
to address concerns associated with the listing and trading of index-
linked such notes. In this regard, the Exchange 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.\35\ The Commission

[[Page 19600]]

believes that such information barrier procedures will address the 
unauthorized transfer and misuse of material, non-public information.
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    \35\ See PCX Rule 7.3(b)(12).
---------------------------------------------------------------------------

    Lastly, the Exchange has represented pursuant to Rule 10A-3 of the 
Act \36\ and Section 3 of the Sarbanes-Oxley Act of 2002,\37\ that it 
will prohibit the initial or continued listing of any security of an 
issuer that is not in compliance with the requirements set forth 
therein.
---------------------------------------------------------------------------

    \36\ 17 CFR 240.10A-3.
    \37\ See Section 3 of Pub. L. 107-204, 116 Stat. 745 (2002).
---------------------------------------------------------------------------

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) \38\ if they meet the standards 
discussed above in the Exchange rules. The Commission notes that with 
respect to any future rules adopted by the Exchange pursuant to Rule 
19b-4(e),\39\ 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.
---------------------------------------------------------------------------

    \38\ 17 CFR 240.19b-4(e).
    \39\ Id.
---------------------------------------------------------------------------

G. Accelerated Approval

    The Commission finds good cause for approving the proposal, as 
amended, prior to the thirtieth day after the date of 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 Exchange proposes to apply existing criteria used 
for other index related products. In addition, the Commission has 
approved the trading of identical products on the Amex, Phlx, and 
CBOE.\40\ Accordingly, the Commission believes that there is good 
cause, consistent with Sections 6(b)(5) and 19(b) of the Act,\41\ to 
approve the proposed rule change, as amended, on an accelerated basis.
---------------------------------------------------------------------------

    \40\ See Securities Exchange Act Release Nos. 46370 (August 16, 
2002), 67 FR 54509 (August 22, 2002) (Order granting accelerated 
approval to SR-CBOE-2002-29); 45082 (November 19, 2001), 66 FR 59282 
(November 27, 2001) (Order granting accelerated approval to SR-Phlx-
2001-92); and 44621 (July 30, 2001), 66 FR 41064 (August 6, 2001) 
(Order granting accelerated approval to SR-Amex-2001-29).
    \41\ 15 U.S.C. 78f(b)(5) and 78s(b).
---------------------------------------------------------------------------

IV. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\42\ that the proposed rule change, as amended, (SR-PCX-2004-01) is 
hereby approved on an accelerated basis.
---------------------------------------------------------------------------

    \42\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\43\
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    \43\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-8265 Filed 4-12-04; 8:45 am]
BILLING CODE 8010-01-P