[Federal Register Volume 69, Number 95 (Monday, May 17, 2004)]
[Notices]
[Pages 27959-27963]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-11055]


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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49670; File No. SR-NASD-2004-068]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of a Proposed Rule Change and Amendment 
No. 1 Thereto by the National Association of Securities Dealers, Inc. 
Relating to the Listing and Trading of Accelerated Return Notes Linked 
to the Nikkei 225 Index

May 7, 2004.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on April 22, 2004, the National Association of Securities Dealers, Inc. 
(``NASD''), through its subsidiary, The Nasdaq Stock Market, Inc. 
(``Nasdaq''), 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 Nasdaq. Nasdaq 
filed Amendment No. 1 to the proposed rule change on May 7, 2004.\3\ 
The Commission is publishing this notice to solicit comments on the 
proposed rule change, as amended, from interested persons and is 
approving the proposal on an accelerated basis.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(l).
    \2\ 17 CFR 240. 19b-4.
    \3\ See letter from Alex Kogan, Associate General Counsel, 
Nasdaq, to Katherine A. England, Assistant Director, Division of 
Market Regulation (``Division''), Commission, dated May 7, 2004 
(``Amendment No. 1''). In Amendment No. 1, Nasdaq provided certain 
details about the Nikkei 225 Index.
---------------------------------------------------------------------------

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

    Nasdaq proposes to list and trade Accelerated Return Notes Linked 
to the Nikkei 225[reg] Index (``Notes'') issued by Merrill Lynch & Co., 
Inc. (``Merrill Lynch''). This proposed rule change pertains to the 
Notes described and due as indicated in Merrill Lynch's Prospectus 
Supplements dated February 26, 2004 and April 28, 2004.

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

    In its filing with the Commission, Nasdaq included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item III below. Nasdaq has prepared summaries, set forth in Sections A, 
B, and C below, of the most significant aspects of such statements.

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

1. Purpose
    Nasdaq proposes to list and trade notes, the return on which is 
based upon the Nikkei 225 Index (``Index'').
    Under NASD Rule 4420(f), Nasdaq may approve for listing and trading 
securities which cannot be readily categorized under traditional 
listing guidelines.\4\ Nasdaq proposes to list for trading notes based 
on the Index under NASD Rule 4420(f). The Notes, which will be 
registered under section 12 of the Act, will initially be subject to 
Nasdaq's listing criteria for other securities under NASD Rule 4420(f). 
Specifically, under NASD Rule 4420(f)(1):
---------------------------------------------------------------------------

    \4\ See Securities Exchange Act Release No. 32988 (September 29, 
1993), 58 FR 52124 (October 6, 1993).
---------------------------------------------------------------------------

    (A) The issuer shall have assets in excess of $100 million and 
stockholders' equity of at least $10 million.\5\ In the case of an 
issuer which is unable to satisfy the income criteria set forth in 
paragraph (a)(1), Nasdaq generally will require the issuer to have the 
following: (i) Assets in excess of $200 million and stockholders' 
equity of at least $10 million; or (ii) assets in excess of $100 
million and stockholders' equity of at least $20 million;
---------------------------------------------------------------------------

    \5\ Merrill Lynch satisfies this listing criterion.
---------------------------------------------------------------------------

    (B) There must be a minimum of 400 holders of the security, 
provided, however, that if the instrument is traded in $1,000 
denominations, there must be a minimum of 100 holders;
    (C) For equity securities designated pursuant to this paragraph, 
there must be a minimum public distribution of 1,000,000 trading units;
    (D) The aggregate market value/principal amount of the security 
will be at least $4 million.
    In addition, Merrill Lynch satisfies the listed marketplace 
requirement set forth in NASD Rule 4420(f)(2).\6\ Lastly, pursuant to 
NASD Rule 4420(f)(3), prior to the commencement of trading of the 
Notes, Nasdaq will distribute a circular

[[Page 27960]]

to members providing guidance regarding compliance responsibilities and 
requirements, including suitability recommendations, and highlighting 
the special risks and characteristics of the Notes. In particular, 
Nasdaq will advise members recommending a transaction in the Notes to 
have reasonable grounds for believing that the recommendation is 
suitable for such customer upon the basis of the facts, if any, 
disclosed by such customer as to his other security holdings and as to 
his financial situation and needs. In addition, prior to the execution 
of a transaction in the Notes that has been recommended to a non-
institutional customer, a member shall make reasonable efforts to 
obtain information concerning: (1) The customer's financial status; (2) 
the customer's tax status; (3) the customer's investment objectives; 
and (4) such other information used or considered to be reasonable by 
such member in making recommendations to the customer.
---------------------------------------------------------------------------

    \6\ NASD Rule 4420(f)(2) requires issuers of securities 
designated pursuant to this paragraph to be listed on The Nasdaq 
National Market or the New York Stock Exchange, Inc. (``NYSE'') or 
be an affiliate of a company listed on The Nasdaq National Market or 
the NYSE; provided, however, that the provisions of NASD Rule 4450 
will be applied to sovereign issuers of ``other'' securities on a 
case-by-case basis.
---------------------------------------------------------------------------

    The Notes will be subject to Nasdaq's continued listing criterion 
for other securities pursuant to NASD Rule 4450(c). Under this 
criterion, the aggregate market value or principal amount of publicly-
held units must be at least $1 million. The Notes also must have at 
least two registered and active market makers as required by NASD Rule 
4310(c)(1). Nasdaq will also consider prohibiting the continued listing 
of the Notes if Merrill Lynch is not able to meet its obligations on 
the Notes.
    The Notes are a series of senior non-convertible debt securities 
that will be issued by Merrill Lynch and will not be secured by 
collateral. The Notes will have a term of not less than one, nor more 
than four, years. The Notes will be issued in denominations of whole 
units (``Unit''), with each Unit representing a single Note. The 
original public offering price will be $10 per Unit. The Notes will not 
pay interest and are not subject to redemption by Merrill Lynch or at 
the option of any beneficial owner before maturity in 2005. The Notes 
will mature on June 16, 2005.
    At maturity, if the value of the Index has increased, a beneficial 
owner will be entitled to receive a payment on the Notes based on 
triple the amount of that percentage increase, not to exceed a maximum 
payment per Unit (the ``Capped Value'') of $11.80. Thus, the Notes 
provide investors the opportunity to obtain upside leveraged returns 
based on the Index subject to a cap that is expected to represent an 
appreciation of 18% over the original public offering price of the 
Notes. Unlike ordinary debt securities, the Notes do not guarantee any 
return of principal at maturity. However, the Notes are not leveraged 
on the downside; rather, the value of the Notes declines on a one-to-
one basis with the Index. Therefore, if the value of the Index has 
declined at maturity, a beneficial owner will receive less, and 
possibly significantly less, than the original public offering price of 
$10 per Unit.
    The payment that a beneficial owner will be entitled to receive 
(the ``Redemption Amount'') depends entirely on the relation of the 
average of the values of the Index at the close of the market on five 
business days shortly before the maturity of the Notes (the ``Ending 
Value'') and the closing value of the Index on the date the Notes are 
priced for initial sale to the public (the ``Starting Value'').
    If the Ending Value is less than or equal to the Starting Value, 
the Redemption Amount per Unit will equal:
[GRAPHIC] [TIFF OMITTED] TN17MY04.010

    If the Ending Value is greater than the Starting Value, the 
Redemption Amount per Unit will equal:
[GRAPHIC] [TIFF OMITTED] TN17MY04.011

 provided, however, the Redemption Amount cannot exceed the Capped 
Value.
    The Notes are cash-settled in U.S. dollars and do not give the 
holder any right to receive a portfolio security, dividend payments, or 
any other ownership right or interest in the portfolio or index of 
securities comprising the Index. The Notes are designed for investors 
who want to participate or gain exposure to the Index, subject to a 
cap, and who are willing to forego market interest payments on the 
Notes during such term. The Commission has previously approved the 
listing of other securities the performance of which has been linked to 
or based on, the Index.\7\
---------------------------------------------------------------------------

    \7\ See Securities Exchange Act Release Nos. 38940 (August 15, 
1997), 62 FR 44735 (August 22, 1997) (approving the listing and 
trading of Market Index Target-Term Securities the return on which 
is based on changes in the value of a portfolio of 11 foreign 
indexes, including the Nikkei 225 Index); and 27565 (December 22, 
1989), 55 FR 376 (January 4, 1990) (approving listing of Index 
Warrants based on the Nikkei Stock Average and noting the existence 
of a Memorandum of Understanding between the Commission and the 
Japanese Ministry of Finance for surveillance purposes).
---------------------------------------------------------------------------

    The Index is a stock index calculated, published and disseminated 
by Nihon Keizai Shimbun, Inc. (``NKS''). The Notes are not sponsored, 
endorsed, sold or promoted by NKS. NKS is a recognized service with 
business information in Japan and publishes a large business daily, The 
Nihon Keizai Shimbon, and for other financial newspapers. NKS is not 
affiliated with a securities broker or dealer.
    The Index measures the composite price performance of selected 
Japanese stocks. The Index is currently based on 225 Underlying Stocks 
trading on the Tokyo Stock Exchange (``TSE'') and represents a broad 
cross-section of Japanese industry. All 225 of the stocks underlying 
the Index are stocks listed in the First Section of the TSE. Stocks 
listed in the First Section are among the most actively traded stocks 
on the TSE.
    The Index is a modified, price-weighted index. Each stock's weight 
in the Index is based on its price per share rather than the total 
market capitalization of the issuer. NKS calculates the Index by 
multiplying the per share price of each Underlying Stock by the 
corresponding weighting factor for that Underlying Stock (a ``Weight 
Factor''), calculating the sum of all these products and dividing that 
sum by a divisor. The divisor, initially set on May 16, 1949 at 225, 
was 23.156 as of April 30, 2004, and is subject to periodic adjustments 
as set forth below. Each Weight Factor is computed by dividing [yen]50 
by the par value of the relevant Underlying Stock, so that the share 
price of each Underlying Stock when multiplied by its Weight Factor 
corresponds to a share price based on a uniform par value of [yen]50. 
Each Weight Factor represents the number of shares of the related 
Underlying Stock which are included in one trading unit of the Index. 
The stock prices used in the calculation of the Index are those 
reported by a primary market for the Underlying Stocks, which is 
currently the TSE. The level of the Index is calculated once per minute 
during TSE

[[Page 27961]]

trading hours. The value of the Index is readily accessible by U.S. 
investors at the following Web sites: http://www.nni.nikkei.co.jp and 
http://www.bloomberg.com. As noted below, because of the time 
difference between Tokyo and New York, the closing level of the Index 
on a trading day will generally be available in the United States by 
the opening of business on the same calendar day.
    In order to maintain continuity in the level of the Index in the 
event of certain changes due to non-market factors affecting the 
Underlying Stocks, such as the addition or deletion of stocks, 
substitution of stocks, stock dividends, stock splits or distributions 
of assets to stockholders, the divisor used in calculating the Index is 
adjusted in a manner designed to prevent any instantaneous change or 
discontinuity in the level of the Index. The divisor remains at the new 
value until a further adjustment is necessary as the result of another 
change. As a result of each change affecting any Underlying Stock, the 
divisor is adjusted in such a way that the sum of all share prices 
immediately after the change multiplied by the applicable Weight Factor 
and divided by the new divisor, i.e., the level of the Index 
immediately after the change, will equal the level of the Index 
immediately prior to the change.\8\
---------------------------------------------------------------------------

    \8\ Underlying Stocks may be deleted or added by NKS. However, 
to maintain continuity in the Index, the policy of NKS is generally 
not to alter the composition of the Underlying Stocks except when an 
Underlying Stock is deleted in accordance with the following 
criteria. Any stock becoming ineligible for listing in the First 
Section of the TSE due to any of the following reasons will be 
deleted from the Underlying Stocks: bankruptcy of the issuer; merger 
of the issuer into, or acquisition of the issuer by, another 
company; delisting of the stock or transfer of the stock to the 
``Seiri-Post'' because of excess debt of the issuer or because of 
any other reason; or transfer of the stock to the Second Section of 
the TSE. Upon deletion of a stock from the Index, NKS will select, 
in accordance with certain criteria established by it, a replacement 
for the deleted Underlying Stock. In an exceptional case, a newly 
listed stock in the First Section of the TSE that is recognized by 
NKS to be representative of a market may be added to the Underlying 
Stocks. As a result, an existing Underlying Stock with low trading 
volume and not representative of a market will be deleted.
---------------------------------------------------------------------------

    As of April 30, 2004, the average daily trading volume for a single 
Index component was approximately 4.8 million shares.\9\ As of the same 
date, the market capitalization of the components ranged from 14.4 
trillion yen to 33.7 billion yen. These figures correspond 
approximately to 130 billion U.S. dollars and 305 million U.S. dollars.
---------------------------------------------------------------------------

    \9\ This figure represents the average number of shares traded 
for the past 30 trading days. It is calculated by taking the sum of 
the volumes of the individual Index components for the past 30 
trading days and dividing it by 30.
---------------------------------------------------------------------------

    The Index is composed of 225 securities and is broad-based. The 
highest-weighted stock in the Index has the weight of 3.35%; all other 
components have lower weights. The top five stocks in the Index have 
the cumulative weight of approximately 14.3%.
    NKS is under no obligation to continue the calculation and 
dissemination of the Index. In the event the calculation and 
dissemination of the Index is discontinued, Nasdaq will contact 
Commission staff and consider prohibiting the continued listing of the 
Notes.\10\
---------------------------------------------------------------------------

    \10\ The TSE is one of the world's largest securities exchanges 
in terms of market capitalization. Trading hours are currently from 
9 a.m. to 11 a.m. and from 12:30 p.m. to 3 p.m., Tokyo time, Monday 
through Friday. Due to the time zone difference, on any normal 
trading day the TSE will close prior to the opening of business in 
New York City on the same calendar day. Therefore, the closing level 
of the Index on a trading day will generally be available in the 
United States by the opening of business on the same calendar day.
    The TSE has adopted certain measures, including daily price 
floors and ceilings on individual stocks, intended to prevent any 
extreme short-term price fluctuations resulting from order 
imbalances. In general, any stock listed on the TSE cannot be traded 
at a price lower than the applicable price floor or higher than the 
applicable price ceiling. These price floors and ceilings are 
expressed in absolute Japanese yen, rather than percentage limits 
based on the closing price of the stock on the previous trading day. 
In addition, when there is a major order imbalance in a listed 
stock, the TSE posts a ``special bid quote'' or a ``special asked 
quote'' for that stock at a specified higher or lower price level 
than the stock's last sale price in order to solicit counter-orders 
and balance supply and demand for the stock. Prospective investors 
should also be aware that the TSE may suspend the trading of 
individual stocks in certain limited and extraordinary 
circumstances, including, for example, unusual trading activity in 
that stock. As a result, changes in the Index may be limited by 
price limitations or special quotes, or by suspension of trading, on 
individual stocks which comprise the Index, and these limitations 
may, in turn, adversely affect the value of the Notes.
---------------------------------------------------------------------------

    Since the Notes will be deemed equity securities for the purpose of 
NASD Rule 4420(f), the NASD and Nasdaq's existing equity trading rules 
will apply to the Notes. First, pursuant to NASD Rule 2310 and NASD IM-
2310-2, members must have reasonable grounds for believing that a 
recommendation to a customer regarding the purchase, sale, or exchange 
of any security is suitable for such customer upon the basis of the 
facts, if any, disclosed by such customer as to his other security 
holdings and as to his financial situation and needs.\11\ In addition, 
as previously described, Nasdaq will distribute a circular to members 
providing guidance regarding compliance responsibilities and 
requirements, including suitability recommendations, and highlighting 
the special risks and characteristics of the Notes. Furthermore, the 
Notes will be subject to the equity margin rules. Lastly, the regular 
equity trading hours of 9:30 a.m. to 4 p.m. will apply to transactions 
in the Notes.
---------------------------------------------------------------------------

    \11\ NASD Rule 2310(b) requires members to make reasonable 
efforts to obtain information concerning a customer's financial 
status, a customer's tax status, the customer's investment 
objectives, and such other information used or considered to be 
reasonable by such member or registered representative in making 
recommendations to the customer.
---------------------------------------------------------------------------

    Nasdaq represents that NASD's surveillance procedures are adequate 
to properly monitor the trading of the Notes. Specifically, NASD will 
rely on its current surveillance procedures governing equity securities 
and will include additional monitoring on key pricing dates.
    If manipulative activity or other types of trading activity that 
raise regulatory concerns are suspected and involve Index component 
stocks, the NASD will rely on the Intermarket Surveillance Group 
(``ISG'') Agreement to obtain the needed information from the TSE. This 
Agreement obligates the NASD and the TSE to compile and transmit market 
surveillance information and resolve in good faith any disagreements 
regarding requests for information or responses thereto. Also, if it 
ever became necessary (for example, if, hypothetically, the TSE 
withdrew from the ISG), NASD would seek the Commission's assistance 
pursuant to memoranda of understanding or similar inter-governmental 
agreements or arrangements that may exist between the Commission and 
the Japanese securities regulators.\12\
    Merrill Lynch will deliver a prospectus in connection with the 
initial purchase of the Notes. The procedure for the delivery of a 
prospectus will be the same as Merrill Lynch's current procedure 
involving primary offerings.
---------------------------------------------------------------------------

    \12\ Telephone conversation between Alex Kogan, Associate 
General Counsel, Nasdaq, and Florence Harmon, Senior Special 
Counsel, Division, Commission, dated May 7, 2004.
---------------------------------------------------------------------------

2. Statutory Basis
    Nasdaq believes that the proposed rule change, as amended, is 
consistent with the provisions of section 15A of the Act,\13\ in 
general, and with section 15A(b)(6) of the Act,\14\ in particular, in 
that the proposal is designed to prevent fraudulent and manipulative 
acts and practices, to promote just and equitable principles of trade, 
to remove impediments to and perfect the mechanism of a free and open 
market and, in general, to protect investors and

[[Page 27962]]

the public interest. Specifically, the proposed rule change will 
provide investors with another investment vehicle based on the Index.
---------------------------------------------------------------------------

    \13\ 15 U.S.C. 78o-3.
    \14\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

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

    Nasdaq does not believe that the proposed rule change, as amended, 
will result in any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Act, as amended.

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

    Written comments were neither solicited nor received.

III. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, is consistent with the Act. Comments may be 
submitted by any of the following methods:
    Electronic comments:
     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to [email protected]. Please include 
File No. SR-NASD-2004-68 on the subject line.
    Paper comments:
     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609. All submissions should refer to File No. SR-
NASD-2004-068. This 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, please use only one method. The Commission 
will post all comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). 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 Section, 450 Fifth Street, NW., Washington, DC 20549. Copies 
of such filing also will be available for inspection and copying at the 
principal office of Nasdaq. All comments received will be posted 
without change; the Commission does not edit personal identifying 
information from submissions. You should submit only information that 
you wish to make available publicly. All submissions should refer to 
File No. SR-NASD-2004-068 and should be submitted on or before June 7, 
2004.

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

    Nasdaq has asked the Commission to approve the proposal on an 
accelerated basis to accommodate the timetable for listing the Notes. 
The Commission notes that it has previously approved the listing of 
securities the performance of which have been linked to or based on, 
the Index.\15\ The Commission has also previously approved the listing 
of securities with a structure similar to that of the Notes.\16\
---------------------------------------------------------------------------

    \15\ See Securities Exchange Act Release No. 34-38940 (August 
15, 1997), 62 FR 44735 (August 22, 1997) (approving the listing and 
trading of Market Index Target-Term Securities the return on which 
is based on changes in the value of a portfolio of 11 foreign 
indexes, including the Nikkei 335 Index).
    \16\ See Securities Exchange Act Release Nos. 47464 (March 7, 
2003), 68 FR 12116 (March 13, 2003) (approving the listing and 
trading of Market Recovery Notes Linked to the S&P 500 Index); 47009 
(December 16, 2002), 67 FR 78540 (December 24, 2002) (approving the 
listing and trading of Market Recovery Notes linked to the Nasdaq-
100 Index); and 46883 (November 21, 2002), 67 FR 71216 (November 29, 
2002) (approving the listing and trading of Market Recovery Notes 
linked to the Dow Jones Industrial Average).
---------------------------------------------------------------------------

    After careful consideration, the Commission finds that the proposed 
rule change, as amended, is consistent with the requirements of the Act 
and the rules and regulations thereunder,\17\ applicable to a national 
securities association, and, in particular, with the requirements of 
section 15A(b)(6) of the Act,\18\ in that it is designed to promote 
just and equitable principles of trade, to remove impediments to and 
perfect the mechanism of a free and open market, and, in general, to 
protect investors and the public interest.\19\ The Commission believes 
that the Notes will provide investors with a means to participate in 
any percentage increase in the Index that exists at the maturity of the 
Notes, subject to the Capped Value. Specifically, as described more 
fully above, if the value of the Nikkei 225 Index has increased, a 
beneficial owner will be entitled to receive at maturity a payment on 
the Notes based on triple the amount of any percentage increase in the 
Index, not to exceed the Capped Value.
---------------------------------------------------------------------------

    \17\ The Commission findings in this approval order are 
prospective only from the date of this order. Prior to this approval 
order, Nasdaq began trading the Notes described in Merrill Lynch's 
Prospectus Supplement dated February 26, 2004. The Commission is 
concerned that Nasdaq failed to seek approval for the listing and 
trading of this product until after it began trading on Nasdaq.
    \18\ 15 U.S.C. 78o-3(b)(6).
    \19\ 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).
---------------------------------------------------------------------------

    The Commission notes that the Notes are non-principal protected 
instruments, but are not leveraged on the downside. The Notes are debt 
instruments, the price of which will be derived from and based upon the 
value of the Nikkei 225 Index. The Notes do not have a minimum 
principal amount that will be repaid at maturity, and the payments of 
the Notes prior to or at maturity may be less than the original issue 
price of the Notes. Accordingly, the level of risk involved in the 
purchase or sale of the Notes is similar to the risk involved in the 
purchase or sale of traditional common stock. Because the final rate of 
return of the Notes is derivatively priced, based on the performance of 
the 225 common stocks underlying the Nikkei 225 Index, and because the 
Notes are instruments that do not guarantee a return of principal, 
there are several issues regarding the trading of this type of product. 
However, for the reasons discussed below, the Commission believes that 
Nasdaq's proposal adequately addresses the concerns raised by this type 
of product.
    The Commission notes that the protections of NASD Rule 4420(f) were 
designed to address the concerns attendant to the trading hybrid 
securities like the Notes. In particular, by imposing the hybrid 
listing standards, suitability, disclosure, and compliance requirements 
noted above, the Commission believes that Nasdaq has addressed 
adequately the potential problems that could arise from the hybrid 
nature of the Notes. The Commission notes that Nasdaq will distribute a 
circular to its membership calling attention to the specific risks 
associated with the Notes. The Commission also notes that Merrill Lynch 
will deliver a prospectus in connection with the initial sales of the 
Notes. In addition, the Commission notes that Nasdaq will incorporate 
and rely upon its existing surveillance procedures governing equities, 
which have been deemed adequate under the Act.
    In approving the product, the Commission recognizes that the Index 
is a stock index calculated, published and disseminated by NKS, which 
measures the composite price performance of selected Japanese stocks. 
The Index is currently based on 225 common stocks

[[Page 27963]]

traded on the TSE and represents a broad cross-section of Japanese 
industry. All 225 underlying stocks are listed in the First Section of 
the TSE and are, therefore, among the most actively traded stocks on 
the TSE. The Nikkei is a modified, price-weighted index, which means a 
component stock's weight in the Nikkei is based on its price per share 
rather than total market capitalization of the issuer.
    As stated above, NKS is under no obligation to continue the 
calculation and dissemination of the Index. In the event the 
calculation and dissemination of the Index is discontinued, Nasdaq 
represents that it will contact Commission staff and consider 
prohibiting the continued listing of the Notes. The Commission notes 
that the changes in the composition of the Nikkei 225 Index as made 
solely by NKS. The changes to these common stocks tend to be made 
infrequently with most substitutions the result of mergers and other 
extraordinary corporate actions. As of April 30, 2004, the average 
daily trading volume for a single Index component was approximately 4.8 
million shares.\20\ As of the same date, the market capitalization of 
the components ranged from 14.4 trillion yen to 33.7 billion yen. These 
figures correspond approximately to 130 billion U.S. dollars and 305 
million U.S. dollars. The highest-weighted stock in the Index has the 
weight of 3.35%; all other components have lower weights. The top five 
stocks in the Index have the cumulative weight of approximately 14.3%. 
Given the compositions of the stocks underlying the Nikkei 225 Index, 
the Commission believes that the listing and trading of the Notes that 
are linked to the Nikkei 225 Index should not unduly impact the market 
for the underlying securities comprising the Nikkei 225 Index or raise 
manipulative concerns. As discussed more fully above, the underlying 
stocks comprising the Nikkei 225 Index are well-capitalized, highly 
liquid stocks.
---------------------------------------------------------------------------

    \20\ This figure represents the average number of shares traded 
for the past 30 trading days. It is calculated by taking the sum of 
the volumes of the individual index components for the past 30 
trading days and dividing it by 30.
---------------------------------------------------------------------------

    In light of the fact that the Nikkei is a foreign index, the 
Commission believes adequate surveillance sharing agreements between 
the NASD and the TSE is a necessary prerequisite to deter and detect 
potential manipulations or other improper or illegal trading involving 
the Notes. While many of the issuers of the underlying securities 
comprising the Nikkei 225 are not subject to reporting requirements 
under the Act, Nasdaq represents that an adequate surveillance sharing 
agreement exists through the ISG between the NASD and the TSE to deter 
and detect potential manipulations or other improper trading in the 
underlying components. Therefore, Nasdaq's surveillance procedures will 
serve to deter as well as detect any potential manipulation. This 
agreement obligates the NASD and TSE to compile and transmit market 
surveillance information and resolve in good faith any disagreements 
regarding requests for information. Accordingly, the Commission 
believes that the surveillance sharing Agreement through ISG is 
adequate for the NASD to surveil the components of the Nikkei 225 for 
potential manipulation or other trading abuses between the markets with 
respect to the trading of the Notes based on the Nikkei 225.
    Furthermore, the Commission notes that the Notes are depending upon 
the individual credit of the issuer, Merrill Lynch. To some extent this 
credit risk is minimized by the NASD's listing standards in NASD Rule 
4420(f), which provide the only issuers satisfying substantial asset 
and equity requirements may issue securities such as the Notes. In 
addition, the NASD's hybrid listing standards further require that the 
Notes have a market value of at least $4 million. In any event, 
financial information regarding Merrill Lynch, in addition to the 
information on the 225 common stocks comprising the Nikkei 225 Index, 
will be publicly available.\21\
---------------------------------------------------------------------------

    \21\ See http://www.nni.nikkei.co.jp and http://www.bloomberg.com.
---------------------------------------------------------------------------

    The Commission also has a systemic concern, however, that a broker-
dealer such as Merrill Lynch, or a subsidiary providing a hedge for the 
issuer will incur position exposure. However, as the Commission has 
concluded in previous approval orders for other hybrid instruments 
issued by broker-dealers,\22\ the Commission believes that this concern 
is minimal given the size of the Notes issuance in relation to the net 
worth of Merrill Lynch.
---------------------------------------------------------------------------

    \22\ See, e.g., Securities Exchange Act Release Nos. 44913 
(October 9, 2001), 66 FR 52469 (October 15, 2001) (order approving 
the listing and trading of notes whose return is based on the 
performance of the Nasdaq-100 Index) (File No. SR-NASD-2001-73); 
44483 (June 27, 2001), 66 FR 35677 (July 6, 2001) (order approving 
the listing and trading of notes whose return is based on a 
portfolio of 20 securities selected from the Amex Institutional 
Index) (File No. SR-Amex-2001-40); and 37744 (September 27, 1996), 
61 FR 52480 (October 7, 1996) (order approving the listing and 
trading of notes whose return is based on a weighted portfolio of 
healthcare/biotechnology industry securities) (File No. SR-Amex-96-
27).
---------------------------------------------------------------------------

    Finally, the Commission notes that the value of the Nikkei 225 
Index will be disseminated at least once every minute throughout the 
trading day. Because the Nikkei 225 Index contains foreign securities 
and is composed of highly liquid and well capitalized securities, the 
Commission believes that providing access to the value of the Index at 
least once every minute throughout the trading day is sufficient and 
will provide benefits to investors in the product.
    The Commission finds good cause for approving the proposed rule 
change, as amended, prior to the thirtieth day after the date of 
publication of notice of filing thereof in the Federal Register. The 
Commission believes that the Notes will provide investors with an 
additional investment choice and that accelerated approval of the 
proposal will allow investors to begin trading the Notes promptly. In 
addition, the Commission notes that it has previously approved the 
listing and trading of other derivative securities based on the Index 
and securities with a structure similar to that of the Notes.\23\ 
Accordingly, the Commission believes that there is good cause, 
consistent with sections 15A(b)(6) and 19(b)(2) of the Act,\24\ to 
approve the proposal, on an accelerated basis.
---------------------------------------------------------------------------

    \23\ See supra notes 15 and 16.
    \24\ 15 U.S.C. 78o-3(b)(6) and 78s(b)(2).
---------------------------------------------------------------------------

V. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\25\ that the proposed rule change, as amended (SR-NASD-2004-068) 
is hereby approved on an accelerated basis.
---------------------------------------------------------------------------

    \25\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\26\
Jill M. Peterson,
Assistant Secretary.
---------------------------------------------------------------------------

    \26\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

[FR Doc. 04-11055 Filed 5-14-04; 8:45 am]
BILLING CODE 8010-01-P