[Federal Register Volume 59, Number 200 (Tuesday, October 18, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-25727]
[[Page Unknown]]
[Federal Register: October 18, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34820; File No. SR-Amex-94-27]
Self-Regulatory Organizations; Order Approving a Proposed Rule
Change by the American Stock Exchange, Inc. Relating to the Listing and
Trading of Basic Industry Portfolio Index Term Notes
October 11, 1994.
I. Introduction
On August 8, 1994, the American Stock Exchange, Inc. (``Amex'' or
``Exchange''), pursuant to Section 19(b)(1) of the Securities Exchange
Act of 1934 (``Act'')\1\ and Rule 19B-4 Thereunder,\2\ filed with the
Securities and Exchange Commission (``SEC'' or ``Commission'') a
proposed rule change to list and trade Indexed Term Notes (``Notes''),
the return on which is based upon a portfolio of securities issued by
companies involved in ``basic'' industries\3\ (``Basic Industry
Portfolio''). The Exchange filed Amendment No. 1 to the proposal on
August 24, 1994.\4\ Notice of the proposal, as amended, appeared in the
Federal Register on August 31, 1994.\5\ No comment letters were
received on the proposed rule change. This order approves the proposal,
as amended.
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\1\15 U.S.C. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1992).
\3\Basic industries would include such industries as chemicals,
steel, aluminum, paper, and oil (``Basic Industries'').
\4\In Amendment No. 1 to the proposed rule change, the Exchange
proposes to: (1) provide that at maturity, holders of the indexed
term notes will receive a minimum of 90% of the principal amount of
the indexed term notes; and (2) amend the listing standards
regarding foreign securities and American Depository Receipts
(``ADRs'') represented in the index underlying the indexed term
notes. See Letter from Benjamin Krause, Senior Vice President,
Capital Markets Group, Amex, to Michael Walinskas, Branch Chief,
Office of Market Supervision (``OMS''), Division of Market
Regulation (``Division''), Commission, dated August 24, 1994.
\5\See Securities Exchange Act Release No. 34597 (August 25,
1994), 59 FR 45048 (August 31, 1994).
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II. Description of the Proposal
Under Section 107 of the Amex Company Guide (``Guide''), the
Exchange may approve for listing and trading securities which cannot be
readily categorized under the listing criteria for common and preferred
stocks, bonds, debentures, or warrants.\6\ The Amex now proposes to
list for trading, under Section 107A of the Guide, Notes whose value is
based in whole or in part on a static index composed of twenty-six
actively-traded equity securities issued by companies involved in Basic
Industries.\7\
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\6\See Securities Exchange Act Release No. 27753 (March 1,
1990), 55 FR 8626 (March 8, 1990).
\7\The specific components of the Basic Industry Portfolio are:
Alcan Aluminum; American Barrick Resources; Bethlehem Steel; Cyprus
Amax Minerals; Dow Chemical; Du Pont (E.I.) De Nemours; Echo Bay
Mines; Geneva Steel; Georgia Gulf; Georgia Pacific; IMC Fertilizer;
Inco; International Paper; Kerr McGee; Kaiser Aluminum; Lyondell
Petrochemical; Monsanto; Morton International; Northwestern Steel;
Nucor; Phelps Dodge; Placer Dome; Reynolds Metals; USX-U.S. Steel
Group; Weirton Steel; and Weyerhaeuser.
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The Notes are non-convertible debt securities of Lehman Brothers,
Inc. (``Lehman Brothers'') and will conform to the listing guidelines
under Section 107A of the Guide.\8\ Although the specific maturity date
will not be established until immediately prior to the time of the
offering, the Notes will provide for maturity within a period of not
less than one nor more than seven years from the date of issue. The
Notes provide for a single payment at maturity, and will bear no
periodic payments of interest. Basic Industry Portfolio Notes will
entitle the owner at maturity to receive an amount based upon the
percentage change between the ``Original Portfolio Value'' and the
``Ending Average Portfolio Value;'' provided, however, that: (1) the
amount payable at maturity will not be less than 90% of the principal
amount of the Notes; and (2) the issuer may place a cap on the amount
to be paid on the Notes at maturity.\9\ The ``Original Portfolio
Value'' is the value of the Basic Industry Portfolio on the date on
which the issuer prices the Notes for the initial offering to the
public. The ``Ending Average Portfolio Value'' is the average of the
closing prices of the Basic Industry Portfolio securities for a
specified number of days prior to maturity of the Notes.\10\ The Ending
Average Portfolio Value will be used in calculating the amount owners
will receive upon maturity.\11\
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\8\Specifically, the Notes must have: (1) A minimum public
distribution of one million trading units; (2) a minimum of 400
holders; (3) an aggregate market value of at least $4 million; and
(4) a term of at least one year. Additionally, the issuer of the
Notes (i.e., Lehman Brothers) must have assets of at least $100
million, stockholders' equity of at least $10 million, and pre-tax
income of at least $750,000 in the last fiscal year or in two of the
three prior fiscal years. As an alternative to these financial
criteria, the issuer must have either: (1) assets in excess of $200
million and stockholders' equity in excess of $10 million; or (2)
assets in excess of $100 million and stockholders' equity in excess
of $20 million.
\9\For example, Lehman Brothers could place a cap on the amount
to be received at maturity as a stated percentage of the issuance
price, e.g., 150% of the issuance price. Alternatively, a cap could
be in the form of a participation rate whereby a holder of the Notes
would participate in a stated percentage of the total percentage
change between the Ending Portfolio Value and the Original Portfolio
Value, e.g. 80% of the total appreciation of the Basic Industry
Portfolio during the term of the Notes. The Commission notes that
these examples are by way of illustration, not of limitation, as to
how a cap on the amount to be paid to holders of the Notes at
maturity could be constructed by Lehman Brothers.
\10\Specifically, the Ending Average Portfolio Value will equal
the average of the closing prices for the Basic Industry Portfolio
securities for the first 10 of the last 20 trading days prior to
maturity of the Notes. Telephone conversation between Benjamin
Krause, Senior Vice President, Capital Markets Groups, Amex, and
Brad Ritter, Senior PCounsel, OMS, Division, Commission, on October
5, 1994.
\11\The Basic Industry Portfolio Notes will entitle a holder at
maturity to receive not less than 90% of the original issue price
for the Notes. Additionally, holders of the Notes may not receive
the full amount of the change between the Ending Portfolio Value and
the Original Portfolio Value.
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If the market value of the Basic Industry Portfolio has declined,
the owners of the Basic Industry Portfolio Notes will receive at least
90% of the principal amount of the Notes. The payment at maturity is
based on changes in the value of the Basic Industry Portfolio, subject
to any cap on appreciation that may be included by the issuer, but does
not reflect the payment of dividends on the securities that comprise
the portfolio. Basic Industry Portfolio Notes are cash-settled in that
they do not give the holder any right to receive a portfolio security
or any other ownership right or interest in the portfolio securities,
although the return on the investment is based on the aggregate value
of the Basic Industry Portfolio securities.
According to the Amex, Basic Industry Portfolio Notes will allow
investors to combine the protection of a portion of the principal
amount of the Notes with a potential additional payment based upon the
performance of a portfolio of securities representing 26 highly
capitalized companies engaged in Basic Industries. In particular, the
proposed Basic Industry Portfolio Notes will provide at least 90%
principal protection with the opportunity to participate in any upside
appreciation of the underlying Basic Industry Portfolio, subject to any
cap on appreciation that may be included by the issuer.
The Basic Industry Portfolio consists of securities of 26 companies
that collectively, at the time of issuance,\12\ will satisfy the
generic listing requirements approved by the Commission for the listing
and trading of options on newly established narrow-based indexes.\13\
Specifically, the component securities of the Basic Industry Portfolio
satisfy the following criteria: (1) A minimum market capitalization of
$75 million, except that up to 10% of the component securities may have
a market capitalization of not less than $50 million; (2) trading
volume in each of the six months prior to the offering of the Notes of
not less than one million shares, except that up to 10% of the
component securities may have a trading volume in each of the six
months prior to the offering of the Notes of not less than 500,000
shares, (3) at least 90% of the component securities will meet the then
current criteria for standardized options trading set forth in Exchange
Rule 915; (4) all components of the Basic Industry Portfolio will be
listed on the Amex or the New York Stock Exchange, or will be National
Market securities traded through Nasdaq; (5) all components of the
Basic Industry Portfolio will be subject to last sale reporting
pursuant to Rule 11Aa3-1 of the Act; and (6) no more than 20% of the
weight of the Basic Industry Portfolio shall be represented by foreign
securities or ADRs for which the Exchange does not have in place a
comprehensive surveillance sharing agreement with the appropriate
regulatory organization(s) in such country(ies).\14\
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\12\The Commission notes that because the Basic Industry
Portfolio is a static portfolio, the Amex will not make adjustments
subsequent to issuance of the Notes for purposes of maintaining
compliance with these standards.
\13\See Securities Exchange Act Release No. 34157 (June 3,
1994), 59 FR 30062 (June 10, 1994).
\14\The Exchange has represented that Lehman Brothers may
conclude prior to issuance of the Notes, based on changes in its
market research and investment strategy, that the composition of the
Basic Industry Portfolio should be altered. In such an event, Lehman
Brothers would be allowed, with the concurrence of the staff of the
Commission, to replace component securities accounting for up to 10%
of the number of components of the Basic Industry Portfolio (i.e.,
two components) provided that with the replacement components, the
Basic Industry Portfolio still satisfies the requirements for the
listing and trading of options on newly established narrow-based
indexes. Id. If Lehman Brothers determines to make any changes to
the Basic Industry Portfolio that do not satisfy these conditions,
the Exchange would be required to obtain approval from the
Commission pursuant to Section 19(b) of the Act before listing Notes
based on the altered Basic Industry Portfolio.
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At the outset, each of the securities in the Basic Industry
Portfolio will have equal representation. Specifically, each security
included in the Basic Industry Portfolio will be assigned a multiplier
on the date of issuance so that the security represents an equal
percentage of the value of the entire portfolio on the date of
issuance. The multiplier indicates the number of shares (or fraction of
one share) of a security, given its market price on an exchange or
through Nasdaq, to be included in the calculation of the portfolio.
Accordingly, each of the 26 companies included in the Basic Industry
Portfolio will represent approximately 3.85 percent of the total
portfolio at the time of issuance.
The multiplier for each security in the Basic Industry Portfolio
will generally remain unchanged except for limited adjustments that may
be necessary as a result of stock splits or stock dividends.\15\ There
will be no adjustments to the multipliers to reflect cash dividends
paid with respect to a portfolio security. In addition, no adjustments
of any multiplier of a portfolio security will be made unless such
adjustment would require a change of at least 1% in the multiplier then
in effect.
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\15\Lehman Brothers will adjust the multiplier of any portfolio
security if the security is subject to a stock split or reverse
split to equal the product of the number of shares issued with
respect to one share of the portfolio security and the prior
multiplier. In the case of a stock dividend, the multiplier will be
adjusted so that the new multiplier will equal the former multiplier
plus the product of the number of shares of such portfolio security
issued with respect to one share of the portfolio security and the
prior multiplier.
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If the issuer of a security included in the Basic Industry
Portfolio no longer exists, whether for reason of a merger, acquisition
or similar type of corporate control transaction, then Lehman Brothers
will assign to that security a value equal to the security's final
value for the purposes of calculating portfolio values. For example, if
a company included in the portfolio is acquired by another company,
Lehman Brother shall thereafter assign a value to the shares of the
acquired company's securities equal to the value per share at the time
that the acquisition takes place.
If the issuer of a Basic Industry Portfolio security is in the
process of liquidation or subject to a bankruptcy proceeding,
insolvency, or other similar adjudication, such security will continue
to be included in the Basic Industry Portfolio so long as a market
price on an exchange or through Nasdaq for such security is available.
If such a market price is no longer available for a portfolio security,
including, but not limited to, liquidation, bankruptcy, insolvency, or
any other similar proceeding, the value of the portfolio security will
be assigned a value of zero in connection with calculating the daily
portfolio value and the closing portfolio value of the Basic Industry
Portfolio, for so long as no such market price exists for that
security.\16\
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\16\Lehman Brothers will not attempt to find a replacement stock
or to compensate for the extinction of a security due to bankruptcy
or a similar event.
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The value of the Basic Industry Portfolio will be calculated
continuously by the Amex and will be disseminated every 15 seconds over
the Consolidated Tape Association's Network B. The portfolio value will
equal the sum of the products of the most recently available market
prices and the applicable multipliers for the portfolio securities.
The Notes may not be redeemed prior to maturity and are not
callable by the issuer. Holders of Basic Industry Portfolio Notes will
be able to cash-out of their investment by selling the security on the
Amex. The Exchange anticipates that the trading value of the security
in this secondary trading market will depend in large part on the value
of the securities comprising the Basic Industry Portfolio and also on
such other factors as the level of interest rates, the volatility of
the value of the Basic Industry Portfolio, the time remaining to
maturity, dividend rates, and the creditworthiness of the issuer,
Lehman Brothers.
Because Basic Industry Portfolio Notes are linked to a portfolio of
equity securities, the Amex's existing equity floor trading rules will
apply to the trading of Basic Industry Portfolio Notes. First, pursuant
to Amex Rule 411, the exchange will impose a duty of due diligence on
its members and member firms to learn the essential facts relating to
every customer prior to trading Basic Industry Portfolio Notes.\17\
Second, consistent with Amex Rule 411, the Exchange will further
require that a member or member firm specifically approve a customer's
account for trading Basic Industry Portfolio Notes prior to, or
promptly after, the completion of the transaction. Third, Basic
Industry Portfolio Notes will be subject to the equity margin rules of
the Exchange. Fourth, the Exchange will, prior to trading Basic
Industry Portfolio Notes, distribute a circular to the membership
providing guidance with regard to member firm compliance
responsibilities (including suitability recommendations) when handling
transactions in Basic Industry Portfolio Notes and highlighting the
special risks and characteristics of the Basic Industry Portfolio
Notes.\18\
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\17\Amex Rule 411 requires that every member, member firm or
member corporation use due diligence to learn the essential facts
relative to every customer and to every order or account accepted.
\18\The circular shall also highlight any cap on appreciation,
if any, that the issuer includes in the Notes.
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III. Commission Findings and Conclusions
The Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to a national securities exchange, and, in
particular, the requirements of Section 6(b)(5) of the Act.\19\
Specifically, the Commission believes that providing for exchange-
trading of Basic Industry Portfolio Notes will offer a new and
innovative means of participating in the market for securities of
companies involved in Basic Industries.\20\ In particular, the
Commission believes that Basic Industry Portfolio Notes will permit
investors to gain equity exposure in such companies, while at the same
time, limiting the downside risk of the original investment. For the
reasons discussed in the MITTS Approval Orders, the Commission finds
that the listing and trading of Basic Industry Portfolio Notes is
consistent with the Act.\21\
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\19\15 U.S.C. 78f(b)(5) (1988).
\20\The Commission Notes that the Basic Industry Portfolio Notes
are very similar in structure to several Market Index Target-Term
Securities (``MITTS'') recently approved for listing on the New York
Stock Exchange, Inc. (``NYSE''). See Securities Exchange Act Release
Nos. 34692 (September 20, 1994), 59 FR 49267 (September 27, 1994),
34691 (September 20, 1994), 59 FR 49264 (September 27, 1994), and
34655 (September 12, 1994), 59 FR 47966 (September 19, 1994)
(``MITTS Approval Orders'').
\21\Id.
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As with the MITTS products, Basic Industry Portfolio Notes are not
leveraged instruments. Their price, however, will still be derived and
based upon the underlying linked securities. Accordingly, the level of
risk involved in the purchase or sale of Basic Industry Portfolio Notes
is similar to the risk involved in the purchase or sale of traditional
common stock. Nonetheless, the Commission has several specific concerns
with this type of product because the final rate or return of the Notes
is derivatively priced, based on the performance of the underlying
securities. The concerns include: (1) Investor protection concerns, (2)
dependence on the credit of the issuer of the security, (3) systemic
concerns regarding position exposure of issuers with partially hedged
positions or dynamically hedged positions, and (4) the impact on the
market for the underlying linked securities.\22\
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\22\Id.
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The Commission believes the Amex has adequately addressed each of
these issues such that the Commission's regulatory concerns are
adequately minimized.\23\ In particular, by imposing the listing
standards, suitability, disclosure, and compliance requirements noted
above, the Amex has adequately addressed the potential public customers
concerns that could arise from the hybrid nature of the Notes.\24\
Further, the Commission believes that the listing standards and
issuance restrictions should help to reduce the likelihood of any
adverse market impact on the securities comprising the Basic Industry
Portfolio.
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\23\Id.
\24\The Exchange will also distribute a circular to its
membership, in a form approved by the Commission, calling attention
to the specific risks associated with Basic Industry Portfolio
Notes.
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The Commission realizes that Basic Industry Portfolio Notes are
dependent upon the individual credit of the issuer, Lehman Brothers. To
some extent this credit risk is minimized by the Exchange's continued
listing standards which require issuers to maintain an aggregate market
value of $1 million for its publicly-held shares.\25\ In addition, the
Exchange's hybrid listing standards further require that Basic Industry
Portfolio Notes have at least $4 million in market value.\26\ In any
event, financial information regarding Lehman Brothers, in addition to
the information on the issuers of the underlying securities comprising
the Basic Industry Portfolio, will be publicly available.\27\
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\25\See Amex Company Guide Sec. 1003(b).
\26\See Amex Company Guide Sec. 107A.
\27\The companies that comprise the Basic Industry Portfolio are
reporting companies under the Act.
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It is therefore ordered, Pursuant to Section 19(b)(2) of the
Act,\28\ that the proposed rule change (File No. SR-Amex-94-27), as
amended, is approved.
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\28\15 U.S.C. 78s(b)(2) (1988).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\29\
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\29\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-25727 Filed 10-17-94; 8:45 am]
BILLING CODE 8010-01-M