[Federal Register Volume 63, Number 239 (Monday, December 14, 1998)]
[Notices]
[Pages 68811-68814]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-33072]
[[Page 68811]]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
(Release No. 34-40754; File No. SR-Amex-98-25)
Self-Regulatory Organizations; Order Approving Proposed Rule
Change and Notice of Filing and Order Granting Accelerated Approval to
Amendment No. 2 to the Proposed Rule Change by the American Stock
Exchange, Inc. Relating to Listing and Trading Stock Upside Note
Securities on the Lehman Brothers European Stock Basket
December 7, 1998.
I. Introduction
On July 1, 1998, the American Stock Exchange, Inc. (``Amex'' or
``Exchange'') filed with the Securities and Exchange Commission
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to list and trade Stock Upside
Note Securities on the Lehman Brothers European Stock Basket. On July
31, 1998, and October 9, 1998, respectively, the Exchange submitted
Amendments Nos. 1 \3\ and 2 \4\ to the proposed rule change to the
Commission.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See letter from Claire P. McGrath, Vice President and
Special Counsel, Dervatives Legal Counsel, Amex, to Richard
Strasser, Assistant Director, Division of Market Regulation
(``Division''), SEC dated July 30, 1998 (``Amendment No. 1'').
\4\ See letter from Claire P. McGrath, Vice President and
Special Counsel, Derivatives Legal Counsel, Amex, to Richard
Strasser, Assistant Director, Division, SEC, dated October 8, 1998
(``Amendment No. 2'').
---------------------------------------------------------------------------
The proposed rule change, including Amendment No. 1, was published
for comment in the Federal Register on August 26, 1998.\5\ No comments
were received on the proposal. This order approves the proposal as
amended.
---------------------------------------------------------------------------
\5\ Securities Exchange Act Release No. 40338 (August 19, 1998),
63 FR 45539.
---------------------------------------------------------------------------
II. Description of the Proposal
The Amex proposes to trade Stock Upside Note Securities (``SUNS'')
on the Lehman Brothers European Stock Basket (``Basket''), a new basket
of stocks developed by Lehman Brothers Holdings, Inc. (``Lehman
Brothers'') based entirely on the shares of European companies. SUNS on
the Basket are designed to allow investors to combine the protection of
a portion of the principal amount of the SUNS with a potential
additional payment based upon the performance of a portfolio of highly
captalized European stocks. In particular, the proposed SUNS will
provide at least 90% principal protection with the opportunity to
participate in any upside appreciation of the Basket, subject to any
cap on appreciation that may be included by the issuer.
Criteria Under Section 107A of the Amex Company Guide
Under section 107A of the Amex Company Guide, the Exchange may
approve for listing and trading securities that can not be readily
categorized under the listing criteria for common and preferred stocks,
bonds, debentures or warrants.\6\ SUNS issues on the Basket will
conform to the listing guidelines under Section 107A of the Amex
Company Guide, which provide, among other things, that the issuer shall
satisfy the earnings criteria set forth in Section 101 \7\ of the Amex
Company Guide and have assets in excess of $100 million and
stockholders' equity of at least $10 million. Where the issuer does not
satisfy the earnings criteria set forth in Section 101 of the Amex
Company Guide, the issuer must have assets in excess of $200 million
and stockholders' equity of at least $10 million; or have assets in
excess of $100 million and stockholders' equity of at least $20
million. Further, SUNS will have a minimum public distribution of
1,000,000 units with a minimum of 400 public shareholders, except, if
traded in thousand dollar denominations, then no minimum number of
holders will be required. SUNS will have a principal amount/aggregate
market value of not less than $4 million. In addition, Amex will apply
the continued listing guidelines for the proposed SUNS as set forth in
Sections 1001 through 1003 of the Amex Company Guide. In particular,
Section 1003(b)(iii) regarding suspensions and delistings with respect
to limited distribution and reduced market value bonds will apply to
the SUNS.
---------------------------------------------------------------------------
\6\ The Commission has previously approved the listing and
trading of hybrid securities similar to SUNS based upon portfolios
of securities or stock indices. See e.g., Securities Exchange Act
Release Nos. 32840 (September 2, 1993), 58 FR 47485 (September 9,
1993); 33368 (December 22, 1993), 58 FR 68975 (December 29, 1993);
33495 (January 19, 1994), 59 FR 3883 (January 27, 1994); 34692
(September 20, 1994), 59 FR 49267 (September 27, 1994); 37533
(August 7, 1996), 61 FR 42075 (August 13, 1996); and 37744
(September 27, 1996), 61 FR 52480 (October 7, 1996) (``Term Notes
Approval Orders'').
\7\ Section 101 of the Amex Company Guide requires issuers to
have pre-tax earnings of at least $750,000 in the last fiscal year
of two of the last three fiscal years.
---------------------------------------------------------------------------
The SUNS are non-convertible debt securities of Lehman Brothers and
will conform to the above listing standards. Although the specific
maturity date will not be established until immediately prior to the
time of the offering, the SUNS will provide for maturity within a
period of not less than two years and not more than seven years from
the date of issue. The SUNS will provide for a single payment at
maturity, and will bear no periodic payments of interest. The European
Stock Basket SUNS will be denominated in U.S. dollars and will entitle
the owner at maturity to receive an amount based on the percentage
change between the ``Original Portfolio Value'' and the ``Ending
Average Portfolio Value,'' provided: (1) the amount payable at maturity
will not be less than 90% of the principal amount of the SUNS; and (2)
the issuer may place a cap on the maximum amount of be paid on the SUNS
at maturity. Thus, holders of the SUNS may not receive the full amount
of the appreciation of the Ending Average Portfolio Value over the
Original Portfolio Value. For example, Lehman Brothers may 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
SUNS 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 European Stock Basket
during the term of the SUNS. The Original Portfolio Value is the value
of the European Stock Basket on the date on which the issuer prices the
SUNS for the initial offering to the public. The Ending Average
Portfolio Value is the average of the closing prices of the European
Stock Basket securities for a ten-day period beginning on the twelfth
trading day prior to maturity of the SUNS. The European Stock Basket
SUNS will be cash-settled and will not give holders any right to
receive any Basket security or any other ownership right or interest in
such security even though the return on the investment is based on the
value of the Basket.
The SUNS Basket and Components
The European Stock Basket will consist of not less than ten nor
more than thirty stocks of highly capitalized European companies.\8\
Each stock included in the Basket will meet the following criteria: (1)
a market capitalization in excess of $75 million;
[[Page 68812]]
alternatively, the lowest weighted securities in the Basket that do not
account for more than 10% of the weight of the Basket, may have a
market capitalization of $50 million or greater; (2) the trading volume
of each component in the Basket will be at least one million shares
during each of the six months preceding the listing of the SUNS;
alternatively, the lowest weighted securities in the Basket that do not
account for more than 10% of the weight of the Basket, may have a
volume of at least 500,000 shares during each of the six months
preceding the listing of the SUNS; (3) the market price for each
component stock used for the calculation of the Basket will be obtained
from the stock's primary market; and (4) the market price for each
component will be at least $5 for the majority of business days during
the three calendar months preceding the listing of the SUNS.
---------------------------------------------------------------------------
\8\ The Exchange represents that once a determination is made by
Lehman Brothers as to which securities will be included in the
Basket, the Exchange will provide a list of those securities to the
Commission. This list will be provided prior to the commencement of
trading of the SUNS on the Basket. See Amendment No. 2, supra note
4.
---------------------------------------------------------------------------
Basket Calculation
The Basket will be calculated using the modified equal-dollar
weighting methodology. Thus, prior to the issuance of the SUNS, Lehman
Brothers will establish a weighting for each of the securities in the
Basket. Specifically, each security included in the Basket will be
assigned a multiplier so that the security represents the established
percentage of the value of the entire Basket on the date of issuance.
The multiplier indicates the number of shares (or fraction of one
share) of a security, given its market price, to be included in the
calculation of the Basket. The weightings established for each security
will assure that: (1) no single stock will represent more than 25% of
the weight of the Basket; (2) the five highest weighted stocks will
represent no more than 50% of the weight of the Basket; (3) foreign
country securities that are not subject to comprehensive surveillance
agreements will not in the aggregate represent more than 40% of the
weight of the Basket; (4) stocks for which the primary market is in any
one country that is not subject to a comprehensive surveillance
agreement do not represent 20% or more of the weight of the Basket; and
(5) stocks for which the primary market is in any two countries that
are not subject to the comprehensive surveillance agreements do not
represent 33% or more of the weight of the Basket.
The multiplier of each security of the Basket will generally remain
unchanged except for adjustments that may be necessary as a result of
stock splits or stock dividends.\9\ 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. If the issuer of a
security included in the Basket no longer exists, whether for reason of
a merger, acquisition or similar type of corporate control transaction,
Lehman Brothers will assign to that security a value equal to the
security's final value for the purposes of calculating portfolio
values.
---------------------------------------------------------------------------
\9\ The Exchange represents that the independent calculation
agent will be responsible for making any changes to the multiplier
that become necessary due to a stock split or dividend. See
Amendment No. 2, supra note 4.
---------------------------------------------------------------------------
If the issuer of a European Stock Basket 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 Basket so long as a market price for such security is available.
If such a market price is no longer available for a Basket security due
to a liquidation, bankruptcy, insolvency, or any other similar
proceeding, then the value of the security will be zero in connection
with calculating the daily Basket value and the Ending Average
Portfolio Value, for so long as no such market price exists for that
security. Lehman Brothers will not attempt to find a replacement stock,
or to compensate in a manner other than what is set forth above, for
the extinction of a security due to a bankruptcy or similar event.
The value of the Basket will be disseminated every 15 seconds from
9:30 a.m. until 4:00 p.m. each trading day by the Exchange. Such
disseminated value will be calculated by the Amex or by an independent
calculation agent appointed by Lehman Brothers. The Basket value will
be calculated based on real-time prices during the hours the European
markets overlap trading hours with the Exchange. After the close of the
European markets, the Basket value will be calculated based on the last
sale price of the component security. The Basket will be calculated
using the last sale value for each component security from its primary
market place. The exchange rate for each currency represented in the
Basket will be from one of two sources: (i) the WM/Reuter closing value
reported in London at about 12:00 (New York time) each trading day or
(ii) the best bid and offer price posted by two or more contributing
banks as provided by Bridge/Telesphere.\10\ If the market place for any
one of the securities constituting the European Stock Basket has not
opened for trading on any given business day, the previous closing
value will be used in the calculation. The Basket value, for any day,
will equal the sum of the products of the most recently available
market prices, expressed in U.S. dollars and the applicable multipliers
for the Basket securities. Lehman Brothers will undertake to implement
certain surveillance and compliance procedures with respect to the
dissemination of the Basket value, requiring that the Basket value be
announced only through public dissemination and restricting the access
of the Lehman Brothers trading desk to the Basket value determined by
the calculation agent until after public dissemination of that value.
---------------------------------------------------------------------------
\10\ See Amendment No. 2, supra note 4.
---------------------------------------------------------------------------
Exchange Rules Applicable to SUNS
The Exchange's equity trading rules will apply to the trading of
SUNS linked to the European Stock Basket. Those rules include Rule 411,
which requires members to use due diligence to learn the essential
facts relative to every customer and to every order or account
accepted; and Rule 462 which requires the application of equity margin
rules to the trading of indexed term notes. The Exchange will, prior to
trading the proposed SUNS, distribute an Information Circular to the
membership: (1) highlighting the essential features of the SUNS product
including, but not limited to, if applicable, the less than 100%
principal protection feature and the fact that the issuer has placed a
cap on the amount to be paid on the SUNS at maturity; and (2) providing
guidance with regard to member firm compliance responsibilities
(including suitability recommendations) when handling transactions in
the SUNS and highlighting their special risks and characteristics. The
circular will state that before a member, member organization, or
employee of such member organization undertakes to recommend a
transaction in the security, such member or member organization should
make a determination that the security is suitable for such customer
and the person making the recommendation should have a reasonable basis
for believing at the time of making the recommendation, that the
customer has such knowledge and experience in financial matters that
they may be capable of evaluating the risks and the special
characteristics of the recommended transaction, including
[[Page 68813]]
those highlighted, and is financially able to bear the risks of the
recommended transaction.
III. Discussion
The Commission finds that the proposed rule change is consistent
with the Act and the rules and regulations thereunder applicable to a
national securities exchange, and, in particular, with the requirements
of Section 6(b)(5) of the Act.\11\ Specifically, the Commission
believes that providing for exchange-trading of SUNS on the Basket \12\
will offer a new and innovative means of participating in the market
for highly capitalized European stocks. In particular, the Commission
believes that SUNS on the Basket will permit investors to gain equity
exposure in such companies, while, at the same time, limiting the
downside risk of the original investment due to the principle guarantee
feature.\13\ Accordingly, for the same reasons as discussed in the Term
Notes Approval Orders,\14\ the Commission finds that the listing and
trading of SUNS on the Basket is consistent with the Act.\15\
---------------------------------------------------------------------------
\11\ 15 U.S.C. 78f(b)(5).
\12\ The Commission notes that this approval order is limited to
the SUNS product; separate Commission approval may be required for
the Exchange to list and trade any other derivative product based on
the Lehman Brothers European Stock Basket.
\13\ Pursuant to Section 6(b)(5) of the Act, the Commission must
predicate approval of exchange trading of new products upon a
finding that the introduction of such new derivative instrument is
in the public interest. Such a finding would be difficult for a
derivative instrument that served no hedging or other economic
function, because any benefits that might be derived by market
participants likely would be outweighed by the potential for
manipulation, diminished public confidence in the integrity of the
markets, and other valid regulatory concerns.
\14\ See Term Notes Approval Orders, supra note 6.
\15\ In approving this rule change, the Commission has
considered the proposed rule's impact on efficiency, competition,
and capital formation. 15 U.S.C. 78c(f).
---------------------------------------------------------------------------
As with other derivative products similar to SUNS, SUNS on the
Basket are not leveraged instruments; however, their price will still
be derived from and based upon the underlying linked security.
Accordingly, the level of risk involved in the purchase or sale of SUNS
on the Basket is similar to the risk involved in the purchase or sale
of traditional common stock. Nonetheless, because the final rate of
return of SUNS is derivatively priced, based on the performance of a
portfolio of securities, there are several issues regarding the trading
of this type of product.
The Commission believes that the Exchange has adequately addressed
these issues for several reasons. First, the Commission notes that the
Exchange's rules and procedures that address the special concerns
attendant to the trading of hybrid securities will be applicable to
SUNS on the Basket. In particular, by imposing the hybrid listing
standards, and the suitability, disclosure, and compliance requirements
noted above, the Commission believes the Exchange has addressed
adequately the potential problems that could arise from the hybrid
nature of SUNS on the Basket. Moreover, the Exchange will distribute a
circular to its membership calling attention to the specific risks
associated with SUNS on the Basket. In particular, the circular will
highlight, among other things, that the SUNS on the Basket allow
investors to participate in appreciation only to the extent that the
Basket outperforms the initial Basket value based on the average of the
closing prices of the European Stock Basket securities for a ten-day
period beginning on the twelfth trading day prior to maturity of the
SUNS and any cap on appreciation.
Second, SUNS on the Basket remain a non-leveraged product with the
issuer guaranteeing no less than 90 percent of principal return.\16\
The Commission realizes that the final payout on the SUNS on the Basket
is dependent in part upon the individual credit of the issuer. To some
extent this credit risk is minimized by the Exchange's listing
standards in Section 107A of the Amex Company Guide which provides that
only issuers satisfying substantial asset and equity requirements may
issue securities such as SUNS.\17\ In addition, the Exchange's hybrid
listing standards further require that the proposed indexed term notes
have at least $4 million in market value.\18\ In any event, financial
information regarding the issuer, in addition to information on the
underlying securities, will be publicly available to investors.
---------------------------------------------------------------------------
\16\ The Commission notes that the Amex may not list for trading
SUNS with less than a 90% principal guarantee without first
consulting with the Commission. For example, the Commission may
determine that SUNS with less than a 90% principal guarantee should
only be sold to customers meeting certain heightened account
approval and suitability requirements.
\17\ See supra note 7 and accompanying text.
\18\ See Amex Company Guide Sec. 107A.
---------------------------------------------------------------------------
Third, the component securities in the Basket are highly-
capitalized, actively-traded European stocks. In addition, the
components are all publicly traded on the home country's primary
market. Accordingly, both the history and performance of these
securities, as well as current pricing trends, should be readily
available though a variety of public sources.
Further, the Commission notes that the value of the Basket will be
disseminated on a real time basis at least once every 15 seconds
throughout the trading day. As noted above, to the extent that European
and U.S. market hours overlap, last sale prices on the primary market
will be used to calculate the value of the Basket. The Commission
believes that this information will be extremely useful and beneficial
for investors in SUNS on the Basket.
Although the SUNS are denominated in U.S. dollars, as noted above,
the Basket value will be derived from converting the value of each
security from its home currency into U.S. dollars. The Exchange
represents that the calculation agent will determine, prior to the
listing of the SUNS on the Basket, which source it will use.\19\ The
currency conversion of the Basket will have a significant effect on
both the intraday value of the Basket as well as the ultimate payout at
settlement. Accordingly, the currency conversion methodology must be
fair and accurate and applied in a consistent manner. In this regard,
the Commission expects the Amex to carefully monitor and surveil the
currency conversion method, as well as the prices of the foreign
securities used in the conversion, to ensure the fairness and accuracy
of valuing the Basket, especially at settlement.
---------------------------------------------------------------------------
\19\ As noted above, the currency conversion will be from one of
two sources: (i) the WM/Reuter closing value reported in London at
about 12:00 (New York time) each trading day or (ii) the best bid
and offer price posted by two or more contributing banks as provided
by Bridge/Telesphere. The Commission expects that, once chosen, the
calculation agent will not change the source it uses to convert
currency values during the life of the SUNS on the Basket.
---------------------------------------------------------------------------
Fourth, while the Commission has a systematic concern that a
broker-dealer or a subsidiary providing a hedge for the issuer will
incur position exposure, the Commission believes this concern is
minimal given the size of the proposed SUNS issuance in relation to the
net worth of the issuer.\20\
---------------------------------------------------------------------------
\20\ See Term Notes Approval Orders, supra note 6.
---------------------------------------------------------------------------
Finally, the Exchange's surveillance procedures will serve to deter
as well as detect any potential manipulation. As discussed above, Amex
represents that: (1) foreign country securities that are not subject to
comprehensive surveillance agreements will not in the aggregate
represent more than 40% of the weight of the Basket; (2) stocks for
which the primary market is in any one country that is not subject to a
comprehensive surveillance agreement do not represent 20% or more of
the weight of the Basket; and (3) stocks for which the primary market
is in any two
[[Page 68814]]
countries that are not subject to the comprehensive surveillance
agreements do not represent 33% or more of the weight of the Basket.
Further, if the surveillance coverage should fall below certain levels,
as discussed above, no new SUNS will be listed. The Commission believes
that this should help to ensure that adequate surveillance mechanisms
exist in the future.
The Commission finds good cause for approving Amendment No. 2 to
the proposed rule change prior to the thirtieth day after the date of
publication of notice thereof in the Federal Register. In Amendment No.
2, the Exchange indicates that: (1) either the Amex or an independent
calculation agent will calculate the value of the Basket; (2) the
calculation agent will, if necessary, determine the changes in the
multipliers of the securities in the Basket; (3) the calculation agent
will only use the Bridge/Telesphere source for currency conversion
rates if it is able to obtain the bid and offer prices from two or more
contributing banks for each currency; and (4) the Exchange will notify
the Commission once Lehman Brothers determines which securities will be
included in the Basket. The Commission does not believe that Amendment
No. 2 raises any regulatory issues that were not addressed by the Term
Notes Approval Orders. In addition, to the extent that the Basket has
certain characteristics that differ from the previous Term Notes
Approval Orders, the Commission believes that the Amex has adequately
addressed those issues. In this regard, as to the use of Bridge/
Telesphere for currency conversion rates, the Amendment will help to
ensure that such source will only be used when there are a minimum
number of bids and offers available. The Commission notes that this
proposal was published for the full notice and comment period during
which no comments were received. Accordingly, the Commission believes
that good cause exists, consistent with Section 6(b)(5) \21\ and
Section 19(b)(2) \22\ of the Act, to grant accelerated approval to the
proposed rule change.
---------------------------------------------------------------------------
\21\ 15 U.S.C. 78f(b)(5).
\22\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment No. 2, including whether Amendment No. 2
is consistent with the Act. Persons making written submissions should
file six copies thereof with the Secretary, Securities and Exchange
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. Copies of
the submission, all subsequent amendments, all written statements with
respect to the proposed rule change that are filed with the Commission,
and all written communications relating to the proposed rule change
between the Commission and any person, other than those that may be
withheld from the public in accordance with the provisions of 5 U.S.C.
552, will be available for inspection and copying at the Commission's
Public Reference Room. Copies of such filing will also be available for
inspection and copying at the principal office of the above-mentioned
self-regulatory organization. All submissions should refer to File No.
SR-Amex-98-25 and should be submitted by January 4, 1999.
V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\23\ that the proposed rule change (SR-Amex-98-25) is approved on
an accelerated basis.
\23\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\24\
---------------------------------------------------------------------------
\24\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-33072 Filed 12-11-98; 8:45 am]
BILLING CODE 8010-01-M
