[Federal Register Volume 59, Number 186 (Tuesday, September 27, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-23793]
[[Page Unknown]]
[Federal Register: September 27, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34691; File No. SR-NYSE-94-14]
Self-Regulatory Organizations; Order Approving a Proposed Rule
Change and Notice of Filing and Order Granting Accelerated Approval of
Amendment No. 1 to the Proposed Rule Change by the New York Stock
Exchange, Inc., Relating to Health Care Portfolio Market Index Target-
Term Securities (``MITTS'').
I. Introduction
September 20, 1994.
On April 12, 1994, the New York Stock Exchange, Inc. (``NYSE'' 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 Market Index Target-Term
Securities (``MITTS''),\3\ the return on which is based upon a
portfolio of securities of health care companies (``Health Care
Portfolio'').\4\ Notice of the proposal appeared in the Federal
Register on April 28, 1994.\5\ No comment letters were received on the
proposed rule change. On August 9, 1994, the NYSE filed Amendment No. 1
to the proposed rule change.\6\ 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\``MITTS'' and ``Market Index Target-Term Securities'' are
service marks of Merrill Lynch & Co., Inc. (``Merrill Lynch'').
\4\The Health Care Portfolio is a static portfolio consisting of
22 equity securities listed as common shares in the United States.
The components of the portfolio represent companies that offer a
variety of goods and services in the health care industry.
\5\See Securities Exchange Act Release No. 33933 (April 20,
1994), 59 FR 22030 (April 28, 1994).
\6\Amendment No. 1 to the proposed rule change provides that the
value of the Health Care Portfolio will be calculated continuously
and disseminated to the Options Price Reporting Authority (``OPRA'')
no less frequently than once every minute throughout the trading
day. See Letter from James Buck, Senior Vice President and
Secretary, NYSE, to Sharon Lawson, Assistant Director, Office of
Market Supervision, Division of Market Regulation, Commission, dated
August 9, 1994 (``Amendment No. 1'').
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II. Description of the Proposal
Under Section 703.19 of the Exchange's Listed Company Manual
(``Manual''), the NYSE may approve for listing securities which can not
be readily categorized under the listing criteria for common and
preferred stocks, bonds, debentures, and warrants.\7\ The NYSE is now
proposing under Section 703.19 of the Manual to list for trading MITTS
based on the Health Care Portfolio (``Health Care Portfolio
MITTS'').\8\
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\7\See Securities Exchange Act Release Nos. 29229 (May 23,
1991), 56 FR 24852 (May 31, 1991); and 28217 (July 18, 1990), 55 FR
30056 (July 24, 1990'') (``Hybrid Approval Orders'').
\8\The Commission recently approved the listing and trading on
the Exchange of MITTS based upon (1) a global portfolio of
securities representing telecommunications companies, and (2) a
portfolio of European companies. See Securities Exchange Act Release
Nos. 32840 (September 2, 1993), 58 FR 47485 (September 9, 1993); and
33368 (December 22, 1993), 58 FR 68975 (December 29, 1993) (``MITTS
Approval Orders'').
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As with the other MITTS products, the Health Care Portfolio MITTS
will conform to the listing guidelines under Section 703.19 of the
Manual, which provides that: (1) Issues must have a minimum public
distribution of one million securities; (2) a minimum of 400
shareholders; (3) a minimum duration of one year; (4) a market value of
at least $4 million; and (5) otherwise comply with the NYSE's initial
listing criteria.\9\ In addition, the Exchange will monitor the Health
Care Portfolio MITTS to verify compliance with the Exchange's continued
listing criteria.\10\ MITTS are non-callable senior hybrid debt
securities of Merrill Lynch that provide for a single payment at
maturity, and will bear no periodic payments of interest. Health Care
Portfolio MITTS 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,'' subject to a
minimum repayment amount. The ``Original Portfolio Value'' is the value
of the Health Care Portfolio on the date on which the issuer prices the
Health Care Portfolio MITTS issue for the initial offering to the
public. The ``Ending Average Portfolio Value'' is the average of the
values of the Health Care Portfolio at the end of the five calendar
quarters preceding the expiration of the Health Care Portfolio MITTS on
December 31, 1999.\11\ The Ending Average Portfolio Value will be used
in calculating the amount owners will receive upon maturity.\12\
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\9\The hybrid listing standards in Section 703.19 of the Manual
are intended to accommodate listed companies in good standing, their
subsidiaries and affiliates, and non-listed equities which meet the
Exchange's original listing standards. Domestic issuers must also
meet the earnings and net tangible assets criteria set forth in
Sections 102.01 and 102.02 of the Manual. Specifically, the minimum
original listing criteria requires that issuers have: (1) 2,000
holders holding 100 shares or more or have 2,200 holders with an
average monthly trading volume of 100,000 shares; (2) a public float
of 1.1 million shares; (3) an aggregate public market value of $18
million or total net tangible assets of $18 million; and (4)
earnings before taxes of $2.5 million in the latest fiscal year and
earnings before taxes of $2 million in each of the preceding two
fiscal years, or earnings before taxes of $6.5 million in the
aggregate for the last three fiscal years with a $4.5 million
minimum in the most recent fiscal year (all three years are required
to be profitable).
\10\The continued listing criteria for capital or common stock
requires that: (1) The number of holders of 100 shares or more is
equal to or greater than 1,200; (2) the number of publicly-held
shares is equal to or greater than 600,000; (3) the aggregate market
value of publicly-held shares is equal to or greater than $5
million; (4) the aggregate market value of shares outstanding
(excluding treasury stock) is equal to or greater than $8 million
and average net income after taxes for the past three years is equal
to or greater than $600,000; and (5) net tangible assets available
to common stock are equal to or greater than $8 million and average
net income after taxes for the past three years is equal to or
greater than $600,000. In addition, the continued listing standards
for bonds require that outstanding publicly-held bonds have an
aggregate market value or principal amount equal to or greater than
$1 million. See Section 802 of the Manual.
\11\Specifically, the Ending Average Portfolio Value will equal
average of the quarterly values of the Health Care Portfolio
beginning in the calendar quarter ending December 31, 1998. The
quarterly value for each of the first four of the final five
calendar quarters shall be the Health Care Portfolio value on the
last scheduled Exchange trading day on which there is no market
disruption event. The quarterly value for the final calendar quarter
shall be the Health Care Portfolio Value on the seventh scheduled
Exchange trading day preceding maturity of the Health Care MITTS
unless there is a market disruption event in which case the sixth
trading day preceding maturity shall be used.
\12\The Health Care Portfolio MITTS will entitle a holder at
maturity to receive for each $10 principal amount of MITTS an amount
equal to the Ending Average Portfolio Value of the Health Care
Portfolio divided by 10, but in any event no less than $9 per each
$10 principal amount of Health Care Portfolio MITTS.
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If the market value of the portfolio has declined, the owner will
receive not less than a specified percentage of the principal amount of
the security. (For instance, if the market value of the portfolio used
to calculate the amount payable at maturity has declined more than 10%,
the owners of the Health Care Portfolio MITTS will receive 90% of the
principal amount of the securities.) The payment at maturity is based
on changes in the value of the portfolio, but does not reflect the
payment of dividends on the securities that comprise the portfolio.
Health Care Portfolio MITTS 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 portfolio value of
the Health Care Portfolio securities.
According to the NYSE, Health Care Portfolio MITTS will allow
investors to combine the protection of a portion of the principal
amount of the MITTS with a potential additional payment based upon the
performance of a portfolio of securities representing 22 highly
capitalized health care companies. Health Care Portfolio MITTS will
mature on December 31, 1999.
The Health Care Portfolio consists of securities of 22 health care
companies that have significantly different levels of market
capitalization, ranging from a high of approximately $28.0 billion
(Bristol Meyers Squibb Co.) to a low of approximately $311 million
(Living Centers of America, Inc.).\13\ Nineteen of the securities in
the Health Care Portfolio are traded on the NYSE and the remainder are
National Market securities traded through NASDAQ. The average daily
trading volume for the components of the Health Care Portfolio for the
period from November 5, 1992, through March 7, 1994, ranged from a high
of approximately 1.03 million shares (Abbott Laboratories), to a low of
approximately 20,335 shares (Living Centers of America, Inc.).
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\13\These values are as of March 7, 1994.
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At the outset, each of the securities in the Health Care Portfolio
will have equal representation. Specifically, each security included in
the 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 22 companies
included in the Health Care Portfolio will represent approximately 4.54
percent of the total portfolio at the time of issuance.
The multiplier for each security in the Health Care Portfolio will
generally remain unchanged except for limited adjustments that may be
necessary as a result of stock splits or stock dividends.\14\ 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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\14\Merrill Lynch 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 Health Care Portfolio
no longer exists, whether for reason of a merger, acquisition or
similar type of corporate control transaction, then Merrill Lynch 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, Merrill Lynch
shall thereafter assign a value to the shares of the acquired company's
securities equal to the value per share at which time the acquisition
takes place.
If the issuer of a 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
Health Care 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, then 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 Health Care Portfolio, for so
long as no such market price exists for that security.\15\
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\15\Merrill Lynch 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 Health Care Portfolio will be calculated by an
independent third party and will be disseminated through OPRA at least
one each minute throughout the trading day.\16\ 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.
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\16\See Amendment No. 1, supra note 6.
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Like other issues of MITTS listed on the NYSE, Health Care
Portfolio MITTS may not be redeemed prior to maturity and are not
callable by the issuer. Holders of Health Care Portfolio MITTS will be
able to cash-out of their investment by selling the security on the
NYSE. 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 Health Care Portfolio and also on such
other factors as the level of interest rates, the volatility of the
value of the Health Care Portfolio, the time remaining to maturity,
dividend rates, and the credit worthiness of the issuer, Merrill
Lynch.\17\
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\17\Merrill Lynch will deposit registered securities
representing Health Care Portfolio MITTS with its depository, the
Depository Trust Company (``DTC''), so as to permit book-entry
settlement of transactions by participants in DTC.
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Because Health Care Portfolio MITTS are linked to a portfolio of
equity securities, the NYSE'S existing equity floor trading rules will
apply to the trading of Health Care Portfolio MITTS. First, pursuant to
NYSE Rule 405, 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 Health Care Portfolio MITTS.\18\ Second,
consistent with NYSE Rule 405, the Exchange will further require that a
member or member firm specifically approve a customer's account for
trading Health Care Portfolio MITTS prior to, or promptly after, the
completion of the transaction. Third, Health Care Portfolio MITTS will
be subject to the equity margin rules of the Exchange. Fourth, in
accordance with the NYSE's Hybrid Approval Orders, the Exchange will,
prior to trading Health Care Portfolio MITTS, distribute a circular to
the membership providing guidance with regard to member firm compliance
responsibilities (including suitability recommendations) when handling
transactions in Health Care Portfolio MITTS and highlighting the
special risks and characteristics of the Health Care Portfolio
MITTS.\19\
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\18\NYSE Rule 405 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.
\19\See Hybrid Approval Orders, supra note 7.
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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). Specifically, the
Commission believes that providing for exchange-trading of Health Care
Portfolio MITTS will offer a new and innovative means of participating
in the market for health care securities. In particular, the Commission
believes that Health Care Portfolio MITTS will permit investors to gain
equity exposure in health care 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 Health Care Portfolio MITTS is consistent with
the Act.\20\
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\20\See MITTS Approval Orders, supra note 8.
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As with other MITTS products, Health Care Portfolio MITTS are not
leveraged instruments, however, their price will still be derived and
based upon the underlying linked security. Accordingly, the level of
risk involved in the purchase or sale of a Health Care Portfolio MITTS
is similar to the risk involved in the purchase or sale of traditional
common stock. Nonetheless, because the final rate of return of a MITTS
is derivatively priced, based on the performance of a portfolio of
securities, the Commission has several specific concerns regarding the
trading of this type of product.
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 Health Care Portfolio MITTS. In
particular, by imposing the hybrid listing standards, 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 Health Care Portfolio MITTS.
Moreover, the Exchange will distribute a circular to its membership
calling attention to the specific risks associated with Health Care
Portfolio MITTS.
The Commission realizes that Health Care Portfolio MITTS are
dependent upon the individual credit of the issuer, Merrill Lynch. 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 $5 million for its publicly-held shares.\21\ In addition, the
Exchange's hybrid listing standards further require that Health Care
Portfolio MITTS have at least $4 million in market value. In any event,
financial information regarding Merrill Lynch, in addition to the
information on the issuers of the underlying securities comprising the
Health Care Portfolio, will be publicly available.\22\
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\21\See supra note 10.
\22\The companies that comprise the Health Care Portfolio are
reporting companies under the Act.
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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. As discussed in the MITTS
Approval Orders, the Commission believes this concern is minimal given
the size of Health Care Portfolio MITTS issuance in relation to the net
worth of Merrill Lynch.\23\
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\23\See MITTS Approval Orders, supra note 8.
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The Commission also believes that the listing and trading of Health
Care Portfolio MITTS should not unduly impact the market for the
underlying securities comprising the Health Care Portfolio. First, as
discussed above, the underlying securities comprising the portfolio are
well-capitalized, highly liquid stocks. Second, because all of the
components of the Health Care Portfolio will initially be equally
weighed, no single stock or group of stocks dominates the Health Care
Portfolio. Finally, the issuers of the underlying securities comprising
the Health Care Portfolio, are subject to reporting requirements under
the Act, and all of the portfolio securities are either listed or
traded on, or traded through the facilities of U.S. securities
markets.\24\ Additionally, the NYSE's surveillance procedures will
serve to deter as well as detect any potential manipulation.
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\24\The Commission notes that 19 of the component securities are
traded on the NYSE and the remainder are National Market securities
traded through Nasdaq.
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Finally, the Commission notes that the value of the Health Care
Portfolio will be disseminated at least once every minute throughout
the trading day. The Commission believes that this result is
appropriate because, unlike previously approved MITTS products which
contain foreign components, the Health Care Portfolio is comprised
solely of securities traded in the U.S. for which real-time price
information is available. The Commission believes that providing access
to the value of the Health Care Portfolio at least once every minute
throughout the trading day is extremely important and will provide
benefits to investors in the product.\25\
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\25\In this regard, the Commission believes that it is useful
and beneficial for all investors and market participants to have
access to the value of the Health Care Portfolio as frequently as
possible and encourages the NYSE and Merrill Lynch to further
explore the possibilities in this area, i.e., calculating and
disseminating the value of the portfolio at least once every 15
seconds as is done with other derivative products.
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The Commission finds good cause for approving Amendment No. 1 to
the proposed rule change prior to the thirtieth day after the date of
publication of notice thereof in the Federal Register. As discussed
above, the Commission believes that investors and market participants
will benefit from having the value of the Health Care Portfolio
calculated and disseminated as frequently as possible throughout the
trading day. The Commission believes that Amendment No. 1 provides this
benefit without unduly burdening either the Exchange or the issuer of
the Health Care Portfolio MITTS. Additionally, the Commission notes
that Amendment No. 1 provides for significantly greater access by
investors and market participants to current values of the Health Care
Portfolio than did the original proposal which was noticed for the full
21-day comment period without any comments being received by the
Commission. Accordingly, the Commission believes it is consistent with
Section 6(b)(5) of the Act to approve Amendment No. 1 to the proposed
rule change on an accelerated basis.
Interested persons are invited to submit written data, views and
arguments concerning Amendment No. 1 to the proposed rule change.
Persons making written submissions should file six copies thereof with
the Secretary, Securities and Exchange Commission, 450 Fifth Street
NW., Washington DC 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 in the Commission's Public
Reference Section, 450 Fifth Street NW., Washington, DC. Copies of such
filing will also be available for inspection and copying at the
principal office of the NYSE. All submissions should refer to File No.
SR-NYSE-94-14 and should be submitted by October 18, 1994.
It Is Therefore Ordered, pursuant to Section 19(b)(2) of the
Act,\26\ that the proposed rule change (File No. SR-NYSE-94-14), as
amended, is approved.
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\26\15 U.S.C. 78s(b)(2) (1988).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\27\
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\27\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-23793 Filed 9-26-94; 8:45 am]
BILLING CODE 8010-01-M
