Self-Regulatory Organizations; Order Approving Proposed Rule Change and Notice of Filing and Order Granting Accelerated Approval of Amendment No. 1 to Proposed Rule Change by the American Stock Exchange, Inc. Relating to the Listing and Trading of Warrants on the Nikkei Stock Index 300

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-34821; International Series Release No. 729; File No.

SR-Amex-94-24]

Self-Regulatory Organizations; Order Approving Proposed Rule

Change and Notice of Filing and Order Granting Accelerated Approval of

Amendment No. 1 to Proposed Rule Change by the American Stock Exchange,

Inc. Relating to the Listing and Trading of Warrants on the Nikkei

Stock Index 300

October 11, 1994.

I. Introduction

On June 17, 1994, the American Stock Exchange, Inc. (``Amex'' or

``Exchange'') filed with the Securities and Exchange Commission

(``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 warrants on the Nikkei Stock

Index 300 (``Nikkei 300 Index'' or ``Index''). On September 7, 1994,

the Exchange filed Amendment No. 1 to the proposed rule change.\3\

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\1\15 U.S.C. 78s(b)(1) (1982).

\2\17 CFR 240.19b-4 (1993).

\3\In Amendment No. 1, the Amex represented that (1) the Amex

will advise its member firms that Index warrants may only be sold to

investors whose accounts have been approved for options trading

pursuant to Amex Rule 921; (2) Index warrants will, for margin

purposes, be treated as if they were option contracts subject to

Amex Rule 462(d); (3) the Amex will use the same surveillance

procedures that it currently has in place for index warrants listed

and traded on the Exchange to surveil trading in warrants on the

Index; and (4) the Exchange is currently negotiating with the Tokyo

Stock Exchange to obtain a surveillance sharing agreement and

expects to have such an agreement in place prior to the listing and

trading of Index warrants. See Letter from Claire P. McGrath,

Managing Director and Special Counsel, Derivative Securities, Amex,

to Michael Walinskas, Branch Chief, Derivatives Regulation, Division

of Market Regulation, Commission, dated September 7, 1994.

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Notice of the proposed rule change appeared in the Federal Register

on July 20, 1994.\4\ No comments were received on the proposed rule

change. This order approves the proposed rule change and Amendments No.

1 thereto.

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\4\See Securities Exchange Act Release No. 34365 (July 13,

1994), 59 FR 37106 (July 20, 1994).

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II. Description of the Proposal

The Amex proposes to list index warrants based on the Nikkei 300

Index, and index comprised of 300 representative stocks of the first

section\5\ of the Tokyo Stock Exchange (``TSE''). On August 11, 1994,

the Commission approved a proposal by the Exchange to list and trade

options and full-value and reduced-value long-term options on the

Index.\6\

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\5\First section stocks are distinguished from second section

stocks by more stringent listing standards.

\6\See Securities Exchange Act Release No. 34526 (August 11,

1994), 59 FR 42610 (August 18, 1994).

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A. Composition and Maintenance of the Index

The Nikkei 300 Index was designed by Nihon Keizai Shimbun, Inc.

(``NKS''). The Amex represents that Index component stocks were

selected by NKS for their high market capitalizations, and their high

degree of liquidity, and are representative of the relative

distribution of industries within the broader Japanese equity market.

As of July 8, 1994, the total capitalization of the Index was

approximately US$2.47 trillion.\7\ Market capitalization of the

individual stocks in the Index ranged from a high of US$83.8 billion to

a low of US$1.03 billion, with a median of US$3.56 billion and a mean

of US$8.25 billion. In addition, the average daily trading volume of

the stocks in the Index, for the six-month period ending June 30, 1994,

ranged from a high of 4,740,000 shares to a low of 6,000 shares, with a

mean and median of approximately 676,000 and 417,000 shares,

respectively. The highest weighted component stock in the Index

accounts for 3.39 percent of the Index. The five largest Index

components account for approximately 14.9 percent of the Index's value.

The lowest weighted component stock comprises 0.042 percent of the

Index, and the five smallest Index components account for approximately

0.25 percent of the Index's value.

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\7\Based on the July 8, 1994 exchange rate of Y98.2 per US$1.00.

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The Index is maintained by NKS. To maintain the continuity of the

Index, NKS will adjust the Index divisor to reflect certain events

relating to the component stocks. These events include, but are not

limited to, changes in the number of shares outstanding, spin-offs,

certain rights issuances, and mergers and acquisitions. The Amex

represents that NKS reviews the composition of the Index periodically.

B. Calculation of the Index

The Nikkei 300 Index is capitalization-weighted and reflects

changes in the prices of the Index component securities relative to the

base date of the Index (October 1, 1982). The value of the Index is

calculated by multiplying the price of each component security by the

number of shares outstanding of each such security, adding the

products, and dividing by the current Index divisor. The Index divisor

is adjusted to reflect certain events relating to the component

stocks.\8\ The Index had a closing value of 299.47 on July 13, 1994.

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\8\See supra Section II.A. The Index divisor was set to give the

Index a value of 100 on its base date.

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Because trading does not occur on the TSE during the Amex's trading

hours, the daily dissemination of the Index value is calculated by the

Amex once each day based on the most recent official closing price of

each Index component security as reported by the TSE. This closing

value is disseminated throughout the trading day on the Amex.

C. Warrant Listing Standards and Customer Safeguards

The Exchange proposes to trade Nikkei 300 Index warrants pursaunt

to Section 106 of the Amex Company Guide (``Section 106''). Under

Section 106, the Amex may approve for listing warrants on established

foreign and domestic market indexes. The Commission has previously

approved the listing and trading on the Amex of certain foreign index

warrants based on the Nikkei Stock Average,\9\ the FT-SE 100 Index,\10\

the CAC-40 Index,\11\ and the Hong Kong 30 Index,\12\ all listed in

accordance with Section 106.

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\9\See Securities Exchange Act Release No. 27565 (December 22,

1989), 55 FR 376 (January 4, 1990).

\10\See Securities Exchange Act Release No. 27769 (March 6,

1990), 55 FR 9380.

\11\See Securities Exchange Act Release No. 28544 (October 17,

1990), 55 FR 42792 (October 23, 1990).

\12\See Securities Exchange Act Release No. 33036 (October 8,

1993), 58 FR 53588 (October 15, 1993).

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The Amex represents that the Index warrant issues will conform to

the index warrant listing guidelines contained in Section 106.

Specifically, the listing guidelines of the Amex will require that (1)

the issuer thereof shall have assets in excess of $100,000,000 and

otherwise substantially exceed the size and earnings requirements of

Amex Company Guide Section 101(a);\13\ the term of warrants shall be

for a period ranging from one to five years from the date of issuance;

and (3) the minimum public distribution of such issues shall be

1,000,000 warrants, together with a minimum of 400 public holders, and

a minimum aggregate market value of $4,000,000.

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\13\Section 101(a) requires the issuer to have stockholders'

equity of at least $4,000,000 and pre-tax income of at least

$750,000 in its last fiscal year, or in two of its last three fiscal

years.

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The Amex has proposed applying the same margin treatment as it

requires for Amex-listed options, as wet forth in Amex Rule 462(d), to

the purchase of Index warrants.\14\

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\14\See Amendment No. 1, supra note 3.

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The Amex also proposes that Nikkei 300 Index warrants will be

direct obligations of their issuer, subject to cash settlement in U.S.

dollars, and either exercisable throughout their life (i.e., American

style) or exercisable only on their expiration date (i.e., European

style). Upon exercise, or at the warrant expiration date (if not

exercisable prior to such date), the holder of a warrant structured as

a ``put'' would receive payment in U.S. dollars to the extent that the

Index has declined below a pre-stated cash settlement value.

Conversely, holders of a warrant structured as a ``call'' would, upon

exercise or at expiration, receive payment in U.S. dollars to the

extent that the Index has increased above the pre-stated cash

settlement value. If ``out-of-the-money'' at the time of expiration,

the warrants would expire worthless.

Because warrants are derivative in nature and closely resemble

index options, the Amex has proposed safeguards that are designed to

meet the investor protection concerns raised by the trading of index

options. First, the Exchange represents that it will require that Index

warrants only be sold to investors whose accounts have been approved

for options trading pursuant to Amex Rule 921.\15\ Second, pursuant to

Amex rule 411, Commentary .02, the Exchange's options suitability

standards contained in Amex Rule 923 shall apply to recommendations in

Index warrants. Third, pursuant to Amex Rule 421, Commentary .02,

discretionary orders in Index warrants must be approved and initialled

on the day entered by a Senior Registered Options Principal or a

Registered Options Principal. Finally, the Amex, prior to commencement

of trading in Index warrants, will distribute a circular to its

membership to call attention to the specific risks associated with

Index warrants.

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\15\See Amendment No. 1, supra note 3.

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D. Surveillance

The Exchange will use the same surveillance procedures currently

utilized for each of the Exchange's other index warrants to monitor

trading in Index warrants. The Exchange represents that it is currently

negotiating with the TSE to obtain a surveillance sharing agreement and

expects to have such an agreement in place prior to the listing and

trading of Index warrants.\16\

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\16\See Amendment No. 1, supra note 3.

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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.\17\

Specifically, the Commission finds that the trading of warrants based

on the Nikkei 300 Index will serve to protect investors, promote the

public interest, and help to remove impediments to a free and open

securities market by providing investors with a means to hedge exposure

to market risk associated with the Japanese equity market and provide a

surrogate instrument for trading in the Japanese securities market.\18\

The trading of warrants based on the Nikkei 300 Index should provide

investors with a valuable hedging vehicle that should reflect

accurately the overall movement of the Japanese equity market.

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\17\15 U.S.C. Sec. 78f(b)(5) (1988).

\18\Pursuant to Section 6(b)(5) of the Act, the Commission must

predicate approval of any new securities product upon a finding that

the introduction of such product is in the public interest. Such a

finding would be difficult with respect to a warrant 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.

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In addition, the Commission believes, for the reasons discussed

below, that the Amex has adequately addressed issues related to

customer protection, index design, surveillance, and market impact of

Nikkei 300 Index warrants.

A. Customer Protection

Due to the derivative nature of index warrants, the Commission

believes that Nikkei 300 Index warrants should only be sold to

investors capable of evaluating and bearing the risks associated with

trading in such instruments and that adequate risk disclosure be made

to investors. In this regard, the Commission notes that the rules and

procedures of the Exchange that address the special concerns attendant

to the secondary market trading of index warrants will be applicable to

the Nikkei 300 Index warrants. In particular, by imposing the special

suitability, account approval, disclosure, and compliance requirements

noted above, the Amex has adequately addressed potential public

customer problems that could arise from the derivative nature of Nikkei

300 Index warrants. Moreover, the Amex plans to distribute a circular

to its members identifying the specific risks associated with warrants

on the Nikkei 300 Index and, pursuant to the Amex's listing guidelines,

only substantial companies capable of meeting their warrant obligations

will be eligible to issue Nikkei 300 Index warrants.

B. Index Design and Structure

The Commission finds, as it did in approving Nikkei 300 Index

options, that it is appropriate and consistent with the Act to classify

the Index as a broad-based index. Specifically, the Commission believes

the Index is broad-based because it reflects a substantial segment of

the Japanese equity market, and, among other things, contains a large

number of stocks that trade in that market. First, the Index consists

of 300 actively-traded stocks traded on the first section of the TSE,

representing 36 different industry groups in Japan. Second, the market

capitalizations of the stocks comprising the Index are very large.

Specifically, the total capitalization of the Index, as of July 8,

1994, was US$2.47 trillion, with the market capitalizations of the

individual stocks in the Index ranging from a high of US$83.8 billion

to a low of US$1.03 billion, with a medium value of US$3.56 billion and

a mean of US$8.25 billion. Third, no one particular stock or group of

stocks dominates the Index. Specifically, no single stock comprises

more than 3.39 percent of the Index's total value, and the percentage

weighting of the five largest issues in the Index accounts for 14.9

percent of the Index's value. Accordingly, the Commission believes it

is appropriate to classify the Index as broad-based.

C. Surveillance

As a general matter, the Commission believes that comprehensive

surveillance sharing agreements between the relevant foreign and

domestic exchanges are important where an index product comprised of

foreign securities is to be traded in the United States. In most cases,

in the absence of such a comprehensive surveillance sharing agreement,

the Commission believes that it would not be possible to conclude that

a derivative product, such as a Nikkei 300 Index warrant, was not

readily susceptible to manipulation.

Although the Amex and the TSE do not yet have a written

comprehensive surveillance sharing agreement that covers the trading of

Nikkei 300 Index warrants,\19\ a number of factors support approval of

the proposal at this time. First, while the size of an underlying

market is not determinative of whether a particular derivative product

based on that market is readily susceptible to manipulation, the size

of the market for the securities underlying the Nikkei 300 Index makes

it less likely that the proposed Index warrants are readily suceptible

to manipulation.\20\ In addition, the Commission notes that the TSE is

under the regulatory oversight of the Japanese Ministry of Finance

(``MOF''). The MOF has responsibility for both the Japanese securities

and derivatives markets. Accordingly, the Commission believes that the

ongoing oversight of the trading activity on the TSE by the MOF will

help to ensure that the trading of Nikkei 300 Index warrants will be

carefully monitored with a view toward preventing unnecessary market

disruptions.

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\19\The Amex and the TSE, however, currently have a surveillance

sharing agreement in place that covers other derivative products

traded on the Amex. That agreement has been previously amended by

the Amex and the TSE to include new products, such as the trading of

Japan Index options. The Exchange represents that it currently is

pursuing a comprehensive surveillance sharing agreement with the TSE

with respect to Nikkei 300 Index Warrants.

\20\In evaluating the manipulative potential of a proposed index

derivative product, as it relates to the securities that comprise

the index and the index product itself, the Commission has

considered several factors, including (1) the number of securities

comprising the index or group; (2) the capitalizations of those

securities; (3) the depth and liquidity of the group or index; (4)

the diversification of the group or index; (5) the manner in which

the index or group is weighted; and (6) the ability to conduct

surveillance on the product. See Securities Exchange Act Release No.

31016 (August 11, 1992), 57 FR 37012 (August 17, 1992).

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Finally, the Commission and the MOF have concluded a Memorandum of

Understanding (``MOU'') that provides a framework for mutual assistance

in investigatory and regulatory matters.\21\ Morever, the Commission

also has a longstanding working relationship with the MOF on these

matters. Based on the longstanding relationship between the Commission

and the MOF and the existence of the MOU, the Commission is confident

that it and the MOF could acquire information from one another similar

to that which would be available in the event that a comprehensive

surveillance sharing agreement were executed between the Amex and the

TSE with respect to transactions in TSE-traded stocks related to Nikkei

300 Index warrant transactions on the Amex.\22\

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\21\See Memorandum of United States Securities and Exchange

Commission and the Securities Bureau of the Japanese Ministry of

Finance on the Sharing of Information, dated May 23, 1986.

\22\It is the Commission's expectation that this information

would include transaction, clearing, and customer information

necessary to conduct an investigation.

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Nevertheless, the Commission continues to believe strongly that a

comprehensive surveillance sharing agreement between the TSE and the

Amex covering Nikkei 300 Index warrants would be an important measure

to deter and detect potential manipulations or other improper or

illegal trading involving Nikkei 300 Index warrants. Accordingly, the

Commission believes it is critical that the TSE and the Amex continue

to work together to consummate a formal comprehensive surveillance

sharing agreement to cover Nikkei 300 Index warrants and the component

securities as soon as practicable.\23\

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\23\See supra note 19.

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D. Market Impact

The Commission believes that the listing and trading of Nikkei 300

Index warrants on the Amex will not adversely impact the securities

markets in the United States or in Japan. First, the existing index

warrant surveillance procedures of the Amex will apply to warrants on

the Index. In addition, the Commission notes that the Index is broad-

based on diversified and includes highly capitalized securities that

are actively traded on the TSE.

IV. Accelerated Approval of Amendment No. 1

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 on notice of filing thereof in the Federal Register.

Amendment No. 1 is consistent with Section 6(b)(5), in that it contains

representations by the Exchange, concerning margin, options approved

accounts, and surveillance, which serve to protect investors and the

public interest, promote just and equitable principles of trade, and

prevent fraudulent and manipulative acts and practices. Further, these

representations are consistent with those which were made in connection

with the Amex's proposal to list warrants on the Hong kong 30

Index.\24\ That proposal was published for the full 21-day comment

period, and no comments were received. Therefore, the Commission finds

that no new regulatory issues are raised by Amendment No. 1.

Accordingly, the Commission believes it is consistent with Sections

19(b)(2) and 6(b)(5) of the Act to approve Amendment No. 1 on an

accelerated basis.

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\24\See supra note 12.

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V. Solicitation of Comments

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,

N.W., Washington, D.C. 20549. Copies of the submission, all subsequent

amendments, all written statements with respect to the foregoing that

are filed with the Commission, and all written communications relating

to the foregoing 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. Sec. 552, will be available for inspection and

copying in the Commission's Public Reference Section, 450 Fifth Street,

N.W. Washington, D.C. Copies of such filings also will 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-94-24, and should be submitted by November 8, 1994.

It is therefore ordered, Pursuant to Section 19(b)(2) of the

Act,\25\ that the proposed rule change (SR-Amex-94-24), as amended, is

hereby approved.

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\25\15 U.S.C. 78s(b)(2) (1988).

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\26\

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\26\17 CFR 200.30-3(a)(12) (1993).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 94-25726 Filed 10-17-94; 8:45 am]

BILLING CODE 8010-01-M