Self-Regulatory Organizations; Order Granting Accelerated Approval of a Proposed Rule Change and Notice of Filing and Order Granting Accelerated Approval of Amendment No. 1 to the Proposed Rule Change by the American Stock Exchange, Inc. Relating to the Listing and Trading of Banking Industry Portfolio Indexed Term Notes

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-34848; File No. SR-Amex-94-39]

Self-Regulatory Organizations; Order Granting Accelerated

Approval of a Proposed Rule Change and Notice of Filing and Order

Granting Accelerated Approval of Amendment No. 1 to the Proposed Rule

Change by the American Stock Exchange, Inc. Relating to the Listing and

Trading of Banking Industry Portfolio Indexed Term Notes

October 17, 1994.

I. Introduction

On September 22, 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 static portfolio of

banking industry securities (``Banking Industry Portfolio''). Notice of

the proposal appeared in the Federal Register on October 4, 1994.\3\ No

comment letters were received on the proposed rule change. The Exchange

filed Amendment No. 1 to the proposal on October 11, 1994.\4\ 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\See Securities Exchange Act Release No. 34723 (September 27,

1994), 59 FR 50631 (October 4, 1994).

\4\In Amendment No. 1 to the proposed rule change, the Exchange

proposes to remove Crestar Financial Corp from the Banking Industry

Portfolio and replace it with Citizens Bancorp (Md.). See Letter

from Claire McGrath, Managing Director and Special Counsel, Amex, to

Michael Walinskas, Branch Chief, Office of Market Supervision

(``OMS''), Division of Market Regulation (``Division''), Commission,

dated October 11, 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.\5\ 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

actively-traded bank stocks.\6\

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\5\See Securities Exchange Act Release No. 27753 (March 1,

1990), 55 FR 8626 (March 8, 1990).

\6\The specific components of the Banking Industry Portfolio

are: Bancorp Hawaii, Inc.; Barnett Banks, Inc.; Baybanks, Inc.;

Citizens Bancorp (Md.); City National Corp.; Corestates Financial;

First American Corp.; First Chicago Corp.; Hibernia Corp.;

Mercantile Bancorp; Michigan National; Midlantic Corp.; North Fork

Bancorp; Provident Bankshares; Summit Bancorp; U.S. Bancorp; UJB

Financial Corp.; Union Planters Corp.; UST Corp.; and Vermont

Financial Services.

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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.\7\ 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. Banking 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.\8\ The ``Original Portfolio

Value'' is the value of the Banking 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 Banking Industry Portfolio securities for a

specified number of days prior to maturity of the Notes.\9\ The Ending

Average Portfolio Value will be used in calculating the amount owners

will receive upon maturity.\10\

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\7\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.

\8\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 Banking 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.

\9\Specifically, the Ending Average Portfolio Value will equal

the average of the closing prices for the Banking 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 Group, Amex, and Brad

Ritter, Senior Counsel, OMS, Division, Commission, on October 11,

1994.

\10\The Banking 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 market value of the Banking Industry Portfolio has declined, the

owners of the Banking Industry Portfolio Notes will receive at least

90% of the principal amount of the Notes. The payment at maturity is

based on charges in the value of the Banking 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. Banking Industry Portfolio Notes are cash-

settled in that they do not give 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 Banking Industry Portfolio securities.

According to the Amex, Banking 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 20 highly capitalized banking industry

stocks. In particular, the proposed Banking Industry Portfolio Notes

will provide at least 90% principal protection with the opportunity to

participate in any upside appreciation of the underlying Banking

Industry Portfolio, subject to any cap on appreciation that may be

included by the issuer.

The Banking Industry Portfolio consists of securities of 20

companies that collectively, at the time of issuance,\11\ will satisfy

the generic listing requirements approved by the Commission for the

listing and trading of options on newly established narrow-based

indexes.\12\ Specifically, the component securities of the Banking

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 Banking 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 Banking 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 Banking 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).\13\

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\11\The Commission notes that because the Banking 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.

\12\See Securities Exchange Act Release No. 34157 (June 3,

1994), 59 FR 30062 (June 10, 1994).

\13\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

Banking 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 Banking Industry Portfolio

(i.e., two components) provided that with the replacement

components, the Banking 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 Banking 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 Banking Industry

Portfolio.

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At the outset, each of the securities in the Banking Industry

Portfolio will have equal representation. Specifically, each security

included in the Banking 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 20 companies included in the Banking Industry

Portfolio will represent approximately 5.0% of the total portfolio at

the time of issuance.

The multiplier for each security in the Banking Industry 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\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 Banking 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 Brothers 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 Banking 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 Banking 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, 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 Banking

Industry Portfolio, for so long as no such market price exists for that

security.\15\

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\15\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 Banking 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 Banking 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 Banking Industry Portfolio

and also on such other factors as the level of interest rates, the

volatility of the value of the Banking Industry Portfolio, the time

remaining to maturity, dividend rates, and the creditworthiness of the

issuer, Lehman Brothers.

Because Banking 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 Banking 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 Banking Industry Portfolio

Notes.\16\ 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 Banking Industry Portfolio Notes prior

to, or promptly after, the completion of the transaction. Third,

Banking Industry Portfolio Notes will be subject to the equity margin

rules of the Exchange. Fourth, the Exchange will, prior to trading

Banking 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 Banking Industry Portfolio Notes and highlighting the

special risks and characteristics of the Banking Industry Portfolio

Notes.\17\

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\16\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.

\17\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.\18\

Specifically, the Commission believes that providing for exchange-

trading of Banking Industry Portfolio Notes will offer a new and

innovative means of participating in the market for banking industry

securities.\19\ In particular, the Commission believes that Banking

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

Commission's order approving the listing of Basic Industry Portfolio

Notes,\20\ the Commission finds that the listing and trading of Banking

Industry Portfolio Notes is consistent with the Act.

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\18\15 U.S.C. 78f(b)(5) (1988).

\19\The Commission Notes that the Banking Industry Portfolio

Notes are very similar in structure to Basic Industry Portfolio

Notes recently approved for listing on the Amex. See Securities

Exchange Act Release No. 34820 (October 11, 1994) (``Exchange Act

Release No. 34820'').

\20\Id.

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As with the Basic Industry Portfolio Notes, Banking 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

Banking 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.\21\ The Commission believes the Amex has adequately

addressed each of these issues such that the Commission's regulatory

concerns are adequately minimized.\22\ In particular, by imposing the

listing standards, suitability, disclosure, and compliance requirements

noted above, the Amex has adequately addressed the potential public

customer concerns that could arise from the hybrid nature of the

Notes.\23\ 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 Banking Industry

Portfolio.

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\21\Id.

\22\Id.

\23\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 Banking Industry Portfolio

Notes.

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The Commission realizes that Banking 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.\24\ In addition, the

Exchange's hybrid listing standards further require that Banking

Industry Portfolio Notes have at least $4 million in market value.\25\

In any event, financial information regarding Lehman Brothers, in

addition to the information on the issuers of the underlying securities

comprising the Banking Industry Portfolio, will be publicly

available.\26\

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\24\See Amex Company Guide Sec. 1003(b).

\25\See Amex Company Guide Sec. 107A.

\26\The companies that comprise the Banking Industry Portfolio

are reporting companies under the Act.

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The Commission finds good cause for approving the proposed rule

change and Amendment No. 1 to the proposal prior to the thirtieth day

after the date of publication of notice of filing thereof in the

Federal Register. Specifically, the Commission believes that the

proposal, as amended, does not raise any regulatory issues that were

not addressed by the Amex in its proposal to list and trade Basic

Industry Portfolio Notes.\27\ Additionally, the Exchange's proposal to

list and trade Basic Industry Portfolio Notes was noticed for the full

comment period without any comments being received by the Commission.

Accordingly, the Commission believes that it is consistent with Section

6(b)(5) of the Act to approve the proposed rule change and Amendment

No. 1 thereto on an accelerated basis.

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\27\See Exchange Act Release No. 34820, supra note 19.

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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 submissions, 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 Section, 450 Fifth Street, NW., Washington, DC 20549. Copies

of such filings will also be available for inspection and copying at

the principal office of the Amex. All submissions should refer to File

No. SR-Amex-94-39 and should be submitted by November 14, 1994.

It is Therefore Ordered, pursuant to Section 19(b)(2) of the

Act,\28\ that the proposed rule change (File No. SR-Amex-94-39), as

amended, is approved.

\28\15 U.S.C. 78s(b)(2) (1988).

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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. 94-26169 Filed 10-20-94; 8:45 am]

BILLING CODE 8010-01-M