Self-Regulatory Organizations; Notice of Filing and Order Granting Accelerated Approval of a Proposed Rule Change by the Pacific Stock Exchange Incorporated Relating to the Listing and Trading of Equity-Linked Notes

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-37648; International Series Release No. 1016; File No.

SR-PSE-96-23]

Self-Regulatory Organizations; Notice of Filing and Order

Granting Accelerated Approval of a Proposed Rule Change by the Pacific

Stock Exchange Incorporated Relating to the Listing and Trading of

Equity-Linked Notes

September 5, 1996.

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934

(``Act''),\1\ notice is hereby given that on June 24, 1996, the Pacific

Stock Exchange Incorporated (``PSE'' or ``Exchange'') filed with the

Securities and Exchange Commission (``SEC'' or ``Commission'') the

proposed rule change as described in Items I and II below, which Items

have been prepared by the self-regulatory organization (``SRO''). On

July 25, 1996, the Exchange submitted Amendment No. 1 to the

Commission.\2\ On September 4, 1996, the Exchange submitted Amendment

No. 2 to the Commission.\3\ The Commission is publishing this notice to

solicit comments on the proposed rule change from interested persons

and to grant accelerated approval to the proposed rule change, as

amended.

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

\2\ Amendment No. 1 clarified that the requisite trading volume

levels concerning the linked security must occur in the United

States. In addition, Amendment No. 1 removed the unnumbered

paragraph in proposed PSE Rule 3.1(j)(3)(D)(i) that referenced

proposed PSE Rule 3.1(j)(3)(C)(iii)(b)(2) because the language in

that paragraph did not take into consideration the provisions

contained in proposed PSE Rule 3.1(j)(3)(C)(iii)(b)(3). See letter

from Michael D. Pierson, Senior Attorney, Regulatory Policy, PSE, to

Anthony P. Pecora, Attorney, Office of Market Supervision, Division

of Market Regulation, SEC, dated July 24, 1996.

\3\ Amendment No. 2 conforms the definition of ELNs contained in

PSE Rule 3.1(b)(16) with the other rules in this proposal concerning

ELNs in that the use of American Depositary Receipts (``ADRs'') is

limited to sponsored ADRs. See letter from Michael D. Pierson,

Senior Attorney, Regulatory Policy, PSE, to Anthony P. Pecora,

Attorney, Office of Market Supervision, Division of Market

Regulation, SEC, dated September 3, 1996.

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I. Self-Regulatory Organization's Statement of the Terms of Substance

of the Proposed Rule Change

The Exchange proposes to amend its listing rules to provide for the

listing

[[Page 48196]]

and trading of Equity-Linked Notes (``ELNs''). The text of the proposed

rule change is available for inspection and copying at the PSE and at

the Commission.

II. Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

In its filing with the Commission, the self-regulatory organization

included statements concerning the purpose of and basis for the

proposed rule change and discussed any comments it received on the

proposed rule change. The text of these statements may be examined at

the places specified in Item III below. The self-regulatory

organization has prepared summaries, set forth in Sections A, B, and C

below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

1. Purpose

The Exchange is proposing to list for trading Equity-Linked Notes,

which are notes that are linked, in whole or in part, to the market

performance of common stocks, non-convertible preferred stocks, or

sponsored ADRs \4\ overlying such equity securities. The proposal

states that the Exchange will consider for listing ELNs that meet the

Exchange's issuer listing standards, ELN listing standards, minimum

standards applicable to linked securities, and limits on the number of

ELNs linked to a particular security, as set forth below.

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\4\ ADR programs may be ``sponsored'' or ``unsponsored.'' A

sponsored ADR is established by a single U.S. depository bank at the

request, or with the consent, of the foreign issuer of the

underlying security.

With a sponsored ADR program, a single depository bank, working

closely with the issuer, acts as the central source of information

for buyers, sellers, and intermediaries. In addition, the depository

generally is required to distribute notices of shareholder meetings

and voting instructions to ADR holders, thereby ensuring the ADR

holders will be able to exercise voting rights through the

depository with respect to the underlying securities.

ELNs may be linked only to sponsored ADRs. Telephone

conversation between Michael D. Pierson, Senior Attorney, Regulatory

Policy, PSE, and Anthony P. Pecora, Attorney, Office of Market

Supervision, Division of Market Regulation, SEC (Sept. 3, 1996).

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a. Issuer Listing Standards

Under the proposal, the issuer of ELNs must be an entity that: (a)

Is listed on a national securities exchange or the Nasdaq National

Market or is an affiliate of a company listed on a national securities

exchange or the Nasdaq National Market; and (b) has a minimum net worth

of $150 million. In addition, the market value of an ELN offering, when

combined with the market value of all other ELN offerings previously

completed by the issuer and currently traded on a national securities

exchange or the Nasdaq National Market, may not be greater than 25% of

the issuer's net worth at the time of issuance.

b. ELN Listing Standards

The proposal states that the issue must have: (a) A minimum public

distribution of one million ELNs; (b) a minimum of 400 holders of the

ELNs (provided, however, that if the ELN is traded in $1,000

denominations, there is no minimum number of holders); (c) a minimum

market value of $4 million; and (d) a term of two to seven years,

provided that if the issuer of the underlying security is a non-U.S.

company, or if the underlying security is a sponsored ADR, the issue

may not have a term of more than three years.

c. Minimum Standards Applicable to the Linked Security

The proposed new rules state that the underlying security must

have: (a) A market capitalization of at least $3 billion and trading

volume in the United States of at least 2.5 million shares in the one-

year period preceding the listing of the ELNs; or (b) a market

capitalization of at least $1.5 billion and trading volume in the

United States of at least 10 million shares in the one-year period

preceding the listing of the ELNs; or (c) a market capitalization of at

least $500 million and trading volume in the United States of at least

15 million shares in the one-year period preceding the listing of the

ELNs.\5\

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\5\ If an issuer proposes to list an offering of ELNs that does

not satisfy the market capitalization or trading volume requirements

discussed above, the PSE, with the concurrence of the staff to the

Commission, may evaluate the trading volume, public float, and

market capitalization of that security, as well as other relevant

factors, and determine on a case-by-case basis that it is

appropriate to list ELNs overlying that security. However, depending

on the proposed facts, the Commission may require the PSE to submit

a rule filing pursuant to Section 19(b) of the Act that addresses

the pertinent regulatory issues. In this regard, the Commission

notes that any proposal to list an ELN that is linked to a security

with a market capitalization of less than $500 million would raise

significant regulatory concerns for which a Section 19(b) rule

filing would be required. See Securities Exchange Act Release No.

34758 (Sept. 30, 1994), 59 FR 50943 (approving listing of Selected

Equity-Linked Debt Securities (``SEEDS'') by the National

Association of Securities Dealers, Inc. (``NASD'')).

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In addition, the notes must be issued by a company that has a

continuous reporting obligation under the Act, as amended, and the

security must be listed on a national securities exchange or the Nasdaq

National Market and be subject to last sale reporting.

Furthermore, the notes must be issued by either: (a) A U.S.

company; or (b) a non-U.S. company \6\ (including a company that is

traded in the United States through sponsored ADRs) provided that one

of the following three criteria is met: First, the Exchange must have a

comprehensive surveillance sharing agreement in place with the primary

exchange in the country where the linked security is primarily traded

(in the case of an ADR, the primary exchange on which the security

underlying the ADR is traded).

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\6\ For the purposes of this rule, a non-U.S. company is any

company formed or incorporated outside of the United States.

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Second, as an alternative, the combined trading volume of the non-

U.S. security (a security issued by a non-U.S. company) and other

related non-U.S. securities occurring in the U.S. market and in markets

with which the Exchange has in place a comprehensive surveillance

sharing agreement must represent (on a share equivalent basis for any

ADRs) at least 50% of the combined world-wide trading volume in the

non-U.S. security, other related non-U.S. securities, and other classes

of common stock related to the non-U.S. security over the six month

period preceding the date of listing.

Third, an alternate trading volume test would permit an ELN on a

non-U.S. security if: (a) The combined trading volume of the non-U.S.

security and other related non-U.S. securities occurring in the U.S.

market represents (on a share equivalent basis) at least 20% of the

combined world-wide trading volume in the non-U.S. security and in

other related non-U.S. securities over the six-month period preceding

the date of listing of the non-U.S. security for an ELN listing; (b)

the average daily trading volume for the non-U.S. security in the U.S.

markets over the six-month period preceding the date of listing of the

non-U.S security for an ELN listing is 100,000 or more shares; and (c)

the trading volume for the non-U.S. security in the U.S. market is at

least 60,000 shares per day for a majority of the trading days for the

six-month period preceding the date of selection of the non-U.S.

security for an ELN listing.\7\

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\7\ The Commission notes that volume in foreign markets with

which the Exchange has a comprehensive surveillance information

sharing agreement in place is not included in these calculations.

See Securities Exchange Act Release no. 37405 (July 7, 1996), 61 FR

36596, at n.8.

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In addition, if the underlying security to which the ELN is to be

linked is the stock of a non-U.S. company that is traded in the U.S.

market as a sponsored

[[Page 48197]]

ADR, ordinary shares or otherwise, then the minimum number of holders

of the underlying security shall be 2,000.

d. Limits on the Number of ELNs Linked to a Particular Security

The proposal provides that the issuance of ELNs relating to any

underlying U.S. security may not exceed five percent of the total

outstanding shares of such underlying security. In addition, the

issuance of ELNs relating to any underlying non-U.S. security or

sponsored ADR may not exceed: (a) Two percent of the total shares

outstanding worldwide if at least 20 percent of the worldwide trading

volume in such security occurs in the U.S. market during the six-month

period preceding the date of listing; or (b) three percent of the total

shares outstanding worldwide if at least 50 percent of the worldwide

trading volume in such security occurs in the U.S. market during the

six-month period preceding the date of listing; or (c) five percent of

the total shares outstanding worldwide if at least 70 percent of the

worldwide trading volume in such security occurs in the U.S. market

during the six-month period preceding the date of listing.\8\

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\8\ Id. at n.9.

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In addition, if an issuer proposes to issue ELNs that relate to

more than the allowable percentages of the underlying security

specified above, then the Exchange, with the concurrence of the staff

of the Division of Market Regulation of the SEC, will evaluate the

maximum percentage of ELNs that may be issued on a case-by-case

basis.\9\

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\9\ As with the market capitalization and trading volume

requirements, the Commission notes that the Exchange may be required

to submit a rule filing to the Commission pursuant to Section 19(b)

of the Act to address regulatory issues raised by any Exchange

proposal to list an ELN related to more than the allowable

percentages of outstanding shares of the underlying security. See

supra note 4.

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Finally, the proposed rule states that prior to the commencement of

trading of particular ELNs listed pursuant to PSE Rule 3.1(j)(3), the

Exchange will distribute a circular to its membership providing

guidance regarding member firm compliance responsibilities (including

suitability recommendations and account approval) when handling

transactions in ELNs.

2. Statutory Basis

The Exchange believes the proposed rule change is consistent with

Section 6(b) \10\ of the Act in general and furthers the objectives of

Section 6(b)(5) \11\ in particular in that it is designed to promote

just and equitable principles of trade, to prevent fraudulent and

manipulative acts and practices, and, in general, to protect investors

and the public interest.

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\10\ 15 U.S.C. 78f(b).

\11\ 15 U.S.C. 78f(b)(5).

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B. Self-Regulatory Organization's Statement on Burden on Competition

The Exchange believes the proposed rule change will impose no

burden on competition that is not necessary or appropriate in

furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed

Rule Change Received From Members, Participants, or Others

The Exchange has neither solicited nor received written comments.

III. Solicitation of Comments

Interested persons are invited to submit written data, views, and

arguments concerning the foregoing. 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 Section, 450 Fifth Street, N.W.,

Washington, D.C. 20549. Also, copies of such filing will be available

for inspection and copying at the principal office of the PSE. All

submissions should refer to File No. SR-PSE-96-23 and should be

submitted by October 3, 1996.

IV. Commission's Findings and Order Granting Accelerated Approval of

the Proposed Rule Change

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.\12\

Specifically, the Commission believes that providing for the listing

and trading of ELNs will offer a new and innovative means for investors

to participate in the securities markets. In particular, the Commission

believes that the availability of ELNs will permit investors to more

closely approximate their desired investment objectives through, for

example, shifting some of the opportunity for upside gain in return for

additional income.\13\ Accordingly, for these reasons, as well as for

the reasons stated in the Commission's prior approval orders concerning

equity-linked debt securities,\14\ the Commission finds that the PSE's

standards for the listing and

[[Page 48198]]

trading of ELNs are consistent with the Act.

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\12\ 15 U.S.C. 78f(b)(5).

\13\ Pursuant to Section 6(b) of the Act, the Commission must

predicate approval of trading for new products upon a finding that

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

finding would be difficult with respect to a product that served no

investment, hedging, or other economic function because any benefits

that might be derived by market participants would likely be

outweighed by the potential for manipulation, diminished public

confidence in the integrity of the markets, and other valid

regulatory concerns.

\14\ The Commission notes that it previously has approved the

listing of equity-linked debt securities by the American Stock

Exchange, Inc. (``Amex''), the Chicago Board Options Exchange,

Incorporated (``CBOE''), the NASD, the New York Stock Exchange, Inc.

(``NYSE''), and the Philadelphia Stock Exchange, Inc. (``Phlx'').

See Securities Exchange Act Release Nos. 32343 (May 20, 1993), 58 FR

30833 (order originally approving the listing of ELNs by the Amex);

33328 (Dec. 13, 1993), 58 FR 66041 (approving revised market

capitalization and trading volume requirements for the listing of

ELNs by the Amex); 33468 (Jan. 13, 1994), 59 FR 3387 (order

originally approving the listing of Equity-Linked Debt Securities

(``ELDS'') by the NYSE); 34545 (Aug. 18, 1994), 59 FR 43877 (order

approving the listing of ELDS by the NYSE linked to securities

issued by non-U.S. companies); 34549 (Aug. 18, 1994), 59 FR 43873

(order approving the listing of ELNs by the Amex linked to

securities issued by non-U.S. companies); 34758 (Sept. 30 1994), 59

50943 (order originally approving the listing of SEEDS by the NASD);

34759 (Sept. 30, 1994), 59 FR 50939 (order originally approving the

listing of ELNs by the CBOE); 34765 (Sept. 30, 1994), 59 FR 51220

(approving revised market capitalization and trading volume

requirements for the listing of ELNs by the Amex); 34766 (Sept. 30,

1994), 59 FR 51220 (approving revised market capitalization and

trading volume requirements for the listing of SEEDS by the NASD);

34985 (Nov. 18, 1994), 59 FR 60860 (order approving alternative

market capitalization and trading volume requirements for the

listing of ELDS by the NYSE); 35479 (Mar. 13, 1995), 60 FR 14993

(order originally approving the listing of ELNs by the Phlx); 36578

(Dec. 13, 1995), 60 FR 65700 (approving revised market

capitalization and trading volume requirements for the listing of

ELNs by the Amex); 36990 (Mar. 20, 1996), 61 FR 13545 (approving

revised market capitalization and trading volume requirements for

the listing of ELNs by the Amex); 36993 (Mar. 20, 1996), 61 FR 13557

(approving revised market capitalization and trading volume

requirements for the listing of ELDS by the NYSE); 36994 (Mar. 20,

1996), 61 FR 13553 (approving revised market capitalization and

trading volume requirements for the listing of SEEDS by the NASD);

36995 (Mar. 20, 1996), 61 FR 13550 (approving revised market

capitalization and trading volume requirements for the listing of

ELNs by the CBOE); 37405 (July 3, 1996), 61 FR 36596 (approving

revised market capitalization and trading volume requirements for

the listing of ELDS by the NYSE) (collectively, ``Equity-Linked Note

Approval Orders''). The discussions articulated in the Equity-Linked

Note Approval Orders are incorporated herein.

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As with previously approved ELNs, ELDS, and SEEDS, the ELNs, the

PSE is proposing to trade are not leveraged instruments. Their price,

however, will be derived and based upon the underlying linked security.

Accordingly, the level of risk involved in the purchase and sale of an

ELN is similar to the risk involved in the purchase or sale of

traditional common stock. Nonetheless, in considering other SROs'

respective proposals to list and trade ELNs, ELDS, and SEEDS, the

Commission had several specific concerns with this type of product

because the final rate of return of an ELN is derivately priced (i.e.,

based on the performance of the underlying security). The concerns

included: (1) Investor protection concerns, (2) dependence on the

credit of the issuer of the instrument, (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 security.\15\ The Commission concluded, however, that

the SROs' proposals adequately addressed each of these issues such that

the Commission's regulatory concerns were minimized adequately.\16\

Similarly, in this proposal, the PSE has proposed safeguards, as

described above, that the Commission finds to be equivalent to those

approved for the trading of equity-linked debt securities in other

markets. In particular, by imposing the listing standards, suitability,

disclosure, and compliance requirements noted above, the PSE has

adequately addressed the potential public customer concerns that could

arise from the hybrid nature of ELNs. 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

underlying the ELNs.

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\15\ See Equity-Linked Note Approval Orders, supra note 14.

\16\ See Equity-Linked Note Approval Orders, supra note 14.

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The Commission finds good cause for approving the amended proposed

rule change prior to the thirtieth day after the date of publication of

notice thereof in the Federal Register in order to allow the PSE to

begin listing ELNs without delay. As discussed above, the proposal

merely provides the PSE with the ability to list equity-linked debt

securities on the same basis as other SROs. Moreover, the Commission

notes that the prior proposals by other SROs to list and trade equity-

linked debt securities were published by the Commission for the full

statutory comment period without any comments being received by the

Commission. In light of the Commission's approval of the listing and

trading equity-linked debt securities by other SROs, accelerating

approval of this proposal does not raise any new regulatory issues and

will allow the PSE to compete on an equal basis with other markets with

regard to these equity-linked products.\17\ Therefore, the Commission

there is good cause to grant accelerated approval to the proposed rule

change, as amended, consistent with Section 6(b)(5) and Section

19(b)(2) of the Act.\18\

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\17\ See Equity-Lined Note Approval Orders, supra note 14.

\18\ 15 U.S.C. 78f(b)(5) and 78s(b)(2).

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V. Conclusion

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

Act,\19\ that the proposed rule change (SR-PSE-96-23), as amended, is

hereby approved on an accelerated basis.

\19\ 15 U.S.C. 78s(b)(2).

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For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\20\

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\20\ 17 C.F.R. 200.30-3(a)(12).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 96-23308 Filed 9-11-96; 8:45 am]

BILLING CODE 8010-01-M