Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the Chicago Board Options Exchange, Incorporated Relating to the Listing and Trading of Principal-Protected Notes

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40481; File No. SR-CBOE-98-38]

Self-Regulatory Organizations; Notice of Filing of Proposed Rule

Change by the Chicago Board Options Exchange, Incorporated Relating to

the Listing and Trading of Principal-Protected Notes

September 25, 1998.

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

(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that

on September 14, 1998, the Chicago Board Options Exchange, Incorporated

(``Exchange'' or ``CBOE'') filed with the Securities and Exchange

Commission (``Commission'') the proposed rule change as described in

Items I, II, and III below, which Items have been prepared by the

Exchange. The Commission is publishing this notice to solicit comments

on the proposed rule change from interested persons.

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

\2\ 17 CFR 240.19b-4.

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

Substance of the Proposed Rule Change

The Exchange seeks to list the trade four separate Principal-

Protected Notes. The value of each Principal-Protected Note will be

linked to an index comprised of a single specified domestic mutual fund

portfolio (``Index'' or collectively ``Indexes'').

The text of the proposed rule change is available at the Office of

the Secretary, the Exchange, 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 Exchange 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 IV below. The Exchange 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

Under Exchange Rule 31.5(F), the Exchange may approve for listing

and trading securities which cannot be readily categorized under the

Exchange's listing criteria for preferred stock, bonds and debentures,

or warrants. The Exchange seeks to list four Principal-Protected Notes,

each of which shall be separately linked to a specified domestic mutual

fund portfolio Index.\3\ The four mutual fund portfolios underlying the

Indexes are registered under the Investment Company Act of 1940.

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\3\ The Exchange notes that the Commission recently approved a

similarly structured product for listing and trading on the American

Stock Exchange--Market Index Target Term Securities linked to the

Merrill Lynch EuroFund Index. See Securities Exchange Act Release

No. 40367 (Aug. 26, 1998), 63 FR 47052 (Sept. 3, 1998).

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The Principal-Protected notes will be senior, unsecured debt

securities that will conform to the listing guidelines under Exchange

Rule 31.5(F) in all respects.\4\ Although a specific maturity date will

not be established until the

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time of the offering, the Principal-Protected Notes will provide for a

maturity of between two and seven years from the date of issuance. Each

Principal-Protected Note may provide for payments at maturity based in

whole or in part on changes in the value of the corresponding Index.

Each Index will measure the total return of the corresponding mutual

fund portfolio. The total return value shall reflect the Changes in the

Net Value (``NAV'') of the corresponding mutual fund portfolio, plus

any cash dividends and/or distributions paid on those shares.\5\

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\4\ Exchange Rule 31.5(F) states that the Exchange will consider

listing any security not otherwise covered by the Exchange's listing

requirements, provided the security satisfied the following

criteria:

(a) Assets/Equity--The issuer shall have assets in excess of

$100 million and stockholders' equity of at least $10 million. In

the case of an issuer which is unable to satisfy the earnings

criteria set forth in paragraph (A) (i.e., pre-tax income of

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

years and net income of at least $400,000), the Exchange generally

will require the issuer to have the following: (i) assets in excess

of $200 million and stockholders' equity of at least $10 million; or

(ii) assets in excess of $100 million and stockholders' equity of at

least $20 million.

(b) Distribution--Minimum public distribution of $1,000,000

trading units including a minimum of 400 holders or, if traded in

thousand dollar denominations, no minimum number of holders.

(c) Principal Amount/Aggregate Market Value--Not less than $4

million.

\5\ As discussed infra in Section II(A)(1)(c), ``Settlement of

Principal Protected Notes,'' the total return value may be reduced

by an adjustment factor.

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The Exchange will calculate the value of each Index once each

business day. Holders of the Principal-Protected Notes will not receive

any interest payments. However, holders of the Principal-Protected

Notes will received at maturity the full principal amount of their

Notes, plus a ``Supplemental Redemption Amount,'' if any, based on a

formula to be set forth in the Prospectus. The Exchange notes that the

formula may produce a total return at maturity which is lower than what

a holder of the corresponding mutual fund portfolio might receive

during the same period. At maturity, holders of the Principal-Protected

Notes will not receive less than 100% of the initial issue price.

a. Description of Principal-Protected Notes and the Underlying

Mutual Funds. Similar to other Exchange traded index-linked notes, both

the issues (Principal-Protected Notes) and the issuer meet the general

criteria set forth in Exchange Rule 31.5(F). Furthermore, the Exchange

has represented that the issuer has a minimum tangible net worth in

excess of $100,000,000 and otherwise substantially exceeds the earnings

requirements set forth in Exchange Rule 31.5(A).\6\ Each mutual fund

portfolio underlying an Index includes several hundred stocks from

among a wide variety of industry groups. As of the latest reporting

period, the underlying mutual fund portfolios ranged in value from $900

million to $2.1 billion in total net assets. The NAV of each mutual

fund portfolio is reported each business day through the facilities of

the National Association of Securities Dealers Automated Quotation

System (``Nasdaq'') and also is reported in the Mutual Fund Tables of

the Wall Street Journal and other newspapers. The Principal-Protected

Notes will be subject to the suspension and delisting policies of the

Exchange set forth in Exchange Rule 31.94.\7\

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\6\ Exchange Rule 31.5(A), ``Equity Securities,'' requires that

an issuer have pre-tax income of $750,000 in its last fiscal year,

or in two of its last three fiscal years and net income of at least

$400,000.

\7\ Under Exchange Rule 31.94(C)(b)(iii), the Exchange may

consider delisting debt securities if the aggregate market value or

the principal amount of debt securities publicly held is less than

$400,000 or, the issuer is not able to meet its obligations on the

listed debt securities.

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b. Calculation and Dissemination of Net Asset Values and Index

Values. Each Index will measure the total return of its underlying

mutual fund portfolio. Such amount shall be equal to the change in the

mutual fund's NAV, plus any cash dividends and/or distributions paid on

the mutual fund portfolio shares. The value for each Index will be

disseminated once a day over the Consolidated Tape Association's

Network B or through the Option Price Reporting Authority (``OPRA'').

If any mutual fund portfolio does not comply with Rule 22c-1 of the

Investment Company Act of 1940,\8\ which requires daily computation of

a fund's current NAV, the Exchange will use the last available NAV in

its calculation of the Index.

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\8\ 17 CFR 270.22c-1.

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c. Settlement of Principal-Protected Notes. The Principal-Protected

Notes will be settled at maturity by either a cash payment or by

delivering shares in the corresponding mutual fund portfolio, at the

determination of the Issuer. The value of the Principal-Protected Notes

at maturity will be equal to the principal amount of such Notes plus a

Supplemental Redemption Amount. The Supplemental Redemption Amount,

which may not be less than zero, will equal the principal amount of

such Principal-Protected Note multiplied by the percentage difference

between the Adjusted Ending Index Value and the Starting Index Value.

The Adjusted Ending Index Value means the ending value of the Index \9\

reduced by an adjustment factor, if any, to be set forth in the

prospectus.

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\9\ The ending value of the Index shall represent the average of

the values of the Index during a period prior to the stated maturity

as specified in the prospectus.

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d. Other Exchange Rules. Trading in Principal-Protected Notes will

be governed by Chapter XXX of the Exchange's Rules.\10\ The Principal-

Protected Notes will trade during the normal trading hours for Chapter

XXX securities, 8:30 A.M. to 3:00 P.M. Central Standard Time. The

Principal-Protected Notes also will be subject to the equity margin

rules of the Exchange.\11\ Consistent with the Exchange's practice with

respect to the offering of structured products, the Exchange will

distribute an informational circular to its membership prior to the

commencement of trading in the Principal-Protected Notes to provide

guidance regarding member firm compliance responsibilities, including

appropriate suitability criteria and/or guidelines. The circular shall

require that before a member, member organization, or employee of such

member organization, undertakes to recommend a transaction in a

Principal-Protected Note, such member or member organization should

make a determination that the Principal-Protected Note is suitable for

such customer. As part of that determination, the person making the

recommendation should have a reasonable basis for believing at the time

of making the recommendation, that the customer has such knowledge and

experience in financial matters that they may be capable of evaluating

the risks and special characteristics of the recommended transaction,

including those highlighted, and that the customer is financially able

to bear the risks of the recommended transaction. Lastly, as with other

similarly structured products, the Exchange will closely monitor

trading activity in Principal-Protected Notes to identify and deter any

potential improper trading activity in such securities.

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\10\ See Exchange Rules, Chapter XXX, ``Trading in Stocks,

Warrants and Other Securities.''

\11\ See Exchange Rules, Chapter XII, ``Margins.''

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2. Statutory Basis

The Exchange believes the proposed rule change is consistent with

Section 6 of the Act,\12\ in general, and furthers the objectives of

Section 6(b)(5),\13\ in particular, in that it is designed to prevent

fraudulent and manipulative acts and practices; promote just and

equitable principles of trade; foster cooperation and coordination with

persons facilitating transactions in securities; remove impediments to

and perfect the mechanism of a free and open market and a national

market system; and protect investors and the public interest. The

Exchange further believes the listing and trading of the Principal-

Protected Notes will provide investors an opportunity to invest in a

mutual fund portfolio without being subject to the risk of principal

loss.

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\12\ 15 U.S.C. 78f.

\13\ 15 U.S.C. 78f(b)(5).

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[[Page 53739]]

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

The Exchange does not believe the proposed rule change will impose

any inappropriate burden on competition.

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

Rule Change Received From Members, Participants or Others

The Exchange did not solicit or receive written comments with

respect to the proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing

for Commission Action

Within 35 days of the date of publication of this notice in the

Federal Register or within such longer period (i) as the Commission may

designate up to 90 days of such date if it finds such longer period to

be appropriate and publishes its reasons for so finding, or (ii) as to

which the Exchange consents, the Commission will:

(A) by order approve the proposed rule change, or

(B) institute proceedings to determine whether the proposed rule

change should be disapproved.

IV. Solicitation of Comments

Interested persons are invited to submit written data, views and

arguments concerning the foregoing, including whether the proposed rule

change is consistent with the Act. Persons making written submissions

should file six copies thereof with the Secretary, Securities and

Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.

Copies of the 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 persons, 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, N.W.,

Washington, D.C. 20549. Copies of such filings will also be available

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

submissions should refer to File No. SR-CBOE-98-38 and should be

submitted by October 27, 1998.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\14\

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\14\ 17 CFR 200.30-3(a)(12).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 98-26661 Filed 10-5-98; 8:45 am]

BILLING CODE 8010-01-M