[Federal Register: June 27, 2003 (Volume 68, Number 124)]
[Notices]
[Page 38414-38418]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr27jn03-131]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-48065; File No. SR-NASD-2003-100]
Self-Regulatory Organizations; Notice of Filing and Order
Granting Accelerated Approval of Proposed Rule Change by the National
Association of Securities Dealers, Inc. Relating to the Listing and
Trading of Performance Leveraged Upside Securities Based on the Value
of the Nasdaq-100 Index
June 19, 2003.
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 June 19, 2003, the National Association of Securities Dealers, Inc.
(``NASD''), through its subsidiary, The Nasdaq Stock Market, Inc.
(``Nasdaq''), filed with the Securities and Exchange
[[Page 38415]]
Commission (``SEC'' or ``Commission'') the proposed rule change as
described in Items I and II below, which Items have been prepared by
Nasdaq. 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
Nasdaq proposes to list and trade Performance Leveraged Upside
Securities (``PLUS'') based on the value of the Nasdaq-100 Index
(``Notes'') issued by Morgan Stanley & Co., Inc. (``Morgan Stanley'').
II. Self-Regulatory Organization's Statements of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, Nasdaq 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. Nasdaq 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
Nasdaq proposes to list and trade Performance Leveraged Upside
Securities (``PLUS''), the return on which is based upon the Nasdaq-100
Index.\3\
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\3\ The Nasdaq-100 Index is a modified capitalization-weighted
index of 100 of the largest non-financial companies listed on The
Nasdaq National Market tier of The Nasdaq Stock Market. The Index
constitutes a broadly diversified segment of the largest securities
listed on the The Nasdaq Stock Market and includes companies across
a variety of major industry groups. The securities in the Index
must, among other things, have an average daily trading volume on
Nasdaq of at least 200,000 shares.
In order to limit domination of the Index by a few large stocks,
the Index is calculated under a ``modified capitalization-weighted''
methodology, which is a hybrid between equal weighting and
conventional capitalization weighting. Under the methodology
employed, on a quarterly basis coinciding with Nasdaq's quarterly
scheduled weight adjustment procedures, the Index Securities are
categorized as either ``Large Stocks'' or ``Small Stocks'' depending
on whether their current percentage weights (after taking into
account such scheduled weight adjustments due to stock repurchases,
secondary offerings, or other corporate actions) are greater than,
or less than or equal to, the average percentage weight in the Index
(i.e., as a 100-stock index, the average percentage weight in the
Index is 1.0%). Such quarterly examination will result in an Index
rebalancing if either one or both of the following two weight
distribution requirements are not met: (1) the current weight of the
single largest market capitalization Index component security must
be less than or equal to 24.0%, and (2) the ``collective weight'' of
those Index component securities whose individual current weights
are in excess of 4.5%, when added together, must be less than or
equal to 48.0%. Index securities are ranked by market value and are
evaluated annually to determine which securities will be included in
the Index. Moreover, if at any time during the year an Index
security is no longer trading on the Nasdaq Stock Market, or is
otherwise determined by Nasdaq to become ineligible for continued
inclusion in the Index, the security will be replaced with the
largest market capitalization security not currently in the Index
that meets the Index eligibility criteria.
For a detailed description of the Nasdaq-100 Index, see the
prospectus supplement that will be filed by Morgan Stanley with the
Commission prior to the issuance of the Notes.
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Under Rule 4420(f), Nasdaq may approve for listing and trading
innovative securities which cannot be readily categorized under
traditional listing guidelines.\4\ Nasdaq proposes to list for trading
notes based on the Nasdaq-100 Index under Rule 4420(f).
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\4\ See Securities Exchange Act Release No. 32988 (September 29,
1993); 58 FR 52124 (October 6, 1993).
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The Notes, which will be registered under section 12 of the Act,
will initially be subject to Nasdaq's listing criteria for other
securities under Rule 4420(f). Specifically, under Rule 4420(f)(1):
(A) The issuer shall have assets in excess of $100 million and
stockholders' equity of at least $10 million.\5\ In the case of an
issuer which is unable to satisfy the income criteria set forth in
paragraph (a)(1), Nasdaq 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;
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\5\ Morgan Stanley satisfies this listing criterion.
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(B) There must be a minimum of 400 holders of the security,
provided, however, that if the instrument is traded in $1,000
denominations, there must be a minimum of 100 holders;
(C) For equity securities designated pursuant to this paragraph,
there must be a minimum public distribution of 1,000,000 trading units;
(D) The aggregate market value/principal amount of the security
will be at least $4 million.
In addition, Morgan Stanley satisfies the listed marketplace
requirement set forth in Rule 4420(f)(2).\6\ Lastly, pursuant to Rule
4420(f)(3), prior to the commencement of trading of the Notes, Nasdaq
will distribute a circular to members providing guidance regarding
compliance responsibilities and requirements, including suitability
recommendations, and highlighting the special risks and characteristics
of the Notes. In particular, Nasdaq will advise members recommending a
transaction in the Notes to: (1) Determine that such transaction is
suitable for the customer; and (2) have a reasonable basis for
believing that the customer can evaluate the special characteristics
of, and is able to bear the financial risks of, such transaction.
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\6\ Rule 4420(f)(2) requires issuers of securities designated
pursuant to this paragraph to be listed on The Nasdaq National
Market or the New York Stock Exchange (``NYSE'') or be an affiliate
of a company listed on The Nasdaq National Market or the NYSE;
provided, however, that the provisions of Rule 4450 will be applied
to sovereign issuers of ``other'' securities on a case-by-case
basis.
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The Notes will be subject to Nasdaq's continued listing criterion
for other securities pursuant to Rule 4450(c). Under this criterion,
the aggregate market value or principal amount of publicly-held units
must be at least $1 million. The Notes also must have at least two
registered and active market makers as required by Rule 4310(c)(1).
Nasdaq will also consider prohibiting the continued listing of the
Notes if Morgan Stanley is not able to meet its obligations on the
Notes.
The Notes are a series of medium-term, senior non-convertible debt
securities that will be issued by Morgan Stanley. The original public
offering price of the Notes will be $10 per PLUS. The Notes will not
pay interest and are not subject to redemption by Morgan Stanley or at
the option of any beneficial owner before maturity on August 30, 2004.
At maturity, if the value of the Nasdaq-100 Index has increased, a
beneficial owner will be entitled to receive a payment on the Notes
based on 300% the amount of that percentage increase, subject to a
maximum total payment at maturity that is expected to be between $11.80
and $12.00 (the ``Maximum Payment at Maturity'').\7\ Thus, the Notes
provide investors the opportunity to obtain leveraged returns based on
the Nasdaq-100 Index subject to a cap that is expected to represent an
appreciation of 18% to 20% over the original issue price of the Notes.
Unlike ordinary debt securities, the Notes do not guarantee any return
of principal at maturity. Therefore, if the value of the Nasdaq-100
Index has declined at maturity, a beneficial owner will receive less,
and possibly significantly less, than the original issue price of $10
per PLUS.
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\7\ The actual Maximum Payment at Maturity will be determined at
the time of issuance of the Notes.
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The payment that a beneficial owner will be entitled to receive at
maturity depends entirely on the relation of the
[[Page 38416]]
value of the Nasdaq-100 Index on August 26, 2004 (the ``Final Index
Value'') and the value of the Nasdaq-100 Index on the day the PLUS is
offered for initial sale to the public (the ``Initial Index Value'').
If the Final Index Value is greater than the Initial Index Value, the
payment at maturity per PLUS will equal the lesser of (a) $10 plus the
Leveraged Upside Payment \8\ and (b) the Maximum Payment at Maturity.
If the Final Index Value is less than or equal to the Initial Index
Value, the payment at maturity per PLUS will equal $10 times the Index
Performance Factor.\9\
The Notes are cash-settled in U.S. dollars and do not give the
holder any right to receive a portfolio security, dividend payments or
any other ownership right or interest in the portfolio or index of
securities comprising the Nasdaq-100 Index. The Commission has
previously approved the listing of options on, and other securities the
performance of which has been linked to or based on, the Nasdaq-100
Index.\10\
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\8\ The Leveraged Upside Payment is the product of (i) $10 and
(ii) 300% and (iii) the Index Percent Increase (a fraction, the
numerator of which is the Final Index Value minus the Initial Index
Value and the denominator of which is the Initial Index Value).
\9\ The Index Performance Factor is a fraction, the numerator of
which is the Final Index Value and the denominator of which is the
Initial Index Value.
\10\ See Securities Exchange Act Release No. 45429 (February 11,
2002), 67 FR 7438 (February 19, 2002) (approving the listing and
trading of Enhanced Return Notes Linked to the Nasdaq-100 Index);
Securities Exchange Act Release No. 45024 (November 5, 2001), 66 FR
56872 (November 13, 2001) (approving the listing and trading of
Enhanced Return Notes Linked to the Nasdaq-100 Index); Securities
Exchange Act Release No. 44913 (October 9, 2001), 66 FR 52469
(October 15, 2001) (approving the listing and trading of Performance
Leveraged Upside Securities based upon the performance of the
Nasdaq-100 Index); Securities Exchange Act Release No. 43000 (June
30, 2000), 65 FR 42409 (July 10, 2000) (approving the listing and
trading of options based upon one-tenth of the value of the Nasdaq-
100 Index); Securities Exchange Act Release No. 41119 (February 26,
1999), 64 FR 11510 (March 9, 1999) (approving the listing and
trading of Portfolio Depositary Receipts based on the Nasdaq-100
Index); Securities Exchange Act Release No. 33428 (January 5, 1994),
59 FR 1576 (January 11, 1994) (approving the listing and trading of
options on the Nasdaq-100 Index).
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As of May 31, 2003, the adjusted market capitalization of the
securities included in the Nasdaq-100 Index ranged from a high of
$170.3 billion to a low of $2.2 billion. The average daily trading
volume for these same securities for the last five months, as of the
same date, ranged from a high of 68.1 million shares to a low of
527,400 shares.
Since the Notes will be deemed equity securities for the purpose of
Rule 4420(f), the NASD and Nasdaq's existing equity trading rules will
apply to the Notes. First, pursuant to Rule 2310 and IM-2310-2, members
must have reasonable grounds for believing that a recommendation to a
customer regarding the purchase, sale or exchange of any security is
suitable for such customer upon the basis of the facts, if any,
disclosed by such customer as to his other security holdings and as to
his financial situation and needs.\11\ In addition, as previously
described, Nasdaq will distribute a circular to members providing
guidance regarding compliance responsibilities and requirements,
including suitability recommendations, and highlighting the special
risks and characteristics of the Notes. Furthermore, the Notes will be
subject to the equity margin rules. Lastly, the regular equity trading
hours of 9:30 a.m. to 4 p.m. will apply to transactions in the Notes.
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\11\ Rule 2310(b) requires members to make reasonable efforts to
obtain information concerning a customer's financial status, a
customer's tax status, the customer's investment objectives, and
such other information used or considered to be reasonable by such
member or registered representative in making recommendations to the
customer.
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Nasdaq represents that NASD's surveillance procedures are adequate
to properly monitor the trading of the Notes. Specifically, NASD will
rely on its current surveillance procedures governing equity
securities, and will include additional monitoring on key pricing
dates.
Morgan Stanley will deliver a prospectus in connection with the
initial purchase of the Notes. The procedure for the delivery of a
prospectus will be the same as Morgan Stanley's current procedure
involving primary offerings.
2. Statutory Basis
Nasdaq believes that the proposed rule change is consistent with
section 15A of the Act,\12\ in general, and furthers the objectives of
section 15A(b)(6)\13\ of the Act, in particular, in that the proposed
rule change is designed to prevent fraudulent and manipulative acts and
practices, to promote just and equitable principles of trade, to remove
impediments to and perfect the mechanism of a free and open market,
and, in general, to protect investors and the public interest.
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\12\ 15 U.S.C. 78o-3.
\13\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition
Nasdaq does not believe that the proposed rule change will result
in any 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
Written comments were neither solicited nor received on the
proposed rule change.
III. 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, NW., Washington, DC 20549-0609.
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 Room. Copies of such filing will also be
available for inspection and copying at the principal office of the
NASD. All submissions should refer to File No. SR-NASD-2003-100 and
should be submitted by July 18, 2003.
IV. Commission's Findings and Order Granting Accelerated Approval of
the Proposed Rule Change
Nasdaq has asked the Commission to approve the proposal on an
accelerated basis to accommodate the timetable for listing the Notes.
The Commission notes that it has previously approved the listing and
trading of options on, and securities (including similar ``leveraged''
products) the performance of which have been linked to or based on the
Nasdaq-100 Index.\14\
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\14\ See n. 10, supra.
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After careful consideration, 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
association, and, in particular, the requirements of section 15A of the
Act.\15\ Specifically, the Commission finds that the proposal is
consistent with section 15A(b)(6) of the Act,\16\ which requires in
part that the rules be designed to promote just and equitable
principles of trade, to remove
[[Page 38417]]
impediments to and perfect the mechanism of a free and open market,
and, in general, to protect investors and the public interest.\17\ The
Commission believes that the proposal to list and trade the PLUS will
provide investors flexibility in satisfying their investment needs by
providing them with the opportunity to obtain leveraged returns based
on the Nasdaq-100 Index, subject to the Maximum Payment at Maturity.
Specifically, as described more fully above, if the value of the
Nasdaq-100 Index has increased, a beneficial owner will be entitled to
receive at maturity a payment on the Notes based on triple the amount
of any percentage increase in the Index, subject to the specified
Maximum Payment at Maturity.
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\15\ 15 U.S.C. 78o-3.
\16\ 15 U.S.C. 78o-3(b)(6).
\17\ In approving this rule, the Commission notes that it has
considered the proposed rule's impact on efficiency, competition,
and capital formation. 15 U.S.C. 78c(f).
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The Commission notes that the PLUS are leveraged debt instruments
and that their price will be derived and based upon the performance and
value of the Nasdaq-100 Index. In addition, as discussed more fully
above, the Notes do not guarantee any return of principal at maturity.
Thus if the Index has declined at maturity, a beneficial owner may
receive significantly less than the original public offering price of
the Notes. Accordingly, the level of risk involved in the purchase or
sale of the PLUS is similar to the risk involved in the purchase or
sale of traditional common stock. In addition, because the final rate
of return of the PLUS is derivatively priced and is based on the
performance of an index of securities, because the Notes are debt
instruments that do not guarantee a return of principal, and because
investors' potential return is limited by the Maximum Payment at
Maturity, there are several issues regarding the trading of this type
of product.
The Commission notes that Nasdaq's rules and procedures that
address the special concerns attendant to the trading of hybrid
securities will be applicable to the PLUS. In particular, by imposing
the hybrid listing standards, suitability, disclosure, and compliance
requirements noted above, the Commission believes Nasdaq has addressed
adequately the potential problems that could arise from the hybrid
nature of the PLUS. Moreover, Nasdaq will distribute a circular to its
membership calling attention to the specific risks associated with the
PLUS.
In approving the product, the Commission recognizes that the
components of the Nasdaq-100 Index may change each year over the life
of the product. Nevertheless, the Commission believes that this is
acceptable because Nasdaq has clearly stated its guidelines and formula
for replacing components from a specific group of the largest and most
actively traded securities listed on the Nasdaq, including companies
across a variety of major industry groups. Each year, as noted above,
the index of securities comprising the Nasdaq-100 Index will represent
the 100 largest non-financial companies listed on The Nasdaq National
Market tier of Nasdaq. Nasdaq will do the calculation for replacements
based on a set formula to determine which of the securities will be in
the Nasdaq-100 Index for the following year. The Commission believes
that within these confines the potential changes in the components of
the Nasdaq-100 Index are reasonable and will meet the expectation of
investors.
In addition, the Commission notes that, unlike traditional debt
securities, the PLUS are non-principal protected. The PLUS will not
have a minimum principal amount that will be repaid and may be less
than the original issue price of the PLUS. The Commission also notes
that the PLUS will be registered under section 12 of the Act and will
be treated as equity securities, subject to NASD and Nasdaq's existing
equity trading rules, including rules on suitability, margin,
disclosure, trading hours, and surveillance.
Nasdaq represents that the PLUS meet NASD requirements for
depository eligibility under NASD Market Place Rules 4310 and 11310 for
purposes of clearance and settlement. The Commission notes that Morgan
Stanley will deliver a prospectus to investors with the initial
purchase of the PLUS. In addition, Nasdaq will issue a circular to NASD
members explaining the unique characteristics and risks of the PLUS.
The circular will also note NASD member and member organization
responsibilities under Marketplace Rule 2310 and IM-2310-2.
Specifically, NASD members must have reasonable grounds for believing
that a recommendation to a customer regarding the purchase, sale or
exchange of any security is suitable for such customer upon the basis
of the facts, if any, disclosed by such customer as to his other
security holdings and as to his financial situation and needs.
Furthermore, the Commission notes that the PLUS are dependent upon
the individual credit of the issuer, Morgan Stanley. To some extent
this credit risk is minimized by Nasdaq's listing standards in NASD
Marketplace Rule 4420(f), which provide the only issuers satisfying
substantial asset and equity requirements may issue securities such as
the PLUS. In addition, Nasdaq's hybrid listing standards further
require that the PLUS have at least $4 million in market value.\18\ In
any event, financial information regarding Morgan Stanley, in addition
to the information on the issuers of the underlying securities
comprising the Nasdaq-100 Index, will be publicly available.\19\
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\18\ See NASD Marketplace rule 4420(f).
\19\ The companies that comprise the Nasdaq-100 Index are
reporting companies under the Act.
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The Commission also has a systemic concern, however, that a broker-
dealer, such as Morgan Stanley, or a subsidiary providing a hedge for
the issuer will incur position exposure. As discussed in the prior
approval orders for other hybrid instruments,\20\ the Commission
believes this concern is minimal given the size of the PLUS issuance in
relation to the net worth of Morgan Stanley.
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\20\ See, e.g., Securities Exchange Act Release No. 44913,
(October 9, 2001), 66 FR 52469 (October 15, 2001) (SR-NASD-2001-73)
(order approving the listing and trading of notes issued by Morgan
Stanley Dean Witter & Co. whose return is based on the performance
of the Index).
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The Commission also believes that the listing and trading of the
PLUS should not unduly impact the market for the underlying securities
comprising the Nasdaq-100 Index or raise manipulative concerns. The
Commission notes that the Index is determined, composed, and calculated
by Nasdaq according to objective, publicly-available criteria. As of
May 31, 2003, the adjusted market capitalization of the securities
included in the Nasdaq-100 Index ranged from a high of $170.3 billion
to a low of $2.2 billion. The average daily trading volume for these
same securities for the last five months, as of the same date, ranged
from a high of 68.1 million shares to a low of 527,400 shares. Given
the large capitalizations, liquid markets, and relative weightings of
the Index's component stocks, the Commission continues to believe, as
it has concluded previously, that the listing and trading of the Notes
that are linked to the Nasdaq-100 Index should not unduly impact the
market for the underlying securities comprising the Nasdaq-100 Index or
raise manipulative concerns.\21\ First, the underlying securities
comprising the Nasdaq-100 Index are well-capitalized, highly liquid
stocks listed on the Nasdaq. Second, the Commission believes that the
weighting and potential quarterly rebalancing of the Nasdaq-100 Index
should ensure that no single stock or group of stocks will likely
dominate the Nasdaq-100 Index, significantly minimizing the potential
for manipulation of the index.
[[Page 38418]]
Third, the Commission believes that the Nasdaq-100 would be difficult
to manipulate based on the wide range of instruments that provide
economic exposure to the Index. Finally, Nasdaq's surveillance
procedures will serve to deter as well as detect any potential
manipulation. The Commission also notes that the value of the Nasdaq-
100 Index is disseminated every 15 seconds over the Nasdaq Trade
Dissemination System.
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\21\ See n. 8, supra.
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The Commission finds good cause for approving the proposed rule
change prior to the thirtieth day after the date of publication of
notice thereof in the Federal Register. Nasdaq has requested
accelerated approval in order to begin listing and trading the PLUS
immediately. In determining to grant the accelerated approval for good
cause, the Commission notes that the Nasdaq-100 Index is an index of
large, actively traded securities listed on the Nasdaq. Additionally,
the PLUS will be listed pursuant to existing hybrid security listing
standards as described above. Moreover, the Nasdaq-100 Index's
weighting methodology is a commonly applied index calculation method.
The Commission believes that the Notes will provide investors with an
additional investment choice and that accelerated approval of the
proposal will allow investors to begin trading the Notes promptly.
Based on the above, the Commission finds, consistent with sections
15A(b)(6) \22\ and 19(b) \23\ of the Act, that there is good cause for
accelerated approval of the product.
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\22\ 15 U.S.C. 78o-3(b)(6).
\22\ 15 U.S.C. 78s(b).
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The Commission is approving Nasdaq's proposed listing and trading
standards for the PLUS. The Commission specifically notes that,
notwithstanding approval of the listing standards for the PLUS, other
similarly structured products will require review by the Commission
prior to being trading on Nasdaq.
V. Conclusion
It is therefore ordered, pursuant to section 19(b)(2) of the
Act,\24\ that the proposed rule change (SR-NASD-2003-100) is hereby
approved on an accelerated basis.
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\24\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\25\
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\25\ 17 CFR 200.30-2(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-16268 Filed 6-26-03; 8:45 am]
BILLING CODE 8010-01-P