Document ID: SEC-2006-0096-0001
Agency: sec
Document Type: Notice
Title: Self-regulatory organizations; proposed rule changes: National Association of Securities Dealers, Inc.
Posted Date: 2006-01-25T05:00Z

[Federal Register: January 25, 2006 (Volume 71, Number 16)]
[Notices]               
[Page 4180-4187]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr25ja06-119]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-53142; File No. SR-NASD-2006-001]

 
Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Notice of Filing and Order Granting Accelerated Approval 
of a Proposed Rule Change and Amendment No. 1 Thereto To Establish 
Generic Listing Standards for Index-Linked Securities

January 19, 2006.
    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 January 3, 2006, the National Association of Securities Dealers, 
Inc. (``NASD''), through its subsidiary, The Nasdaq Stock Market, Inc. 
(``Nasdaq''), filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I and 
II below, which Items have been prepared by the Nasdaq. On January 13, 
2006, the Exchange filed Amendment No. 1 to the proposed rule 
change.\3\ The Commission is publishing this notice to solicit comments 
on the proposed rule change, as amended, from interested persons and to 
approve the proposal, as amended, on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1 Nasdaq made minor revisions to the 
proposed rule text and clarified certain details of its proposal.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    Nasdaq proposes to adopt generic listing standards for index-linked 
securities (``Index Securities'') pursuant to Rule 19b-4(e) under the 
Act.\4\ Nasdaq will implement the proposed rule change immediately upon 
approval by the Commission.
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    \4\ 17 CFR 240.19b-4(e).
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    The proposed rule change is available on the NASD's Web site at 
http://www.nasd.com, at the principal office of the NASD, and at the 

Commission's Public Reference Room. The text of the proposed rule 
change is also set forth below. Proposed new language is italicized; 
proposed deletions are in [brackets].
* * * * *

4420. Quantitative Designation Criteria

    In order to be designated for the Nasdaq National Market, an issuer 
shall be required to substantially meet the criteria set forth in 
paragraphs (a), (b), (c), (d), (e), (f), (g), (h), (i), (j), (k), [or] 
(l) or (m) below. Initial Public Offerings substantially meeting such 
criteria are eligible for immediate inclusion in the Nasdaq National 
Market upon prior application and with the written consent of the 
managing underwriter that immediate inclusion is desired. All other 
qualifying issues, excepting special situations, are included on the 
next inclusion date established by Nasdaq.
    (a)-(l) No Change.
    (m) Index-Linked Securities
    Index-linked securities are securities that provide for the payment 
at maturity of a cash amount based on the performance of an underlying 
index or indexes. Such securities may or may not provide for the 
repayment of the original principal investment amount. Nasdaq may 
submit a rule filing pursuant to Section 19(b)(2) of the Securities 
Exchange Act of 1934 to permit the listing and trading of index-linked 
securities that do not otherwise meet the standards set forth below in 
paragraphs (1) through (9). Nasdaq will consider for listing and 
trading pursuant to Rule 19b-4(e) under the Securities Exchange Act of 
1934 index-linked securities, provided:
    (1) Both the issue and the issuer of such security meet the 
criteria for other securities set forth in paragraph (f) of this rule, 
except that the minimum public distribution of the security shall be 
1,000,000 units with a minimum of 400 public holders, unless the 
security is traded in $1,000 denominations, in which case there is no 
minimum number of holders.
    (2) The issue has a term of not less than one (1) year and not 
greater than ten (10) years.
    (3) The issue must be the non-convertible debt of the issuer.
    (4) The payment at maturity may or may not provide for a multiple 
of the positive performance of an underlying index or indexes; however, 
in no event will payment at maturity be based on a multiple of the 
negative performance of an underlying index or indexes.
    (5) The issuer will be expected to have a minimum tangible net 
worth in excess of $250,000,000 and to exceed by at least 20% the 
earnings requirements set forth in paragraph (a)(1) of this Rule. In 
the alternative, the issuer will be expected: (i) To have a minimum 
tangible net worth of $150,000,000 and to exceed by at least 20% the 
earnings requirement set forth in paragraph (a)(1) of this Rule, and 
(ii) not to have issued securities where the original issue price of 
all the issuer's other index-linked note offerings (combined with 
index-linked note offerings of the issuer's affiliates) listed on a 
national securities exchange or traded through the facilities of Nasdaq 
exceeds 25% of the issuer's net worth.
    (6) The issuer is in compliance with Rule 10A-3 under the 
Securities Exchange Act of 1934.
    (7) Initial Listing Criteria--Each underlying index is required to 
have at least ten (10) component securities. In addition, the index or 
indexes to which the security is linked shall either (A) have been 
reviewed and approved for the trading of options or other derivatives 
by the Commission under Section 19(b)(2) of the 1934 Act and rules 
thereunder and the conditions set forth in the Commission's approval 
order, including comprehensive surveillance sharing agreements for non-
U.S. stocks, continue to be satisfied, or (B) the index or indexes meet 
the following criteria:
    (i) Each component security has a minimum market value of at least 
$75 million, except that for each of the lowest weighted component 
securities in the index that in the aggregate account for no more than 
10% of the weight of the index, the market value can be at least $50 
million;
    (ii) Each component security shall have trading volume in each of 
the last six months of not less than 1,000,000 shares, except that for 
each of the lowest weighted component securities in the index that in 
the aggregate account for no more than 10% of the weight of the index, 
the trading volume shall be at least 500,000 shares in each of the last 
six months;
    (iii) In the case of a capitalization-weighted or modified 
capitalization-weighted index, the lesser of the five highest weighted 
component securities in the index or the highest weighted component 
securities in the index that

[[Page 4181]]

in the aggregate represent at least 30% of the total number of 
component securities in the index, each have an average monthly trading 
volume of at least 2,000,000 shares over the previous six months;
    (iv) No underlying component security will represent more than 25% 
of the weight of the index, and the five highest weighted component 
securities in the index do not in the aggregate account for more than 
50% of the weight of the index (60% for an index consisting of fewer 
than 25 component securities);
    (v) 90% of the index's numerical value and at least 80% of the 
total number of component securities will meet the then current 
criteria for standardized option trading on a national securities 
exchange or a national securities association;
    (vi) Each component security shall be issued by a 1934 Act 
reporting company which is listed on Nasdaq or a national securities 
exchange and shall be an ``NMS'' stock as defined in SEC Rule 600 of 
Regulation NMS under the 1934 Act; and
    (vii) Foreign country securities or American Depository Receipts 
(``ADRs'') that are not subject to comprehensive surveillance 
agreements do not in the aggregate represent more than 20% of the 
weight of the index.
    (8) Index Methodology and Calculation--(i) Each index will be 
calculated based on either a capitalization, modified capitalization, 
price, equal-dollar or modified equal-dollar weighting methodology. 
(ii) Indexes based upon the equal-dollar or modified equal-dollar 
weighting method will be rebalanced at least quarterly. (iii) If the 
index is maintained by a broker-dealer, the broker-dealer shall erect a 
``firewall'' around the personnel who have access to information 
concerning changes and adjustments to the index and the index shall be 
calculated by a third party who is not a broker-dealer. (iv) The 
current value of an index will be widely disseminated at least every 15 
seconds, except as provided in the next clause (v). (v) The values of 
the following indexes need not be calculated and widely disseminated at 
least every 15 seconds if, after the close of trading, the indicative 
value of the index-linked security based on one or more of such indexes 
is calculated and disseminated to provide an updated value: CBOE S&P 
500 BuyWrite Index(sm), CBOE DJIA BuyWrite Index(sm), CBOE Nasdaq-100 
BuyWrite Index(sm). (vi) If the value of an index-linked security is 
based on more than one (1) index, then the composite value of such 
indexes must be widely disseminated at least every 15 seconds.
    (9) Surveillance Procedures. Nasdaq will implement written 
surveillance procedures for index-linked securities, including adequate 
comprehensive surveillance sharing agreements for non-U.S. securities, 
as applicable.
    (10) Index-linked securities will be treated as equity instruments. 
Furthermore, for the purpose of fee determination, index-linked 
securities shall be deemed and treated as Other Securities.
* * * * *

4450. Quantitative Maintenance Criteria

    (a) and (b) No change.
    (c) Other Securities Designated Pursuant to Rule 4420(f) and Index-
Linked Securities.
    (1) The aggregate market value or principal amount of publicly-held 
units must be at least $1 million.
    (2) Delisting or removal proceedings will be commenced (unless the 
Commission has approved the continued trading) with respect to any 
index-linked security that was listed pursuant to paragraph (7)(B) of 
Rule 4420(m) if any of the standards set forth in paragraph (7)(B) of 
such rule are not continuously maintained, except that:
    (i) the criteria that no single component represent more than 25% 
of the weight of the index and the five highest weighted components in 
the index may not represent more than 50% (or 60% for indexes with less 
than 25 components) of the weight of the Index, need only be satisfied 
for capitalization weighted and price weighted indexes as of the first 
day of January and July in each year;
    (ii) the total number of components in the index may not increase 
or decrease by more than 33\1/3\% from the number of components in the 
index at the time of its initial listing, and in no event may be less 
than ten (10) components;
    (iii) the trading volume of each component security in the index 
must be at least 500,000 shares for each of the last six months, except 
that for each of the lowest weighted components in the index that in 
the aggregate account for no more than 10% of the weight of the index, 
trading volume must be at least 400,000 shares for each of the last six 
months; and
    (iv) in a capitalization-weighted or modified capitalization-
weighted index, the lesser of the five highest weighted component 
securities in the index or the highest weighted component securities in 
the index that in the aggregate represent at least 30% of the total 
number of stocks in the index have had an average monthly trading 
volume of at least 1,000,000 shares over the previous six months.
    (3) With respect to an index-linked security that was listed 
pursuant to paragraph (7)(A) of Rule 4420(m), delisting or removal 
proceedings will be commenced (unless the Commission has approved the 
continued trading of the subject index-linked security) if an 
underlying index or indexes fails to satisfy the maintenance standards 
or conditions for such index or indexes as set forth by the Commission 
in its order under Section 19(b)(2) of the 1934 Act approving the index 
or indexes for the trading of options or other derivatives.
    (4) Delisting or removal proceedings will also be commenced with 
respect to any index-linked security listed pursuant to Rule 4420(m) 
(unless the Commission has approved the continued trading of the 
subject index-linked security), under any of the following 
circumstances:
    (i) if the aggregate market value or the principal amount of the 
securities publicly held is less than $400,000;
    (ii) if the value of the index or composite value of the indexes is 
no longer calculated or widely disseminated on at least a 15-second 
basis, provided, however, that the values of the following indexes need 
not be calculated and disseminated at least every 15 seconds if, after 
the close of trading, the indicative value of any index-linked security 
linked to one or more of such indexes is calculated and disseminated to 
provide an updated value: CBOE S&P 500 BuyWrite Index(sm), CBOE DJIA 
BuyWrite Index(sm), CBOE Nasdaq-100 BuyWrite Index(sm); or
    (iii) if such other event shall occur or condition exists which in 
the opinion of Nasdaq makes further dealings on Nasdaq inadvisable.
    (d) through (i) No change.
* * * * *

II. Self-Regulatory Organization's Statement 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 IV below. Nasdaq has prepared summaries, set forth in Sections A, 
B, and C below, of the most significant aspects of such statements.

[[Page 4182]]

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The proposed rule change will establish generic listing standards 
to permit the listing and trading of Index Securities pursuant to Rule 
19b-4(e) under the Act.\5\ Rule 19b-4(e) under the Act provides that 
the listing and trading of a new derivative securities product by a 
self-regulatory organization shall not be deemed a proposed rule 
change, pursuant to paragraph (c)(1) of Rule 19b-4 under the Act,\6\ if 
the Commission has approved, pursuant to Section 19(b) of the Act,\7\ 
the self-regulatory organization's trading rules, procedures and 
listing standards for the product class that would include the new 
derivatives securities product, and the self-regulatory organization 
has a surveillance program for the product class.\8\ Hence Nasdaq is 
proposing to adopt generic listing standards under new NASD Rules 
4420(m) and 4450(c) for this product class, pursuant to which it will 
be able to trade Index Securities without individual Commission 
approval of each product pursuant to Section 19(b)(2) of the Act.\9\ 
Instead, Nasdaq represents that any securities it lists will satisfy 
all of the standards set forth in NASD Rules 4420(m) and 4450(c). The 
Exchange states that within five (5) business days of the commencement 
of trading of an Index Security in reliance on NASD Rule 4420(m), 
Nasdaq will file Form 19b-4(e).\10\
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    \5\ 17 CFR 240.19b-4(e).
    \6\ 17 CFR 240.19b-4(c)(1).
    \7\ 15 U.S.C. 78s(b).
    \8\ See Securities Exchange Act Release No. 40761 (December 8, 
1998), 63 FR 70952 (December 22, 1998)(the ``19b-4(e) Order'').
    \9\ 15 U.S.C. 78s(b)(2).
    \10\ 17 CFR 240.19b-4(e)(2)(ii); 17 CFR 249.820.
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a. Generic Listing Standards

    The Commission previously approved the generic listing standards 
for Index Securities on the American Stock Exchange LLC (``Amex'').\11\ 
Nasdaq states that the proposed rule is substantially the same as the 
Amex Rule. The Commission has also previously approved the listing on 
Nasdaq of multiple Index Securities based on a variety of debt 
structures and market indexes.\12\
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    \11\ See Securities Exchange Act Release No. 51563 (April 15, 
2005), 70 FR 21257 (April 25, 2005)(the ``Amex Rule''); see also 
Securities Exchange Act Release No. 52204 (Aug. 3, 2005), 70 FR 
46559 (August 10, 2005) (PCX Exchange rules applicable to the 
Archipelago Exchange (``Area Exchange'').
    \12\ See, e.g., Securities Exchange Act Release Nos. 52725 
(November 3, 2005), 70 FR 68486 (November 10, 2005)(approving the 
listing and trading of 9% Targeted Income Strategic Total Return 
Securities Linked to the CBOE Nasdaq-100 BuyWrite Index); 50724 
(November 23, 2004), 69 FR 69655 (November 30, 2004)(approving the 
listing and trading of Accelerated Return Notes Linked to the 
Russell 2000 Index), 49670 (May 7, 2004), 69 FR 27959 (May 17, 
2004)(approving the listing and trading of Accelerated Return Notes 
Linked to the Nikkei 225 Index).
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    Adopting generic listing standards for these securities and 
applying Rule 19b-4(e) under the Act should fulfill the intended 
objective of that Rule by allowing those Index Securities that satisfy 
the proposed generic listing standards to commence trading, without the 
need for the public comment period and Commission approval. This has 
the potential to reduce the time frame for bringing Index Securities to 
market and thereby reducing the burdens on issuers and other market 
participants. The failure of a particular index to comply with the 
proposed generic listing standards under Rule 19b-4(e) under the Act, 
however, would not preclude a separate filing pursuant to Section 
19(b)(2) of the Act, requesting Commission approval to list and trade a 
particular index-linked product.

b. Index Securities

    Index Securities are designed for investors who desire to 
participate in a specific market segment or combination of market 
segments through an identifiable market index or combination of market 
indexes (the ``Underlying Index'' or ``Underlying Indexes'').\13\ Index 
Securities are the non-convertible debt of an issuer that have a term 
of at least one (1) year but not greater than ten years. Each Index 
Security is intended to provide investors with exposure to an 
identifiable underlying market index. Index Securities may or may not 
make interest payments, dividends or other cash distributions paid in 
the securities compromising the Underlying Index or Indexes to the 
holder during their term.\14\ Despite the fact that Index Securities 
are linked to an underlying index, each will trade as a single, 
exchange-listed security.
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    \13\ Nasdaq understands that the holder of an Index Security may 
or may not be fully exposed to the appreciation and/or depreciation 
of the underlying component securities. For example, an Index 
Security may be subject to a ``cap'' on the maximum principal amount 
to be repaid to holders or a ``floor'' on the minimum principal 
amount to be repaid to holders at maturity.
    \14\ Interest payments may be based on a fixed or floating rate.
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    The Exchange states that an Index Security cannot exist and 
therefore has no value without reference to the underlying index. In 
contrast to a typical corporate security (e.g., a share of common stock 
of a corporation), whose value is determined by the interplay of supply 
and demand in the marketplace, the fair value of an index-based 
security can be determined only by reference to the underlying index 
itself, which is a proprietary creation of the particular index 
provider. For this reason, the Commission has always required that 
markets that list or trade index-based securities continuously monitor 
the qualifications of not just the actual securities being traded 
(e.g., exchange-traded funds (``ETF''), index options, or Index 
Securities), but also of the underlying indexes and of the index 
providers.
    Because the value and function of an Index Security are inseparable 
from the Underlying Index or Underlying Indexes, such indexes and their 
providers must either meet the criteria set forth herein or be indexes 
previously approved by the Commission under Section 19(b)(2) of the Act 
and rules thereunder for the trading of options or other derivative 
securities on a national securities exchange or national securities 
association (and be subject to the conditions of such prior approvals). 
In all cases, an Underlying Index is required to have a minimum of ten 
(10) component securities. Certain specific criteria for each 
underlying component security are set forth below.
    A typical Index Security listed and traded on Nasdaq provides for a 
payment amount in a multiple greater than one (1) times the positive 
index return or performance, subject to a maximum gain or cap. Nasdaq 
represents that the proposed generic listing standards will not be 
applicable to Index Securities where the payment at maturity may be 
based on a multiple of negative performance of an underlying index or 
indexes.
    Some Index Securities do not provide for a minimum guaranteed 
amount to be repaid, i.e., no ``principal protection.'' Other Index 
Securities provide for participation in the positive return or 
performance of an index with the added protection of receiving a 
payment guarantee of the issuance price or ``principal protection.'' 
Further iterations may also provide ``contingent'' or partial 
protection of the principal amount, whereby the principal protection 
may disappear if the Underlying Index at any point in time during the 
life of such security reaches a certain pre-determined level. Nasdaq 
believes that the flexibility to list a variety of Index Securities 
will offer investors the opportunity to more

[[Page 4183]]

precisely focus their specific investment strategies.
    The original public offering price of Index Securities may vary 
with the most common offering price expected to be $10 or $1,000 per 
unit. As discussed above, Index Securities entitle the owner at 
maturity to receive a cash amount based upon the performance of a 
particular market index or combination of indexes. The structure of an 
Index Security may provide ``principal protection'' or provide that the 
principal amount is fully exposed to the performance of a market index. 
The Index Securities 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 
Underlying Index. Because an index-linked security has no value without 
reference to the Underlying Index, the current value of an Underlying 
Index or composite value of the Underlying Indexes will be widely 
disseminated at least every 15 seconds during the trading day.\15\
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    \15\ The values of CBOE S&P 500 BuyWrite Index(sm), CBOE DJIA 
BuyWrite Index(sm), and CBOE Nasdaq-100 BuyWrite Index(sm) do not 
need to be so disseminated if, after the close of trading, the 
indicative value of any index-linked security linked to these 
indexes is disseminated.
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    Index Securities may (but do not need to) be structured with 
accelerated returns, upside or downside, based on the performance of 
the Underlying Index.\16\ For example, an Index Security may provide 
for an accelerated return of 3-to-1 if the Underlying Index achieves a 
positive return at maturity. Index Securities are ``hybrid'' securities 
whose rates of return are largely the result of the performance of an 
Underlying Index or Indexes comprised of component securities. In 
connection with the listing and trading of Index Securities, Nasdaq 
will issue an information circular to members detailing the special 
risks and characteristics of the securities. Accordingly, the 
particular structure and corresponding risk of any Index Security 
traded on Nasdaq will be highlighted and disclosed.
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    \16\ See, e.g., Securities Exchange Act Release No. 48280 
(August 1, 2003), 68 FR 47121 (August 7, 2003). As stated, however, 
the proposed generic listing standards will not be applicable to 
Index Securities that are structured with ``downside'' accelerated 
returns.
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    The initial offering price for an Index Security is established on 
the date the security is priced for sale to the public. The final value 
of an Index Security is determined on the valuation date at or near 
maturity consistent with the mechanics detailed in the prospectus for 
such Index Security.

c. Eligibility Standards for Issuers

    The following standards are proposed for each issuer of Index 
Securities:
    (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 income criteria set forth 
in NASD Rule 4420(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.\17\
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    \17\ Telephone conversation between Alex Kogan, Associate 
General Counsel, Nasdaq, and Florence E. Harmon, Senior Special 
Counsel, Division, Commission, on January 11, 2006.
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    (B) Distribution--Minimum public distribution of 1,000,000 notes 
with a minimum of 400 public shareholders, except, if traded in 
thousand dollar denominations, then no minimum number of holders.
    (C) Principal Amount/Aggregate Market Value--Not less than $4 
million.
    (D) Term--The Index Security must have a term of at least one (1) 
year but not longer than ten (10) years.
    (E) Tangible Net Worth--The issuer will be expected to have a 
minimum tangible net worth\18\ in excess of $250,000,000 and to exceed 
by at least 20% the earnings requirements set forth in NASD Rule 
4420(a)(1). In the alternative, the issuer will be expected: (i) To 
have a minimum tangible net worth of $150,000,000 and to exceed by at 
least 20% the earnings requirement set forth in NASD Rule 4420(a)(1); 
and (ii) not to have issued securities where the original issue price 
of all the issuer's other index-linked note offerings (combined with 
index-linked note offerings of the issuer's affiliates) listed on a 
national securities exchange (or on Nasdaq) exceeds 25% of the issuer's 
net worth.
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    \18\ ``Tangible net worth'' is defined as total assets less 
intangible assets and total liabilities. Intangibles include non-
material benefits such as goodwill, patents, copyrights and 
trademarks.
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d. Description of Underlying Indexes

    Each Underlying Index will either be: (i) An index meeting the 
specific criteria set forth below: or (ii) an index approved by the 
Commission under Section 19(b)(2) of the Act and rules thereunder for 
the trading of options or other derivatives securities. However, in all 
cases, an Underlying Index must contain at least ten (10) component 
securities.
    Examples of Underlying Indexes intended to be covered under the 
proposed generic listing standards include the Standard & Poor's 500 
(``S&P 500''), the Nasdaq-100, the Dow Jones Industrial Average 
(``DJIA''), Nikkei 225, the Dow Jones EuroSTOXX 50, the Global Titans 
50, the Amex Biotechnology Index, the Russell 2000 Index, the CBOE S&P 
500 BuyWrite Index, the CBOE DJIA BuyWrite Index, the CBOE Nasdaq-100 
BuyWrite Index, and certain other indexes that represent various 
industry and/or market segments.\19\ An Index Security would lose its 
eligibility for continued Nasdaq listing if a change to the Underlying 
Index, including the deletion and addition of underlying component 
securities, index rebalancings and changes to the calculation of the 
index, resulted in this Underlying Index no longer satisfying the 
criteria for indexes that are either set forth below as part of the 
continued listing standards for Index Securities or contained in a 
Commission's Section 19(b)(2) order that approved the similar 
derivative product containing the Underlying Index.
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    \19\ See note 12 supra.
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    In order to satisfy the proposed generic listing standards, the 
Underlying Index will typically be calculated based on a market 
capitalization,\20\ modified market capitalization,\21\ price,\22\ 
equal-dollar,\23\ or modified equal-dollar \24\ weighting

[[Page 4184]]

methodology. If a broker-dealer is responsible for maintaining (or has 
a role in maintaining) the Underlying Index, such broker-dealer is 
required to erect and maintain a ``firewall,'' in a form satisfactory 
to Nasdaq, to prevent the flow of information regarding the Underlying 
Index from the index production personnel to the sales and trading 
personnel.\25\ In addition, an Underlying Index that is maintained by a 
broker-dealer is also required to be calculated by an independent third 
party that is not a broker-dealer.
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    \20\ A ``market capitalization'' index is the most common type 
of stock index. The components are weighted according to the total 
market value of the outstanding shares, i.e., share price times the 
number of shares outstanding. This type of index will fluctuate in 
line with the price moves of the component stocks.
    \21\ A ``modified market capitalization'' index is similar to 
the market capitalization index, except that an adjustment to the 
weights of one or more of the components occurs. This is typically 
done to avoid having an index that has one or a few stocks 
representing a disproportionate amount of the index value.
    \22\ A ``price weighted'' index is an index in which the 
component stocks are weighted by their share price. The most common 
example is the DJIA.
    \23\ An ``equal dollar weighted'' index is an index structured 
so that share quantities for each of the component stocks in the 
index are determined as if one were buying an equal dollar amount of 
each stock in the index. Equal dollar weighted indexes are usually 
rebalanced to equal weightings either quarterly, semiannually, or 
annually.
    \24\ A ``modified equal-dollar weighted'' index is designed to 
be a fair measurement of the particular industry or sector 
represented by the index, without assigning an excessive weight to 
one or more index components that have a large market capitalization 
relative to the other index components. In this type of index, each 
component is assigned a weight that takes into account the relative 
market capitalization of the securities comprising the index. The 
index is subsequently rebalanced to maintain these pre-established 
weighting levels. Like equal-dollar weighted indexes, the value of a 
modified equal-dollar weighted index will equal the current combined 
market value of the assigned number of shares of each of the 
underlying components divided by the appropriate index divisor. A 
modified equal-dollar weighted index will typically be re-balanced 
quarterly.
    \25\ For certain indexes, an index provider, such as Dow Jones, 
may select the components and calculate the index, but overseas 
broker-dealer affiliates of U.S. registered broker-dealers may sit 
on an ``advisory'' committee that recommends component selections to 
the index provider. In such case, appropriate information barriers 
and insider trading policies should exist for this advisory 
committee. See Securities Exchange Act Release No. 50501 (October 7, 
2004), 69 FR 61533 (October 19, 2004) (approving SR-NASD-2004-138, 
pertaining to index-linked notes on the Dow Jones Euro Stoxx 50 
Index).
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e. Eligibility Standards for Underlying Securities

    Index Securities will be subject to both initial and continued 
listing criteria. For an Underlying Index to be appropriate for the 
initial listing of an Index Security, such Index must either have been 
previously approved for the trading (on a national securities exchange 
or national securities association) of options or other derivative 
securities by the Commission under Section 19(b)(2) of the Act and 
rules thereunder, or meet the following requirements:
     A minimum market value of at least $75 million, except 
that for each of the lowest weighted Underlying Securities in the index 
that in the aggregate account for no more than 10% of the weight of the 
index, the market value can be at least $50 million;
     Trading volume in each of the last six months of not less 
than 1,000,000 shares, except that for each of the lowest weighted 
Underlying Securities in the index that in the aggregate account for no 
more than 10% of the weight of the index, the trading volume shall be 
at least 500,000 shares in each of the last six months;
     In the case of a capitalization-weighted index or modified 
capitalization weighted index, the lesser of the five highest weight 
Underlying Securities in the index or the highest weighted Underlying 
Securities in the index that in the aggregate represent at least 30% of 
the total number of Underlying Securities in the index, each have an 
average monthly trading volume of at least 2,000,000 shares over the 
previous six months;
     No component security will represent more than 25% of the 
weight of the index, and the five highest weighted component securities 
in the index will not in the aggregate account for more than 50% of the 
weight of the index (60% for an index consisting of fewer than 25 
Underlying Securities);
     90% of the index's numerical index value and at least 80% 
of the total number of component securities will meet the then current 
criteria for standardized options trading on a national securities 
exchange or a national securities association;
     Each component security shall be issued by an Act 
reporting company under the Act, shall be listed on Nasdaq or a 
national securities exchange and be subject to last sale reporting as a 
``NMS'' stock; and
     Foreign country securities or American Depository Receipts 
(``ADRs'') that are not subject to comprehensive surveillance 
agreements do not in the aggregate represent more than 20% of the 
weight of the index.
    As stated above, under Description of Underlying Indexes, all 
Underlying Indexes are required to have at least ten (10) component 
securities.
    For Index Securities listed under NASD Rule 4420(m)(7)(B),\26\ 
Nasdaq will commence delisting or removal proceedings (unless the 
Commission has approved the continued trading of the Index Security) if 
the applicable standard for Underlying Indexes under which the 
particular security's initial eligibility was determined is not being 
continuously met, except that:
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    \26\ The Commission expects Nasdaq to continuously monitor these 
continued listing criteria, unless the particular standard sets 
forth the particular dates on which such standard should be 
satisfied. Telephone conversation between Alex Kogan, Associate 
General Counsel, Nasdaq, and Florence E. Harmon, Senior Special 
Counsel, Division, Commission, on January 18, 2006.
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     The criteria that no single component represent more than 
25% of the weight of the index and the five highest weighted components 
in the index can not represent more than 50% (or 60% for indexes with 
less than 25 components) of the weight of the Index, need only be 
satisfied for capitalization weighted and price weighted indexes as of 
the first day of January and July in each year;
     The total number of components in the index may not 
increase or decrease by more than 33\1/3\% from the number of 
components in the index at the time of its initial listing, and in no 
event may be less than ten (10) components;
     The trading volume of each component security in the index 
must be at least 500,000 shares for each of the last six months, except 
that for each of the lowest weighted components in the index that in 
the aggregate account for no more than 10% of the weight of the index, 
trading volume must be at least 400,000 shares for each of the last six 
months; and
     In a capitalization-weighted index or modified 
capitalization weighted index, the lesser of the five highest weighted 
component securities in the index or the highest weighted component 
securities in the index that in the aggregate represent at least 30% of 
the total number of stocks in the index have had an average monthly 
trading volume of at least 1,000,000 shares over the previous six 
months.
    In the case of an Index Security that is listed pursuant to NASD 
Rule 4420(m)(7)(A) (previously approved index), Nasdaq will commence 
delisting or removal proceedings (unless the Commission has approved 
the continued trading of the Index Security) if an underlying index or 
indexes fails to satisfy the maintenance standards or conditions for 
such index or indexes as set forth by the Commission in its order under 
Section 19(b)(2) of the Act approving the index or indexes for the 
trading of options or other derivatives.
    Finally, as set forth in proposed rule, Nasdaq will commence 
delisting or removal proceedings with respect to an Index Security 
(unless the Commission has approved the continued trading of the Index 
Security), under any of the following circumstances:
     If the aggregate market value or the principal amount of 
the securities publicly held is less than $400,000;
     With a minor exception referenced below, if the value of 
the Underlying Index or composite value of the Underlying Indexes is no 
longer calculated and widely disseminated on at least a 15-second basis 
(because an index-linked security has no value without reference to the 
underlying index); or
     If such other event shall occur or condition exists which 
is the opinion of the Nasdaq makes further dealings on Nasdaq 
inadvisable.
    The requirement that the value of the index be calculated and 
widely disseminated every 15 seconds does not apply to the following 
indexes: the CBOE S&P 500 BuyWrite Index, the CBOE DJIA BuyWrite Index, 
and the CBOE Nasdaq-100 BuyWrite Index.\27\

[[Page 4185]]

The Commission has previously approved for listing and trading several 
Index Securities linked to these three indexes,\28\ and the exception 
for the first two of them is already incorporated in the Amex Rule. The 
Commission did not require dissemination of the BuyWrite index values 
every 15 seconds during trading hours because the value of these 
indexes is readily approximated from observable market prices from the 
current price of the relevant securities indexes and the nearest-to-
expiration call and put options on these securities indexes.\29\ 
Consistent with the Amex Rule, indicative values of Index Securities 
based on one of these three indexes must be calculated and disseminated 
after the close of trading to provide an updated value.
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    \27\ A ``buy-write'' is a conservative options strategy in which 
an investor buys a stock or portfolio and writes call options on the 
stock or portfolio. This strategy is also known as a ``covered 
call'' strategy. A buy-write strategy provides option premium income 
to cushion decreases in the value of an equity portfolio, but will 
under perform stocks in a rising market.
    \28\ See, e.g., Securities Exchange Act Release Nos. 52756 
(November 9, 2005), 70 FR 70006 (November 18, 2005) (approving the 
listing and trading of Index Securities linked to the CBOE Nasdaq-
100 Buy Write Index); 52725 (November 3, 2005), 70 FR 68486 
(November 10, 2005) (approving the listing and trading of Index 
Securities linked to the CBOE Nasdaq-100 BuyWrite Index); 51840 
(June 14, 2005), 70 FR 35468 (June 20, 2005) (approving the listing 
and trading of Index Securities linked to the CBOE DJIA BuyWrite 
Index); and 51634 (April 29, 2005), 70 FR 24138 (May 6, 2005) 
(approving the listing and trading of Index Securities linked to the 
CBOE S&P 500 BuyWrite Index).
    \29\ Telephone conversation between Alex Kogan, Associate 
General Counsel, Nasdaq, and Florence E. Harmon, Senior Special 
Counsel, Commission, Division on January 11, 2006.
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    The issuers of the Index Securities listed on Nasdaq will be 
required to comply with Rule 10A-3 under the Act, but not the Index 
Securities themselves.\30\
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    \30\ See Rule 10A-3(c)(7) under the Act, 17 CFR 240.10A-3(c)(7)
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f. Nasdaq Rules Applicable to Index Securities

    Index Securities will be treated as equity instruments and will be 
subject to all Nasdaq rules governing the trading of equity securities, 
including trading halt rules. Index Securities will be subject to the 
same fee schedule as Other Securities listed under Rule 4420(f). The 
applicable fee schedule is currently codified as Rule 4530.

g. Information Circular

    In addition, Nasdaq will evaluate the nature and complexity of each 
Index Security and, if appropriate, distribute a circular to the 
membership, prior to the commencement of trading, providing guidance 
with respect to, among other things, member firm compliance 
responsibilities when handling transactions in Index Securities and 
highlighting the special risks and characteristics. Specifically, the 
circular, among other things, will discuss and emphasize the structure 
and operation of the Index Security, the requirement under the 
Securities Act of 1933 (``1933 Act'') \31\ that members and member 
firms deliver a prospectus to investors purchasing an Index Security in 
the initial distribution prior to or concurrently with the confirmation 
of a transaction, applicable Nasdaq rules, dissemination information 
regarding the Underlying Index, trading information and applicable 
suitability rules.\32\
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    \31\ 15 U.S.C. 77e(b)(2).
    \32\ Members conducting a public securities business are subject 
to the rules and regulations of the NASD, including NASD Rule 
2310(a) and (b). Accordingly, NASD Notice to Members 03-71 regarding 
nonconventional investments or ``NCIs'' applies to members 
recommending/selling index-linked securities to public customers. 
This Notice specifically reminds members in connection with NCIs 
(such as index-lined securities) of their obligations to: (1) 
Conduct adequate due diligence to understand the features of the 
product; (2) perform a reasonable-basis suitability analysis; (3) 
perform customer-specific suitability analysis in connection with 
any recommended transactions; (4) provide a balanced disclosure of 
both the risks and rewards associated with the particular product, 
especially when selling to retail investors; (5) implement 
appropriate internal controls; and (6) train registered persons 
regarding the features, risk and suitability of the products.
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h. Surveillance

    The NASD will monitor activity in Index Securities to identify and 
discipline any improper trading activity in Index Securities.\33\ For 
this purpose, the NASD will rely on its existing surveillance 
procedures applicable to equities, including derivative products. The 
NASD will maintain such procedures in writing. The NASD will also be 
developing, for future implementation, procedures for monitoring 
activity in the Index Security and in related Underlying Indexes and 
their underlying securities, which will enhance the NASD's ability to 
identify improper trading activity. Overall, while the NASD's existing 
surveillance procedures are adequate to properly monitor the trading of 
Index Securities, the NASD is expecting to begin phasing in significant 
enhancements to such procedures in 2006.
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    \33\ The Nasdaq Market Watch Department also performs certain 
day-to-day surveillance activities that will be applicable to the 
trading of the Index Securities. Telephone conversation between Alex 
Kogan, Associate General Counsel, Nasdaq, and Florence E. Harmon, 
Senior Special Counsel, Commission, division on January 18, 2006.
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    Nasdaq has a general policy prohibiting the distribution of 
material, non-public information by its employees. As detailed above in 
the description of the generic standards, if the issuer or a broker-
dealer is responsible for maintaining (or has a role in maintaining) 
the Underlying Index, such issuer or broker-dealer is required to erect 
and maintain a ``firewall'' in a form satisfactory to Nasdaq, in order 
to prevent the flow of information regarding the Underlying Index from 
the index production personnel to sales and trading personnel. In 
addition, Nasdaq will require that calculation of Underlying Indexes be 
performed by an independent third party that is not a broker-dealer.
2. Statutory Basis
    Nasdaq believes that the proposed rule change, as amended, is 
consistent with the provisions of Section 15A of the Act,\34\ in 
general, and with Section 15A(b)(6) of the Act,\35\ in particular, in 
that it is designed to prevent fraudulent and manipulative acts and 
practices, to promote just and equitable principles of trade, remove 
impediments to a free and open market and a national market system, 
and, in general, to protect investors and the public interest.
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    \34\ 15 U.S.C. 78o-3.
    \35\ 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, as amended, 
will result in any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Act, as amended.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    Written comments on the proposed rule change, as amended, were 
neither solicited nor received.

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. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml.
); or     Send an e-mail to rule-comments@sec.gov. Please include 

File Number SR-NASD-2006-001 on the subject line.

[[Page 4186]]

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-9303.

    All submissions should refer to File Number SR-NASD-2006-001. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml
). 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 Section. Copies of the 
filing also will be available for inspection and copying at the 
principal office of the NASD. All comments received will be posted 
without change; the Commission does not edit personal identifying 
information from submissions. You should submit only information that 
you wish to make available publicly. All submissions should refer to 
File Number SR-NASD-2006-001 and should be submitted on or before 
February 15, 2006.

IV. Commission's Findings

    After careful consideration, the Commission finds that the proposed 
rule change, as amended, is consistent with the requirements of the Act 
and the rules and regulations thereunder applicable to a national 
securities association.\36\ In particular, the Commission believes that 
the proposed rule change is consistent with Section 15A(b)(6) of the 
Act \37\ in that it is designed to prevent fraudulent and manipulative 
acts and practices, to promote just and equitable principles of trade, 
to foster cooperation and coordination with persons engaged in 
facilitating transactions in securities, and to remove impediments to 
and perfect the mechanism of a free and open market and a national 
market system and, in general, to protect investors and the public 
interest.
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    \36\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \37\ 15 U.S.C. 78o-3(b)(6).
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    The Commission has previously approved the listing and trading of 
several Index Securities based on a variety of debt structures and 
market indexes.\38\ The Commission has also approved, pursuant to Rule 
19b-4(e) under the Act,\39\ generic listing standards for these 
securities proposed by the Amex that, in all material respects, are 
identical to those listing standards proposed by Nasdaq.
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    \38\ See Securities Exchange Act Release Nos. 41091 (February 
23, 1999), 64 FR 10515 (March 4, 1999) (Narrow-Based Index Options); 
42787 (May 15, 2000), 65 FR 33598 (May 24, 2000) (ETFs); and 43396 
(September 29, 2000), 65 FR 60230 (October 10, 2000) (TIRs).
    \39\ 17 CFR 240.19b-4(e).
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    Consistent with its previous orders, the Commission believes that 
generic listing standards proposed by Nasdaq for Index Securities 
should fulfill the intended objective of Rule 19b-4(e) under the Act by 
allowing those Index Securities that satisfy the generic listing 
standards to commence trading without public comment and Commission 
approval.\40\ This has the potential to reduce the time frame for 
bringing Index Securities to market and thereby reduce the burdens on 
issuers and other market participants and thus enhances investors' 
opportunities.
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    \40\ The Commission notes that the failure of a particular index 
to comply with the proposed generic listing standards under Rule 
19b-4(e) under the Act, however, would not preclude Nasdaq from 
submitting a separate filing pursuant to Section 19(b)(2) of the 
Act, requesting Commission approval to list and trade a particular 
index-linked product.
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A. Trading of Index Securities

    Taken together, the Commission finds that Nasdaq's proposal 
contains adequate rules and procedures to govern the trading of Index 
Securities listed pursuant to Rule 19b-4(e) on Nasdaq. All Index 
Security products listed under the standards will be subject to the 
full panoply of Nasdaq rules and procedures that now govern the trading 
of Index Securities and the trading of equity securities on Nasdaq.
    Nasdaq has proposed asset/equity requirements and tangible net 
worth for each Index Security issuer, as well as minimum distribution, 
principal/market value, and term thresholds for each issuance of Index 
Securities. As set forth more fully above, Nasdaq's proposed listing 
criteria include minimum market capitalization, monthly trading volume, 
and relative weighting requirements for the Index Securities. These 
requirements are designed to ensure that the trading markets for index 
components underlying Index Securities are adequately capitalized and 
sufficiently liquid, and that no one stock dominates the index. The 
Commission believes that these requirements should significantly 
minimize the potential for of manipulation. The Commission also finds 
that the requirement that each component security underlying an Index 
Security be listed on a national securities exchange or traded through 
the facilities of a national securities system and subject to last sale 
reporting will contribute significantly to the transparency of the 
market for Index Securities. Alternatively, if the index component 
securities are foreign securities that are not reporting companies, the 
generic listing standards permit listing of an Index Security if the 
Commission previously approved the underlying index for trading in 
connection with another derivative product and if certain surveillance 
sharing arrangements exist with foreign markets. The Commission 
believes that if it has previously determined that such index and its 
components were sufficiently transparent, then Nasdaq may rely on this 
finding, provided it has comparable surveillance sharing arrangements 
with the foreign market that the Commission relied on in approving the 
previous product.
    The Commission believes that by requiring pricing information for 
both the relevant underlying index or indexes and the Index Security to 
be readily available and disseminated, the proposed listing standards 
should help ensure a fair and orderly market for Index Securities 
approved pursuant to such proposed listing standards.
    The Commission also believes that the requirement that at least 90 
percent of the component securities, by weight, and 80 percent of the 
total number of Underlying Securities, be eligible individually for 
options trading will prevent an Index Security from being a vehicle for 
trading options on a security not otherwise options eligible.
    Nasdaq has also developed delisting criteria that will permit 
Nasdaq to suspend trading of an Index Security in case of circumstances 
that make further dealings in the product inadvisable. The Commission 
believes that the delisting criteria will help ensure a minimum level 
of liquidity exists for each Index Security to allow for the 
maintenance of fair and orderly markets. Also, Nasdaq will commence 
delisting proceedings in the event that the value of the underlying 
index or index is no longer calculated and widely disseminated on at 
least a 15-second basis.\41\
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    \41\ In the case of the BuyWrite Index Securities, CBOE 
disseminates a daily index value. Additionally, a daily indicative 
value for the product is also disseminated.

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[[Page 4187]]

B. Surveillance

    Nasdaq must have surveillance procedures to monitor trading in any 
products listed under the generic listing standards. An Index Security, 
just like an ETF, derives its value by reference to the underlying 
index. For this reason, the Commission has required that markets that 
list index based securities monitor the qualifications of not just the 
actual security (e.g., the ETF, index option, or Index Securities), but 
also of the underlying indexes (and of the index providers). In this 
regard, the Commission believes that a surveillance sharing agreement 
between a self-regulatory organization proposing to list a stock index 
derivative product and the self-regulatory organization trading the 
stocks underlying the derivative product is an important measure for 
surveillance of the derivative and underlying securities markets. When 
a new derivative securities product based upon domestic securities is 
listed and traded on an exchange or national securities association 
pursuant to Rule 19b-4(e) under the Act, the self-regulatory 
organization should determine that the markets upon which all of the 
U.S. component securities trade are members of the Intermarket 
Surveillance Group (``ISG''), which provides information relevant to 
the surveillance of the trading of securities on other market 
centers.\42\ For derivative securities products based on previously 
approved indexes that contain securities from one or more foreign 
markets, the self-regulatory organization should have a comprehensive 
Intermarket Surveillance Agreement, as prescribed in the prior 
Commission order, which covers the securities underlying the new 
securities product.\43\ With respect to indexes not previously approved 
by the Commission, the Commission finds that Nasdaq's commitment to 
implement comprehensive surveillance sharing agreements,\44\ as 
necessary, and the definitive requirements that: (i) Each component 
security shall be a registered reporting company under the Act; and 
(ii) no more than 20 percent of the weight of the Underlying Index or 
Underlying Indexes may be comprised of foreign country securities or 
ADRs not subject to a comprehensive surveillance sharing agreement,\45\ 
will make possible adequate surveillance of trading of Index Securities 
listed pursuant to the proposed generic listing standards.
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    \42\ See Securities Exchange Act Release No. 40761 (December 8, 
1998), 63 FR 70952 (December 22, 1998) (File No. S7-13-98). ISG was 
formed on July 14, 1983, to, among other things, coordinate more 
effectively surveillance and investigative information sharing 
arrangements in the stock and options markets. The Commission notes 
that all of the registered national securities exchanges, including 
the ISE, as well as the NASD, are members of the ISG.
    \43\ Id.
    \44\ Proposed NASD Rule 4420(m)(9).
    \45\ Proposed NASD Rules 4420(m)(7)(vi)-(vii).
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    With regard to actual oversight, Nasdaq represents that its 
surveillance procedures are sufficient to detect fraudulent trading 
among members in the trading of Index Securities pursuant to the 
proposed generic listing standards.

C. Acceleration

    The Commission finds good cause for approving proposed rule change, 
as amended, prior to the 30th day after the date of publication of 
notice of filing thereof in the Federal Register. The proposal 
implements generic listing standards substantially identical to those 
already approved for the Amex. The Commission does not believe that 
Nasdaq's proposal raises any novel regulatory issues. The proposed 
generic listing criteria should enable more expeditious review and 
listing of Index Securities by Nasdaq, thereby reducing administrative 
burdens and benefiting the investing public. Thus, the Commission finds 
good cause to accelerate approval of the proposed rule change, as 
amended.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\46\ that the proposed rule change, as amended (SR-NASD-2006-001), 
is hereby approved on an accelerated basis.
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    \46\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\47\
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    \47\ 17 CFR 200.30-3(a)(12).
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Nancy M. Morris,
Secretary.
[FR Doc. E6-864 Filed 1-24-06; 8:45 am]

BILLING CODE 8010-01-P