[Federal Register: November 21, 2002 (Volume 67, Number 225)]
[Notices]
[Page 70276-70285]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr21no02-145]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-46834; File No. SR-CHX-2002-27]
Self-Regulatory Organizations; Notice of Filing and Order
Granting Accelerated Approval of Proposed Rule Change and Amendment No.
1 Thereto by the Chicago Stock Exchange, Incorporated Relating to the
Listing and Trading of Fixed Income ETFs
November 14, 2002.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Exchange Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby
given that on September 26, 2002, the Chicago Stock Exchange,
Incorporated (``CHX'' or ``Exchange'') 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 Exchange. On November 12, 2002, CHX submitted 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 grant accelerated approval to the proposed
rule change, as amended.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See letter Ellen J. Neely, Senior Vice President and General
Counsel, CHX, to Nancy J. Sanow, Division of Market Regulation
(``Division''), Commission, dated November 8, 2002 (``Amendment No.
1''). In Amendment No. 1, the Exchange added a representation
relating to its surveillance procedures and explained why its rule
prohibiting certain relationships between specialists and the issuer
of a security did not apply to this rule filing.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The Exchange proposes to amend CHX Article XXVIII, Rule 24, to
permit the listing and trading of fixed income Exchange Traded Funds
(``ETFs''), which are based on indices of fixed income securities.
Additionally, the Exchange seeks approval to trade, pursuant to
unlisted trading privileges, the following series of the iShares Trust:
iShares 1-3 Year Treasury Index Fund, iShares 7-10 Year Treasury Index
Fund, iShares 20+ Year Treasury Index Fund, iShares Treasury Index
Fund, iShares Government/Credit Index Fund, iShares Lehman Corporate
Bond Fund and iShares Goldman Sachs Corporate Bond Fund. The text of
the proposed rule change is below; new text is italicized.
* * * * *
Chicago Stock Exchange Rules
Article XXVIII
* * * * *
Investment Company Units
RULE 24. The Exchange will consider for trading, whether by listing
or pursuant to unlisted trading privileges, units of trading
(``Units'') that meet the criteria of this Rule. A Unit is a security
that represents an interest in a registered investment company
(``Investment Company'') that could be organized as a unit investment
trust, an open-end management investment company, or a similar entity.
(A) Original Unit Listing Standards
(1) The Investment Company must:
(a) Hold securities (including fixed income securities) comprising,
or otherwise based on or representing an interest in, an index or
portfolio of securities; or
(b) hold securities in another registered investment company that
holds securities as described in (a) above.
An index or portfolio may be revised as necessary or appropriate to
maintain the quality and character of the index or portfolio.
(2) The Investment Company must issue Units in a specified
aggregate
[[Page 70277]]
number in return for a deposit (the ``Deposit'') consisting of either:
(a) A specified number of shares of securities (or, if applicable,
a specified portfolio of fixed income securities) that comprise the
index or portfolio, or are otherwise based on or represent an
investment in securities comprising such index or portfolio, and/or a
cash amount; or
(b) shares of a registered investment company, as described in
clause (A)(1)(a) above, and/or a cash amount.
(3) Units must be redeemable, directly or indirectly, from the
Investment Company for securities (including fixed income securities)
and/or cash then comprising the Deposit. Units must pay holders
periodic cash payments corresponding to the regular cash dividends or
distributions declared with respect to the securities held by the
Investment Company, less applicable expenses and charges.
* * * * *
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 CHX included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received regarding the proposed rule change.
The text of these statements may be examined at the places specified in
Item IV below. The CHX has prepared summaries, set forth in Sections A,
B and C below, of the most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
The Exchange proposes to amend CHX Article XXVIII, Rule 24 to
permit the Exchange to list and trade fixed income ETFs, which are
based on indices of fixed income securities.
CHX Article XXVIII, Rule 24 provides standards for listing
Investment Company Units, which are defined as securities representing
``an interest in a registered investment company that could be
organized as a unit investment trust, open-end management investment
company or similar entity.'' In addition to being registered under the
Investment Company Act of 1940 (the ``1940 Act''), these securities are
registered under the Exchange Act. The Exchange is proposing to amend
this definition to permit the listing and trading of index-based fixed
income investment products that are based on an index of fixed income
securities. Examples of such products include U.S. government
securities and corporate and non-corporate (other than U.S. government)
debt securities. As amended, CHX Article XXVIII, Rule 24 would
accommodate the listing and trading of Units based on an index of U.S.
government debt securities (e.g., securities issued or guaranteed by
the U.S. Treasury, an agency or instrumentality of the U.S. government,
or by a government-sponsored entity). Other products that could be
listed or traded under this rule, as amended, could include Units based
on an index of corporate and/or non-corporate debt securities.\4\ The
Commission has recently approved the requests of both the American
Stock Exchange LLC (``Amex'') and the New York Stock Exchange
(``NYSE'') to list and trade fixed income ETFs.\5\ The Exchange
believes that its proposed rule changes are substantially similar to
those of the Amex and NYSE.
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\4\ Investment Company Units based on a fixed income securities
index are not eligible for listing or trading under the Exchange's
generic listing criteria (CHX Article XXVIII, Rule 24,
Interpretation and Policy .04). The Exchange understands that it
must make separate rule filings for any additional series of such
Investment Company Units based on fixed income indices prior to
listing or trading those products, even if the Exchange is only
trading the product on a UTP basis.
\5\ See Securities Exchange Act Release No. 46252 (July 24,
2002), 67 FR 49715 (July 31, 2002) (SR-Amex-2001-35); and Securities
Exchange Act Release No. 46299 (August 1, 2002), 67 FR 51907 (August
9, 2002) (SR-NYSE-2002-26).
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Accordingly, the Exchange proposes to amend CHX Article XXVIII,
Rule 24 to specify that Investment Company Units may be: (1) Based on a
portfolio of fixed income securities; (2) issued in return for a
deposit of a specified portfolio of fixed income securities and/or
cash; and (3) redeemed at a holder's request by the investment company,
which will pay the redeeming holder fixed income securities and/or
cash.
Upon approval of the proposed amendments to CHX Article XXVIII,
Rule 24, the Exchange proposes to trade on a UTP basis the following
seven series of the iShares Trust, a registered open-end management
investment company (the ``Trust''): iShares 1-3 Year Treasury Index
Fund, iShares 7-10 Year Treasury Index Fund, iShares 20+ Year Treasury
Index Fund, iShares Treasury Index Fund; iShares Government/Credit
Index Fund, iShares Lehman Corporate Bond Fund, and iShares Goldman
Sachs Corporate Bond Fund (each, a ``Fund,'' and jointly, the
``Funds'').
Each Fund will hold certain fixed income securities selected to
correspond generally to the price and yield performance of a specified
U.S. Treasury, Government/Credit, or Corporate Bond Index (each, an
``Underlying Index'') maintained either by Lehman Brothers, or, for the
Goldman Sachs Corporate Bond Fund, by Goldman Sachs & Co.
Barclays Global Fund Advisors (``Advisor'') is the investment
advisor for each Fund. The Advisor is registered under the Investment
Advisers Act of 1940. The Advisor is a wholly owned subsidiary of
Barclays Global Investors, N.A., which is in turn a wholly owned
indirect subsidiary of Barclays Bank PLC of the United Kingdom. SEI
Investments Distribution Co. (``Distributor''), a Pennsylvania
corporation and broker-dealer registered under the Exchange Act, is the
principal underwriter and distributor of Creation Unit Aggregations (as
defined below) of iShares. The Distributor is not affiliated with the
Exchange or the Advisor.
A. Operation of the Funds
Each Fund is designed to provide investment results that correspond
generally to the price and yield performance of its Underlying Index.
In seeking to achieve its respective investment objective, each Fund
will utilize ``passive'' indexing investment strategies. Each Fund may
fully replicate its Underlying Index, but currently intends to use a
``representative sampling'' strategy to track its Underlying Index. A
Fund utilizing a representative sampling strategy generally will hold a
basket of the component securities (``Component Securities'') of its
Underlying Index, but it may not hold all of the Component Securities
of its Underlying Index (as compared to a Fund that uses a replication
strategy which invests in substantially all of the Component Securities
in its Underlying Index in the same approximate proportions as in the
Underlying Index).\6\
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\6\ The Commission approved an ``Application'' by the Trust, the
Advisor and the Distributor (``Applicants'') for an Order under
Sections 6(c) and 17(b) of the 1940 Act for the purpose of exempting
the Funds from various provisions of the 1940 Act. See Investment
Company Act Release No. 25622 (June 24, 2002) (approving File No.
812-12390). The information provided in this Rule 19b-4 filing
relating to the Funds is based on information included in the
Application and order, as well as in the rule change proposals
submitted by the NYSE and Amex.
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When using a representative sampling strategy, the Advisor attempts
to match the risk and return characteristics of a Fund's portfolio to
the risk and return characteristics of the Underlying Index. As part of
this process, the Advisor subdivides each Underlying Index into
[[Page 70278]]
smaller, more homogenous pieces. These subdivisions are sometimes
referred to as ``cells.'' A cell will contain securities with similar
characteristics. For fixed income indices, the Advisor generally
divides the index according to the five parameters that determine a
bond's risk and expected return: duration, sector, credit rating,
coupon and the presence of embedded options. When completed, all bonds
in the index will have been assigned a cell. The Advisor then begins to
construct the portfolio by selecting representative bonds from these
cells. The representative sample of bonds chosen from each cell is
designed closely to correlate to the duration, sector, credit rating,
coupon and embedded option characteristics of each cell. The
characteristics of each cell when combined are, in turn, designed to
closely correlate to the duration, sector, credit rating, coupon and
embedded option characteristics of the Underlying Index as a whole. The
Advisor may exclude less liquid bonds in order to create a more
tradable portfolio and improve arbitrage opportunities.\7\
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\7\ As stated in the Application, the Goldman Sachs Index
excludes bonds with embedded options. Although the Lehman Indices
may include bonds with embedded options, the bonds in each Lehman
Index (and the respective Deposit Securities and Fund Securities, as
defined herein) should be liquid and easily tradable because each
Lehman Index consists of U.S. Treasury and agency securities and/or
liquid corporate and non-corporate bonds. To the extend a particular
bond is less liquid than another bond with similar characteristics,
the Advisor's representative sampling techniques should permit the
Advisor to replace the less liquid bond with a more liquid one. For
these reasons, the Applicants do not believe the presence of bonds
with embedded options in an Underlying Index, the Deposit Securities
or Fund Securities would have any material impact on the creation/
redemption process and the efficiency of the arbitrage mechanism for
each Fund.
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According to the Application, the representative sampling
techniques used by the Advisor to manage fixed income funds do not
materially differ from the representative sampling techniques it uses
to manage equity funds. Due to the differences between bonds and
equities, the Advisor analyzes different information, e.g., coupon
rates instead of dividend payments.
According to the Application, the Funds' use of the representative
sampling strategy is beneficial for a number of reasons. First, the
Advisor can avoid bonds that are ``expensive names'' (i.e., bonds that
trade at perceived higher prices or lower yields because they are in
short supply) but have the same essential risk, value, duration and
other characteristics as less expensive names. Second, the use of
representative sampling techniques permits the Advisor to exclude bonds
that it believes will soon be deleted from the Underlying Index. Third,
the Advisor can avoid holding bonds it deems less liquid than other
bonds with similar characteristics. Fourth, the Advisor can develop a
basket that is easier to construct and cheaper to trade, thereby
potentially improving arbitrage opportunities.
From time to time, adjustments may be made in the portfolio of each
Fund in accordance with changes in the composition of the Underlying
Index or to maintain compliance with requirements applicable to a
regulated investment company (``RIC'') under the Internal Revenue Code.
For example, if at the end of a calendar quarter a Fund would not
comply with the RIC diversification tests, the Advisor would make
adjustments to the portfolio to ensure continued RIC status. It should
be noted, however, that Applicants do not anticipate that the Funds
would need to make such adjustments, particularly since these Funds
(other than the iShares Lehman Corporate Bond Fund and the iShares
Goldman Sachs Corporate Bond Fund) invest a very large percentage of
their assets in U.S. Treasury securities.
The Applicants noted in the Application that they expect that each
Fund will have a tracking error relative to the performance of its
respective Underlying Index of no more than five percent (5%). Each
Fund's investment objectives, policies and investment strategies will
be fully disclosed in its prospectus (``Prospectus'') and statement of
additional information (``SAI''). At least 90% of each of the iShares
1-3 Year Treasury Index Fund, iShares 7-10 Year Treasury Index Fund,
iShares 20+ Year Treasury Index Fund, iShares Treasury Index Fund, and
iShares Government/Credit Index Fund's assets will be invested in
Component Securities of its respective Underlying Index. Each of these
Funds may also invest up to 10% of its assets in bonds not included in
its Underlying Index, but which the Advisor believes will help the Fund
track its Underlying Index, as well as in certain futures, options and
swap contracts, cash and cash equivalents. For example, these Funds may
invest in securities not included in the relevant Underlying Index in
order to reflect prospective changes in the relevant Underlying Index
(such as future corporate actions and index reconstitutions, additions
and deletions). Each of the iShares Lehman Corporate Bond Fund and the
iShares Goldman Sachs Corporate Bond Fund may at times invest up to 20%
of its assets in certain futures, options and swap contracts, cash and
cash equivalents as well as in bonds not included in its Underlying
Index, but which the Advisor believes will help the Fund track its
Underlying Index and which are either (i) included in the broader index
upon which such Underlying Index is based (i.e., the Lehman Credit
Index for the Lehman Credit VLI Index or the Goldman Sachs Investment
Grade Index for the Goldman Sachs InvesTop Index): or (ii) new issues
entering or about to enter the Underlying Index or the broader index
upon which such Underlying Index is based.
B. Issuance of Creation Unit Aggregations
1. In General. Shares of each Fund (the ``iShares'') will be issued
on a continuous offering basis in groups of 50,000 or more. These
``groups'' of shares are called ``Creation Unit Aggregations.'' The
Funds will issue and redeem iShares only in Creation Unit
Aggregations.\8\ As with other open-end investment companies, iShares
will be issued at the net asset value (``NAV'') per share next
determined after an order in proper form is received. The anticipated
price at which the iShares will initially trade is approximately $100.
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\8\ Each Creation Unit Aggregation will consist of 50,000 or
more iShares and the estimated initial value per Creation Unit
Aggregation will be approximately $5 million.
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The NAV per share of each Fund is determined as the close of the
regular trading session on the Exchange on each day that the Exchange
is open. The Trust sells Creation Unit Aggregations of each Fund only
on business days at the next determined NAV of each Fund. Creation Unit
Aggregations will be issued by Each Fund in exchange for the in-kind
deposit of portfolio securities designated by the Advisor to correspond
generally to the price and yield performance of the Fund's Underlying
Index (the ``Deposit Securities''). Purchasers will generally be
required to deposit a specified cash payment in the manner more fully
described in the Application. Creation Unit Aggregations will be
redeemed by each fund in exchange for portfolio securities of the Fund
(``Fund Securities'') and a specified cash payment in the manner more
fully described herein. Fund Securities received on redemption may not
be identical to Deposit Securities deposited in connection with
creations of Creation Unit Aggregations for the same day. The
Distributor will act on an agency basis and will be the Trust's
principal underwriter for the iShares in
[[Page 70279]]
Creation Unit Aggregations of each Fund. All orders to purchase iShares
in Creation Unit Aggregations must be placed with the Distributor by or
through an authorized participant (``Authorized Participant'').
Authorized Participants, which are required to be Depository Trust
Company (``DTC'') participants, must enter into a participant agreement
with the Distributor. The Distributor will transmit such orders to the
applicable Fund and furnish to those placing orders confirmation that
the orders have been accepted. The Distributor may reject any order
that is not submitted improper form. The Distributor will be
responsible for delivering the prospectus to those persons creating
iShares in Creation Unit Aggregations and for maintaining records of
both the orders placed with it and the confirmations of acceptance
furnished by it. In addition, the Distributor will maintain a record of
the instructions given to the Trust to implement the delivery of
iShares.
2. In-Kind Deposit of Portfolio Securities. Payment for Creation
Unit Aggregations placed through the Distributor will be made by the
purchasers generally by an in-kind deposit with the Fund of the Deposit
Securities together with an amount of cash (the ``Balancing Amount'')
specified by the Advisor in the manner described below. The Balancing
Amount is an amount equal to the differences between (1) the NAV (per
Creation Unit Aggregation) of the Fund and (2) the total aggregate
market value (per Creation Unit Aggregation) of the Deposit Securities
(such value referred to herein as the ``Deposit Amount''). The
Balancing Amount serves the function of compensating for differences,
if any, between the NAV per Creation Unit Aggregation and that of the
Deposit Amount. The deposit of the requisite Deposit Securities and the
Balancing Amount are collectively referred to herein as a ``Portfolio
Deposit.'' The Advisor will make available to the market through the
National Securities Clearing Corporation (the ``NSCC'') on each
Business Day, prior to the opening of trading on the Exchange
(currently 9:30 a.m. Eastern Time), the list of the names and the
required number of shares of each Deposit Security included in the
current Portfolio Deposit (based on the information at the end of the
previous Business Day) for the relevant Fund. The Portfolio Deposit
will be applicable to a Fund (subject to any adjustments to the
Balancing Amount, as described below) in order to effect purchases of
Creation Unit Aggregations of the Fund until such time as the next-
announced Portfolio Deposit composition is made available.
The identity and number of shares of the Deposit Securities
required for the Portfolio Deposit for each Fund will change from time
to time. The composition of the Deposit Securities may change in
response to adjustments to the weighting of composition of the
Component Securities in the relevant Underlying Index. These
adjustments will reflect changes, known to the Advisor to be in effect
by the time of determination of the Deposit Securities, in the
composition of the Underlying Index being tracked by the relevant Fund,
or resulting from rebalance or additions or deletions to the relevant
Underlying Index. In addition, the Trust reserves the right with
respect to each Fund to permit or require the substitution of an amount
of cash (i.e., a ``cash in lieu'' amount) to be added to the Balancing
Amount to replace any Deposit Security: (1) that may be unavailable or
not available in sufficient quantity for delivery to the Trust upon the
purchase of iShares in Creation Unit Aggregations, or (2) that may not
be eligible for trading by an Authorized Participant or the investor on
whose behalf the Authorized Participant is acting.
C. Availability of Information Regarding iShares and Underlying Indices
1. In General. On each Business Day, the list of names and amount
of each treasury security, government security or corporate bond
constituting the current Deposit Securities of the Portfolio Deposit
and the Balancing Amount effective as of the previous Business Day will
be made available. An amount per iShare representing the sum of the
estimated Balancing Amount effective through and including the previous
Business Day, plus the current value of the Deposit Securities, on a
per iShare basis (the ``Intra-day Optimized Portfolio Value'' or
``IOPV'') will be calculated by Bloomberg L.P. (``Bloomberg'') every 15
seconds during the Exchange's regular trading hours and disseminated
every 15 seconds on the Consolidated Tape. Bloomberg will use Bloomberg
Generic Prices (``BGN Prices'') to reflect changing bond prices and
update the IOPV throughout the day. BGN Prices are current prices on
individual bonds as determined by Bloomberg using an automated pricing
program that analyzes multiple bond prices contributed to Bloomberg by
third-party price contributors (such as broker-dealers). BGN Prices are
updated throughout the day based on an ongoing analysis of the bid/ask
prices submitted by the third-party price contributors. When Bloomberg
receives bid/ask prices from a price contributor, the prices are
filtered and screened according to pre-determined criteria and set
parameters in order to maximize the accuracy of the pricing data. The
net result of this process is an individual bond ``price'' based on an
analysis of multiple pricing sources. BGN Prices are available on
Bloomberg systems and Applicants expect that the pricing of the Deposit
Securities will be transparent to anyone with access to Bloomberg
systems.
The Lehman Indices and the Goldman Sachs Index will not be
calculated or disseminated intra-day. The value and return of each
Lehman Index is updated on a daily basis by Lehman Brothers. The value
and return of the Goldman Sachs Index is updated on a daily basis by
Goldman Sachs.
Each Fund will make available through NSCC on a daily basis the
names and required number of shares of each of the Deposit Securities
in a Creation Unit Aggregation, as well as information regarding the
Balancing Amount. The NAV for each Fund will be calculated and
disseminated daily. There will also be disseminated a variety of data
with respect to each Fund on a daily basis by means of CTA and CQ High
speed Lines; information with respect to recent NAV, shares
outstanding, estimated cash amount and total cash amount per Creation
Unit Aggregation will be made available prior to the opening of the
Exchange. The closing prices of the Funds' Deposit Securities are
readily available from published or other public sources, or on-line
information services provided by Merrill Lynch, IDC, Bridge, Bloomberg,
Lehman Brothers and other pricing services commonly used by bond mutual
funds. In addition, the website for the Trust, which will be publicly
accessible at no charge, will contain the following information, on a
per iShare basis, for each Fund: (a) The prior Business Day's NAV and
the mid-point of the bid-ask price \9\ at the time of calculation of
such NAV (``Bid/Ask Price''), and a calculation of the premium or
discount of such price against such NAV; and (b) data in chart format
displaying the frequency distribution of discounts and premiums of the
Bid/Ask Price against the NAV, within appropriate ranges, for each of
the four previous calendar quarters.
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\9\ The Bid-Ask Price of a Fund is determined using the highest
bid and lowest offer on the Exchange as of the time of calculation
of each Fund's NAV.
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2. Information Regarding the Underlying Debt Securities. The
[[Page 70280]]
secondary market for Treasury securities is a highly organized over-
the-counter market. Many dealers, and particularly the primary dealers,
make markets in Treasury securities. Trading activity takes place
between primary dealers, non-primary dealers, and customers of these
dealers, including financial institutions, non-financial institutions
and individuals. Increasingly, trading in Treasury securities occurs
through automated trading systems.\10\
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\10\ See ``eCommerce in the Fixed-Income Markets: The 2001
Review of Electronic Transaction Systems,'' December 2001. This
survey of electronic trading systems in the bond market was prepared
by the staff of The Bond Market Association and is available through
the Association's Web site: http://www.bondmarkets.com.
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The primary dealers are among the most active participants in the
secondary market for Treasury securities. The primary dealers and other
large market participants frequently trade with each other, and most of
these transactions occur through an interdealer broker.\11\ The
interdealer brokers provide primary dealers and other large
participants in the Treasury market with electronic screens that
display the bid and offer prices among dealers and allow trades to be
consummated.
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\11\ E.g., BrokerTec Global, Cantor Fitzgerald, Garban-
Intercapital, and Liberty Brokerage.
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Quote and trade information regarding Treasury securities is widely
available to market participants from a variety of sources. The
electronic trade and quote systems of the dealers and interdealer
brokers are one such source. Groups of dealers and interdealer brokers
also furnish trade and quote information to vendors such as Bloomberg,
Reuters, Bridge, Moneyline Telerate, and CQG. GovPX,\12\ for example,
is a consortium of leading government securities dealers and
subscribers that provides market data from leading government
securities dealers and interdealer brokers to market data vendors and
subscribers. TradeWeb, another example, is a consortium of 18 primary
dealers that, in addition to providing a trading platform, also
provides market data direct to subscribers or to other market data
vendors.\13\
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\12\ See http://www.govpx.com.
\13\ See http://www.tradeweb.com.
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Real-time price quotes for corporate and non-corporate debt
securities are available to institutional investors via proprietary
systems such as Bloomberg, Reuters and Dow Jones Telerate. Additional
analytical data and pricing information may also be obtained through
vendors such as Bridge Information Systems, Muller Data, Capital
Management Sciences, Interactive Data Corporation and Barra.
Retail investors do have access to free intra-day bellwether
quotes.\14\ The Bond Market Association provides links to price and
other bond information sources on its investor Web site at http://
www.investinginbonds.com. In addition, transaction prices and volume
data for the most actively-traded bonds on the exchanges are published
daily in newspapers and on a variety of financial websites.
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\14\ Corporate prices are available at 20 minute intervals from
Capital Management Services at http://www.bondvu.com/quotmenu.htm.
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Closing corporate and non-corporate bond prices are also available
through subscription services (e.g., IDC, Bridge) that provide
aggregate pricing information based on prices from several dealers, as
well as subscription services from broker-dealers with a large bond
trading operation, such as Lehman Brothers and Goldman, Sachs & Co.
D. Redemption of iShares
Creation Unit Aggregations of each Fund will be redeemable at the
NAV next determined after receipt of a request for redemption. Creation
Unit Aggregations of each fund will be redeemed principally in-kind,
together with a balancing cash payment (although, as described below,
Creation Unit Aggregations may sometimes be redeemed for cash). The
value of each Fund's redemption payments on a Creation Unit Aggregation
basis will equal the NAV per the appropriate number of iShares of such
Fund. Owners of iShares may sell their iShares in the secondary market,
but must accumulate enough iShares to constitute a Creation Unit
Aggregation in order to redeem through the Fund. Redemption orders must
be placed or through an Authorized Participant.
Creation Unit Aggregations of any Fund generally will be redeemable
on any Business Day in exchange for Fund Securities and the Cash
Redemption Payment (defined below) in effect on the date a request for
redemption is made. The Advisor will publish daily through NSCC the
list of securities which a creator of Creation Unit Aggregations must
deliver to the Fund (the ``Creation List'') and which a redeemer will
receive from the Fund (the ``Redemption List''). The Creation List is
identical to the list of the names and the required numbers of shares
of each Deposit Security included in the current Portfolio Deposit.
In addition, just as the Balancing Amount is delivered by the
purchaser of Creation Unit Aggregations to the Fund, the Trust will
also deliver to the redeeming Beneficial Owner in cash the ``Cash
Redemption Payment.'' The Cash Redemption Payment on any given Business
Day will be an amount calculated in the same manner as that for the
Balancing Amount, although the actual amounts may differ in the Fund
Securities received upon redemption are not identical to the Deposit
Securities applicable for creations on the same day. To the extent that
the Fund Securities have a value greater than the NAV of iShares being
redeemed, a cash payment equal to the differential is required to be
paid by the redeeming Beneficial Owner to the Fund. The Trust may also
make redemptions in cash in lieu of transferring one or more Fund
Securities to a redeemer if the Trust determines, in its discretion,
that such method is warranted due to unusual circumstances. An unusual
circumstance could arise, for example, when a redeeming entity is
restrained by regulation or policy from transacting in certain Fund
Securities, such as the presence of such Fund Securities, on a
redeeming investment banking firm's restricted list.
E. Clearance and Settlement
The Deposit Securities and Fund Securities of each Fund will settle
via free delivery through the Federal Reserve System for U.S.
government securities and the DTC for corporate securities and non-
corporate (other than U.S. government securities). The iShares will
settle through the DTC. The Custodian will monitor the movement of the
Deposit Securities and will instruct the movement of the iShares only
upon validation that the Deposit Securities have settled correctly or
that required collateral is in place.
As with the settlement of domestic ETF transactions outside of the
NSCC Continuous Net Settlement System (the ``CNS System''), (i) iShares
of the Funds and corporate and non-corporate securities (other than
U.S. government securities) will clear and settle through DTC, and (ii)
U.S. government securities and cash will clear and settle through the
Federal Reserve system. More specifically, creation transactions will
settle as follows. On settlement date (T + 3), an Authorized
Participant will transfer Deposit Securities that are corporate and
non-corporate bonds (other than U.S. government securities) through DTC
to a DTC account maintained by the Funds' Custodian, and Deposit
Securities that are U.S. government securities, together with any
Balancing Amount, to the Custodian through the Federal Reserve system.
Once the Custodian has verified the
[[Page 70281]]
receipt of all the Deposit Securities (or in the case of failed
delivery of one or more bonds, collateral in the amount of 105% or more
of the missing Deposit Securities) and the receipt of any Balancing
Amount, the Custodian will notify the Distributor and the Advisor. The
Fund will issue Creation Unit Aggregations of iShares and the Custodian
will deliver the iShares to the Authorized Participant through DTC. DTC
will then credit the Authorized Participant's DTC account. The
clearance and settlement of redemption transactions essentially
reverses the process described above. After the Trust has received a
redemption request in proper form and the Authorized Participant
transfers Creation Unit Aggregations of iShares to the Funds' Custodian
through DTC, the Trust will cause the Custodian to initiate procedures
to transfer the requisite Fund Securities and any Cash Redemption
Payment. On T + 3, assuming the Custodian has verified receipt of the
Creation Unit Aggregations, the Custodian will transfer Fund Securities
that are corporate and non-corporate bonds to the Authorized
Participant through DTC and Fund Securities that are U.S. government
securities, together with any Cash Redemption Payment, through the
Federal Reserve system.
iShares of the Funds will be debited or credited by the Custodian
directly to the DTC accounts of the Authorized Participants. With
respect to domestic equity-based ETFs using the CNS System, Creation
Unit Aggregations of iShares are deposited or charged to the Authorized
Participants' DTC accounts through the CNS System. Since creation/
redemption transactions for iShares of the Funds will not clear and
settle through the CNS System, the failed delivery of one or more
Deposit Securities (on a create) or one or more Fund Securities (on a
redemption) will not be facilitated by the CNX System. Therefore,
Authorized Participants will be required to provide collateral to cover
the failed delivery of Deposit Securities in connection with an ``in-
kind'' creation of iShares. In case of a failed delivery of one or more
Deposit Securities, the Funds will hold the collateral until the
delivery of such Deposit Security. The Funds will be protected from
failure to receive the Deposit Securities because the Custodian will
not effect the Fund's side of the transaction (the issuance of iShares)
until the Custodian has received confirmation of receipt of the
Authorized Participant's incoming Deposit Securities (or collateral for
failed Deposit Securities) and Balancing Amount. In the case of
redemption transactions, the Funds will be protected from failure to
receive Creation Unit Aggregations of iShares because the Custodian
will not now effect the Fund's side of the transaction (the delivery of
Fund Securities and the Cash Redemption Payment) until the Transfer
Agent has received confirmation of receipt of the Authorized
Participant's incoming Creation Unit Aggregations. In order to simplify
the transfer agency process and align the settlement of iShares of the
Funds with the settlement of the Deposit Securities and Fund
Securities, Applicants plan to settle transactions in U.S. government
securities, corporate bonds, non-corporate bonds (other than U.S.
government securities) and iShares on the same T + 3 settlement cycle.
The issuer does not believe that the clearing and settlement
process will affect the arbitrage of iShares of the Funds.
F. Dividends and Distributions
Dividends from net investment income will be declared and paid to
Beneficial Owners of record at least annually by each Fund. Certain of
the Funds may pay dividends, if any, on a quarterly or more frequent
basis. Distributions of realized securities gains, if any, generally
will be declared and paid once a year, but each Fund may make
distributions on a more frequent basis to comply with the distribution
requirements of the Internal Revenue Code and consistent with the 1940
Act.
Dividends and other distributions on iShares of each Fund will be
distributed on a pro rata basis to Beneficial Owners of such iShares.
Dividend payments will be made through the Depository and the DTC
Participants to Beneficial Owners then of record with amount received
from each Fund.
The Trust will not make the DTC book-entry Dividend Reinvestment
Service (the ``Service'') available for use by Beneficial Owners for
reinvestment of their cash proceeds, but certain individual brokers may
make the Service available to their clients. The SAI will inform
investors of this fact and direct interested investors to contact such
investor's broker to ascertain the availability and a description of
the Service through such broker. The SAI will also caution interested
Beneficial Owners that they should note that each broker may require
investors to adhere to specific procedures and timetables in order to
participate in the Service and such investors should ascertain from
their broker such necessary details. iShares acquired pursuant to the
Service will be held by the Beneficial Owners in the same manner, and
subject to the same terms and conditions, as for original ownership of
iShares.
G. Other Issues
1. Criteria for Initial and Continued Listing. iShares are subject
to the criteria for initial and continued listing of Investment Company
Units in CHX Article XXVIII, Rule 24. It is anticipated that a minimum
of two Creation Units (100,000 iShares) will be required to be
outstanding at the start of trading. This minimum number of iShares
required to be outstanding at the start of trading will be comparable
to requirements that have been applied to previously traded series of
Investment Company Units.
The Exchange believes that the proposed minimum number of iShares
outstanding at the start of trading is sufficient to provide market
liquidity and to further the Trust's objective to seek to provide
investment results that correspond generally to the price and yield
performance of the Index.
2. Original and Annual Listing Fees. If the Funds were to list on
the Exchange, they would be subject to the listing fees set out in the
Exchange's Schedule of Membership Dues and Fees.
3. Prospectus Delivery. The Exchange, in an Information Circular to
Exchange members and member organizations, will inform members and
member organizations, prior to commencement of trading, of the
prospectus or product description delivery requirements applicable to
iShares.
4. Trading Halts. Any decision to halt trading of fixed income ETFs
is subject to CHX Article IX, Rule 10A and CHX Article IX, Rule 10(b).
In exercising the discretion described in CHX Article IX, Rule 10(b),
appropriate Exchange officials may consider a variety of factors,
including the extent to which trading is not occurring in underlying
security(s); whether trading has been halted or suspended in the
primary market(s) for any combination of underlying stocks accounting
for 20% or more of the applicable current portfolio value; and whether
other unusual conditions or circumstances detrimental to the
maintenance of a fair and orderly market are present.
5. Suitability. The Information Circular distributed by the
Exchange to its members will remind members of their obligations
pursuant to CHX Article VIII, Rule 25 (Business Conduct).
6. Purchases and Redemptions in Creation Unit Size. In the
Information Circular referenced above, members and member organizations
will be informed
[[Page 70282]]
that procedures for purchases and redemptions of iShares in Creation
Unit Size are described in the Fund prospectus and Statement of
Additional Information, and that iShares are not individually
redeemable, but may redeemed only in Creation Unit Size aggregations or
multiples thereof.\15\
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\15\ Other exchanges that have sought permission to list and/or
trade the Funds have noted, in their filings, that their rules that
prohibit certain types of relationships between an issuer and the
specialist in the issuer's securities do not prohibit specialists
from certain transactions in the Funds. See Release No. 46299
(August 1, 2002), 67 FR 51907 (August 9, 2002) (NYSE's Rule 460.10);
and Release No. 46252 (July 24, 2002), 67 FR 49715 (July 31, 2002)
(Amex's Rule 190). The Exchange has a similar rule that prohibits
certain relationships between its specialists and the issuer of a
security, but it applies only to issues that are exclusively listed
on the Exchange; therefore, this rule does not prohibit CHX
specialists from certain transactions in the Funds. See CHX Article
XXX, Rule 23.
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7. Surveillance. Exchange surveillance procedures applicable to
trading in the proposed iShares are comparable to those applicable to
other Investment Company Units currently trading on the Exchange. The
Exchange believes that these surveillance efforts will be adequate to
properly monitor the trading of the Funds.
8. Hours of Trading/Minimum Price Variation. The Funds will trade
on the Exchange until 4:15 p.m. (Eastern time), or, if the Exchange is
trading the Funds pursuant to unlisted trading privileges, during the
same hours that they are traded on the primary market. See CHX Article
IX, Rule 10(b). The minimum price variation for quoting will be $.01.
2. Statutory Basis
The Exchange believes that the proposed rule is consistent with the
requirements of the Exchange Act and the rules and regulations
thereunder that are applicable to a national securities exchange, and,
in particular, with the requirements of Section 6(b).\16\ In
particular, the proposed rule is consistent with Section 6(b)(5) of the
Exchange Act \17\ in that it is designed to promote just and equitable
principles of trade, to remove impediments and to 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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\16\ 15 U.S.C. 78f(b).
\17\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement of Burden on Competition
The Exchange does not believe that the proposed rule change will
impose any inappropriate burden on competition.
C. Self-Regulatory Organization's Statement on Comments Regarding the
Proposed Rule Change Received from Members, Participants or Others
No written comments were either solicited or 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 Exchange 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 at the Commission's Public Reference Room. Copies of such
filing will also be available for inspection and copying at the
principal office of the Exchange. All submissions should refer to File
No. SR-CHX-2002-27 and should be submitted by December 12, 2002.
IV. Commission's Findings and Order Granting Accelerated Approval of
Proposed Rule Change
After careful review, the Commission finds that implementation of
the proposed rule change, as amended, is consistent with the
requirements of Section 6 of the Exchange Act \18\ and the rules and
regulations thereunder applicable to a national securities
exchange.\19\ Specifically, the Commission believes that the proposal
is consistent with Section 6(b)(5) of the Exchange Act.\20\ The
Commission believes that the Exchange's proposal to list and trade
fixed income ETFs (including the trading thereof on a UTP basis) \21\
will provide investors with a convenient way of participating in the
U.S. government, corporate and non-corporate (other than U.S.
government) fixed income markets. The Exchange's proposal should help
to provide investors with increased flexibility in satisfying their
investment needs by allowing them to purchase and sell securities at
negotiated prices throughout the business day that replicate the
performance of several portfolios of stocks. The Commission believes
that the availability of the Funds will provide an instrument for
investors to achieve desired investment results that correspond
generally to the price and yield performance of the underlying U.S.
Treasury, Government/Credit, or Corporate Bond Index. The investment
objective of each Fund will be to provide investment results that
correspond generally to the price and yield performance of the
underlying index based on fixed income securities. Accordingly, the
Commission finds that the Exchange's proposal will facilitate
transactions in securities, remove impediments to and perfect the
mechanism of a free and open market and a national market system, and,
in general, protect investors and the public interest, and is not
designed to permit unfair discrimination between customers, issuers,
brokers, or dealers.\22\
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\18\ 15 U.S.C. 78f.
\19\ In approving this proposed rule change, the Commission
notes that it has considered the proposed rule's impact on
efficiency, competition, and capital formation. 15 U.S.C. 78c(f).
\20\ 15 U.S.C. 78f(b)(5).
\21\ The Commission notes that, pursuant to Rule 12f-5 under the
Act, prior to trading a particular class or type of security
pursuant to UTP, NYSE must have listing standards comparable to
those of the primary market on which the security is listed. 17 CFR
240.12f-5. The Commission finds that adequate rules and procedures
exist to govern the trading of the Fund on NYSE, pursuant to UTP.
\22\ Pursuant to Section 6(b)(5) of the Act, the Commission must
predicate approval of exchange trading for new products upon a
finding that the introduction of the product is in the public
interest. Such a finding would be difficult with respect to a
product that served no investment, hedging or other economic
functions, because any benefits that might be derived by market
participants would likely be outweighed by the potential for
manipulation, diminished public confidence in the integrity of the
markets, and other valid regulatory concerns.
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iShares Trust and iShares, Inc. are each registered in the 1940 Act
as an open-ended management investment company with multiple series.
iShares Trust has created (or identified for creation) 66 separate
series, while iShares, Inc. has created (or identified for creation) 35
separate series. All of these series operate (or will operate) as ETFs
pursuant to six prior exemptive orders from the 1940 Act, and each of
the ETFs seeks to match the return of an equity securities index.
Additionally, the Commission has granted the Funds appropriate relief
under various sections of the 1940 Act, including sections 6(c) and
17(b), so that each Fund may register under the 1940 Act as an open-end
fund and issue shares that are redeemable in Creation Units, shares of
Funds may trade in the secondary market at negotiated prices, and
certain persons affiliated with a Fund by reason of owning 5% or more,
and in some
[[Page 70283]]
cases more than 25%, of its outstanding securities may do in-kind
purchases and redemptions of Creation Units.\23\
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\23\ Investment Company Act Release No. 25622 (June 25, 2002).
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Barclays is registered as an investment adviser under the 1940 Act
and serves as the investment adviser to the series of iShares Trust and
iShares, Inc. Distributor acts as the principal underwriter and
distributor for iShares Trust and iShares, Inc.
iShares Trust will create seven new series each of which operates
as an ETF seeking to match the performance of a fixed income securities
index. The seven indices are the following:
[sbull] Lehman Brothers 1-3 Year U.S. Treasury Index (containing
U.S. Treasury securities with remaining maturities of between 1 and 3
years);
[sbull] Lehman Brothers 7-10 Year U.S. Treasury Index (containing
U.S. Treasury securities with remaining maturities of between 7 and 10
years);
[sbull] Lehman 20+ Year U.S. Treasury Index (containing U.S.
Treasury securities with remaining maturities of more than 20 years);
[sbull] Lehman U.S. Treasury Index (containing U.S. Treasury
securities with remaining maturities of more than 1 year);
[sbull] Lehman Government/Credit Index (containing certain
investment grade government and credit securities with maturities of
more than 1 year);
[sbull] Lehman Credit VLI Index (containing the largest issues of
investment grade credit securities with remaining maturities of more
than 1 year); and
[sbull] Goldman Sachs InvesTop Index (containing the 100 most
liquid and representative bonds in the U.S. investment grade corporate
market with remaining maturities of at least 3 years).\24\
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\24\ As of July 1, 2002, the composition of the Goldman Sachs
Index, which underlies the iShares Goldman Sachs Corporate Bond
Fund, was expanded from 30 to 100 investment grade bonds, and the
index is permitted to include more than one bond per issuer.
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The Commission notes that this is the first ETF based on an
underlying index of fixed income securities (``Fixed Income ETFs'').
The Funds will operate in substantially the same manner as Equity ETFs.
Like many other ETFs, each Fund will use a representative sampling
strategy to track its index. With a sampling strategy, a Fund will seek
to match the return of its index by holding some, but not all, of the
fixed income securities contained in its underlying index. In
constructing the portfolio for a Fund, Barclays will select a sample of
bonds that will correlate to the duration, sector, credit rating,
coupon, and embedded option characteristics of the underlying index as
a whole. Barclays may also exclude less liquid bonds in order to create
a more tradable portfolio to enhance arbitrage efficiency. As with its
Equity ETFs, Barclays represents that the Funds will have a tracking
error relative to the performance of their respective underlying
indices of no more than 5%.
Shares of the Funds will be issued and redeemed in Creation Units
priced at NAV in exchange for Portfolio Deposits and Redemption Baskets
consisting of Bonds selected and announced by Barclays at the beginning
of each business day.
The Commission finds that the Funds will provide benefits to
investors in allowing investors to trade baskets of bonds in a single
transaction at a cost comparable to that of trading existing equity
securities and will allow investors to trade baskets of bonds
throughout the day and thereby permit them to take advantage of (or
protect themselves against) intra-day market movements. The Funds may
make it easier for individual investors to diversify their portfolios
across a broader range of assets and will provide institutional and
other large investors with an alternative to futures for various
hedging and other investment strategies that involve fixed income
securities. Finally, the Funds will provide investors with a fund
product that discloses its portfolio on a daily basis rather than semi-
annually.
While the Funds will be operated in a manner that closely parallels
the manner in which Equity ETFs are operated, one key potential
difference may be the efficiency of the arbitrage process. The
arbitrage mechanism for Equity ETFs generally has caused the market
price of ETF shares to track closely the NAV of the ETF shares. With
respect to liquidity of the debt securities likely to be in the ETF
portfolios, to the extent these debt securities could not be readily
purchased and sold, the arbitrage process would be less efficient.
However, the Commission notes that the Funds will invest in some of the
most liquid debt securities, including U.S. Government securities and
investment grade corporate and non-corporate bonds.\25\ In addition,
Barclays will employ a sampling method of portfolio management that
would allow the Funds to exclude any bonds contained in an underlying
index that may not have sufficient liquidity for easy trading. As a
result, the Commission believes that the Funds have addressed the
liquidity issues that might hamper arbitrage.
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\25\ The Lehman Government/Credit Index, Lehman Credit VLI
Index, and Goldman Sachs InvesTop Index may include investment grade
corporate and non-corporate bonds issued by non-U.S. issuers
(sovereign, supra-national, foreign agency, and foreign local
government). In Barclays' 1940 Act Application, it stated that these
bonds will be dollar denominated, registered for sale in the U.S.,
and traded on U.S. markets at negotiated and readily available
prices. Barclays does not believe that these bonds present any
unique pricing or liquidity issues and does not expect the bonds to
negatively affect arbitrage efficiency. The Commission notes that if
any of these major characteristics of these fixed income indices
(e.g., investment grade, face amount issued, maturity
classification) were to materially change, the Commission would
expect NYSE to attend these listing standards accordingly.
---------------------------------------------------------------------------
In addition, differences in the degree of price transparency in the
debt and equity markets could lead to larger discounts and premiums for
the Funds than have been experienced by Equity ETFs. Specifically,
because the pricing of debt securities can be less transparent than the
pricing of equity securities, arbitrageurs might account for pricing
uncertainty by waiting for greater premiums or discounts to develop in
the market price of the ETF shares before engaging in arbitrage
transactions.
The Commission finds that because of the nature of the particular
debt securities to be included in the portfolios of the Funds (i.e.,
U.S. Government securities and investment grade corporate and non-
corporate bonds), the pricing information should be available. The
Exchange has indicated that real-time price quotes for corporate and
non-corporate debt securities are available to institutional investors
via proprietary systems such as Bloomberg, Reuters and Dow Jones
Telerate. Additional analytical data and pricing information may also
be obtained through vendors such as Bridge Information Systems, Muller
Data, Capital Management Sciences, Interactive Data Corporation and
Barra.
The Exchange has also represented that retail investors would have
access to free intra-day bellwether quotes.\26\ For instance, the Bond
Market Association provides links to price and other bond information
sources on its investor Web site at http://www.investinginbonds.com. In
addition, transaction prices and volume data for the most actively-
traded bonds on the exchanges are published daily in newspapers and on
a variety of financial websites. Closing corporate and non-corporate
bond prices are also available through subscription services (e.g.,
IDC, Bridge) that provide aggregate pricing
[[Page 70284]]
information based on prices from several dealers, as well as
subscription services from broker-dealers with a large bond trading
operation, such as Lehman Brothers and Goldman Sachs & Co.
---------------------------------------------------------------------------
\26\ Corporate prices are available at 20 minute intervals from
Capital Management Services at http://www.bondvu.com/quotmenu.htm.
---------------------------------------------------------------------------
The Commission also believes that pricing information for the
Treasury securities should also be available. Quote and trade
information regarding Treasury securities is widely available to market
participants from a variety of sources. The electronic trade and quote
systems of the dealers and interdealer brokers are one such source.
Groups of dealers and interdealer brokers also furnish trade and quote
information to vendors such as Bloomberg, Reuters, Bridge, Moneyline
Telerate, and CQG.
CHX represents that every 15 seconds a price calculated by
Bloomberg reflecting the current value of the Portfolio Deposit on a
per ETF share basis for the Funds will be disseminated. To calculate
this intra-day value, Bloomberg intends to use Bloomberg Generic
Prices, which are current prices for individual bonds as determined by
Bloomberg using an automated pricing program that analyzed multiple
bond prices contributed by third-part price contributors such as
broker-dealers.\27\ Accordingly, NYSE believes that the pricing of the
bonds included in the Portfolio Deposit (and in the Redemption Basket)
will be transparent to anyone with access to Bloomberg systems. Because
the arbitrageurs of ETF shares are generally large institutional
investors, including broker-dealers, the Commission believes that these
investors likely will have access to Bloomberg systems, as well as
other bond pricing information sources that should permit efficient
arbitrage to occur. While the Commission believes that differences in
the liquidity and pricing transparency of the underlying fixed income
markets, as compared to the equity markets, may result in the Funds
trading at slightly higher discounts and premiums, the Commission does
not believe that this effect is likely to be so substantial as to
undermine the benefits that Funds will provide to the markets and to
investors. The Commission expects the Exchange to review the discounts
or premiums for these products and to respond appropriately if there is
in fact a significant pricing disparity.
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\27\ The Lehman Indices and the Goldman Sachs Index will not be
calculated or disseminated intra-day. The value and return of each
Lehman Index is updated on a daily basis by Lehman Brothers. The
value and return of the Goldman Sachs Index is updated on a daily
basis by Goldman Sachs.
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The Commission has also granted the issuer, Barclays, exemptive
relief from Section 24(d) of the 1940 Act so that dealers may effect
secondary market transaction in Barclays ETF shares without delivery a
prospectus to the purchaser. Instead, under the exemption and under
CHX's listing standards, sales in the secondary market must be
accompanied by a ``product description,'' describing the ETF and its
shares.\28\ The Commission believes a product description, which not
only highlights the basic characteristics of the product and the manner
in which the ETF shares trade in the secondary market, but also
highlights the differences of the Funds from existing equity ETFs and
notes the unique characteristics and risks of this product, should
provide market participants with adequate notice of the salient
features of the product.
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\28\ Recently approved Nasdaq listing standards for ETFs clarify
that NASD members trading equity ETFs through electronic
communication networks (``ECNs'') would be subject to NASD Rules
4420(i)(2) and 4420(j)(2) requiring the delivery of product
descriptions in connection with sales of ETF shares. See Securities
Exchange Act Release No. 45920 (May 13, 2002), 67 FR 35605 (May 20,
2002). The Commission expects NASD members to observe the same
standards for the secondary market trading of Funds.
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The Commission also notes that upon the initial listing of any ETF
under CHX Article XXVIII, Rule 24 the Exchange issues a circular to its
members explaining the unique characteristics and risks of the
security; in this instance, Fixed Income ETFs. In particular, the
circular should include, among other things, a discussion of the risks
that may be associated with the Funds, in addition to details on the
composition of the fixed income indices upon which they are based and
how each Fund would use a representative sampling strategy to track its
index. The circular also should note Exchange members' responsibilities
under CHX Article VIII, Rule 25 (``know your customer rule'') regarding
transactions in such Fixed Income ETFs. CHX Article VIII, Rule 25
generally requires that members use due diligence to learn the
essential facts relative to every customer, every order or account
accepted. The circular also will address members' prospectus delivery
requirements as well as highlight the characteristics of purchases in
Funds, including that they only are redeemable in Creation Unit size
aggregations. Based on these factors, the Commission finds that the
proposal to trade the Funds is consistent with Section 6(b)(5) of the
Exchange Act.\29\
---------------------------------------------------------------------------
\29\ 15 U.S.C. 78f(b)(f).
---------------------------------------------------------------------------
The Commission also notes that the Exchange's rules and procedures
should address the special concerns attendant to the trading of new
derivative products. In particular, by imposing the Investment Company
Unit listing standards in CHX Article XXVIII, Rule 24, and addressing
the suitability, disclosure, and compliance requirements noted above,
the Commission believes that the Exchange has addressed adequately the
potential problems that could arise from the derivative nature of the
Funds.
In particular, the Commission finds that adequate rules and
procedures exist to govern the trading of Investment Company Units,
including Funds. Funds will be deemed equity securities subject to CHX
rules governing the trading of equity securities. These rules include
general and floor rules, such as priority, parity, and precedence of
orders, market volatility related trading halt provisions, members
dealing for their own accounts, specialists, odd-lot brokers, and
market makers, and handling of orders and reports; office rules, such
as conduct of accounts, margin rules, and advertising; and contract
rules, such as duty to report transactions, comparisons of
transactions, marking to the market, delivery of securities, dividends
and interest, closing of contracts, and money and security loans.\30\
CHX also will consider halting trading in any series of Investment
Company Units under certain other circumstances such as the presence of
other unusual conditions or circumstances detrimental to the
maintenance of a fair and orderly market.\31\ The Commission believes
that the application of these rules should strengthen the integrity of
the Funds.
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\30\ Telephone conversation between Ellen J. Neely, Senior Vice
President and General Counsel, CHX; and Jennifer Lewis, Division,
Commission, on November 7, 2002.
\31\ Id.
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The Commission also notes that certain concerns are raised when a
broker-dealer, such as Lehman or Goldman, is involved in the
development and maintenance of a stock index upon which an ETF is
based. Previously, the Commission noted the importance of an exchange
adopting adequate procedures to prevent the misuse of material, non-
public information regarding changes to component stocks in a fixed
income securities index.\32\ Goldman and Lehman each have procedures in
place to prevent the misuse of material, non-public information
regarding changes to component stocks to the Funds. \33\ The
[[Page 70285]]
Commission believes that these provisions should help to address
concerns raised by Goldman and Lehman's involvement in the management
of the indices.
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\32\ See supra, note 4.
\33\ The Commission expects that the procedures implemented by
Goldman and Lehman will monitor and prevent the misuse of material,
non-public information as it relates to the development, maintenance
and calculation of the indices.
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The Commission also believes that CHX has appropriate surveillance
procedures in place to detect and deter potential manipulation for
similar index-linked products. By applying these procedures to the
Funds, the Commission believes that the potential for manipulation
should be minimized, while protecting investors and the public
interest.
CHX has requested that the Commission find 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. CHX has
requested accelerated approval because the 1940 Act Application
relating to the Funds has been reviewed by the Division of Investment
Management and notice of the Application has been published in the
Federal Register.\34\ The Application disclosed the characteristics and
risks associated with the Funds. No comments were submitted and the
Commission granted the relief requested in the Application.\35\ The
Funds will trade on the Exchange in the same manner as Investment
Company Units previously approved by the Commission. Furthermore, the
Commission notes that it recently granted accelerated approval to the
requests of the Amex and NYSE to list and trade fixed income ETFs.\36\
Based on the above, the Commission finds good cause to accelerate
approval of the proposed rule change.
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\34\ Investment Company Act Release No. 25594 (May 29, 2002), 67
FR 38681 (June 5, 2002).
\35\ Investment Company Act Release No. 25622 (June 25, 2002).
\36\ See supra, note 5.
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It is therefore ordered, pursuant to Section 19(b)(2) of the
Exchange Act,\37\ that the proposed rule change (File No. SR-CHX-2002-
27), as amended, is hereby approved on an accelerated basis.
---------------------------------------------------------------------------
\37\ 15 U.S.C. 78s(b)(2).
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\38\
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\38\ 17 CFR 200.3-3(a)(12).
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J. Lynn Taylor,
Assistant Secretary.
[FR Doc. 02-29541 Filed 11-20-02; 8:45 am]
BILLING CODE 8010-01-P