[Federal Register: December 15, 2003 (Volume 68, Number 240)]
[Notices]
[Page 69739-69748]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr15de03-91]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-48881; File No. SR-NYSE-2003-39]
Self-Regulatory Organizations; Notice of Filing and Order
Granting Accelerated Approval of Proposed Rule Change by the New York
Stock Exchange, Inc. Relating to the Listing and Trading of iShares
Lehman U.S. Aggregate Bond Fund and iShares Lehman TIPS Bond Fund
December 4, 2003.
Pursuant to section 19(b)(1) of the Securities Exchange Act of
1934, (``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby
given that on November 25, 2003 the New York Stock Exchange, Inc.
(``NYSE'' or ``Exchange'') filed with the Securities and Exchange
Commission (``SEC'' or ``Commission'') the proposed rule change as
described in Items I and II below, which Items have been prepared by
the Exchange. On December 3, 2003, the NYSE 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 is approving 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\ See letter from Darla Stuckey, Corporate Secretary, NYSE, to
Florence Harmon, Senior Special Counsel, Division of Market
Regulation (``Division''), Commission, dated December 3, 2003
(``Amendment No. 1''). Amendment No. 1 provides for certain
technical changes and clarification to the original proposal,
particularly settlement and clearance procedures for TIPS Fund.
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1. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The Exchange proposes to trade pursuant to unlisted trading
privileges (``UTP'') iShares Lehman U.S. Aggregate Bond Fund (the
``Aggregate Bond Fund'') and to list and trade the iShares Lehman TIPS
Bond Fund \4\ (the ``TIPS Fund'') and together with the Aggregate Bond
Fund, (the ``ETFs'' or the ``Funds''), each a series of iShares Trust
(the ``Trust''), an exchange traded fund which is a type of Investment
Company Unit.
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\4\ Telephone conversation between Janet Kissane, Milbank,
Tweed, Hadley & McCloy LLP, Counsel for NYSE, and Florence Harmon,
Senior Special Counsel, Division, Commission dated December 4, 2003.
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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 NYSE included statements
concerning the purpose of, and basis for, the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
item III below. The NYSE 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 the
Statutory Basis for, the Proposed Rule Change
1. Purpose
Section 703.16 of the NYSE Listed Company Manual provides standards
for listing and trading Investment Company Units (``ICUs''), which are
securities issued by an open-end management company.\5\ The Commission
previously approved amendments to section 703.16 of the NYSE Listed
Company Manual to accommodate the listing and trading of ICUs based on
an index of fixed income securities, but such standards are not generic
listing standards. Hence, the NYSE has filed NYSE-2003-39 to
accommodate the trading pursuant to UTP of the Aggregate Bond Fund and
the listing and trading of the TIPS Fund under section 703.16 of the
Listed Company Manual. The Funds have been approved for listing on the
Amex.\6\
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\5\ In 1996, the Commission approved Section 703.16 of the
Listed Company Manual (the ``Company Manual''), which sets forth the
rules related to the listing of ICUs. See Securities Exchange Act
Release No. 36923 (March 5, 1996), 61 FR 10410 (March 13, 1996). In
2000, the Commission also approved the Exchange's generic listing
standards for listing and trading, or the trading pursuant to UTP,
of ICUs under Section 703.16 of the Company Manual and NYSE Rule
1100. See Securities Exchange Act Release No. 43679 (December 5,
2000), 65 FR 77949 (December 13, 2000). In 2002, the Commission
approved amendments to Section 703.16 of the Company Manual to
accommodate the listing of ICUs based on an index of fixed income
securities. See Securities Exchange Act Release No 46306 (August 2,
2002), 67 FR 51916 (August 9, 2002).
\6\ See Securities Exchange Act Release No. 48534 (September 24,
2003), 68 FR 56353 (September 30, 2003).
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As set forth in detail below, the Funds will hold certain fixed
income securities (the ``Component Securities'') selected to correspond
generally to the performance of the relevant Underlying Index (the
``Underlying Index'') and, in the case of the Aggregate Bond Fund will
also invest in mortgage pass-through securities through TBA
[[Page 69740]]
transactions, in each instance as described in Exhibit A to NYSE-2003-
39. The ETFs intend to qualify as a ``regulated investment company''
(the ``RIC'') under the Internal Revenue Code (the ``Code'').
Barclays Global Fund Advisors (the ``Advisor'' or the ``BGFA'') is
the investment advisor to the ETFs. The Advisor is registered under the
Investment Advisers Act of 1940 (the ``Advisers Act''). The Advisor is
the wholly owned subsidiary of Barclays Global Investors, N.A. (the
``BGI''), a national banking association. BGI is an indirect subsidiary
of Barclays Bank PLC of the United Kingdom.
SEI Investments Distribution Co. (the ``Distributor''), a
Pennsylvania corporation and broker-dealer registered under the Act, is
the principal underwriter and distributor of Creation Unit Aggregations
of iShares. The Distributor is not affiliated with the Exchange or the
Advisor.
Administrator/Custodian/Fund Accountant/Transfer Agent/Dividend
Disbursing Agent. The Trust has appointed Investors Bank & Trust Co.
(the ``IBT'') to act as administrator (the ``Administrator''),
custodian, fund accountant, transfer agent, and dividend disbursing
agent for the ETFs. The performance of their duties and obligations
will be conducted within the provisions of the Advisers Act and the
rules thereunder. There is no affiliation between IBT and the Trust,
the Advisor or the Distributor.
a. Operation of the ETFs. The investment objective of each ETF will
be to provide investment results that correspond generally to the
performance of its Underlying Index. In seeking to achieve its
investment objective, the ETFs will utilize ``passive'' indexing
investment strategies. Each ETF may fully replicate is 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 (the ``Component Securities'') of its Underlying
Index, but it may not hold all of the Component Securities of its
Underlying Index (as compared to an ETF that uses a replication
strategy which invests in substantially all of the Component Securities
in its Underlying Index in the same appropriate proportions as in the
Underlying Index).\7\ The representative sampling techniques that will
be used by the Advisor to manage the Aggregate Bond Fund and the TIPS
do not differ from the representative sampling techniques it uses to
manage the Funds that were the subject of the Commission's June 25,
2002 order under the 1940 Act relating to other series of the iShares
Trust indexes of fixed income securities.\8\
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\7\ The Trust, Advisor and Distributor (the ``Applicants'') have
filed with the Commission an Application for an Amended Order (the
``Application'') under sections 6(c) and 17(b) of the Investment
Company Act of 1940 (``1940'') for the purpose of exempting the ETFs
from various provisions of the 1940 Act. (File No. 812-13003). A
notice of Application was issued in Investment Company Act Release
No. 26151, August 5, 2003. The information provided herein relating
to the Funds is based on information regarding the Trust and the
Finds/ See Investment Company Act Release No. 25622 (June 25, 2002)
for the approval of the initial Application for additional series of
the iShares Trust based on indexes of fixed income securities (the
``Original Application'').
\8\ Telephone conversation between Janet Kissane, Milbank,
Tweed, Hadley & McCloy LLP, Counsel for NYSE, and Florence Harmon,
Senior Special Counsel, Division, Commission dated December 2, 2003.
See in the Matter of iShares Trust, et al., Investment Company Act
Release; No. 25622 (June 25, 2002) (relating to the iShares 1-3 Year
Treasury Index Fund, 7-10 Year Treasury Index Fund, 20+Year Treasury
Index Fund, Treasury Index Fund, Government/Credit Index Fund,
Lehman Corporate Bond Fund and GS$InvesTop Corporate Bond Fund).
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When using a representative sampling strategy, the Advisor attempts
to match the risk and return characteristics of an ETFs portfolio to
the risk and return characteristics of the Underlying Index. As part of
this process, the Advisor subdivides each Underlying Index into
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: (1) Duration, (2) Sector, (3) Credit
Rating, (4) Coupon, and (5) 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 to closely 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.
According to the Original 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 Original Application, the ETFs' 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
ETF in accordance with changes in the composition of the Underlying
Index or to maintain compliance with requirements applicable to a RIC
under the Code. For example, if at the end of a calendar quarter an ETF
would not comply with the RIC diversification tests, the Advisor would
make adjustments to the portfolio to ensure continued RIC status. The
Exchange represents that the Advisor \9\ expects 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 ETF's
investment objectives, policies and investment strategies will be fully
disclosed in its prospectus (``Prospectus'') and statement of
additional information (``SAI''). The TIPS Fund will invest at least
90% of its assets in Component Securities of its Underlying Index. The
TIPS Fund 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
TIPS Fund track its Underlying Index, as well as in certain futures,
options and swap contracts, cash and cash equivalents. For example, the
TIPS Fund may invest in securities not included in the Underlying Index
in order to reflect prospective changes in the Underlying Index (such
as future corporate actions and index
[[Page 69741]]
reconstitutions, additions and deletions).
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\9\ See supra note 3.
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However, additional portfolio flexibility would benefit the
Aggregate Bond Fund, while at the same time permitting it to closely
track the performance of its Underlying Index. The Aggregate Bond Fund
will: (1) Seek to track the performance of that portion of its
Underlying Index comprised of U.S. Treasury securities, U.S. agency
securities, corporate bonds, non-corporate bonds (e.g., bonds issued by
supra-national entities such as the International Monetary Fund),
asset-backed securities, and commercial mortgage-backed securities
(approximately 65% of the Underlying Index as of December 3, 2003) by
investing a corresponding percentage of its net assets (i.e.,
approximately 65%) in the Component Securities of its Underlying Index;
\10\ and (2) seek to track the performance of that portion of its
Underlying Index invested in U.S. agency mortgage pass-through
securities (approximately 35% of the Underlying Index as of December 3,
2003) by investing a corresponding percentage of its net assets (i.e.,
approximately 35%) \11\ through TBA transactions (as described below)
on U.S. agency mortgage pass-through securities. Through the Aggregate
Bond Fund's direct investments in Component Securities of its
Underlying Index and its investment in mortgage pass-through securities
through TBA transactions, the Aggregate Bond Fund will have at least
90% of its net assets invested (i) in Component Securities of its
Underlying Index and (ii) and investments that have economic
characteristics that are substantially identical to the economic
characteristics of the Component Securities of its Underlying Index
(i.e., TBA transactions).
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\10\ With respect to this portion of its portfolio, the
Aggregate Bond Fund may invest up to 10% of its portfolio in bonds
not included in its Underlying Index, but which the Advisor believes
will help the Aggregate Bond Fund track its Underlying Index, as
well as in certain futures, options and swap contracts, cash and
cash equivalents.
\11\ Telephone conversation between Janet Kissane, Milbank,
Tweed, Hadley & McCloy LLP, Counsel for NYSE, and Florence Harmon,
Senior Special Counsel, Division, Commission dated December 4, 2003.
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According to the Application, the Aggregate Bond Fund needs the
investment flexibility to engage in TBA transactions as described above
primarily because approximately 35% of the securities in the Aggregate
Bond Fund's Underlying Index are expected to be pools of U.S. agency
mortgage pass-through securities.\12\ As discussed below, it is easier
to trade and obtain intra-day prices of TBAs than it is to trade and
obtain intra-day prices of specific pools of mortgage pass-through
securities. The readily available information about intra-day pricing
of TBAs and the ease with which they can be traded should make it
easier to create and redeem Creation Unit Aggregations and help
maintain the efficiency of the Aggregate Bond Fund's arbitrage
mechanism.
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\12\ As used herein, the term ``U.S. agency mortgage pass-
through security'' or ``mortgage pass-through security'' refers to a
category of pass-through securities backed by pools of mortgages and
issued by one of several U.S. Government-sponsored enterprises: the
Government National Mortgage Association (``GNMA''), Federal
National Mortgage Association (``FNMA'') or Federal Home Loan
Mortgage Corporation (``FHLMC''). In the basic pass-through
structure, mortgages with similar issuer, term and coupon
characteristics are collected and aggregated into a pool. The pool
is assigned a CUSIP number and undivided interests in the pool are
traded and sold as pass-through securities. The holder of the
security is entitled to a pro rata share of principal and interest
payments (including unscheduled prepayments) from the pool of
mortgage loans. The portion of the Underlying Index representing the
mortgage pass-through segment of the U.S. investment grade bond
market is comprised of multiple pools of mortgage pass-through
securities.
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The Application states that, although the market or mortgage pass-
through securities is extremely deep and liquid, it is impractical to
trade mortgage pass-through securities on a pool-by-pool basis,
particularly when large dollar amounts are involved. For this reason,
the vast majority of mortgage pools are traded using ``to-be-
announced'' or ``TBA'' transactions. A TBA transaction is essentially a
purchase or sale of a pass-through security for future settlement at an
agreed upon date.\13\ It has been estimated that 90% of mortgage pass-
through securities (as measured by total dollar volume) are executed as
TBA trades.\14\ TBA transactions increase the liquidity and pricing
efficiency of transactions in mortgage pass-through securities since
they permit similar mortgage pass-through securities to be traded
interchangeably pursuant to commonly observed settlement and delivery
requirements.
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\13\ ``TBA'' refers to a mechanism for the forward settlement of
agency mortgage pass-through securities, and not to a separate type
of mortgage-backed security. TBA trades generally are conducted in
accordance with widely-accepted ``Good Delivery'' guidelines
published by The Bond Market Association (``TBMA''). The Good
Delivery guidelines facilitate transactions in mortgage pass-through
securities by establishing commonly observed terms and conditions
for execution, settlement, and delivery. In a TBA trade, the buyer
and seller decide on general trade parameters, such as agency,
coupon, term to maturity, settlement date, par amount, and price.
The actual pools delivered are determined two days prior to
settlement date. TBA transactions promote efficient pricing because
the Goog Delivery guidelines permit only a small variance between
the face amount of the pools actually delivered and the nominal
agreed upon amount. Intra-day and end-of-day pricing of TBAs is
available from multiple pricing sources, such as Bloomberg L.P.
(``Bloomberg'') and Trade Web. TBMA publishes standard notification
and settlement dates for TBA trades specifying uniform settlement
dates for specific classes of securities. The most active trading
market for TBA trades is usually for next-month settlement. See
generally TBAs: To-Be-Announced Mortgage Securities Transactions,
TBMA (1999).
\14\ Id. at 3.
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The Aggregate Bond Fund intends to use TBA transactions to acquire
and maintain exposure to that portion of the Underlying Index comprised
of pools of mortgage pass-through securities in either of two ways.
First, and more commonly, the Aggregate Bond Fund will enter into TBA
agreements and ``roll over'' such agreements prior to the settlement
date stipulated in such agreements. This type of TBA transaction is
commonly known as a ``TBA roll.'' In a ``TBA roll'' the Aggregate Bond
Fund generally will sell the obligation to purchase the pools
stipulated in the TBA agreement prior to the stipulated settlement date
and will enter into a new TBA agreement for future delivery of pools of
mortgage pass-through securities. Second, and less frequently, the
Aggregate Bond Fund will enter into TBA agreements and settle such
transactions on the stipulated settlement date by actual receipt or
delivery of the pools of mortgage pass-through securities stipulated in
the TBA agreement. Since intra-day-prices of TBA agreements are more
readily available than intra-day prices on specific mortgage pools and
because mortgage pools tend to be less liquid than TBA agreements, the
use of TBA agreements should help maintain the efficiency of the
Aggregate Bond Fund's arbitrage mechanism. The Aggregate Bond Fund will
accept actual delivery of mortgage pools only when the Advisor believes
it is in the best interests of the Aggregate Bond Fund and its
shareholders to do so. In determining whether to accept actual delivery
of mortgage pools, the Advisor will consider, among other things, the
potential impact of such acceptance on the efficiency of the Aggregate
Bond Fund's arbitrage mechanism and the Aggregate Bond Fund's ability
to track its Underlying Index. For these reasons, the Advisor believes
that the ability to invest a significant portion of the Aggregate Bond
Fund's assets through TBA transactions and to maintain such exposure
through the use of TBA rolls would increase the liquidity and pricing
efficiency of the Aggregate Bond Fund's portfolio. In addition, since
holding a TBA position exposes the holder to
[[Page 69742]]
substantially identical market and economic risks as holding a position
in a corresponding pool of mortgage pass-through securities, the
Advisor believes that the use of TBA transactions as described herein
should permit the Aggregate Bond Fund to closely track the performance
of its Underlying Index.
The use of TBA transactions is not intended to help the Aggregate
Bond Fund ETF outperform its Underlying Index, but rather to increase
pricing efficiency while at the same time maintaining the Aggregate
Bond Fund's exposure to its Underlying Index.
b. Issuance of Creation Unit Aggregations.
1. In General. The issuance of Creation Unit Aggregations will
operate, except as noted below, in a manner identical to that of the
ETFs described in the Original Application.\15\ Shares of each ETF (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 ETFs will issue and redeem iShares only in Creation
Unit Aggregations.\16\ 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 both Funds will initially trade on the NYSE is
approximately $100. The NYSE represents that the Aggregate Bond Fund is
currently trading at $100.82 on the Amex as of December 3, 2003.\17\
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\15\ See Investment Company Act Release No. 25622 (June 25,
2002). Telephone conversation between Janet Kissane, Milbank, Tweed,
Hadley & McCloy LLP, Counsel for NYSE, and Florence Harmon, Senior
Special Counsel, Division, Commission dated December 2, 2003.
\16\ 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.
\17\ Telephone conversation between Janet Kissane, Milbank,
Tweed, Hadley & McCloy LLP, Counsel for NYSE, and Florence Harmon,
Senior Special Counsel, Division, Commission dated December 4, 2003.
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The NAV per share of each ETF is determined as of the close of the
regular trading session on the NYSE on each day that the NYSE is open.
The Trust sells Creation Unit Aggregations of each ETF only on business
days at the next determined NAV of each ETF.
Creation Unit Aggregations will be issued by each ETF 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 ETF'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 ETF in exchange for portfolio
securities of the applicable ETF (the ``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 Creation Unit Aggregations of
each ETF. All orders to purchase iShares in Creation Unit Aggregations
must be placed with the Distributor by or through an authorized
participant (the ``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 ETF and furnish to those placing orders confirmation that
the orders have been accepted. The Distributor may reject any order
that is not submitted in proper 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 ETF 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 difference between (1) the NAV (per
Creation Unit Aggregation) of the ETF 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 in the current Portfolio Deposit (based on
information at the end of the previous Business Day) for the relevant
Fund. The Portfolio Deposit will be applicable to an ETF (subject to
any adjustments to the Balancing Amount, as described below) in order
to effect purchases of Creation Unit Aggregations of the ETF 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 ETF will change from time
to time. The composition of the Deposit Securities may change in
response to adjustments to the weighting or 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 ETF,
or resulting from rebalance or additions or deletions to the relevant
Underlying Index. In addition, the Trust reserves the right with
respect to each ETF 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.
The Aggregate Bond Fund may invest in and hold mortgage pass-
through securities on a TBA basis. Since a TBA transaction is
essentially an agreement for future settlement of a mortgage security,
it is not possible to accept TBAs as part of the Portfolio Deposit.
Instead, the Aggregate Bond Fund will designate the mortgage pass-
through TBAs to be included in a Portfolio Deposit just as it would any
other Deposit Securities of a Portfolio Deposit, and will accept ``cash
in lieu'' of delivery of the designated mortgage pass-through TBAs. The
Aggregate Bond Fund will then enter into TBA agreements included as
Deposit Securities in the Portfolio Deposit.\18\
[[Page 69743]]
According to the Application, this will substantially minimize the
Aggregate Bond Fund's transaction costs, enhance operational
efficiencies and otherwise reduce any operational issues which the
acceptance of pools of mortgage pass-through securities might otherwise
present.\19\
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\18\ Prior to settlement of such TBA transactions, the ``cash in
lieu'' portion of the Portfolio Deposit will be invested in cash
equivalents, including money market mutual funds, and such
investments, along with cash and other liquid assets identified by
BGFA, will be segregated on the books and records of the Aggregate
Bond Fund or its Custodian in accordance with Section 18 of the 1940
Act and Investment Company Act Release No. 10666. Since the price of
a TBA transaction includes an assumed rate of return on the cash
held in anticipation of settlement, the Aggregate Bond Fund's
investment in cash equivalents prior to settlement is not expected
to have a material impact on potential tracking error or the
Aggregate Bond Fund's ability to track its Underlying Index. In
addition, since the interest or dividends that the Aggregate Bond
Fund accrues on a daily basis on its investment in cash equivalents
will be relatively small and will be included as part of the Cash
Component published on a daily basis according to the procedures
currently used for the ICUs, Applicants expect that such dividends
and interest will be reflected in the secondary market trading price
of iShares of the Aggregate Bond Fund. The Commission's order
relating to the Original Application permits acceptance of a ``cash
in lieu'' amount to replace Deposit Securities that are unavailable
for delivery or for other reasons. In addition, prior iShares orders
expressly permit ``cash-only purchases of Creation Unit
Aggregations'' where the Advisor believes such transactions would
``substantially minimize * * * transaction costs or would enhance *
* * operational efficiencies.'' See Investment Company Act Release
No. 24452 (May 12, 2000).
\19\ Intra-day and end-of-day pricing of TBAs is available from
multiple pricing sources, such as Bloomberg and TradeWeb. In
addition, the fungible nature of TBAs and commonly observed
execution and settlement procedures create significant pricing
efficiencies and market liquidity for TBAs. TBAs typically trade at
very narrow spreads on transactions of up to $300 million or more.
Since intra-day pricing of TBAs is readily available and the market
for mortgage pass-through TBAs is extremely liquid, the designation
of TBAs in the Portfolio Deposit and their inclusion as Fund
Securities should make pricing of the Aggregate Bond Fund and the
Deposit Amount more efficient and transparent, thus increasing
arbitrage efficiency.
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c. Availability of Information Regarding iShares and Underlying
Indices. 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 the ``IOPV'')
will be calculated by independent third parties (such as Bloomberg)
every 15 seconds during the NYSE's regular trading hours and
disseminated by the NYSE every 15 seconds on the Consolidated Tape.\20\
The IOPV will be updated throughout the day to reflect changing bond
prices, as well as TBA prices, using multiple prices from independent
third party pricing sources. Information about the intra-day prices for
the Deposit Securities of the each Fund is readily available to the
marketplace.\21\ Applicants represent that (1) IOPV will be calculated
by an independent third party; (2) IOPV will be calculated using prices
obtained from multiple independent third-party pricing sources (such as
broker-dealers) throughout the day; and (3) IOPV will be calculated in
accordance with pre-determined criteria and set parameters so that an
individual bond ``price'' based on an analysis of multiple pricing
sources is obtained for each security in the Portfolio Deposit.\22\
Closing prices of the ETFs' Deposit Securities are readily available
from published or other public sources, such as the NYSE's Automated
Bond System (ABS[reg]), the Trace Reporting and Compliance Engine
(``TRACE''), or on-line client-based information services provided by
Credit Suisse First Boston, Goldman Sachs, Lehman Brothers, IDC,
Merrill Lynch, Bridge, Bloomberg, TradeWeb and other pricing services
commonly used by bond mutual funds.\23\
---------------------------------------------------------------------------
\20\ Telephone conversation between Janet Kissane, Milbank,
Tweed, Hadley & McCloy LLP, Counsel for NYSE, and Florence Harmon,
Senior Special Counsel, Division, Commission dated December 4, 2003.
\21\ Authorized Participants and other market participants have
a variety of ways to access the intra-day security prices that form
the basis of the ETF's IOPV calculation. For example, intra-day
prices for treasury securities, agency securities and TBAs are
available from Bloomberg, TradeWeb, ABS[reg] and TRACE. Intra-day
prices for inflation protected public obligations of the U.S.
Treasury are available from Bloomberg and TradeWeb. Intra-day prices
of callable agency securities are available from TradeWeb. Intra-day
prices of corporate bonds are available from ABS[reg] and TRACE. In
addition, intra-day prices for each of these securities are
available by subscription or otherwise to Authorized Participants
and clients of major U.S. broker-dealers (such as Credit Suisse
First Boston, Goldman Sachs and Lehman Brothers). See supra note 6.
\22\ For example, Bloomberg Generic Prices could be used.
Bloomberg Generic Prices are current prices on individual bonds as
determined by Bloomberg using a proprietary automated pricing
program that analyzes multiple bond prices contributed to Bloomberg
by third-party price contributors (such as broker-dealers).
\23\ The Exchange understands that Credit Suisse First Boston,
Goldman Sachs, Lehman Brothers, Merrill Lynch, IDC, Bridge and
Bloomberg provide prices for each type of Deposit Security. TradeWeb
provides prices for each type of Deposit Security except mortgage
backed securities and corporate bonds. ABS[reg] and TRACE provide
prices for corporate bonds. Telephone conversation between Janet
Kissane, Milbank, Tweed, Hadley & McCloy LLP, Counsel for NYSE, and
Florence Harmon, Senior Special Counsel, Division, Commission dated
December 4, 2003.
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The Indices underlying the Aggregate Bond Fund will not be
calculated or disseminated intra-day because Lehman Brothers does not
calculate or disseminate intra-day values for these indices. The value
and return of the underlying Lehman Index is calculated and
disseminated each business day, at the end of the day, by Lehman
Brothers.\24\
---------------------------------------------------------------------------
\24\ Telephone conversation between Janet Kissane, Milbank,
Tweed, Hadley & McCloy, LLP, Counsel for NYSE, and Florence Harmon,
Senior Special Counsel, Division, Commission dated December 4, 2003.
---------------------------------------------------------------------------
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. 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 \25\ 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.\26\
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\25\ The Bid-Ask Price of each ETF is determined using the
highest bid and lowest offer on the Exchange as of the time of
calculation of each ETF's NAV.
\26\ The 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. 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.
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 (e.g., BrokerTec Global, Cantor Fitzgerald, Garban-
Intercapital, and Liberty Brokerage). 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.
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, 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.
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. Corporate prices are available at 20-minute intervals from
Capital Management Services at http://www.bondvu.com/quotmenu.htm.
TBMA provides links to price and other bond information sources on
its investors 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 Web sites.
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.
---------------------------------------------------------------------------
[[Page 69744]]
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 by 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.\27\
---------------------------------------------------------------------------
\27\ Investors redeeming Creation Unit Aggregations of the
Aggregate Bond Fund will receive cash for any Component Securities
that are mortgage pass-through TBAs.
---------------------------------------------------------------------------
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 if 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.\28\ In order to simplify the creation
and redemption process and align the settlement of iShares of the Fund
with the settlement of the Deposit Securities and Fund Securities
(i.e., the underlying U.S. Government securities, corporate and other
bonds) contributed or received in connection with creation and
redemption transactions, Applicants plan to settle transactions in
Deposit Securities and Fund Securities and iShares on the same
settlement cycle. (For the sake of clarity, the Exchange notes that
transactions in iShares in the secondary market will generally settle
on T + 3).\29\ 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.
---------------------------------------------------------------------------
\28\ See supra note 3.
\29\ Telephone conversation between Janet Kissane, Milbank,
Tweed, Hadley & McCloy LLP, Counsel for NYSE, and Florence Harmon,
Senior Special Counsel, Division, Commission dated December 4, 2003.
---------------------------------------------------------------------------
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 (generally T + 3 for the
Aggregate Bond Fund and T + 1 for the TIPS Fund), 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 receipt of all of 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. Each 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 Fund's Custodian through DTC, the trust will cause the
Custodian to initiate procedures to transfer the requisite Fund
Securities and any Cash Redemption Payment. On settlement
[[Page 69745]]
date, 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 CNS 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 Creations Unit Aggregations of iShares because the Custodian
will not new effect the Funds'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.
The Exchange represents that according to the Application and the
Advisor, the clearance and settlement process will not 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 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 amounts 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 my
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 Section 703.16 of the Manual. It is anticipated that a minimum
of two Creation Units (100,000 iShares) will be required to be
outstanding at the start of trading on the NYSE. 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 NYSE 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 Underlying Index.
2. Original and Annual Listing Fees. The NYSE's original listing
fees that would be applicable to each Fund if listed on the Exchange is
$5,000, and the continuing fees would be $2,000. The TIPS Fund will
list on the NYSE.
3. Stop and Stop Limit Orders. Commentary .30 to NYSE Rule 13
provides that stop and stop limit orders in an Investment Company Unit
shall be elected by a quotation, but specifies that if the electing bid
on an offer is more that 0.10 points away from the list sale and is for
the specialist's dealer account, prior Floor Official approval is
required for the election to be effective. This rule applies to
Investment Company Units generally, including fixed income ETFs.
4. NYSE Rule 460.10. NYSE Rule 460.10 generally precludes certain
business relationships between an issuer and specialist in the issuer's
securities. Exceptions in the Rule permit specialists in ETF shares,
including fixed income ETFs, to enter into Creation Unit transactions
through the Distributor to facilitate the maintenance of a fair and
orderly market. A specialist Creation Unit transaction may only be
effected on the same terms and conditions as any other investor and
only at the net asset value of the ETF shares. A specialist may acquire
a position in excess of 10% of the outstanding issue of the ETF shares;
provided, however, that a specialist registered in a security issued by
an investment company may purchase and redeem the investment company
unit, or securities that can be subdivided or converted into such unit,
from the investment company as appropriate to facilitate the
maintenance of a fair and orderly market in the subject security.
5. Prospectus Delivery. The Commission has granted the Trust an
exemption from certain prospectus delivery requirements under section
24(d) of the 1940 Act.\30\ Any product description used in reliance on
a section 24(d) exemptive order will comply with all representations
made therein and all conditions thereto. The NYSE, 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 the Funds.
---------------------------------------------------------------------------
\30\ See Investment Company Act Release No. 25623 (June 25,
2002).
---------------------------------------------------------------------------
6. Trading Halts. In order to halt the trading of an ETF, the
Exchange may consider, among other things, factors such as the extent
to which trading is not occurring in underlying security(s) and whether
other unusual conditions or circumstances detrimental to the
maintenance of a fair and orderly market are present. In addition,
trading in ETF shares is subject to trading halts caused by
extraordinary market volatility pursuant to NYSE Rule 80B.
[[Page 69746]]
7. Suitability. Pursuant to NYSE Rule 405, before a member, member
organization, allied member or employee of such member organization
undertakes to recommend a transaction in ETF shares, including fixed
income ETFs, such member or member organization should make a
determination that such shares are suitable for such customer. If any
recommendation is made with respect to such shares, the person making
the recommendation should have a reasonable basis for believing at the
time of making the recommendation, that the customer has such knowledge
and experience in financial matters that he or she may reasonably be
expected to be capable of evaluating the risks and any special
characteristics of the recommended transaction, and is financially able
to bear the risks of the recommended transaction. In the Exchange's
Information Circular references above, the Exchange will inform members
and member organizations of the requirements of NYSE Rule 405.\31\
---------------------------------------------------------------------------
\31\ See supra note 3.
---------------------------------------------------------------------------
8. Purchases and Redemptions in Creation Unit Size. In the
Information Circular referenced above, members and member organizations
will be informed that procedures for purchases and redemptions of
iShares in Creation Unit Size are described in the relevant Fund
Prospectus and SAI, and that iShares are not individually redeemable
but are redeemable only in Creation Unit Size aggregations or multiples
thereof.
9. 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 represents that its surveillance procedures are adequate to
properly monitor the trading of the Funds. The Exchange's current
trading surveillances focus on detecting securities trading outside
their normal patterns. When such situations are detected, surveillance
analysis follows and investigations are opened, where appropriate, to
review the behavior of all relevant parties for all relevant trading
violations. Through its member organizations and otherwise through its
membership in the Intermarket Surveillance Group, the Exchange is able
to obtain information regarding trading on any U.S. market in both the
Funds and the Component Securities.
If a broker-dealer is responsible for maintaining (or has a role in
maintaining), or calculating the underlying Index, it would be required
to erect and maintain a ``Fire Wall'' designed to prevent the flow of
information regarding the underlying index from the index production
personnel and index calculation personnel to the sales and trading
personnel. In the course of member organization examinations,\32\ the
Exchange will examine and test the broker-dealer's ``Fire Wall''
procedures to determine whether they are reasonably designed to prevent
the misuse of material non-public information by sales and trading
personnel that originates from index production personnel and
calculation personnel.
---------------------------------------------------------------------------
\32\ The Exchange will examine the member organization's
procedures for the first two years after the listing of the ETF and
thereafter periodically based on its assessment of risk in planning
the annual examination.
---------------------------------------------------------------------------
10. Hours of Trading/Minimum Price Variation. The Fund will trade
on the Exchange until 4:15 p.m. (eastern time). The minimum price
variation for quoting will be $.01.
2. Statutory Basis
The Exchange believes that the proposed rule change is consistent
with section 6(b) of the Act,\33\ in general, and furthers the
objectives of section 6(b)(5) of the Act,\34\ in particular, 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 regulating,
clearing, settling, processing information with respect to, and
facilitating transaction in securities, and, in general to protect
investors and the public interest.
---------------------------------------------------------------------------
\33\ 15 U.S.C. 78f(b).
\34\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------
B. Self-Regulatory Organization's Statement on Burden on Competition
The Exchange does not believe that the proposed rule change will
impose any burden on competition.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants or Others
No written comments were solicited or received with respect to the
proposed rule change.
III. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposal is
consistent with the Act. Persons making written submissions should file
six copies thereof with the Secretary, Securities and Exchange
Commission, 450 Fifth Street NW., Washington, DC 20549-0609. Comments
may also be submitted electronically at the following e-mail address: rule-comments@sec.gov. All comment letters should refer to File No.
NYSE-2003-39. The 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, comments should be sent in hardcopy or by e-mail but
not by both methods. 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
Commisson and any person, other than those that may be witheld from the
public in accordance with the provisions of 5 U.S.C. 552, will be
available for inspection and copying in the Commission's Public
Reference Room. Copies of such filing will also be available for
inspection and copying at the principal office of the NYSE. All
submissions should refer to the File No. SR-NYSE-2003-39 and should be
submitted by January 5, 2004.
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 is consistent with the requirements of section
6 of the Act \35\ and the rules and regulations thereunder applicable
to a national securities exchange.\36\ Specifically, the Commission
believes that the proposal is consistent with section 6(b)(5) of the
Act.\37\ 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 fixed income indices. 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.
---------------------------------------------------------------------------
\35\ 15 U.S.C. 78f.
\36\ 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).
\37\ Id.
---------------------------------------------------------------------------
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
[[Page 69747]]
general, protect investors and the public interest, and is not designed
to permit unfair discrimination between customers, issuers, brokers, or
dealers.\38\
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\38\ 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.
---------------------------------------------------------------------------
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 the 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 cases more than 25%, of its outstanding securities may do in-kind
purchases and redemptions of Creation Units.\39\
---------------------------------------------------------------------------
\39\ Investment Company Act Release No. 25622 (June 25, 2002).
---------------------------------------------------------------------------
The Commission notes that the Funds will operate in substantially
the same manner as the funds that were the subject of the Previous
Approval Order. The Commission notes one difference is that with
respect to the Aggregate Bond Fund, approximately 35% of its assets
will be invested in TBA transactions, which is a purchase or sale of a
pass-through security for future settlement at an agreed upon date. The
Exchange represented that the use of TBA transactions is not intended
to help the Aggregate Bond Fund outperform its Underlying Index, but
rather to increase pricing efficiency while at the same time
maintaining the Aggregate Bond Fund's exposure to its Underlying Index.
Since the intra-day prices of TBA agreements are more readily available
than intra-day prices on specific mortgage pools and because mortgage
pools tend to be less liquid that TBA agreements, the Commission agrees
that the use of TBA agreements should help maintain the efficiency of
the Aggregate Bond Fund's arbitrage mechanism.
For the reasons stated in the Notice, above, the Commission finds
that adequate rules and procedures exist to govern the trading of ICUs,
including the Funds. For the reasons stated in the Notice, above, the
Commission finds that because of the nature of the particular fixed
income securities to be included in the portfolios of the Funds (i.e.,
U.S. Government securities, investment grade corporate bonds, and TBA
transactions), the pricing information should be available. However,
the Commission notes that 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 because arbitrators may wait for greater premiums or
discounts to develop in the market price of the ETF shares before
engaging in arbitrage transactions. The Commission expects the Exchange
to contact Commission staff if the tracking error for these Funds
exceeds the represented 5%.
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 ETF shares without delivery a
prospectus to the purchaser.\40\ Instead, under the exemption and under
NYSE's listing standards, sales in the secondary market must be
accompanied by a ``product description,'' describing the ETF and its
shares.\41\ 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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\40\ See Investment Company Act Release Nos. 25595 (May 29,
2002) (notice) and 25623 (June 25, 2002) (order).
\41\ 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 EFT
under section 703.16 of the NYSE Listed Company Manual 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 Exchange Rule 405 (``know your
customer rule'') regarding transactions in such fixed income ETFs.
Exchange Rule 405 generally requires that members use due diligence to
learn the essential facts relative to every customer when a transaction
in the Fund shares is recommended and determine that such shares are
suitable for such customer.\42\ 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 Act.\43\
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\42\ NYSE Rule 405.
\43\ 15 U.S.C. 78f(b)(f).
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The Commission also notes that certain concerns are raised when a
broker-dealer, such as Lehman, is involved in the development,
maintenance, and calculation of an index upon which an ETF is based.
Lehman has represented that it has procedures in place to prevent the
misuse of material, non-public information relating to the index.\44\
The Commission believes that these provisions should help to address
concerns raised by Lehman's involvement in the management of the
indices. The Commission believes that this should act to further
minimize the possibility of manipulation.
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\44\ The Commission expects that the procedures implemented by
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 the NYSE has appropriate
surveillance procedures in place to detect and deter potential
manipulation for similar index-linked products. By applying these
procedures to Funds, the Commission believes that the potential for
manipulation should be minimized, while protecting investors and the
public interest.
NYSE has requested that the Commission find good cause for
approving the proposed rule change, as amended, prior to the thirtieth
day after the date of publication of notice thereof in the Federal
Register. The Funds will trade on the Exchange in the same manner as
the funds that were the subject of the Previous Approval Order and the
proposed rule change. The proposed rule change raises no novel issues.
Based on the above, the Commission finds good cause to accelerate
approval of the proposed rule change.
[[Page 69748]]
It is Therefore ordered, pursuant to section 19(b)(2) of the Act
\45\ that the proposed rule change (SR-NYSE-2003-39) is hereby approved
on an accelerated basis.
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\45\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\46\
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\46\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-30840 Filed 12-12-03; 8:45 am]
BILLING CODE 8010-01-M