[Federal Register Volume 62, Number 188 (Monday, September 29, 1997)]
[Notices]
[Pages 50973-50977]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-25687]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39117; File No. SR-CHX-96-14]


Self-Regulatory Organizations; Order Granting Approval to 
Proposed Rule Change by the Chicago Stock Exchange, Inc., Relating to 
Trading of Particular Investment Company Units

September 22, 1997.

I. Introduction

    On April 23, 1996, the Chicago Stock Exchange, Inc. (``CHX'' or 
``Exchange'') submitted to the Securities and Exchange Commission 
(``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \1\ and Rule 19(b)-4 thereunder,\2\ a 
proposed rule change to amend Article XXVIII of the CHX's Rules to 
permit them to trade certain units representing an interest in a 
registered investment company (``Units'') on CHX.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    The proposed rule change, together with the substance of the 
proposal, was published for comment in Securities Exchange Act Release 
No. 37228 (May 20, 1996) 61 FR 26940 (May 29, 1996). One comment letter 
was received in response to the proposal.\3\
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    \3\ See Letter from James F. Duffy, Executive Vice President and 
General Counsel, Legal and Regulatory Policy, American Stock 
Exchange (``Amex''), to Jonathan G. Katz, Secretary, Commission, 
dated June 20, 1996 (``Amex letter'').
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II. Background and Description

    In SR-CHX-96-12, the Exchange requested and received approval of 
proposed rule changes allowing the listing and/or trading of Units.\4\ 
CHX is proposing to apply its existing listing standards for the 
trading of Units to the trading of World Equity Benchmark Securities 
(``WEBS'') pursuant to unlisted trading privileges (``UTP''). CHX is 
also proposing to amend Article

[[Page 50974]]

XXVIII, Rule 24, to add Interpretation and Policy .02 to specifically 
allow the Exchange to trade WEBS pursuant to unlisted trading 
privileges. WEBS currently are approved for trading on the American 
Stock Exchange (``Amex'').\5\ If at a later time CHX desires to list 
WEBS, rather than only trade WEBS pursuant to UTP, the Exchange will 
request Commission approval for that listing in a separate proposed 
rule change filed pursuant to Section 19(b) of the Act.\6\
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    \4\ See Securities Exchange Act Release Nos. 37121 (April 17, 
1996), 61 FR 17932 (April 23, 1996) (notice of File No. SR-CHX-96-
12) and 37589 (August 21, 1996), 61 FR 44370 (August 28, 1996) 
approval order). In that rule filing, the Exchange also stated its 
intent to trade CountryBasket securities, pursuant to a request for 
unlisted trading privileges. CountryBasket securities are Units 
designed to track the performance of specific foreign indices, more 
fully described in SR-CHX-96-12 and SR-NYSE-95-23. Id. See also 
Securities Exchange Act Release No. 36923 (March 5, 1996), 61 FR 
10410 (March 13, 1996) (order approving File No. SR-NYSE-95-23).
    \5\ See Securities Exchange Act Release No. 36947 (March 8, 
1996), 61 FR 10606 (March 14, 1996) (``Amex WEBS Approval Order'').
    \6\ The remainder of this section discusses the structure of 
WEBS, the details of which are taken from SR-Amex-95-43 and its 
Amendments Nos. 1, 2, 3. The information provided here is 
significantly condensed from Amex's filing. CHX notes that the Amex 
has represented that customers who purchase WEBS will receive a 
detailed prospectus from the issuer.
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Structure of WEBS

    Rules to accommodate the trading of Index Fund Shares generally on 
Amex, along with Amex's trading of WEBS, were previously approved by 
the Commission.\7\ The information provided below is intended to 
provide a description of how WEBS are created and traded and is similar 
to that discussed in the original Amex WEBS Approval Order.
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    \7\ See Amex WEBS Approval Order, supra note 5.
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    WEBS are issued by Foreign Fund, Inc., and based on seventeen 
Morgan Stanley Capital International (``MSCI'') Indices (each 
individually an ``MSCI Index'' or ``Index'' and collectively ``MSCI 
Indices'' or ``Indices''). The countries whose markets are represented 
by those indices are: Australia, Austria, Belgium, Canada, France, 
Germany, Hong Kong, Italy, Japan, Malaysia, Mexico, Netherlands, 
Singapore, Spain, Sweden, Switzerland, and the United Kingdom.
    The investment objective of each WEBS series is to seek to provide 
investment results that correspond generally to the price and yield 
performance of public securities traded in the aggregate in particular 
foreign markets, as represented by specific MSCI Indices. Each WEBS 
series will use a ``passive'' or indexing investment approach which 
attempts to approximate the investment performance of its benchmark 
index through quantitative analytical procedures.
    A WEBS series normally will invest at least 95% of its total assets 
in stocks that are represented in the relevant MSCI Index and will at 
all times invest at least 90% of its total assets in such stocks. A 
WEBS series will not hold all of the issues that comprise the subject 
MSCI Index, but will attempt to hold a representative sample of the 
securities in the Index in a technique known as ``portfolio sampling.''
    Foreign Fund, Inc. will issue and redeem WEBS of each Index Series 
only in aggregations of shares specified for each Index Series (each 
aggregation a ``Creation Unit''). The number of shares per Creation 
Unit will range from 40,000 to 600,000. In its original filing to list 
and trade WEBS, Amex anticipated that the value of a Creation Unit at 
the start of trading would range from $450,000 to $10,000,000, and the 
net asset value (``NAV'') of an individual WEBS would range from $10 to 
$20.

The MSCI Indices

    MSCI generally seeks to have 60% of the capitalization of a 
country's stock market index reflected in the MSCI Index for such 
country. Thus, the MSCI Indices seek to balance the inclusiveness of an 
``all share'' index against the replicability of a ``blue chip'' index. 
MSCI applies the same criteria and calculation methodology across all 
markets for all indices, developed and emerging.
    All single-country MSCI Indices are market capitalization weighted. 
For countries that restrict foreign ownership, MSCI calculates two 
Indices. The additional Indices are called ``free'' Indices, and they 
exclude companies and share classes not purchasable by foreigners. Free 
Indices are currently calculated for Singapore, Mexico, the 
Philippines, and Venezuela, and for those regional and international 
indices which include such markets. The Mexico and Singapore WEBS 
series will be based on the free Indices for those countries. There are 
no WEBS series corresponding to the Philippines and Venezuela MSCI 
Indices.
    All MSCI Indexes are calculated daily. The calculation method 
weights stocks in an index by their beginning-of-period market 
capitalization. Share prices are ``swept clean'' daily and adjusted for 
any rights issues, stock dividends or splits. The MSCI Indices 
currently are calculated in local currency and in U.S. dollars, without 
dividends and with gross dividends reinvested.
    Prices used to calculate the MSCI Indices are the official exchange 
closing prices. All prices are taken from the dominant exchange in each 
market. To calculate the applicable foreign currency exchange rate, 
MSCI uses WM/Reuters Closing Spot Rates for all developed and emerging 
markets except those in Latin America. Because of the high volatility 
of currencies in some Latin American countries, MSCI continue to 
calculate its own rates for those countries. Under exceptional 
circumstances MSCI may elect to use an alternative exchange rate for 
any country if the WM/Reuters rate is believed not to be representative 
for a given currency on a particular day.
    Each MSCI Index on which a WEBS series is based is calculated by 
MSCI for each trading day in the applicable foreign exchange market 
based on official closing prices in such exchange market. For each 
trading day, MSCI publicly disseminates each Index value for the 
previous day's close. MSCI Indices are reported periodically in major 
financial publications and also are available through vendors of 
financial information.
    Foreign Fund, Inc. will cause to be made available daily the names 
and required number of shares of each of the securities to be deposited 
in connection with the issuance of WEBS in Creation Unit size 
aggregations for each WEBS series, as well as information relating to 
the required cash payment representing, in part, the amount of accrued 
dividends applicable to such WEBS series. This information will be made 
available by the Fund Advisor to any National Securities Clearing 
Corporation (``NSCC'') participant requesting such information. In 
addition, other investors can request such information directly from 
the Fund distributor. The NAV for each WEBS series will be calculated 
directly by the Fund administrator, PFPC, Inc. NAVs will be made 
available to the public from the Fund distributor by means of a toll-
free number, and also will be available to NSCC participants through 
data made available from NSCC.
    To provide current WEBS pricing information, Amex represented that 
it anticipated it would disseminate through the facilities of the 
Consolidated Tap Association (``CTA'') an indicative optimized 
portfolio value'' (``Value'') for each WEBS series as calculated by 
Bloomberg, L.P. (``Bloomberg''). The Value will be disseminated on a 
per WEBS basis every fifteen seconds during regular Amex trading hours 
of 9:30 A.M. to 4:00 P.M. New York time.\8\
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    \8\ These are the same trading hours as at the CHX.
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    The Value likely will not reflect the value of all securities 
included in the applicable benchmark MSCI Index. In addition, the Value 
will not necessarily reflect the precise composition of the current 
portfolio of securities held by the Fund for each WEBS series at a 
particular moment. Therefore, the Value on a per WEBS basis 
disseminated during Amex trading hours should not

[[Page 50975]]

be viewed as a real-time update of the net asset value of the Fund, 
which is calculated only once a day. It is expected, however, that 
during the trading day the Value will closely approximate the value per 
WEBS share of the portfolio of securities for each WEBS series except 
under unusual circumstances.
    The Exchange will distribute an information circular to its members 
in connection with the trading of WEBS. The circular will discuss the 
special characteristics and risks of trading this type of security. 
Specifically, the circular, among other issues, will discuss what WEBS 
are, how they are created and redeemed, the requirement that members 
and member firms deliver a prospectus to investors purchasing WEBS 
prior to or concurrently with the confirmation of a WEBS transaction, 
applicable Exchange rules, dissemination information, trading 
information, and the applicability of suitability rules.\9\ The 
Exchange also intends to utilize its existing surveillance procedures 
to surveil trading in WEBS, including surveilling specialist compliance 
with Article XXX, Rule 23(a), which contemplates specialists engaging 
in transactions with the issuer of WEBS under certain circumstances.
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    \9\ The Commission notes that CHX has filed a proposed rule 
change (SR-CHX-97-21) which would require, in part, that any CHX 
member, before recommending a transaction in any security, have 
reasonable grounds for believing that the recommendation is suitable 
for such customer upon the basis of the facts, if any, disclosed by 
such customer as to his other security holdings and as to his 
financial situation and needs.
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III. Summary of Comments

    Amex filed a comment letter to the proposed rule change.\10\ Amex 
states that CHX, or any market trading or proposing to trade WEBS, 
should be required to submit for Commission review an information 
circular to distribute to their members prior to trading WEBS on the 
exchange. Amex also states that any such information circular should 
adequately explain the unique characteristics and risks of this type of 
security, including member responsibilities, and identify the Exchange 
personnel who can be contacted to discuss any issues or answer any 
inquiries relating to the trading of WEBS.
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    \10\ See supra note 3.
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IV. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities exchange, and, in 
particular, with the requirements of Section 6(b)(5).\11\ The 
Commission believes that the Exchange's proposal to trade WEBS pursuant 
to unlisted trading privileges will provide investors with a convenient 
way of participating in foreign securities markets and could produce 
added benefits to investors through the increased competition between 
other market centers trading the product. Specifically, the Commission 
believes that CHX's proposal should help provide investors with 
increased flexibility in satisfying their investment needs, by allowing 
them to purchase and sell at negotiated prices throughout the trading 
day securities that replicate the performance of several portfolios of 
stock,\12\ and by increasing the availability of WEBS as an investment 
tool. Accordingly, as discussed below, the rule proposal is consistent 
with the requirements of Section 6(b)(5) that Exchange rules 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.\13\
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    \11\ 15 U.S.C. 78f(b)(5).
    \12\ The Commission notes that unlike typical open-end 
investment companies, where investors have the right to redeem their 
fund shares on a daily basis, investors in WEBS can redeem them in 
creation unit size aggregations only.
    \13\ In approving this rule, the Commission notes that it has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
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    As the Commission noted in greater detail in the order approving 
WEBS for listing and trading on Amex, \14\ the estimated cost of an 
individual WEBS \15\ should make it attractive to individual retail 
investors who wish to hold a security replicating the performance of a 
portfolio of foreign stocks. The Commission also notes that WEBS should 
provide investors with several advantages over standard open-end 
investment companies; in particular, investors can trade WEBS 
continuously throughout the day in secondary markets at negotiated 
prices.\16\ In contrast, Investment Company Act Rule 22c-1 \17\ limits 
holders and prospectus holders of open-end management investment 
company shares to purchasing or redeeming securities of the fund based 
on the net asset value of the securities held by the fund as designated 
by the board of directors. Thus, WEBS should allow investors to respond 
quickly to market changes through intra-day trading opportunities, 
expand the opportunity for retail investors to engage in hedging 
strategies, and reduce transaction costs for trading a portfolio of 
stocks. The Commission notes that under the proposed rule change, these 
benefits of WEBS will now be available to investors trading on CHX and 
believes that the addition of their trading on CHX pursuant to UTP 
could produce added benefits to investors through the increased 
competition.
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    \14\ See Amex WEBS Approval Order, supra note 5. The Commission 
hereby incorporates by reference the discussion and rational for 
approving WEBS provided in the Amex WEBS Approval Order.
    \15\ As noted in the Background and Description section supra, 
the estimated cost at the time of the approval for trading on Amex 
was $10 to $20 per individual WEBS.
    \16\ The Commission believes that WEBS will not trade at a 
material discount or premium in relation to their net asset value, 
because of potential arbitrage opportunities. See Amex WEBS Approval 
Order, supra note 5, at 31. the mere potential for arbitrage should 
keep the market price of WEBS comparable to their net asset values; 
therefore, arbitrage activity likely will not be significant. In 
addition, the Fund will redeem in-kind, thereby enabling the Fund to 
invest virtually all of its assets in securities comprising the MSCI 
Indices.
    \17\ 17 CFR 270.22c-1. Investment Company Act Rule 22c-1 
generally provides that a registered investment company issuing a 
redeemable security, its principal underwriter, and dealers in that 
security may sell, redeem, or repurchase the security only at a 
price based on the net asset value next computed after receipt of an 
investor's request to purchase, redeem, or resell. The net asset 
value of an open-end management investment company generally is 
computed once daily Monday to Friday as designated by the investment 
company's board of directors. The Commission granted WEBS an 
exemption from this provision to allow them to trade in the 
secondary market at negotiated prices. See Amex WEBS Approval Order, 
supra note 5.
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    The Commission notes that although the value of WEBS are based on 
the value of the securities and cash held in the Fund, WEBS are not 
leveraged instruments. WEBS are essentially equity securities that 
represent an interest in a portfolio of stocks designed to reflect 
substantially the applicable MSCI Index. Accordingly, it is appropriate 
to regulate WEBS in a manner similar to other equity securities. 
Nonetheless, the Commission believes that the unique nature of WEBS 
raises certain, disclosure, trading, and other issues that need to be 
addressed. The remainder of this section addresses these issues, 
although they are discussed in greater detail in the Amex WEBS Approval 
Order, where the Commission initially approved WEBS for trading as a 
new product.

Trading of WEBS On CHX

    The Commission notes that, pursuant to Rule 12f-5 under the Act, 
\18\ prior to trading a particular class or type of security pursuant 
to UTP, CHX must

[[Page 50976]]

have listing standards comparable to those of the primary market on 
which the security is listed. The Commission finds that adequate rules 
and procedures exist to govern the trading of WEBS on CHX, pursuant to 
UTP. WEBS will be deemed equity securities subject to CHX's rules 
governing the trading of equity securities. Accordingly, the Exchange's 
existing general rules that currently apply to the trading of equity 
securities will also apply to WEBS. In addition, CHX's Article XXVIII, 
rule 24,\19\ which contains specific listing and delisting criteria to 
accommodate the trading of Units, will apply to the trading of 
WEBS.\20\ These criteria should help to ensure that a minimum level of 
liquidity will exist in each WEBS series to allow for the maintenance 
of fair and orderly markets. The delisting criteria allow the Exchange 
to consider the suspension of trading and the delisting of a series of 
Units, including suspending trading in WEBS traded on the Exchange 
pursuant to UTP, if an event were to occur that made further dealings 
in such securities inadvisable. This will give the Exchange flexibility 
to suspend trading in WEBS if circumstances warrant such action. 
Accordingly, the Commission believes that CHX's equity rules in 
general, and CHX's Article XXVIII, Rule in 24 particular, provide 
adequate safeguards to prevent manipulative acts and practices and to 
protect investors and the public interest.\21\
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    \18\ 17 CFR 240.12f-5.
    \19\ The Commission approved generic rules for the listing and/
or trading of investment company units on CHX in 1996. See 
Securities Exchange Act Release No. 37589 (August 21, 1996), 61 FR 
44370 (August 28, 1996).
    \20\ The Commission notes the listing and delisting criteria is 
similar to those adopted by Amex to trade WEBS.
    \21\ The Commission also believes that the proposed rule change 
should help protect investors and the public interest, and help 
perfect the mechanisms of a national market system, in that it will 
allow for the trading of WEBS on CHX pursuant to UTP, making WEBS 
more broadly available to the investing public.
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    The Commission notes that once CHX receives approval to trade WEBS 
pursuant to UTP, CHX intends to request that WEBS be declared an 
Intermarket Trading System (``ITS'') eligible security. WEBS could then 
be traded through ITS, subjecting the trading of WEBS to all the ITS 
rules and procedures, including the ITS trade-through rule.

Disclosure

    The Commission believes that CHX's proposal should provide for 
adequate disclosure to investors relating to the terms, 
characteristics, and risks of trading WEBS. All WEBS investors, 
including those purchasing WEBS on CHX pursuant to UTP, will receive a 
prospectus regarding the product. Because WEBS trading on CHX pursuant 
to UTP will be in continuous distribution, the prospectus delivery 
requirements of the Securities Act of 1933 will apply to both the 
initial investors and to investors purchasing such securities in the 
secondary market on CHX. The prospectus addresses the special 
characteristics of WEBS, including a statement regarding their 
redeemability and method of creation, and that WEBS are not 
individually redeemable.
    CHX has also drafted an information circular that will be sent to 
all CHX members prior to the commencement of trading of WEBS. The 
Commission notes that it has reviewed this draft information circular 
and believes it adequately explains the unique characteristics and 
risks of WEBS. The circular will note, for example, Exchange member 
responsibilities, including that before an Exchange member undertakes 
to recommend a transaction in WEBS, it should make a determination that 
it is in compliance with applicable rules of other self-regulatory 
organizations of which it is a member, including suitability rules.\22\ 
The circular will also address members' responsibility to deliver a 
prospectus to all investors purchasing WEBS, as well as highlight the 
characteristics of WEBS, including that they are only redeemable in 
Creation Unit size aggregation.\23\ The Commission also notes that 
CHX's draft circular is essentially the same as the Amex WEBS circular 
previously reviewed by the Commission. The Commission also believes 
that CHX's draft information circular adequately addresses Amex's 
comments.\24\
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    \22\ See supra note 9.
    \23\ The Commission notes that the information circular also 
discusses exemptive relief granted by the Commission from certain 
rules under the Act, exemptions that CHX members can rely upon. The 
applicable rules are: Rule 10b-10(e); Rule 10b-13; Rule 10b-
17(b)(2); Rule 11(d)(1); Rules 15cl-5 and 15cl-6; and Regulation M 
to the extent it superseded Rules 10b-6 and 10b-7.
    \24\ In particular, in response to the comments in Amex's 
comment letter, the Commission notes it has reviewed CHX's draft 
information circular and that it believes the circular adequately 
explains the unique characteristics and risks of WEBS, including 
member responsibilities, and that it identifies the Exchange 
personnel to contact regarding issues relating to the trading of 
WEBS.
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Dissemination of WEBS Portfolio Information

    The Commission believes that since Amex is disseminating the Values 
for the seventeen WEBS series, investors will be provided with timely 
and useful information concerning the value of WEBS, on per WEBS basis. 
The Commission notes that information is disseminated through 
facilities of the CTA and reflects the currently available information 
concerning the value of the assets comprising the Deposit securities. 
The information is disseminated every 15 seconds during the hours of 
9:30 a.m. to 4:00 p.m., Eastern standard time and will be available to 
all investors, irrespective of where the transaction is executed. Also, 
since the value is expected to closely track the applicable WEBS 
series, the Commission believes the Values will provide investors with 
adequate information to determine the intra-day value of a given WEBS 
series.\25\ In the Amex WEBS Approval Order, the Commission noted that 
it expected Amex to monitor the disseminated Value, and if Amex 
determines that the Value does not closely track applicable WEBS 
series, it will arrange to disseminate an adequate alternative.
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    \25\ In addition, the Amex WEBS Approval Order states that the 
statement of additional information (``SAI'') to the preliminary 
prospectus states that each series will calculate its NAV per share 
at the close of the regular trading session for the NYSE on each day 
that the Amex is open for business. NAV generally will be based on 
the last quoted sales price on the exchange where the security 
primarily is traded. See Amex WEBS Approval Order, supra note 5.
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Surveillance

    The Commission notes that CHX has submitted surveillance procedures 
for WEBS and believes that those procedures are adequate to address 
concerns associated with the listing and trading of such securities, 
including any concerns associated with specialists purchasing and 
redeeming Creation Units. The Exchange has represented that its 
surveillance procedures should allow it to identify situations where 
specialists purchase or redeem Creation Units to ensure compliance with 
CHX Article XXX, Rule 23(a), which requires that such purchases or 
redemptions facilitate the maintenance of a fair and orderly market in 
the subject security.\26\
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    \26\ The Commission notes that, in the Amex WEBS Approval Order, 
it discussed the concerns raised when a broker-dealer is involved in 
the development and maintenance of a stock index upon which a 
product such as WEBS is based. Adequate procedures to prevent the 
misuse of material, non-public information regarding changes to 
component stocks in an MSCI Index have been adopted and should help 
to address concerns raised by Morgan Stanley's involvement in the 
management of the Indices.
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Specialists

    The Commission finds that it is consistent with the Act to allow a 
specialist registered in a security issued by an Investment Company to 
purchase or redeem the listed security from the

[[Page 50977]]

issuer as appropriate to facilitate the maintenance of a fair and 
orderly market in that security. The Commission believes that such 
market activities should enhance liquidity in such security and 
facilitate a specialist's market making responsibilities. In addition, 
because the specialist only will be able to purchase and redeem WEBS on 
the same terms and conditions as any other investor (and only at the 
NAV), and Creation transactions must occur through the distributor and 
not directly with the issuer, the Commission believes that concerns 
regarding potential abuse are minimized. As noted above, the Exchange's 
surveillance procedures also should ensure that such purchases are only 
for the purpose of maintaining fair and orderly markets, and not for 
any other improper or speculative purposes. Finally, the Commission 
notes that its approval of this aspect of the Exchange's rule proposal 
does not address any other requirements or obligations under the 
federal securities laws that may be applicable.\27\
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    \27\ The Commission notes that with respect to WEBS, broker-
dealers and other persons are cautioned in the prospectus and/or the 
Fund's SAI that some activities on their part may, depending on the 
circumstances, result in their being deemed statutory underwriters 
and subject them to the prospectus delivery and liability provisions 
of the Securities Act of 1933.
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\28\ that the proposed rule change (SR-CHX-96-14) is approved.
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    \28\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\29\
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    \29\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-25687 Filed 9-26-97; 8:45 am]
BILLING CODE 8010-01-M