[Federal Register Volume 62, Number 209 (Wednesday, October 29, 1997)]
[Notices]
[Pages 56211-56217]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-28572]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-39268; File No. SR-CSE-97-10]
Self-Regulatory Organizations; Notice of Filing and Order
Granting Accelerated Approval of Proposed Rule Change by the Cincinnati
Stock Exchange, Inc. Relating to Listing and Trading Standards for
Portfolio Depositary Receipts
October 22, 1997.
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 October 14, 1997,\3\ the Cincinnati Stock Exchange, Inc. (``CSE'' or
``Exchange'') filed with the Securities and Exchange Commission
(``Commission'') the proposed rule change as described in Items I and
II below, which Items have been prepared by the self-regulatory
organization. The Commission is publishing this notice to solicit
comments on the proposed rule change from interested persons. The
Commission is also granting accelerated approval of the proposed rule
change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ The Exchange filed Amendment No. 1 to the proposed rule
change on October 20, 1997, the substance of which is incorporated
into this release. See letter from Adam Gurwitz, Vice President
Legal, CSE, the Heather Seidel, Attorney, Market Regulation,
Commission, dated October 17, 1997 (``Amendment No. 1'').
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The CSE proposes to adopt new Exchange rule 11.9(v), to provide
listing standards for, and trading in Portfolio Depositary Receipts
(``PDRs''). The text of the proposed rule change is available at the
Office of the Secretary, CSE and at the Commission.
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 self-regulatory organization
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 self-regulatory
organization has prepared summaries, set forth in Sections A, B, and C
below, of the most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
a. Listing Requirements for Portfolio Depositary Receipts. The
Exchange proposes to adopt new Rule 11.9(v) to accommodate the trading
of PDRs, i.e., securities that are interests in a unit investment trust
(``Trust'') holding a portfolio of securities linked to an index. Each
Trust will provide investors with an instrument that (1) closely tracks
the underlying portfolio of securities, (2) trades like a share of
common stock, and (3) pays holders of the instrument periodic dividends
proportionate to those paid with respect to the underlying portfolio of
securities, less certain expenses (as described in the Trust
prospectus).
Under the proposal, the Exchange may list and trade, or trade
pursuant to unlisted trading privileges, PDRs based on one or more
stock indices or securities portfolios. PDRs based on each particular
stock index or portfolio will be designated as a separate series and
identified by a unique symbol. The stocks that are included in an index
or portfolio on which PDRs are based will be selected by the Exchange,
or by another person having a proprietary interest in and authorized
use of such index or portfolio, and may be revised as may be deemed
necessary or
[[Page 56212]]
appropriate to maintain the quality and character of the index or
portfolio.
In connection with an initial listing, the Exchange proposes that,
for each Trust of PDRs, the Exchange will establish a minimum number of
PDRs required to be outstanding at the time of commencement of Exchange
trading, and such minimum number will be filed with the Commission in
connection with any required submission under Rule 19b-4 for each
Trust. If the Exchange trades a particular PDR pursuant to unlisted
trading privileges, the Exchange will follow the listing exchange's
determination of the appropriate minimum number.
Because the Trust operates on an open-end type basis, and because
the number of PDR holders is subject to substantial fluctuations
depending on market conditions, the Exchange believes it would be
inappropriate and burdensome on PDR holders to consider suspending
trading in or delisting a series of PDRs, with the consequent
termination of the Trust, unless the number of holders remains severely
depressed during an extended time period. Therefore, twelve months
after the formation of a Trust and commencement of Exchange trading,
the Exchange will consider suspension of trading in, or removal from
listing of, a Trust when, in its opinion, further dealing in such
securities appears unwarranted under the following circumstances:
(a) If the Trust on which the PDRs are based has more than 60 days
remaining until termination and there have been fewer that 50 record
and/or beneficial holders of the PDRs for 30 or more consecutive
trading days; or
(b) If the index on which the Trust is based is no longer
calculated; or
(c) If such other event occurs or condition exists which, in the
opinion of the Exchange, makes further dealings in such securities on
the Exchange inadvisable.
A Trust will terminate upon removal from Exchange listing and its
PDRs will be redeemed in accordance with provisions of the Trust
prospectus. A Trust may also terminate under such other conditions as
may be set forth in the Trust prospectus. For example, the sponsor of
the Trust (the ``Sponsor''), following notice to PDR holders, will have
discretion to direct that the Trust be terminated if the value of
securities in such Trust falls below a specified amount.
B. Trading of PDRs. Dealing in PDRs on the Exchange will be
conducted pursuant to the Exchange's general agency-auction trading
rules. The Exchange's general dealing and settlement rules would apply,
including its rules on clearance and settlement of securities
transactions and its equity margin rules. Other generally applicable
Exchange equity rules and procedures would also apply including, among
others, rules governing the priority, parity and precedence of orders
and the responsibilities of specialists.\4\
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\4\ CSE Rule 3.7, Recommendations to Customers, will also apply
to transactions in PDRs, including SPDRs and MidCap SPDRs. That rule
provides that when recommending to a customer the purchase, sale or
exchange of any security, a member or member organization shall have
reasonable grounds for believing that the recommendation is suitable
for such customer upon the basis of the facts disclosed by such
customer, after reasonable inquiry by the member or member
organization, as to the customer's other securities holdings and as
to the customer's financial situation and needs. Telephone
conversation between Adam Gurwitz, Vice-President Legal, CSE, and
Heather Seidel, Attorney, Market Regulation. Commission, on October
17, 1997.
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The CSE has represented that the Exchange understands that SPDRs
and MidCap SPDRs will both become ITS System securities on October 24,
1997. The Exchange intends to trade both SPDRs and MidCap SPDRs when
they become ITS System securities, but does not intend to trade them
before that time.
With respect to trading halts, the trading of PDRs would be halted,
along with trading of all other listed or traded stocks, in the event
the ``circuit breaker'' thresholds are reached.\5\ In addition, for
PDRs tied to an index, while the triggering of futures price limits for
the S&P 500 Composite Price Index (``S&P 500 Index''), S&P Composite
Price Stock Index (``S&P 100 Index'') or Major Market Index (``MMI'')
futures contracts will not, in themselves, result in a halt in PDR
trading or a delayed opening, such an event could be considered by the
Exchange, along with other factors, such as a halt in trading in S&P
100 Index Options (``OEX''), S&P 500 Index Options (``SPX''), or Major
Market Index Options (``XMI''), in deciding whether to halt trading in
PDRs.
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\5\ See Securities Exchange Act Release No. 38221 (January 31,
1997), 62 FR 5871 (February 7, 1997) and note 7 therein.
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The Exchange will issue a circular to its Members and Member
Organizations informing them of Exchange policies regarding trading
halts in such securities. For a PDR based on an index, these factors
would include whether trading has been halted or suspended in the
primary market(s) for any combination of underlying stocks accounting
for 20% or more of the applicable current index group value; or whether
other unusual conditions or circumstances detrimental to the
maintenance of a fair and orderly market are present.
c. Disclosure. Proposed Rule 11.9(v) requires that Members and
Member Organizations provide to all purchasers of each series of PDRs a
written description of the terms and characteristics of such
securities, in a form approved by the Exchange, not later than the time
a confirmation of the first transaction in such series of PDRs is
delivered to such purchaser. In this regard a Member or Member
Organization carrying an omnibus account for a non-member broker-dealer
will be required to inform such non-member that execution of an order
to purchase PDRs for such omnibus account will be deemed to constitute
an agreement by the non-member to make such written description
available to its customers on the same terms as are directly applicable
to Members and Member Organizations. The written description must be
included with any sales material on that series of PDRs that a Member
provides to customers or the public. Moreover, other written materials
provided by a Member or Member Organization to customers or the public
making specific reference to a series of PDRs as an investment vehicle
must include a statement in substantially the following form: ``A
circular describing the terms and characteristics of [the series of
PDRs] is available from your broker. It is recommended that you obtain
and review such circular before purchasing [the series of PDRs]. In
addition, upon request you may obtain from your broker a prospectus for
[the series of PDRs].'' Additionally, as noted above, the Exchange
requires that Members and Member Organizations provide customers with a
copy of the prospectus for a series of PDRs upon request.
Two existing PDRs, Standard & Poor's Depository Receipts
(``SPDRs'') and Standard & Poor's MidCap 400 Depository Receipts
(``MidCap SPDRs''), are traded on the American Stock Exchange
(``Amex'').\6\ The Exchange is not asking for permission to list SPDRs
or MidCap SPDRs pursuant to unlisted trading privileges once the
generic listing standards set forth herein are approved.
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\6\ SPDRs and MidCap SPDRs are defined and discussed more fully
below.
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Pursuant to SEC Rule 12f-5, in order to trade a particular class or
type of security pursuant to unlisted trading privileges, the Exchange
must have rules providing for transactions in such class or type of
security. The Amex has enacted listing standards for PDRs, and the
Exchange's proposed rule change is
[[Page 56213]]
designed to create similar standards for PDR listing and/or trading on
the CSE. As stated above, the Exchange proposes to trade SPDRs and
MidCap SPDRs pursuant to unlisted trading privileges upon approval of
this rule filing.
If at a later time the Exchange and the issuer of the product
desires to list SPDRs and MidCap SPDRs or any other PDRs on the
Exchange, the Exchange will request SEC approval for that listing in a
separate proposed rule change filed pursuant to Section 19(b) of the
Act. Additionally, in the event a new PDR is listed on another exchange
using listing standards that are different than current Exchange
listing standards or the Exchange listing standards proposed in this
filing, the Exchange will file a proposed rule change pursuant to
Section 19(b) of the Act to adopt the listing standards before it
trades that PDR pursuant to unlisted trading privileges.
With respect to disclosure, because SPDRs and MidCap SPDRs will be
traded pursuant to unlisted trading privileges and will not be listed
on the Exchange at this time, the Exchange does not intend to create
its own product description to satisfy the requirements of proposed
Rule 11.9(v), which requires members to provide to purchasers, a
written description of the terms and characteristics of SPDRs and
MidCap SPDRs in a form approved by the Exchange. Instead, the Exchange
will deem a member or member organization to be in compliance with this
requirement if the member delivers either (i) the current product
description produced by the Amex from time to time, or (ii) the current
prospectus for the SPDR or MidCap SPDR, as the case may be.\7\ It will
be the member's responsibility to obtain these materials directly from
Amex for forwarding to purchasers in the time frames prescribed by
Exchange and Commission rules. The Exchange will notify members and
member organizations of this requirement in a notice to members.
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\7\ CSE plans to notify its members in a regulatory circular
that members must comply with Rule 3.7, Recommendations to
Customers, prior to recommending the purchase of SPDRs or MidCap
SPDRs to customers. The circular will also state that members must
deliver a SPDR or MidCap SPDR product description to all purchasers
of the products and that they must provide the prospectus upon the
request.
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The remainder of this section of the proposed rule change provides
background information on SPDRs and MidCap SPDRs. The information,
requested by CSE to have been copied from SR-AMEX-94-52 and SR-AMEX-92-
18, describes the structure and mechanics of SPDRs and MidCap SPDRs.
d. SPDRs and MidCap SPDRs Generally. On December 11, 1992, the
Commission approved Amex Rules 1000 et seq.\8\ to accommodate trading
on the Amex of PDRs generally. The Sponsor of each series of PDRs
traded on the Amex is PDR Services Corporation, a wholly-owned
subsidiary of the Amex. The PDRs are issued by a Trust in a specified
minimum aggregate quantity (``Creation Unit'') in return for a deposit
consisting of specified numbers of shares of stock plus a cash amount.
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\8\ See Securities Exchange Act Release No. 31591 (December 11,
1992), 57 FR 60253 (December 18, 1992).
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The first Trust to be formed in connection with the issuance of
PDRs was based on the S&P 500 Index, known as Standard & Poor's
Depositary Receipts (``SPDRs''). SPDRs have been trading on the Amex
since January 29, 1993. The second Trust to be formed in connection
with the issuance of PDRs was based on the S&P MidCap 400 Index,\9\
known as Standard & Poor's MidCap 400 Depositary Receipts (``MidCap
SPDRs'').\10\ The sponsor of the two Trusts has entered into trust
agreements with a trustee in accordance with Section 26 of the
Investment Company Act of 1940. PDR Distributors, Inc.
(``Distributor'') acts as underwriter of both SPDRs and MidCap SPDRs on
an agency basis. The Distributor is a registered broker-dealer, a
member of the National Association of Securities Dealers, Inc., and a
wholly-owned subsidiary of Signature Financial Group, Inc.\11\
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\9\ The S&P MidCap 400 Index is a capitalization-weighted index
of 400 actively traded securities that includes issues selected from
a population of 1,700 securities, each with a year-end market-value
capitalization of between $200 million and $5 billion. The issues
included in the Index cover a broad range of major industry groups,
including industrials, transportation, utilities, and financials.
\10\ See Securities Exchange Act Release No. 35534 (March 24,
1995), 60 FR 16686 (March 31, 1995).
\11\ The Commission has recently approved a rule change proposal
covering the trading and listing of PDRs on CHX, including SPDRs and
MidCap SPDRs. See Securities Exchange Act Release No. 39076
(September 15, 1997), 62 FR 49270 (September 19, 1997) (``CHX
Approval Order'').
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E. SPDRs. The Trustee of the SPDR Trust will have the right to vote
any of the voting stocks held by the Trust, and will vote such stocks
of each issuer in the same proportion as all other voting shares of
that issuer voted.\12\ Therefore, SPDR holders will not be able to
directly vote the shares of the issuers underlying the SPDRs.
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\12\ The Trustee will abstain from voting if the stocks held by
the Trust cannot be voted in the same proportion as all other shares
of the securities are voted.
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The Trust will issue SPDRs in exchange for ``Portfolio Deposits''
of all of the S&P 500 Index securities weighted according to their
representation in the Index.\13\ An Investor making a Portfolio Deposit
into the Trust will receive a ``Creation Unit'' composed of 50,000
SPDRs.\14\ The price of SPDRs will be based on a current bid/offer
market. The Amex has designated 1/64's as the minimum increment for
trading in SPDRs. The Exchange has proposed this same minimum variation
for trading of SPDRs on the CSE. SPDRs will not be redeemable
individually, but may be redeemed in Creation Unit size (i.e., 50,000
SPDRs). Specifically, a Creation Unit may be redeemed for an in-kind
distribution of securities identical to a Portfolio Deposit.\15\ PDR
Distribution Services, Inc. a registered broker-dealer, will act as
underwriter of SPDRs on an agency basis.
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\13\ A Portfolio deposit also will include a cash payment equal
to a pro rata portion of the dividends accrued on the Trust's
portfolio securities since the last dividend payment by the Trust
plus or minus an amount designed to compensate for any difference
between the net asset value of the Portfolio Deposit and the S&P 500
Index caused by, among other things, the fact that a Portfolio
Deposit cannot contain fractional shares.
\14\ The Trust is structured so that the net asset value of an
individual SPDR should equal one-tenth of the value of the S&P 500
Index.
\15\ An investor redeeming a Creation Unit will receive Index
securities and cash identical to the Portfolio Deposit required of
an investor wishing to purchase a Creation Unit on that particular
day. Since the Trust will redeem in kind rather than for cash, the
Trustee will not be forced to maintain cash reserves for
redemptions. This should allow the Trust's resources to be committed
as fully as possible to tracking the S&P 500 Index, enabling the
Trust to track the Index more closely than other basket products
that must allocate a portion of their assets for cash redemptions.
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F. MidCap SPDRs. All orders to create MidCap SPDRs in Creation Unit
size aggregations (which has been set at 25,000) must be placed with
the Distributor, and it will be the responsibility of the Distributor
to transmit such orders to the Trustee.
To be eligible to place orders to create MidCap SPDRs as described
below, an entity or person either must be a participant in the
Continuous Net Settlement (``CNS'') system of the National Securities
Clearing Corporation (``NSCC'') or a Depository Trust Company (``DTC'')
participant. Upon acceptance of an order to create a MidCap SPDRs, the
Distributor will instruct the Trustee to initiate the book-entry
movement of the appropriate number of MidCap SPDRs to the account of
the entity placing the order. MidCap SPDRs will be maintained in book-
entry form at DTC.
Payment with respect to creation orders placed through the
Distributor
[[Page 56214]]
will be made by (1) the ``in-kind'' deposit with the Trustee of a
specified portfolio of securities that is formulated to mirror, to the
extent practicable, the component securities of the underlying index or
portfolio, and (2) a cash payment sufficient to enable the Trustee to
make a distribution to the holders of beneficial interests in Trust on
the next dividend payment date as if all the securities had been held
for the entire accumulation period for the distribution (``Dividend
Equivalent Payment''), subject to certain specified adjustments. The
securities and cash accepted by the Trustee are referred to, in the
aggregate, as a ``Portfolio Deposit.''
G. Issuance of MidCap SPDRs. Upon receipt of a Portfolio Deposit in
payment for a creation order placed through the Distributor as
described above, the Trustee will issue a specified number of MidCap
SPDRs, which aggregate number is referred to as a ``Creation Unit.'' A
Creation Unit is made up of 25,000 MidCap SPDRs.\16\ Individual MidCap
SPDRs can then be traded in the secondary market like other equity
securities. Portfolio Deposits are expected to be made primarily by
institutional investors, arbitrageurs, and Exchange specialists.
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\16\ PDRs may be created in other than Creation Unit size
aggregations in connection with the DTC Dividend Reinvestment
Service (``DRS'').
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The Trustee or Sponsor will make available (1) on a daily basis, a
list of the names and required number of shares for each of the
securities in the current Portfolio Deposit; (2) on a minute-by-minute
basis throughout the day, a number representing the value (on a per
MidCap SPDR basis) of the securities portion of a Portfolio Deposit in
effect on such day; and (3) on a daily basis, the accumulated
dividends, less expenses, per outstanding MidCap SPDR.
The Amex has set the minimum fractional trading variation for
MidCap SPDRs at 1/64 of $1.00. The Exchange is proposing this same
minimum variation for MidCap SPDRs.
H. Redemption of MidCap SPDRs. MidCap SPDRs in Creation Unit size
aggregations will be redeemable in kind by tendering them to the
Trustee. While holders may sell MidCap SPDRs in the secondary market at
any time, they must accumulate at least 25,000 (or multiples thereof)
to redeem them through the Trust. MidCap SPDRs will remain outstanding
until redeemed or until the termination of the Trust. Creation Units
will be redeemable on any business day in exchange for a portfolio of
the securities held by the Trust identical in weighting and composition
to the securities portion of a Portfolio Deposit in effect on the date
a request is made for redemption, together with a ``Cash Component''
(as defined in the Trust prospectus), including accumulated dividends,
less expenses, through the date of redemption. The number of shares of
each of the securities transferred to the redeeming holder will be the
number of shares of each of the component stocks in a Portfolio Deposit
on the day a redemption notice is received by the Trustee, multiplied
by the number of Creation Units being redeemed. Nominal service fees
may be charged in connection with the creation and redemption of
Creation Units. The Trustee will cancel all tendered Creation Units
upon redemption.
I. Distributions for MidCap SPDRs. The MidCap SPDR Trust will pay
dividends quarterly. The regular quarterly ex-dividend date for MidCap
SPDRs will be the third Friday in March, June, September, and December,
unless that day is a New York Stock Exchange holiday, in which case the
ex-dividend date will be the preceding Thursday. Holders of MidCap
SPDRs on the business day preceding the ex-dividend date will be
entitled to receive an amount representing dividends accumulated
through the quarterly dividend period preceding such ex-dividend date
net of fees and expenses for such period. The payment of dividends will
be made on the last Exchange business day in the calendar month
following the ex-dividend date (``Dividend Payment Date''). On the
Dividend Payment Date, dividends payable for those securities with ex-
dividend dates falling within the period from the ex-dividend date most
recently preceding the current ex-dividend date will be distributed.
The Trustee will compute on a daily basis the dividends accumulated
within each quarterly dividend period. Dividend payments will be made
through DTC and its participants to all such holders with funds
received from the Trustee.
The MidCap SPDR Trust intends to make the DTC DRS available for use
by MidCap SPDR holders through DTC participant brokers for reinvestment
of their cash proceeds. The DTC DRS is also available to holders of
SPDRs. Because some brokers may choose not to offer the DTC DRS, an
interested investor would have to consult his or her broker to
ascertain the availability of dividend reinvestment through that
broker. The Trustee will use cash proceeds of MidCap SPDR holders
participating in the reinvestment to obtain the Index securities
necessary to create the requisite number of SPDRs.\17\ Any cash
remaining will be distributed pro rata to participants in the dividend
reinvestment.
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\17\ The Creation of PDRs in connection with DTC DRS represents
the only circumstances under which PDRs can be created in other than
Creation Unit size aggregations.
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The Exchange requests accelerated approval of the proposed rule
change pursuant to Section 19(b)(2) of the Act. The Exchange believes
that accelerated approval is appropriate because the listing standards
proposed in the proposed rule change closely mirror both the listing
standards of the primary market for SPDRs and Mid-Cap SPDRs, Amex, and
the standards proposed by two other regional exchanges that have
announced their intention to trade PDRs, the CHX and the Pacific
Exchange. The Exchange believes its proposed rule change should be
granted accelerated approval for the same reasons the Commission
determined to approve the standards of those other exchanges.
2. Statutory Basis
The CSE believes that the proposed rule change is consistent with
Section 6(b) of the Act \18\ in general, and furthers the objectives of
Section 6(b)(5) of the Act \19\ in particular in that it is designed to
promote just and equitable principles of trade and to remove
impediments to and perfect the mechanism of a free and open market and
a national market system, and, in general, to protect investors and the
public interest. Specifically, the proposed rule change will increase
competition in PDR markets by permitting Exchange members to compete
for PDR order flow. By adopting the proposed rule change, the Exchange
will bring the benefits of competition, including increased efficiency
and price competition, to those markets.
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\18\ 15 U.S.C. 78f(b).
\19\ 15 U.S.C. 78f(b)(5).
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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 either solicited or received.
III. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing.
[[Page 56215]]
Persons making written submissions should file six copies thereof with
the Secretary, Securities and Exchange Commission, 450 Fifth Street,
N.W., Washington, D.C. 20549. Copies of the submission, all subsequent
amendments, all written statements with respect to the proposed rule
change that are filed with the Commission, and all written
communications relating to the proposed rule change between the
Commission and any person, other than those that may be withheld from
the public in accordance with the provisions of 5 U.S.C. 552, will be
available for inspection and copying at the Commission's Public
Reference Room. Copies of such filing will also be available for
inspection and copying at the principal office of the Exchange. All
submissions should refer to File No. SR-CSE-97-10 and should be
submitted by November 19, 1997.
IV. Commission's Findings and Order Granting Accelerated Approval of
Proposed Rule Change
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).\20\ The
Commission believes that providing for the exchange-trading on CSE of
PDRs, in general, and SPDRs and MidCap SPDRs, in particular, will offer
investors an efficient way of participating in the securities markets.
Specifically, the Commission believes that the trading on CSE of PDRs,
in general, and SPDRs and MidCap SPDRs pursuant to unlisted trading
privileges, in particular, will provide investors with increased
flexibility in satisfying their investment needs by allowing them to
purchase and sell a low-cost security replicating the performance of a
broad portfolio of stocks at negotiated prices throughout the business
day, and by increasing the availability of SPDRs and MidCap SPDRs as an
investment tool. The Commission also believes that PDRs will benefit
investors by allowing them to trade securities based on unit investment
trusts in secondary market transactions.\21\ Accordingly, as discussed
below, the proposed rule change is consistent with the requirements of
Section 6(b)(5) of the Act that Exchange rules facilitate transactions
in securities while continuing to further investor protection and the
public interest.\22\
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\20\ 15 U.S.C. 78f(b)(5).
\21\ The Commission notes, however, that unlike open-end funds
where investors have the right to redeem their fund shares on a
daily basis, investors could only redeem PDRs in creation unit share
sizes. Nevertheless, PDRs would have the added benefit of liquidity
from the secondary market and PDR holders, unlike holders of most
other open-end funds, would be able to dispose of their shares in a
secondary market transaction.
\22\ 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 the orders approving SPDRs and MidCap
SPDRs for listing and trading on Amex,\23\ the Commission believes that
the trading on CSE of a security like PDRs in general, and SPDRs and
MidCap SPDRs in particular, which replicate the performance of a broad
portfolio of stocks, could benefit the securities markets by, among
other things, helping to ameliorate the volatility occasionally
experienced in these markets. The Commission believes that the creation
of one or more products where actual portfolios of stocks or
instruments representing a portfolio of stocks, such as PDRs, can trade
at a single location in an auction market environment could alter the
dynamics of program trading, because the availability of such single
transaction portfolio trading could, in effect, restore the execution
of program trades to more traditional block trading techniques.\24\
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\23\ See supra notes 8 and 10.
\24\ Program trading is defined as index arbitrage or any
trading strategy involving the related purchase or sale of a
``basket'' or group of fifteen or more stocks having a total market
value of $1 million or more.
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An individual SPDR has a value approximately equal to one-tenth of
the value of the S&P 500 Index, and an individual MidCap SPDR has a
value of approximately one-fifth of the value of the S&P MidCap 400
Index, making them more available and useful to individual retail
investors desiring to hold a security replicating the performance of a
broad portfolio of stocks. Accordingly, the Commission believes that
trading of SPDRs and MidCap SPDRs on CSE will provide retail investors
with a cost efficient means to make investment decisions based on the
direction of the market as a whole and may provide market participants
several advantages over existing methods of effecting program trades
involving stocks.
The Commission also believes that PDRs, in general, and SPDRs and
MidCap SPDRs, in particular, will provide investors with several
advantages over standard open-end S&P 500 Index and S&P MidCap 400
Index mutual fund shares. In particular, investors will have the
ability to trade PDRs continuously throughout the business day in
secondary market transactions at negotiated prices.\25\ In contrast,
pursuant to Investment Company Act Rule 22c-1,\26\ holders and
prospective holders of open-end mutual fund shares are limited 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.\27\ Accordingly, PDRs in general, and SPDRs and MidCap SPDRs
in particular, will allow investors to (1) respond quickly to changes
in the market; (2) trade at a known price; (3) engage in hedging
strategies not currently available to retail investors; and (4) reduce
transaction costs for trading a portfolio of securities.
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\25\ Because of potential arbitrage opportunities, the
Commission believes that PDRs will not trade at a material discount
or premium in relation to their net asset value. The mere potential
for arbitrage should keep the market price of a PDR comparable to
its net asset value, and therefore, arbitrage activity likely will
be minimal. In addition, the Commission believes the Trust will
tract the underlying index more closely than an open-end index fund
because the Trust will accept only in-kind deposits, and, therefore,
will not incur brokerage expenses in assembling its portfolio. In
addition, the Trust will redeem in kind, thereby enabling the Trust
to invest virtually all of its assets in securities comprising the
underlying index.
\26\ Investment Company Act Rule 22c-1 generally requires 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 a mutual fund
generally is computed once daily Monday through Friday as designated
by the investment company's board of directors. The Commission
granted SPDRs and MidCap SPDRs an exemption from this provision in
order to allow them to trade at negotiated prices in the secondary
market. The Commission notes that CSE would need to apply for a
similar exemption in the instance that it wishes to list and trade a
new PDR because the exemptions are specific to SPDRs and MidCap
SPDRs.
\27\ Id.
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Although PDRs in general, and SPDRs and MidCap SPDRs in particular,
are not leveraged instruments, and, therefore, do not possess any of
the attributes of stock index options, their prices will still be
derived and based upon the securities held in their respective Trusts.
In essence, SPDRs are equity securities that are priced off a portfolio
of stocks based on the S&P 500 Index and MidCap SPDRs are equity
securities that are price off a portfolio of stocks based on the S&P
MidCap 400 Index. Accordingly, the level of risk involved in the
purchase or sale of a SPDR or MidCap SPDR (or PDR in general) is
similar to the risk involved in the purchase or sale of traditional
common stock, with the exception that
[[Page 56216]]
the pricing mechanism for SPDRs and MidCap SPDRs (and PDRs in general)
is based on a basket of stocks. Nonetheless, the Commission has several
specific concerns regarding the trading of these securities. In
particular, PDRs raise disclosure, market impact, and secondary market
trading issues that must be addressed adequately. As discussed in more
detail below, and in the Amex Approval Order,\28\ the Commission
believes CSE adequately addresses these concerns.
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\28\ See supra note. 8.
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The Commission believes that the CSE proposal contains several
provisions that will ensure that investors are adequately apprised of
the terms, characteristics, and risks of trading PDRs. As noted above
the proposal contains four aspects addressing disclosure concerns.
First, CSE members must provide their customers trading PDRs with a
written explanation of any special characteristics and risks attendant
to trading such PDR securities (such as SPDRs or MidCap SPDRs), in a
form approved by CSE. As discussed above, CSE's filing states that
SPDRs and MidCap SPDRs product descriptions should be obtained from
Amex.\29\ The Commission believes that it is reasonable under the Act
to allow CSE to require its members to obtain the product description
for SPDRs and MidCap SPDRs from Amex.\30\ Amex might decide to impose a
reasonable charge for this service.\31\
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\29\ The Commission notes that, in the context of a proposed
rule change by CHX to add rules for listing and trading of PDRs in
general, and to trade SPDRs and MidCap SPDRs pursuant to UTP, Amex
commented on CHX's proposed method regarding the delivery of the
SPDR and MidCap SPDR product descriptions, and reserved the right to
charge CHX members for supplying the product description should the
task become burdensome to Amex. Amex did not object to the
underlying policy of CHX members obtaining the product description
from Amex. See CHX Approval Order, supra note 11.
\30\ The Commission notes that the exemptions granted by the
Commission under the Investment Company Act that permit the
secondary market trading of SPDRs and MidCap SPDRs are specifically
conditioned upon the customer disclosure requirements described
above. Accordingly, CSE rules adequately ensure its members must
delivery the current product description to all investors in SPDRs
and MidCap SPDRs.
\31\ The Commission notes that Amex would need to file a
proposed rule change under Section 19(b) of the Act in the event it
decides to charge a fee for supplying the SPDR or MidCap SPDR
product descriptions. The Commission notes that reasonable fees
would have to be imposed on the member firms rather than the
customers entitled to receive the prospectus or the product
description.
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Second, members and member organizations must include this written
product description with any sales material relating to the series of
PDRs that is provided to customers or the public. Third, any other
written materials provided by a member or member organization to
customers or the public referencing PDRs as an investment vehicle must
include a statement, in a form specified by CSE, that a circular and
prospectus are available from a broker upon request. Fourth, a member
or member organization carrying an omnibus account for a non-member
broker-dealer is required to inform such non-member that execution of
an order to purchase a series of PDRs for such omnibus account will be
deemed to constitute agreement by the non-member to make the written
product description available to its customers on the same terms as
member firms. Accordingly, the Commission believes that investors in
PDR securities, in general, and SPDRs and MidCap SPDRs, in particular,
will be provided with adequate disclosure of the unique characteristics
of the PDR instruments and other relevant information pertaining to the
instruments. Finally, CSE's Rule 3.7, Recommendations to Customers,
will apply to the trading of PDRs, including transactions in SPDRs and
MidCap SPDRs.\32\
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\32\ See supra note. 4.
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The Commission believes CSE has adequately addressed the potential
market impact concerns raised by the proposal. First, CSE's proposal
permits listing and trading of specific PDRs only after review by the
Commission. Second, CSE has developed policies regarding trading halts
in PDRs. Specifically, the Exchange would halt PDR trading if the
circuit breaker parameters under CSE Rule 12.11 were reached.\33\ In
addition, in deciding whether to halt trading or conduct a delayed
opening in PDRs, in general, and SPDRs and MidCap SPDRs, in particular,
CSE represents that it will be guided by, but not necessarily bound to,
whether trading has been halted or suspended in the primary market(s)
for any combination of underlying stocks accounting for 20% or more of
the applicable current index group value or whether other unusual
conditions or circumstances detrimental to the maintenance of a fair
and orderly market are present.
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\33\ In addition, for PDRs tied to an index, the triggering of
futures price limits for the S&P 500 Index, S&P 100 Index, or MMI
futures contracts will not, in itself, result in a halt in PDR
trading or a delayed opening. However, the Exchange could consider
such an event, along with other factors, such as a halt in trading
in OEX, SPX, or MMI options, in deciding whether to halt trading in
PDRs.
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The Commission believes that the trading of PDRs in general on CSE
should not adversely impact U.S. securities markets. As to the trading
of SPDRs and MidCap SPDR pursuant to UTP, the Commission notes that the
corpus of the SPDR Trust is a portfolio of stocks replicating the S&P
500 Index, a broad-based capitalization-weighted index consisting of
500 of the most actively-traded and liquid stocks in the U.S. The
corpus of the MidCap SPDR Trust is a portfolio of stocks replicating
the S&P MidCap 400 Index, also a broad-based, capitalization-weighted
index consisting of 400 actively traded and liquid U.S. stocks. In
fact, as described above, the Commission believes SPDRs and MidCap
SPDRs may provide substantial benefits to the marketplace and
investors, including, among others, enhancing the stability of the
markets for individual stocks.\34\ Accordingly, the Commission believes
that SPDRs and MidCap SPDRs do not contain features that will make them
likely to impact adversely the U.S. securities markets, and that the
addition of their trading on CSE pursuant to UTP could produce added
benefits to investors through the increased competition between other
market centers trading the product.\35\
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\34\ Even though PDR transactions may serve as substitutes for
transactions in the cash market, and possibly make the order flow in
individual stocks smaller than would otherwise be the case, the
Commission acknowledges that during turbulent market conditions the
ability of large institutions to redeem or create PDRs could
conceivably have an impact on price levels in the cash market. In
particular, if a PDR is redeemed, the resulting long stock position
could be sold into the market, thereby depressing stock prices
further. The Commission notes, however, that the redemption or
creation of PDRs likely will not exacerbate a price movement because
PDRs will be subject to the equity margin requirements of 50% and
PDRs are non-leveraged instruments. In addition, as noted above,
during turbulent market conditions, the Commission believes PDRs and
SPDRS and MidCap SPDRs, in particular, will serve as a vehicle to
accommodate and ``bundle'' order flow that otherwise would flow to
the cash market, thereby allowing such order flow to be handled more
efficiently and effectively. Accordingly, although PDRs and SPDRs
and MidCap SPDRs could, in certain circumstances, have an impact on
the cash market, on balance we believe the product will be
beneficial to the marketplace and can actually aid in maintaining
orderly markets.
\35\ As mentioned earlier, CSE has represented that it will not
begin to trade SPDRs and MidCap SPDRs until they are eligible to
trade over ITS. The Commission also reiterates its belief, expressed
in the CHX Approval Order, that Amex's statements in its comment
letter regarding the trading of SPDRs and MidCap SPDRs through ITS
should be resolved, as the Amex letter suggests, through the proper
ITS committee, not through Commission action on the CHX (or this)
proposal. The Commission does not want to suggest that Amex's
concerns are unfounded, but only that the proper venue for their
resolution is the proper ITS committee, not the Rule 19b-4 process.
See supra note 11.
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[[Page 56217]]
Finally, the Commission notes that CSE has submitted surveillance
procedures for the trading of PDRs, specifically SPDRs and MidCap
SPDRs, and believes that those procedures, which incorporate and rely
upon existing CSE surveillance procedures governing equities, are
adequate under the Act.
The Commission finds that CSE's proposal contains adequate rules
and procedures to govern the trading of PDR securities, including
trading SPDRs and MidCap SPDRs pursuant to UTP. Specifically, PDRs are
equity securities that will be subject to the full panoply of CSE rules
governing the trading of equity securities on CSE, including, among
others, rules governing the priority, parity and precedence of orders
and the responsibilities of specialists. In addition, CSE has developed
specific listing and delisting criteria for PDRs that will help to
ensure that the markets for PDRs will be deep and liquid. As noted
above, CSE's proposal provides for trading halt procedures governing
PDRs. Finally, the Commission notes that CSE has stated that Rule 3.7,
Recommendations to Customers, will apply to the trading of PDRs in
general, and SPDRs and MidCap SPDRs, in particular.
The Commission finds good cause for approving the proposed rule
change prior the thirtieth day after the date of publication of notice
of filing thereof in the Federal Register. The Commission believes that
accelerated approval of the proposal is appropriate because it is very
similar to CHX's previously approved proposal covering the listing and
trading of PDRs in general, and SPDRs and MidCap SPDRs, in
particular.\36\ As such, the Commission believes that the proposed rule
change does not raise any new regulatory concerns or issues.
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\36\ See supra note 11.
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It is therefore ordered, pursuant to Section 19(b)(2) \37\ that the
proposed rule change is hereby approved on an accelerated basis.
\37\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\38\
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\38\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-28572 Filed 10-28-97; 8:45 am]
BILLING CODE 8010--01-M