[Federal Register Volume 67, Number 122 (Tuesday, June 25, 2002)]
[Notices]
[Pages 42760-42763]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-15919]


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COMMODITY FUTURES TRADING COMMISSION

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46090]


Joint Order Granting the Modification of Listing Standards 
Requirements Under Section 6(h) of the Securities Exchange Act of 1934 
and the Criteria Under Section 2(a)(1) of the Commodity Exchange Act

June 19, 2002.
    The Commodity Futures Modernization Act of 2000 \1\ (``CFMA''), 
which became law on December 21, 2000, lifted the ban on the trading of 
futures on single securities and on narrow-based security indexes 
(``security futures'') \2\ in the United States. In addition, the CFMA 
established a framework for the joint regulation of these newly-
permissible security futures products by the Commodity Futures Trading 
Commission (``CFTC'') and the Securities and Exchange Commission 
(``SEC'') (jointly, the ``Commissions''). Under the CFMA, national 
securities exchanges and national securities associations may trade 
security futures products if they register with the CFTC and comply 
with certain requirements of the Commodity Exchange Act (``CEA'').\3\ 
Likewise, designated contract markets and registered derivatives 
transaction execution facilities (``DTEFs'') may trade security futures 
products if they register with the SEC and comply with certain other 
requirements of the Securities Exchange Act of 1934 (``Exchange 
Act'').\4\
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    \1\ Pub. L. 106-554, 114 Stat. 2763 (2000).
    \2\ Section 6(h)(6) of the Exchange Act provides that options on 
security futures (``security futures products'') may not be traded 
until three years after the enactment of the CFMA and the 
determination jointly by the Securities and Exchange Commission and 
Commodity Futures Trading Commission to permit options on such 
futures. 15 U.S.C. 78f(h)(6).
    \3\ 7 U.S.C. 1 et seq.
    \4\ 15 U.S.C. 78a et seq.
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    As part of this new regulatory framework, the CFMA amended the 
Exchange Act and the CEA by, among other things, establishing the 
criteria and requirements for listing standards regarding the category 
of securities on which security futures products can be based. The 
Exchange Act \5\ provides that it is unlawful for any person to effect 
transactions in security futures products that are not listed on a 
national securities exchange or a national securities association 
registered pursuant to section 15A(a) of the

[[Page 42761]]

Exchange Act. The Exchange Act \6\ further provides that such exchange 
or association is permitted to trade only security futures products 
that conform with listing standards filed with the SEC and that meet 
the criteria specified in section 2(a)(1)(D)(i) of the CEA.\7\ Section 
2(a)(1)(D)(i) of the CEA states that no board of trade shall be 
designated as a contract market with respect to, or registered as a 
DTEF for, any contracts of sale for future delivery of a security 
futures product unless the board of trade and the applicable contract 
meet the criteria specified in that section. Similarly, the Exchange 
Act \8\ requires that the listing standards filed with the SEC by an 
exchange or association meet specified requirements.
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    \5\ Section 6(h)(1) of the Exchange Act, 15 U.S.C. 78f(h)(1).
    \6\ Section 6(h)(2) of the Exchange Act, 15 U.S.C. 78f(h)(2).
    \7\ 7 U.S.C. 2(a)(1)(D)(i).
    \8\ Section 6(h)(3) of the Exchange Act, 15 U.S.C. 78f(h)(3).
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    In particular, the Exchange Act \9\ and the CEA \10\ require that, 
except as otherwise provided in a rule, regulation, or order, security 
futures must be based upon common stock and such other equity 
securities as the Commissions jointly determine appropriate.\11\
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    \9\ Section 6(h)(3)(D) of the Exchange Act, 15 U.S.C. 
78f(h)(3)(D).
    \10\ Section 2(a)(1)(D)(i)(III) of the CEA, 7 U.S.C. 
2(a)(1)(D)(i)(III).
    \11\ See Securities Exchange Act Release No. 44725 (August 20, 
2001), in which the Commissions jointly issued an order permitting 
depositary shares to underlie a security future, and to be a 
component of a narrow-based security index, subject to certain 
conditions.
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    The Commissions have been asked to permit a national securities 
exchange, national securities association, designated contract market, 
or registered DTEF to list and trade a security future based on a share 
of an exchange-traded fund (``ETF''), a trust issued receipt (``TIR''), 
or a share of a registered closed-end management investment company 
(``Closed-End Fund'').\12\ ETF shares, TIRs, and Closed-End Fund shares 
may not be common stock.\13\ Accordingly, unless the Commissions 
jointly determine that ETF shares, TIRs, and Closed-End Fund shares are 
equity securities on which security futures may be based, futures on 
ETF shares, TIRs, and Closed-End Fund shares may not be eligible for 
listing and trading on a national securities exchange, national 
securities association, designated contract market, or registered DTEF 
because the requirement specified in section 6(h)(3)(D) of the Exchange 
Act and the criterion specified in section 2(a)(1)(D)(i)(III) of the 
CEA would not be satisfied.
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    \12\ See letter from Claire P. McGrath, Vice President and 
Deputy General Counsel, American Stock Exchange, to Catherine D. 
Dixon, Assistant Secretary, CFTC, and Jonathan G. Katz, Secretary, 
SEC, dated December 13, 2001, and letter from David F. Harris, 
General Counsel, Nasdaq Liffe Markets, LLC, to Jean A. Webb, 
Secretary, CFTC, and Jonathan G. Katz, Secretary, SEC, dated June 7, 
2002.
    \13\ A registered investment company formed as a corporation 
rather than as a business trust could issue common stock. Because 
section 6(h)(3)(D) of the Exchange Act and section 
2(a)(1)(D)(i)(III) of the CEA permit the listing of security futures 
products based on common stock, a security futures product could be 
based on the common stock of a registered management investment 
company without a joint order modifying the requirement of section 
6(h)(3) of the Exchange Act and the criterion of section 
2(a)(1)(D)(i)(III) of the CEA.
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Exchange-Traded Funds

    An ETF is an investment company that is registered under the 
Investment Company Act of 1940 (``1940 Act'') \14\ either as a unit 
investment trust (``UIT'') or as an open-end management investment 
company.\15\ The fund itself issues shares only in large aggregate 
amounts, usually 50,000 shares (referred to as ``Creation Units'') at a 
price based on the net asset value (``NAV'') of the ETF's portfolio. 
These Creation Units are composed of individual shares (``ETF Shares'') 
that represent an ownership interest in the ETF's underlying portfolio 
of assets. ETFs do not redeem individual ETF Shares from holders at 
NAV.\16\ Instead, an investor wishing to purchase or sell ETF Shares in 
an amount less than the size of a Creation Unit may do so in the 
secondary market. Because to date ETF Shares are listed and traded on 
national securities exchanges, they are registered under Section 12 of 
the Exchange Act.
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    \14\ 15 U.S.C. 80a-1 et. seq.
    \15\ Section 4(2) of the 1940 Act defines a UIT as an investment 
company that is organized under a trust indenture or similar 
instrument, that does not have a board of directors, and that issues 
only redeemable securities, each of which represents an undivided 
interest in a unit of specified securities. 15 U.S.C. 80a-4(2). 
Section 5(a)(1) of the 1940 Act defines an open-end company as an 
investment company that is a management company which offers or has 
outstanding any redeemable security of which it is an issuer. 15 
U.S.C. 80a-5(a)(1).
    \16\ The NAV of a share of an investment company is equal to the 
value of the investment company's total assets, minus liabilities, 
divided by the number of outstanding shares.
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    Currently, all ETFs traded in the United States are based on 
specific domestic and foreign market indexes, most of which would not 
be considered to be a ``narrow-based security index'' under section 
3(a)(55) of the Exchange Act and section 1a(25) of the CEA. An ETF 
seeks to track the performance of its benchmark index by holding in its 
portfolio either the contents of the index or a representative sample 
of the securities in the index. ETF Shares do not represent a direct 
ownership interest in the securities the ETF holds in its portfolio 
(rather, they represent a direct ownership interest in the fund itself) 
and do not provide for the ``delivery'' of the benchmark index. The 
holder of an ETF Share bears the risk that the performance of the ETF 
may not correspond exactly to the performance of the benchmark index, 
and the ETF Shares ultimately are tied in value to the fund's specific 
securities holdings rather than the value of the index.

Trust Issued Receipts

    TIRs are securities representing beneficial ownership of the 
specific deposited securities represented by the receipts. Currently, 
Holding Company Depositary Receipts (``HOLDRs'') are the only TIRs 
listed and traded on national securities exchanges. Generally, HOLDRS 
represent an ownership interest in the underlying securities of the 
trust and are based on the securities of a particular industry. HOLDRS 
are not based on a particular benchmark index and do not track the 
performance of any index. The HOLDRS Trusts have not registered as 
investment companies under the 1940 Act.\17\ TIRs generally are 
designed to allow investors to hold securities investments from a 
variety of companies in a single instrument that represents their 
beneficial ownership in the deposited securities. Beneficial owners 
have the same rights, privileges and obligations as they would have if 
they beneficially owned the deposited securities outside of the TIR 
program.\18\ Holders of TIRs may cancel their TIRs at any time to 
receive the deposited securities. TIRs are registered under Section 
12(b) of the Exchange Act.
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    \17\ The SEC's Division of Investment Management indicated that 
it would not recommend enforcement action if the HOLDRS Trust did 
not register as an investment company under the 1940 Act. See letter 
from Veena K. Jain, Staff Attorney, Division of Investment 
Management, SEC, to Merrill Lynch, Pierce, Fenner & Smith 
Incorporated, dated September 3, 1999.
    \18\ For example, beneficial owners have the right to instruct 
the trustee to vote the deposited securities, to receive reports, 
proxies and other information distributed by the issuers of the 
deposited securities to their security holders, and to receive 
dividends and other distributions if any are declared and paid by 
the issuers of the deposited securities to the trustee.
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Closed-End Funds

    In contrast to an open-end management investment company that 
continuously offers redeemable shares, a Closed-End Fund is a 
management investment company that raises funds for investment by 
issuing a fixed number of non-redeemable shares through an initial 
public offering (``IPO'').\19\ Following the IPO, investors

[[Page 42762]]

may purchase and sell Closed-End Fund shares in secondary market 
transactions only. A registered investment adviser manages the assets 
of a Closed-End Fund consistent with the fund's objectives and 
policies, and a Closed-End Fund may invest in a variety of financial 
instruments. In addition to funds comprised of domestic securities, 
Closed-End Funds include funds that invest in securities of issuers 
located in a particular foreign country, a particular geographic 
region, or throughout the world. Shares of Closed-End Funds (``Closed-
End Funds Shares'') are listed and traded on national securities 
exchanges.
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    \19\ Section 5(a)(2) of the 1940 Act defines a ``closed-end 
company'' as ``any management company other than an open-end 
company.'' Section 5(a)(1) of the 1940 Act defines an ``open-end 
company'' as ``a management company which is offering for sale or 
has outstanding any redeemable security for which it is the 
issuer.'' 15 U.S.C. 80a-5(a)(1) and (2).
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Discussion

    Section 6(h)(4) of the Exchange Act \20\ and section 
2(a)(1)(D)(v)(I) of the CEA \21\ provide that the Commissions, by rule, 
regulation, or order, may jointly modify the listing standards 
requirement specified in sections 6(h)(3)(D) of the Exchange Act, and 
the criterion specified in sections 2(a)(1)(D)(i)(III) of the CEA to 
the extent the modification fosters the development of fair and orderly 
markets in security futures products, is necessary or appropriate in 
the public interest, and is consistent with the protection of 
investors. For the reasons discussed below, the Commissions believe 
that the joint modification of the requirement specified in Section 
6(h)(3)(D) of the Exchange Act and the criterion specified in Section 
2(a)(1)(D)(i)(III) of the CEA to permit an ETF Share, TIR, or Closed-
End Fund Share to underlie a security future will foster the 
development of fair and orderly markets in security futures products, 
is necessary or appropriate in the public interest, and is consistent 
with the protection of investors.
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    \20\ 15 U.S.C. 78f(h)(4).
    \21\ 7 U.S.C. 2(a)(1)(D)(v)(I).
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    Because ETF Shares, TIRs, and Closed-End Fund Shares are registered 
under section 12 of the Exchange Act, an investor effecting a 
transaction in ETF Shares, TIRs, or Closed-End Fund Shares, or futures 
thereon, would have publicly available information about the ETF, TIR, 
or Closed-End Fund prior to making an investment decision. In addition, 
the listing and trading of security futures based on ETF Shares, TIRs, 
and Closed-End Fund Shares will make additional products available to 
market participants. The Commissions note that the combined assets of 
ETFs and Closed-End Funds, respectively, are significant and that 
futures on ETF Shares and Closed-End Fund Shares will provide investors 
with additional means to hedge positions in these products.\22\ In 
addition, the conditions imposed by the Commissions, which are set 
forth below, will help to ensure that only liquid, widely-held ETF 
Shares, TIRs, and Closed-End Fund Shares will be eligible to underlie 
security futures contracts, and that therefore the futures will not be 
readily susceptible to manipulation. Therefore, the Commissions believe 
that it would foster the development of fair and orderly markets in 
security futures products, would be necessary or appropriate in the 
public interest, and would be consistent with the protection of 
investors to modify by joint order the listing standards requirements 
specified in subparagraph (D) of Exchange Act Section 6(h)(3) and 
subclause (III) of Section 2(a)(1)(D)(i) of the CEA, to permit, in 
certain specified circumstances, a national securities exchange, 
national securities association, designated contract market, or 
registered DTEF to list and trade security futures products based on an 
ETF Share, TIR, or Closed-End Fund Share.\23\
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    \22\ For example, as of January 2002, the combined assets of the 
102 U.S. ETFs amounted to $82 billion. See Investment Company 
Institute, ``Exchange-Traded Fund Assets, January 2002'' at http://
www.ici.org/facts--figures/. As of December 2000, the total assets 
invested in closed-end funds amounted to $134.5 billion. See 
``Closed-End Fund Assets, Year-End 2000'' at http://www.ici.org/
facts--figures/.
    \23\ A national securities exchange, national securities 
association, designated contract market or registered DTEF that 
relies on this order to list and trade a security futures product 
based on an ETF Share, TIR, or Closed-End Fund Share must comply 
with the other requirements and criteria specified in the Exchange 
Act and the CEA, respectively, and the listing standards 
requirements of the national securities exchange or national 
securities association.
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    For these reasons, the Commissions by order are jointly modifying 
the requirement specified in section 6(h)(3)(D) of the Exchange Act and 
the criterion specified in section 2(a)(1)(D)(i)(III) of the CEA to 
permit an ETF Share, TIR, or Closed-End Fund Share to underlie a 
security future, provided that:
    (1) The underlying ETF Shares, TIRs, or Closed-End Fund Shares are 
registered under Section 12 of the Exchange Act, and are listed and 
traded on a national securities exchange or through the facilities of a 
national securities association and reported as national market system 
securities as set forth in Rule 11Aa3-1 under the Exchange Act;\24\
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    \24\ Accordingly, this order does not include certain closed-end 
funds known as ``interval funds'' that operate pursuant to Rule 23c-
3 under the 1940 Act and are not listed on a national securities 
exchange or traded through the facilities of Nasdaq. In addition, 
this order does not include closed-end funds with a quarterly tender 
offer feature that are not listed on a national securities exchange 
or traded through the facilities of Nasdaq.
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    (2) There are a minimum of 7,000,000 of such ETF Shares, TIRs, or 
Closed-End Fund Shares that are owned by persons other than those 
required to report their security holdings under Section 16(a) of the 
Exchange Act;
    (3) Total trading volume in the ETF Shares, TIRs, or Closed-End 
Fund Shares has been at least 2,400,000 shares in the preceding 12 
months;
    (4) The market price per share of the ETF or Closed-End Fund, or 
per TIR, has been at least $7.50 for the majority of business days 
during the three calendar months preceding the date the national 
securities exchange, national securities association, designated 
contract market, or registered DTEF lists the overlying future, as 
measured by the lowest closing price reported in any market in which 
the ETF Shares, TIRs, or Closed-End Fund Shares traded on each of the 
subject days; and
    (5) The issuer of the ETF, TIR, or Closed-End Fund is in compliance 
with all applicable requirements of the Exchange Act.
    Accordingly,
    It is ordered, pursuant to section 6(h)(4) of the Exchange Act and 
section 2(a)(1)(D)(v)(I) of the CEA, that the requirement specified in 
section 6(h)(3)(D) of the Exchange Act and the criterion specified in 
Section 2(a)(1)(D)(i)(III) are modified, subject to the conditions set 
forth above, provided however, this order does not affect the CFTC's 
exclusive jurisdiction under section 2(a)(1)(C) of the CEA over any 
futures contract based on an index that is not a ``narrow-based 
security index,'' as defined in section 3(a)(55) of the Exchange Act 
and section 1a(25) of the CEA. Accordingly, nothing in this order shall 
affect or limit the exclusive authority and jurisdiction of the CFTC 
with respect to any futures contract, now or in the future, including 
the CFTC's authority to approve any futures contract that is based upon 
an index that is not a ``narrow-based security index,'' including an 
index that is not a ``narrow-based security index'' that underlies an 
ETF, TIR or Closed-End Fund on which approved security futures are 
based.

    By the Commodity Futures Trading Commission.


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    Dated: June 19, 2002.
Jean A. Webb,
Secretary,
    By the Securities and Exchange Commission.

    Dated: June 19, 2002.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-15919 Filed 6-24-02; 8:45 am]
BILLING CODE 8010-01-P; 6351-01-P