[Federal Register Volume 68, Number 43 (Wednesday, March 5, 2003)]
[Notices]
[Pages 10553-10557]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-5156]


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SECURITIES AND EXCHANGE COMMISSION

[Release Number IC-25948; 812-12546]


Rydex ETF Trust, et al.; Notice of Application

February 27, 2003.
AGENCY: Securities and Exchange Commission (``Commission'').

ACTION: Notice of an application for an order under section 6(c) of the 
Investment Company Act of 1940 (the ``Act'') for an exemption from 
sections 2(a)(32), 5(a)(1), 22(d) and 24(d) of the Act and rule 22c-1 
under the Act, and under sections 6(c) and 17(b) of the Act for an 
exemption from sections 17(a)(1) and (a)(2) of the Act.

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Summary of Application: Applicants request an order that would permit 
(a) series of an open-end management investment company, whose 
portfolios will consist of the component securities of certain equity 
securities indexes, to issue shares of limited redeemability; (b)

[[Page 10554]]

secondary market transactions in the shares of the series to occur at 
negotiated prices on The Nasdaq Stock Market (``Nasdaq'') or a national 
securities exchange (each, a ``Listing Market''); (c) dealers to sell 
shares of the series to purchasers in the secondary market 
unaccompanied by a prospectus, when prospectus delivery is not required 
by the Securities Act of 1933 (the ``Securities Act''); and (d) 
affiliated persons of the series to deposit securities into, and 
receive securities from, the series in connection with the purchase and 
redemption of aggregations of the series' shares.

Applicants: Rydex ETF Trust (``Trust''), Rydex Distributors, Inc. 
(``Distributor''), PADCO Advisors II, Inc. (``Adviser'').

Filing Dates: The application was filed on June 8, 2001, and amended on 
February 24, 2003 and February 27, 2003.

Hearing or Notification of Hearing: An order granting the requested 
relief will be issued unless the Commission orders a hearing. 
Interested persons may request a hearing by writing to the Commission's 
Secretary and serving applicants with a copy of the request, personally 
or by mail. Hearing requests should be received by the Commission by 
5:30 p.m. on March 24, 2003, and should be accompanied by proof of 
service on applicants, in the form of an affidavit or, for lawyers, a 
certificate of service. Hearing requests should state the nature of the 
writer's interest, the reason for the request, and the issues 
contested. Persons who wish to be notified of a hearing may request 
notification by writing to the Commission's Secretary.

ADDRESSES: Secretary, Securities and Exchange Commission, 450 Fifth 
Street, NW., Washington, DC 20549-0609. Applicants, 9601 Blackwell 
Road, Suite 500, Rockville, MD 20850.

FOR FURTHER INFORMATION CONTACT: Julia Kim Gilmer, Senior Counsel, at 
(202) 942-0528, or Michael W. Mundt, Senior Special Counsel, at (202) 
942-0564 (Division of Investment Management, Office of Investment 
Company Regulation).

SUPPLEMENTARY INFORMATION: The following is a summary of the 
application. The complete application may be obtained for a fee at the 
Commission's Public Reference Branch, 450 Fifth Street, NW., 
Washington, DC 20549-0102 (tel. 202-942-8090).

Applicants' Representations

    1. The Trust is an open-end management investment company 
registered under the Act and organized as a Delaware statutory trust. 
The Trust is organized as a series investment company with one 
portfolio (the ``Initial Fund'' and together with the ``Future Funds,'' 
as defined below, the ``Funds''). The Adviser is registered as an 
investment adviser under the Investment Advisers Act of 1940 and will 
serve as the investment adviser to the Funds. The Adviser may, in the 
future, enter into subadvisory agreements with additional investment 
advisers to act as subadvisers with respect to particular Funds. The 
Distributor is registered as a broker-dealer under the Securities 
Exchange Act of 1934 (``Exchange Act'') and will be the principal 
underwriter and distributor of the shares of each Fund (``Shares'').
    2. Each Fund will invest in a portfolio of equity securities 
generally consisting of the component securities of a specified equity 
securities index (an ``Underlying Index'').\1\ The Initial Fund will be 
based on the Equal Weighted S&P 500 Index. In the future, applicants 
expect to offer multiple series based on other equity securities 
indices (each, a ``Future Fund''). Any Future Fund will (a) be advised 
by the Adviser or an entity controlled by or under common control with 
the Adviser and (b) comply with the terms and conditions of this 
application. No entity that creates, compiles, sponsors or maintains an 
Underlying Index is or will be an affiliated person, as defined in 
section 2(a)(3) of the Act, or an affiliated person of an affiliated 
person, of the Trust, the Adviser, a subadviser or promoter of a Fund, 
or the Distributor.
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    \1\ At least 90% of each Fund's total assets (exclusive of 
collateral held from securities lending) will be invested in the 
component securities of its Underlying Index. Each Fund may also 
invest up to 10% of its total assets in stocks that are not included 
in the Underlying Index, futures contracts, options on futures 
contracts, options and swaps related to its Underlying Index, and 
cash and cash equivalents.
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    3. The investment objective of each Fund will be to provide 
investment results that correspond generally to the price and yield 
performance of its Underlying Index. Intra-day values of each 
Underlying Index will be disseminated every 15 seconds throughout 
regular trading hours on the Listing Market. A Fund will utilize either 
a replication strategy or a representative sampling strategy to track 
its Underlying Index. A Fund using a replication strategy generally 
will invest in substantially all of the component securities of its 
Underlying Index in the same approximate proportions as in the 
Underlying Index. When a component security is illiquid or when there 
are practical difficulties or substantial costs involved in holding 
every security in an Underlying Index, a Fund may use a representative 
sampling strategy where it holds a representative sample of the 
component securities of the Underlying Index and will invest in some 
but not all of the component securities of its Underlying Index.\2\ 
Applicants anticipate that a Fund using the representative sampling 
technique will not track its Underlying Index with the same degree of 
accuracy as an investment vehicle that invests in every component 
security of the Underlying Index with the same weighting as the 
Underlying Index. Applicants anticipate that, over time, the expected 
tracking error of a Fund using the representative sampling technique 
will not exceed 5%, net of fees or expenses.
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    \2\ Securities selected for inclusion in a Fund by the Adviser 
will have aggregate investment characteristics (based on market 
capitalization and industry weightings), fundamental characteristics 
(such as return variability, earnings valuation and yield) and 
liquidity measures similar to those of the Underlying Index taken in 
its entirety.
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    4. Shares will be issued in aggregations of at least 50,000 or more 
(``Creation Units''). The price of a Creation Unit will range from 
$3,000,000 to $5,000,000. All orders to purchase Creation Units must be 
placed with the Distributor by or through a Depository Trust Company 
(``DTC'') participant that has executed a participation agreement with 
the Distributor. Creation Units generally will be issued in exchange 
for an in-kind deposit of securities and cash. A Fund also may sell 
Creation Units on a ``cash only'' basis in limited circumstances. A 
person purchasing a Creation Unit from a Fund must make a ``Creation 
Deposit'' consisting of: (a) securities selected by the Adviser to 
correspond to the price and yield performance of the relevant 
Underlying Index (``Deposit Securities''), and (b) a cash payment equal 
to the difference between the market value of the Deposit Securities 
and the net asset value (``NAV'') of a Creation Unit (``Cash 
Amount'').\3\ An investor purchasing or

[[Page 10555]]

redeeming Creation Units from a Fund will be charged a fee 
(``Transaction Fee'') to prevent the dilution of the interests of the 
remaining shareholders resulting from costs incurred by the Fund in 
connection with the purchase and redemption of the Creation Units.\4\ 
Each Fund will provide complete disclosure about the Transaction Fee in 
its prospectus, including the maximum amount of the Transaction Fee, 
and the method of calculating the Transaction Fee will be disclosed in 
the Trust's statement of additional information (``SAI'').
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    \3\ On each day that the Listing Market is open for business 
(``Business Day''), the Adviser will make available through the 
National Securities Clearing Corporation (``NSCC''), prior to the 
opening of trading on the Listing Market, the list of the names and 
the required number of shares of each Deposit Security to be 
included in the Creation Deposit for each Fund as well as 
information regarding the Cash Amount. That Creation Deposit will 
apply to all purchases of Creation Units until a new Creation 
Deposit composition is announced. A purchasing investor may be 
permitted or required to substitute an amount of cash or a different 
security for a Deposit Security in certain circumstances. The 
Listing Market will disseminate every 15 seconds throughout the 
regular trading hours of the Listing Market, an amount representing 
on a per Share basis the sum of the current value of the Deposit 
Securities and the estimated Cash Amount.
    \4\ Where a Fund permits a purchaser to deposit cash in lieu of 
depositing one or more Deposit Securities, the purchaser will be 
assessed a higher Transaction Fee to offset the transaction cost to 
the Fund of buying those particular Deposit Securities.
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    5. Orders to purchase Creation Units must be placed with the 
Distributor who will be responsible for transmitting the orders to the 
relevant Fund. The Distributor will maintain a record of Creation Unit 
purchases and send out confirmations to purchasers. The Distributor 
will also furnish a copy of the Fund's prospectus to those placing 
purchase orders.
    6. Persons purchasing Creation Units from a Fund may hold the 
Shares or sell some or all of them in the secondary market. Shares of 
the Funds will be listed on a Listing Market, which will either be 
Nasdaq or a national securities exchange as defined in section 2(a)(26) 
of the Act, and traded in the secondary market in the same manner as 
other equity securities. It is expected that one or more member firms 
of the Listing Market will act as a market maker or specialist 
(``Market Maker'') and maintain a market on the Listing Market for the 
Shares.\5\ The price of Shares traded on a Listing Market will be based 
on a current bid/offer market. Each Share is expected to have a market 
value of between $60 and $100. Purchases and sales of Shares in the 
secondary market will be subject to customary brokerage commissions and 
charges.
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    \5\ The listing requirements established by Nasdaq require that 
at least two market makers be registered in Shares in order for the 
Shares to maintain a listing on Nasdaq. Registered market makers 
must make a continuous two-sided market in a listing or face 
regulatory sanctions.
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    7. Applicants expect that purchasers of Creation Units will include 
institutional investors and arbitrageurs. A Market Maker, in providing 
for a fair and orderly secondary market for Shares, also may purchase 
Creation Units in connection with its market-making activities. 
Applicants expect that secondary market purchasers of Shares will 
include both institutional and retail investors.\6\ Applicants expect 
that arbitrage opportunities created by the ability to continually 
purchase or redeem Creation Units at NAV, will ensure that the market 
price of Shares will not vary much from its NAV.
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    \6\ Shares will be registered in book-entry form only. DTC or 
its nominee will be the record or registered owner of all 
outstanding Shares. DTC or its participants will maintain records 
reflecting the beneficial owners of Shares.
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    8. Shares will not be individually redeemable. Shares will only be 
redeemable in Creation Units from a Fund. To redeem, an investor will 
have to accumulate enough Shares to constitute a Creation Unit. An 
investor redeeming a Creation Unit in most cases will receive a 
portfolio of securities (``Redemption Securities'') plus a balancing 
cash amount representing the difference between the NAV of a Creation 
Unit and the market value of the Redemption Securities. As with 
purchases, a redeeming investor will pay a Transaction Fee. An investor 
may receive the cash equivalent of a Redemption Security in certain 
circumstances, such as if the investor is unable, by law or policy, to 
own a particular Redemption Security.
    9. Applicants state that neither the Trust nor any Fund will be 
advertised, marketed, or otherwise held out as a traditional open-end 
investment company or mutual fund. Rather, applicants state that each 
Fund and the Trust will be marketed as a ``Nasdaq-traded fund,'' 
``exchange-traded fund,'' ``investment company,'' ``fund,'' and 
``trust'' without reference to an ``open-end fund'' or ``mutual fund,'' 
except to compare and contrast the Trust and the Funds with 
conventional open-end investment companies. All marketing materials 
that describe the features or method of obtaining, buying, or selling 
Creation Units or Shares will prominently disclose that Shares are not 
individually redeemable and that Shares may be acquired or redeemed 
from the Fund in Creation Units only. The same type of disclosure will 
be provided in each Fund's prospectus, SAI, shareholder reports and 
investor educational materials issued or circulated in connection with 
the Shares. The Trust will provide copies of its annual and semi-annual 
shareholder reports to DTC participants for distribution to beneficial 
holders of Shares.

Applicants' Legal Analysis

    1. Applicants request an order under section 6(c) of the Act 
granting an exemption from sections 2(a)(32), 5(a)(1), 22(d) and 24(d) 
of the Act and rule 22c-1 under the Act; and under sections 6(c) and 
17(b) of the Act granting an exemption from sections 17(a)(1) and 
(a)(2) of the Act.
    2. Section 6(c) of the Act provides that the Commission may exempt 
any person, security or transaction, or any class of persons, 
securities or transactions, from any provision of the Act, if and to 
the extent that such exemption is necessary or appropriate in the 
public interest and consistent with the protection of investors and the 
purposes fairly intended by the policy and provisions of the Act.

Sections 5(a)(1) and 2(a)(32) of the Act

    3. Section 5(a)(1) of the Act defines an ``open-end company'' as a 
management investment company that is offering for sale or has 
outstanding any redeemable security of which it is the issuer. Section 
2(a)(32) of the Act defines a redeemable security as any security, 
other than short-term paper, under the terms of which the holder, upon 
its presentation to the issuer, is entitled to receive approximately 
his proportionate share of the issuer's current net assets, or the cash 
equivalent. Because Shares will not be individually redeemable, 
applicants request an order that would permit the Trust to register as 
an open-end management investment company and issue Shares that are 
redeemable in Creation Units only. Applicants state that investors may 
purchase Shares in Creation Units from each Fund and redeem Creation 
Units. Applicants further state that because the market price of Shares 
will be disciplined by arbitrage opportunities, the market price of 
Shares will not vary much from its NAV.

Section 22(d) of the Act and Rule 22c-1 under the Act

    4. Section 22(d) of the Act, among other things, prohibits a dealer 
from selling a redeemable security, which is currently being offered to 
the public by or through a principal underwriter, except at a current 
public offering price described in the prospectus. Rule 22c-1 under the 
Act generally requires that a dealer selling, redeeming, or 
repurchasing a redeemable security do so only at a price based on its 
NAV. Applicants state that secondary market trading in Shares will take 
place at negotiated prices, not at an offering price described in the 
prospectus, and not at a price based on NAV. Thus, purchases and sales 
of Shares in the secondary market will not comply with section 22(d) of 
the Act and rule 22c-1 under the Act. Applicants request an exemption 
under section 6(c) from these provisions.

[[Page 10556]]

    5. Applicants assert that the concerns sought to be addressed by 
section 22(d) of the Act and rule 22c-1 under the Act with respect to 
pricing are equally satisfied by the proposed method of pricing Shares. 
Applicants maintain that while there is little legislative history 
regarding section 22(d), its provisions, as well as those of rule 22c-
1, appear to have been designed to (a) prevent dilution caused by 
certain riskless-trading schemes by principal underwriters and contract 
dealers, (b) prevent unjust discrimination or preferential treatment 
among buyers, and (c) ensure an orderly distribution of investment 
company shares by eliminating price competition from dealers offering 
shares at less than the published sales price and repurchasing shares 
at more than the published redemption price.
    6. Applicants believe that none of these purposes will be thwarted 
by permitting Shares to trade in the secondary market at negotiated 
prices. Applicants state (a) that secondary market trading in Shares 
will not cause dilution for owners of Shares because such transactions 
do not directly involve Fund assets, and (b) to the extent different 
prices exist during a given trading day, or from day to day, these 
variances occur as a result of third-party market forces, such as 
supply and demand and not as a result of unjust or discriminatory 
manipulation. Therefore, applicants assert that secondary market 
transactions in Shares will not lead to discrimination or preferential 
treatment among purchasers. Finally, applicants contend that the 
proposed distribution system will be orderly because competitive forces 
in the marketplace will ensure that the difference between the market 
price of Shares and their NAV remains narrow.

Section 24(d) of the Act

    7. Section 24(d) of the Act provides, in relevant part, that the 
prospectus delivery exemption provided to dealer transactions by 
section 4(3) of the Securities Act does not apply to any transaction in 
a redeemable security issued by an open-end investment company. 
Applicants request an exemption from section 24(d) to permit dealers 
selling Shares to rely on the prospectus delivery exemption provided by 
section 4(3) of the Securities Act.\7\
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    \7\ Applicants do not seek relief from the prospectus delivery 
requirement for non-secondary market transactions, such as purchases 
of shares from the Fund or an underwriter. Applicants state that a 
Fund's prospectus will caution persons purchasing Creation Units 
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. For example, a broker-dealer firm and/or its 
client may be deemed a statutory underwriter if it purchases 
Creation Units from a Fund, breaks them down into the constituent 
Shares, and sells those Shares directly to customers, or if it 
chooses to couple the creation of a supply of new Shares with an 
active selling effort involving solicitation of secondary market 
demand for Shares. Each Fund's prospectus will state that whether a 
person is an underwriter depends upon all the facts and 
circumstances pertaining to that person's activities. Each Fund's 
prospectus also will caution dealers who are not ``underwriters'' 
but are participating in a distribution (as contrasted to ordinary 
secondary market trading transactions), and thus dealing with Shares 
that are part of an ``unsold allotment'' within the meaning of 
section 4(3)(C) of the Securities Act, that they would be unable to 
take advantage of the prospectus delivery exemption provided by 
section 4(3) of the Securities Act.
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    8. Applicants state that Shares will be listed on a Listing Market 
and will be traded in a manner similar to other equity securities. 
Applicants note that dealers selling shares of closed-end investment 
companies in the secondary market generally are not required to deliver 
a prospectus to the purchaser.
    9. Applicants contend that Shares, as a listed security, merit a 
reduction in the compliance costs and regulatory burdens resulting from 
the imposition of prospectus delivery obligations in the secondary 
market. Because Shares will be listed on a Listing Market, prospective 
investors will have access to several types of market information about 
Shares. Applicants state that information regarding market price and 
volume will be continually available on a real-time basis throughout 
the day on brokers' computer screens and other electronic services. The 
previous day's price and volume information for Shares also will be 
published daily in the financial section of newspapers. In addition, 
the Trust (or the Listing Market) also intends to maintain a website 
that includes quantitative information updated on a daily basis, 
including, for each Fund, daily trading volume, the closing NAV and the 
reported closing price. The website for the Trust will also include, 
for each Fund, on a per Share basis, (a) a calculation of the premium 
or discount of the closing price against NAV, and (b) data in chart 
format displaying the frequency distribution of discounts and premiums 
of the daily closing price against NAV, within appropriate ranges, for 
each of the four previous calendar quarters.
    10. Investors also will receive a product description (``Product 
Description'') describing a Fund and its Shares. Applicants state that, 
while not intended as a substitute for a Prospectus, the Product 
Description will contain information about Shares that is tailored to 
meet the needs of investors purchasing Shares in the secondary market.

Sections 17(a)(1) and (2) of the Act

    11. Section 17(a) of the Act generally prohibits an affiliated 
person of a registered investment company, or an affiliated person of 
such a person, from selling any security to or purchasing any security 
from the company. Section 2(a)(3) of the Act defines ``affiliated 
person'' to include any person directly or indirectly owning, 
controlling, or holding with power to vote 5% or more of the 
outstanding voting securities of the other person and any person 
directly or indirectly controlling, controlled by, or under common 
control with, the other person. Section 2(a)(9) of the Act provides 
that a control relationship will be presumed where one person owns 25% 
or more of another person's voting securities. Applicants state that 
with respect to one or more Funds and the Trust, a large institutional 
investor, including a Market Maker, could own 5% or more or in excess 
of 25% of the outstanding Shares of a Fund or the Trust, making that 
investor an affiliated person of the Fund or Trust. Applicants request 
an exemption from section 17(a) under sections 6(c) and 17(b), to 
permit persons that are affiliated persons of a Fund or the Trust 
solely by virtue of a 5% or more or in excess of a 25% ownership 
interest (and affiliated persons of such affiliated persons that are 
not otherwise affiliated with such Fund or Trust) to purchase and 
redeem Creation Units through in-kind transactions.
    12. Section 17(b) of the Act authorizes the Commission to exempt a 
proposed transaction from section 17(a) of the Act if evidence 
establishes that the terms of the transaction, including the 
consideration to be paid or received, are reasonable and fair and do 
not involve overreaching on the part of any person concerned, and the 
proposed transaction is consistent with the policies of the registered 
investment company and the general provisions of the Act. Applicants 
contend that no useful purpose would be served by prohibiting the 
affiliated persons of a Fund or the Trust described above from 
purchasing or redeeming Creation Units through in-kind transactions. 
The deposit procedure for in-kind purchases and the redemption 
procedure for in-kind redemptions will be the same for all purchases 
and redemptions. Deposit Securities and Redemption Securities will be 
valued in the same manner as the securities in the Fund's portfolio. 
Therefore, applicants state that in-kind

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purchases and redemptions will afford no opportunity for an affiliated 
person described above to effect a transaction detrimental to the other 
holders of Shares. Applicants also believe that in-kind purchases and 
redemptions will not result in abusive self-dealing or overreaching by 
affiliated persons of the Funds or Trust.

Applicants' Conditions

    Applicants agree that any order granting the requested relief will 
be subject to the following conditions:
    1. Applicants will not register a Future Fund, by means of filing a 
post-effective amendment to the Trust's registration statement or by 
any other means, unless (a) applicants have requested and received with 
respect to such Future Fund, either exemptive relief from the 
Commission or a no-action letter from the Division of Investment 
Management of the Commission; or (b) the Future Fund will be listed on 
a Listing Market without the need for a filing pursuant to rule 19b-4 
under the Exchange Act.
    2. Each Fund's prospectus and Product Description will clearly 
disclose that, for purposes of the Act, Shares are issued by the Funds 
and that the acquisition of Shares by investment companies is subject 
to the restrictions of section 12(d)(1) of the Act.
    3. As long as the Trust operates in reliance on the requested 
order, the Shares will be listed on a Listing Market.
    4. Neither the Trust nor any of the Funds will be advertised or 
marketed as an open-end fund or a mutual fund. Each Fund's prospectus 
will prominently disclose that Shares are not individually redeemable 
shares and will disclose that the owners of the Shares may acquire 
those Shares from a Fund and tender those Shares for redemption to a 
Fund in Creation Units only. Any advertising material that describes 
the purchase or sale of Creation Units or refers to redeemability will 
prominently disclose that the Shares are not individually redeemable 
and that owners of the Shares may acquire those Shares from a Fund and 
tender those Shares for redemption to a Fund in Creation Units only.
    5. The Web site for the Trust, which will be publicly accessible at 
no charge, will contain the following information, on a per Share 
basis, for each Fund: (a) The prior Business Day's NAV and the reported 
closing price, and a calculation of the premium or discount of such 
price against such NAV; and (b) data in chart format displaying the 
frequency distribution of discounts and premiums of the daily closing 
price against the NAV, within appropriate ranges, for each of the four 
previous calendar quarters. In addition, the Product Description for 
each Fund will state that the Web site for the Trust has information 
about the premiums and discounts at which the Fund's Shares have 
traded.
    6. The prospectus and annual report for each Fund will also 
include: (a) The information listed in condition 5(b), (i) in the case 
of the prospectus, for the most recently completed year (and the most 
recently completed quarter or quarters, as applicable) and (ii) in the 
case of the annual report, for the immediately preceding five years, as 
applicable; and (b) the following data, calculated on a per Share basis 
for one, five and ten year periods (or life of the Fund), (i) the 
cumulative total return and the average annual total return based on 
NAV and closing price, and (ii) the cumulative total return of the 
relevant Underlying Index.
    7. Before a Fund may rely on the order, the Commission will have 
approved, pursuant to rule 19b-4 under the Exchange Act, a Listing 
Market rule requiring Listing Market members and member organizations 
effecting transactions in Shares to deliver a Product Description to 
purchasers of Shares.

    For the Commission, by the Division of Investment Management, 
under delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-5156 Filed 3-4-03; 8:45 am]
BILLING CODE 8010-01-P