[Federal Register Volume 68, Number 240 (Monday, December 15, 2003)]
[Notices]
[Pages 69739-69748]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-30840]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48881; File No. SR-NYSE-2003-39]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change by the New York 
Stock Exchange, Inc. Relating to the Listing and Trading of iShares 
Lehman U.S. Aggregate Bond Fund and iShares Lehman TIPS Bond Fund

December 4, 2003.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 
1934, (``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby 
given that on November 25, 2003 the New York Stock Exchange, Inc. 
(``NYSE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``SEC'' or ``Commission'') the proposed rule change as 
described in Items I and II below, which Items have been prepared by 
the Exchange. On December 3, 2003, the NYSE filed Amendment No. 1 to 
the proposed rule change.\3\ The Commission is publishing this notice 
to solicit comments on the proposed rule change, as amended, from 
interested persons and is approving the proposal, as amended, on an 
accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Darla Stuckey, Corporate Secretary, NYSE, to 
Florence Harmon, Senior Special Counsel, Division of Market 
Regulation (``Division''), Commission, dated December 3, 2003 
(``Amendment No. 1''). Amendment No. 1 provides for certain 
technical changes and clarification to the original proposal, 
particularly settlement and clearance procedures for TIPS Fund.
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1. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to trade pursuant to unlisted trading 
privileges (``UTP'') iShares Lehman U.S. Aggregate Bond Fund (the 
``Aggregate Bond Fund'') and to list and trade the iShares Lehman TIPS 
Bond Fund \4\ (the ``TIPS Fund'') and together with the Aggregate Bond 
Fund, (the ``ETFs'' or the ``Funds''), each a series of iShares Trust 
(the ``Trust''), an exchange traded fund which is a type of Investment 
Company Unit.
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    \4\ Telephone conversation between Janet Kissane, Milbank, 
Tweed, Hadley & McCloy LLP, Counsel for NYSE, and Florence Harmon, 
Senior Special Counsel, Division, Commission dated December 4, 2003.
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II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the NYSE included statements 
concerning the purpose of, and basis for, the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
item III below. The NYSE has prepared summaries, set forth in Sections 
A, B, and C below of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and the 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    Section 703.16 of the NYSE Listed Company Manual provides standards 
for listing and trading Investment Company Units (``ICUs''), which are 
securities issued by an open-end management company.\5\ The Commission 
previously approved amendments to section 703.16 of the NYSE Listed 
Company Manual to accommodate the listing and trading of ICUs based on 
an index of fixed income securities, but such standards are not generic 
listing standards. Hence, the NYSE has filed NYSE-2003-39 to 
accommodate the trading pursuant to UTP of the Aggregate Bond Fund and 
the listing and trading of the TIPS Fund under section 703.16 of the 
Listed Company Manual. The Funds have been approved for listing on the 
Amex.\6\
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    \5\ In 1996, the Commission approved Section 703.16 of the 
Listed Company Manual (the ``Company Manual''), which sets forth the 
rules related to the listing of ICUs. See Securities Exchange Act 
Release No. 36923 (March 5, 1996), 61 FR 10410 (March 13, 1996). In 
2000, the Commission also approved the Exchange's generic listing 
standards for listing and trading, or the trading pursuant to UTP, 
of ICUs under Section 703.16 of the Company Manual and NYSE Rule 
1100. See Securities Exchange Act Release No. 43679 (December 5, 
2000), 65 FR 77949 (December 13, 2000). In 2002, the Commission 
approved amendments to Section 703.16 of the Company Manual to 
accommodate the listing of ICUs based on an index of fixed income 
securities. See Securities Exchange Act Release No 46306 (August 2, 
2002), 67 FR 51916 (August 9, 2002).
    \6\ See Securities Exchange Act Release No. 48534 (September 24, 
2003), 68 FR 56353 (September 30, 2003).
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    As set forth in detail below, the Funds will hold certain fixed 
income securities (the ``Component Securities'') selected to correspond 
generally to the performance of the relevant Underlying Index (the 
``Underlying Index'') and, in the case of the Aggregate Bond Fund will 
also invest in mortgage pass-through securities through TBA

[[Page 69740]]

transactions, in each instance as described in Exhibit A to NYSE-2003-
39. The ETFs intend to qualify as a ``regulated investment company'' 
(the ``RIC'') under the Internal Revenue Code (the ``Code'').
    Barclays Global Fund Advisors (the ``Advisor'' or the ``BGFA'') is 
the investment advisor to the ETFs. The Advisor is registered under the 
Investment Advisers Act of 1940 (the ``Advisers Act''). The Advisor is 
the wholly owned subsidiary of Barclays Global Investors, N.A. (the 
``BGI''), a national banking association. BGI is an indirect subsidiary 
of Barclays Bank PLC of the United Kingdom.
    SEI Investments Distribution Co. (the ``Distributor''), a 
Pennsylvania corporation and broker-dealer registered under the Act, is 
the principal underwriter and distributor of Creation Unit Aggregations 
of iShares. The Distributor is not affiliated with the Exchange or the 
Advisor.
    Administrator/Custodian/Fund Accountant/Transfer Agent/Dividend 
Disbursing Agent. The Trust has appointed Investors Bank & Trust Co. 
(the ``IBT'') to act as administrator (the ``Administrator''), 
custodian, fund accountant, transfer agent, and dividend disbursing 
agent for the ETFs. The performance of their duties and obligations 
will be conducted within the provisions of the Advisers Act and the 
rules thereunder. There is no affiliation between IBT and the Trust, 
the Advisor or the Distributor.
    a. Operation of the ETFs. The investment objective of each ETF will 
be to provide investment results that correspond generally to the 
performance of its Underlying Index. In seeking to achieve its 
investment objective, the ETFs will utilize ``passive'' indexing 
investment strategies. Each ETF may fully replicate is Underlying 
Index, but currently intends to use a ``representative sampling'' 
strategy to track its Underlying Index. A Fund utilizing a 
representative sampling strategy generally will hold a basket of the 
component securities (the ``Component Securities'') of its Underlying 
Index, but it may not hold all of the Component Securities of its 
Underlying Index (as compared to an ETF that uses a replication 
strategy which invests in substantially all of the Component Securities 
in its Underlying Index in the same appropriate proportions as in the 
Underlying Index).\7\ The representative sampling techniques that will 
be used by the Advisor to manage the Aggregate Bond Fund and the TIPS 
do not differ from the representative sampling techniques it uses to 
manage the Funds that were the subject of the Commission's June 25, 
2002 order under the 1940 Act relating to other series of the iShares 
Trust indexes of fixed income securities.\8\
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    \7\ The Trust, Advisor and Distributor (the ``Applicants'') have 
filed with the Commission an Application for an Amended Order (the 
``Application'') under sections 6(c) and 17(b) of the Investment 
Company Act of 1940 (``1940'') for the purpose of exempting the ETFs 
from various provisions of the 1940 Act. (File No. 812-13003). A 
notice of Application was issued in Investment Company Act Release 
No. 26151, August 5, 2003. The information provided herein relating 
to the Funds is based on information regarding the Trust and the 
Finds/ See Investment Company Act Release No. 25622 (June 25, 2002) 
for the approval of the initial Application for additional series of 
the iShares Trust based on indexes of fixed income securities (the 
``Original Application'').
    \8\ Telephone conversation between Janet Kissane, Milbank, 
Tweed, Hadley & McCloy LLP, Counsel for NYSE, and Florence Harmon, 
Senior Special Counsel, Division, Commission dated December 2, 2003. 
See in the Matter of iShares Trust, et al., Investment Company Act 
Release; No. 25622 (June 25, 2002) (relating to the iShares 1-3 Year 
Treasury Index Fund, 7-10 Year Treasury Index Fund, 20+Year Treasury 
Index Fund, Treasury Index Fund, Government/Credit Index Fund, 
Lehman Corporate Bond Fund and GS$InvesTop Corporate Bond Fund).
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    When using a representative sampling strategy, the Advisor attempts 
to match the risk and return characteristics of an ETFs portfolio to 
the risk and return characteristics of the Underlying Index. As part of 
this process, the Advisor subdivides each Underlying Index into 
smaller, more homogenous pieces. These subdivisions are sometimes 
referred to as ``cells.'' A cell will contain securities with similar 
characteristics. For fixed income indices, the Advisor generally 
divides the index according to the five parameters that determine a 
bond's risk and expected return: (1) Duration, (2) Sector, (3) Credit 
Rating, (4) Coupon, and (5) the presence of embedded options. When 
completed, all bonds in the index will have been assigned a cell. The 
Advisor then begins to construct the portfolio by selecting 
representative bonds from these cells. The representative sample of 
bonds chosen from each cell is designed to closely correlate to the 
duration, sector, credit rating, coupon and embedded option 
characteristics of each cell. The characteristics of each cell when 
combined are, in turn, designed to closely correlate to the duration, 
sector, credit rating, coupon and embedded option characteristics of 
the Underlying Index as a whole. The Advisor may exclude less liquid 
bonds in order to create a more tradable portfolio and improve 
arbitrage opportunities.
    According to the Original Application, the representative sampling 
techniques used by the Advisor to manage fixed income funds do not 
materially differ from the representative sampling techniques it uses 
to manage equity funds. Due to the differences between bonds and 
equities, the Advisor analyzes different information, (e.g., coupon 
rates instead of dividend payments).
    According to the Original Application, the ETFs' use of the 
representative sampling strategy is beneficial for a number of reasons. 
First, the Advisor can avoid bonds that are ``expensive names'' (i.e., 
bonds that trade at perceived higher prices or lower yields because 
they are in short supply) but have the same essential risk, value, 
duration and other characteristics as less expensive names. Second, the 
use of representative sampling techniques permits the Advisor to 
exclude bonds that it believes will soon be deleted from the Underlying 
Index. Third, the Advisor can avoid holding bonds it deems less liquid 
than other bonds with similar characteristics. Fourth, the Advisor can 
develop a basket that is easier to construct and cheaper to trade, 
thereby potentially improving arbitrage opportunities.
    From time to time, adjustments may be made in the portfolio of each 
ETF in accordance with changes in the composition of the Underlying 
Index or to maintain compliance with requirements applicable to a RIC 
under the Code. For example, if at the end of a calendar quarter an ETF 
would not comply with the RIC diversification tests, the Advisor would 
make adjustments to the portfolio to ensure continued RIC status. The 
Exchange represents that the Advisor \9\ expects that each Fund will 
have a tracking error relative to the performance of its respective 
Underlying Index of no more than five percent (5%). Each ETF's 
investment objectives, policies and investment strategies will be fully 
disclosed in its prospectus (``Prospectus'') and statement of 
additional information (``SAI''). The TIPS Fund will invest at least 
90% of its assets in Component Securities of its Underlying Index. The 
TIPS Fund may also invest up to 10% of its assets in bonds not included 
in its Underlying Index, but which the Advisor believes will help the 
TIPS Fund track its Underlying Index, as well as in certain futures, 
options and swap contracts, cash and cash equivalents. For example, the 
TIPS Fund may invest in securities not included in the Underlying Index 
in order to reflect prospective changes in the Underlying Index (such 
as future corporate actions and index

[[Page 69741]]

reconstitutions, additions and deletions).
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    \9\ See supra note 3.
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    However, additional portfolio flexibility would benefit the 
Aggregate Bond Fund, while at the same time permitting it to closely 
track the performance of its Underlying Index. The Aggregate Bond Fund 
will: (1) Seek to track the performance of that portion of its 
Underlying Index comprised of U.S. Treasury securities, U.S. agency 
securities, corporate bonds, non-corporate bonds (e.g., bonds issued by 
supra-national entities such as the International Monetary Fund), 
asset-backed securities, and commercial mortgage-backed securities 
(approximately 65% of the Underlying Index as of December 3, 2003) by 
investing a corresponding percentage of its net assets (i.e., 
approximately 65%) in the Component Securities of its Underlying Index; 
\10\ and (2) seek to track the performance of that portion of its 
Underlying Index invested in U.S. agency mortgage pass-through 
securities (approximately 35% of the Underlying Index as of December 3, 
2003) by investing a corresponding percentage of its net assets (i.e., 
approximately 35%) \11\ through TBA transactions (as described below) 
on U.S. agency mortgage pass-through securities. Through the Aggregate 
Bond Fund's direct investments in Component Securities of its 
Underlying Index and its investment in mortgage pass-through securities 
through TBA transactions, the Aggregate Bond Fund will have at least 
90% of its net assets invested (i) in Component Securities of its 
Underlying Index and (ii) and investments that have economic 
characteristics that are substantially identical to the economic 
characteristics of the Component Securities of its Underlying Index 
(i.e., TBA transactions).
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    \10\ With respect to this portion of its portfolio, the 
Aggregate Bond Fund may invest up to 10% of its portfolio in bonds 
not included in its Underlying Index, but which the Advisor believes 
will help the Aggregate Bond Fund track its Underlying Index, as 
well as in certain futures, options and swap contracts, cash and 
cash equivalents.
    \11\ Telephone conversation between Janet Kissane, Milbank, 
Tweed, Hadley & McCloy LLP, Counsel for NYSE, and Florence Harmon, 
Senior Special Counsel, Division, Commission dated December 4, 2003.
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    According to the Application, the Aggregate Bond Fund needs the 
investment flexibility to engage in TBA transactions as described above 
primarily because approximately 35% of the securities in the Aggregate 
Bond Fund's Underlying Index are expected to be pools of U.S. agency 
mortgage pass-through securities.\12\ As discussed below, it is easier 
to trade and obtain intra-day prices of TBAs than it is to trade and 
obtain intra-day prices of specific pools of mortgage pass-through 
securities. The readily available information about intra-day pricing 
of TBAs and the ease with which they can be traded should make it 
easier to create and redeem Creation Unit Aggregations and help 
maintain the efficiency of the Aggregate Bond Fund's arbitrage 
mechanism.
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    \12\ As used herein, the term ``U.S. agency mortgage pass-
through security'' or ``mortgage pass-through security'' refers to a 
category of pass-through securities backed by pools of mortgages and 
issued by one of several U.S. Government-sponsored enterprises: the 
Government National Mortgage Association (``GNMA''), Federal 
National Mortgage Association (``FNMA'') or Federal Home Loan 
Mortgage Corporation (``FHLMC''). In the basic pass-through 
structure, mortgages with similar issuer, term and coupon 
characteristics are collected and aggregated into a pool. The pool 
is assigned a CUSIP number and undivided interests in the pool are 
traded and sold as pass-through securities. The holder of the 
security is entitled to a pro rata share of principal and interest 
payments (including unscheduled prepayments) from the pool of 
mortgage loans. The portion of the Underlying Index representing the 
mortgage pass-through segment of the U.S. investment grade bond 
market is comprised of multiple pools of mortgage pass-through 
securities.
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    The Application states that, although the market or mortgage pass-
through securities is extremely deep and liquid, it is impractical to 
trade mortgage pass-through securities on a pool-by-pool basis, 
particularly when large dollar amounts are involved. For this reason, 
the vast majority of mortgage pools are traded using ``to-be-
announced'' or ``TBA'' transactions. A TBA transaction is essentially a 
purchase or sale of a pass-through security for future settlement at an 
agreed upon date.\13\ It has been estimated that 90% of mortgage pass-
through securities (as measured by total dollar volume) are executed as 
TBA trades.\14\ TBA transactions increase the liquidity and pricing 
efficiency of transactions in mortgage pass-through securities since 
they permit similar mortgage pass-through securities to be traded 
interchangeably pursuant to commonly observed settlement and delivery 
requirements.
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    \13\ ``TBA'' refers to a mechanism for the forward settlement of 
agency mortgage pass-through securities, and not to a separate type 
of mortgage-backed security. TBA trades generally are conducted in 
accordance with widely-accepted ``Good Delivery'' guidelines 
published by The Bond Market Association (``TBMA''). The Good 
Delivery guidelines facilitate transactions in mortgage pass-through 
securities by establishing commonly observed terms and conditions 
for execution, settlement, and delivery. In a TBA trade, the buyer 
and seller decide on general trade parameters, such as agency, 
coupon, term to maturity, settlement date, par amount, and price. 
The actual pools delivered are determined two days prior to 
settlement date. TBA transactions promote efficient pricing because 
the Goog Delivery guidelines permit only a small variance between 
the face amount of the pools actually delivered and the nominal 
agreed upon amount. Intra-day and end-of-day pricing of TBAs is 
available from multiple pricing sources, such as Bloomberg L.P. 
(``Bloomberg'') and Trade Web. TBMA publishes standard notification 
and settlement dates for TBA trades specifying uniform settlement 
dates for specific classes of securities. The most active trading 
market for TBA trades is usually for next-month settlement. See 
generally TBAs: To-Be-Announced Mortgage Securities Transactions, 
TBMA (1999).
    \14\ Id. at 3.
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    The Aggregate Bond Fund intends to use TBA transactions to acquire 
and maintain exposure to that portion of the Underlying Index comprised 
of pools of mortgage pass-through securities in either of two ways. 
First, and more commonly, the Aggregate Bond Fund will enter into TBA 
agreements and ``roll over'' such agreements prior to the settlement 
date stipulated in such agreements. This type of TBA transaction is 
commonly known as a ``TBA roll.'' In a ``TBA roll'' the Aggregate Bond 
Fund generally will sell the obligation to purchase the pools 
stipulated in the TBA agreement prior to the stipulated settlement date 
and will enter into a new TBA agreement for future delivery of pools of 
mortgage pass-through securities. Second, and less frequently, the 
Aggregate Bond Fund will enter into TBA agreements and settle such 
transactions on the stipulated settlement date by actual receipt or 
delivery of the pools of mortgage pass-through securities stipulated in 
the TBA agreement. Since intra-day-prices of TBA agreements are more 
readily available than intra-day prices on specific mortgage pools and 
because mortgage pools tend to be less liquid than TBA agreements, the 
use of TBA agreements should help maintain the efficiency of the 
Aggregate Bond Fund's arbitrage mechanism. The Aggregate Bond Fund will 
accept actual delivery of mortgage pools only when the Advisor believes 
it is in the best interests of the Aggregate Bond Fund and its 
shareholders to do so. In determining whether to accept actual delivery 
of mortgage pools, the Advisor will consider, among other things, the 
potential impact of such acceptance on the efficiency of the Aggregate 
Bond Fund's arbitrage mechanism and the Aggregate Bond Fund's ability 
to track its Underlying Index. For these reasons, the Advisor believes 
that the ability to invest a significant portion of the Aggregate Bond 
Fund's assets through TBA transactions and to maintain such exposure 
through the use of TBA rolls would increase the liquidity and pricing 
efficiency of the Aggregate Bond Fund's portfolio. In addition, since 
holding a TBA position exposes the holder to

[[Page 69742]]

substantially identical market and economic risks as holding a position 
in a corresponding pool of mortgage pass-through securities, the 
Advisor believes that the use of TBA transactions as described herein 
should permit the Aggregate Bond Fund to closely track the performance 
of its Underlying Index.
    The use of TBA transactions is not intended to help the Aggregate 
Bond Fund ETF outperform its Underlying Index, but rather to increase 
pricing efficiency while at the same time maintaining the Aggregate 
Bond Fund's exposure to its Underlying Index.
    b. Issuance of Creation Unit Aggregations.
    1. In General. The issuance of Creation Unit Aggregations will 
operate, except as noted below, in a manner identical to that of the 
ETFs described in the Original Application.\15\ Shares of each ETF (the 
``iShares'') will be issued on a continuous offering basis in groups of 
50,000 or more. These ``groups'' of shares are called ``Creation Unit 
Aggregations.'' The ETFs will issue and redeem iShares only in Creation 
Unit Aggregations.\16\ As with other open-end investment companies, 
iShares will be issued at the net asset value (``NAV'') per share next 
determined after an order in proper form is received. The anticipated 
price at which both Funds will initially trade on the NYSE is 
approximately $100. The NYSE represents that the Aggregate Bond Fund is 
currently trading at $100.82 on the Amex as of December 3, 2003.\17\
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    \15\ See Investment Company Act Release No. 25622 (June 25, 
2002). Telephone conversation between Janet Kissane, Milbank, Tweed, 
Hadley & McCloy LLP, Counsel for NYSE, and Florence Harmon, Senior 
Special Counsel, Division, Commission dated December 2, 2003.
    \16\ Each Creation Unit Aggregation will consist of 50,000 or 
more iShares and the estimated initial value per Creation Unit 
Aggregation will be approximately $5 million.
    \17\ Telephone conversation between Janet Kissane, Milbank, 
Tweed, Hadley & McCloy LLP, Counsel for NYSE, and Florence Harmon, 
Senior Special Counsel, Division, Commission dated December 4, 2003.
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    The NAV per share of each ETF is determined as of the close of the 
regular trading session on the NYSE on each day that the NYSE is open. 
The Trust sells Creation Unit Aggregations of each ETF only on business 
days at the next determined NAV of each ETF.
    Creation Unit Aggregations will be issued by each ETF in exchange 
for the in-kind deposit of portfolio securities designated by the 
Advisor to correspond generally to the price and yield performance of 
the ETF's Underlying Index (the ``Deposit Securities''). Purchasers 
will generally be required to deposit a specified cash payment in the 
manner more fully described in the Application. Creation Unit 
Aggregations will be redeemed by each ETF in exchange for portfolio 
securities of the applicable ETF (the ``Fund Securities'') and a 
specified cash payment in the manner more fully described herein. Fund 
Securities received on redemption may not be identical to Deposit 
Securities deposited in connection with creations of Creation Unit 
Aggregations for the same day.
    The Distributor will act on an agency basis and will be the Trust's 
principal underwriter for the iShares in Creation Unit Aggregations of 
each ETF. All orders to purchase iShares in Creation Unit Aggregations 
must be placed with the Distributor by or through an authorized 
participant (the ``Authorized Participant''). Authorized Participants, 
which are required to be Depository Trust Company (``DTC'') 
participants, must enter into a participant agreement with the 
Distributor. The Distributor will transmit such orders to the 
applicable ETF and furnish to those placing orders confirmation that 
the orders have been accepted. The Distributor may reject any order 
that is not submitted in proper form. The Distributor will be 
responsible for delivering the Prospectus to those persons creating 
iShares in Creation Unit Aggregations and for maintaining records of 
both the orders placed with it and the confirmations of acceptance 
furnished by it. In addition, the Distributor will maintain a record of 
the instructions given to the Trust to implement the delivery of 
iShares.
    2. In-Kind Deposit of Portfolio Securities. Payment for Creation 
Unit Aggregations placed through the Distributor will be made by the 
purchasers generally by an in-kind deposit with the ETF of the Deposit 
Securities together with an amount of cash (the ``Balancing Amount'') 
specified by the Advisor in the manner described below. The Balancing 
Amount is an amount equal to the difference between (1) the NAV (per 
Creation Unit Aggregation) of the ETF and (2) the total aggregate 
market value (per Creation Unit Aggregation) of the Deposit Securities 
(such value referred to herein as the ``Deposit Amount''). The 
Balancing Amount serves the function of compensating for differences, 
if any, between the NAV per Creation Unit Aggregation and that of the 
Deposit Amount. The deposit of the requisite Deposit Securities and the 
Balancing Amount are collectively referred to herein as a ``Portfolio 
Deposit.''
    The Advisor will make available to the market through the National 
Securities Clearing Corporation (the ``NSCC'') on each Business Day, 
prior to the opening of trading on the Exchange (currently 9:30 a.m. 
eastern time), the list of the names and the required number of shares 
of each Deposit Security in the current Portfolio Deposit (based on 
information at the end of the previous Business Day) for the relevant 
Fund. The Portfolio Deposit will be applicable to an ETF (subject to 
any adjustments to the Balancing Amount, as described below) in order 
to effect purchases of Creation Unit Aggregations of the ETF until such 
time as the next-announced Portfolio Deposit composition is made 
available.
    The identity and number of shares of the Deposit Securities 
required for the Portfolio Deposit for each ETF will change from time 
to time. The composition of the Deposit Securities may change in 
response to adjustments to the weighting or composition of the 
Component Securities in the relevant Underlying Index. These 
adjustments will reflect changes, known to the Advisor to be in effect 
by the time of determination of the Deposit Securities, in the 
composition of the Underlying Index being tracked by the relevant ETF, 
or resulting from rebalance or additions or deletions to the relevant 
Underlying Index. In addition, the Trust reserves the right with 
respect to each ETF to permit or require the substitution of an amount 
of cash (i.e., a ``cash in lieu'' amount) to be added to the Balancing 
Amount to replace any Deposit Security: (1) that may be unavailable or 
not available in sufficient quantity for delivery to the Trust upon the 
purchase of iShares in Creation Unit Aggregations, or (2) that may not 
be eligible for trading by an Authorized Participant or the investor on 
whose behalf the Authorized Participant is acting.
    The Aggregate Bond Fund may invest in and hold mortgage pass-
through securities on a TBA basis. Since a TBA transaction is 
essentially an agreement for future settlement of a mortgage security, 
it is not possible to accept TBAs as part of the Portfolio Deposit. 
Instead, the Aggregate Bond Fund will designate the mortgage pass-
through TBAs to be included in a Portfolio Deposit just as it would any 
other Deposit Securities of a Portfolio Deposit, and will accept ``cash 
in lieu'' of delivery of the designated mortgage pass-through TBAs. The 
Aggregate Bond Fund will then enter into TBA agreements included as 
Deposit Securities in the Portfolio Deposit.\18\

[[Page 69743]]

According to the Application, this will substantially minimize the 
Aggregate Bond Fund's transaction costs, enhance operational 
efficiencies and otherwise reduce any operational issues which the 
acceptance of pools of mortgage pass-through securities might otherwise 
present.\19\
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    \18\ Prior to settlement of such TBA transactions, the ``cash in 
lieu'' portion of the Portfolio Deposit will be invested in cash 
equivalents, including money market mutual funds, and such 
investments, along with cash and other liquid assets identified by 
BGFA, will be segregated on the books and records of the Aggregate 
Bond Fund or its Custodian in accordance with Section 18 of the 1940 
Act and Investment Company Act Release No. 10666. Since the price of 
a TBA transaction includes an assumed rate of return on the cash 
held in anticipation of settlement, the Aggregate Bond Fund's 
investment in cash equivalents prior to settlement is not expected 
to have a material impact on potential tracking error or the 
Aggregate Bond Fund's ability to track its Underlying Index. In 
addition, since the interest or dividends that the Aggregate Bond 
Fund accrues on a daily basis on its investment in cash equivalents 
will be relatively small and will be included as part of the Cash 
Component published on a daily basis according to the procedures 
currently used for the ICUs, Applicants expect that such dividends 
and interest will be reflected in the secondary market trading price 
of iShares of the Aggregate Bond Fund. The Commission's order 
relating to the Original Application permits acceptance of a ``cash 
in lieu'' amount to replace Deposit Securities that are unavailable 
for delivery or for other reasons. In addition, prior iShares orders 
expressly permit ``cash-only purchases of Creation Unit 
Aggregations'' where the Advisor believes such transactions would 
``substantially minimize * * * transaction costs or would enhance * 
* * operational efficiencies.'' See Investment Company Act Release 
No. 24452 (May 12, 2000).
    \19\ Intra-day and end-of-day pricing of TBAs is available from 
multiple pricing sources, such as Bloomberg and TradeWeb. In 
addition, the fungible nature of TBAs and commonly observed 
execution and settlement procedures create significant pricing 
efficiencies and market liquidity for TBAs. TBAs typically trade at 
very narrow spreads on transactions of up to $300 million or more. 
Since intra-day pricing of TBAs is readily available and the market 
for mortgage pass-through TBAs is extremely liquid, the designation 
of TBAs in the Portfolio Deposit and their inclusion as Fund 
Securities should make pricing of the Aggregate Bond Fund and the 
Deposit Amount more efficient and transparent, thus increasing 
arbitrage efficiency.
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    c. Availability of Information Regarding iShares and Underlying 
Indices. On each Business Day, the list of names and amount of each 
treasury security, government security or corporate bond constituting 
the current Deposit Securities of the Portfolio Deposit and the 
Balancing Amount effective as of the previous Business Day will be made 
available. An amount per iShare representing the sum of the estimated 
Balancing Amount effective through and including the previous Business 
Day, plus the current value of the Deposit Securities, on a per iShare 
basis (the ``Intra-day Optimized Portfolio Value'' or the ``IOPV'') 
will be calculated by independent third parties (such as Bloomberg) 
every 15 seconds during the NYSE's regular trading hours and 
disseminated by the NYSE every 15 seconds on the Consolidated Tape.\20\ 
The IOPV will be updated throughout the day to reflect changing bond 
prices, as well as TBA prices, using multiple prices from independent 
third party pricing sources. Information about the intra-day prices for 
the Deposit Securities of the each Fund is readily available to the 
marketplace.\21\ Applicants represent that (1) IOPV will be calculated 
by an independent third party; (2) IOPV will be calculated using prices 
obtained from multiple independent third-party pricing sources (such as 
broker-dealers) throughout the day; and (3) IOPV will be calculated in 
accordance with pre-determined criteria and set parameters so that an 
individual bond ``price'' based on an analysis of multiple pricing 
sources is obtained for each security in the Portfolio Deposit.\22\ 
Closing prices of the ETFs' Deposit Securities are readily available 
from published or other public sources, such as the NYSE's Automated 
Bond System (ABS[reg]), the Trace Reporting and Compliance Engine 
(``TRACE''), or on-line client-based information services provided by 
Credit Suisse First Boston, Goldman Sachs, Lehman Brothers, IDC, 
Merrill Lynch, Bridge, Bloomberg, TradeWeb and other pricing services 
commonly used by bond mutual funds.\23\
---------------------------------------------------------------------------

    \20\ Telephone conversation between Janet Kissane, Milbank, 
Tweed, Hadley & McCloy LLP, Counsel for NYSE, and Florence Harmon, 
Senior Special Counsel, Division, Commission dated December 4, 2003.
    \21\ Authorized Participants and other market participants have 
a variety of ways to access the intra-day security prices that form 
the basis of the ETF's IOPV calculation. For example, intra-day 
prices for treasury securities, agency securities and TBAs are 
available from Bloomberg, TradeWeb, ABS[reg] and TRACE. Intra-day 
prices for inflation protected public obligations of the U.S. 
Treasury are available from Bloomberg and TradeWeb. Intra-day prices 
of callable agency securities are available from TradeWeb. Intra-day 
prices of corporate bonds are available from ABS[reg] and TRACE. In 
addition, intra-day prices for each of these securities are 
available by subscription or otherwise to Authorized Participants 
and clients of major U.S. broker-dealers (such as Credit Suisse 
First Boston, Goldman Sachs and Lehman Brothers). See supra note 6.
    \22\ For example, Bloomberg Generic Prices could be used. 
Bloomberg Generic Prices are current prices on individual bonds as 
determined by Bloomberg using a proprietary automated pricing 
program that analyzes multiple bond prices contributed to Bloomberg 
by third-party price contributors (such as broker-dealers).
    \23\ The Exchange understands that Credit Suisse First Boston, 
Goldman Sachs, Lehman Brothers, Merrill Lynch, IDC, Bridge and 
Bloomberg provide prices for each type of Deposit Security. TradeWeb 
provides prices for each type of Deposit Security except mortgage 
backed securities and corporate bonds. ABS[reg] and TRACE provide 
prices for corporate bonds. Telephone conversation between Janet 
Kissane, Milbank, Tweed, Hadley & McCloy LLP, Counsel for NYSE, and 
Florence Harmon, Senior Special Counsel, Division, Commission dated 
December 4, 2003.
---------------------------------------------------------------------------

    The Indices underlying the Aggregate Bond Fund will not be 
calculated or disseminated intra-day because Lehman Brothers does not 
calculate or disseminate intra-day values for these indices. The value 
and return of the underlying Lehman Index is calculated and 
disseminated each business day, at the end of the day, by Lehman 
Brothers.\24\
---------------------------------------------------------------------------

    \24\ Telephone conversation between Janet Kissane, Milbank, 
Tweed, Hadley & McCloy, LLP, Counsel for NYSE, and Florence Harmon, 
Senior Special Counsel, Division, Commission dated December 4, 2003.
---------------------------------------------------------------------------

    Each Fund will make available through NSCC on a daily basis the 
names and required number of shares of each of the Deposit Securities 
in a Creation Unit Aggregation, as well as information regarding the 
Balancing Amount. The NAV for each Fund will be calculated and 
disseminated daily. There will also be disseminated a variety of data 
with respect to each Fund on a daily basis by means of CTA and CQ High 
Speed Lines; information with respect to recent NAV, shares 
outstanding, estimated cash amount and total cash amount per Creation 
Unit Aggregation will be made available prior to the opening of the 
Exchange. In addition, the website for the Trust, which will be 
publicly accessible at no charge, will contain the following 
information, on a per iShare basis, for each Fund: (a) The prior 
Business Day's NAV and the mid-point of the bid-ask price \25\ at the 
time of calculation of such NAV (``Bid/Ask Price''), and a calculation 
of the premium or discount of such price against such NAV; and (b) data 
in chart format displaying the frequency distribution of discounts and 
premiums of the Bid/Ask Price against the NAV, within appropriate 
ranges, for each of the four previous calendar quarters.\26\
---------------------------------------------------------------------------

    \25\ The Bid-Ask Price of each ETF is determined using the 
highest bid and lowest offer on the Exchange as of the time of 
calculation of each ETF's NAV.
    \26\ The secondary market for Treasury securities is a highly 
organized over-the-counter market. Many dealers, and particularly 
the primary dealers, make markets in Treasury securities. Trading 
activity takes place between primary dealers, non-primary dealers, 
and customers of these dealers, including financial institutions, 
non-financial institutions and individuals. Increasingly, trading in 
Treasury securities occurs through automated trading systems. See, 
``eCommerce in the Fixed-Income Markets: The 2001 Review of 
Electronic Transaction Systems,'' December 2001. This survey of 
electronic trading systems in the bond market was prepared by the 
staff of The Bond Market Association and is available through the 
Association's Web site: www.bondmarkets.com.
    The primary dealers are among the most active participants in 
the secondary market for Treasury securities. The primary dealers 
and other large market participants frequently trade with each 
other, and most of these transactions occur through an interdealer 
broker (e.g., BrokerTec Global, Cantor Fitzgerald, Garban-
Intercapital, and Liberty Brokerage). The interdealer brokers 
provide primary dealers and other large participants in the Treasury 
market with electronic screens that display the bid and offer prices 
among dealers and allow trades to be consummated.
    Quote and trade information regarding Treasury securities is 
widely available to market participants from a variety of sources. 
The electronic trade and quote systems of the dealers and 
interdealer brokers are one such source. Groups of dealers and 
interdealer brokers also furnish trade and quote information to 
vendors such as Bloomberg, Reuters, Bridge, Moneyline Telerate, and 
CQG. GovPX, for example, is a consortium of leading government 
securities dealers and subscribers that provides market data from 
leading government securities dealers and interdealer brokers to 
market data vendors and subscribers. TradeWeb, another example, is a 
consortium of 18 primary dealers that, in addition to providing a 
trading platform, also provides market data direct to subscribers or 
to other market data vendors.
    Real-time price quotes for corporate and non-corporate debt 
securities are available to institutional investors via proprietary 
systems such as Bloomberg, Reuters and Dow Jones Telerate. 
Additional analytical data and pricing information may also be 
obtained through vendors such as Bridge Information Systems, Muller 
Data, Capital Management Sciences, Interactive Data Corporation and 
Barra.
    Retail investors do have access to free intra-day bellwether 
quotes. Corporate prices are available at 20-minute intervals from 
Capital Management Services at http://www.bondvu.com/quotmenu.htm. 
TBMA provides links to price and other bond information sources on 
its investors Web site at http://www.investinginbonds.com. In 
addition, transaction prices and volume data for the most actively-
traded bonds on the exchanges are published daily in newspapers and 
on a variety of financial Web sites.
    Closing corporate and non-corporate bond prices are also 
available through subscription services (e.g., IDC, Bridge) that 
provide aggregate pricing information based on prices from several 
dealers, as well as subscription services from broker-dealers with a 
large bond trading operation, such as Lehman Brothers and Goldman, 
Sachs & Co.

---------------------------------------------------------------------------

[[Page 69744]]

    d. Redemption of iShares. Creation Unit Aggregations of each fund 
will be redeemable at the NAV next determined after receipt of a 
request for redemption. Creation Unit Aggregations of each Fund will be 
redeemed principally in-kind, together with a balancing cash payment 
(although, as described below, Creation Unit Aggregations may sometimes 
be redeemed for cash). The value of each Fund's redemption payments on 
a Creation Unit Aggregation basis will equal the NAV per the 
appropriate number of iShares of such Fund. Owners of iShares may sell 
their iShares in the secondary market, but must accumulate enough 
iShares to constitute a Creation Unit Aggregation in order to redeem 
through the Fund. Redemption orders must be placed by or through an 
Authorized Participant.
    Creation Unit Aggregations of any Fund generally will be redeemable 
on any Business Day in exchange for Fund Securities and the Cash 
Redemption Payment (defined below) in effect on the date a request for 
redemption is made. The Advisor will publish daily through NSCC the 
list of securities which a creator of Creation Unit Aggregations must 
deliver to the Fund (the``Creation List'') and which a redeemer will 
receive from the Fund (the ``Redemption List''). The Creation List is 
identical to the list of the names and the required numbers of shares 
of each Deposit Security included in the current Portfolio Deposit.\27\
---------------------------------------------------------------------------

    \27\ Investors redeeming Creation Unit Aggregations of the 
Aggregate Bond Fund will receive cash for any Component Securities 
that are mortgage pass-through TBAs.
---------------------------------------------------------------------------

    In addition, just as the Balancing Amount is delivered by the 
purchaser of Creation Unit Aggregations to the Fund, the Trust will 
also deliver to the redeeming Beneficial Owner in cash the ``Cash 
Redemption Payment.'' The Cash Redemption Payment on any given Business 
Day will be an amount calculated in the same manner as that for the 
Balancing Amount, although the actual amounts may differ if the Fund 
Securities received upon redemption are not identical to the Deposit 
Securities applicable for creations on the same day. To the extent that 
the Fund Securities have a value greater than the NAV of iShares being 
redeemed, a cash payment equal to the differential is required to be 
paid by the redeeming Beneficial Owner to the Fund. The Trust may also 
make redemptions in cash in lieu of transferring one or more Fund 
Securities to a redeemer if the Trust determines, in its discretion, 
that such method is warranted due to unusual circumstances. An unusual 
circumstance could arise, for example, when a redeeming entity is 
restrained by regulation or policy from transacting in certain Fund 
Securities, such as the presence of such Fund Securities, on a 
redeeming investment banking firm's restricted list.
    e. Clearance and Settlement.\28\ In order to simplify the creation 
and redemption process and align the settlement of iShares of the Fund 
with the settlement of the Deposit Securities and Fund Securities 
(i.e., the underlying U.S. Government securities, corporate and other 
bonds) contributed or received in connection with creation and 
redemption transactions, Applicants plan to settle transactions in 
Deposit Securities and Fund Securities and iShares on the same 
settlement cycle. (For the sake of clarity, the Exchange notes that 
transactions in iShares in the secondary market will generally settle 
on T + 3).\29\ The Deposit Securities and Fund Securities of each fund 
will settle via free delivery through the Federal Reserve System for 
U.S. government securities and the DTC for corporate securities and 
non-corporate (other than U.S. government securities). The iShares will 
settle through the DTC. The Custodian will monitor the movement of the 
Deposit Securities and will instruct the movement of the iShares only 
upon validation that the Deposit Securities have settled correctly or 
that required collateral is in place.
---------------------------------------------------------------------------

    \28\ See supra note 3.
    \29\ Telephone conversation between Janet Kissane, Milbank, 
Tweed, Hadley & McCloy LLP, Counsel for NYSE, and Florence Harmon, 
Senior Special Counsel, Division, Commission dated December 4, 2003.
---------------------------------------------------------------------------

    As with the settlement of domestic ETF transactions outside of the 
NSCC Continuous Net Settlement System (the ``CNS System''), (i) iShares 
of the Funds and corporate and non-corporate securities (other than 
U.S. government securities) will clear and settle through DTC, and (ii) 
U.S. government securities and cash will clear and settle through the 
Federal Reserve system. More specifically, creation transactions will 
settle as follows. On settlement date (generally T + 3 for the 
Aggregate Bond Fund and T + 1 for the TIPS Fund), an Authorized 
Participant will transfer Deposit Securities that are corporate and 
non-corporate bonds (other than U.S. government securities) through DTC 
to a DTC account maintained by the Funds' Custodian, and Deposit 
Securities that are U.S. government securities, together with any 
Balancing Amount, to the Custodian through the Federal Reserve system. 
Once the Custodian has verified the receipt of all of the Deposit 
Securities (or in the case of failed delivery of one or more bonds, 
collateral in the amount of 105% or more of the missing Deposit 
Securities) and the receipt of any Balancing Amount, the Custodian will 
notify the Distributor and the Advisor. Each Fund will issue Creation 
Unit Aggregations of iShares and the Custodian will deliver the iShares 
to the Authorized Participant through DTC. DTC will then credit the 
Authorized Participant's DTC account. The clearance and settlement of 
redemption transactions essentially reverses the process described 
above. After the Trust has received a redemption request in proper form 
and the Authorized Participant transfers Creation Unit Aggregations of 
iShares to the Fund's Custodian through DTC, the trust will cause the 
Custodian to initiate procedures to transfer the requisite Fund 
Securities and any Cash Redemption Payment. On settlement

[[Page 69745]]

date, assuming the Custodian has verified receipt of the Creation Unit 
Aggregations, the Custodian will transfer Fund Securities that are 
corporate and non-corporate bonds to the Authorized Participant through 
DTC and Fund Securities that are U.S. government securities, together 
with any Cash Redemption Payment, through the Federal Reserve system.
    iShares of the Funds will be debited or credited by the Custodian 
directly to the DTC accounts of the Authorized Participants. With 
respect to domestic equity-based ETFs using the CNS System, Creation 
Unit Aggregations of iShares are deposited or charged to the Authorized 
Participants' DTC accounts through the CNS System. Since creation/
redemption transactions for iShares of the Funds will not clear and 
settle through the CNS System, the failed delivery of one or more 
Deposit Securities (on a create) or one or more Fund Securities (on a 
redemption) will not be facilitated by the CNS System. Therefore, 
Authorized Participants will be required to provide collateral to cover 
the failed delivery of Deposit Securities in connection with an ``in-
kind'' creation of iShares. In case of a failed delivery of one or more 
Deposit Securities, the Funds will hold the collateral until the 
delivery of such Deposit Security. The Funds will be protected from 
failure to receive the Deposit Securities because the Custodian will 
not effect the Fund's side of the transaction (the issuance of iShares) 
until the Custodian has received confirmation of receipt of the 
Authorized Participant's incoming Deposit Securities (or collateral for 
failed Deposit Securities) and Balancing Amount. In the case of 
redemption transactions, the Funds will be protected from failure to 
receive Creations Unit Aggregations of iShares because the Custodian 
will not new effect the Funds's side of the transaction (the delivery 
of Fund Securities and the Cash Redemption Payment) until the Transfer 
Agent has received confirmation of receipt of the Authorized 
Participant's incoming Creation Unit Aggregations.
    The Exchange represents that according to the Application and the 
Advisor, the clearance and settlement process will not affect the 
arbitrage of iShares of the Funds.
    f. Dividends and Distributions. Dividends from net investment 
income will be declared and paid to Beneficial Owners of record at 
least annually by each Fund. Certain of the Funds may pay dividends, if 
any, on a quarterly or more frequent basis. Distributions of realized 
securities gains, if any, generally will be declared and paid once a 
year, but each Fund may make distributions on a more frequent basis to 
comply with the distribution requirements of the Code and consistent 
with the 1940 Act.
    Dividends and other distributions on iShares of each Fund will be 
distributed on a pro rata basis to Beneficial Owners of such iShares. 
Dividend payments will be made through the Depository and the DTC 
Participants to Beneficial Owners then of record with amounts received 
from each Fund.
    The Trust will not make the DTC book-entry Dividend Reinvestment 
Service (the ``Service'') available for use by Beneficial Owners for 
reinvestment of their cash proceeds, but certain individual brokers my 
make the Service available to their clients. The SAI will inform 
investors of this fact and direct interested investors to contact such 
investor's broker to ascertain the availability and a description of 
the Service through such broker. The SAI will also caution interested 
Beneficial Owners that they should note that each broker may require 
investors to adhere to specific procedures and timetables in order to 
participate in the Service and such investors should ascertain from 
their broker such necessary details. iShares acquired pursuant to the 
Service will be held by the Beneficial Owners in the same manner, and 
subject to the same terms and conditions, as for original ownership of 
iShares.
    g. Other Issues.
    1. Criteria for Initial and Continued Listing. iShares are subject 
to the criteria for initial and continued listing of Investment Company 
Units in Section 703.16 of the Manual. It is anticipated that a minimum 
of two Creation Units (100,000 iShares) will be required to be 
outstanding at the start of trading on the NYSE. This minimum number of 
iShares required to be outstanding at the start of trading will be 
comparable to requirements that have been applied to previously traded 
series of investment Company Units.
    The NYSE believes that the proposed minimum number of iShares 
outstanding at the start of trading is sufficient to provide market 
liquidity and to further the Trust's objective to seek to provide 
investment results that correspond generally to the price and yield 
performance of the Underlying Index.
    2. Original and Annual Listing Fees. The NYSE's original listing 
fees that would be applicable to each Fund if listed on the Exchange is 
$5,000, and the continuing fees would be $2,000. The TIPS Fund will 
list on the NYSE.
    3. Stop and Stop Limit Orders. Commentary .30 to NYSE Rule 13 
provides that stop and stop limit orders in an Investment Company Unit 
shall be elected by a quotation, but specifies that if the electing bid 
on an offer is more that 0.10 points away from the list sale and is for 
the specialist's dealer account, prior Floor Official approval is 
required for the election to be effective. This rule applies to 
Investment Company Units generally, including fixed income ETFs.
    4. NYSE Rule 460.10. NYSE Rule 460.10 generally precludes certain 
business relationships between an issuer and specialist in the issuer's 
securities. Exceptions in the Rule permit specialists in ETF shares, 
including fixed income ETFs, to enter into Creation Unit transactions 
through the Distributor to facilitate the maintenance of a fair and 
orderly market. A specialist Creation Unit transaction may only be 
effected on the same terms and conditions as any other investor and 
only at the net asset value of the ETF shares. A specialist may acquire 
a position in excess of 10% of the outstanding issue of the ETF shares; 
provided, however, that a specialist registered in a security issued by 
an investment company may purchase and redeem the investment company 
unit, or securities that can be subdivided or converted into such unit, 
from the investment company as appropriate to facilitate the 
maintenance of a fair and orderly market in the subject security.
    5. Prospectus Delivery. The Commission has granted the Trust an 
exemption from certain prospectus delivery requirements under section 
24(d) of the 1940 Act.\30\ Any product description used in reliance on 
a section 24(d) exemptive order will comply with all representations 
made therein and all conditions thereto. The NYSE, in an Information 
Circular to Exchange members and member organizations, will inform 
members and member organizations, prior to commencement of trading, of 
the prospectus or product description delivery requirements applicable 
to the Funds.
---------------------------------------------------------------------------

    \30\ See Investment Company Act Release No. 25623 (June 25, 
2002).
---------------------------------------------------------------------------

    6. Trading Halts. In order to halt the trading of an ETF, the 
Exchange may consider, among other things, factors such as the extent 
to which trading is not occurring in underlying security(s) and whether 
other unusual conditions or circumstances detrimental to the 
maintenance of a fair and orderly market are present. In addition, 
trading in ETF shares is subject to trading halts caused by 
extraordinary market volatility pursuant to NYSE Rule 80B.

[[Page 69746]]

    7. Suitability. Pursuant to NYSE Rule 405, before a member, member 
organization, allied member or employee of such member organization 
undertakes to recommend a transaction in ETF shares, including fixed 
income ETFs, such member or member organization should make a 
determination that such shares are suitable for such customer. If any 
recommendation is made with respect to such shares, the person making 
the recommendation should have a reasonable basis for believing at the 
time of making the recommendation, that the customer has such knowledge 
and experience in financial matters that he or she may reasonably be 
expected to be capable of evaluating the risks and any special 
characteristics of the recommended transaction, and is financially able 
to bear the risks of the recommended transaction. In the Exchange's 
Information Circular references above, the Exchange will inform members 
and member organizations of the requirements of NYSE Rule 405.\31\
---------------------------------------------------------------------------

    \31\ See supra note 3.
---------------------------------------------------------------------------

    8. Purchases and Redemptions in Creation Unit Size. In the 
Information Circular referenced above, members and member organizations 
will be informed that procedures for purchases and redemptions of 
iShares in Creation Unit Size are described in the relevant Fund 
Prospectus and SAI, and that iShares are not individually redeemable 
but are redeemable only in Creation Unit Size aggregations or multiples 
thereof.
    9. Surveillance. Exchange surveillance procedures applicable to 
trading in the proposed iShares are comparable to those applicable to 
other Investment Company Units currently trading on the Exchange. The 
Exchange represents that its surveillance procedures are adequate to 
properly monitor the trading of the Funds. The Exchange's current 
trading surveillances focus on detecting securities trading outside 
their normal patterns. When such situations are detected, surveillance 
analysis follows and investigations are opened, where appropriate, to 
review the behavior of all relevant parties for all relevant trading 
violations. Through its member organizations and otherwise through its 
membership in the Intermarket Surveillance Group, the Exchange is able 
to obtain information regarding trading on any U.S. market in both the 
Funds and the Component Securities.
    If a broker-dealer is responsible for maintaining (or has a role in 
maintaining), or calculating the underlying Index, it would be required 
to erect and maintain a ``Fire Wall'' designed to prevent the flow of 
information regarding the underlying index from the index production 
personnel and index calculation personnel to the sales and trading 
personnel. In the course of member organization examinations,\32\ the 
Exchange will examine and test the broker-dealer's ``Fire Wall'' 
procedures to determine whether they are reasonably designed to prevent 
the misuse of material non-public information by sales and trading 
personnel that originates from index production personnel and 
calculation personnel.
---------------------------------------------------------------------------

    \32\ The Exchange will examine the member organization's 
procedures for the first two years after the listing of the ETF and 
thereafter periodically based on its assessment of risk in planning 
the annual examination.
---------------------------------------------------------------------------

    10. Hours of Trading/Minimum Price Variation. The Fund will trade 
on the Exchange until 4:15 p.m. (eastern time). The minimum price 
variation for quoting will be $.01.
2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with section 6(b) of the Act,\33\ in general, and furthers the 
objectives of section 6(b)(5) of the Act,\34\ in particular, in that it 
is designed to prevent fraudulent and manipulative acts and practices, 
to promote just and equitable principles of trade, to foster 
cooperation and coordination with persons engaged in regulating, 
clearing, settling, processing information with respect to, and 
facilitating transaction in securities, and, in general to protect 
investors and the public interest.
---------------------------------------------------------------------------

    \33\ 15 U.S.C. 78f(b).
    \34\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    No written comments were solicited or received with respect to the 
proposed rule change.

III. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposal is 
consistent with the Act. Persons making written submissions should file 
six copies thereof with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street NW., Washington, DC 20549-0609. Comments 
may also be submitted electronically at the following e-mail address: 
[email protected]. All comment letters should refer to File No. 
NYSE-2003-39. The file number should be included on the subject line if 
e-mail is used. To help the Commission process and review your comments 
more efficiently, comments should be sent in hardcopy or by e-mail but 
not by both methods. Copies of the submission, all subsequent 
amendments, all written statements with respect to the proposed rule 
change that are filed with the Commission, and all written 
communications relating to the proposed rule change between the 
Commisson and any person, other than those that may be witheld from the 
public in accordance with the provisions of 5 U.S.C. 552, will be 
available for inspection and copying in the Commission's Public 
Reference Room. Copies of such filing will also be available for 
inspection and copying at the principal office of the NYSE. All 
submissions should refer to the File No. SR-NYSE-2003-39 and should be 
submitted by January 5, 2004.

IV. Commission's Findings and Order Granting Accelerated Approval of 
Proposed Rule Change

    After careful review, the Commission finds that implementation of 
the proposed rule change is consistent with the requirements of section 
6 of the Act \35\ and the rules and regulations thereunder applicable 
to a national securities exchange.\36\ Specifically, the Commission 
believes that the proposal is consistent with section 6(b)(5) of the 
Act.\37\ The Commission believes that the availability of the Funds 
will provide an instrument for investors to achieve desired investment 
results that correspond generally to the price and yield performance of 
the underlying fixed income indices. The investment objective of each 
Fund will be to provide investment results that correspond generally to 
the price and yield performance of the underlying index based on fixed 
income securities.
---------------------------------------------------------------------------

    \35\ 15 U.S.C. 78f.
    \36\ In approving this proposed rule change, the Commission 
notes that it has considered the proposed rule's impact on 
efficiency, competition, and capital formation. 15 U.S.C. 78c(f).
    \37\ Id.
---------------------------------------------------------------------------

    Accordingly, the Commission finds that the Exchange's proposal will 
facilitate transactions in securities, remove impediments to and 
perfect the mechanism of a free and open market and a national market 
system, and, in

[[Page 69747]]

general, protect investors and the public interest, and is not designed 
to permit unfair discrimination between customers, issuers, brokers, or 
dealers.\38\
---------------------------------------------------------------------------

    \38\ Pursuant to section 6(b)(5) of the Act, the Commission must 
predicate approval of exchange trading for new products upon a 
finding that the introduction of the product is in the public 
interest. Such a finding would be difficult with respect to a 
product that served no investment, hedging or other economic 
functions, because any benefits that might be derived by market 
participants would likely be outweighed by the potential for 
manipulation, diminished public confidence in the integrity of the 
markets, and other valid regulatory concerns.
---------------------------------------------------------------------------

    The Commission has granted the Funds appropriate relief under 
various Sections of the 1940 Act, including sections 6(c) and 17(b), so 
that each Fund may register under the 1940 Act as an open-end fund and 
issue shares that are redeemable in Creation Units, shares of the Funds 
may trade in the secondary market at negotiated prices, and certain 
persons affiliated with a Fund by reason of owning 5% or more, and in 
some cases more than 25%, of its outstanding securities may do in-kind 
purchases and redemptions of Creation Units.\39\
---------------------------------------------------------------------------

    \39\ Investment Company Act Release No. 25622 (June 25, 2002).
---------------------------------------------------------------------------

    The Commission notes that the Funds will operate in substantially 
the same manner as the funds that were the subject of the Previous 
Approval Order. The Commission notes one difference is that with 
respect to the Aggregate Bond Fund, approximately 35% of its assets 
will be invested in TBA transactions, which is a purchase or sale of a 
pass-through security for future settlement at an agreed upon date. The 
Exchange represented that the use of TBA transactions is not intended 
to help the Aggregate Bond Fund outperform its Underlying Index, but 
rather to increase pricing efficiency while at the same time 
maintaining the Aggregate Bond Fund's exposure to its Underlying Index. 
Since the intra-day prices of TBA agreements are more readily available 
than intra-day prices on specific mortgage pools and because mortgage 
pools tend to be less liquid that TBA agreements, the Commission agrees 
that the use of TBA agreements should help maintain the efficiency of 
the Aggregate Bond Fund's arbitrage mechanism.
    For the reasons stated in the Notice, above, the Commission finds 
that adequate rules and procedures exist to govern the trading of ICUs, 
including the Funds. For the reasons stated in the Notice, above, the 
Commission finds that because of the nature of the particular fixed 
income securities to be included in the portfolios of the Funds (i.e., 
U.S. Government securities, investment grade corporate bonds, and TBA 
transactions), the pricing information should be available. However, 
the Commission notes that differences in the degree of price 
transparency in the debt and equity markets could lead to larger 
discounts and premiums for the Funds than have been experienced by 
Equity ETFs because arbitrators may wait for greater premiums or 
discounts to develop in the market price of the ETF shares before 
engaging in arbitrage transactions. The Commission expects the Exchange 
to contact Commission staff if the tracking error for these Funds 
exceeds the represented 5%.
    The Commission has also granted the issuer, Barclays, exemptive 
relief from Section 24(d) of the 1940 Act so that dealers may effect 
secondary market transaction in ETF shares without delivery a 
prospectus to the purchaser.\40\ Instead, under the exemption and under 
NYSE's listing standards, sales in the secondary market must be 
accompanied by a ``product description,'' describing the ETF and its 
shares.\41\ The Commission believes a product description, which not 
only highlights the basic characteristics of the product and the manner 
in which the ETF shares trade in the secondary market, but also 
highlights the differences of the Funds from existing equity ETFs and 
notes the unique characteristics and risks of this product, should 
provide market participants with adequate notice of the salient 
features of the product.
---------------------------------------------------------------------------

    \40\ See Investment Company Act Release Nos. 25595 (May 29, 
2002) (notice) and 25623 (June 25, 2002) (order).
    \41\ Nasdaq listing standards for ETFs clarify that NASD members 
trading equity ETFs through electronic communication networks 
(``ECNs'') would be subject to NASD Rules 4420(i)(2) and 4420(j)(2) 
requiring the delivery of product descriptions in connection with 
sales of ETF shares. See Securities Exchange Act Release No. 45920 
(May 13, 2002), 67 FR 35605 (May 20, 2002). The Commission expects 
NASD members to observe the same standards for the secondary market 
trading of Funds.
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    The Commission also notes that upon the initial listing of any EFT 
under section 703.16 of the NYSE Listed Company Manual the Exchange 
issues a circular to its members explaining the unique characteristics 
and risks of the security; in this instance, fixed income ETFs. In 
particular, the circular should include, among other things, a 
discussion of the risks that may be associated with the Funds, in 
addition to details on the composition of the fixed income indices upon 
which they are based and how each Fund would use a representative 
sampling strategy to track its index. The circular also should note 
Exchange members' responsibilities under Exchange Rule 405 (``know your 
customer rule'') regarding transactions in such fixed income ETFs. 
Exchange Rule 405 generally requires that members use due diligence to 
learn the essential facts relative to every customer when a transaction 
in the Fund shares is recommended and determine that such shares are 
suitable for such customer.\42\ The circular also will address members' 
prospectus delivery requirements as well as highlight the 
characteristics of purchases in Funds, including that they only are 
redeemable in Creation Unit size aggregations. Based on these factors, 
the Commission finds that the proposal to trade the Funds is consistent 
with section 6(b)(5) of the Act.\43\
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    \42\ NYSE Rule 405.
    \43\ 15 U.S.C. 78f(b)(f).
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    The Commission also notes that certain concerns are raised when a 
broker-dealer, such as Lehman, is involved in the development, 
maintenance, and calculation of an index upon which an ETF is based. 
Lehman has represented that it has procedures in place to prevent the 
misuse of material, non-public information relating to the index.\44\ 
The Commission believes that these provisions should help to address 
concerns raised by Lehman's involvement in the management of the 
indices. The Commission believes that this should act to further 
minimize the possibility of manipulation.
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    \44\ The Commission expects that the procedures implemented by 
Lehman will monitor and prevent the misuse of material, non-public 
information as it relates to the development, maintenance and 
calculation of the indices.
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    The Commission also believes that the NYSE has appropriate 
surveillance procedures in place to detect and deter potential 
manipulation for similar index-linked products. By applying these 
procedures to Funds, the Commission believes that the potential for 
manipulation should be minimized, while protecting investors and the 
public interest.
    NYSE has requested that the Commission find good cause for 
approving the proposed rule change, as amended, prior to the thirtieth 
day after the date of publication of notice thereof in the Federal 
Register. The Funds will trade on the Exchange in the same manner as 
the funds that were the subject of the Previous Approval Order and the 
proposed rule change. The proposed rule change raises no novel issues. 
Based on the above, the Commission finds good cause to accelerate 
approval of the proposed rule change.

[[Page 69748]]

    It is Therefore ordered, pursuant to section 19(b)(2) of the Act 
\45\ that the proposed rule change (SR-NYSE-2003-39) is hereby approved 
on an accelerated basis.
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    \45\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\46\
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    \46\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-30840 Filed 12-12-03; 8:45 am]
BILLING CODE 8010-01-M