[Federal Register Volume 62, Number 182 (Friday, September 19, 1997)]
[Notices]
[Pages 49270-49277]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-24968]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-39076; File No. SR-CHX-97-06]
Order Granting Approval to Proposed Rule Change
September 15, 1997.
Self-Regulatory Organizations; Order Granting Approval to
Proposed Rule Change by the Chicago Stock Exchange, Inc., Relating
to Listing and Trading Standards for Portfolio Depositary Receipts.
I. Introduction
On March 17, 1997,\1\ the Chicago Stock Exchange, Inc. (``CHX'' or
``Exchange'') submitted to the Securities and Exchange Commission
(``Commission''), pursuant to section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'') \2\ and Rule 19b-4 thereunder,\3\ a
proposed rule change to add Rule 25 to Article XXVIII of CHX's rules
relating to the listing and trading of Portfolio Depository Receipts
(``PDRs'').
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\1\ On June 4, 1997, the Exchange filed Amendment No. 1 to this
rule filing. Amendment No. 1 supersedes entirely the Exchange's rule
filing and was incorporated into the notice in its entirety. On June
17, 1997 and June 24, 1997, the Exchange filed Amendment Nos. 2 and
3 respectively; Amendment No. 3 replaces Amendment No. 2 in its
entirety and the substance of Amendment No. 3 was incorporated into
the notice. See letter from J. Craig Long, Attorney, Foley &
Lardner, to Ivette Lopez, Assistant Director, Market Regulation,
Commission, dated May 27, 1997 (``Amendment No. 1'') and letters
from David T. Rusoff, Attorney, Foley & Lardner, to Sharon Lawson,
Senior Special Counsel, Market Regulation, Commission, dated June
13, 1997 (``Amendment No. 2'') and June 18, 1997 (``Amendment No.
3'') respectively.
\2\ 15 U.S.C. 78s(b)(1).
\3\ 17 CFR 240.19b-4.
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The proposed rule change as amended by Amendment Nos. 1, 2, and 3,
together with the substance of the proposal, was published for comment
in Securities Exchange Act Release No. 38777 (June 26, 1997) 62 FR
35866 (July 2, 1997). One comment letter was received in response to
the proposal.\4\
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\4\ See Letter from James F. Duffy, Executive Vice President and
General Counsel, Legal and Regulatory Policy, American Stock
Exchange, to Jonathan G. Katz, Secretary, Commission, dated July 31,
1997 (``Amex Comment Letter'').
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II. Background and Description
The Exchange proposes to adopt new Rule 25 under Article XXVIII to
accommodate the trading of PDRs, securities which are interests in a
unit investment trust (``Trust'') holding a
[[Page 49271]]
portfolio of securities linked to an index. Each Trust will provide
investors with an instrument that: (i) Closely tracks the underlying
portfolio of securities, (ii) trades like a share of common stock, and
(iii) pays holders of the instrument periodic dividends proportionate
to those paid with respect to the underlying portfolio of securities,
less certain expenses (as described in the Trust prospectus).
Under the proposal, the exchange may list and trade, or trade
pursuant to unlisted trading privileges (``UTP''), PDRs based on one or
more stock indexes or securities portfolios. PDRs based on each
particular stock index or portfolio shall be designated as a separate
series and identified by a unique symbol. The stocks that are included
in an index or portfolio on which PDRs are based shall be selected by
the Exchange, or by such other person as shall have a proprietary
interest in and authorized use of such index or portfolio, and may be
revised as deemed necessary or appropriate to maintain the quality and
character of the index or portfolio. As discussed in more detail below,
CHX intends to trade two existing PDRs currently traded on the American
Stock Exchange (``Amex'')--Standard & Poor's Depositary Receipts
(``SPDRs'') and Standard & Poor's MidCap 400 Depositary Receipts
(``MidCap SPDRs'')--pursuant to UTP upon approval of these listing
standards. CHX is not asking for permission to list SPDRs or MidCap
SPDRs at this time, but rather will trade SPDRs and MidCap SPDRs
pursuant to unlisted trading privileges once the generic listing
standards set forth herein are approved. Pursuant to Rule 12f-5 under
the Act, in order to trade a particular class or type of security
pursuant to unlisted trading privileges, CHX must have rules providing
for transactions in such class or type of security. The Amex has
enacted listing standards for PDRs, and CHX's proposed rule change is
designed to create similar standards for PDR listing and/or trading on
CHX.
If at a later time CHX and the issuer of the product desire to list
SPDRs and MidCap SPDRs or any other PDRs on the Exchange, the Exchange
will request Commission approval for that listing in a separate
proposed rule change filed pursuant to Section 19(b)of the Act.\5\
Additionally, in the event a new PDR is listed on another exchange
using listing standards that are different than current CHX listing
standards or the CHX listing standards proposed in this filing, the CHX
will file a proposed rule change pursuant to Section 19(b) of the Act
to adopt the listing standard before it trades that PDR pursuant to
unlisted trading privileges.
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\5\ The Commission notes that CHX, if it were to file a proposed
rule change to list and trade a new PDR, would have to request the
appropriate exemptions for the new product under the Investment
Company Act of 1940 (``Investment Company Act'') (such as those
exemptions requested for SPDRs and MidCap SPDRs), such an exemption
from Investment Company Act Section 22(d) and Rule 22c-1 thereunder
to allow the PDR to trade in the secondary market.
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Criteria for Initial and Continued Listing
In connection with an initial listing, the Exchange proposes that,
for each Trust of PDRs, the Exchange will establish a minimum number of
PDRs required to be outstanding at the time of commencement of Exchange
trading, and such minimum number will be filed with the Commission in
connection with any required submission under Rule 19b-4 for each
Trust. If the Exchange trades a particular PDR pursuant to unlisted
trading privileges, the Exchange will follow the listing exchange's
determination of the appropriate minimum number.
Because the Trust operates an open-end type basis, and because the
number of PDR holders is subject to substantial fluctuations depending
on market conditions, the Exchange believes it would be inappropriate
and burdensome on PDR holders to consider suspending trading in or
delisting a series of PDRs, with the consequent termination of the
Trust, unless the number of holders remains severely depressed during
an extended time period. Therefore, twelve months after the formation
of a Trust and commencement of Exchange trading, the Exchange will
consider suspension of trading in, or removal from listing of, a Trust
when, in its opinion, further dealing in such securities appears
unwarranted under the following circumstances:
(a) If the Trust on which the PDRs are based has more than 60 days
remaining until termination and there have been fewer than 50 record
and/or beneficial holders of the PDRs for 30 or more consecutive
trading days; or
(b) If the index on which the Trust is based is no longer
calculated, or
(c) If such other event shall occur or condition exists which, in
the opinion of the Exchange, makes further dealings on the Exchange
inadvisable.
A Trust shall terminate upon removal from Exchange listing and its
PDRs will be redeemed in accordance with provisions of the Trust
prospectus. A Trust may also terminate under such other conditions as
may be set forth in the Trust prospectus. For example, the sponsor of
the Trust (``Sponsor''), following notice to PDR holders, shall have
discretion to direct that the Trust be terminated if the value of
securities in such Trust falls below a specified amount.
Trading of PDRs
Dealings in PDRs on the Exchange will be conducted pursuant to the
Exchange's general agency-auction trading rules. The Exchange's general
dealing and settlement rules will apply, including its rules on
clearance and settlement of securities transactions and its equity
margin rules. Other generally applicable Exchange equity rules and
procedures will also apply, including, among others, rules governing
the priority, parity and precedence of orders and the responsibilities
of specialists.\6\
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\6\ The Commission notes that CHX has stated its intention to
file a proposed rule change in the near future in order to create a
know-your-customer rule in which a member, before recommending a
transaction in a security, would have to use due diligence to learn
the essential facts relating to every customer, every order, and
every account accepted by the member. Telephone call between Craig
Long, Attorney, Foley & Lardner, Sharon Lawson, Senior Special
Counsel, Market Regulation, Commission, and Heather Seidel,
Attorney, Market Regulation, Commission, on July 29, 1997.
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With respect to trading halts, the trading of PDRs will be halted,
along with the trading of all other listed or traded stocks, in the
event the ``circuit breaker'' thresholds of CHX Article IX, Rule 10A
are reached. In addition, for PDRs tied to an index, the triggering of
futures price limits for the Standard & Poor's 500 Composite Price
Index (``S&P 500 Index''), Standard & Poor's 100 Composite Price Stock
Index (``S&P 100 Index''), or Major Market Index (``MMI'') futures
contracts will not, in itself, result in a halt in PDR trading or a
delayed opening. However, the Exchange could consider such an event,
along with other factors, such as a halt in trading in S&P 100 Index
Options (``OEX''), S&P 500 Index Options (``SPX''), or MMI Options
(``XMI''), in deciding whether to halt trading in PDRs.
Under the proposed rule change, the Exchange will issue a circular
to members informing them of Exchange policies regarding trading halts
in such securities. The circular will make clear that, in addition to
other factors that may be relevant, the Exchange may consider factors
such as those set forth in Article XXXVI, Rule 19, the Exchange's rule
governing trading halts for Basket trading (except that the term
``Basket'' shall be replaced by ``stock index'') in exercising its
direction to
[[Page 49272]]
halt or suspend trading. For a PDR based on an index, these factors
would include whether trading has been halted or suspended in the
primary market(s) for any combination of underlying stocks accounting
for 20% or more of the applicable current index group value, or whether
other unusual conditions or circumstances detrimental to the
maintenance of a fair and orderly market are present.
Disclosure
Proposed Rule 25 of Article XXVIII requires that members and member
organizations provide to all purchasers of each series of PDRs a
written description of the terms and characteristics of such
securities, in a form approved by the Exchange, not later than the time
a confirmation of the first transaction in such series of PDRs is
delivered to such purchaser. In this regard, a member or member
organization carrying an omnibus account for a non-member broker-dealer
will be required to inform such non-member that execution of an order
to purchase PDRs for such omnibus account will be deemed to constitute
an agreement by the non-member to make such written description
available to its customers on the same terms as are directly applicable
to member and member organizations. The written description must be
included with any sales material on that series of PDRs that a member
provides to customers or the public. Moreover, other written materials
provided by a member or member organization to customers or the public
making specific reference to a series of PDRs as an investment vehicle
must include a statement in substantially the following form: ``A
circular describing the terms and characteristics of [the series of
PDRs] is available from your broker. It is recommended that you obtain
and review such circular before purchasing [the series of PDRs]. In
addition, upon request you may obtain from your broker a prospectus for
[the series of PDRs].'' Additionally, as noted above, the Exchange
requires that members and member organizations provide customers with a
copy of the prospectus for a series of PDRs upon request.
With respect to disclosure, because SPDRs and MidCap SPDRs will be
traded pursuant to unlisted trading privileges and will not be listed
on CHX at this time, CHX does not intend to create its own product
description to satisfy the requirements of proposed Rule 25(c) of
Article XXVIII, which requires members to provide to purchasers, a
written description of the terms and characteristics of SPDRs and
MidCap SPDRs in a form approved by the Exchange. Instead, the CHX will
deem a member or member organization to be in compliance with this
requirement if the member delivers either: (i) The current product
description produced by the Amex from time to time, or (ii) the current
prospectus for the SPDR or MidCap SPDR, as the case may be.\7\ It will
be the member's responsibility to obtain these materials directly from
Amex \8\ for forwarding to purchasers in the time frames prescribed by
CHX and Commission rules. The CHX will notify members and member
organizations of this requirement in a notice to members.
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\7\ CHX plans to notify its members in an information circular
that it is their responsibility to inform customers of the nature
and terms of SPDRs an MidCap SPDRs prior to recommending their
purchase. The circular also states that members must deliver a SPDR
or MidCap SPDR product description to all purchases of the products
and that they must provide the prospectus upon request.
\8\ The Commission notes that Amex, in its comment letter to
this rule filing, stated that the Distributor does not have
responsibility for disseminating the SPDR and MidCap SPDR product
descriptions; therefore, CHX members cannot obtain the product
description from the Distributor, as noted in the notice release,
but can obtain its form Amex. See Amex Comment Letter, supra note 4,
and Section III infra.
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Notwithstanding the foregoing discussion concerning the
applicability of the Exchange's equity trading rules to PDRs generally,
the Intermarket Trading System (``ITS'') rules briefly will not be
applicable to SPDRs and MidCap SPDRs traded on the CHX pursuant to
unlisted trading privileges. Currently, ITS is being modified in order
to accommodate trading in a minimum variation of \1/64\, but the
changes are not yet complete. When such changes are made, which is
expected in the near future, CHX intends to request that SPDRs and
MidCap SPDRs be designated as ITS Securities. At such time as they are
designated ITS securities, the ITS rules will apply to trading in SPDRs
and MidCap SPDRs.
The current inapplicability of the ITS rules means, among other
things, that the ITS trade-through rule will not apply. However, the
CHX's BEST Rule, Article XX, Rule 37(a), will still be applicable to
SPDRs and MidCap SPDRs, thereby guaranteeing the execution of certain
agency orders on the basis of the size and price associated with the
best bid (for a sell order) or best offer (for a buy order) among the
Amex, Boston, Cincinnati, Chicago, New York, Pacific, Philadelphia and
the Intermarket Trading System/Computer Assisted Execution System
quote, which quote is defined in SR-CHX-97-9 as the ``ITS BBO.'' \9\
Because SPDRs and MidCap SPDRs are not traded in all of these market
centers,\10\ for purposes of this filing only, the ITS BBO is limited
to those market centers listed above that trade SPDRs and MidCap
SPDRs.\11\ For example, if a CHX specialist receives an agency limit
order for a SPDR, so long as all of the eligibility requirements of the
BEST Rule are met, the specialist will be required to execute that
order if there has been a price penetration in the primary market. In
addition, if the Amex specialist is disseminating the best quote for
SPDRs, the CHX specialist will be required to execute eligible agency
market orders for SPDRs at the price quoted on the Amex, even if the
CHX specialist is not, himself, quoting at that price. The CHX SPDR and
MidCap SPDR specialist will have the ability to monitor the current
quotations being disseminated by the Amex specialist on a real-time
basis. The quotations for SPDRs and MidCap SPDRs are disseminated
through the Consolidated Quotation System and are available for viewing
by the CHX specialist at his or her post. Finally, the CHX specialist
will have access to the Amex through the Amex's PER System (albeit
through a correspondent firm). This will enable the CHX specialist to
place limit orders on the Amex specialist's book or send market orders
to the Amex specialist for execution against the Amex specialist's
quote. In its filing, CHX states that these factors should minimize the
possibility that a
[[Page 49273]]
CHX originated trade-through will occur.
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\9\ The Commission notes that SR-CHX-97-9, as amended to remove
the phrase ``size and price associated with the'' from the filing,
has become effective. See Securities Exchange Act Release No. 38772
(June 25, 1997). In addition, CHX represents that it will submit a
separate rule filing pursuant to Section 19(b)(2) of the Act further
amending the BEST Rule to add size and price to the definition of
the ITS/BBO. Phone conversation between David Rusoff, Attorney,
Foley & Lardner, and David Sieradzki, Attorney, Market Regulation,
Commission, on June 17, 1997.
\10\ Currently SPDRs and MidCap SPDRs are only traded on Amex.
\11\ Under the BEST Rule, Exchange specialists are required to
guarantee executions of all agency market and limit orders for Dual
Trading System issues from 100 up to and including 2099 shares.
Subject to the requirements of the short sale rule, the specialist
must fill all agency market orders at a price equal to or better
than the ITS BBO. For all agency limit orders in Dual Trading System
issues, the specialist must fill the order if: (1) The ITS BBO at
the limit price has been exhausted in the primary market; (2) there
has been a price penetration of the limit in the primary market
(generally known as a trade-through of a CHX limit order); or (3)
the issue is trading at the limit price on the primary market unless
it can be demonstrated that the order would not have been executed
if it had been transmitted to the primary market or the broker and
specialist agree to a specific volume related to, or other criteria
for, requiring a fill.
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SPDRs and MidCap SPDRs Generally
As discussed above, rules to accommodate the trading of PDRs
generally on Amex, along with Amex's trading of SPDRs and MidCap SPDRs,
were previously approved by the Commission.\12\ The information
provided below is intended to provide a description of how SPDRs and
MidCap SPDRs are created and traded and is almost identical to that
discussed in the original Amex Approval Order. The Sponsor of each
series of PDRs traded on the Amex is PDR Services Corporation, a
wholly-owned subsidiary of the Amex. The PDRs are issued by a Trust in
a specified minimum aggregate quantity (``Creation Unit'') in return
for a deposit consisting of specified numbers of shares of stock plus a
cash amount.
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\12\ See Securities Exchange Act Release No. 31591 (December 11,
1992), 57 FR 60253 (December 18, 1992) (``Amex Approval Order'').
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The first Trust to be formed in connection with the issuance of
PDRs was based on the S&P 500 Index, known as Standard & Poor's
Depositary Receipts (``SPDRs''). SPDRs have been trading on the Amex
since January 29, 1993. The second Trust to be formed in connection
with the issuance of PDRs was based on the S&P MidCap 400 Index,\13\
known as Standard & Poor's MidCap 400 Depositary Receipts (``MidCap
SPDRs'').\14\ The Sponsor of the two Trusts has entered into trust
agreements with a trustee in accordance with Section 26 of the
Investment Company Act of 1940. PDR Distributors, Inc.
(``Distributor'') acts as underwriter of both SPDRs and MidCap SPDRs on
an agency basis. The Distributor is a registered broker-dealer, a
member of the National Association of Securities Dealers, Inc., and a
wholly-owned subsidiary of Signature Financial Group, Inc.
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\13\ The S&P MidCap 400 Index is a capitalization-weighted index
of 400 actively traded securities that includes issues selected from
a population of 1,700 securities, each with a year-end market-value
capitalization of between $200 million and $5 billion. The issues
included in the Index cover a broad range of major industry groups,
including industrials, transportation, utilities, and financials.
\14\ See Securities Exchange Act Release No. 35534 (March 24,
1995), 60 FR 16686 (March 31, 1995) (``Amex MidCap Approval
Order'').
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SPDR and MidCap SPDR Creation
All orders to create SPDRs or MidCap SPDRs in creation unit size
must be placed with the Distributor, and it is the responsibility of
the Distributor to transmit such orders to the Trustee.\15\ Payment
with respect to creation orders placed through the Distribution will be
made by: (1) The ``in-kind'' deposit with the Trustee of a specified
portfolio of securities that is formulated to mirror, to the extent
practicable, the component securities of the underlying index or
portfolio, and (2) a cash payment sufficient to enable the Trustee to
make a distribution to the holders of beneficial interests in the Trust
on the next dividend payment date as if all the securities had been
held for the entire accumulation period for the distribution
(``Dividend Equivalent Payment''), subject to certain specified
adjustments. The securities and cash accepted by the trustee are
referred to, in the aggregate, as a ``Portfolio Deposit.'' \16\ Upon
receipt of a Portfolio Deposit in payment for a creation order placed
through the Distributor as described above, the Trustee will issue a
specified number of SPDRs or MidCap SPDRs, which aggregate numbers are
referred to as a ``Creation Unit.'' Currently, a Creation Unit will be
made up of 25,000 MidCap SPDRs or 50,000 SPDRs.\17\ Individual SPDRs or
MidCap SPDRs can then be traded in the secondary market like other
equity securities. Portfolio Deposits are expected to be made primarily
by institutional investors, arbitragers, and the Exchange specialist.
The price of SPDRs and MidCap SPDRs will be based on a current bid/
offer market. The minimum fraction for trading in SPDRs and MidCap
SPDRs on Amex is \1/64\ths. The CHX has proposed this same minimum
variation for the trading of SPDRs and MidCap SPDRs on CHX.
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\15\ To be eligible to place orders to create MidCap SPDRs as
described below, an entity or person either must be a participant in
the Continuous Net Settlement (``CNS'') system of the National
Securities Clearing Corporation (``NSCC'') or a Depository Trust
Company (``DTC'') participant. Upon acceptance of an order to create
MidCap SPDRs, the Distributor will instruct the Trustee to initiate
the book-entry movement of the appropriate number of MidCap SPDRs to
the account of the entity placing the order. MidCap SPDRs will be
maintained in book-entry form at DTC.
\16\ A Portfolio Deposit also will include a cash payment equal
to a pro rata portion of the dividends accrued on the Trust's
portfolio securities since the last dividend payment by the Trust,
plus or minus an amount designed to compensate for any difference
between the net asset value of the Portfolio Deposit and the
underlying Index caused by, among other things, the fact that a
Portfolio Deposit cannot contain fractional shares.
\17\ The Trust will issue SPDRs in exchange for ``Portfolio
Deposits'' of all of the S&P 500 Index securities, weighted
according to their representation in the Index. The Trust is
structured so that the net asset value of an individual SPDR should
equal one-tenth of the value of the S&P 500 Index.
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The Trustee or Sponsor will make available: (1) On a daily basis, a
list of the names and required number of shares for each of the
securities in the current Portfolio Deposit; (2) on a minute-by-minute
basis throughout the day, a number representing the value (on a per
SPDR or MidCap SPDR basis) of the securities portion of a Portfolio
Deposit in effect on such day; and (3) on a daily basis, the
accumulated dividends, less expenses, per outstanding SPDR or MidCap
SPDR.\18\
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\18\ The Trustee of the SPDR Trust will have the right to vote
any of the voting stocks held by the Trust, and will vote such
stocks of each issuer in the same proportion as all other voting
shares of that issuer voted. Therefore, SPDR holders will not be
able to directly vote the shares of the issuers underlying the
SPDRs.
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Redemption of SPDRs and MidCap SPDRs
SPDRs and MidCap SPDRs in Creation Unit size aggregations will be
redeemable in kind by tendering them to the Trustee. While holders may
sell SPDRs and MidCap SPDRs in the secondary market at any time, they
must accumulate at least 50,000 (or multiples thereof) to redeem SPDRs
or 25,000 (or multiples thereof) to redeem MidCap SPDRs through the
Trust. SPDRs and MidCap SPDRs will remain outstanding until redeemed or
until the termination of the Trust. Creation Units will be redeemable
on any business day in exchange for a portfolio of the securities held
by the Trust identical in weighting and composition to the securities
portion of a Portfolio Deposit in effect on the date a request is made
for redemption, together with a ``Cash Component'' (as defined in the
Trust prospectus), including accumulated dividends, less expenses,
through the date of redemption. The number of shares of each of the
securities transferred to the redeeming holder will be the number of
shares of each of the component stocks in a Portfolio Deposit on the
day a redemption notice is received by the Trustee, multiplied by the
number of Creation Units being redeemed. Nominal service fees may be
charged in connection with the creation and redemption of Creation
Units. The Trustee will cancel all tendered Creation Units upon
redemption.\19\
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\19\ An investor redeeming a Creation Unit will receive Index
securities and cash identical to the Portfolio Deposit required of
an investor wishing to purchase a Creation Unit on that particular
day. Since the Trust will redeem in kind rather than for cash, the
Trustee will not be forced to maintain cash reserves for
redemptions. This should allow the Trust's resources to be committed
as fully as possible to tracking the underlying Index, enabling the
Trust to track the Index more closely than other basket products
that must allocate a portion of their assets for cash redemptions.
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Distribution of SPDRs and MidCap SPDRs
The SPDR Trust and the MidCap SPDR Trust pay dividends quarterly.
[[Page 49274]]
The regular quarterly ex-dividend date for SPDRs and MidCap SPDRs is
the third Friday in March, June, September, and December, unless that
day is a New York Stock Exchange holiday, in which case the ex-dividend
date will be the preceding Thursday. Holders of SPDRs and MidCap SPDRs
on the business day preceding the ex-dividend date will be entitled to
receive an amount representing dividends accumulated through the
quarterly dividend period preceding such ex-dividend date net of fees
and expenses for such period. The payment of dividends will be made on
the last Exchange business day in the calendar month following the ex-
dividend date (``Dividend Payment Date''). On the Dividend Payment
Date, dividends payable for those securities with ex-dividend dates
following within the period from the ex-dividend date most recently
preceding the current ex-dividend date will be distributed. The Trustee
will compute on a daily basis the dividends accumulated within each
quarterly dividend period. Dividend payments will be made through DTC
and its participants to all such holders with funds received from the
Trustee.
The MidCap SPDR Trust intends to make the DTC DRS available for use
by MidCap SPDR holders through DTC participant brokers for reinvestment
of their cash proceeds. The DTC DRS is also available to holders of
SPDRs. Because some brokers may choose not to offer the DTC DRS, an
interested investor would have to consult his or her broker to
ascertain the availability of dividend reinvestment through that
broker. The Trustee will use the cash proceeds of MidCap SPDR holders
participating in the reinvestment to obtain the Index securities
necessary to create the requisite number of SPDRs.\20\ Any cash
remaining will be distributed pro rata to participants in the dividend
reinvestment.
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\20\ The creation of PDRs in connection with the DTC DRS
represents the only circumstances under which PDRs can be created in
other than Creation Unit size aggregations.
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III. Summary of Comments
The Commission received one comment letter on the proposed rule
change, from Amex.\21\ Amex commented on two aspects of the proposal,
the requirement that CHX members deliver a product description to
purchasers of PDRs no later than the time a confirmation is delivered
to the purchasers, and on the trading of SPDRs and MidCap SPDRs
pursuant to the ITS.
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\21\ See supra note 4.
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With regard to the first issue, Amex notes that CHX will not create
its own product description but will deem its members in compliance
with the delivery requirement if it delivers Amex's current product
description or the current SPDR or MidCap SPDR prospectus, as
applicable. CHX does not intend to supply these materials to its
members but will require them to obtain the documents from Amex or the
distributor of SPDRs and MidCap SPDRs.
Amex states that is does not object to the occasional request for
prospectuses and Product Descriptions made in connection with trades on
CHX, but reserves the right to charge a reasonable amount for the
materials, if it finds that the requests become burdensome.\22\ Amex
also notes that the Distributor is not responsible for providing the
Product Descriptions, that it is Amex's responsibility to provide the
materials to Amex members in connection with the Exchange trading and
compliance with Amex Rule 1000.
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\22\ The Commission notes that any imposition of fees would have
to be in compliance with the Act, including the filing requirements
under Section 19(b) of the Act. See infra note 34 and accompanying
text.
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Second, while Amex acknowledges that SPDRs and MidCap SPDRs are not
traded through ITS at this time because ITS cannot currently handle
trading in \1/64\ths (the minimum increment for MidCap and SPDRs
MidCap), it is concerned about the future application of ITS rules to
trading of SPDRs and MidCap SPDRs due to ongoing modifications to ITS
to permit commitments to trade in increments as small as \1/256\ths.
Amex states that SPDRs and MidCap SPDRs be designated as ITS securities
once these system changes are made. Amex states that while it has no
objection to the use of ITS as an intermarket access mechanism for
trading of SPDRs and MidCap SPDRs, it has serious concerns about the
application of ITS trade through procedures to the trading of these
products because of the nature of the product in that they are priced
quite differently from common stocks
Specifically, because of the extreme frequency of quotation changes
in SPDRs and MidCap SPDRs, Amex believes that cancellation or
expiration of ITS commitments in these products would pose
proportionally greater market risk for market makers and investors than
for other ITS securities because a price change is far more likely to
occur before an ITS commitment can be resent. Amex also believes that
because of the frequency of quotation changes in SPDRs and MidCap
SPDRs, the Amex specialist must be able to receive very rapid
confirmation that his commitment sent to another market through ITS has
been executed, and that a one or two minute time frame (the time during
which an ITS commitment is irrevocable) would subject all market
participants to an unacceptable level of market risk in a market with
rapid quotation changes. Amex states that it intends to address with
the Commission and the ITS Operating Committee the ITS procedures that
it believes must be changed to permit SPDRs to continue to trade as
they were designed to trade.\23\
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\23\ Additionally, Amex believes it is problematic to apply the
current ITS trade-through rule to index-based securities such as
SPDRs that trade in \1/64\th increments. In addition, Amex believes
that the trade through rule's five minute time frame for making a
compliant is inappropriately long for these securities.
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IV. Discussion
The Commission finds that the proposed rule changes are consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to a national securities exchange, and, in
particular, with the requirements of section 6(b)(5).\24\ The
Commission believes that providing for the exchange-trading on CHX of
PDRs, in general, and SPDRs and MidCap SPDRs, in particular, will offer
investors an efficient way of participating in the securities markets.
Specifically, the Commission believes that the trading on CHX of PDRs,
in general, and SPDRs and MidCap SPDRs pursuant to unlisted trading
privileges, in particular, will provide investors with increased
flexibility in satisfying their investment needs by allowing them to
purchase and sell a low-cost security replicating the performance of a
broad portfolio of stocks at negotiated prices throughout the business
day, and by increasing the availability of SPDRs and MidCap SPDRs as an
investment tool. The Commission also believes that PDRs will benefit
investors by allowing them to trade securities based on unit investment
trusts in secondary market transactions.\25\ Accordingly, as discussed
below, the proposed rule change is consistent with the requirements of
Section 6(b)(5) that Exchange rules facilitate transactions in
securities while continuing to further investor protection and the
public interest.\26\
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\24\ 15 U.S.C. 78f(b)(5).
\25\ The Commission notes, however, that unlike open-end funds
where investors have the right to redeem their fund shares on a
daily basis, investors could only redeem PDRs in creation unit share
sizes. nevertheless, PDRs would have the added benefit of liquidity
from the secondary market and PDR holders, unlike holders of most
other open-end funds, would be able to dispose of their shares in a
secondary market transaction.
\26\ In approving this rule, the Commission notes that it has
considered the proposed rule's impact on efficiency, competition,
and capital formation. 15 U.S.C. 78c(f).
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[[Page 49275]]
As the Commission noted in the orders approving SPDRs and MidCap
SPDRs for listing and trading on Amex,\27\ the Commission believes that
the trading on CHX of a security like PDRs in general, and SPDRs and
MidCap SPDRs in particular, which replicate the performance of a broad
portfolio of stocks, could benefit the securities markets by, among
other things, helping to ameliorate the volatility occasionally
experienced in these markets. The Commission believes that the creation
of one or more products where actual portfolios of stocks or
instruments representing a portfolio of stocks, such as PDRs, can trade
at a single location in an auction market environment could alter the
dynamics of program trading, because the availability of such single
transaction portfolio trading could, in effect, restore the execution
of program trades to more traditional block trading techniques.\28\
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\27\ See supra notes 12 and 14.
\28\ Program trading is defined as index arbitrage or any
trading strategy involving the related purchase or sale of a
``basket'' or group of fifteen or more stocks having a total market
value of $1 million or more.
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An individual SPDR has a value approximately equal to one-tenth of
the value of the S&P 500 Index, and an individual MidCap SPDRs has a
value of approximately one-fifth of the value of the S&P MidCap 400
Index, making them more available and useful to individual retail
investors desiring to hold a security replicating the performance of a
broad portfolio of stocks. Accordingly, the Commission believes that
trading of SPDRs and MidCap SPDRs on CHX will provide retail investors
with a cost efficient means to make investment decisions based on the
direction of the market as a whole and may provide market participants
several advantages over existing methods of effecting program trades
involving stocks.
The Commission also believes that PDRs, in general, and SPDRs and
MidCap SPDRs, in particular, will provide investors with several
advantages over standard open-end S&P 500 Index and S&P MidCap 400
Index mutual fund shares. In particular, investors will have the
ability to trade PDRs continuously throughout the business day in
secondary market transactions at negotiated prices.\29\ In contrast,
pursuant to Investment Company Act Rule 22c-1,\30\ holders and
prospective holders of open-end mutual fund shares are limited to
purchasing or redeeming securities of the fund based on the net asset
value of the securities held by the fund as designated by the board of
directors.\31\ Accordingly, PDRs in general, and SPDRs and MidCap SPDRs
in particular, will allow investors to (1) Respond quickly to changes
in the market; (2) trade at a known price; (3) engage in hedging
strategies not currently available to retail investors; and (4) reduce
transaction costs for trading a portfolio of securities.
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\29\ Because of potential arbitrage opportunities, the
Commission believes that PDRs will not trade at a material discount
or premium in relation to their net asset value. The mere potential
for arbitrage should keep the market price of a PDR comparable to
its net asset value, and therefore, arbitrage activity likely will
be minimal. In addition, the Commission believes that Trust will
tract the underlying index more closely than an open-end index fund
because the Trust will accept only in-kind deposits, and, therefore,
will not incur brokerage expenses in assembling its portfolio. In
addition, the Trust will redeem on in kind, thereby enabling the
Trust to invest virtually all of its assets in securities comprising
the underlying index.
\30\ Investment Company Act Rule 22c-1 generally requires that a
registered investment company issuing a redeemable security, its
principal underwriter, and dealers in that security, may sell,
redeem, or repurchase the security only at a price based on the net
asset value next computed after receipt of an investor's request to
purchase, redeem, or resell. The net asset value of a mutual fund
generally is computed once daily Monday through Friday as designated
by the investment company's board of directors. The Commission
granted SPDRs and MidCap SPDRs and exemption from this provision in
order to allow them to trade at negotiated prices in the secondary
market. The Commission notes that CHX would need to apply for a
similar exemption in the instance that it wishes to list and trade a
new PDR because the exemptions are specific to SPDRs and MidCap
SPDRs.
\31\ Id.
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Although PDRs in general, and SPDRs and MidCap SPDRs in particular,
are not leveraged instruments, and, therefore, do not possess any of
the attributes of stock index options, their prices will still be
derived and based upon the securities held in their respective Trusts.
In essence, SPDRs are equity securities that are priced off a portfolio
of stocks based on the S&P 500 Index and MidCap SPDRs are equity
securities that are priced off a portfolio of stocks based on the S&P
MidCap 400 Index. Accordingly, the level of risk involved in the
purchase or sale of a SPDR or MidCap SPDR (or a PDR in general) is
similar to the risk involved in the purchase or sale of traditional
common stock, with the exception that the pricing mechanism for SPDRs
and MidCap SPDRs (and PDRs in general) is based on a basket of stocks.
Nonetheless, the Commission has several specific concerns regarding the
trading of these securities. In particular, PDRs raise disclosure,
market impact, and secondary market trading issues that must be
addressed adequately. As discussed in more detail below, and in the
Amex Approval Order,\32\ the Commission believes CHX adequately
addresses these concerns.
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\28\ See supra note 12.
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The Commission believes that the CHX proposal contains several
provisions that will ensure that investors are adequately apprised of
the terms, characteristics, and risks of trading PDRs. As noted above,
the proposal contains four aspects addressing disclosure concerns.
First, CHX members must provide their customers trading PDRs with a
written explanation of any special characteristics and risks attendant
to trading such PDR securities (such as SPDRs or MidCap SPDRs), in a
form approved by CHX. As discussed above, CHX's filing states that
SPDRs and MidCap SPDRs product descriptions should be obtained from
Amex. The Commission notes that although Amex commented on CHX's
proposed method regarding the delivery of the SPDR and MidCap SPDR
product descriptions, and reserved the right to charge CHX members for
supplying the product description should the task become burdensome to
Amex, Amex did not object to the underlying policy of CHX members
obtaining the product description from Amex. The Commission believes
that it is reasonable under the Act to allow CHX to require its members
to obtain the product description for SPDRs and MidCap SPDRs from
Amex.\33\ Amex might decide to impose a reasonable charge for this
service.\34\ The Commission also notes that Amex states that the SPDR
and MidCap SPDR product descriptions are only available from Amex, not
the Distributor, and therefore CHX members cannot obtain them from the
Distributor.
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\33\ The Commission notes that the exemptions granted by the
Commission under the Investment Company Act that permit the
secondary market trading of SPDRs and MidCap SPDRs are specifically
conditioned upon the customer disclosure requirements described
above. Accordingly, CHX rules adequately ensue its members must
deliver the current product description to all investors in SPDRs
and MidCap SPDRs.
\34\ The Commission notes that Amex would need to file proposed
rule change under Section 19(b) of the Act in the event it decides
to charge a fee for supplying the SPDR of MidCap SPDR product
descriptions. The Commission notes that reasonable fees would have
to be imposed on the member firms rather than the customers entitled
to receive the prospectus or the product description.
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Second, members and member organizations must include this written
product description with any sales material relating to the series of
PDRs that is provided to customers or the
[[Page 49276]]
public. Third, any other written materials provided by a member or
member organization to customers or the public referencing PDRs as an
investment vehicle must include a statement, in a form specified by
CHX, that a circular and prospectus are available from a broker upon
request. Fourth, a member or member organization carrying an omnibus
account for a non-member broker-dealer is required to inform such non-
member that execution of an order to purchase a series of PDRs for such
omnibus account will be deemed to constitute agreement by the non-
member to make the written product description available to its
customers on the same terms as member firms. Accordingly, the
Commission believes that investors in PDR securities, in general, and
SPDRs and MidCap SPDRs, in particular, will be provided with adequate
disclosure of the unique characteristics of the PDR instruments and
other relevant information pertaining to the instruments.
Finally, under CHX's proposal there will be no special account
opening or customer suitability rules applicable to the trading of
PDRs.\35\ Nevertheless, pursuant to CHX Rules Article VIII, Rule 17,
CHX's equity rule governing account opening will apply. In addition,
the Commission notes that CHX intends to file a proposed rule change to
create a rule that would require members, before recommending any
transactions in securities, to use due diligence to learn the essential
facts relative to every customer, every order, and every account
accepted by the member. Upon adoption of this rule, it would apply to
recommendations in PDRs generally, including transactions in SPDRs and
MidCap SPDRs.
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\35\ This reflects the fact that PDRs are equity products and
not an options product, and, therefore, do not necessitate the
imposition of options-like rules.
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The Commission believes CHX has adequately addressed the potential
market impact concerns raised by the proposal. First, CHX's proposal
permits listing and trading of specific PDRs only after review by the
Commission. Second, CHX has developed policies regarding trading halts
in PDRs. Specifically, the Exchange would halt PDR trading if the
circuit breaker parameters under CHX Article IX, Rule 10A were
reached.\36\ In addition, in deciding whether to halt trading or
conduct a delayed opening in PDRs, in general, and SPDRs and MidCap
SPDRs, in particular, CHX represents that it will be guided by, but not
necessarily bound to, relevant stock index option trading rules.
Specifically, consistent with CHX Article XXXVI, Rule 19, CHX may
consider whether trading has been halted or suspended in the primary
market(s) for any combination of underlying stocks accounting for 20%
or more of the applicable current index group value or whether other
unusual conditions or circumstances detrimental to the maintenance of a
fair and orderly market are present.
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\36\ In addition, for PDRs tied to an index, the triggering of
futures price limits for the S&P 500 Index, S&P 100 Index, or MMI
futures contracts will not, in itself, result in a halt in PDR
trading or a delayed opening. However, the Exchange could consider
such an event, along with other factors, such as a halt in trading
in OEX, SPX, or MMI options, in deciding whether to halt trading in
PDRs.
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The Commission believes that the trading of PDRs in general on CHX
should not adversely impact U.S. securities markets. As to the trading
of SPDRs and MidCap SPDRs pursuant to UTP, the Commission notes that
the corpus of the SPDR Trust is a portfolio of stocks replicating the
S&P 500 Index, a broad-based capitalization-weighted index consisting
of 500 of the most actively-traded and liquid stocks in the U.S.. The
corpus of the MidCap SPDR Trust is a portfolio of stocks replicating
the S&P MidCap 400 Index, also a broad-based, capitalization-weighted
index consisting of 400 actively traded and liquid U.S. stocks. In
fact, as described above, the Commission believes SPDRs and MidCap
SPDRs may provide substantial benefits to the marketplace and
investors, including, among others, enhancing the stability of the
markets for individual stocks.\37\ Accordingly, the Commission believes
that SPDRs and MidCap SPDRs do not contain features that will make them
likely to impact adversely the U.S. Securities markets, and that the
addition of their trading on CHX pursuant to UTP could produce added
benefits to investors through the increased competition between other
market centers trading the product.
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\37\ Even though PDR transactions may serve as substitutes for
transactions in the cash market, and possibly make the order flow in
individual stocks smaller than would otherwise be the case, the
Commission acknowledges that during turbulent market conditions the
ability of large institutions to redeem or create PDRs could
conceivably have an impact on price levels in the cash market. In
particular, if a PDR is redeemed, the resulting long stock position
could be sold into the market, thereby depressing stock prices
further. The Commission notes, however, that the redemption or
creation of PDRs likely will not exacerbate a price movement because
PDRs will be subject to the equity margin requirements of 50% and
PDRs are non-leveraged instruments. In addition, as noted above,
during turbulent market conditions, the Commission believes PDRs and
SPDRs and MidCap SPDRs, in particular, will serve as a vehicle to
accommodate and ``bundle'' order flow that otherwise would flow to
the cash market, thereby allowing such order flow to be handled more
efficiently and effectively. Accordingly, although PDRs and SPDRs
and MidCap SPDRs could, in certain circumstances, have an impact on
the cash market, on balance we believe the product will be
beneficial to the marketplace and can actually aid in maintaining
orderly markets.
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Finally, the Commission notes that CHX has submitted surveillance
procedures for the trading of PDRs, specifically SPDRs and MidCap
SPDRs, and believes that those procedures, which incorporate and rely
upon existing CHX surveillance procedures governing equities, are
adequate under the Act.
The Commission finds that CHX's proposal contains adequate rules
and procedures to govern the trading of PDR securities, including
trading SPDRs and MidCap SPDRs pursuant to UTP. Specifically, PDRs are
equity securities that will be subject to the full panoply of CHX rules
governing the trading of equity securities on CHX, including, among
others, rules governing the priority, parity and precedence of orders
and the responsibilities of specialists. In addition, CHX has developed
specific listing and delisting criteria for PDRs that will help to
ensure that the markets for PDRs will be deep and liquid. As noted
above, CHX's proposal provides for trading halt procedures governing
PDRs. Finally, the Commission notes that CHX has stated its intention
to file a rule requiring members, prior to recommending a transaction
in any security, to use due diligence to learn the essential facts
relative to the customer, every order, and every account accepted by
the member.
As mentioned earlier, the trading of SPDRs and MidCap SPDRs will
not be subject to ITS for a brief period of time until ITS can
accommodate trading in increments of 1/64ths. In most instances, the
Commission would predicate the trading of an equity product on more
than one exchange on application of relevant ITS rules and procedures.
In this instance, however, the delay in ITS implementation will be very
brief.\38\ The Commission believes that the procedures specified by CHX
to replace the ITS trade-through rule during this brief period will
help ensure that a customer receives the best price for a transaction
in SPDRs or MidCap SPDRs among the market centers that
[[Page 49277]]
trade the products. In particular, CHX's BEST Rule, which will apply to
the trading of SPDRs and MidCap SPDRs, guarantees the execution of
agency orders from 100 shares up to 2099 shares at the best bid or
offer on any ITS market center that trades SPDRs and MidCap SPDRs. In
addition, CHX specialists will have the ability to monitor the current
SPDR and MidCap SPDR quotations disseminated by Amex through the
Consolidated Quotation System. Finally, CHX specialists will have the
ability to place limit orders on the Amex specialist's book or send
market orders to the Amex specialist for execution against the Amex
specialist's quote, through Amex's PER System (although through a
correspondent firm). Though not as efficient as full ITS access, these
alternative procedures are reasonable given the very short time until
ITS accepts 64ths.
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\38\ The ITS Operating Committee has indicated that it will be
able to accommodate 64ths after its September 18, 1997 meeting.
Consequently, the discussion regarding alternatives to ITS will only
need to be used for an extremely short period of time. If ITS cannot
handle 64ths after the next meeting, the Commission still expects
ITS to be made available for SPDRs for messages in increments of
16ths or greater until ITS can accommodate 64ths.
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The Commission believes that Amex's statements in its comment
letter regarding the trading of SPDRs and MidCap SPDRs through ITS
should be resolved, as the Amex letter suggests, through the proper ITS
committee, not through Commission action on the CHX proposal.
Otherwise, the ITS process could be used to prevent action on the CHX's
proposal for competitive reasons.\39\
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\39\ The Commission does not want to suggest that Amex's
concerns are unfounded, but only that the proper venue for their
resolution is the proper ITS committee, not the Rule 19b-4 process.
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V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\40\ that the proposed rule change (SR-CHX-97-6) is approved.
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\40\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\41\
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\41\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-24968 Filed 9-18-97; 8:45 am]
BILLING CODE 8010-01-M
