[Federal Register Volume 62, Number 248 (Monday, December 29, 1997)]
[Notices]
[Pages 67674-67679]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-33712]
[[Page 67674]]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-39461; File No. SR-PCX-97-35]
Self-Regulatory Organizations; Order Granting Approval to
Proposed Rule Change by the Pacific Exchange Inc., Relating to Listing
and Trading Standards for Portfolio Depositary Receipts
December 17, 1997.
I. Introduction
On August 25, 1997, the Pacific Exchange Inc., (``PCX'' or
``Exchange'') submitted to the Securities and Exchange Commission
(``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\, a
proposed rule change to add Commentary to Rule 5.3(b) and add Rule
8.300 of PCX's rules relating to the listing and trading of Portfolio
Depositary Receipts (``PDRs'').
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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The proposed rule change together with the substance of the
proposal, was published for comment in the Federal Register on October
14, 1997.\3\ No comments were received on the proposal. This order
approves the proposal.
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\3\ Securities Exchange Act Release No. 39188 (October 2, 1997),
62 FR 53373.
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II. Background and Description
The Exchange proposes to adopt new Comnmentary to Rule 5.3(b) and
new Rule 8.300 to accommodate the trading of PDRs, i.e., securities
which are interests in a unit investment trust (``Trust'') holding a
portfolio of securities linked to an index. Each Trust will provide
investors with an instrument that (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,
PCX 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. PCX is not asking for permission to list SPDRs or MidCap
SPDRs at this time, but rather will trade SPDRs and MidCap SPDRs
pursuant to UTP 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, PCX must have rules providing for transactions in such
class or type of security. The Amex has enacted listing standards for
PDRs, and PCX's proposed rule change is designed to create similar
standards for PDR listing and/or trading on PCX.
If at a later time PCX 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 the change filed pursuant to Section 19(b) of the Act.\4\
Additionally, in the event a new PDR is listed on another exchange
using listing standards that are different than current PCX listing
standards or the PCX listing standards proposed in this filing, the PCX
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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\4\ The Commission notes that PCX, 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 UTP, the
Exchange will follow the listing exchange's determination of the
appropriate minimum number.
Because the Trust operates on an open-end type basis, and because
the number of PDR holders is subject to substantial fluctuations
depending on market conditions, the Exchange believes it would be
inappropriate and burdensome on PDR holders to consider suspending
trading in or delisting a series of PDRs, with the consequent
termination of the Trust, unless the number of holders remains severely
depressed during an extended time period. Therefore, twelve months
after the formation of a Trust and commencement of Exchange trading,
the Exchange will consider suspension of trading in, or removal from
listing of, a Trust when, in its opinion, further dealing in such
securities appears unwarranted under the following circumstances:
(a) If the Trust on which the PDRs are based has more than 60 days
remaining until termination and there have been fewer 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
[[Page 67675]]
priority, parity and precedence of orders and the responsibilities of
specialists.\5\
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\5\ PCX Rule 9.2(a) will also apply to transactions in PDRs,
including SPDRs and MidCap SPDRs. That rule provides, in part, that
every member and member firm shall use due diligence to learn the
essential facts relative to every customer, every order, every
account accepted or carried by such member or member firm.
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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 are reached.\6\ 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.
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\6\ See Securities Exchange Act Release No. 38221 (January 31,
1997), 62 FR 5871 (February 7, 1997) and not 7 therein.
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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
Rule 7.11 the Exchange's rule governing trading halts for index options
in exercising its discretion to 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 circumstance
detrimental to the maintenance of a fair and orderly market are
present.
Disclosure
Proposed Rule 8.300(c) 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 characteristic 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 UTP and will not be listed on PCX at this time, PCX
does not intend to create its own product description to satisfy the
requirements of proposed Rule 8.300(c) 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 PCX will deem a member or member organization to
be in compliance with this requirement if the member delivers either
(i) the current product description produced by the Amex from time to
time, or (ii) the current prospectus for the SPDR or MidCap SPDR, as
the case may be.\7\ It will be the member's responsibility to obtain
these materials directly from Amex for forwarding to purchasers in the
time frames prescribed by PCX and Commission rules. The PCX will notify
members and member organizations of this requirement in a notice to
members.
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\7\ PCX plans to notify its members in an information circular
that it is their responsibility to inform customers of the nature
and terms of SPDRs and MidCap SPDRs prior to recommending their
purchase. The circular also states that members must deliver a SPDR
or MidCap SPDR product description to all purchasers of the products
and that they must provide the prospectus upon request.
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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.\8\ 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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\8\ 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 SPDRs. SPDRs have been
trading on the Amex since January 29, 1993. The second Trust to be
formed in connection with the issuance of PDRs was based on the S&P
MidCap 400 index,\9\ known as MidCap SPDRs.\10\ The Sponsor of the two
Trusts has entered into trust agreements with a trustee in accordance
with Section 26 of the Investment Company Act. PDR Distributors, Inc.
(``Distributor'') acts as underwriter of both SPDRs and MidCap SPDRs on
an agency basis. The Distributor is a registered broker-dealer, a
member of the National Association of Securities Dealers, Inc., and a
wholly-owned subsidiary of Signature Financial Group, Inc.\11\
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\9\ The S&P MidCap 400 Index is a capitalization-weighted index
of 400 actively traded securities that includes issues selected from
a population of 1,700 securities, each with a year-end market-value
capitalization of between $200 million and $5 billion. The issues
included in the Index cover a broad range of major industry groups,
including industrials, transportation, utilities, and financials.
\10\ See Securities Exchange Act Release No. 35534 (March 24,
1995), 60 FR 16686 (March 31, 1995) (``Amex MidCap Approval
Order'').
\11\ The Commission recently approved rule change proposals
covering the trading and listing of PDRs on the Chicago Stock
Exchange (``CHX'') and the Cincinnati Stock Exchange (``CSE''),
including SPDRs and MidCap SPDRs. See Securities Exchange Act
Release Nos. 39076 (September 15, 1997), 62 FR 49270 (September 19,
1997) (``CHX approval order); 39268 (October 22, 1997), 62 FR 56211
(October 29, 1997) (``CSE 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.\12\
[[Page 67676]]
Payment with respect to creation orders placed through the Distributor
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.'' \13\ 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.\14\ 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 PCX has proposed this same minimum
variation for the trading of SPDRs and MidCap SPDRs on PCX.
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\12\ 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.
\13\ A Portfolio Deposit also will include a cash payment equal
to a pro rata portion of the dividends accrued on the Trust's
portfolio securities since the last dividend payment by the Trust,
plus or minus an amount designed to compensate for any difference
between the net asset value of the Portfolio Deposit and the
underlying Index caused by, among other things, the fact that a
Portfolio Deposit cannot contain fractional shares.
\14\ 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.\15\
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\15\ 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.\16\
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\16\ 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.
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
falling within the period from the ex-dividend date most recently
preceding the current ex-dividend date will be distributed. The Trustee
will compute on a daily basis the dividends accumulated within each
quarterly dividend period. Dividend payments will be made through DTC
and its participants to all such holders with fund received from the
Trustee.
The MidCap SPDR Trust intends to make the DTC DRS available for use
by MidCap SPDR holders through DTC participants 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.\17\ Any cash
remaining will be distributed pro rata to participants in the dividend
reinvestment.
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\17\ The creation of PDRs in connection with 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. 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).\18\ The
Commission believes that providing for the exchange-trading on PCX 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
[[Page 67677]]
Commission believes that the trading on PCX of PDRs, in general, and
SPDRs and MidCap SPDRs pursuant to UTP, 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.\19\ Accordingly, as discussed below, the proposed
rule change is consistent with the requirements of Section 6(b)(5) of
the Act that Exchange rules facilitate transactions in securities while
continuing to further investor protection and the public interest.\20\
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\18\ 15 U.S.C. 78f(b)(5).
\19\ 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.
\20\ In approving this rule, the Commission notes that it has
considered the proposed rule's impact on efficiency, competition,
and capital formation. 15 U.S.C. 78c(f).
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As the Commission noted in the orders approving SPDRs and MidCap
SPDRs for listing and trading on Amex,\21\ the Commission believes that
the trading on PCX 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.\22\
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\21\ See supra notes 8 and 10.
\22\ Program trading is defined as index arbitrage or any
trading strategy involving the related purchase or sale of a
``basket'' or group of fifteen or more stocks having a total market
value of $1 million or more.
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An individual SPDR has a value approximately equal to one-tenth of
the value of the S&P 500 Index, and an individual MidCap SPDR has a
value of approximately one-fifth of the value of the S&P MidCap 400
Index, making them more available and useful to individual retail
investors desiring to hold a security replicating the performance of a
broad portfolio of stocks. Accordingly, the Commission believes that
trading of SPDRs and Mid-Cap SPDRs on PCX 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.\23\ In contrast,
pursuant to Investment Company Act Rule 22c-1,\24\ 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.\25\ 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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\23\ Because of potential arbitrage opportunities, the
Commission believes that PDRs will not trade at a material discount
or premium in relation to their net asset value. The mere potential
for arbitrage should keep the market price of a PDR comparable to
its net asset value, and therefore, arbitrage activity likely will
be minimal. In addition, the Commission believes the Trust will
tract the underlying index more closely than an open-end index fund
because the Trust will accept only in-kind deposits, and, therefore,
will not incur brokerage expenses in assembling its portfolio. In
addition, the Trust will redeem in kind, thereby enabling the Trust
to invest virtually all of its assets in securities comprising the
underlying index.
\24\ Investment Company Act Rule 22c-1 generally requires that a
registered investment company issuing a redeemable security, its
principal underwriter, and dealers in that security, may sell,
redeem, or repurchase the security only at a price based on the net
asset value next computed after receipt of an investor's request to
purchase, redeem, or resell. The net asset value of a mutual fund
generally is computed once daily Monday through Friday as designated
by the investment company's board of directors. The Commission
granted SPDRs and MidCap SPDRs an exemption from this provision in
order to allow them to trade at negotiated prices. In the secondary
market. The Commission notes that PCX 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.
\25\ Id.
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Although PDRs in general, and SPDRs and MidCap SPDRs in particular,
are not leveraged instruments, and, therefore, do not possess any of
the attributes of stock index options, their prices will still be
derived and based upon the securities held in their respective Trusts.
In essence, SPDRs are equity securities that are priced off a portfolio
of stocks based on the S&P 500 Index and MidCap SPDRs are equity
securities that are price off a portfolio of stocks based on the S&P
MidCap 400 Index. Accordingly, the level of risk involved in the
purchase or sale of a SPDR or MidCap SPDR (or 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,\26\ the Commission believes PCX adequately
addresses these concerns.
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\26\ See supra note 8.
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The Commission believes that the PCX 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, PCX 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 PCX. As discussed above, PCX's filing states that
SPDRs and MidCap SPDRs product descriptions should be obtained from
Amex.\27\ The
[[Page 67678]]
Commission believes that it is reasonable under the Act to allow PCX to
require its members to obtain the product description for SPDRs and
MidCap SPDRs from Amex.\28\ Amex might decide to impose a reasonable
charge for this service.\29\ 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 PCX members cannot obtain
them from the Distributor.
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\27\ The Commission notes that, in the context of a proposed
change by the Chicago Stock Exchange (``CHX'') to add rules for
listing and trading of PDRs in general, and to trade SPDRs and
MidCap SPDRs pursuant to UTP, Amex commented on CHX's proposed
method regarding the delivery of the SPDR and the MidCap SPDR
product descriptions, and reserved the right to charge CHX members
for supplying the product description should the task become
burdensome to Amex. Amex did not object to the underlying policy of
CHX members obtaining the product description from Amex. See CHX
Approval Order, supra note 11.
\28\ 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, PCX rules adequately ensure its members must
deliver the current product description to all investors in SPDRs
and MidCap SPDRs.
\29\ The Commission notes that Amex would need to file a
proposed rule change under Section 19(b) of the Act in the event it
decides to charge a fee for supplying the SPDR or MidCap SPDR
product descriptions. The Commission notes that reasonable fees
would have to be imposed on the member firms rather than the
customers entitled to receive the prospectus or the product
description.
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Second, members and member organizations must include this written
product description with any sales material relating to the series of
PDRs that is provided to customers or the public. Third, any other
written materials provided by a member or member organization to
customers or the public referencing PDRs as an investment vehicle must
include a statement, in a form specified by PCX, 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,
PCX's rule 9.2(a), Diligence as to Accounts, will apply to the trading
of PDRs, including transactions in SPDRs and MidCap SPDRs.\30\
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\30\ See supra note. 5.
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The Commission believes PCX has adequately addressed the potential
market impact concerns raised by the proposal. First, PCX's proposal
permits listing and trading of specific PDRs only after review by the
Commission. Second, PCX has developed policies regarding trading halts
in PDRs. Specifically, the exchange would halt PDR trading if the
circuit breaker parameters under PCX Rule 7.11 were reached.\31\ In
addition, in deciding whether to halt trading or conduct a delayed
opening in PDRs, in general, and SPDRs and MidCap SPDRs, in particular,
PCX represents that it will be guided by, but not necessarily bound to,
relevant stock index option trading rules. Specifically, consistent
with PCX Rule 7.11, PCX 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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\31\ 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 PCX
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.\32\ 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 PCX pursuant to UTP could produce added
benefits to investors through the increased competition between other
market centers trading the product.
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\32\ 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 PCX 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 PCX surveillance procedures governing equities, are
adequate under the Act.
The Commission finds that PCX'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 PCX rules
governing the trading of equity securities on PCX, including, among
others, rules governing the priority, parity and precedence of orders
and the responsibilities of specialists. In addition, PCX 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, PCX's proposal provides for trading halt procedures governing
PDRs. Finally, the Commission notes that PCX has stated that Rule
9.2(a), Diligence as to Accounts, will apply to the trading of PDRs in
general, and SPDRs and MidCap SPDRs, in particular.
IV. Conclusion
It Is Therefore Ordered, pursuant to Section 19(b)(2) of the
Act,\33\ that the proposed rule change (SR-PCX-97-35) is approved.
\33\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\34\
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\34\ 17 CFR 200.30-3(a)(12).
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[[Page 67679]]
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-33712 Filed 12-24-97; 8:45 am]
BILLING CODE 8010-01-M