Self-Regulatory Organizations; Order Granting Approval to Proposed Rule Change by the Chicago Stock Exchange, Inc., Relating to Trading of Particular Investment Company Units

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39117; File No. SR-CHX-96-14]

Self-Regulatory Organizations; Order Granting Approval to

Proposed Rule Change by the Chicago Stock Exchange, Inc., Relating to

Trading of Particular Investment Company Units

September 22, 1997.

I. Introduction

On April 23, 1996, 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'') \1\ and Rule 19(b)-4 thereunder,\2\ a

proposed rule change to amend Article XXVIII of the CHX's Rules to

permit them to trade certain units representing an interest in a

registered investment company (``Units'') on CHX.

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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 Securities Exchange Act Release

No. 37228 (May 20, 1996) 61 FR 26940 (May 29, 1996). One comment letter

was received in response to the proposal.\3\

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\3\ See Letter from James F. Duffy, Executive Vice President and

General Counsel, Legal and Regulatory Policy, American Stock

Exchange (``Amex''), to Jonathan G. Katz, Secretary, Commission,

dated June 20, 1996 (``Amex letter'').

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II. Background and Description

In SR-CHX-96-12, the Exchange requested and received approval of

proposed rule changes allowing the listing and/or trading of Units.\4\

CHX is proposing to apply its existing listing standards for the

trading of Units to the trading of World Equity Benchmark Securities

(``WEBS'') pursuant to unlisted trading privileges (``UTP''). CHX is

also proposing to amend Article

[[Page 50974]]

XXVIII, Rule 24, to add Interpretation and Policy .02 to specifically

allow the Exchange to trade WEBS pursuant to unlisted trading

privileges. WEBS currently are approved for trading on the American

Stock Exchange (``Amex'').\5\ If at a later time CHX desires to list

WEBS, rather than only trade WEBS pursuant to UTP, the Exchange will

request Commission approval for that listing in a separate proposed

rule change filed pursuant to Section 19(b) of the Act.\6\

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\4\ See Securities Exchange Act Release Nos. 37121 (April 17,

1996), 61 FR 17932 (April 23, 1996) (notice of File No. SR-CHX-96-

12) and 37589 (August 21, 1996), 61 FR 44370 (August 28, 1996)

approval order). In that rule filing, the Exchange also stated its

intent to trade CountryBasket securities, pursuant to a request for

unlisted trading privileges. CountryBasket securities are Units

designed to track the performance of specific foreign indices, more

fully described in SR-CHX-96-12 and SR-NYSE-95-23. Id. See also

Securities Exchange Act Release No. 36923 (March 5, 1996), 61 FR

10410 (March 13, 1996) (order approving File No. SR-NYSE-95-23).

\5\ See Securities Exchange Act Release No. 36947 (March 8,

1996), 61 FR 10606 (March 14, 1996) (``Amex WEBS Approval Order'').

\6\ The remainder of this section discusses the structure of

WEBS, the details of which are taken from SR-Amex-95-43 and its

Amendments Nos. 1, 2, 3. The information provided here is

significantly condensed from Amex's filing. CHX notes that the Amex

has represented that customers who purchase WEBS will receive a

detailed prospectus from the issuer.

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Structure of WEBS

Rules to accommodate the trading of Index Fund Shares generally on

Amex, along with Amex's trading of WEBS, were previously approved by

the Commission.\7\ The information provided below is intended to

provide a description of how WEBS are created and traded and is similar

to that discussed in the original Amex WEBS Approval Order.

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\7\ See Amex WEBS Approval Order, supra note 5.

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WEBS are issued by Foreign Fund, Inc., and based on seventeen

Morgan Stanley Capital International (``MSCI'') Indices (each

individually an ``MSCI Index'' or ``Index'' and collectively ``MSCI

Indices'' or ``Indices''). The countries whose markets are represented

by those indices are: Australia, Austria, Belgium, Canada, France,

Germany, Hong Kong, Italy, Japan, Malaysia, Mexico, Netherlands,

Singapore, Spain, Sweden, Switzerland, and the United Kingdom.

The investment objective of each WEBS series is to seek to provide

investment results that correspond generally to the price and yield

performance of public securities traded in the aggregate in particular

foreign markets, as represented by specific MSCI Indices. Each WEBS

series will use a ``passive'' or indexing investment approach which

attempts to approximate the investment performance of its benchmark

index through quantitative analytical procedures.

A WEBS series normally will invest at least 95% of its total assets

in stocks that are represented in the relevant MSCI Index and will at

all times invest at least 90% of its total assets in such stocks. A

WEBS series will not hold all of the issues that comprise the subject

MSCI Index, but will attempt to hold a representative sample of the

securities in the Index in a technique known as ``portfolio sampling.''

Foreign Fund, Inc. will issue and redeem WEBS of each Index Series

only in aggregations of shares specified for each Index Series (each

aggregation a ``Creation Unit''). The number of shares per Creation

Unit will range from 40,000 to 600,000. In its original filing to list

and trade WEBS, Amex anticipated that the value of a Creation Unit at

the start of trading would range from $450,000 to $10,000,000, and the

net asset value (``NAV'') of an individual WEBS would range from $10 to

$20.

The MSCI Indices

MSCI generally seeks to have 60% of the capitalization of a

country's stock market index reflected in the MSCI Index for such

country. Thus, the MSCI Indices seek to balance the inclusiveness of an

``all share'' index against the replicability of a ``blue chip'' index.

MSCI applies the same criteria and calculation methodology across all

markets for all indices, developed and emerging.

All single-country MSCI Indices are market capitalization weighted.

For countries that restrict foreign ownership, MSCI calculates two

Indices. The additional Indices are called ``free'' Indices, and they

exclude companies and share classes not purchasable by foreigners. Free

Indices are currently calculated for Singapore, Mexico, the

Philippines, and Venezuela, and for those regional and international

indices which include such markets. The Mexico and Singapore WEBS

series will be based on the free Indices for those countries. There are

no WEBS series corresponding to the Philippines and Venezuela MSCI

Indices.

All MSCI Indexes are calculated daily. The calculation method

weights stocks in an index by their beginning-of-period market

capitalization. Share prices are ``swept clean'' daily and adjusted for

any rights issues, stock dividends or splits. The MSCI Indices

currently are calculated in local currency and in U.S. dollars, without

dividends and with gross dividends reinvested.

Prices used to calculate the MSCI Indices are the official exchange

closing prices. All prices are taken from the dominant exchange in each

market. To calculate the applicable foreign currency exchange rate,

MSCI uses WM/Reuters Closing Spot Rates for all developed and emerging

markets except those in Latin America. Because of the high volatility

of currencies in some Latin American countries, MSCI continue to

calculate its own rates for those countries. Under exceptional

circumstances MSCI may elect to use an alternative exchange rate for

any country if the WM/Reuters rate is believed not to be representative

for a given currency on a particular day.

Each MSCI Index on which a WEBS series is based is calculated by

MSCI for each trading day in the applicable foreign exchange market

based on official closing prices in such exchange market. For each

trading day, MSCI publicly disseminates each Index value for the

previous day's close. MSCI Indices are reported periodically in major

financial publications and also are available through vendors of

financial information.

Foreign Fund, Inc. will cause to be made available daily the names

and required number of shares of each of the securities to be deposited

in connection with the issuance of WEBS in Creation Unit size

aggregations for each WEBS series, as well as information relating to

the required cash payment representing, in part, the amount of accrued

dividends applicable to such WEBS series. This information will be made

available by the Fund Advisor to any National Securities Clearing

Corporation (``NSCC'') participant requesting such information. In

addition, other investors can request such information directly from

the Fund distributor. The NAV for each WEBS series will be calculated

directly by the Fund administrator, PFPC, Inc. NAVs will be made

available to the public from the Fund distributor by means of a toll-

free number, and also will be available to NSCC participants through

data made available from NSCC.

To provide current WEBS pricing information, Amex represented that

it anticipated it would disseminate through the facilities of the

Consolidated Tap Association (``CTA'') an indicative optimized

portfolio value'' (``Value'') for each WEBS series as calculated by

Bloomberg, L.P. (``Bloomberg''). The Value will be disseminated on a

per WEBS basis every fifteen seconds during regular Amex trading hours

of 9:30 A.M. to 4:00 P.M. New York time.\8\

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\8\ These are the same trading hours as at the CHX.

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The Value likely will not reflect the value of all securities

included in the applicable benchmark MSCI Index. In addition, the Value

will not necessarily reflect the precise composition of the current

portfolio of securities held by the Fund for each WEBS series at a

particular moment. Therefore, the Value on a per WEBS basis

disseminated during Amex trading hours should not

[[Page 50975]]

be viewed as a real-time update of the net asset value of the Fund,

which is calculated only once a day. It is expected, however, that

during the trading day the Value will closely approximate the value per

WEBS share of the portfolio of securities for each WEBS series except

under unusual circumstances.

The Exchange will distribute an information circular to its members

in connection with the trading of WEBS. The circular will discuss the

special characteristics and risks of trading this type of security.

Specifically, the circular, among other issues, will discuss what WEBS

are, how they are created and redeemed, the requirement that members

and member firms deliver a prospectus to investors purchasing WEBS

prior to or concurrently with the confirmation of a WEBS transaction,

applicable Exchange rules, dissemination information, trading

information, and the applicability of suitability rules.\9\ The

Exchange also intends to utilize its existing surveillance procedures

to surveil trading in WEBS, including surveilling specialist compliance

with Article XXX, Rule 23(a), which contemplates specialists engaging

in transactions with the issuer of WEBS under certain circumstances.

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\9\ The Commission notes that CHX has filed a proposed rule

change (SR-CHX-97-21) which would require, in part, that any CHX

member, before recommending a transaction in any security, have

reasonable grounds for believing that the recommendation is suitable

for such customer upon the basis of the facts, if any, disclosed by

such customer as to his other security holdings and as to his

financial situation and needs.

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III. Summary of Comments

Amex filed a comment letter to the proposed rule change.\10\ Amex

states that CHX, or any market trading or proposing to trade WEBS,

should be required to submit for Commission review an information

circular to distribute to their members prior to trading WEBS on the

exchange. Amex also states that any such information circular should

adequately explain the unique characteristics and risks of this type of

security, including member responsibilities, and identify the Exchange

personnel who can be contacted to discuss any issues or answer any

inquiries relating to the trading of WEBS.

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\10\ See supra note 3.

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IV. Discussion

The Commission finds that the proposed rule change is 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).\11\ The

Commission believes that the Exchange's proposal to trade WEBS pursuant

to unlisted trading privileges will provide investors with a convenient

way of participating in foreign securities markets and could produce

added benefits to investors through the increased competition between

other market centers trading the product. Specifically, the Commission

believes that CHX's proposal should help provide investors with

increased flexibility in satisfying their investment needs, by allowing

them to purchase and sell at negotiated prices throughout the trading

day securities that replicate the performance of several portfolios of

stock,\12\ and by increasing the availability of WEBS as an investment

tool. Accordingly, as discussed below, the rule proposal is consistent

with the requirements of Section 6(b)(5) that Exchange rules facilitate

transactions in securities, remove impediments to and perfect the

mechanism of a free and open market and a national market system, and,

in general, protect investors and the public interest, and is not

designed to permit unfair discrimination between customers, issuers,

brokers, or dealers.\13\

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\11\ 15 U.S.C. 78f(b)(5).

\12\ The Commission notes that unlike typical open-end

investment companies, where investors have the right to redeem their

fund shares on a daily basis, investors in WEBS can redeem them in

creation unit size aggregations only.

\13\ 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 greater detail in the order approving

WEBS for listing and trading on Amex, \14\ the estimated cost of an

individual WEBS \15\ should make it attractive to individual retail

investors who wish to hold a security replicating the performance of a

portfolio of foreign stocks. The Commission also notes that WEBS should

provide investors with several advantages over standard open-end

investment companies; in particular, investors can trade WEBS

continuously throughout the day in secondary markets at negotiated

prices.\16\ In contrast, Investment Company Act Rule 22c-1 \17\ limits

holders and prospectus holders of open-end management investment

company shares 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. Thus, WEBS should allow investors to respond

quickly to market changes through intra-day trading opportunities,

expand the opportunity for retail investors to engage in hedging

strategies, and reduce transaction costs for trading a portfolio of

stocks. The Commission notes that under the proposed rule change, these

benefits of WEBS will now be available to investors trading on CHX and

believes that the addition of their trading on CHX pursuant to UTP

could produce added benefits to investors through the increased

competition.

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\14\ See Amex WEBS Approval Order, supra note 5. The Commission

hereby incorporates by reference the discussion and rational for

approving WEBS provided in the Amex WEBS Approval Order.

\15\ As noted in the Background and Description section supra,

the estimated cost at the time of the approval for trading on Amex

was $10 to $20 per individual WEBS.

\16\ The Commission believes that WEBS will not trade at a

material discount or premium in relation to their net asset value,

because of potential arbitrage opportunities. See Amex WEBS Approval

Order, supra note 5, at 31. the mere potential for arbitrage should

keep the market price of WEBS comparable to their net asset values;

therefore, arbitrage activity likely will not be significant. In

addition, the Fund will redeem in-kind, thereby enabling the Fund to

invest virtually all of its assets in securities comprising the MSCI

Indices.

\17\ 17 CFR 270.22c-1. Investment Company Act Rule 22c-1

generally provides 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 an open-end management investment company generally is

computed once daily Monday to Friday as designated by the investment

company's board of directors. The Commission granted WEBS an

exemption from this provision to allow them to trade in the

secondary market at negotiated prices. See Amex WEBS Approval Order,

supra note 5.

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The Commission notes that although the value of WEBS are based on

the value of the securities and cash held in the Fund, WEBS are not

leveraged instruments. WEBS are essentially equity securities that

represent an interest in a portfolio of stocks designed to reflect

substantially the applicable MSCI Index. Accordingly, it is appropriate

to regulate WEBS in a manner similar to other equity securities.

Nonetheless, the Commission believes that the unique nature of WEBS

raises certain, disclosure, trading, and other issues that need to be

addressed. The remainder of this section addresses these issues,

although they are discussed in greater detail in the Amex WEBS Approval

Order, where the Commission initially approved WEBS for trading as a

new product.

Trading of WEBS On CHX

The Commission notes that, pursuant to Rule 12f-5 under the Act,

\18\ prior to trading a particular class or type of security pursuant

to UTP, CHX must

[[Page 50976]]

have listing standards comparable to those of the primary market on

which the security is listed. The Commission finds that adequate rules

and procedures exist to govern the trading of WEBS on CHX, pursuant to

UTP. WEBS will be deemed equity securities subject to CHX's rules

governing the trading of equity securities. Accordingly, the Exchange's

existing general rules that currently apply to the trading of equity

securities will also apply to WEBS. In addition, CHX's Article XXVIII,

rule 24,\19\ which contains specific listing and delisting criteria to

accommodate the trading of Units, will apply to the trading of

WEBS.\20\ These criteria should help to ensure that a minimum level of

liquidity will exist in each WEBS series to allow for the maintenance

of fair and orderly markets. The delisting criteria allow the Exchange

to consider the suspension of trading and the delisting of a series of

Units, including suspending trading in WEBS traded on the Exchange

pursuant to UTP, if an event were to occur that made further dealings

in such securities inadvisable. This will give the Exchange flexibility

to suspend trading in WEBS if circumstances warrant such action.

Accordingly, the Commission believes that CHX's equity rules in

general, and CHX's Article XXVIII, Rule in 24 particular, provide

adequate safeguards to prevent manipulative acts and practices and to

protect investors and the public interest.\21\

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\18\ 17 CFR 240.12f-5.

\19\ The Commission approved generic rules for the listing and/

or trading of investment company units on CHX in 1996. See

Securities Exchange Act Release No. 37589 (August 21, 1996), 61 FR

44370 (August 28, 1996).

\20\ The Commission notes the listing and delisting criteria is

similar to those adopted by Amex to trade WEBS.

\21\ The Commission also believes that the proposed rule change

should help protect investors and the public interest, and help

perfect the mechanisms of a national market system, in that it will

allow for the trading of WEBS on CHX pursuant to UTP, making WEBS

more broadly available to the investing public.

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The Commission notes that once CHX receives approval to trade WEBS

pursuant to UTP, CHX intends to request that WEBS be declared an

Intermarket Trading System (``ITS'') eligible security. WEBS could then

be traded through ITS, subjecting the trading of WEBS to all the ITS

rules and procedures, including the ITS trade-through rule.

Disclosure

The Commission believes that CHX's proposal should provide for

adequate disclosure to investors relating to the terms,

characteristics, and risks of trading WEBS. All WEBS investors,

including those purchasing WEBS on CHX pursuant to UTP, will receive a

prospectus regarding the product. Because WEBS trading on CHX pursuant

to UTP will be in continuous distribution, the prospectus delivery

requirements of the Securities Act of 1933 will apply to both the

initial investors and to investors purchasing such securities in the

secondary market on CHX. The prospectus addresses the special

characteristics of WEBS, including a statement regarding their

redeemability and method of creation, and that WEBS are not

individually redeemable.

CHX has also drafted an information circular that will be sent to

all CHX members prior to the commencement of trading of WEBS. The

Commission notes that it has reviewed this draft information circular

and believes it adequately explains the unique characteristics and

risks of WEBS. The circular will note, for example, Exchange member

responsibilities, including that before an Exchange member undertakes

to recommend a transaction in WEBS, it should make a determination that

it is in compliance with applicable rules of other self-regulatory

organizations of which it is a member, including suitability rules.\22\

The circular will also address members' responsibility to deliver a

prospectus to all investors purchasing WEBS, as well as highlight the

characteristics of WEBS, including that they are only redeemable in

Creation Unit size aggregation.\23\ The Commission also notes that

CHX's draft circular is essentially the same as the Amex WEBS circular

previously reviewed by the Commission. The Commission also believes

that CHX's draft information circular adequately addresses Amex's

comments.\24\

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\22\ See supra note 9.

\23\ The Commission notes that the information circular also

discusses exemptive relief granted by the Commission from certain

rules under the Act, exemptions that CHX members can rely upon. The

applicable rules are: Rule 10b-10(e); Rule 10b-13; Rule 10b-

17(b)(2); Rule 11(d)(1); Rules 15cl-5 and 15cl-6; and Regulation M

to the extent it superseded Rules 10b-6 and 10b-7.

\24\ In particular, in response to the comments in Amex's

comment letter, the Commission notes it has reviewed CHX's draft

information circular and that it believes the circular adequately

explains the unique characteristics and risks of WEBS, including

member responsibilities, and that it identifies the Exchange

personnel to contact regarding issues relating to the trading of

WEBS.

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Dissemination of WEBS Portfolio Information

The Commission believes that since Amex is disseminating the Values

for the seventeen WEBS series, investors will be provided with timely

and useful information concerning the value of WEBS, on per WEBS basis.

The Commission notes that information is disseminated through

facilities of the CTA and reflects the currently available information

concerning the value of the assets comprising the Deposit securities.

The information is disseminated every 15 seconds during the hours of

9:30 a.m. to 4:00 p.m., Eastern standard time and will be available to

all investors, irrespective of where the transaction is executed. Also,

since the value is expected to closely track the applicable WEBS

series, the Commission believes the Values will provide investors with

adequate information to determine the intra-day value of a given WEBS

series.\25\ In the Amex WEBS Approval Order, the Commission noted that

it expected Amex to monitor the disseminated Value, and if Amex

determines that the Value does not closely track applicable WEBS

series, it will arrange to disseminate an adequate alternative.

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\25\ In addition, the Amex WEBS Approval Order states that the

statement of additional information (``SAI'') to the preliminary

prospectus states that each series will calculate its NAV per share

at the close of the regular trading session for the NYSE on each day

that the Amex is open for business. NAV generally will be based on

the last quoted sales price on the exchange where the security

primarily is traded. See Amex WEBS Approval Order, supra note 5.

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Surveillance

The Commission notes that CHX has submitted surveillance procedures

for WEBS and believes that those procedures are adequate to address

concerns associated with the listing and trading of such securities,

including any concerns associated with specialists purchasing and

redeeming Creation Units. The Exchange has represented that its

surveillance procedures should allow it to identify situations where

specialists purchase or redeem Creation Units to ensure compliance with

CHX Article XXX, Rule 23(a), which requires that such purchases or

redemptions facilitate the maintenance of a fair and orderly market in

the subject security.\26\

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\26\ The Commission notes that, in the Amex WEBS Approval Order,

it discussed the concerns raised when a broker-dealer is involved in

the development and maintenance of a stock index upon which a

product such as WEBS is based. Adequate procedures to prevent the

misuse of material, non-public information regarding changes to

component stocks in an MSCI Index have been adopted and should help

to address concerns raised by Morgan Stanley's involvement in the

management of the Indices.

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Specialists

The Commission finds that it is consistent with the Act to allow a

specialist registered in a security issued by an Investment Company to

purchase or redeem the listed security from the

[[Page 50977]]

issuer as appropriate to facilitate the maintenance of a fair and

orderly market in that security. The Commission believes that such

market activities should enhance liquidity in such security and

facilitate a specialist's market making responsibilities. In addition,

because the specialist only will be able to purchase and redeem WEBS on

the same terms and conditions as any other investor (and only at the

NAV), and Creation transactions must occur through the distributor and

not directly with the issuer, the Commission believes that concerns

regarding potential abuse are minimized. As noted above, the Exchange's

surveillance procedures also should ensure that such purchases are only

for the purpose of maintaining fair and orderly markets, and not for

any other improper or speculative purposes. Finally, the Commission

notes that its approval of this aspect of the Exchange's rule proposal

does not address any other requirements or obligations under the

federal securities laws that may be applicable.\27\

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\27\ The Commission notes that with respect to WEBS, broker-

dealers and other persons are cautioned in the prospectus and/or the

Fund's SAI that some activities on their part may, depending on the

circumstances, result in their being deemed statutory underwriters

and subject them to the prospectus delivery and liability provisions

of the Securities Act of 1933.

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V. Conclusion

It is therefore ordered, pursuant to Section 19(b)(2) of the

Act,\28\ that the proposed rule change (SR-CHX-96-14) is approved.

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\28\ 15 U.S.C. 78s(b)(2).

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\29\

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\29\ 17 CFR 200.30-3(a)(12).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 97-25687 Filed 9-26-97; 8:45 am]

BILLING CODE 8010-01-M