e40vappza
File No. 812-13478
UNITED STATES OF AMERICA
BEFORE THE
U.S. SECURITIES AND EXCHANGE COMMISSION
Amended and Restated Application for an Order under Section 6(c) of the Investment
Company Act of 1940 (the “Act”) for an exemption from Sections 2(a)(32), 5(a)(1), 22(d) and 22(e)
of the Act and Rule 22c-1 under the Act and under Sections 6(c) and 17(b) of the Act for an
exemption from Sections 17(a)(1) and 17(a)(2) of the Act and under Section 12(d)(1)(J) granting an
exemption from Sections 12(d)(1)(A) and 12(d)(1)(B) of the Act
In the Matter of
Highland Capital Management, L.P.
Highland Funds I
13455 Noel Road, Suite 800
Dallas, TX 75240
Please send all communications to:
W. John McGuire, Esq.
Michael Berenson, Esq.
Morgan, Lewis & Bockius LLP
1111 Pennsylvania Avenue, N.W.
Washington, D.C. 20004
Page 1 of 88 pages (including exhibits)
As
filed with the Securities and Exchange Commission on July 1, 2010
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TABLE OF CONTENTS
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2
TABLE OF CONTENTS
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3
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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In the Matter of:
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Amended and Restated Application for an Order
under Section 6(c) of the Investment Company Act of 1940 (the “Act”) for
an exemption from Sections 2(a)(32), 5(a)(1), 22(d)and 22(e) of the Act and Rule 22c-1
under the Act and under Sections 6(c) and 17(b) of the Act for an exemption from Sections 17(a)(1)
and 17(a)(2) of the Act and under Section 12(d)(1)(J) granting an exemption from Sections 12(d)(1)(A)
and 12(d)(1)(B) of the Act |
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Highland Capital Management, L.P.
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Highland Funds I
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13455 Noel Road, Suite 800
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Dallas, TX 75240
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File No. 812-13478 |
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I. SUMMARY OF APPLICATION
A. Request for Order
In this amended and restated application originally filed on January 17, 2008 and previously
amended on June 21.2008 (“Application”), the undersigned applicant Highland Capital Management,
L.P. (the “Adviser”), together with Highland Funds I (the “Trust”) (collectively, the “Applicants”)
apply for and request an order under Section 6(c) of the Investment Company Act of 1940 (the “Act”)
for an exemption from Sections 2(a)(32), 5(a)(1), 22(d) and 22(e) of the Act and Rule 22c-1 under
the Act and under Sections 6(c) and 17(b) of the Act for an exemption from Sections 17(a)(1) and
17(a)(2) of the Act (the “Order”). The requested Order would permit, among other things, (a)
certain series of an open-end management investment company (each a “Fund” and collectively, the
“Funds”) to be redeemable in large aggregations only (“Creation Unit Aggregations”); (b) the
open-end management investment
5
company shares (“Shares” or “Fund Shares”) to trade on a national securities exchange as
defined in Section 2(a)(26) of the Act (“Exchange”), such as the New York Stock Exchange Arca
(“NYSE”) or the Nasdaq Stock Market, Inc. (“Nasdaq”), at negotiated market prices rather than at
net asset value (“NAV”); (c) relief from the seven (7) calendar day redemption requirement for
certain Funds under specified limited circumstances; and (d) certain affiliated persons of the
investment company to buy securities from, and sell securities to, the investment company, in
connection with the in-kind purchase and redemption of the investment company’s exchange-traded
Shares (referred to as the “ETF Relief”).1 Applicants believe that the requested ETF
Relief is appropriate in the public interest and consistent with the protection of investors and
the purposes fairly intended by the policy and provisions of the Act.
Applicants also apply for and request an order pursuant to Section 12(d)(l)(J) of the Act
exempting certain transactions from Sections 12(d)(l)(A) and 12(d)(l)(B) of the Act, and under
Sections 6(c) and 17(b) of the Act exempting certain transactions from Section 17(a) of the Act
(included in the term “Order”). Applicants ask that this requested relief (sometimes referred to
herein as the “12(d)(l) Relief”) be applicable to (i) the initial Fund and any Future Funds, as
described below, (ii) “Acquiring Funds” as defined immediately below, and (iii) any broker-dealer
registered under the Securities Exchange Act of 1934, as amended (“Exchange Act”) selling Shares to
Acquiring Funds (“Brokers”). The Order, if granted, would permit registered management investment
companies and unit investment trusts (“UITs”) that are not advised or sponsored by the Adviser or
an entity controlling, controlled by or under common control with the Adviser, and not part of the
same “group of investment companies” as defined in Section 12(d)(l)(G)(ii) of the Act as the Funds,
to acquire Shares beyond the limits of Section 12(d)(l)(A)
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Open-end investment companies and UITs that
trade on an Exchange are often referred to as exchange traded funds (“ETFs”). |
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of the Act. (Such management companies are referred to herein as the “Acquiring Management
Companies,” such UITs are referred to herein as “Acquiring Trusts,” and are collectively referred
to herein as the “Acquiring Funds”). The requested exemptions would also permit each Fund and/or a
Broker to sell Shares to an Acquiring Fund beyond the limits of Section 12(d)(l)(B). In addition,
Applicants request relief from Sections 17(a)(l) and (2) (also included in the term “Order”) to
permit each Fund to sell its Shares to, and redeem its Shares from, an Acquiring Fund that owns
5% or more of the shares of such Fund. An Acquiring Fund may rely on the requested
Order, if granted, only to invest in the Funds and not in any other registered investment company.
Applicants believe that (i) with respect to the relief requested pursuant to Section 6(c), the
requested exemption for the proposed transactions is appropriate in the public interest and
consistent with the protection of investors and the purposes fairly intended by the policy and
provisions of the Act, and (ii) with respect to the relief requested pursuant to Section 17(b), the
proposed transactions are reasonable and fair and do not involve overreaching on the part of any
person concerned; the proposed transactions are consistent with the policy of each Initial and
Future Fund (each as defined below) and that the proposed transactions are consistent with the
general purposes of the Act.
The relief described in this Sub-Section 1.A will be collectively referred to as the “Relief.”
The Relief requested in this Application relates to the Fund identified in Exhibit A
to this Application, whose performance will correspond generally to the price and yield
performance of the Highland/Markit Liquid Loan Index™ (“Initial Fund”). In the future, the Adviser
intends to create additional series that are not yet described or identified in Exhibit A (“Future
Funds” and, together with the Initial Fund, included in the term “Funds”). Each Future
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Fund will be advised by the Adviser or an entity controlling, controlled by or under common
control with the Adviser.
No form having been specifically prescribed for this Application, Applicants proceed under
Rule 0-2 of the General Rules and Regulations under the Act of the U.S. Securities and Exchange
Commission (the “Commission”).
B. Comparability of Relief Sought to Prior Relief Granted by the Commission
The requested Relief is very similar to the relief granted by the Commission to other open-end
management investment companies including: Wisdom Tree Trust, the Select Sector SPDR Trust and the
iShares Trust,2 (collectively, the “Management Companies”) pursuant to their respective
applications for exemptive relief (“Prior Management Company Orders”).
The relief requested herein is also substantially similar to that granted by the Commission to
certain UITs: the BLDRS Index Funds Trust (“BLDRS”), Nasdaq-100 Trust, Series 1 (“QQQQs”), Diamonds
Trust (“DIAMONDS”), and MidCap SPDR Trust, Series 1 (“MidCap SPDRs”), the SPDR Trust, Series I, a
unit investment trust (“SPDR Trust”).3 The Prior UIT Orders and the Prior Management
Company Orders are collectively referred to herein as the “Prior Orders.” The Management Companies
and the UITs are collectively referred to herein as the “Prior ETFs.”
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WisdomTree Investments, et al.,
Investment Company Act Release No. 27391 (June 12, 2006) and as subsequently
amended (the “WisdomTree Order”); Barclays Global Fund Advisor,
Investment Company Act Release No. 24451 (May 12, 2000) and as subsequently
amended (the “iShares Order”); Select Sector SPDR Trust, Investment
Company Act Release No. 23534 (November 13, 1998) and as subsequently amended
(the “Select Sector SPDRs Order”). |
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In the Matter of BLDRS Index Fund Trust,
et al., Investment Company Act Release Nos. 27768 (March 21, 2007) and
25797 (November 8, 2002) (the “BLDRS Orders”); In the Matter of the
Nasdaq-100 Trust, et al. Investment Company Act Release No. (23702,
February 22, 1999) (the “Nasdaq-100 Trust Order”); In the Matter of
Diamonds Trust, et al., Investment Company Act Release No. 22979 (December
30, 1997) (the “Diamonds Order”); and In the Matter of MidCap SPDR Trust,
Series 1, Investment Company Act Release No. 20844 (January 18, 1995) (the
“MidCap Order”); and In the Matter of SPDR Trust Series 1, Investment
Company Act Release No. 19055 (October 26, 1992) (the “SPDR Order”); (The term
“Prior UIT Orders” is used herein when referring to the four aforementioned
orders). |
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II. BACKGROUND
A. The Trust
The Trust is a Delaware statutory trust registered under the Act as an open-end management
investment company. It is authorized to offer an unlimited number of series. The Trust offers and
sell its securities pursuant to a registration statement on Form N-1A (File No. 333-132400) filed
with the Commission under the Act and the Securities Act of 1933 (“Securities Act”)(“Registration
Statement”). The Trust will create new Funds, each of which will operate pursuant to the terms and
conditions stated in the Application. Each Fund will consist of a portfolio of securities
(“Portfolio Securities”) selected to correspond generally to the price and yield performance of a
specified index (each securities index is an “Underlying Index” or “Index”). The Applicants
request that any order issued apply to any Future Fund, or any series of a registered open-end
management investment company registered under the Act which operates pursuant to the terms and
conditions stated in this Application and is advised by the Adviser, as defined below, or an entity
controlled by or under common control with the Adviser. The Initial Fund will be a domestic fund
based on the Highland/Markit Liquid Loan™ Index. Future Funds may be based on global equity
(“Global Equity”) Indices and global fixed income (“Global Fixed Income”) Indices (collectively,
any Future Fund based on a Global Fixed Income or Global Equity Index are the “Global Funds”).
Other Future Funds may be based on (i) domestic equity (“Domestic Equity”), domestic fixed income
(“Domestic Fixed Income”), or an Index containing a blend of domestic equity and fixed income
Indices (“Blended Domestic”) (Domestic Equity, Domestic Fixed Income, and Blended Domestic Funds,
collectively, are the “Domestic Funds”); (ii) international equity (“International Equity”),
international fixed income (“International Fixed Income”), or (iii) an Index containing a blend of
international equity and international fixed income securities (“Blended International”),
(International Equity,
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International Fixed Income, and Blended International Funds, collectively, are the “International
Funds”, the Blended Domestic Funds, Blended International Funds and a combination of Blended
Domestic and Blended International Funds (“Blended Global Funds”)4 are the “Blended
Funds”), as further described herein.5 All existing entities that intend to rely on the
requested Order have been named as Applicants. Any other existing or future entity that
subsequently relies on the Order will comply with the terms and conditions of the Application.
Each Fund intends to qualify as a “regulated investment company” (a “RIC”) under the Internal
Revenue Code (the “Code”). Each Fund will be entitled to use its Underlying Index pursuant to a
licensing agreement with the relevant Index provider, any entity that creates, compiles, sponsors,
or maintains an Underlying Index, (“Index Provider”) or pursuant to a sub-licensing arrangement
with the Adviser, which will enter into a licensing agreement with the relevant Index Provider. An
Index Provider will not provide recommendations to a Fund regarding the purchase or sale of
specific securities. In addition, an Index Provider will not provide any information relating to
changes to an Underlying Index’s methodology for the inclusion of securities in the index (the
constituent securities of an Index are referred to as “Component Securities”), the inclusion or
exclusion of specific Component Securities, or methodology for the calculation of the return of
Component Securities, in advance of a public announcement of such changes by the Index Provider.
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A Blended Global Fund would be based on an
Index which includes both domestic and international equity and fixed income
securities. |
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For purposes of this Application, the
Component Securities of Indices used for Domestic Funds are those that
principally trade in the U.S. The Component Securities of Indices used for
International Funds will principally trade in a market other than the U.S.
Finally, certain of the Component Securities of Indices used for Global Funds
will trade in the U.S. while other Component Securities will trade in a market
other than the U.S. |
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B. The Adviser
The Adviser will be the investment adviser to the Funds. The Adviser is a Delaware limited
partnership, with its principal office in Dallas, Texas. The Adviser is registered as an
investment adviser under Section 203 of the Investment Advisers Act of 1940 (the “Advisers Act”).
The Adviser may enter into sub-advisory agreements with investment advisers to act as subadvisers
with respect to the Trust and any of its series, if warranted. Any subadviser to the Trust or a
Fund will be registered under the Advisers Act and will not otherwise be affiliated (within the
meaning of Section 2(a)(3) of the Act) with the Trust (each a “Subadviser” and, collectively, the
“Subadvisers”).
The Adviser, subject to the oversight and authority of the board of trustees of the Trust (the
“Board”), will implement each Fund’s investment program and oversee the day-to-day portfolio
activities of each Fund. If the Adviser engages a Subadviser, the Adviser will develop the overall
investment program for each Fund and oversee the Subadviser’s activities. The Subadviser’s role
will be the same, regardless of whether a Fund uses a replication or representative sampling
strategy, as discussed herein.
The Adviser will arrange and oversee the provision of necessary services for the Funds
(including custodial, transfer agency and administration services) and furnish office facilities,
equipment, services and executive and administrative personnel necessary for managing the
investment program of each Fund.
Applicants note that affiliates of the Adviser or any Subadviser may be hired to provide other
services, such as administration, custody, distribution, or transfer agency services, to the Funds,
subject to the Board’s approval.
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C. The Underlying Index
The Underlying Index for the Initial Fund is described in Exhibit A. No Index Provider is or
will be an “affiliated person,” as defined in Section 2(a)(3) of the Act, or an affiliated person
of an affiliated person, of the Trust or a Fund, a promoter, the Adviser, a Subadviser, or a
Distributor (as defined below). The Adviser will obtain any necessary licensing arrangements with
the Index Provider to offer the Fund Shares. To the extent such licensing arrangements are legally
required, they have already been entered into or will be in effect at the time secondary market
trading of such Fund Shares commences. The Adviser will provide any licenses without charge to the
Funds. The Index Provider for the Initial Fund will be Markit, Inc.
D. The Distributor
A broker-dealer registered under the Exchange Act will act as the distributor and principal
underwriter of the Creation Unit Aggregations of Shares (the “Distributor”). The Distributor will
distribute Shares on an agency basis. (See Section III.A. below for a discussion of the
Distributor’s role and duties.) The Distributor will not be affiliated with any Exchange or any
Index Provider. The Distributor will be identified as such in the current prospectus of each Fund
(“Prospectus”) and will comply with the terms of the Application, to the extent
applicable.6
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All representations and conditions contained
in the application that require a Fund to disclose particular information in
the Fund’s Prospectus and/or annual report shall be effective with respect to
the Fund until the time that the Fund complies with the disclosure requirements
adopted by the Commission in Investment Company Act Release No. 28584 (Jan. 13,
2009). |
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III. APPLICANT’S PROPOSAL
A. Operation of the Funds
1. Capital Structure and Voting Rights; Book-Entry
Beneficial Owners of a Fund, as defined below, will have one vote per Fund Share with respect
to matters for which a shareholder vote is required consistent with the requirements of the Act and
the rules promulgated thereunder and Delaware statutory trust law. Fund Shares will be registered
in book-entry form only. The Depository Trust Company, New York, New York, a limited purpose trust
company organized under the laws of the State of New York (the “Depository” or “DTC”), or its
nominee will be the record or registered owner of all outstanding Fund Shares. Beneficial
ownership of Shares (owners of such beneficial interest referred to herein as “Beneficial Owners”)
will be shown on the records of DTC or DTC participants (e.g., brokers, banks, trust companies, and
other financial institutions) (“DTC Participants”). Beneficial Owners of Fund Shares will exercise
their rights in such securities indirectly through the Depository and DTC Participants. Beneficial
Owners of Fund Shares will receive all of the notices, statements, shareholder reports and other
communications required under the Act and other applicable laws. No Beneficial Owner shall have
the right to receive a certificate representing Fund Shares. Delivery of all notices, statements,
shareholder reports and other communications from any Fund to Beneficial Owners will be at the
Fund’s expense through the customary practices and facilities of Depository and the DTC
Participants.
2. Investment Objectives
As described in more detail in each Fund’s Prospectus and statement of additional information
(“SAI”), the investment objective of each Fund will be to provide investment returns that closely
correspond to the price and yield performance of its Underlying Index. In seeking to
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achieve the respective investment objective of each Fund, the Adviser and/or Subadviser may utilize
a “replication” strategy (as described below), or a “representative sampling” strategy to track its
Underlying Index. Each Fund’s Prospectus will indicate whether the Fund will follow a replication
or representative sampling strategy. Using the sampling strategy, the Adviser or Subadviser will
select each security for inclusion in the Fund’s portfolio to have aggregate investment
characteristics, fundamental characteristics, and liquidity measures similar to those of the Fund’s
Underlying Index, taken in its entirety. If representative sampling is used, a Fund will not be
expected to track its Underlying Index with the same degree of accuracy as a Fund employing the
replication strategy. A Fund using a replication strategy will invest in substantially all of the
Component Securities in its Underlying Index in the same approximate proportions as in the
Underlying Index. A Fund utilizing a representative sampling strategy generally will hold a
significant number of the Component Securities of its Underlying Index, but it may not hold all of
the Component Securities of its Underlying Index. This may be the case, for example, when there
are practical difficulties or substantial costs involved in compiling an entire Underlying Index or
when a Component Security of an Underlying Index is illiquid. From time to time, adjustments will
be made in the portfolio of each Fund in accordance with changes in the composition of its
Underlying Index or to maintain RIC compliance. Applicants expect that each Fund will
have a tracking error relative to the performance of its Underlying Index of no more than five
percent (5%), net of fees or expenses. Each Fund’s investment objectives, policies and investment
strategies will be fully disclosed in its Prospectus and SAI.
As disclosed in each Fund’s Registration Statement, each Fund will invest at least 90% (in
some cases, 80%) of its total assets (exclusive of collateral held from securities lending) in the
Component Securities of its Underlying Index and depositary receipts representing such
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securities.7 Each Fund may also invest the remaining 10% or 20% of its total
assets in securities not included in its Underlying Index (the “10% or 20% asset basket”). For
example, a Fund may invest in securities that are not components of its Underlying Index in order
to reflect various corporate actions (such as mergers) and other changes in such Index (such as
reconstitutions, additions and deletions). Any security selected by the Adviser or Subadviser for
inclusion in the Fund’s 10% or 20% asset basket, as the case may be, will be selected based on the
Adviser’s or the Subadviser’s belief that such an investment will assist the Fund in tracking the
performance of its Underlying Index. As long as each Fund invests at least 90% or 80% of its total
assets in Component Securities of its Underlying Index, each Fund may invest its other assets in
futures contracts, options on futures contracts, options and swaps, as well as cash and cash
equivalents and other investment companies8 all in accordance with the requirements of
the Act and rules promulgated thereunder.
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Any depository receipts held by an
International or Global Fund, will be negotiable securities that represent
ownership of a non-U.S. company’s publicly-traded stock. Depository receipts
will typically be American Depositary Receipts (“ADRs”), but may include Global
Depositary Receipts (“GDRs”), and Euro Depositary Receipts (“EDRs”). ADRs,
GDRs and EDRs are collectively referred to herein as “Depositary Receipts.” |
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Each Fund is permitted to invest in shares of
other ETFs (including other Funds) to the extent that such investment is
consistent with the Fund’s investment objective, registration statement, and
any applicable investment restrictions. Such investments would be made within
the limits of Section 12(d)(l) of the Act and would be made through purchases
of shares in the secondary market or through receipt of shares as
part of the Deposit Securities contributed to a Fund through the in-kind
purchase of one or more Creation Unit Aggregations. A Fund would only hold
shares of another ETF if doing so was in the best interest of the investing
Fund such as, for example, where doing so would improve the liquidity,
tradability or settlement of the Portfolio Securities, thereby potentially
reducing the costs of creation and redemption activity, or help the Fund track
its Underlying Index. For example, a Fund might invest in shares of a
single ETF instead of shares of one or more Component Securities in its
Underlying Index. The ability to submit or receive a single easily tradable
security (i.e., shares of an ETF) as a substitute for a group of Portfolio
Securities is expected to decrease the costs of creation and redemption
activity, particularly for Funds that invest in multiple non-U.S. markets and
especially for non-U.S. securities subject to transfer restrictions or stamp
(transaction) taxes in their home markets. The decreased costs should improve
the efficiency of the creation and redemption process and facilitate more
efficient arbitrage activity, while at the same time permitting the Fund to
obtain exposure to Component Securities in its Underlying Index through its
investment in a single ETF holding similar securities. |
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3. Listing and Trading
The Trust intends to submit an application to list the Shares on an Exchange. The Distributor
will serve as principal underwriter only of the Creation Unit Aggregations of Shares. The
principal secondary market for the Shares will be the Exchange on which they are primarily listed,
as applicable (the “Primary Listing Exchange”). The Distributor will not maintain a secondary
market in Shares. Shares traded on the Primary Listing Exchange or other Exchange will be traded
in a manner similar to SPDRs, MidCap SPDRs, DIAMONDS, and iShares and it is expected that one or
more Exchange member firms will be designated to act as a specialist or market maker and maintain a
market for the Shares trading on the Primary Listing Exchange or such other Exchange.9
No Exchange Specialist for Shares of any Fund will be an affiliated person of the Fund, except
under Section 2(a)(3)(A) of the Act solely due to ownership of shares.
B. Purchases and Redemptions of Fund Shares and Creation Unit Aggregations
The Trust will offer, issue and sell Fund Shares of each Fund to investors only in Creation
Unit Aggregations through the Distributor on a continuous basis at the NAV per share next
determined after an order in proper form is received. The NAV of each Fund is expected to be
determined as of 4:00 p.m. ET on each Business Day, which is defined to include any day that the
Trust is open for business as required by Section 22(e) of the Act and on days not required under
Section 22(e) of the Act. The Trust will sell and redeem Creation Unit Aggregations of each Fund
only on a Business Day. Applicants anticipate that the price of a Fund Share will range from $25
to $250, and that the price of one Creation Unit Aggregation will range from $1,000,000 to
$10,000,000.
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Each specialist or market maker designated as
such for a particular Fund listed on an Exchange is referred to as the
“Exchange Specialist.” |
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Fund Shares will be listed and traded on an Exchange in the same manner as other equity
securities. The price of Fund Shares trading on an Exchange will based on a current bid-offer
market. No secondary sales will be made to Brokers at a concession by the Distributor or by a
Fund. Purchases and sales of Fund Shares on an Exchange, which will not involve a Fund, will be
subject to customary brokerage commissions and charges.
The pricing of Fund Shares by means of bids and offers in the secondary market is not novel.
This is the method by which the shares of closed-end investment companies are priced and sold after
initial issuance. This also is the method employed by QQQQs, BLDRS, SPDRs, MidCap SPDRs, DIAMONDS
and iShares, whose individual securities all trade in the secondary market. Applicants have been
informed that QQQQs, BLDRS, SPDRs, MidCap SPDRs, DIAMONDS and iShares have traded at, or very close
to, their respective NAVs since their trading commenced. Like those products, the price at which
Fund Shares trade will be disciplined by arbitrage opportunities created by the ability to purchase
or redeem Creation Unit Aggregations at NAV, which should ensure that Fund Shares similarly do not
trade at a material premium or discount in relation to NAV.
1. Placement of Orders to Purchase Creation Unit Aggregations
a. General
Applicants have determined that purchases and redemptions of Creation Unit Aggregations will
be made generally by means of an in-kind tender of specified securities (referred to as “Deposit
Securities” for purposes of purchases, and referred to as “Redemption Securities” for purposes of
redemptions), with any cash portion of the purchase price and
17
redemption proceeds to be kept to a minimum, all in the manner described herein.10
This in-kind approach will minimize the need to liquidate Portfolio Securities to meet redemptions
of Creation Unit Aggregations and would permit each Fund to more closely achieve the desired
correlation to its Underlying Index. However, in some circumstances it may not be practicable or
convenient to operate on an in-kind basis exclusively. In addition, over time, the Trust may
conclude that operating on an exclusively in-kind basis for one or more Funds may present
operational problems for such Funds. Therefore, the Trust may permit, in its discretion, with
respect to one or more Funds, under certain circumstances, an in-kind purchaser to substitute cash
in lieu of depositing some or all of the requisite Deposit Securities. Substitution might be
permitted, for example, in circumstances where one or more Deposit Securities may not be available
in the quantity needed to make a Creation Deposit (defined below), may not be eligible for transfer
through either the NSCC Clearing Process or DTC Process (each defined below), may not be eligible
for trading by an Authorized Participant (defined below) or the investor on whose behalf the
Authorized Participant is acting. In the case of certain Funds, i.e., Funds whose Deposit
Securities’ primary market is outside the U.S., one or more Deposit Securities may not be eligible
for trading due to local trading restrictions, local restrictions on securities transfers or other
similar circumstances. Brokerage commissions incurred by a Fund to acquire any Deposit Security
not part of a Creation Deposit are expected to be immaterial, and in any event the
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10 |
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The Funds must comply with the federal
securities laws in accepting Deposit Securities and satisfying redemptions with
Redemption Securities, including that the Deposit Securities and Redemption
Securities are sold in transactions that would be exempt from registration
under the Securities Act. In accepting Deposit Securities and satisfying
redemptions with Redemption Securities that are restricted securities eligible
for resale pursuant to rule 144A under the Securities Act, the Funds will
comply with the conditions of rule 144A. The prospectus for a Fund will also
state that an Authorized Participant that is not a “Qualified Institutional
Buyer,” as defined in rule 144A under the Securities Act, will not be able to
receive, as part of a redemption, restricted securities eligible for resale
under rule 144A. The specified Deposit Securities and Redemption Securities
will generally correspond pro rata to the Portfolio Securities. In limited
circumstances and only when doing so would be in the best interest of the Fund,
each Fund may designate Deposit Securities that may not be an exact pro rata
reflection of such Fund’s Portfolio Securities. |
18
Adviser may adjust the relevant Transaction Fee (defined below) to ensure that the Fund
collects the extra expense from the purchaser.
The Trust also intends to substitute a cash-in-lieu amount to replace any Deposit Security or
Redemption Security of a Domestic Fixed Income Fund that is a “to-be-announced transaction” or “TBA
Transaction.” A TBA Transaction is a method of trading mortgage-backed securities. In a TBA
Transaction, the buyer and seller agree upon general trade parameters such as agency, settlement
date, par amount and price. The actual pools delivered generally are determined two days prior to
the settlement date. The amount of substituted cash in the case of TBA Transactions will be
equivalent to the value of the TBA Transaction listed as a Deposit Security or Redemption
Security.11
In order for the Trust to preserve maximum efficiency and flexibility, the Trust also reserves
the right to determine in the future that Fund Shares of one or more Funds may be purchased in
Creation Unit Aggregations on a cash-only basis. The decision to permit cash-only purchases of
Creation Unit Aggregations, to the extent such a decision is made, would be made if the Trust and
the Adviser believed such method would substantially minimize the Trust’s transactional costs or
would enhance the Trust’s operational efficiencies. This would likely happen only in limited
circumstances. For example, on days when a substantial rebalancing of a Fund’s portfolio is
required, it might be preferable for the Fund to receive cash rather than in-kind securities so
that it has the liquid resources at hand to make the necessary purchases. If a Fund were to
receive in-kind securities on such a day, it may have to sell many of the securities received and
acquire new securities to properly track its Underlying Index, thus incurring
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11 |
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Applicants expect that a cash-in-lieu amount
would replace any TBA Transaction that is listed as a Deposit Security or
Redemption Security of any Fund. |
19
transaction costs which could have been avoided (or at least minimized) if the Fund had
received payment for the Creation Unit Aggregations in cash.
All orders to purchase Creation Unit Aggregations must be placed with the Distributor by or
through an “Authorized Participant,” which is either: (1) a “participating party,” i.e., a Broker
or other participant in the Continuous Net Settlement (“CNS”) System of the National Securities
Clearing Corporation (“NSCC”), a clearing agency registered with the Commission and affiliated with
DTC, or (2) a DTC Participant, which in any case, has executed a participant agreement with the
Distributor. Investors may obtain a list of Authorized Participants from the Distributor. An
investor does not have to be an Authorized Participant, but must place an order through, and make
appropriate arrangements with, an Authorized Participant.
b. NSCC Clearing Process, DTC Process and Process for the Funds
Purchase orders for creations and redemptions of each Fund’s Creation Unit Aggregations will
be processed either through an enhanced clearing process or through a manual clearing process as
described immediately below.12 For Blended Funds, the clearance and settlement of each
Blended Fund’s Creation Unit Aggregations will depend on the nature of the security, consistent
with the processes discussed below.
For Domestic Equity Funds, the enhanced clearing process is available only to those DTC
Participants that also are participants in the CNS System of the NSCC. The NSCC/CNS system has
been enhanced specifically to effect purchases and redemptions of domestic ETF securities, such as
Domestic Equity Fund Shares. The enhanced clearing process (the “NSCC Clearing Process”)
simplifies the process of transferring a basket of securities between two
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12 |
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Settlement and clearing of foreign equity
securities presently cannot be made using either the NSCC Clearing Process or
the DTC Process. This is true for current ETFs which hold foreign securities
(see International iShares and the International Vanguard ETFs, for example). |
20
parties by treating all of the securities that comprise the basket as a single unit. By
contrast, the manual clearing process (the “DTC Process”), which is available to all DTC
participants, involves a manual line-by-line movement of each securities position. Because the DTC
Process involves the movement of hundreds of securities individually, while the NSCC Process can
act on instructions regarding the movement of one unitary basket which automatically processes the
movement of hundreds of securities, DTC will charge a Fund more than NSCC to manually settle a
purchase or redemption of Creation Unit Aggregations.
For Global Funds and International Equity Funds, the purchase of a Creation Unit Aggregation
will operate as follows. Once a purchase order has been placed with the Distributor, the
Distributor will inform the Adviser and the Custodian. The Custodian will then inform the
appropriate subcustodians. The Authorized Participant will deliver to the appropriate
sub-custodians, on behalf of itself or the Beneficial Owner, the relevant Deposit Securities (or
the cash value of all or a part of such securities, in the case of a permitted or required cash
purchase or “cash in lieu” amount), with any appropriate adjustments as determined by the Fund.
Deposit Securities must be delivered to the accounts maintained at the applicable subcustodians.
The subcustodians will confirm to the Custodian that the required securities have been delivered,
and the Custodian will notify the Adviser and Distributor. The Distributor will then furnish the
purchaser with a confirmation and Prospectus.
Except as described below, Fund Shares and Deposit Securities of the Domestic and
International Fixed Income Funds will clear and settle in the same manner as the Fund Shares and
Deposit Securities of the Global, Domestic Equity and International Equity Funds. The Fixed Income
Fund Shares and Deposit Securities will clear and settle in the same manner as the
21
fixed income securities and shares of other ETFs that invest in fixed income
securities.13 Deposit Securities that are U.S. government or U.S. agency securities and
any cash will settle via free delivery through the Federal Reserve System. Non-U.S. fixed income
securities will settle in accordance with the normal rules for settlement of such securities in the
applicable non-U.S. market. The Fund Shares will settle through the DTC. The Custodian will
monitor the movement of the underlying Deposit Securities and will instruct the movement of Fund
Shares only upon validation that such securities have settled correctly. The settlement
of Fund Shares will be aligned with the settlement of the underlying Deposit Securities and will
generally occur on a settlement cycle of T+3 Business Days or shorter, at the sole discretion of
the Trust on behalf of each Global, Domestic and International Fixed Income Fund. Applicants do not
believe the issuance and settlement of Creation Unit Aggregations in the manner described above
will have any negative impact on the arbitrage efficiency or the secondary market trading of
Domestic and International Fixed Income Fund Shares.
Each Fund recoups the settlement costs charged by NSCC and DTC by imposing a transaction fee
(“Transaction Fee”) on investors purchasing or redeeming Creation Unit Aggregations. For this
reason, investors purchasing or redeeming through the DTC process generally will pay a higher
Transaction Fee than will investors doing so through the NSCC Process.
c. Transaction Fees
The Transaction Fees will be borne only by purchasers and redeemers of Creation Unit
Aggregations and will be limited to amounts that have been determined by the Adviser to appropriate
in order to defray the transaction expenses that will be incurred by a Fund when
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13 |
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See In the Matter of iShares Trust, et
al., Investment Company Act Release No. 25622 (June 25, 2002), as amended. |
22
investors purchase or redeem Creation Unit Aggregations.14 The purpose of the
Transaction Fee is to protect the existing shareholders of the Funds from the dilutive costs
associated with the purchase and redemption of Creation Unit Aggregations.15
Transaction Fees will differ for each Fund, depending on the transaction expenses related to each
Fund’s Portfolio Securities. Every purchaser of a Creation Unit Aggregation will receive a
Prospectus that contains complete disclosure about the Transaction Fee, including the maximum
amount of the Transaction Fee charged by the Fund. The method of calculating the Transaction Fees
will be fully disclosed in the Fund’s SAI. Variations in the Transaction Fee may be imposed from
time to time as disclosed in the Fund’s Prospectus and the method of determining such variations
will be disclosed in the SAI.
d. Timing and Transmission of Purchase Orders
All orders to purchase Creation Unit Aggregations, whether through the NSCC Process or the DTC
Process, must be received by the Distributor no later than the NAV calculation time (“NAV
Calculation Time”), generally 4:00 p.m. ET on the date the order is placed (the “Transmittal Date”)
in order for the purchaser to receive the NAV determined on the Transmittal Date.
The Distributor will transmit all purchase orders to the relevant Fund. The Fund and/or the
Distributor may reject any order that is not in proper form. After a Fund has accepted a
purchase order and received delivery of the Deposit Securities and any accompanying cash payment,
NSCC or DTC, as the case may be, will instruct the Fund to initiate “delivery” of the
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14 |
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In all cases, the Transaction Fees will be
limited in accordance with the requirements of the Commission applicable to
open-end management investment companies offering redeemable securities. |
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15 |
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Where a Fund permits an in-kind purchaser to
deposit cash in lieu of depositing one or more Deposit Securities, the
purchaser may be assessed a higher Transaction Fee to offset the transaction
cost to the Fund of buying those particular Deposit Securities. |
23
appropriate number of Shares to the book-entry account specified by the purchaser. The
Prospectus or SAI of each Fund will disclose any foreseeable grounds for rejection of purchase
orders. The Distributor will furnish a Prospectus and a confirmation to those placing purchase
orders.
A Creation Unit Aggregation of a Fund will not be issued until the transfer of good title to
the Trust of the Deposit Securities and the payment of any cash portion of the purchase price have
been completed. Notwithstanding the foregoing, to the extent contemplated by the agreement between
the Distributor and an Authorized Participant (a “Participant Agreement”), Creation Unit
Aggregations will be issued to an Authorized Participant notwithstanding the fact that the
corresponding Deposit Securities and cash payment have not been received in part or in whole, in
reliance on the undertaking of such Authorized Participant to deliver the missing Deposit
Securities or cash payment as soon as possible, which undertaking shall be secured by such
Authorized Participant’s delivery and maintenance of collateral. The Participant Agreement will
permit the Fund to buy the missing Deposit Securities at any time and will subject the Authorized
Participant to liability for any shortfall between the cost to the Trust of purchasing such
securities and the value of the collateral. The SAI may contain further detail relating to such
collateral procedures.
2. Payment for Creation Unit Aggregations
a. General
Persons purchasing Creation Unit Aggregations from a Fund must make an in-kind deposit of
Deposit Securities together with an amount of cash specified by the Adviser (the “Cash Amount”),
plus the applicable Transaction Fee. The Deposit Securities and the Cash Amount collectively are
referred to as the “Creation Deposit.” The Cash Amount is a cash
24
payment designed to ensure that the NAV of a Creation Deposit is identical to the NAV of the
Creation Unit it is used to purchase.16
The Adviser or the Subadviser will make available through NSCC or the Distributor on each
Business Day, prior to the opening of trading on the Primary Listing Exchange (expected to be 9:30
a.m. ET), a list of securities and the required number of shares of each Deposit
Security to be included in the Creation Deposit for each Fund.17 That Creation Deposit
will apply to all purchases of Creation Unit Aggregations until a new Creation Deposit composition
is announced. The Adviser or Subadviser also will make available on a daily basis information about
the previous day’s Cash Amount. The Adviser or Subadviser will make this information available
through NSCC or the Distributor along with the information about the Deposit Securities.
b. Domestic Funds
Creation Deposits placed using the DTC Process must be delivered through an Authorized
Participant. Authorized Participants wishing to place an order creating Creation Unit Aggregations
to be effected using the DTC Process must state that they are not using the NSCC Process and that
the creation of Creation Unit Aggregations will instead be effected through a
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16 |
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If the market value of the Deposit
Securities is greater than the NAV of a Creation Unit Aggregation, then the
Cash Amount will be a negative number, in which case the Cash Amount will be
paid by the Fund to the purchaser, rather than vice-versa. |
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17 |
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Personnel of the Adviser and Subadviser, if
any, who are responsible for the designation and dissemination of the Deposit
Securities or Redemption Securities will be prohibited from communicating any
changes in either basket to other personnel within their organizations, any
affiliates, or other unauthorized individuals or organizations until after such
changes have been publicly disclosed. Also, in reviewing the policies and
procedures of any Subadviser pursuant to Rule 38a-1 under the Act, Applicants
will seek to ensure that the policies and procedures of the Subadviser are
consistent with the foregoing. The Adviser, any Subadviser and the Distributor
will each have adopted a code of ethics as required by Rule 17j-1 under the
Act, which contains provisions reasonably necessary to prevent Access Persons
(as defined in Rule 17j-1) from engaging in any conduct prohibited in Rule
17j-1. In addition, the Adviser and the Subadviser, as required under Section
204A of the Advisers Act, will have adopted policies and procedures that are
reasonably designed, taking into account the nature of its business, to prevent
the misuse, in violation of the Advisers Act or the Exchange Act or the rules
or regulations thereunder, of material non-public information by the Adviser or
the Subadviser or any associated person. Any Subadviser to a Fund will be
required to adopt and maintain a similar code of ethics and/or insider trading
and similar policies and procedures. |
25
transfer of securities and cash. The Creation Deposit transfer must be ordered on the
Transmittal Date in a timely fashion so as to ensure the delivery of the requisite number of
Deposit Securities through DTC to the account of the Fund by no later than 11:00 a.m. ET of the
next Business Day immediately following such Transmittal Date. The cash equal to the Cash Amount
must be transferred directly to the Fund through the Federal Reserve Bank wire transfer system in a
timely manner so as to be received by the Fund no later than 2:00 p.m. ET on the next Business Day
immediately following the Transmittal Date. An order to create Creation Unit
Aggregations using the DTC Process is deemed received by the Distributor on the Transmittal Date if
(i) such order is received by the Distributor not later than the NAV Calculation Time on such
Transmittal Date; and (ii) all other procedures set forth in the Participant Agreement are properly
followed. However, if the Fund does not receive both the requisite Deposit Securities and the Cash
Amount in a timely fashion on the next Business Day immediately following the Transmittal Date,
such order will be canceled. Upon written notice to the Distributor, such canceled order may be
resubmitted the following Business Day using the Creation Deposit for that Business Day. The
delivery of Creation Unit Aggregations purchased through the DTC Process will occur within the
normal settlement cycle, currently no later than the third (3rd) Business Day following the day on
which the creation order is deemed received by the Distributor.
c. Global Funds and International Funds
The purchase of a Creation Unit Aggregation of a Global Fund and International Fund will
operate as follows. Once a purchase order has been placed with the Distributor, the Distributor
will inform the Adviser and Custodian. The Custodian will then inform the appropriate
sub-custodians. The Authorized Participant will deliver to the appropriate sub-custodians, on
behalf of itself or the Beneficial Owner on whose behalf it is acting, the relevant
26
Deposit Securities (or the cash value of all or a part of such securities, in the case of a
permitted cash purchase or “cash in lieu” amount), with any appropriate adjustments as determined
by the Fund. Deposit Securities must be delivered to the accounts maintained at the applicable
sub-custodians. All sub-custodians will comply with Rule 17f-5 under the Act.
In the case of each of the Domestic Funds, Global Funds and the International Funds, the
securities and the number of shares of the Deposit Securities required for the Creation Deposit for
each Fund will change as rebalancing adjustments and corporate action events are reflected from
time to time by the Adviser or Subadviser in light of the investment objective of such Fund. The
composition of the Deposit Securities may also change in response to adjustments to the weighting
or composition of the Component Securities in the relevant Underlying Index.
Applicants reserve the right to permit a purchasing investor to substitute an amount of cash
or a different security to replace any prescribed Deposit
Security.18 Any security that
a Fund accepts that is not in the Fund’s Underlying Index will be held by the Fund in its 10% or
20% asset basket, as applicable. Substitution might be permitted, for example, because one or more
Deposit Securities: (1) may be unavailable, or may not be available in the quantity needed to make
a Creation Deposit; (2) may not be eligible for transfer through the NSCC Process; or (3) may not
be eligible for trading by an Authorized Participant or the investor on whose behalf the Authorized
Participant is acting. Brokerage commissions incurred by a Fund to acquire any Deposit Security
not part of the Creation Deposit are expected to be immaterial, and in any event, the Adviser may
adjust the relevant Transaction Fee to ensure that the Fund collects the extra expense from the
purchaser.
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18 |
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In certain circumstances, an investor that
tenders a non-conforming basket of Deposit Securities to purchase Creation Unit
Aggregations through the DTC Process because the NSCC Process can only handle
non-conforming deposits in specified situations. |
27
3. Redemption
Just as Fund Shares can be purchased from a Fund only in Creation Unit Aggregations, such Fund
Shares similarly may be redeemed only if tendered in Creation Unit Aggregations (except in the
event the Fund is liquidated). To redeem, an investor must accumulate enough Shares to
constitute a Creation Unit Aggregation. Redemption requests must be placed by or through an
Authorized Participant. As required by law, redemption requests in good order will receive the NAV
next determined after the request is received. Therefore, all redemption requests received by the
Funds prior to the NAV Calculation Time will receive the NAV determined immediately thereafter,
whereas all redemption requests received by the Funds after the NAV Calculation Time will receive
the NAV calculated on the immediately following Business Day. The Trust has, pursuant to its
organizational documents, the right to make redemption payments in respect of a Fund in cash,
in-kind or a combination of both, provided the value of its redemption payments on a Creation Unit
Aggregation basis equals the NAV times the appropriate number of Fund Shares of such Fund.
Applicants currently contemplate that Creation Unit Aggregations of each Fund will be redeemed
principally in-kind (together with a balancing cash payment), except in certain circumstances in
which Creation Unit Aggregations may be redeemed in exchange for cash.
In the case of a redemption request made through the DTC Process, such request must be
preceded or accompanied by the requisite number of Fund Shares specified, which delivery must be
made through DTC to the Fund no later than 11:00 a.m. ET on the next Business Day immediately
following the Transmittal Date and all other procedures set forth in the Participant Agreement must
be properly followed. When using the DTC Process, an in-kind redemption involves delivery of
Shares in Creation Unit Aggregations from the entity placing the request to
28
the Fund corresponding with a delivery of the requisite amounts of each of the underlying
Portfolio Securities from the Fund to the entity placing the redemption request. The DTC Process
involves a non-automatic line-by-line position movement of the underlying Portfolio Securities and
Fund Shares. Therefore, both the Fund and the entity placing the request will be required to
reconcile delivery and receipt of the correct share amounts for the transfer of Shares and the
corresponding transfer of each underlying Portfolio Security. Transmission of the Cash Amount and
the Transaction Fee (which includes the processing, settlement and clearing costs associated with
securities transfers) must be accomplished in a manner acceptable to the Fund, normally through a
DTC cash transfer system. An entity redeeming Shares in Creation Unit Aggregations using the DTC
Process will be required to pay a higher Transaction Fee than would have been charged had the
redemption been effected through the NSCC Clearing Process, as disclosed in the Fund’s Prospectus.
For Global Funds and International Funds, a redemption request will not be made through DTC.
Creation Unit Aggregations of each Fund will be redeemed principally in-kind, except in certain
circumstances. However, the Fund has the right to make redemption payments in cash, in kind, or a
combination of each, provided that the value of its redemption payments equals the NAV of the
Shares tendered for redemption. The Fund may make redemptions partly or wholly in cash in lieu of
transferring one or more of its Portfolio Securities to a redeeming investor if the Fund
determines, in its discretion, that such alternative is warranted due to unusual circumstances.
This could happen if the redeeming investor is unable, by law or policy, to own a particular
security. For example, a foreign country’s regulations may restrict or prohibit a redeeming
investor from holding shares of a particular issuer located in that country. The
29
Adviser may adjust the Transaction Fee imposed on a redemption wholly or partly in
cash to take into account any additional brokerage or other transaction costs incurred by the Fund.
Shares in Creation Unit Aggregations will be redeemable on any Business Day for the Redemption
Securities. The Adviser or Subadviser will publish daily the list of Redemption Securities.
Applicants expect that the Redemption Securities received by a redeeming investor in most cases
will be the same as the Deposit Securities required of investors purchasing Creation Unit
Aggregations on the same
day.19 Depending on whether the NAV of a Creation Unit
Aggregation is higher or lower than the market value of the Redemption Securities, the redeemer of
a Creation Unit Aggregation will either receive from or pay to the Fund, a balancing amount in
cash. The redeeming investor also must pay to the Fund a Transaction Fee.
A Fund may make redemptions partly in cash in lieu of transferring one or more Redemption
Securities to a redeeming investor if the Fund determines, in its discretion, that such alternative
is warranted.20 This could happen if the redeeming investor is unable, by law or policy,
to own a particular Redemption Security. For example, a redeeming investor may be an
investment-banking firm or broker-dealer restricted from holding shares of a company whose
securities it recently
underwrote.21
The right to redeem Fund Shares will not be suspended nor payment upon redemption delayed,
consistent with Section 22(e) of the Act and Rule 22e-2 under the Act, except as
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19 |
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There may be limited circumstances, however,
where the Deposit Securities and Redemption Securities could differ from each
other. For example, if the stock of issuer #1 were replacing the
stock of issuer #2 in a Fund’s Index at the close of today’s trading session,
today’s prescribed Deposit Securities might include the stock of issuer
#1 but not issuer #2, while today’s prescribed Redemption Securities
might include the stock of issuer #2 but not that of issuer #l. This
flexibility to prescribe different baskets for creation and redemption promotes
efficient portfolio management and lowers the Fund’s brokerage costs, and thus
is in the best interests of the Fund’s shareholders. |
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20 |
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A Fund also may decide, on any given
day, to provide all redeeming shareholders with cash proceeds, rather than a
prescribed basket of securities, if doing so would benefit the Fund and its
investors. |
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21 |
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If a redeeming investor is permitted to take
cash in lieu of one or more Redemption Securities, the investor will be
required to use the DTC Process rather than the NSCC Process. See
footnote 18
above. |
30
subsequently provided in the request for relief from Section 22(e) with respect to certain
Global Funds and International Funds.
4. Pricing of Shares
The price of Fund Shares will be based on a current bid/offer in the secondary market. The
price of Fund Shares of any Fund, like the price of all traded securities, is subject to factors
such as supply and demand, as well as the current value of the Portfolio Securities held by the
Fund. Fund Shares, available for purchase or sale on an intra-day basis, do not have a fixed
relationship to the previous day’s NAV or the current day’s NAV. Therefore, prices on an Exchange
may be below, at, or above the most recently calculated NAV of such Fund Shares. No secondary
sales will be made to brokers or dealers at a concession by the Distributor or by a Fund.
Transactions involving the purchases or sales of Fund Shares on an Exchange will be subject to
customary brokerage fees and charges.
Applicants believe that the existence of a continuous trading market on the Exchange for Fund
Shares, together with the publication by the Exchange of the current market value of the sum of the
Deposit Securities and the estimated Cash Amount, will be key features of the Trust particularly
attractive to certain types of investors. The pricing of Fund Shares by means of bids and offers
on an Exchange would be similar to the pricing of shares of many other ETFs.
The pricing of Fund Shares by means of bids and offers in the secondary market is not novel.
This is the method by which the shares of closed-end investment companies are priced and sold after
initial issuance. This also is the method employed by QQQQs, BLDRS, SPDRs, MidCap SPDRs, DIAMONDS,
iShares and Select Sector SPDRs, whose individual securities all trade in the secondary market.
The Applicant has been informed that QQQQs, BLDRS, SPDRs, MidCap SPDRs, DIAMONDS, iShares and
Select Sector SPDRs have traded at, or very close to,
31
their respective NAVs since their trading commenced. Like those products, the price at which
Fund Shares trade will be disciplined by arbitrage opportunities created by the ability to purchase
or redeem Creation Unit Aggregations at NAV, which, Applicants believe, should ensure that Fund
Shares similarly do not trade at a material premium or discount in relation to NAV.
C. Depositary Receipts
Each Fund is subject to representations as to the percentage of its portfolio that
will be invested in Component Securities of its Underlying Index. As discussed above, it is
represented that each Fund will invest at least 80% or 90% of its assets in Component Securities.
With respect to the Initial Fund, at least 90% of the Initial Fund’s assets will be invested in
Component Securities and Depositary Receipts. Although each Fund seeks to reserve the ability to
invest in Depositary Receipts representing Component Securities, it is not anticipated that any of
the Funds will invest a significant portion of its assets in Depositary Receipts. Applicants
intend that any Global Fund and International Fund would be able to treat Depositary Receipts that
represent Component Securities of its Underlying Index as Component Securities for purposes of any
requirements related to the percentage of Component Securities held in a Global Fund’s and
International Fund’s portfolio.
Depositary Receipts are typically issued by a financial institution (a “depository”) and
evidence ownership interests in a security or a pool of securities (the “underlying securities”)
that have been deposited with the
depository.22 To the extent that a Global Fund or an
International Fund invests in Depositary Receipts in lieu of Component Securities, the Depositary
Receipts
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22 |
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With respect to ADRs, the depository is
typically a U.S. financial institution and the underlying securities are issued
by a foreign issuer. The ADR is registered under the Securities Act of 1933 on
Form F-6. With respect to other Depositary Receipts, the depository may be a
foreign or a U.S. entity, and the underlying securities may have a foreign or a
U.S. issuer. No affiliated person of a Fund, the Adviser or any Subadviser
will serve as the depositary bank for any Depositary Receipts held by a Global
Fund or International Fund. |
32
will be listed on a Primary Listing Exchange, Nasdaq, or a foreign exchange. A Global Fund or an
International Fund will not, as part of its 80% basket of Component Securities, invest in any
unlisted Depositary Receipts or any listed Depositary Receipts that the Adviser deems to be
illiquid or for which pricing information is not readily available. A Global Fund or an
International Fund, as part of its 80% basket of Component Securities, will only invest in
sponsored Depositary Receipts, except for certain listed ADRs that
remain
unsponsored.23
Generally, a Global or an International Fund would only hold Depositary Receipts in situations
where the Adviser believes that holding the Depositary Receipt, rather than the underlying foreign
Component Security, would benefit the Global Fund or International Fund. This could occur where
an investment in a Depositary Receipt offers greater liquidity or would otherwise improve the
liquidity, tradability or settlement of the Global Fund’s and International Fund’s current Deposit
Securities. For example, in some cases, a Depositary Receipt may provide more liquidity than its
corresponding underlying security simply because the demand for the Depositary Receipt is higher,
creating a more active and liquid market for the Depositary Receipt. In certain countries (e.g.,
South Korea), local market regulations place restrictions on the transfer of local securities that
act to prohibit the in-kind delivery and receipt of local securities as part of the creation and
redemption process. In addition, in situations where a Global Fund and International Fund invests
in securities of multiple countries, the use of Depositary Receipts, particularly ADRs, can reduce
the expense and difficulty of assembling a Creation Deposit upon creation and of disposing of
Portfolio Securities received through
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23 |
|
Applicants understand that since 1984 all
listed ADRs are required to be sponsored. Applicants also understand that a
few listed, but unsponsored ADRs that existed prior to the 1984 requirement
have been “grandfathered.” Applicants do not believe that these unsponsored
listed ADRs pose any special pricing or liquidity issues. Thus, although the
Applicants have no present intention for a Global Fund or International Fund to
invest in these unsponsored listed ADRs, Applicants seek to reserve the ability
for a Global Fund or International Fund to hold these unsponsored listed ADRs
in those situations where the use of these ADRs would otherwise benefit the
Global Fund or International Fund. |
33
redemption. In addition, since GDRs and EDRs may trade in more developed countries with more
efficient custodial, clearance and settlement mechanisms than the underlying securities they
represent, the use of GDRs and EDRs should, in certain instances, reduce trading, settlement and
other costs. For example, it may be less expensive to trade and settle a transaction in GDRs
traded in London than it would be to trade and settle the corresponding local securities in Moscow
or Seoul. In each of the above scenarios, the use of Depositary Receipts potentially decreases the
cost of trading and settling securities included in the Creation Deposit or distributed as
Redemption Securities. This should improve the efficiency of the creation and redemption process
and facilitate efficient arbitrage activity.
Applicants note that factors such as supply and demand and differences between the
market-trading hours of the exchanges on which Depositary Receipts and underlying securities trade
may cause Depositary Receipts to trade at premiums or discounts to the trading price of the
underlying securities they represent. To the extent a Global Fund or International Fund is
invested in Depositary Receipts and an Underlying Index contains local securities, any premium or
discount between the price of the underlying security and the corresponding Depositary Receipt
creates the potential for tracking error between the Fund and its
Underlying
Index.24
Applicants expect any such impact to be insignificant as the Adviser monitors each Global Fund’s or
International Fund’s portfolio and Underlying Index on a daily basis and would take appropriate
action as warranted (such as rebalancing the Fund’s portfolio) to reduce potential tracking error.
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24 |
|
The value of an Underlying Index will reflect
the value of its Component Securities, rather than the value of any Depositary
Receipt representing a Component Security. Nonetheless, with respect to
certain Underlying Indices, a Component Security may be a Depositary Receipt. |
34
Applicants do not believe the potential for premiums and discounts between the price of
Depositary Receipts and corresponding underlying securities will have any material negative impact
on the efficiency of the creation/redemption process because market participants have access to
both the prices of the Depositary Receipts and the prices of the corresponding underlying
securities. Applicants believe the pricing transparency for listed Depositary Receipts will be
substantially equivalent to the pricing transparency of the corresponding underlying securities,
since both are traded and priced intra-day on securities exchanges and markets. The Global Funds
or International Funds will be transparent and will publish each Business Day a list of the current
Deposit Securities (including any Depositary Receipts). The intra-day values of the Portfolio
Deposit will be updated throughout the day. Authorized Participants that wish to create or redeem
will have equal access to this information and access to the Deposit Securities (including any
Depositary Receipts) in a Creation Deposit. Applicants therefore expect that a Global Fund’s or
International Fund’s investment in Depositary Receipts will not have any material negative impact
on the arbitrage efficiency of the Global Funds or International Funds. Further, Applicants
believe that there would be no significant differences in the pricing and pricing transparency of
Depositary Receipts held by a Global Fund or International Fund and that of equity securities held
by other ETFs that do not invest in Depositary Receipts. Finally, the Applicants do not anticipate
any liquidity issues with respect to any Global Fund’s or International Fund’s use of Depositary
Receipts. The Adviser does not intend to use Depositary Receipts unless they are liquid enough to
facilitate efficient creations and redemptions and the use of Depositary Receipts would otherwise
benefit the Global Funds or International Funds.
35
D. Applicability to Funds
The Applicants have identified in Exhibit A to this Application the Underlying Index on which
the Initial Fund is to be based and for which the Relief is requested. In the future, the Trust
may offer Shares of Future Funds that seek to match the performance of other Underlying Indices.
The requested Order would permit the introduction of Funds that (1) are advised by the Adviser or
an entity controlling, controlled by or under common control with the Adviser; (2) track Underlying
Indices that are created, compiled, sponsored and maintained by a nonaffiliated person of the
Adviser, the Distributor, the Trust or any Subadviser; and (3) comply with the respective terms and
conditions of the
Order.25
Each Fund will always have a fixed number of Fund Shares in a Creation Unit Aggregation as
specified in the Prospectus for such
Fund.26 As discussed in Section III.A.4. above,
Shares will be listed on an Exchange and traded in the secondary market in the same manner as other
equity securities.
E. Likely Purchasers of Fund Shares
Applicants believe that there will be four main types of market participants interested in
buying and selling Fund Shares in Creation Unit Aggregations:
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• |
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institutional investors who wish to keep a portion of their portfolio indexed to
one or more Underlying Indices, and who choose Fund Shares because they are a cost
effective means to do so and/or because they can be bought and sold intra-day,
unlike most investment company securities; |
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25 |
|
Each Future Fund would remain fully subject
to the requirements of the Exchange Act and to any applicable listing standards
or individualized listing approvals required under Rule 19b-4 under the
Exchange Act, but the listing process under the Exchange Act would not affect
the exemptive relief under the Act. |
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26 |
|
It is currently expected that a Creation Unit
Aggregation will consist of 50,000 Shares with a $100 Share price for the
Initial Fund as of the first day of trading on the Primary Listing Exchange, in
which case the Creation Unit Aggregation value on such day would be $5,000,000. |
36
|
• |
|
arbitrageurs and liquidity suppliers who seek to profit from any slight premium
or discount in the market price of individual Fund Shares on the Exchange versus
the NAV of those Fund Shares; |
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• |
|
Authorized Participants who may from time to time find it appropriate to
purchase or redeem Creation Unit Aggregations in connection with their
market-making activities on an Exchange; and |
|
• |
|
institutional investors who purchase Creation Unit Aggregations and break them
down into the constituent Fund Shares and sell those Fund Shares directly to
individual investors. |
Applicants expect that secondary market purchasers of Fund Shares will include both
institutional and retail investors for whom such Fund Shares provide a useful, “retail-priced”
exchange-traded mechanism for investing in the industry, market, market segment or market sector
represented by the Underlying Index.
F. Disclosure Documents
Section 5(b)(2) of the Securities Act makes it unlawful to carry or cause to be carried
through interstate commerce any security for the purpose of sale or delivery after sale unless
accompanied or preceded by a statutory prospectus. Although Section 4(3) of the Securities Act
excepts certain transactions by dealers from the provisions of Section 5 of the
Securities Act, Section 24(d) of the Act disallows such exemption for transactions in redeemable
securities issued by a UIT or an open-end management company if any other security of the same
class is currently being offered or sold by the issuer or by or through an underwriter in a public
distribution.
37
Because Creation Unit Aggregations will be redeemable, will be issued by an open-end
management company and will be continually in distribution, the provisions cited above require the
delivery of a statutory prospectus prior to or at the time of the confirmation of each secondary
market sale involving a dealer.
Each Fund’s Prospectus and/or SAI will make clear that Fund Shares may be bought from and
redeemed with the Fund only in Creation Unit Aggregations and will contain a detailed explanation
of the procedures for purchasing and redeeming Creation Unit Aggregations. It will note that an
investor may incur brokerage costs in purchasing enough Fund Shares to constitute a Creation Unit
Aggregation.
A Fund’s Prospectus also will disclose certain legal risks that are unique to persons
purchasing Creation Unit Aggregations from the Fund. Because new Fund Shares may be issued on an
ongoing basis, a “distribution” of Fund Shares could be occurring at any time. The Prospectus
and/or SAI will caution Brokers and others that some activities on their part, depending on the
circumstances, may result in their being deemed participants in the distribution of Fund Shares in
a manner that could render them statutory underwriters and subject them to the prospectus delivery
and liability provisions of the Securities Act. For example, a Broker and/or its client may be
deemed a statutory underwriter if it purchases Creation Unit Aggregations from a Fund, breaks them
down into the constituent Fund Shares, and sells those Fund Shares directly to customers, or if it
chooses to couple the creation of a supply of new Fund Shares with an active selling effort
involving solicitation of secondary market demand for Fund Shares. Each Fund’s Prospectus will
state that whether a person is an underwriter depends upon all of the facts and circumstances
pertaining to that person’s activities. Each Fund’s Prospectus also will caution dealers who are
not “underwriters” but are participating in a distribution (as contrasted to
38
ordinary secondary trading transactions), and thus dealing with Fund Shares that are part of
an “unsold allotment” within the meaning of Section 4(3)(C) of the Securities Act, that they would
be unable to take advantage of the prospectus delivery exemption provided by Section 4(3)
of the Securities Act.
Each Fund’s Prospectus will provide a plain English overview of the Fund offered, including
its investment objective and investment strategies and the material risks of owning Fund Shares.
It also will provide a clear, brief description of the essential features of Fund Shares, e.g., (1)
the manner in which Fund Shares will be traded on an Exchange, including application of trading
halt procedures; (2) the identity of the Adviser and any Subadviser; (3) the composition and
frequency of net dividend distributions; (4) a basic description of the Underlying Index and the
manner in which its value is reported; and (5) the actions, if any, that would be taken by the Fund
if its Fund Shares were delisted or if its rights to the use of the Underlying Index are
terminated.
The Distributor will coordinate the production and distribution of Prospectuses to Brokers.
It will be the responsibility of the Brokers to provide a Prospectus for every secondary market
purchase of Fund Shares.
G. Sales and Marketing Materials
The Applicants will take such steps as may be necessary to avoid confusion in the public’s
mind between the Trust and its Funds on the one hand, and on the other hand, a traditional
“open-end investment company” or “mutual fund.” For example, with respect to disclosure in the
Prospectus concerning the description of a Fund and Fund Shares, the Trust and the Funds will
observe the following policies: (1) the term “mutual fund” will not be used except
39
to compare and contrast the Trust or a Fund with conventional mutual funds; (2) the term
“open-end management investment company” will be used in the Prospectus only to the extent required
by Form N-1A or other securities law requirements and this phrase will not be included on the
Prospectus cover page or summary; (3) the Prospectus will include a distinct paragraph or
paragraphs setting forth the fact that Fund Shares will be listed on an Exchange (which will be
identified) and cannot be redeemed individually; (4) the Prospectus will disclose that the owners
of Fund Shares may acquire those Fund Shares and tender those Shares for redemption to the Fund
only in Creation Unit Aggregations; and (5) the Prospectus will clearly disclose that individual
Fund Shares prices in the secondary market may be below, above, or at the most recently calculated
NAV. The Prospectus will also state that, while Creation Unit Aggregations may be redeemed,
brokerage and other costs may be associated with aggregating a sufficient number of Fund Shares to
redeem them in a Creation Unit Aggregation, will indicate the estimated cost of a Creation Unit
Aggregation of each Fund based on the NAV of Fund Shares as of a recent date, and will refer to the
SAI for details. After a Fund has traded for 12 months or more, the Prospectus or SAI and any
advertising or sales literature will provide supplementary information on market premiums or
discounts relative to the NAV to enable present and prospective shareholders to evaluate the
relative desirability of the Fund Shares’ intra-day marketability versus a conventional mutual fund
share’s redeemability at NAV.
Although the Trust is classified and registered under the Act as an open-end management
investment company, neither the Trust nor any individual Fund will be marketed or otherwise “held
out” as a traditional open-end investment company or a mutual fund. Instead, the Trust will be
marketed as an “exchange-traded fund.” To that end, the designation of the Trust and the Funds in
all marketing materials will be limited to the terms “exchange-traded fund,” investment
40
company,” “fund” and “trust” without reference to an “open-end fund” or a “mutual fund,”
except to compare and contrast the Trust and the Funds with traditional open-end management
investment companies (which may be referred to as “mutual funds”). All marketing materials that
describe the features or method of obtaining, buying or selling Creation Unit Aggregations, or Fund
Shares being listed and traded on an Exchange or refer to redeemability, will prominently disclose
that Fund Shares are not individually redeemable shares and will disclose that the owners of Fund
Shares may acquire those Fund Shares from the Fund or tender such Fund Shares for redemption to the
Fund only in Creation Unit Aggregations. This type of disclosure will be provided in the
Prospectus, SAI, shareholder reports and investor educational materials issued or circulated in
connection with Fund Shares.
H. Availability of Information Regarding Fund Shares and Underlying Indices
1. Blended Funds, Global Funds, Domestic Funds and International Equity Funds
In addition to the list of names and amounts of each security constituting the current Deposit
Securities of the Creation Deposit, it is intended that, on each Business Day, the Cash Amount
effective as of the previous Business Day, per each outstanding Fund Share, will be made available.
Neither the Trust nor any Fund will be involved in, or responsible for, the calculation or
dissemination of any such amount and will make no warranty as to its accuracy. In addition, the
following information will be disseminated: (i) continuously throughout the regular trading hours
on the relevant Primary Listing Exchange (anticipated to be 9:30 a.m. to 4:00 p.m. ET)
the market value of Shares by the Primary Listing Exchange over the Consolidated Tape, and
(ii) every 15 seconds throughout such regular trading hours, the estimated intra-day NAV of Fund
Shares (which estimate will include the previous day’s Cash Amount and is expected to be
41
accurate to within a few basis points).27 Comparing these two figures allows an
investor to determine whether, and to what extent, Shares are selling at a premium or a discount to
NAV.28 The intra-day value of each Index, based on the market price of its Component
Securities,29 will be disseminated every 15 seconds over the Consolidated Tape and may
also be disseminated through organizations authorized by the Index Provider each Business
Day.30
These intra-day values of each Underlying Index will be disseminated every 15 seconds
throughout the regular trading hours through the Consolidated Tape, Consolidated Quote Association
or by organizations authorized by the Index Provider. In addition, the Index Provider will
disseminate, over the Consolidated Tape or these organizations, values for each Underlying Index
once each trading day, based on closing prices of the securities in such Indices.
5Each Fund will make available on a daily basis through NSCC the names and
required number of shares of each of the Deposit Securities in a Creation Unit Aggregation as well
as information regarding the Cash Amount. The NAV for each Fund will be calculated and
disseminated daily. As discussed further herein, the website, accessible to all investors at no
charge, will publish the current version of the Prospectus and SAI, the Underlying Index for each
Fund, as well as
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27 |
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The Applicants understand that Nasdaq listed
securities are subject to the Nasdaq Unlisted Trading Privileges Plan (the “UTP
Plan”), which provides for dissemination of quotation and trade information for
Nasdaq securities, whereas securities from other Listing Exchanges (e.g., the
NYSE or the AMEX) are subject to the Consolidated Tape Association Plan (the
“CTA Plan”). The UTP Plan and the CTA Plan were each approved by the
Commission pursuant to the provisions of Section 11A of the Exchange Act. |
|
28 |
|
The Applicants understand that Nasdaq
disseminates market-traded fund valuation information via its Nasdaq Index
Dissemination Service data feed. This information is currently disseminated to
the public through many of the major market data vendors, including Thomson
Financial, Reuters, Bloomberg, and Standard & Poor’s Comstock. |
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29 |
|
With respect to the Initial Fund, because
the Portfolio Securities of such Fund and the Component Securities of its Index
are not listed on an exchange, the estimated intra-day NAV of the Initial Fund
Shares and the intra-day value of the Index will be calculated no less
frequently than every 15 seconds. |
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30 |
|
Applicants intend that all Index values will
be disseminated only during U.S. market hours. The values of the domestic
Indices will be disseminated every 15 seconds each Business Day
throughout regular U.S. market hours. As with international and global Indices
underlying existing ETFs, the value of each international and global Index will
be disseminated every 15 seconds each Business Day to reflect (i) changing
market prices if there is any overlap between the normal market hours in the
U.S. and the market(s) covered by such Index (otherwise closing or last-sale
prices in the applicable non-U.S. market are used), and (ii) changing currency
exchange rates. |
42
additional quantitative information that is updated on a daily basis, including daily trading
volume, closing price and closing NAV for each Fund. Also, Applicants expect that the Primary
Listing Exchange will disseminate a variety of data with respect to each Fund on a daily basis;
information with respect to recent NAV, net accumulated dividend, final dividend amount to be paid,
Fund Shares outstanding, estimated Cash Amount and total Cash Amount per Creation Unit Aggregation
will be made available prior to the opening of the Primary Listing Exchange.
As discussed above, the closing prices of the Funds’ Deposit Securities are readily available
from, as applicable, the relevant markets, automated quotation systems, published or other public
sources or on-line information services such as Bloomberg L.P. (“Bloomberg”) or Reuters.
2. Blended Funds, Domestic Funds and International Fixed Income Funds
Except as noted herein, Applicants expect that information regarding the Blended Funds (with
respect to its ownership of fixed income securities), International Fixed Income Funds and their
respective Underlying Indices will be made available exactly as described above.31
a. Calculation of Intra-day NAV
As with the equity securities held by Blended Funds, Global Funds, Domestic Equity and
International Equity Funds, an estimated intra-day NAV will be calculated by an independent third
party such as Bloomberg every 15 seconds during the Primary Listing Exchange’s regular trading
hours and disseminated every 15 seconds on the Consolidated Tape associated with the Primary
Listing Exchange. The estimated NAV will be updated throughout the day to reflect
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31 |
|
The composition and return of each
Underlying Index for an International Fixed Income Fund will be calculated and
disseminated once each Business Day at the end of the day. The end-of-day
values of any Global Fund or International Fixed Income Fund will be adjusted
to reflect currency exchange rates at the end of each Business Day. |
43
changing bond prices using multiple prices from independent third party pricing sources.
Applicants represent (i) that the estimated NAV will be calculated by an independent third party;
(ii) that the estimated NAV will be calculated using prices obtained from multiple independent
third-party pricing sources throughout the day; and (iii) that the estimated NAV will be calculated
in accordance with pre-determined criteria and set parameters so that an individual bond “price”
based on an analysis of multiple pricing sources is obtained for each of the Deposit Securities.
Because all bonds typically trade through “over-the-counter” or “OTC” transactions,
information about the intra-day prices of such bonds comes from a variety of sources. The
estimated NAV will be calculated by using a combination of: (i) executed bond transactions as
reported on the National Association of Securities Dealers’ (“NASD”) Trace Reporting and Compliance
System (“TRACE” or the “TRACE System”); (ii) intra-day bond prices obtained directly from Brokers;
and/or (iii) intra-day bond prices obtained from subscription services, such as Bloomberg. For
these purposes, “intra-day bond prices” may include executed transaction prices, executable prices
or indicative prices, all of which are available to Authorized Participants and other investors
from major broker-dealers. “Executed transaction prices,” as the term suggests, are the prices at
which completed bond transactions actually occurred, such as those executed transactions reported
on TRACE or other transaction reporting systems. “Executable quotations” are price quotations
provided by broker-dealers that indicate the price at which such broker-dealer would buy or sell a
specified amount of securities. “Indicative quotations” are price quotations provided by
broker-dealers that, while not necessarily executable, provide an indication of the price at which
such broker-dealer would buy or sell a specified amount of securities.
44
b. Availability of Intra-day Pricing and Other Information
As previously noted, one source of intra-day U.S. bond prices is the TRACE system. The TRACE
system reports executed transaction prices on corporate bonds. The development of the TRACE system
provides evidence that transparency in the U.S. bond market is increasing. TRACE reported prices
are available without charge on the NASD’s website on a “real time” basis (subject to a fifteen
minute delay as of July 1, 2005) and also are available by subscription from various information
providers (e.g., Bloomberg). In addition, Authorized Participants and other market participants,
particularly those that regularly deal or trade in bonds have access to intra-day bond prices from
a variety of sources other than TRACE. One obvious source of information for Authorized
Participants is their own trading desks. Applicants understand that many Authorized Participants
already make markets in the bonds included in the Underlying Indices and that, when acting as such,
they have access to intra-day bond prices through their own trading desks and will be able to
assess the intra-day value of each Blended Fund, Global Fund, International Fund, or Domestic Fixed
Income Fund’s Deposit Securities and the reasonableness of such Fund’s estimated intra-day NAV
using this information. Market participants, particularly large institutional investors, regularly
receive executable and indicative quotations on bonds from broker-dealers. Authorized Participants
and other market participants also can obtain bond prices by subscription from third parties
through on-line client-based services.32
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32 |
|
“[M]ost professional market participants,
dealers, investors and issuers have access to reliable bond price data through
commercial vendors.” Statement of William H. James of the Bond Market
Association before the House Committee on Commerce Subcommittee on Finance and
Hazardous Materials, September 29, 1998, reported in The Bond Market
Association — Legislative Issues (discussing the increasing availability of
pricing information in all sectors of the bond market). |
45
Another source of information about intra-day bond prices is the market for
over-the-counter-derivatives — in particular, the market for credit default swaps (each, a
“CDS”).33 The total notional amount outstanding of CDS increased from $632 billion in
2001 to over $17 trillion in 2005. Because swap traders need to continually assess the value of
the bonds on which credit default swaps are based, the CDS market provides another source of
intra-day price transparency for the bond market. In addition, the CDS market, by providing an
additional method for obtaining or hedging exposure to bonds, increases the liquidity and
accessibility of the market for bonds.
In addition to the available information described above, the Applicants note that shares of
existing ETFs have been, and should continue to be, followed closely by many stock market and
mutual fund professionals, as well as by major newspapers and magazines, that offer their analysis
of why investors should purchase, avoid, hold or sell the shares of the various ETFs. This should
help to ensure not only that there is a large amount of data available about the Funds, including
information about intra-day pricing, but also that such data is packaged, analyzed and widely
disseminated to the investing public.
Because, as discussed above, information about the intra-day prices of the bonds in each
Underlying Index is readily available, Applicants expect that Authorized Participants and other
market participants will have sufficient information to make their own assessments of the intra-day
value of each Blended, Global and Fixed Income Fund’s Deposit Securities and such Fund’s
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33 |
|
A CDS is a privately negotiated derivative
instrument pursuant to which payments are exchanged based on the occurrence of
specified credit events relating to the issuer of an underlying fixed income
security, such as a corporate bond (including high-yield bonds) or groups of
corporate bonds. The buyer of a CDS pays a premium to the seller to assume the
risk that the issuer(s) of the bond (or group of bonds) will default or
experience other defined credit events. A CDS may be used for investment
purposes or as a hedge against credit risks. |
46
estimated NAV and to use this information to take advantage of arbitrage
opportunities.34
I. Dividend Reinvestment Service
The Trust will not make the DTC book-entry dividend reinvestment service available for use by
Beneficial Owners for reinvestment of their cash proceeds, but certain individual Brokers may make
a dividend reinvestment service available to their clients. The SAI will inform investors of this
fact and direct interested investors to contact their Brokers to ascertain the availability and a
description of such a service through such Brokers.
J. Shareholder Transaction Expenses
No sales charges for purchases of Fund Shares of any Fund will be imposed. As indicated above
in Section III.B.1.c., each Fund may impose a Transaction Fee in connection with the purchase and
redemption of Creation Unit Aggregations. Investors purchasing and selling Fund Shares in the
secondary market may incur customary brokerage commissions, fees and expenses.
K. Shareholder Reports
With each distribution by a Fund, the Trust will furnish to the DTC Participants for
distribution to Beneficial Owners of Fund Shares of each Fund a statement setting forth the amount
being distributed, expressed as a dollar amount per Fund Share, as well as an annual notification
as to the tax status of the Funds’ distributions.
Promptly after the end of each fiscal year, the Trust will furnish to the DTC Participants,
for distribution to each person who was a Beneficial Owner of Fund Shares at the end of the fiscal
year, an annual report containing financial statements audited by independent public
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34 |
|
In the unusual event that the Adviser or any
Subadviser determines there is not sufficient intra-day pricing information
about a bond in an Underlying Index, the Adviser or any Subadviser would likely
exclude the bond from the Fund’s Deposit Securities and, in accordance with the
parameters set forth herein, would invest in bonds that are not included in the
Underlying Index, but for which more pricing information is available. |
47
accountants of nationally recognized standing and such other information as may be required by
applicable laws, rules and regulations. Copies of annual and semi-annual shareholder reports will
also be provided to the DTC Participants for distribution to Beneficial Owners of Fund Shares.
IV. IN SUPPORT OF THE APPLICATION
A. Summary of the Application
1. Relief Relating to the Funds’ ETF Structure
Applicants seek an Order from the Commission permitting (1) the Funds to issue Fund Shares
that are redeemable in Creation Unit Aggregations only; (2) secondary market transactions in Fund
Shares at negotiated prices, rather than at the current offering price as described in the Fund’s
Prospectus; (3) dealers to sell Fund Shares to secondary market purchasers unaccompanied by a
Prospectus, when prospectus delivery is not required by the Securities Act; (4) redemption of Fund
Shares beyond seven (7) calendar days in cases of certain International Funds which hold Portfolio
Securities with a longer settlement period; and (5) certain affiliated persons of the Funds to
deposit securities into, and receive securities from, the Funds in connection with the purchase and
redemption of Creation Unit Aggregations; all as more fully set forth below.
The Relief specified below is requested pursuant to Section 6(c) of the Act, which provides
that the Commission may exempt any person, security or transaction or any class of persons,
securities or transactions from any provision of the Act:
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if and to the extent that such exemption is necessary or appropriate
in the public interest and consistent with the protection of
investors and the purposes fairly intended by the policy and
provisions of [the Act]. |
48
Applicants believe that Fund Shares of each Fund afford significant benefits in the public
interest. Among other benefits, availability of Fund Shares should provide increased investment
opportunities which should encourage diversified investment; provide in the case of individual
tradable Fund Shares, a low-cost market-basket security for small and medium-sized accounts of
individuals and institutions that would be available at intra-day prices reflecting
minute-by-minute market conditions rather than only closing prices; make available a vehicle that
would track the selected Underlying Indices more closely than most alternative market-basket
investments due, in part, to the realization of efficiencies, cost savings and economies of scale;
provide a security that should be freely available in response to market demand; provide
competition for comparable products available in the U.S. market; attract capital to the U.S.
equity market; provide enhanced liquidity; facilitate the implementation of diversified investment
management techniques; and provide a more tax efficient investment vehicle than most traditional
mutual funds or closed-end funds. As such, Applicants believe the Shares of the Trust are
appropriate for exemptive relief under Section 6(c).
With respect to the exemptive relief specified below regarding Sections 17(a)(1) and 17(a)(2),
relief is also requested pursuant to Section 17(b), which provides that the Commission may approve
the sale of securities to a registered investment company and the purchase of securities from a
registered investment company, in both cases by an affiliated person of such company, if the
Commission finds that:
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the terms of the proposed transaction . . . are reasonable and fair
and do not involve any overreaching on the part of any person
concerned, the proposed transaction is consistent with the policy of
each registered investment company concerned . . . and the proposed
transaction is consistent with the general purposes of [the Act]. |
49
The sale and redemption of Creation Unit Aggregations of each Fund is on the same terms for
all investors, whether or not such investor is an affiliate. In each case, Creation Unit
Aggregations are sold and redeemed by the Trust at their NAV. The Creation Deposit for a Fund and
the Redemption Securities and balancing cash amount are based on a standard applicable to all and
valued in the same manner in all cases. Such transactions do not involve “overreaching” by an
affiliated person. Accordingly, Applicants believe the proposed transactions described herein meet
the Section 17(b) standards for relief because the terms of such proposed transactions, including
the consideration to be paid or received for the Creation Unit Aggregations, are reasonable and
fair and do not involve overreaching on the part of any person concerned; the proposed transactions
will be consistent with the Trust’s policies and that of each Fund as described herein; and are
consistent with the general purposes of the Act.
Applicants believe that the exemptions requested are necessary and appropriate in the public
interest and consistent with the protection of investors and the purposes fairly intended by the
Act. The exemptions and Order requested are also substantially similar to those granted in the
WisdomTree Order, the iShares orders and the Select Sector SPDRS Order.
B. |
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Benefits of the Proposal |
The Applicants understand that SPDRS, DIAMONDS, QQQQs and iShares, among other ETFs, have
consistently traded at, or very close to, their respective NAVs during the period from January 29,
1993 through December 31, 2007. While past performance is no guarantee of future results, the
Applicants believe that the close correspondence between the NAVs and market prices of SPDRs,
DIAMONDS, QQQQs and iShares, is due to the unique feature of in-kind purchases and redemptions,
which historically has facilitated price-correcting arbitrage activity. Given that the Funds’
structure will be virtually identical to these ETFs, the Applicants expect
50
Fund Shares to trade at or close to NAV. Since each Fund intends to replicate its Underlying
Index (unless the Board has determined that doing so would not be in the best interests of the Fund
investors), the Applicants believe that there will be an extremely high correlation between the
Underlying Indices and the Funds. The Applicants believe that this high correlation will tend to
minimize tracking error.
C. |
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The Product Does Not Raise Concerns |
1. Structure and Operation of the Trust and its Funds Compared to Current ETFs
Applicants assert that the arbitrage opportunities offered by the Trust and its Funds will be
the same as those offered by existing ETFs. Therefore, Applicants believe that the secondary market
prices of the Shares will closely track their respective NAVs or otherwise correspond to the fair
value of their underlying portfolios. The Commission has granted exemptive relief to existing ETFs
in large part because their structures enable efficient arbitrage, thereby minimizing the premium
or discount relative to such ETFs’ NAV. Portfolio transparency has been recognized by market
commentators and analysts, as well as by the Commission itself, to be a fundamental characteristic
of current ETFs. This transparency is acknowledged to facilitate the arbitrage mechanism described
in many of the applications for relief submitted by existing ETFs.
51
Although Fund Shares are not yet listed on a Primary Listing Exchange35 and
therefore do not trade in the secondary market, Applicants have every reason to believe that the
design, structure and transparency of the Funds will result in an arbitrage mechanism as efficient
and robust as that which now exists for current ETFs. Applicants expect that the spread between
offer and bid prices for Shares will be very similar to such spreads experienced for shares of
existing ETFs. Therefore, in light of the portfolio transparency and efficient arbitrage mechanism
inherent in each Fund’s structure, Applicants submit that the secondary market prices for Shares of
such Funds should trade at prices close to NAV and should reflect the value of each Fund’s
portfolio.
2. Investor Uses and Benefits of Products
Applicants believe that the Trust and its Funds will offer a variety of benefits that will
appeal to individual and institutional investors alike. Applicants assert that these will be
identical or substantially similar to the benefits offered by current ETFs. These benefits include
flexibility, tradeability, availability, certainty of purchase price and tax efficiencies. Equally
of interest to investors will be the relatively low expense ratios of the Funds as compared to
those of their directly competitive traditional mutual funds, due to their in-kind efficiencies in
portfolio management as well as other reduced infrastructure costs. Reductions in the cost of
trading, clearing, custody processes, shareholder reporting and accounting experienced by ETFs
currently
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35 |
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Applicants are not aware of any
characteristics of a Nasdaq listing that would cause Fund Shares to operate or
trade differently than if they were listed on another domestic Exchange.
Applicants do acknowledge that unlike the structure of the other domestic
Exchanges where a single member is contractually obligated to make a market in
Shares and oversees trading in Shares, the Nasdaq trading system allows
numerous Exchange Specialists who wish to trade Shares to compete for business,
creating liquidity by being willing to buy and sell Shares for their own
accounts on a regular and continuous basis. Applicants note that Nasdaq’s
listing requirements require at least two Exchange Specialists to be registered
in Shares in order to maintain their Nasdaq listing and that registered
Exchange Specialists on Nasdaq must make a continuous, two-sided market at all
times or risk regulatory sanctions. Applicants believe that the competition on
Nasdaq among Exchange Specialists, many of whom may be Authorized Participants,
as defined below, engaging in arbitrage activities would result in
a highly efficient and effective market for Shares. |
52
trading should be similarly experienced by the Trust and its Funds. The last, but by no means
least important benefit, is that investors will have access to extensive information regarding the
Component Securities of the relevant Underlying Index, the Portfolio Securities of each Fund,
Deposit Securities and Redemption Securities. Applicants believe that this updated information
will be used also by fund analysts, fund evaluation services, financial planners and advisors and
broker dealers, among others, and will enhance general market knowledge about the Fund’s holdings
as well as the performance of its Adviser and any Subadviser.
Applicants have made every effort to structure the Funds in a way that would not favor
creators, redeemers and arbitrageurs over retail investors buying and selling in the secondary
market. All investors, large and small, will know how changes in each Underlying Index are
determined and information about such changes will be made available to all investors at the same
time. Given that each Fund will be managed to replicate or closely track its Underlying Index,
neither the Adviser nor any Subadviser will have latitude to change or specify certain Deposit
Securities or Redemption Securities to favor an affiliate.
V. REQUEST FOR EXEMPTIVE RELIEF
A. Exemption from the Provisions of Sections 2(a)(32) and 5(a)(1)
Section 5(a)(1) of the Act defines an “open-end company” as a “management company which is
offering for sale or has outstanding any redeemable security of which it is the issuer.” The term
“redeemable security” is defined in Section 2(a)(32) of the Act as:
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any security, other than short-term paper, under the terms of which
the holder is, upon its presentation to the issuer or to a person
designated by the issuer... is entitled (whether absolutely or only
out of surplus) to receive approximately his proportionate share of
the issuer’s current net assets, or the cash equivalent thereof. |
53
Applicants believe that the Fund Shares could be viewed as satisfying the Section 2(a)(32)
definition of a redeemable security and, consequently, the Funds could be viewed as satisfying the
definitional requirement of an open-end company offering for sale a redeemable security of which it
is the issuer. Fund Shares are securities “under the terms of which” an owner may receive his
proportionate share of the Funds’ current net assets; the unusual aspect of such Fund Shares is
that its terms provide for such a right to redemption only when such individual Fund Shares are
aggregated with a specified number of such other individual Fund Shares that together constitute a
redeemable Creation Unit Aggregation. Because the redeemable Creation Unit Aggregation of a Fund
can be unbundled into individual Fund Shares that are not individually redeemable, a possible
question arises as to whether the definitional requirements of a “redeemable security” or an
“open-end company” under the Act would be met. In light of this possible analysis, Applicants
request an order to permit the Trust to remain registered as an open-end management investment
company and issue Fund Shares that are redeemable in Creation Unit Aggregations only as described
herein. Although Fund Shares will not be individually redeemable, because of the arbitrage
possibilities created by the redeemability of Creation Unit Aggregations, it is expected that the
market price of an individual Fund Share will not vary much from its NAV.
Creation Unit Aggregations will always be redeemable in accordance with the provisions of the
Act. Owners of Fund Shares may purchase the requisite number of Fund Shares and tender the
resulting Creation Unit Aggregation for redemption. Moreover, listing and trading on an Exchange
will afford all holders of Fund Shares the benefit of intra-day liquidity. Because Creation Unit
Aggregations may always be purchased and redeemed at NAV (less certain transactional expenses), the
price of individual Fund Shares on the secondary market should not
54
vary substantially from the NAV. Also, each investor is entitled to purchase or redeem
Creation Unit Aggregations rather than trade the individual Fund Shares in the secondary market,
although in certain cases the brokerage costs incurred to obtain the necessary number of individual
Fund Shares for accumulation into a Creation Unit Aggregation may outweigh the benefits of
redemption.
Applicants believe that the Trust’s Fund Shares may be issued and sold on a basis consistent
with the policies of the Act and without risk of the abuses against which the Act was designed to
protect. Applicants believe that the existence of Fund Shares does not appear to thwart the
purposes of any other provision of the Act that, but for the exemption registered herein with
respect to Sections 2(a)(32) and 5(a)(1), would be applicable to the Trust. Applicants further
believe that exempting the Trust to permit the Trust to remain registered as an open-end investment
company and issue redeemable Creation Unit Aggregations of individual Fund Shares, as described
herein, is appropriate in the public interest and consistent with the protection of investors and
the purposes of Section 1 of the Act, and accordingly, Applicants hereby request that the
Application for an order of exemption be granted.
B. Exemption from the Provisions of Section 22(d) and Rule 22c-1
Section 22(d) of the Act provides that:
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no registered investment company shall sell any redeemable security
issued by it to any person except to or through a principal
underwriter for distribution or at a current public offering price
described in the prospectus, and, if such class of security is being
currently offered to the public by or through an underwriter, no
principal underwriter of such security and no dealer shall sell any
such security to any person except a dealer, a principal
underwriter, or the issuer, except at current public offering price
described in the prospectus. |
55
Rule 22c-1 under the Act provides that:
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no registered investment company issuing any redeemable security, no
person designated in such issuer’s prospectus as authorized to
consummate transactions in .any such security, and no principal
underwriter of, or dealer in, any such security shall sell, redeem,
or repurchase any such security except at a price based on the
current net asset value of such security which is next computed
after receipt of a tender of such security for redemption or of an
order to purchase or sell such security. |
Fund Shares of each Fund will be listed on an Exchange and one or more Exchange Specialists
will maintain a market for such Fund Shares. The Fund Shares will trade on and away
from36 the Primary Listing Exchange at all times at negotiated prices (generally on the
basis of current bid/offer prices and other relevant factors, such as the most recent trading
price, supply and demand, and price improvement) and not on the basis of NAV next calculated after
receipt of any sale order. The purchase and sale of Fund Shares of a Fund will not, therefore, be
accomplished at an offering price described in the Prospectus, as required by Section 22(d), nor
will sales and repurchases be made at a price based on the current NAV next computed after receipt
of an order, as required by Rule 22c-1.
Based on the facts hereinafter set forth, Applicants respectfully request that the Commission
enter an Order under Section 6(c) of the Act exempting Applicants from the provisions of Section
22(d) and Rule 22c-1 to the extent necessary to permit the trading of Fund Shares of each Fund on
and away from the Exchange at prices based on a bid/offer market, rather than the NAV. Applicants
believe that the concerns sought to be addressed by Section 22(d) and Rule 22c-1 with respect to
pricing are equally satisfied by the proposed method of pricing of Fund Shares. While there is
little legislative history regarding Section 22(d), its provisions, as
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36 |
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Consistent with Rule 19c-3 under the
Exchange Act, members of the Primary Listing Exchange are not required to
effect transactions in Fund Shares through the facilities of such Exchange. |
56
well as those of Rule 22c-1, appear to have been intended (1) to prevent dilution caused by
certain riskless-trading schemes by principal underwriters and contract dealers, (2) to prevent
unjust discrimination or preferential treatment among buyers, and (3) to ensure an orderly
distribution system of shares by contract dealers by eliminating price competition from
non-contract dealers who could offer investors shares at less than the published sales price and
who could pay investors a little more than the published redemption price. See Protecting
Investors: A Half Century of Investment Company Regulation at 299-303; Investment Company Act
Release No. 13183 (April 22, 1983).
The first two purposes — preventing dilution caused by riskless-trading schemes and
preventing unjust discrimination among buyers — would not seem to be relevant issues for secondary
trading by dealers in Fund Shares. Secondary market transactions in Fund Shares would not cause
dilution for owners of such Fund Shares, because such transactions do not directly involve Fund
assets. Similarly, secondary market trading in Fund Shares should not create unjust discrimination
or preferential treatment among buyers. To the extent different prices exist during a given
trading day, or from day to day, such variances occur as a result of third-party market forces,
such as supply and demand, but do not occur as a result of unjust or discriminatory manipulation.
With respect to the third possible purpose of Section 22(d), Applicants believe that the
proposed distribution system will be orderly. Because anyone may sell or acquire Fund Shares
either by selling or purchasing them on an Exchange or by redeeming or creating a Creation Unit
Aggregation of such Fund Shares or by making the requisite Creation Deposit (subject to certain
conditions), no dealer should have an advantage over any other dealer in the sale of such Fund
Shares. Indeed, Applicants believe that the presence of an Exchange Specialist on an Exchange
57
will enhance liquidity because the Exchange Specialist has an obligation to promote a fair and
orderly market (e.g., the Exchange Specialist may be expected to effect trades to alleviate
temporary disparities in supply and demand for Fund Shares). In addition, secondary market
transactions in Shares should generally occur at prices roughly equivalent to their NAV. If the
prices for Fund Shares of a Fund should fall below the proportionate NAV of the underlying Fund
assets, an investor needs only to accumulate enough of individual Fund Shares of such Fund to
constitute a Creation Unit Aggregation in order to redeem such Fund Shares at NAV. Competitive
forces in the marketplace should thus ensure that the margin between NAV and the price for Fund
Shares in the secondary market remains narrow. Applicants understand that, to date, SPDRs, MidCap
SPDRs, DIAMONDS and QQQQs have consistently traded on Exchanges, at, or very close to, their
respective NAVs. Applicants therefore have strong reason to believe that the trading experience of
Shares should closely resemble that of SPDRs, MidCap SPDRs, DIAMONDS and QQQQs.
On the basis of the foregoing, Applicants believe (i) that the protections intended to be
afforded by Section 22(d) and Rule 22c-1 are adequately addressed by the proposed methods for
creating, redeeming and pricing Creation Unit Aggregations and pricing and trading Fund Shares, and
(ii) that the relief requested is appropriate in the public interest and consistent with the
protection of investors and the purposes of Section 1 of the Act. Accordingly, Applicants hereby
request that an order of exemption under section 6(c) be granted in respect of Section 22(d) and
Rule 22c- 1.
C. Exemption from the Provisions of Section 22(e)
The Applicants seek an order of the Commission under Section 6(c) granting an exemption from
the seven-day redemption delivery requirement of Section 22(e) of the Act up to
58
a maximum of 12 calendar days to certain Global and International Funds under the
circumstances described below.37
Section 22(e) provides that, except under circumstances not relevant to this request:
No registered company shall suspend the right of redemption, or postpone the
date of payment or satisfaction upon redemption of any redeemable security
in accordance with its terms for more than seven days after the tender of
such security to the company or its agent designated for that purpose for
redemption...
Applicants observe that the settlement of redemptions of Creation Unit Aggregations of the
Global and International Funds is contingent not only on the settlement cycle of the U.S.
securities markets but also on the delivery cycles present in foreign markets in which those Funds
invest. Applicants have been advised that, under certain circumstances, the delivery cycles for
transferring Portfolio Securities to redeeming investors, coupled with local market holiday
schedules, will require a delivery process of up to twelve (12) calendar days, rather than the
seven (7) calendar days required by Section 22(e). Applicants therefore request relief
from Section 22(e) in order to provide payment or satisfaction of redemptions within the maximum
number of calendar days required for such payment or satisfaction in the principal local markets
where transactions in the Portfolio Securities of each Global Fund and International Fund
customarily clear and settle, but in all cases no later than twelve (12) calendar days following
the tender of a Creation Unit Aggregation. With respect to Future Funds based on a global or an
international Underlying Index, Applicants seek the same relief from Section 22(e) only to the
extent that circumstances exist similar to those described herein. Of course, it is possible that
the
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37 |
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Applicants acknowledge that no relief
obtained from the requirements of Section 22(e) will affect any obligations
that Applicants may otherwise have under Rule 15c6-1 under the Exchange Act.
Rule 15c6-1 requires that most securities transactions be settled within three
business days of the trade date. |
59
proclamation of new or special holidays,38 the treatment by market participants of
certain days as “informal holidays”39 (e.g., days on which no or limited securities
transactions occur, as a result of substantially shortened trading hours), the elimination of
existing holidays or changes in local securities delivery practices,40 could
affect the information set forth herein at some time in the future. The Prospectus and/or SAI will
identify those instances in a given year where, due to local holidays, more than seven days will be
needed to deliver redemption proceeds and will list such holidays.
Where relief is requested, the delivery of redemption proceeds would be made within a maximum
of twelve (12), as the case may be, calendar days after the redemption request is
received in proper form except to the extent that a redemption delivery is delayed due to the
proclamation of new or special holidays, the treatment by market participants of certain days as
informal holidays, the elimination of existing holidays or changes in local securities delivery
practices.
The SAI will disclose those local holidays (over the period of at least one year following the
date thereof), if any, that are expected to prevent the delivery of redemption proceeds in
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38 |
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Applicants have been advised that previously
unscheduled holidays are sometimes added to a country’s calendar, and existing
holidays are sometimes moved, with little advance notice. Any such future
changes could impact the analysis of the number of days necessary to satisfy a
redemption request. For example, the following examples of short-notice
holiday announcements: (i) on December 17, 1997, South Korea announced a
special public holiday due to the presidential elections on December 18, 1997;
(ii) on December 30, 1997, Thailand announced that the New Year’s Eve holiday
on December 31, 1997 would be rescheduled to January 2, 1998; and (iii) on
January 22, 1998, Indonesia announced that the religious holiday on January 29
and January 30, 1998, marking the start of Lebaran, would include January 28,
1998. |
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A typical “informal holiday” includes a
trading day in the relevant market that is immediately prior to a regularly
scheduled holiday; early closures of the relevant market or of the offices of
key market participants may occur with little advance notice. Any shortening of
regular trading hours on such a day could impact the analysis of the number of
days necessary to satisfy a redemption request. |
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40 |
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Applicants observe that the trend
internationally in local securities delivery practices has been a reduction in
each market’s standard settlement cycles (e.g., the U.S. markets’ change to T+3
in 1995). It remains possible, if unlikely, that a particular market’s
settlement cycles for securities transfers could be lengthened in the future. |
60
seven calendar days and the maximum number of days needed to deliver the proceeds for each affected
Global Fund and International Fund.
Except as disclosed in the Prospectus and/or SAI for the Global Funds and International Funds
for analogous dates in subsequent years, deliveries of redemption proceeds by the International
Funds relating to those countries or regions are expected to be made within seven (7)
days.
The Applicants propose that allowing redemption payments for Creation Unit Aggregations of a
Fund to be made within the number of days indicated above would not be inconsistent with the spirit
and intent of Section 22(e). The Applicants suggest that a redemption payment occurring within
such number of calendar days following a redemption request would adequately afford investor
protection. The Applicants submit that Congress adopted Section 22(e) to prevent unreasonable,
undisclosed or unforeseen delays in the actual payment of redemption proceeds.
The Applicants desire to incorporate the creation and redemption mechanism for Creation Unit
Aggregations of each Fund as much as possible into the processing and settlement cycles for
securities deliveries currently practicable in the principal market(s) for the Portfolio Securities
of a given Fund. Currently, Applicants believe that no significant additional system or
operational procedures will be needed to purchase or redeem Creation Unit Aggregations beyond those
already generally in place in the relevant jurisdiction. The Applicants believe that this approach
may make creations and redemptions of Creation Unit Aggregations less costly to administer, enhance
the appeal of the product to institutional participants, and thereby promote the liquidity of
Shares in the secondary market with benefits to all holders thereof. As noted above, the
Applicants intend to utilize in-kind redemptions to the maximum extent possible
61
principally as a method of assuring the fullest investment of Fund assets in Portfolio Securities (although as noted
above, cash redemptions, subject to a somewhat higher redemption Transaction Fee, are expected to
be required in respect of certain Global Funds and International
Funds). Applicants are not seeking relief from Section 22(e) for Global or International
Funds that do not effect redemptions of Creation Unit Aggregation in kind.
If the requested relief is granted, Applicants intend to disclose in the SAI and all relevant
sales literature that redemption payments will be effected within the specified number of calendar
days following the date on which a request for redemption in proper form is made. Given the
rationale for what amounts to a delay typically of a few days in the redemption process on certain
occasions and given the facts as recited above, the Applicants believe that the redemption
mechanism described above will not lead to unreasonable, undisclosed or unforeseen delays in the
redemption process. The Applicants assert that the request for relief from the strict seven day
rule imposed by Section 22(e) is not inconsistent with the standards articulated in section 6(c).
Given the facts as recited above, the Applicants believe that the granting of the requested relief
is consistent with the protection of investors and the purposes fairly intended by the policies and
provisions of the Act.
The Applicants note that exemptive relief from Section 22(e) substantially identical to the
relief sought in this Application was obtained in the WisdomTree Order and iShares Order. On the
basis of the foregoing, the Applicants believe (i) that the protections intended to be afforded by
section 22(e) are adequately addressed by the proposed method and securities delivery cycles for
redeeming Creation Unit Aggregations and (ii) that the relief requested is appropriate in the
public interest and consistent with the protection of investors and the purposes fairly intended by
the policy and provisions of the Act. Accordingly, the Applicants hereby respectfully request that
62
an order of exemption be granted under Section 6(c) in respect of Section 22(e) with respect to the
affected International and Global Funds.
D. Exemption from the Provisions of Section 17(a)(1) and 17(a)(2)
Applicants seek an exemption from Sections 17(a) of the Act pursuant to Sections
6(c) and 17(b) of the Act to allow certain affiliated persons to effectuate purchases and
redemptions in-kind. Unless the Commission, upon application pursuant to Section 17(b) of the
Act, grants an exemption from the provisions of Section 17(a), Section 17(a)(1) of the Act,
among other things, makes it unlawful
for any affiliated person or promoter of or principal underwriter for
a registered investment company... or any affiliated person of such a
person, promoter, or principal underwriter, acting as principal,
knowingly to sell any security or other property to such registered
investment company or to any company controlled by such registered
company, unless such sale involves solely (A) securities of which the
buyer is the issuer, (B) securities of which the seller is the issuer
and which are part of a general offering to the holders of a class of
its securities or (C) securities deposited with a trustee of a unit
investment trust... by the depositor thereof.
Section 17(a)(2) of the Act makes it unlawful
for any affiliated person or promoter of or principal underwriter
for a registered investment company ... or any affiliated person of
such a person, promoter, or principal underwriter, acting as
principal — knowingly to purchase from such registered company, or
from any company controlled by such registered company, any security
or other property (except securities of which the seller is the
issuer).
An “affiliated person” of a fund, pursuant to Section 2(a)(3)(A) of the Act, includes “any
person directly or indirectly owning, controlling, or holding with the power to vote, 5 per centum
or more of the outstanding voting securities of such other person” and pursuant to Section
2(a)(3)(C) of the Act “any person directly or indirectly controlling, controlled by, or under
common control with, such other person.”
63
Section 2(a)(9) of the Act defines “control” as
...the power to exercise a controlling influence over the management
or policies of a company, unless such power is solely the result of
an official position with such company. Any person who owns
beneficially, either directly or through one or more controlled
companies, more than 25 per centum of the voting securities of a
company shall be presumed to control such company. Any person who
does not so own more than 25 per
centum of the voting securities of any company shall be presumed not
to control such company.
The Funds may be deemed to be controlled by the Adviser or an entity controlling, controlled by or
under common control with the Adviser and hence affiliated persons of each other. In addition, the
Funds may be deemed to be under common control with any other registered investment company (or
series thereof) advised by the Adviser or an entity controlling, controlled by or under common
control with the Adviser (an “Affiliated Fund”).
Section 17(b) provides that the Commission will grant an exemption from the provisions of
Section 17(a) if evidence establishes that the terms of the proposed transaction are reasonable and
fair, including the consideration to be paid or received, and do not involve overreaching on the
part of any person concerned, that the proposed transaction is consistent with the policy of each
registered investment company concerned, and that the proposed transaction is consistent with the
general purposes of the Act.
Because Section 17(b) could be interpreted to exempt only a single transaction from Section
17(a) and because there may be a number of transactions by persons who may be deemed to be either
first-tier or second-tier affiliates, Applicants are also requesting an exemption under Section
6(c) of the Act as well. See, e.g., Keystone Custodian Funds, Inc., 21 S.E.C. 295 (1945).
64
There exists a possibility that, with respect to one or more Funds and the Trust, a large
institutional investor could own more than 5% of a Fund or the Trust, or in excess of 25% of the
outstanding Fund Shares of a Fund or the Trust, making that investor a first-tier affiliate of each
Fund under Section 2(a)(3)(A) or Section 2(a)(3)(C) of the Act. In addition, there exists a
possibility that, with respect to other registered investment companies (or series thereof) managed
by the Adviser, a large institutional investor could own 5% or more of, or in excess of 25% of the
outstanding shares of such other registered investment companies (or series thereof),
making that investor a second-tier affiliate of a Fund. For so long as such an investor was
deemed to be an affiliate, Section 17(a)(1) could be read to prohibit such person from depositing
the Creation Deposit with a Fund in return for a Creation Unit Aggregation (an in-kind purchase).
Likewise, Section 17(a)(2) could be read to prohibit the investor from entering into an in-kind
redemption procedure with a Fund. The Applicants request an exemption to permit persons that are
affiliated persons or second-tier affiliates of the Funds solely by virtue of (1) holding 5% or
more, or in excess of 25% of the outstanding Fund Shares of one or more Funds; (2) having an
affiliation with a person with an ownership interest described in (1); or (3) holding 5% or more,
or more than 25% of the Fund Shares of one or more Affiliated Funds, to effectuate purchases and
redemptions in-kind.
Applicants assert that no useful purpose would be served by prohibiting such affiliated
persons from making in-kind purchases or in-kind redemptions of Fund Shares of a Fund in Creation
Unit Aggregations. Both the deposit procedures for in-kind purchases of Creation Unit Aggregations
and the redemption procedures for in-kind redemptions will be effected in exactly the same manner
for all purchases and redemptions, regardless of size or number. There will be no discrimination
between purchasers or redeemers. Deposit Securities and Redemption
65
Securities will be valued in the same manner as those Portfolio Securities currently held by the relevant Funds, and the
valuation of the Deposit Securities and Redemption Securities will be made in the same manner,
regardless of the identity of the purchaser or redeemer. Any consideration paid from the types of
affiliated persons listed above for the purchase or redemption, including in-kind purchases and
in-kind redemptions, of Fund Shares directly from a Fund will be based on the NAV of such Fund in
accordance with the policies and procedures set forth in the Registration Statement.
Applicants also note that the ability to take deposits and make redemptions in-kind will help
each Fund to track closely its Underlying Index and, therefore, aid in achieving the Fund’s
objectives. Applicants do not believe that in-kind purchases and redemptions will result in
abusive self-dealing or overreaching, but rather assert that such procedures will be implemented
consistently with the Funds’ objectives and with the general purposes of the Act. Applicants
believe that in-kind purchases and redemptions will be made on terms reasonable to Applicants and
any affiliated persons because they will be valued pursuant to verifiable objective standards. The
method of valuing Portfolio Securities held by a Fund is the same as that used for calculating the
value of in-kind purchases or redemptions and, therefore, creates no opportunity for affiliated
persons or Applicants to effect a transaction detrimental to the other holders of Fund Shares of
that Fund. Similarly, Applicants submit that, by using the same standards for valuing securities
held by a Fund as are used for calculating the value of in-kind redemptions or purchases, the Fund
will ensure that its NAV will not be adversely affected by such securities transactions.
For the reasons set forth above, Applicants believe that: (i) with respect to the relief
requested pursuant to Section 17(b), the terms of the proposed transactions, including the
66
consideration to be paid for received, are reasonable and fair and do not involve overreaching
on the part of any person concerned, the proposed transactions are consistent with the policy of
each registered investment company concerned, and that the proposed transactions are consistent
with the general purposes of the Act, and (ii) with respect to the relief requested pursuant to
Section 6(c), the requested exemption for the proposed transactions is appropriate in the public
interest and consistent with the protection of investors and the purposes fairly intended by the
policy and provisions of the Act.
VI. |
|
REQUEST FOR SECTION 12(d)(1) RELIEF |
|
A. |
|
Exemption from the Provisions of Sections 12(d)(1)(A), 12(d)(1)(B) and 17(a) |
Applicants respectfully request, pursuant to Section 12(d)(l)(J) of the Act, an exemption from
Section 12(d)(l)(A) to permit the Acquiring Funds to acquire Fund Shares of the Funds beyond the
limits of Section 12(d)(l)(A). Pursuant to Section 12(d)(l)(J), Applicants also request an
exemption from Section 12(d)(l)(B) to permit the Funds, their principal underwriters and Brokers to
sell Shares of the Funds to Acquiring Funds beyond the limits of Section 12(d)(l)(B). In addition,
pursuant to Sections 6(c) and 17(b), Applicants request an exemption from Section 17(a) of the Act
to permit a Fund to sell its Shares to, and redeem its Shares from, an Acquiring Fund that owns
5% or more of the Fund’s Shares. Applicants believe that the 12(d)(l) Relief
requested is necessary and appropriate in the public interest and consistent with the protection of
investors and the purposes fairly intended by the policy and provisions of the Act.
67
As stated in Section I.A. above, the Acquiring Funds are registered management investment
companies and UITs, some of which currently are, or may be in the future, affiliated with
Authorized Participants. Each investment adviser to an Acquiring Management Company within the
meaning of Section 2(a)(20)(A) of the Act (“Acquiring Fund Adviser”) will be registered as an
investment adviser under the Advisers Act. No Acquiring Fund Adviser or sponsor of an Acquiring
Trust (“Sponsor”) will control, be controlled by or under common control with the Adviser or
Subadviser(s). No Acquiring Fund will be in the same group of investment companies as the Funds.
Pursuant to the terms and conditions of this Application and the requested order, if granted, each
Acquiring Fund will enter into a written agreement with the relevant Fund(s), as discussed
immediately below.
|
3. |
|
Proposed Conditions and Disclosure |
Like the applicants in iShares Trust, neither the Adviser nor any entity controlling,
controlled by, or under common control with the Adviser, will serve as an Acquiring Fund Adviser or
Acquiring Fund Subadviser (as defined below), to any Acquiring Fund, nor as Sponsor or trustee of
any Acquiring Trust (“Trustee”). In order to ensure that the Acquiring Funds understand and will
comply with the terms and conditions of the requested Order, Applicants propose that any Acquiring
Fund intending to invest in a Fund in reliance on such Order will be required to enter into a
written agreement with the Fund (the “Acquiring Fund Agreement”) (see Section VIII,
Condition 14 below). The Acquiring Fund Agreement will ensure that the Acquiring Fund
understands and agrees to comply with the terms and conditions of the requested Order. The
Acquiring Fund Agreement also will include an acknowledgment
68
from the Acquiring Fund that it may rely on the Order requested herein only to invest in a Fund and
not in any other investment company. Each Acquiring Fund will further be required to represent in
the Acquiring Fund Agreement that the Acquiring Fund intends at all times to fulfill its
responsibilities under the requested Order and to fully comply with the provisions of the Act and
the rules and regulations promulgated thereunder and with Conduct Rule 2830 of the NASD41
pertaining to funds of funds (see Section VIII, Condition 16 below). 42
In addition, Applicants propose that the requested 12(d)(l) Relief will be conditioned upon
certain additional requirements. Any member of an Acquiring Fund’s Advisory Group (as defined
below) individually or the Acquiring Fund’s Advisory Group in the aggregate will not control a Fund
within the meaning of Section 2(a)(9) of the Act (see Section VIII, Condition 7, below). Any
member of an Acquiring Fund’s Subadvisory Group (as defined below) individually or the Acquiring
Fund’s Subadvisory Group in the aggregate will not control a Fund within the meaning of Section
2(a)(9) of the Act (see Section VIII, Condition 7, below). An Acquiring Fund or Acquiring Fund
Affiliate will not cause any existing or potential investment in a Fund to influence the terms of
any services or transactions between the Acquiring Fund or an Acquiring Fund Affiliate43
and the Fund or a Fund Affiliate44 (see Section VIII, Condition 8 below). Each Acquiring
Management Company’s board of directors/trustees, including a
|
|
|
41 |
|
Any references to Conduct Rule 2830 of the
NASD include any successor or replacement rule to Conduct Rule 2830 that may be
adopted by the Financial Industry Regulatory Authority. |
|
42 |
|
Applicants acknowledge that the receipt of
compensation by (a) an affiliated person of an Acquiring Fund, or an affiliated
person of such person, for the purchase by the Acquiring Fund of Fund Shares or
(b) an affiliated person of a Fund, or an affiliated person of such person, for
the sale by the Fund of its Shares to an Acquiring Fund, may be prohibited by
section 17(e) of the Act. The Acquiring Fund Agreement also will include this
acknowledgment. |
|
43 |
|
An “Acquiring Fund Affiliate” is defined as
the Acquiring Fund Adviser, Acquiring Fund Subadviser(s), any Sponsor, promoter
or principal underwriter of an Acquiring Fund and any person controlling,
controlled by or under common control with any of these entities. |
|
44 |
|
A “Fund Affiliate” is defined as the Adviser,
Subadviser(s), promoter or principal underwriter of a Fund and any person
controlling, controlled by or under common control with any of these entities. |
69
majority of the independent directors/trustees, will adopt procedures reasonably designed to assure
that the Acquiring Fund Adviser and Acquiring Fund Subadviser(s) are conducting the investment
program of the Acquiring Management Company without taking into account any consideration received
by the Acquiring Management Company or an Acquiring Fund Affiliate from the Fund or a Fund
Affiliate in connection with any services or transactions (see Section VIII, Condition 9, below).
No Acquiring Fund or Acquiring Fund Affiliate will cause a Fund to purchase a security from an
Affiliated Underwriting45 (see Section VIII Condition 11, below). Finally, no
Fund will acquire securities of any investment company or company relying on Section 3(c)(l) or
3(c)(7) of the Act in excess of the limits contained in Section 12(d)(l)(A) of the Act, except to the extent permitted by exemptive relief from the Commission permitting the Fund to purchase shares of other investment companies for short-term cash management purposes (see Section
VIII, Condition 17, below). A Fund may choose to reject any direct purchase of Creation Unit
Aggregations by an Acquiring Fund. A Fund would also retain its right to reject any initial
investment by an Acquiring Fund in excess of the limits in Section 12(d)(l)(A) of the Act by
declining to execute an Acquiring Fund Agreement with an Acquiring Fund.
Section 12(d)(l)(A) of the Act prohibits a registered investment company from acquiring
securities of an investment company if such securities represent more than 3% of the total
outstanding voting stock of the acquired company, more than 5% of the total assets of the
|
|
|
45 |
|
An “Affiliated Underwriting” is an offering
of securities during the existence of an underwriting or selling syndicate of
which a principal underwriter is an Underwriting Affiliate. An
“Underwriting Affiliate” is defined as a principal underwriter in any
underwriting or selling syndicate that is an officer, director, member of an
advisory board, Acquiring Fund Adviser, Acquiring Fund Subadviser, Sponsor, or
employee of the Acquiring Fund, or a person of which any such officer,
director, member of an advisory board, Acquiring Fund Adviser, Acquiring Fund
Subadviser, Sponsor, or employee is an affiliated person, except any person
whose relationship to the Fund is covered by section 10(f) of the Act
is not an Underwriting Affiliate. |
70
acquiring company, or, together with the securities of any other investment companies, more than
10% of the total assets of the acquiring company.
Section 12(d)(l)(B) of the Act prohibits a registered open-end investment company, its
principal underwriter and any other broker-dealer from selling the investment company’s shares to
another investment company if the sale will cause the acquiring company to own more than 3% of the
acquired company’s voting stock, or if the sale will cause more than 10% of the acquired company’s
voting stock to be owned by investment companies generally.
|
1. |
|
Exemption under Section 12(d)(1)(J) |
The National Securities Markets Improvement Act of 1996 (“NSMIA”) added section 12(d)(l)(J) to
the Act. Section 12(d)(l)(J) of the Act provides that the Commission may exempt any person,
security, or transaction, or any class or classes of persons, securities or transactions, from any
provision of section 12(d)(l) if the exemption is consistent with the public interest and the
protection of investors. The legislative history of NSMIA directs the Commission to consider, among
other things, when granting relief under section 12(d)(l)(J),
the extent to which a proposed arrangement is subject to conditions that are
designed to address conflicts of interest and overreaching by a participant
in the arrangement, so that the abuses that gave rise to the initial
adoption of the Act’s restrictions against investment companies investing in
other investment companies are not repeated.46
Applicants submit that the proposed conditions to the 12(d)(l) Relief requested in this
Application, including the requirement that Acquiring Funds enter into an Acquiring Fund Agreement,
adequately address the concerns underlying the applicable limits in Section 12(d)(l), and that the
requested exemption is consistent with the public interest and the protection of investors.
Applicants also submit that the proposed transactions are consistent with congressional
|
|
|
46 |
|
H.R. Rep. No. 622,
104th Cong., 2d Sess., at 43-44 (1996) (“HR 622”). |
71
intent that the Commission grant exemptions under Section 12(d)(l)(J) in a “progressive way” as the
concept of investment companies investing in other investment companies evolves over
time.47
2. Concerns Underlying Section 12(d)(1)(J)
Congress enacted Section 12(d)(l) (then Section 12(c)(l)) in 1940 to prevent one investment
company from buying control of another investment company.48 In enacting Section
12(d)(l), Congress sought to ensure that the acquiring investment company had no “effective voice”
in the other investment company.49 As originally proposed, Section 12(d)(l) would have
prohibited any investment by an investment company in another investment company. Congress relaxed
the prohibition in the section’s final version, presumably because there was some concern that an
investment company should not be prohibited from taking advantage of a good investment just because
the investment was another investment company:
You may get situations where one investment company may think that the
securities of another investment company are a good buy and it was not
thought advisable to freeze that type of purchase.50
Congress tightened Section 12(d)(l)’s restrictions in 1970 to address certain abuses perceived
to be associated with the development of fund holding companies (i.e., funds that primarily invest
in other investment companies).51 The Commission identified these abuses in its 1966
report to Congress, titled Public Policy Implications of Investment Company Growth (the
|
|
|
47 |
|
Id. at 43-44. |
|
48 |
|
House Hearings, 76th Cong., 3d Sess., at 113
(1940). |
|
49 |
|
Hearings on S. 3580 Before the Subcomm. of
the Comm. on Banking and Currency, 76th Cong., 3d Sess., at 1114 (1940). |
|
50 |
|
House Hearings, 76th Cong., 3d Sess., at 112
(1940) (testimony of David Schenker). |
|
51 |
|
See H.R. Rep. No 91-1382,91st Cong., 2d
Sess., at 11 (1970). |
72
“PPI Report”).52 These abuses included: (i) the threat of large scale redemptions
of the acquired fund’s shares; (ii) layering of fees and expenses (such as sales loads, advisory
fees and administrative costs); and (iii) unnecessary complexity. Applicants propose a number of
conditions designed to address these concerns.
Applicants submit that their proposed conditions (set forth in Section IX, below) address the
concerns about large-scale redemptions identified in the PPI Report, particularly those regarding
the potential for undue influence. For example, Condition 8 limits the ability of an
Acquiring Fund’s Advisory Group or an Acquiring Fund’s Subadvisory Group to control a Fund
within the meaning of Section 2(a)(9) of the Act. For purposes of this Application, an “Acquiring
Fund’s Advisory Group” is defined as:
The Acquiring Fund Adviser, Sponsor, any person controlling,
controlled by or under common control with the Acquiring Fund
Adviser or Sponsor, and any investment company or issuer that would
be an investment company but for Section 3(c)(l) or 3(c)(7) of the
Act, that is advised or sponsored by the Acquiring Fund Adviser,
Sponsor or any person controlling, controlled by or under common
control with the Acquiring Fund Adviser or Sponsor.
Also, for purposes of this Application, an “Acquiring Fund’s Subadvisory Group” is defined as:
any Acquiring Fund Subadviser, any person controlling, controlled
by, or under common control with the Acquiring Fund Subadviser, and
any investment company or issuer that would be an investment company
but for Section 3(c)(l) or 3(c)(7) of the Act (or portion of such
investment company or issuer) advised or sponsored by the Acquiring
Fund Subadviser or any person controlling, controlled by or under
common control with the Acquiring Fund Subadviser.
For purposes of this Application, an “Acquiring Fund Subadviser” is defined as “any investment
advisor within the meaning of Section 2(a)(20)(B) of the Act to an Acquiring Management Company.”
|
|
|
52 |
|
Report of the Securities and Exchange Comm.
on the Public Policy Implications of Investment Company Growth, H.R. Rep. No.
2337, 89th Cong., 2d Sess., 311-324 (1966). |
73
In addition, Condition 8 prohibits Acquiring Funds and Acquiring Fund Affiliates from causing
an investment by an Acquiring Fund in a Fund to influence the terms of services or transactions
between an Acquiring Fund or an Acquiring Fund Affiliate and the Fund or a Fund Affiliate. Further,
conditions &,8, 9, 10, 11 and 12 are specifically designed to address the potential for an
Acquiring Fund and Acquiring Fund Affiliates to exercise undue influence over a Fund and Fund
Affiliates.
With respect to concerns regarding layering of fees and expenses, Applicants propose several
conditions. Applicants have designed Condition 15 of the requested Order to prevent unnecessary
duplication or layering of sales charges and other costs. Also, Applicants propose Condition 16 in
order to prevent any sales charges or service fees on shares of an Acquiring Fund from exceeding
the limits applicable to a fund of funds set forth in Conduct Rule 2830 of the NASD.
With respect to the potential for duplicative advisory fees, Applicants note that Acquiring
Trusts will not pay any advisory fees; accordingly, there will be no potential for duplicative
advisory fees. With respect to Acquiring Management Companies, Applicants note the Board, including
a majority of the independent directors or trustees, of any Acquiring Fund, pursuant to Condition
18, will be required to find that any fees charged under the Acquiring Management Company’s
advisory contract(s) are based on services provided that will be in addition to, rather than
duplicative of, services provided under the advisory contract(s) of any Fund in which the Acquiring
Management Company may invest.
In order to address concerns about complexity, Applicants propose that no Fund will acquire
securities of any investment company or company relying on Section 3(c)(1) or 3(c)(7) of the Act in
excess of the limits contained in Section 12(d)(1)(A) of the Act. Thus, in keeping
74
with the PPI Report’s concern with overly complex structures, Applicants submit that the
requested 12(d)(1) Relief will not create or give rise to circumstances enabling an Acquiring Fund
to invest in excess of the limits of Section 12(d)(1)(A) in a Fund which is in turn able to invest
in another investment company or 3(c)(1) or 3(c)(7) issuer in excess of such limits. In addition
to avoiding excess complexity, Applicants believe that the condition requiring that Funds will not
invest in any other investment company or 3(c)(1) or 3(c)(7) issuer in excess of the limits of
Section 12(d)(1)(A) mitigates the concerns about layering of fees.
Applicants note that certain ETFs now trading have been operating under orders granting relief
that is virtually identical to the 12(d)(1) Relief requested in this Application. Applicants are
not aware of any problems or difficulties encountered by such ETFs or the mutual funds relying upon
such orders, and expect that the experience of the Funds identified herein and Acquiring Funds
should be the same.
B. Sections 17(a), 17(b) and 6(c)
Applicants seek an exemption from Section 17(a) pursuant to Section 17(b) and Section 6(c) of
the Act to permit a Fund, to the extent that the Fund is an affiliated person (as defined in
Section 2(a)(3)(B) of the Act) of an Acquiring Fund, to sell Fund Shares to, and purchase Fund
Shares from, an Acquiring Fund through in-kind Creation Unit Aggregation transactions.
Section 17(a) of the Act generally prohibits sales or purchases of securities between a
registered investment company and any affiliated person of the company. Section 2(a)(3)(B) of the
1940 Act defines an “affiliated person” of another person to include any person 5% or more of whose
outstanding voting securities are directly or indirectly owned, controlled, or held with power to
vote by the other person. An Acquiring Fund relying on the requested exemptive relief could own 5%
or more of the outstanding voting securities of a Fund. In such cases, that Fund
75
would become an affiliated person of the Acquiring Fund, and direct, in-kind sales and
redemptions of its Fund Shares with an Acquiring Fund could be prohibited.
Section 17(b) of the 1940 Act authorizes the Commission to grant an order permitting a
transaction otherwise prohibited by Section 17(a) if it finds that:
(i) the terms of the proposed transaction, including the
consideration to be paid or received, are reasonable and fair and do
not involve overreaching on the part of any person concerned;
(ii) the proposed transaction is consistent with the policy of each
registered investment company concerned; and
(iii) the proposed transaction is consistent with the general
purposes of the Act.
The Commission has interpreted its authority under Section 17(b) as extending only to a single
transaction and not a series of transactions.
Section 6(c) of the Act permits the Commission to exempt any person or transactions from any
provision of the Act if such exemption is necessary or appropriate in the public interest and
consistent with the protection of investors and the purposes fairly intended by the policy and
provisions of the Act. Applicants are seeking relief from any transaction in Creation Unit
Aggregations between a Fund and an Acquiring Fund that owns 5% or more of a Fund before the
transaction. Applicants expect that most Acquiring Funds will purchase Fund Shares in the
secondary market and will not purchase Creation Unit Aggregations directly from a Fund.
Section 17(a) is intended to prohibit affiliated persons in a position of influence or control
over an investment company from furthering their own interests by selling property that they own to
an investment company at an inflated price, purchasing property from an investment company at less
than its fair value, or selling or purchasing property on terms that involve overreaching by that
person. For the reasons articulated in the legal analysis of Section 12(d)(1), above, Applicants
submit that, with regard to Section 17(a), the proposed transactions are
76
appropriate in the public interest, consistent with the protection of investors and do not
involve overreaching.
Applicants believe that an exemption is appropriate under Sections 17(b) and 6(c) because the
proposed arrangement meets the standards in those sections. First, the terms of the proposed
arrangement are fair and reasonable and do not involve overreaching. Any consideration paid for
the purchase or redemption of Fund Shares directly from a Fund will be based on the NAV of the Fund
in accordance with policies and procedures set forth in the Fund’s registration
statement.53
Second, the proposed transactions directly between Funds and Acquiring Funds will be
consistent with the policies of each Acquiring Fund. The purchase of Creation Unit Aggregations by
an Acquiring Fund will be accomplished in accordance with the investment restrictions of the
Acquiring Fund and will be consistent with the investment policies set forth in the Acquiring
Fund’s registration statement. The Acquiring Fund Agreement will require any Acquiring Fund that
purchases Creation Unit Aggregations directly from a Fund to represent that the purchase of
Creation Unit Aggregations from a Fund by an Acquiring Fund will be accomplished in compliance with
the investment restrictions of the Acquiring Fund and will be consistent with the investment
policies set forth in the Acquiring Fund’s registration statement.
Third, Applicants believe that the proposed transactions are consistent with the general
purposes of the Act. Applicants also believe that the requested exemptions are appropriate in the
public interest. Fund Shares offer Acquiring Funds a flexible investment tool that can be used
|
|
|
53 |
|
To the extent that purchases and sales of
Fund Shares of a Fund occur in the secondary market and not through principal
transactions directly between an Acquiring Fund and a Fund, relief from Section
17(a) would not be necessary. However, the requested relief would apply to
direct sales of Fund Shares in Creation Unit Aggregations by a Fund to an
Acquiring Fund and redemptions of those Fund Shares. The requested relief is
intended to cover the in-kind transactions that would accompany such sales and
redemptions. |
77
for a variety of purposes. Applicants also submit that the exemption is consistent with the
protection of investors and the purposes fairly intended by the policy and provisions of the Act.
VIII. Express Conditions to this Application
Applicants agree that any order of the Commission granting the requested Relief will be
subject to the following conditions:54
ETF Relief.
1. Each Fund’s Prospectus will clearly disclose that, for purposes of the Act, Fund Shares are
issued by the Funds and that the acquisition of Shares by investment companies is subject to the
restrictions of Section 12(d)(1) of the Act, except as permitted by an exemptive order that permits
registered investment companies to invest in a Fund beyond the limits in Section 12(d)(1), subject
to certain terms and conditions, including that the registered investment company enter into an
Acquiring Fund Agreement with the Fund regarding the terms of the investment.
2. As long as the Trust operates in reliance on the requested order, Fund Shares will be
listed on an Exchange.
3. Neither the Trust nor any Fund will be advertised or marketed as an open-end investment
company or a mutual fund. Each Fund’s Prospectus will prominently disclose that Fund Shares are
not individually redeemable shares and will disclose that the owners of Fund Shares may acquire
those Fund Shares from a Fund and tender those Fund Shares for redemption to a Fund only in
Creation Unit Aggregations. Any advertising material that describes the purchase or sale of
Creation Unit Aggregations or refers to redeemability will prominently disclose that Fund Shares
are not individually redeemable and that owners of Fund
78
Shares may acquire those Fund Shares from a Fund and tender those Fund Shares for redemption
to a Fund in Creation Unit Aggregations only.
4. The website for the Trust, which will be publicly accessible at no charge, will contain the
following information, on a per Fund Share basis, for each Fund: (a) the prior Business Day’s NAV
and the reported closing price, and a calculation of the premium or discount of such closing price
against such NAV; and (b) data in chart format displaying the frequency distribution of discounts
and premiums of the daily closing price against the NAV, within appropriate ranges, for each of the
four previous calendar quarters (or the life of the Fund, if
shorter).
5. The Prospectus and annual
report for each Fund will also include: (a) the information listed in condition 4(b), (i) in the
case of the Prospectus, for the most recently completed year (and the most recently completed
quarter or quarters, as applicable) and (ii) in the case of the annual report, for the immediately
preceding five years, as applicable; and (b) the following data, calculated on a per Fund Share
basis for one, five and ten year periods (or life of the Fund): (i) the cumulative total return
and the average annual total return based on NAV and closing price, and (ii) the cumulative total
return of the relevant Underlying Index.
6. The requested relief to permit ETF operations will expire on the effective date, of any
Commission rule under the Act that provides relief permitting the operation of index-based
exchange-traded funds.
12(d)(1) Relief
Applicants agree that any Order granting the requested 12(d)(1) Relief will be subject to the
following conditions:
7. The members of the Acquiring Fund’s Advisory Group will not control (individually or in the
aggregate) a Fund within the meaning of Section 2(a)(9) of the Act. The
79
members of an Acquiring Fund’s Subadvisory Group will not control (individually or in the
aggregate) a Fund within the meaning of Section 2(a)(9) of the Act. If, as a result of a decrease
in the outstanding voting securities of a Fund, the Acquiring Fund’s Advisory Group or the
Acquiring Fund’s Subadvisory Group, each in the aggregate, becomes a holder of more than 25 percent
of the outstanding voting securities of a Fund, it will vote its Fund Shares in the same proportion
as the vote of all other holders of the Fund Shares. This condition does not apply to an Acquiring
Fund Subadvisory Group with respect to a Fund for which the Acquiring Fund Subadviser or a person
controlling, controlled by, or under common control with the Acquiring Fund Subadviser acts as the
investment adviser within the meaning of Section 2(a)(20)(A) of the Act.
8. No Acquiring Fund or Acquiring Fund Affiliate will cause any existing or potential
investment by the Acquiring Fund in a Fund to influence the terms of any services or transactions
between the Acquiring Fund or an Acquiring Fund Affiliate and the Fund or a Fund Affiliate.
9. The board of directors or trustees of an Acquiring Management Company, including a majority
of the disinterested directors or trustees, will adopt procedures reasonably designed to ensure
that the Acquiring Fund Adviser and any Acquiring Fund Subadviser are conducting the investment
program of the Acquiring Management Company without taking into account any consideration received
by the Acquiring Management Company or an Acquiring Fund Affiliate from a Fund or a Fund Affiliate
in connection with any services or transactions.
10. Once an investment by an Acquiring Fund in Fund Shares exceeds the limits in Section
12(d)(1)(A)(i) of the Act, the Board, including a majority of the disinterested directors/trustees,
will determine that any consideration paid by the Fund to an Acquiring Fund
80
or an Acquiring Fund Affiliate in connection with any services or transactions: (i) is fair
and reasonable in relation to the nature and quality of the services and benefits received by the
Fund; (ii) is within the range of consideration that the Fund would be required to pay to another
unaffiliated entity in connection with the same services or transactions; and (iii) does not
involve overreaching on the part of any person concerned. This condition does not apply with
respect to any services or transactions between a Fund and its investment adviser(s), or any person
controlling, controlled by or under common control with such investment adviser(s).
11. No Acquiring Fund or Acquiring Fund Affiliate (except to the extent it is acting in its
capacity as an investment adviser to a Fund) will cause the Fund to purchase a security in any
Affiliated Underwriting.
12. The Board, including a majority of the independent trustees, will adopt procedures
reasonably designed to monitor any purchases of securities by the Fund in an Affiliated
Underwriting, once an investment by an Acquiring Fund in the securities of the Fund exceeds the
limit of Section 12(d)(1)(A)(i) of the Act, including any purchases made directly from an
Underwriting Affiliate. The Board will review these purchases periodically, but no less frequently
than annually, to determine whether the purchases were influenced by the investment by the
Acquiring Fund in the Fund. The Board will consider, among other things: (i) whether the
purchases were consistent with the investment objectives and policies of the Fund; (ii) how the
performance of securities purchased in an Affiliated Underwriting compares to the performance of
comparable securities purchased during a comparable period of time in underwritings other than
Affiliated Underwritings or to a benchmark such as a comparable market index; and (iii) whether the
amount of securities purchased by the Fund in Affiliated Underwritings and the amount purchased
directly from an Underwriting Affiliate have changed
81
significantly from prior years. The Board will take any appropriate actions based on its
review, including, if appropriate, the institution of procedures designed to assure that purchases
of securities in Affiliated Underwritings are in the best interest of shareholders of the Fund.
13. Each Fund will maintain and preserve permanently in an easily accessible place a written
copy of the procedures described in the preceding condition, and any modifications to such
procedures, and will maintain and preserve for a period of not less than six years from the end of
the fiscal year in which any purchase in an Affiliated Underwriting occurred, the first two years
in an easily accessible place, a written record of each purchase of securities in Affiliated
Underwritings, once an investment by an Acquiring Fund in the securities of the Fund exceeds the
limit of Section 12(d)(1)(A)(i) of the Act, setting forth from whom the securities were acquired,
the identity of the underwriting syndicate’s members, the terms of the purchase, and the
information or materials upon which the determinations of the Board were made.
14. Before investing in Fund Shares in excess of the limits in Section 12(d)(1)(A), each
Acquiring Fund and the Fund will execute an Acquiring Fund Agreement stating, without limitation,
that their boards of directors or trustees and their investment adviser(s), or their Sponsors or
Trustees, as applicable, understand the terms and conditions of the Order, and agree to fulfill
their responsibilities under the Order. At the time of its investment in Fund Shares in excess of
the limit in Section 12(d)(1)(A)(i), an Acquiring Fund will notify the Fund of the investment. At
such time, the Acquiring Fund will also transmit to the Fund a list of the names of each Acquiring
Fund Affiliate and Underwriting Affiliate. The Acquiring Fund will notify the Fund of any changes
to the list of the names as soon as reasonably practicable after a change occurs. The Fund and the
Acquiring Fund will maintain and preserve a copy of
82
the Order, the Acquiring Fund Agreement, and the list with any updated information for the
duration of the investment and for a period of not less than six years thereafter, the first two
years in an easily accessible place.
15. The Acquiring Fund Adviser, Trustee or Sponsor, as applicable, will waive fees otherwise
payable to it by the Acquiring Fund in an amount at least equal to any compensation (including fees
received pursuant to any plan adopted under Rule 12b-1 under the Act) received from the Fund by the
Acquiring Fund Adviser, Trustee or Sponsor, or an affiliated person of the Acquiring Fund Adviser,
Trustee or Sponsor, other than any advisory fees paid to the Acquiring Fund Adviser, Trustee, or
Sponsor, or its affiliated person by the Fund, in connection with the investment by the Acquiring
Fund in the Fund. Any Acquiring Fund Subadviser will waive fees otherwise payable to the Acquiring
Fund Subadviser, directly or indirectly, by the Acquiring Management Company in an amount at least
equal to any compensation received from a Fund by the Acquiring Fund Subadviser, or an affiliated
person of the Acquiring Fund Subadviser, other than any advisory fees paid to the Acquiring Fund
Subadviser or its affiliated person by the Fund, in connection with any investment by the Acquiring
Management Company in the Fund made at the direction of the Acquiring Fund Subadviser. In the
event that the Acquiring Fund Subadviser waives fees, the benefit of the waiver will be passed
through to the Acquiring Management Company.
16. Any sales charges and/or service fees charged with respect to shares of an Acquiring Fund
will not exceed the limits applicable to a fund of funds as set forth in Conduct Rule 2830 of the
NASD.
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17. No Fund will acquire securities of any other investment company or company relying on
Section 3(c)(1) or 3(c)(7) of the Act in excess of the limits contained in Section 12(d)(1)(A) of
the Act, except to the extent permitted by exemptive relief from the Commission permitting the Fund to purchase shares of other investment companies for short-term cash management purposes.
18. Before approving any advisory contract under Section 15 of the Act, the board of directors
or trustees of each Acquiring Management Company, including a majority of the disinterested
directors or trustees, will find that the advisory fees charged under such advisory contract are
based on services provided that will be in addition to, rather than duplicative of, the services
provided under the advisory contract(s) of any Fund in which the Acquiring Management Company may
invest. These findings and their basis will be recorded fully in the minute books of the
appropriate Acquiring Fund.
IX. NAMES AND ADDRESSES
Pursuant to Rule 0-2(f) under the Act, the Applicants state that their address is as indicated
on the first page of this application. The Applicants further state that all written or oral
communications concerning this Application should be directed to:
W. John McGuire, Esq.
(202) 739-5654
Michael Berenson, Esq.
(202) 739-5450
Morgan, Lewis & Bockius LLP
1111 Pennsylvania Avenue, N.W.
Washington, D.C. 20004
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X. PROCEDURAL MATTERS, CONCLUSION AND SIGNATURES
Applicants file this Application in accordance with Rule 0-2 under the Act, and state that
their address is printed on the Application’s facing page, and that they request that all written
communications concerning the application be directed to the persons and address printed on the
application’s facing page. Also, Applicants have attached as exhibits to the Application the
required verifications.
In accordance with Rule 0-2(c) under the Act, Applicants state that all actions necessary to
authorize the execution and filing of this Application have been taken, and the persons signing and
filing this document are authorized to do so on behalf of the Applicants. Patrick Boyce is
authorized to sign and file this document on behalf of the Adviser pursuant to the general
authority vested in him as Chief Financial Officer of Strand Advisors, Inc., the Adviser’s general
partner. Michael J. Blackburn, Secretary of the Trust, is authorized to sign on behalf of the
Trust.
In accordance with Rule 0-5 under the Act, Applicants request that the Commission issue the
requested Order without holding a hearing.
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Based on the facts, analysis and conditions in the Application, Applicants respectfully
request that the Commission issue an Order under Sections 6(c) and 17(b) of the Act granting the
Relief requested by this Application.
Dated: June 22, 2010
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Highland Funds I
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By: |
/s/ Michael J. Blackburn
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Name: |
Michael J. Blackburn |
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Title: |
Treasurer |
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Highland Capital Management, L.P.
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By: |
Strand Advisors, Inc. Its general partner
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By: |
/s/ Patrick Boyce
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Name: |
Patrick Boyce |
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Title: |
Chief Financial Officer |
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Verification
The undersigned states that he has duly executed the attached Amended and Restated Application
dated July 1, 2010 for and on behalf of Highland Capital Management, L.P.; that he is the chief
financial officer of Strand Advisors, Inc., the general partner of such company; and that all
actions necessary to authorize the undersigned to execute and file such instrument have been
taken. The undersigned further states that he is familiar with such instrument, and the contents
thereof, and that the facts therein set forth are true to the best of his knowledge, information
and belief.
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Highland Capital Management, L.P.
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By: Strand Advisors, Inc. Its general partner
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By: |
/s/ Patrick Boyce
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Name: |
Patrick Boyce |
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Title: |
Chief Financial Officer |
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The undersigned states that he has duly executed the attached Amended and Restated Application
dated July 1, 2010 for and on behalf of Highland Funds I; that he is the treasurer of such
company; and that all actions necessary to authorize deponent to execute and file such instrument
have been taken. The undersigned further states that he is familiar with such instrument, and the
contents thereof, and that the facts therein set forth are true to the best of his knowledge,
information and belief.
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By: |
/s/ Michael J. Blackburn
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Name: |
Michael J. Blackburn |
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Title: |
Treasurer
Highland Funds I |
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EXHIBIT A – Description of Initial Fund and its Index
Markit Group Partners Indices
Highland/Markit Liquid Loan™ Index
The Fund seeks to provide investment results that, before fees and expenses, correspond generally
to the price and yield performance of an index that tracks the largest, most liquid issuers of
senior secured bank loans. The Fund uses a passive management strategy designed to track the total
return performance of a custom index used as a proxy for the senior secured loan universe. The
Index includes the largest most liquid loans as measured by the number of active market
participants trading the security and the dollar face amount of outstanding senior loans issued.
Inclusion requirement include consideration of a broad cross section of industries. In the event
there are no liquid bank loans in a given industry no issuers are selected. If there is only one
qualifying liquid loan in an industry it is the only position taken in that industry. The weighting
of the index corresponds within 5% of the liquid loan universe (as defined by loans having 6 or
more active market makers at the end of the measurement period).
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