[Federal Register Volume 62, Number 182 (Friday, September 19, 1997)]
[Notices]
[Pages 49270-49277]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-24968]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39076; File No. SR-CHX-97-06]


Order Granting Approval to Proposed Rule Change

September 15, 1997.
    Self-Regulatory Organizations; Order Granting Approval to 
Proposed Rule Change by the Chicago Stock Exchange, Inc., Relating 
to Listing and Trading Standards for Portfolio Depositary Receipts.

I. Introduction

    On March 17, 1997,\1\ the Chicago Stock Exchange, Inc. (``CHX'' or 
``Exchange'') submitted to the Securities and Exchange Commission 
(``Commission''), pursuant to section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \2\ and Rule 19b-4 thereunder,\3\ a 
proposed rule change to add Rule 25 to Article XXVIII of CHX's rules 
relating to the listing and trading of Portfolio Depository Receipts 
(``PDRs'').
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    \1\ On June 4, 1997, the Exchange filed Amendment No. 1 to this 
rule filing. Amendment No. 1 supersedes entirely the Exchange's rule 
filing and was incorporated into the notice in its entirety. On June 
17, 1997 and June 24, 1997, the Exchange filed Amendment Nos. 2 and 
3 respectively; Amendment No. 3 replaces Amendment No. 2 in its 
entirety and the substance of Amendment No. 3 was incorporated into 
the notice. See letter from J. Craig Long, Attorney, Foley & 
Lardner, to Ivette Lopez, Assistant Director, Market Regulation, 
Commission, dated May 27, 1997 (``Amendment No. 1'') and letters 
from David T. Rusoff, Attorney, Foley & Lardner, to Sharon Lawson, 
Senior Special Counsel, Market Regulation, Commission, dated June 
13, 1997 (``Amendment No. 2'') and June 18, 1997 (``Amendment No. 
3'') respectively.
    \2\ 15 U.S.C. 78s(b)(1).
    \3\ 17 CFR 240.19b-4.
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    The proposed rule change as amended by Amendment Nos. 1, 2, and 3, 
together with the substance of the proposal, was published for comment 
in Securities Exchange Act Release No. 38777 (June 26, 1997) 62 FR 
35866 (July 2, 1997). One comment letter was received in response to 
the proposal.\4\
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    \4\ See Letter from James F. Duffy, Executive Vice President and 
General Counsel, Legal and Regulatory Policy, American Stock 
Exchange, to Jonathan G. Katz, Secretary, Commission, dated July 31, 
1997 (``Amex Comment Letter'').
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II. Background and Description

    The Exchange proposes to adopt new Rule 25 under Article XXVIII to 
accommodate the trading of PDRs, securities which are interests in a 
unit investment trust (``Trust'') holding a

[[Page 49271]]

portfolio of securities linked to an index. Each Trust will provide 
investors with an instrument that: (i) Closely tracks the underlying 
portfolio of securities, (ii) trades like a share of common stock, and 
(iii) pays holders of the instrument periodic dividends proportionate 
to those paid with respect to the underlying portfolio of securities, 
less certain expenses (as described in the Trust prospectus).
    Under the proposal, the exchange may list and trade, or trade 
pursuant to unlisted trading privileges (``UTP''), PDRs based on one or 
more stock indexes or securities portfolios. PDRs based on each 
particular stock index or portfolio shall be designated as a separate 
series and identified by a unique symbol. The stocks that are included 
in an index or portfolio on which PDRs are based shall be selected by 
the Exchange, or by such other person as shall have a proprietary 
interest in and authorized use of such index or portfolio, and may be 
revised as deemed necessary or appropriate to maintain the quality and 
character of the index or portfolio. As discussed in more detail below, 
CHX intends to trade two existing PDRs currently traded on the American 
Stock Exchange (``Amex'')--Standard & Poor's Depositary Receipts 
(``SPDRs'') and Standard & Poor's MidCap 400 Depositary Receipts 
(``MidCap SPDRs'')--pursuant to UTP upon approval of these listing 
standards. CHX is not asking for permission to list SPDRs or MidCap 
SPDRs at this time, but rather will trade SPDRs and MidCap SPDRs 
pursuant to unlisted trading privileges once the generic listing 
standards set forth herein are approved. Pursuant to Rule 12f-5 under 
the Act, in order to trade a particular class or type of security 
pursuant to unlisted trading privileges, CHX must have rules providing 
for transactions in such class or type of security. The Amex has 
enacted listing standards for PDRs, and CHX's proposed rule change is 
designed to create similar standards for PDR listing and/or trading on 
CHX.
    If at a later time CHX and the issuer of the product desire to list 
SPDRs and MidCap SPDRs or any other PDRs on the Exchange, the Exchange 
will request Commission approval for that listing in a separate 
proposed rule change filed pursuant to Section 19(b)of the Act.\5\ 
Additionally, in the event a new PDR is listed on another exchange 
using listing standards that are different than current CHX listing 
standards or the CHX listing standards proposed in this filing, the CHX 
will file a proposed rule change pursuant to Section 19(b) of the Act 
to adopt the listing standard before it trades that PDR pursuant to 
unlisted trading privileges.
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    \5\ The Commission notes that CHX, if it were to file a proposed 
rule change to list and trade a new PDR, would have to request the 
appropriate exemptions for the new product under the Investment 
Company Act of 1940 (``Investment Company Act'') (such as those 
exemptions requested for SPDRs and MidCap SPDRs), such an exemption 
from Investment Company Act Section 22(d) and Rule 22c-1 thereunder 
to allow the PDR to trade in the secondary market.
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Criteria for Initial and Continued Listing

    In connection with an initial listing, the Exchange proposes that, 
for each Trust of PDRs, the Exchange will establish a minimum number of 
PDRs required to be outstanding at the time of commencement of Exchange 
trading, and such minimum number will be filed with the Commission in 
connection with any required submission under Rule 19b-4 for each 
Trust. If the Exchange trades a particular PDR pursuant to unlisted 
trading privileges, the Exchange will follow the listing exchange's 
determination of the appropriate minimum number.
    Because the Trust operates an open-end type basis, and because the 
number of PDR holders is subject to substantial fluctuations depending 
on market conditions, the Exchange believes it would be inappropriate 
and burdensome on PDR holders to consider suspending trading in or 
delisting a series of PDRs, with the consequent termination of the 
Trust, unless the number of holders remains severely depressed during 
an extended time period. Therefore, twelve months after the formation 
of a Trust and commencement of Exchange trading, the Exchange will 
consider suspension of trading in, or removal from listing of, a Trust 
when, in its opinion, further dealing in such securities appears 
unwarranted under the following circumstances:
    (a) If the Trust on which the PDRs are based has more than 60 days 
remaining until termination and there have been fewer than 50 record 
and/or beneficial holders of the PDRs for 30 or more consecutive 
trading days; or
    (b) If the index on which the Trust is based is no longer 
calculated, or
    (c) If such other event shall occur or condition exists which, in 
the opinion of the Exchange, makes further dealings on the Exchange 
inadvisable.
    A Trust shall terminate upon removal from Exchange listing and its 
PDRs will be redeemed in accordance with provisions of the Trust 
prospectus. A Trust may also terminate under such other conditions as 
may be set forth in the Trust prospectus. For example, the sponsor of 
the Trust (``Sponsor''), following notice to PDR holders, shall have 
discretion to direct that the Trust be terminated if the value of 
securities in such Trust falls below a specified amount.

Trading of PDRs

    Dealings in PDRs on the Exchange will be conducted pursuant to the 
Exchange's general agency-auction trading rules. The Exchange's general 
dealing and settlement rules will apply, including its rules on 
clearance and settlement of securities transactions and its equity 
margin rules. Other generally applicable Exchange equity rules and 
procedures will also apply, including, among others, rules governing 
the priority, parity and precedence of orders and the responsibilities 
of specialists.\6\
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    \6\ The Commission notes that CHX has stated its intention to 
file a proposed rule change in the near future in order to create a 
know-your-customer rule in which a member, before recommending a 
transaction in a security, would have to use due diligence to learn 
the essential facts relating to every customer, every order, and 
every account accepted by the member. Telephone call between Craig 
Long, Attorney, Foley & Lardner, Sharon Lawson, Senior Special 
Counsel, Market Regulation, Commission, and Heather Seidel, 
Attorney, Market Regulation, Commission, on July 29, 1997.
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    With respect to trading halts, the trading of PDRs will be halted, 
along with the trading of all other listed or traded stocks, in the 
event the ``circuit breaker'' thresholds of CHX Article IX, Rule 10A 
are reached. In addition, for PDRs tied to an index, the triggering of 
futures price limits for the Standard & Poor's 500 Composite Price 
Index (``S&P 500 Index''), Standard & Poor's 100 Composite Price Stock 
Index (``S&P 100 Index''), or Major Market Index (``MMI'') futures 
contracts will not, in itself, result in a halt in PDR trading or a 
delayed opening. However, the Exchange could consider such an event, 
along with other factors, such as a halt in trading in S&P 100 Index 
Options (``OEX''), S&P 500 Index Options (``SPX''), or MMI Options 
(``XMI''), in deciding whether to halt trading in PDRs.
    Under the proposed rule change, the Exchange will issue a circular 
to members informing them of Exchange policies regarding trading halts 
in such securities. The circular will make clear that, in addition to 
other factors that may be relevant, the Exchange may consider factors 
such as those set forth in Article XXXVI, Rule 19, the Exchange's rule 
governing trading halts for Basket trading (except that the term 
``Basket'' shall be replaced by ``stock index'') in exercising its 
direction to

[[Page 49272]]

halt or suspend trading. For a PDR based on an index, these factors 
would include whether trading has been halted or suspended in the 
primary market(s) for any combination of underlying stocks accounting 
for 20% or more of the applicable current index group value, or whether 
other unusual conditions or circumstances detrimental to the 
maintenance of a fair and orderly market are present.

Disclosure

    Proposed Rule 25 of Article XXVIII requires that members and member 
organizations provide to all purchasers of each series of PDRs a 
written description of the terms and characteristics of such 
securities, in a form approved by the Exchange, not later than the time 
a confirmation of the first transaction in such series of PDRs is 
delivered to such purchaser. In this regard, a member or member 
organization carrying an omnibus account for a non-member broker-dealer 
will be required to inform such non-member that execution of an order 
to purchase PDRs for such omnibus account will be deemed to constitute 
an agreement by the non-member to make such written description 
available to its customers on the same terms as are directly applicable 
to member and member organizations. The written description must be 
included with any sales material on that series of PDRs that a member 
provides to customers or the public. Moreover, other written materials 
provided by a member or member organization to customers or the public 
making specific reference to a series of PDRs as an investment vehicle 
must include a statement in substantially the following form: ``A 
circular describing the terms and characteristics of [the series of 
PDRs] is available from your broker. It is recommended that you obtain 
and review such circular before purchasing [the series of PDRs]. In 
addition, upon request you may obtain from your broker a prospectus for 
[the series of PDRs].'' Additionally, as noted above, the Exchange 
requires that members and member organizations provide customers with a 
copy of the prospectus for a series of PDRs upon request.
    With respect to disclosure, because SPDRs and MidCap SPDRs will be 
traded pursuant to unlisted trading privileges and will not be listed 
on CHX at this time, CHX does not intend to create its own product 
description to satisfy the requirements of proposed Rule 25(c) of 
Article XXVIII, which requires members to provide to purchasers, a 
written description of the terms and characteristics of SPDRs and 
MidCap SPDRs in a form approved by the Exchange. Instead, the CHX will 
deem a member or member organization to be in compliance with this 
requirement if the member delivers either: (i) The current product 
description produced by the Amex from time to time, or (ii) the current 
prospectus for the SPDR or MidCap SPDR, as the case may be.\7\ It will 
be the member's responsibility to obtain these materials directly from 
Amex \8\ for forwarding to purchasers in the time frames prescribed by 
CHX and Commission rules. The CHX will notify members and member 
organizations of this requirement in a notice to members.
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    \7\ CHX plans to notify its members in an information circular 
that it is their responsibility to inform customers of the nature 
and terms of SPDRs an MidCap SPDRs prior to recommending their 
purchase. The circular also states that members must deliver a SPDR 
or MidCap SPDR product description to all purchases of the products 
and that they must provide the prospectus upon request.
    \8\ The Commission notes that Amex, in its comment letter to 
this rule filing, stated that the Distributor does not have 
responsibility for disseminating the SPDR and MidCap SPDR product 
descriptions; therefore, CHX members cannot obtain the product 
description from the Distributor, as noted in the notice release, 
but can obtain its form Amex. See Amex Comment Letter, supra note 4, 
and Section III infra.
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    Notwithstanding the foregoing discussion concerning the 
applicability of the Exchange's equity trading rules to PDRs generally, 
the Intermarket Trading System (``ITS'') rules briefly will not be 
applicable to SPDRs and MidCap SPDRs traded on the CHX pursuant to 
unlisted trading privileges. Currently, ITS is being modified in order 
to accommodate trading in a minimum variation of \1/64\, but the 
changes are not yet complete. When such changes are made, which is 
expected in the near future, CHX intends to request that SPDRs and 
MidCap SPDRs be designated as ITS Securities. At such time as they are 
designated ITS securities, the ITS rules will apply to trading in SPDRs 
and MidCap SPDRs.
    The current inapplicability of the ITS rules means, among other 
things, that the ITS trade-through rule will not apply. However, the 
CHX's BEST Rule, Article XX, Rule 37(a), will still be applicable to 
SPDRs and MidCap SPDRs, thereby guaranteeing the execution of certain 
agency orders on the basis of the size and price associated with the 
best bid (for a sell order) or best offer (for a buy order) among the 
Amex, Boston, Cincinnati, Chicago, New York, Pacific, Philadelphia and 
the Intermarket Trading System/Computer Assisted Execution System 
quote, which quote is defined in SR-CHX-97-9 as the ``ITS BBO.'' \9\ 
Because SPDRs and MidCap SPDRs are not traded in all of these market 
centers,\10\ for purposes of this filing only, the ITS BBO is limited 
to those market centers listed above that trade SPDRs and MidCap 
SPDRs.\11\ For example, if a CHX specialist receives an agency limit 
order for a SPDR, so long as all of the eligibility requirements of the 
BEST Rule are met, the specialist will be required to execute that 
order if there has been a price penetration in the primary market. In 
addition, if the Amex specialist is disseminating the best quote for 
SPDRs, the CHX specialist will be required to execute eligible agency 
market orders for SPDRs at the price quoted on the Amex, even if the 
CHX specialist is not, himself, quoting at that price. The CHX SPDR and 
MidCap SPDR specialist will have the ability to monitor the current 
quotations being disseminated by the Amex specialist on a real-time 
basis. The quotations for SPDRs and MidCap SPDRs are disseminated 
through the Consolidated Quotation System and are available for viewing 
by the CHX specialist at his or her post. Finally, the CHX specialist 
will have access to the Amex through the Amex's PER System (albeit 
through a correspondent firm). This will enable the CHX specialist to 
place limit orders on the Amex specialist's book or send market orders 
to the Amex specialist for execution against the Amex specialist's 
quote. In its filing, CHX states that these factors should minimize the 
possibility that a

[[Page 49273]]

CHX originated trade-through will occur.
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    \9\ The Commission notes that SR-CHX-97-9, as amended to remove 
the phrase ``size and price associated with the'' from the filing, 
has become effective. See Securities Exchange Act Release No. 38772 
(June 25, 1997). In addition, CHX represents that it will submit a 
separate rule filing pursuant to Section 19(b)(2) of the Act further 
amending the BEST Rule to add size and price to the definition of 
the ITS/BBO. Phone conversation between David Rusoff, Attorney, 
Foley & Lardner, and David Sieradzki, Attorney, Market Regulation, 
Commission, on June 17, 1997.
    \10\ Currently SPDRs and MidCap SPDRs are only traded on Amex.
    \11\ Under the BEST Rule, Exchange specialists are required to 
guarantee executions of all agency market and limit orders for Dual 
Trading System issues from 100 up to and including 2099 shares. 
Subject to the requirements of the short sale rule, the specialist 
must fill all agency market orders at a price equal to or better 
than the ITS BBO. For all agency limit orders in Dual Trading System 
issues, the specialist must fill the order if: (1) The ITS BBO at 
the limit price has been exhausted in the primary market; (2) there 
has been a price penetration of the limit in the primary market 
(generally known as a trade-through of a CHX limit order); or (3) 
the issue is trading at the limit price on the primary market unless 
it can be demonstrated that the order would not have been executed 
if it had been transmitted to the primary market or the broker and 
specialist agree to a specific volume related to, or other criteria 
for, requiring a fill.
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SPDRs and MidCap SPDRs Generally

    As discussed above, rules to accommodate the trading of PDRs 
generally on Amex, along with Amex's trading of SPDRs and MidCap SPDRs, 
were previously approved by the Commission.\12\ The information 
provided below is intended to provide a description of how SPDRs and 
MidCap SPDRs are created and traded and is almost identical to that 
discussed in the original Amex Approval Order. The Sponsor of each 
series of PDRs traded on the Amex is PDR Services Corporation, a 
wholly-owned subsidiary of the Amex. The PDRs are issued by a Trust in 
a specified minimum aggregate quantity (``Creation Unit'') in return 
for a deposit consisting of specified numbers of shares of stock plus a 
cash amount.
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    \12\ See Securities Exchange Act Release No. 31591 (December 11, 
1992), 57 FR 60253 (December 18, 1992) (``Amex Approval Order'').
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    The first Trust to be formed in connection with the issuance of 
PDRs was based on the S&P 500 Index, known as Standard & Poor's 
Depositary Receipts (``SPDRs''). SPDRs have been trading on the Amex 
since January 29, 1993. The second Trust to be formed in connection 
with the issuance of PDRs was based on the S&P MidCap 400 Index,\13\ 
known as Standard & Poor's MidCap 400 Depositary Receipts (``MidCap 
SPDRs'').\14\ The Sponsor of the two Trusts has entered into trust 
agreements with a trustee in accordance with Section 26 of the 
Investment Company Act of 1940. PDR Distributors, Inc. 
(``Distributor'') acts as underwriter of both SPDRs and MidCap SPDRs on 
an agency basis. The Distributor is a registered broker-dealer, a 
member of the National Association of Securities Dealers, Inc., and a 
wholly-owned subsidiary of Signature Financial Group, Inc.
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    \13\ The S&P MidCap 400 Index is a capitalization-weighted index 
of 400 actively traded securities that includes issues selected from 
a population of 1,700 securities, each with a year-end market-value 
capitalization of between $200 million and $5 billion. The issues 
included in the Index cover a broad range of major industry groups, 
including industrials, transportation, utilities, and financials.
    \14\ See Securities Exchange Act Release No. 35534 (March 24, 
1995), 60 FR 16686 (March 31, 1995) (``Amex MidCap Approval 
Order'').
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SPDR and MidCap SPDR Creation

    All orders to create SPDRs or MidCap SPDRs in creation unit size 
must be placed with the Distributor, and it is the responsibility of 
the Distributor to transmit such orders to the Trustee.\15\ Payment 
with respect to creation orders placed through the Distribution will be 
made by: (1) The ``in-kind'' deposit with the Trustee of a specified 
portfolio of securities that is formulated to mirror, to the extent 
practicable, the component securities of the underlying index or 
portfolio, and (2) a cash payment sufficient to enable the Trustee to 
make a distribution to the holders of beneficial interests in the Trust 
on the next dividend payment date as if all the securities had been 
held for the entire accumulation period for the distribution 
(``Dividend Equivalent Payment''), subject to certain specified 
adjustments. The securities and cash accepted by the trustee are 
referred to, in the aggregate, as a ``Portfolio Deposit.'' \16\ Upon 
receipt of a Portfolio Deposit in payment for a creation order placed 
through the Distributor as described above, the Trustee will issue a 
specified number of SPDRs or MidCap SPDRs, which aggregate numbers are 
referred to as a ``Creation Unit.'' Currently, a Creation Unit will be 
made up of 25,000 MidCap SPDRs or 50,000 SPDRs.\17\ Individual SPDRs or 
MidCap SPDRs can then be traded in the secondary market like other 
equity securities. Portfolio Deposits are expected to be made primarily 
by institutional investors, arbitragers, and the Exchange specialist. 
The price of SPDRs and MidCap SPDRs will be based on a current bid/
offer market. The minimum fraction for trading in SPDRs and MidCap 
SPDRs on Amex is \1/64\ths. The CHX has proposed this same minimum 
variation for the trading of SPDRs and MidCap SPDRs on CHX.
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    \15\ To be eligible to place orders to create MidCap SPDRs as 
described below, an entity or person either must be a participant in 
the Continuous Net Settlement (``CNS'') system of the National 
Securities Clearing Corporation (``NSCC'') or a Depository Trust 
Company (``DTC'') participant. Upon acceptance of an order to create 
MidCap SPDRs, the Distributor will instruct the Trustee to initiate 
the book-entry movement of the appropriate number of MidCap SPDRs to 
the account of the entity placing the order. MidCap SPDRs will be 
maintained in book-entry form at DTC.
    \16\ A Portfolio Deposit also will include a cash payment equal 
to a pro rata portion of the dividends accrued on the Trust's 
portfolio securities since the last dividend payment by the Trust, 
plus or minus an amount designed to compensate for any difference 
between the net asset value of the Portfolio Deposit and the 
underlying Index caused by, among other things, the fact that a 
Portfolio Deposit cannot contain fractional shares.
    \17\ The Trust will issue SPDRs in exchange for ``Portfolio 
Deposits'' of all of the S&P 500 Index securities, weighted 
according to their representation in the Index. The Trust is 
structured so that the net asset value of an individual SPDR should 
equal one-tenth of the value of the S&P 500 Index.
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    The Trustee or Sponsor will make available: (1) On a daily basis, a 
list of the names and required number of shares for each of the 
securities in the current Portfolio Deposit; (2) on a minute-by-minute 
basis throughout the day, a number representing the value (on a per 
SPDR or MidCap SPDR basis) of the securities portion of a Portfolio 
Deposit in effect on such day; and (3) on a daily basis, the 
accumulated dividends, less expenses, per outstanding SPDR or MidCap 
SPDR.\18\
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    \18\ The Trustee of the SPDR Trust will have the right to vote 
any of the voting stocks held by the Trust, and will vote such 
stocks of each issuer in the same proportion as all other voting 
shares of that issuer voted. Therefore, SPDR holders will not be 
able to directly vote the shares of the issuers underlying the 
SPDRs.
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Redemption of SPDRs and MidCap SPDRs

    SPDRs and MidCap SPDRs in Creation Unit size aggregations will be 
redeemable in kind by tendering them to the Trustee. While holders may 
sell SPDRs and MidCap SPDRs in the secondary market at any time, they 
must accumulate at least 50,000 (or multiples thereof) to redeem SPDRs 
or 25,000 (or multiples thereof) to redeem MidCap SPDRs through the 
Trust. SPDRs and MidCap SPDRs will remain outstanding until redeemed or 
until the termination of the Trust. Creation Units will be redeemable 
on any business day in exchange for a portfolio of the securities held 
by the Trust identical in weighting and composition to the securities 
portion of a Portfolio Deposit in effect on the date a request is made 
for redemption, together with a ``Cash Component'' (as defined in the 
Trust prospectus), including accumulated dividends, less expenses, 
through the date of redemption. The number of shares of each of the 
securities transferred to the redeeming holder will be the number of 
shares of each of the component stocks in a Portfolio Deposit on the 
day a redemption notice is received by the Trustee, multiplied by the 
number of Creation Units being redeemed. Nominal service fees may be 
charged in connection with the creation and redemption of Creation 
Units. The Trustee will cancel all tendered Creation Units upon 
redemption.\19\
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    \19\ An investor redeeming a Creation Unit will receive Index 
securities and cash identical to the Portfolio Deposit required of 
an investor wishing to purchase a Creation Unit on that particular 
day. Since the Trust will redeem in kind rather than for cash, the 
Trustee will not be forced to maintain cash reserves for 
redemptions. This should allow the Trust's resources to be committed 
as fully as possible to tracking the underlying Index, enabling the 
Trust to track the Index more closely than other basket products 
that must allocate a portion of their assets for cash redemptions.
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Distribution of SPDRs and MidCap SPDRs

    The SPDR Trust and the MidCap SPDR Trust pay dividends quarterly.

[[Page 49274]]

The regular quarterly ex-dividend date for SPDRs and MidCap SPDRs is 
the third Friday in March, June, September, and December, unless that 
day is a New York Stock Exchange holiday, in which case the ex-dividend 
date will be the preceding Thursday. Holders of SPDRs and MidCap SPDRs 
on the business day preceding the ex-dividend date will be entitled to 
receive an amount representing dividends accumulated through the 
quarterly dividend period preceding such ex-dividend date net of fees 
and expenses for such period. The payment of dividends will be made on 
the last Exchange business day in the calendar month following the ex-
dividend date (``Dividend Payment Date''). On the Dividend Payment 
Date, dividends payable for those securities with ex-dividend dates 
following within the period from the ex-dividend date most recently 
preceding the current ex-dividend date will be distributed. The Trustee 
will compute on a daily basis the dividends accumulated within each 
quarterly dividend period. Dividend payments will be made through DTC 
and its participants to all such holders with funds received from the 
Trustee.
    The MidCap SPDR Trust intends to make the DTC DRS available for use 
by MidCap SPDR holders through DTC participant brokers for reinvestment 
of their cash proceeds. The DTC DRS is also available to holders of 
SPDRs. Because some brokers may choose not to offer the DTC DRS, an 
interested investor would have to consult his or her broker to 
ascertain the availability of dividend reinvestment through that 
broker. The Trustee will use the cash proceeds of MidCap SPDR holders 
participating in the reinvestment to obtain the Index securities 
necessary to create the requisite number of SPDRs.\20\ Any cash 
remaining will be distributed pro rata to participants in the dividend 
reinvestment.
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    \20\ The creation of PDRs in connection with the DTC DRS 
represents the only circumstances under which PDRs can be created in 
other than Creation Unit size aggregations.
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III. Summary of Comments

    The Commission received one comment letter on the proposed rule 
change, from Amex.\21\ Amex commented on two aspects of the proposal, 
the requirement that CHX members deliver a product description to 
purchasers of PDRs no later than the time a confirmation is delivered 
to the purchasers, and on the trading of SPDRs and MidCap SPDRs 
pursuant to the ITS.
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    \21\ See supra note 4.
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    With regard to the first issue, Amex notes that CHX will not create 
its own product description but will deem its members in compliance 
with the delivery requirement if it delivers Amex's current product 
description or the current SPDR or MidCap SPDR prospectus, as 
applicable. CHX does not intend to supply these materials to its 
members but will require them to obtain the documents from Amex or the 
distributor of SPDRs and MidCap SPDRs.
    Amex states that is does not object to the occasional request for 
prospectuses and Product Descriptions made in connection with trades on 
CHX, but reserves the right to charge a reasonable amount for the 
materials, if it finds that the requests become burdensome.\22\ Amex 
also notes that the Distributor is not responsible for providing the 
Product Descriptions, that it is Amex's responsibility to provide the 
materials to Amex members in connection with the Exchange trading and 
compliance with Amex Rule 1000.
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    \22\ The Commission notes that any imposition of fees would have 
to be in compliance with the Act, including the filing requirements 
under Section 19(b) of the Act. See infra note 34 and accompanying 
text.
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    Second, while Amex acknowledges that SPDRs and MidCap SPDRs are not 
traded through ITS at this time because ITS cannot currently handle 
trading in \1/64\ths (the minimum increment for MidCap and SPDRs 
MidCap), it is concerned about the future application of ITS rules to 
trading of SPDRs and MidCap SPDRs due to ongoing modifications to ITS 
to permit commitments to trade in increments as small as \1/256\ths. 
Amex states that SPDRs and MidCap SPDRs be designated as ITS securities 
once these system changes are made. Amex states that while it has no 
objection to the use of ITS as an intermarket access mechanism for 
trading of SPDRs and MidCap SPDRs, it has serious concerns about the 
application of ITS trade through procedures to the trading of these 
products because of the nature of the product in that they are priced 
quite differently from common stocks
    Specifically, because of the extreme frequency of quotation changes 
in SPDRs and MidCap SPDRs, Amex believes that cancellation or 
expiration of ITS commitments in these products would pose 
proportionally greater market risk for market makers and investors than 
for other ITS securities because a price change is far more likely to 
occur before an ITS commitment can be resent. Amex also believes that 
because of the frequency of quotation changes in SPDRs and MidCap 
SPDRs, the Amex specialist must be able to receive very rapid 
confirmation that his commitment sent to another market through ITS has 
been executed, and that a one or two minute time frame (the time during 
which an ITS commitment is irrevocable) would subject all market 
participants to an unacceptable level of market risk in a market with 
rapid quotation changes. Amex states that it intends to address with 
the Commission and the ITS Operating Committee the ITS procedures that 
it believes must be changed to permit SPDRs to continue to trade as 
they were designed to trade.\23\
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    \23\ Additionally, Amex believes it is problematic to apply the 
current ITS trade-through rule to index-based securities such as 
SPDRs that trade in \1/64\th increments. In addition, Amex believes 
that the trade through rule's five minute time frame for making a 
compliant is inappropriately long for these securities.
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IV. Discussion

    The Commission finds that the proposed rule changes are consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities exchange, and, in 
particular, with the requirements of section 6(b)(5).\24\ The 
Commission believes that providing for the exchange-trading on CHX of 
PDRs, in general, and SPDRs and MidCap SPDRs, in particular, will offer 
investors an efficient way of participating in the securities markets. 
Specifically, the Commission believes that the trading on CHX of PDRs, 
in general, and SPDRs and MidCap SPDRs pursuant to unlisted trading 
privileges, in particular, will provide investors with increased 
flexibility in satisfying their investment needs by allowing them to 
purchase and sell a low-cost security replicating the performance of a 
broad portfolio of stocks at negotiated prices throughout the business 
day, and by increasing the availability of SPDRs and MidCap SPDRs as an 
investment tool. The Commission also believes that PDRs will benefit 
investors by allowing them to trade securities based on unit investment 
trusts in secondary market transactions.\25\ Accordingly, as discussed 
below, the proposed rule change is consistent with the requirements of 
Section 6(b)(5) that Exchange rules facilitate transactions in 
securities while continuing to further investor protection and the 
public interest.\26\
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    \24\ 15 U.S.C. 78f(b)(5).
    \25\ The Commission notes, however, that unlike open-end funds 
where investors have the right to redeem their fund shares on a 
daily basis, investors could only redeem PDRs in creation unit share 
sizes. nevertheless, PDRs would have the added benefit of liquidity 
from the secondary market and PDR holders, unlike holders of most 
other open-end funds, would be able to dispose of their shares in a 
secondary market transaction.
    \26\ In approving this rule, the Commission notes that it has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).

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[[Page 49275]]

    As the Commission noted in the orders approving SPDRs and MidCap 
SPDRs for listing and trading on Amex,\27\ the Commission believes that 
the trading on CHX of a security like PDRs in general, and SPDRs and 
MidCap SPDRs in particular, which replicate the performance of a broad 
portfolio of stocks, could benefit the securities markets by, among 
other things, helping to ameliorate the volatility occasionally 
experienced in these markets. The Commission believes that the creation 
of one or more products where actual portfolios of stocks or 
instruments representing a portfolio of stocks, such as PDRs, can trade 
at a single location in an auction market environment could alter the 
dynamics of program trading, because the availability of such single 
transaction portfolio trading could, in effect, restore the execution 
of program trades to more traditional block trading techniques.\28\
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    \27\ See supra notes 12 and 14.
    \28\ Program trading is defined as index arbitrage or any 
trading strategy involving the related purchase or sale of a 
``basket'' or group of fifteen or more stocks having a total market 
value of $1 million or more.
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    An individual SPDR has a value approximately equal to one-tenth of 
the value of the S&P 500 Index, and an individual MidCap SPDRs has a 
value of approximately one-fifth of the value of the S&P MidCap 400 
Index, making them more available and useful to individual retail 
investors desiring to hold a security replicating the performance of a 
broad portfolio of stocks. Accordingly, the Commission believes that 
trading of SPDRs and MidCap SPDRs on CHX will provide retail investors 
with a cost efficient means to make investment decisions based on the 
direction of the market as a whole and may provide market participants 
several advantages over existing methods of effecting program trades 
involving stocks.
    The Commission also believes that PDRs, in general, and SPDRs and 
MidCap SPDRs, in particular, will provide investors with several 
advantages over standard open-end S&P 500 Index and S&P MidCap 400 
Index mutual fund shares. In particular, investors will have the 
ability to trade PDRs continuously throughout the business day in 
secondary market transactions at negotiated prices.\29\ In contrast, 
pursuant to Investment Company Act Rule 22c-1,\30\ holders and 
prospective holders of open-end mutual fund shares are limited to 
purchasing or redeeming securities of the fund based on the net asset 
value of the securities held by the fund as designated by the board of 
directors.\31\ Accordingly, PDRs in general, and SPDRs and MidCap SPDRs 
in particular, will allow investors to (1) Respond quickly to changes 
in the market; (2) trade at a known price; (3) engage in hedging 
strategies not currently available to retail investors; and (4) reduce 
transaction costs for trading a portfolio of securities.
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    \29\ Because of potential arbitrage opportunities, the 
Commission believes that PDRs will not trade at a material discount 
or premium in relation to their net asset value. The mere potential 
for arbitrage should keep the market price of a PDR comparable to 
its net asset value, and therefore, arbitrage activity likely will 
be minimal. In addition, the Commission believes that Trust will 
tract the underlying index more closely than an open-end index fund 
because the Trust will accept only in-kind deposits, and, therefore, 
will not incur brokerage expenses in assembling its portfolio. In 
addition, the Trust will redeem on in kind, thereby enabling the 
Trust to invest virtually all of its assets in securities comprising 
the underlying index.
    \30\ Investment Company Act Rule 22c-1 generally requires that a 
registered investment company issuing a redeemable security, its 
principal underwriter, and dealers in that security, may sell, 
redeem, or repurchase the security only at a price based on the net 
asset value next computed after receipt of an investor's request to 
purchase, redeem, or resell. The net asset value of a mutual fund 
generally is computed once daily Monday through Friday as designated 
by the investment company's board of directors. The Commission 
granted SPDRs and MidCap SPDRs and exemption from this provision in 
order to allow them to trade at negotiated prices in the secondary 
market. The Commission notes that CHX would need to apply for a 
similar exemption in the instance that it wishes to list and trade a 
new PDR because the exemptions are specific to SPDRs and MidCap 
SPDRs.
    \31\ Id.
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    Although PDRs in general, and SPDRs and MidCap SPDRs in particular, 
are not leveraged instruments, and, therefore, do not possess any of 
the attributes of stock index options, their prices will still be 
derived and based upon the securities held in their respective Trusts. 
In essence, SPDRs are equity securities that are priced off a portfolio 
of stocks based on the S&P 500 Index and MidCap SPDRs are equity 
securities that are priced off a portfolio of stocks based on the S&P 
MidCap 400 Index. Accordingly, the level of risk involved in the 
purchase or sale of a SPDR or MidCap SPDR (or a PDR in general) is 
similar to the risk involved in the purchase or sale of traditional 
common stock, with the exception that the pricing mechanism for SPDRs 
and MidCap SPDRs (and PDRs in general) is based on a basket of stocks. 
Nonetheless, the Commission has several specific concerns regarding the 
trading of these securities. In particular, PDRs raise disclosure, 
market impact, and secondary market trading issues that must be 
addressed adequately. As discussed in more detail below, and in the 
Amex Approval Order,\32\ the Commission believes CHX adequately 
addresses these concerns.
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    \28\ See supra note 12.
---------------------------------------------------------------------------

    The Commission believes that the CHX proposal contains several 
provisions that will ensure that investors are adequately apprised of 
the terms, characteristics, and risks of trading PDRs. As noted above, 
the proposal contains four aspects addressing disclosure concerns. 
First, CHX members must provide their customers trading PDRs with a 
written explanation of any special characteristics and risks attendant 
to trading such PDR securities (such as SPDRs or MidCap SPDRs), in a 
form approved by CHX. As discussed above, CHX's filing states that 
SPDRs and MidCap SPDRs product descriptions should be obtained from 
Amex. The Commission notes that although Amex commented on CHX's 
proposed method regarding the delivery of the SPDR and MidCap SPDR 
product descriptions, and reserved the right to charge CHX members for 
supplying the product description should the task become burdensome to 
Amex, Amex did not object to the underlying policy of CHX members 
obtaining the product description from Amex. The Commission believes 
that it is reasonable under the Act to allow CHX to require its members 
to obtain the product description for SPDRs and MidCap SPDRs from 
Amex.\33\ Amex might decide to impose a reasonable charge for this 
service.\34\ The Commission also notes that Amex states that the SPDR 
and MidCap SPDR product descriptions are only available from Amex, not 
the Distributor, and therefore CHX members cannot obtain them from the 
Distributor.
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    \33\ The Commission notes that the exemptions granted by the 
Commission under the Investment Company Act that permit the 
secondary market trading of SPDRs and MidCap SPDRs are specifically 
conditioned upon the customer disclosure requirements described 
above. Accordingly, CHX rules adequately ensue its members must 
deliver the current product description to all investors in SPDRs 
and MidCap SPDRs.
    \34\ The Commission notes that Amex would need to file proposed 
rule change under Section 19(b) of the Act in the event it decides 
to charge a fee for supplying the SPDR of MidCap SPDR product 
descriptions. The Commission notes that reasonable fees would have 
to be imposed on the member firms rather than the customers entitled 
to receive the prospectus or the product description.
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    Second, members and member organizations must include this written 
product description with any sales material relating to the series of 
PDRs that is provided to customers or the

[[Page 49276]]

public. Third, any other written materials provided by a member or 
member organization to customers or the public referencing PDRs as an 
investment vehicle must include a statement, in a form specified by 
CHX, that a circular and prospectus are available from a broker upon 
request. Fourth, a member or member organization carrying an omnibus 
account for a non-member broker-dealer is required to inform such non-
member that execution of an order to purchase a series of PDRs for such 
omnibus account will be deemed to constitute agreement by the non-
member to make the written product description available to its 
customers on the same terms as member firms. Accordingly, the 
Commission believes that investors in PDR securities, in general, and 
SPDRs and MidCap SPDRs, in particular, will be provided with adequate 
disclosure of the unique characteristics of the PDR instruments and 
other relevant information pertaining to the instruments.
    Finally, under CHX's proposal there will be no special account 
opening or customer suitability rules applicable to the trading of 
PDRs.\35\ Nevertheless, pursuant to CHX Rules Article VIII, Rule 17, 
CHX's equity rule governing account opening will apply. In addition, 
the Commission notes that CHX intends to file a proposed rule change to 
create a rule that would require members, before recommending any 
transactions in securities, to use due diligence to learn the essential 
facts relative to every customer, every order, and every account 
accepted by the member. Upon adoption of this rule, it would apply to 
recommendations in PDRs generally, including transactions in SPDRs and 
MidCap SPDRs.
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    \35\ This reflects the fact that PDRs are equity products and 
not an options product, and, therefore, do not necessitate the 
imposition of options-like rules.
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    The Commission believes CHX has adequately addressed the potential 
market impact concerns raised by the proposal. First, CHX's proposal 
permits listing and trading of specific PDRs only after review by the 
Commission. Second, CHX has developed policies regarding trading halts 
in PDRs. Specifically, the Exchange would halt PDR trading if the 
circuit breaker parameters under CHX Article IX, Rule 10A were 
reached.\36\ In addition, in deciding whether to halt trading or 
conduct a delayed opening in PDRs, in general, and SPDRs and MidCap 
SPDRs, in particular, CHX represents that it will be guided by, but not 
necessarily bound to, relevant stock index option trading rules. 
Specifically, consistent with CHX Article XXXVI, Rule 19, CHX may 
consider whether trading has been halted or suspended in the primary 
market(s) for any combination of underlying stocks accounting for 20% 
or more of the applicable current index group value or whether other 
unusual conditions or circumstances detrimental to the maintenance of a 
fair and orderly market are present.
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    \36\ In addition, for PDRs tied to an index, the triggering of 
futures price limits for the S&P 500 Index, S&P 100 Index, or MMI 
futures contracts will not, in itself, result in a halt in PDR 
trading or a delayed opening. However, the Exchange could consider 
such an event, along with other factors, such as a halt in trading 
in OEX, SPX, or MMI options, in deciding whether to halt trading in 
PDRs.
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    The Commission believes that the trading of PDRs in general on CHX 
should not adversely impact U.S. securities markets. As to the trading 
of SPDRs and MidCap SPDRs pursuant to UTP, the Commission notes that 
the corpus of the SPDR Trust is a portfolio of stocks replicating the 
S&P 500 Index, a broad-based capitalization-weighted index consisting 
of 500 of the most actively-traded and liquid stocks in the U.S.. The 
corpus of the MidCap SPDR Trust is a portfolio of stocks replicating 
the S&P MidCap 400 Index, also a broad-based, capitalization-weighted 
index consisting of 400 actively traded and liquid U.S. stocks. In 
fact, as described above, the Commission believes SPDRs and MidCap 
SPDRs may provide substantial benefits to the marketplace and 
investors, including, among others, enhancing the stability of the 
markets for individual stocks.\37\ Accordingly, the Commission believes 
that SPDRs and MidCap SPDRs do not contain features that will make them 
likely to impact adversely the U.S. Securities markets, and that the 
addition of their trading on CHX pursuant to UTP could produce added 
benefits to investors through the increased competition between other 
market centers trading the product.
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    \37\ Even though PDR transactions may serve as substitutes for 
transactions in the cash market, and possibly make the order flow in 
individual stocks smaller than would otherwise be the case, the 
Commission acknowledges that during turbulent market conditions the 
ability of large institutions to redeem or create PDRs could 
conceivably have an impact on price levels in the cash market. In 
particular, if a PDR is redeemed, the resulting long stock position 
could be sold into the market, thereby depressing stock prices 
further. The Commission notes, however, that the redemption or 
creation of PDRs likely will not exacerbate a price movement because 
PDRs will be subject to the equity margin requirements of 50% and 
PDRs are non-leveraged instruments. In addition, as noted above, 
during turbulent market conditions, the Commission believes PDRs and 
SPDRs and MidCap SPDRs, in particular, will serve as a vehicle to 
accommodate and ``bundle'' order flow that otherwise would flow to 
the cash market, thereby allowing such order flow to be handled more 
efficiently and effectively. Accordingly, although PDRs and SPDRs 
and MidCap SPDRs could, in certain circumstances, have an impact on 
the cash market, on balance we believe the product will be 
beneficial to the marketplace and can actually aid in maintaining 
orderly markets.
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    Finally, the Commission notes that CHX has submitted surveillance 
procedures for the trading of PDRs, specifically SPDRs and MidCap 
SPDRs, and believes that those procedures, which incorporate and rely 
upon existing CHX surveillance procedures governing equities, are 
adequate under the Act.
    The Commission finds that CHX's proposal contains adequate rules 
and procedures to govern the trading of PDR securities, including 
trading SPDRs and MidCap SPDRs pursuant to UTP. Specifically, PDRs are 
equity securities that will be subject to the full panoply of CHX rules 
governing the trading of equity securities on CHX, including, among 
others, rules governing the priority, parity and precedence of orders 
and the responsibilities of specialists. In addition, CHX has developed 
specific listing and delisting criteria for PDRs that will help to 
ensure that the markets for PDRs will be deep and liquid. As noted 
above, CHX's proposal provides for trading halt procedures governing 
PDRs. Finally, the Commission notes that CHX has stated its intention 
to file a rule requiring members, prior to recommending a transaction 
in any security, to use due diligence to learn the essential facts 
relative to the customer, every order, and every account accepted by 
the member.
    As mentioned earlier, the trading of SPDRs and MidCap SPDRs will 
not be subject to ITS for a brief period of time until ITS can 
accommodate trading in increments of 1/64ths. In most instances, the 
Commission would predicate the trading of an equity product on more 
than one exchange on application of relevant ITS rules and procedures. 
In this instance, however, the delay in ITS implementation will be very 
brief.\38\ The Commission believes that the procedures specified by CHX 
to replace the ITS trade-through rule during this brief period will 
help ensure that a customer receives the best price for a transaction 
in SPDRs or MidCap SPDRs among the market centers that

[[Page 49277]]

trade the products. In particular, CHX's BEST Rule, which will apply to 
the trading of SPDRs and MidCap SPDRs, guarantees the execution of 
agency orders from 100 shares up to 2099 shares at the best bid or 
offer on any ITS market center that trades SPDRs and MidCap SPDRs. In 
addition, CHX specialists will have the ability to monitor the current 
SPDR and MidCap SPDR quotations disseminated by Amex through the 
Consolidated Quotation System. Finally, CHX specialists will have the 
ability to place limit orders on the Amex specialist's book or send 
market orders to the Amex specialist for execution against the Amex 
specialist's quote, through Amex's PER System (although through a 
correspondent firm). Though not as efficient as full ITS access, these 
alternative procedures are reasonable given the very short time until 
ITS accepts 64ths.
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    \38\ The ITS Operating Committee has indicated that it will be 
able to accommodate 64ths after its September 18, 1997 meeting. 
Consequently, the discussion regarding alternatives to ITS will only 
need to be used for an extremely short period of time. If ITS cannot 
handle 64ths after the next meeting, the Commission still expects 
ITS to be made available for SPDRs for messages in increments of 
16ths or greater until ITS can accommodate 64ths.
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    The Commission believes that Amex's statements in its comment 
letter regarding the trading of SPDRs and MidCap SPDRs through ITS 
should be resolved, as the Amex letter suggests, through the proper ITS 
committee, not through Commission action on the CHX proposal. 
Otherwise, the ITS process could be used to prevent action on the CHX's 
proposal for competitive reasons.\39\
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    \39\ The Commission does not want to suggest that Amex's 
concerns are unfounded, but only that the proper venue for their 
resolution is the proper ITS committee, not the Rule 19b-4 process.
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\40\ that the proposed rule change (SR-CHX-97-6) is approved.
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    \40\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\41\
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    \41\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-24968 Filed 9-18-97; 8:45 am]
BILLING CODE 8010-01-M