[Federal Register Volume 77, Number 83 (Monday, April 30, 2012)]
[Notices]
[Pages 25514-25521]
[FR Doc No: 2012-10299]

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SECURITIES AND EXCHANGE COMMISSION

[Investment Company Act Release No. 30045; 812-13868]

Northern Trust Investments, Inc., et al.; Notice of Application

April 24, 2012.
AGENCY: Securities and Exchange Commission (``Commission'').

ACTION: Notice of an application for an order under section 6(c) of the
Investment Company Act of 1940 (``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, under sections 6(c) and 17(b) of the Act for an exemption from
sections 17(a)(1) and (a)(2) of the Act, and under section 12(d)(1)(J)
of the Act for an exemption from sections 12(d)(1)(A) and (B) of the
Act.

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Applicants: Northern Trust Investments, Inc. (``Northern Trust''),
FlexShares Trust (``Trust''), and Foreside Fund Services, LLC
(``Foreside'').

Summary of Application: Applicants request an order that permits: (a)
An actively managed series of the Trust to issue shares (``Shares'')
redeemable in large aggregations only (``Creation Units''); (b)
secondary market transactions in Shares to occur at negotiated market
prices; (c) certain series to pay redemption proceeds, under certain
circumstances, more than seven days from the tender of Shares for
redemption; (d) certain affiliated persons of the series to deposit
securities into, and receive securities from, the series in connection
with the purchase and redemption of Creation Units; (e) certain
registered management investment companies and unit investment trusts
outside of the same group of investment companies as the series to
acquire Shares; and (f) certain series to perform creations and
redemptions of Shares in-kind in a master-feeder structure.

DATES: Filing Dates: The application was filed on February 11, 2011,
and amended on August 8, 2011, January 11, 2012, March 9, 2012, and
April 23, 2012.

Hearing or Notification of Hearing:  An order granting the requested
relief will be issued unless the Commission orders a hearing.
Interested persons may request a hearing by writing to the Commission's
Secretary and serving applicants with a copy of the request, personally
or by mail. Hearing requests should be received by the Commission by
5:30 p.m. on May 21, 2012, and should be accompanied by proof of
service on applicants, in the form of an affidavit or, for lawyers, a
certificate of service. Hearing requests should state the nature of the
writer's interest, the reason for the request, and the issues
contested. Persons who wish to be notified of a hearing may request
notification by writing to the Commission's Secretary.

ADDRESSES: Secretary, U.S. Securities and Exchange Commission, 100 F
Street NE., Washington, DC 20549-1090. Applicants, c/o Northern Trust
Investments, Inc., 50 S. LaSalle Street, Chicago, IL 60603.

FOR FURTHER INFORMATION CONTACT: Courtney S. Thornton, Senior Counsel,
at<PHONE_NUMBER> or Mary Kay Frech, Branch Chief, at<PHONE_NUMBER>
(Division of Investment Management, Office of Investment Company
Regulation).

SUPPLEMENTARY INFORMATION: The following is a summary of the
application. The complete application may be obtained via the
Commission's Web site by searching for the file number, or an applicant
using the Company name box, at http://www.sec.gov/search/search.htm or
by calling<PHONE_NUMBER>.

Applicants' Representations

    1. The Trust is a statutory trust organized under the laws of the
state of Maryland and is registered under the Act as an open-end
management investment company. Subject to market conditions, the
initial series of the Trust (``Initial Fund'') will be FlexShares
Liquid Access Fund, which seeks to achieve its investment objective by
investing in a non-diversified portfolio of fixed income instruments,
including bonds, debt securities and other similar instruments issued
by U.S. and non-U.S. public and private sector entities.
    2. Northern Trust is an Illinois state bank registered as an
investment adviser under the Investment Advisers Act of 1940 (the
``Advisers Act'') and will be the investment adviser to the Initial
Fund. Subject to approval by the board of trustees (``Board'') of the
Trust, Northern Trust, or any entity controlling, controlled by, or
under common control with Northern Trust (collectively with Northern
Trust, the ``Adviser'') will advise the Funds (as defined below). The
Adviser may enter into subadvisory agreements with one or more
investment advisers to serve as subadvisers to a Fund (each, a
``Subadviser''). Any Subadviser will be registered under the Advisers
Act.
    3. The Trust may enter into a distribution agreement with one or
more distributors (each a ``Distributor''). Foreside, a Delaware
limited liability company, is expected to serve as Distributor of the
Initial Fund. Foreside is, and each Distributor will be, a broker-
dealer (``Broker'') registered under the Securities Exchange Act of
1934 (``Exchange Act''). No Distributor is or will be affiliated with
any national securities exchange as defined in section 2(a)(26) of the
Act (``Stock Exchange''). A Distributor may be an ``affiliated
person,'' within the meaning of section 2(a)(3) of the Act, of the
Adviser or any Subadviser.
    4. Applicants are requesting relief to permit the Trust to create
and operate certain actively managed series of the Trust that offer
Shares with limited redeemability (``ETF Relief'') and to operate
certain series in a master-feeder

structure. Applicants request that the ETF Relief also apply to future
series of the Trust and to other open-end management companies that (a)
utilize active management investment strategies, (b) are advised by the
Adviser, and (c) comply with the terms and conditions of the order
(``Future Funds,'' together with the Initial Fund, ``Funds''). Each
Fund will operate as an exchanged-traded fund (``ETF'').\1\
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    \1\ All entities that currently intend to rely on the order are
named as applicants. Any other entity that relies on the order in
the future will comply with the terms and conditions of the
application.
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    5. Applicants also request that the order permit certain investment
companies registered under the Act to acquire Shares of Funds beyond
the limitations in section 12(d)(1)(A) and permit certain Funds, and
any Distributor for the Funds, and any Broker to sell Shares beyond the
limitations in section 12(d)(1)(B) (``Fund of Funds Relief'').
Applicants request that any exemption under section 12(d)(1)(J) from
sections 12(d)(1)(A) and (B) for Fund of Funds Relief apply to any Fund
and each management investment company or unit investment trust
registered under the Act that is not part of the same ``group of
investment companies'' as the Funds within the meaning of section
12(d)(1)(G)(ii) of the Act and that enters into an FOF Participation
Agreement (as defined below) with a Fund (such management investment
companies are referred to as ``Purchasing Management Companies,'' such
unit investment trusts are referred to as ``Purchasing Trusts,'' and
Purchasing Management Companies and Purchasing Trusts are collectively
referred to as ``Purchasing Funds'').\2\ Purchasing Funds do not
include the Funds. The Fund of Funds Relief would not apply to any Fund
that is, either directly or through a master-feeder structure,
acquiring 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 in
section 12(d)(1)(A) of the Act.
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    \2\ Each Purchasing Management Company will be advised by an
investment adviser within the meaning of section 2(a)(20)(A) of the
Act (``Purchasing Fund Adviser'') and may be sub-advised by
investment adviser(s) within the meaning of section 2(a)(20)(B) of
the Act (``Purchasing Fund Subadviser''). Any investment adviser to
a Purchasing Management Company will be registered as an investment
adviser or exempt from registration under the Advisers Act. Each
Purchasing Trust will have a sponsor (``Sponsor'').
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    6. Applicants further request that the order permit the Funds to
acquire shares of other registered investment companies managed by the
Adviser having substantially the same investment objectives as the Fund
(``Master Funds'') beyond the limitation in section 12(d)(1)(A) and
permit the Master Funds, and any principal underwriter for the Master
Funds, to sell shares of the Master Funds to the Funds beyond the
limitations in section 12(d)(1)(B) (``Master-Feeder Relief''). A Future
Fund may invest in a Master Fund instead of directly holding underlying
securities. Applicants may structure certain Funds as feeder funds in a
master-feeder structure (``Feeder Funds'') to generate economies of
scale and tax efficiencies for shareholders of all series of the Master
Fund that could not otherwise be realized. There would be no ability by
Fund shareholders to exchange Shares of Feeder Funds for shares of
another feeder series of the Master Fund.
    7. Future Funds may invest, either directly or through a Master
Fund, in equity securities (``Equity Funds'') or fixed income
securities \3\ (``Fixed Income Funds'') traded in the U.S. or non-U.S.
markets and also may hold short positions in securities (``Short
Positions''). Funds that invest, either directly or through a Master
Fund, in foreign equity and/or fixed income securities are ``Foreign
Funds.'' Funds that invest, either directly or through a Master Fund,
in foreign and domestic equity securities are ``Global Equity Funds.''
Funds that invest directly in foreign and domestic fixed income
securities, either directly or through a Master Fund, are ``Global
Fixed Income Funds'' (and together with the ``Global Equity Funds,
``Global Funds''). The term ``Domestic Funds'' includes any Equity Fund
or Fixed Income Fund that invests, either directly or through a Master
Fund, in domestic equity and/or fixed income securities.
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    \3\ Fixed income securities may include ``to-be-announced
transactions'' (``TBA Transactions''). 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.
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    8. Each Fund may invest in depositary receipts representing foreign
securities in which they seek to invest (``Depositary Receipts''),
including American Depositary Receipts (``ADRs'') and Global Depositary
Receipts (``GDRs''). Depositary Receipts are typically issued by a
financial institution (``Depositary'') and evidence ownership interests
in a security or a pool or securities (``Underlying Securities'') that
have been deposited with the Depositary.\4\ A Fund will not invest in
any Depositary Receipts that the Adviser or Subadviser deems to be
illiquid or for which pricing information is not readily available. No
Fund (or its respective Master Fund, if any) will invest in options
contracts, futures contracts or swap agreements.
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    \4\ With respect to ADRs, the Depositary 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 (``Securities Act'') on Form F-6. ADR trades occur either on a
Stock Exchange or off-exchange. Financial Industry Regulatory
Authority (``FINRA'') Rule 6620 requires all off-exchange
transactions in ADRs to be reported within 90 seconds and ADR trade
reports to be disseminated on a real-time basis. With respect to
GDRs, the Depositary may be a foreign or a U.S. entity, and the
Underlying Securities may have a foreign or a U.S. issuer. All GDRs
are sponsored and trade on a foreign exchange. No affiliated persons
of applicants or any Subadviser will serve as the depositary bank
for any Depositary Receipts held by a Fund.
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    9. Shares of each Fund will be purchased from the Trust only in
Creation Units through the Distributor on a continuous basis at net
asset value (``NAV'') next determined after an order in proper form is
received.\5\ Creation Units will be separable upon issue into
individual Shares, which will be listed and traded at negotiated prices
on a Stock Exchange. The Funds will issue Shares in Creation Units of
at least 25,000 Shares.
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    \5\ While the NAV of each Fund will normally be determined as of
the close of the regular trading session on the New York Stock
Exchange on each day that a Fund is open, including as required by
section 22(e) of the Act (``Business Day''), the NAV of each Fixed
Income Fund and Foreign Fund may be determined prior to 4:00 p.m.
Eastern Time on each Business Day.
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    10. Orders to purchase or redeem Creation Units may be placed by or
through an ``Authorized Participant,'' which is either (i) a Broker or
other participant in the continuous net settlement system of the
National Securities Clearing Corporation (``NSCC''), a clearing agency
registered with the Commission, or (ii) a participant in the Depository
Trust Company (``DTC''), which in either case has executed an agreement
with the Trust and the Distributor with respect to creations and
redemptions of Creation Units.
    11. Shares will be purchased and redeemed in Creation Units and
generally on an in-kind basis. Accordingly, except where the purchase
or redemptions will include cash under the limited circumstances
specified below, purchasers will be required to purchase Creation Units
by making an in-kind deposit of specified instruments (``Deposit
Instruments'') and shareholders redeeming their shares will receive an
in-kind transfer of specified instruments (``Redemption
Instruments'').\6\ On any given Business

Day, the names and quantities of the instruments that constitute the
Deposit Instruments and the names and quantities of the instruments
that constitute the Redemption Instruments will be identical, and these
instruments may be referred to, in the case of either a purchase or a
redemption, as the ``Creation Basket.'' In addition, the Creation
Basket will correspond pro rata to the positions in the Fund's
portfolio (including cash positions),\7\ except: (a) In the case of
bonds, for minor differences when it is impossible to break up bonds
beyond certain minimum sizes needed for transfer and settlement; (b)
for minor differences when rounding is necessary to eliminate
fractional shares or lots that are not tradeable round lots; \8\ or (c)
TBA Transactions, Short Positions or other positions that cannot be
transferred in kind \9\ will be excluded from the Creation Basket.\10\
If there is a difference between the NAV attributable to a Creation
Unit and the aggregate market value of the Creation Basket exchanged
for the Creation Unit, the party conveying instruments with the lower
value will also pay to the other an amount in cash equal to that
difference (``Cash Amount'').
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    \6\ In the case of a Fund that is part of a master-feeder
structure, the Fund will redeem shares from the appropriate master
portfolio and then deliver to the redeeming shareholder the
Redemption Instruments and Cash Amount (as defined below). The Funds
must comply with the federal securities laws in accepting Deposit
Instruments and satisfying redemptions with Redemption Instruments,
including that the Deposit Instruments and Redemption Instruments
are sold in transactions that would be exempt from registration
under the Securities Act. In accepting Deposit Instruments and
satisfying redemptions with Redemption Instruments 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.
    \7\ The portfolio used for this purpose will be the same
portfolio used to calculate the Fund's NAV for that Business Day.
    \8\ A tradeable round lot for a security will be the standard
unit of trading in that particular type of security in its primary
market.
    \9\ This includes instruments that can be transferred in kind
only with the consent of the original counterparty to the extent the
Fund does not intend to seek such consents.
    \10\ Because these instruments will be excluded from the
Creation Basket, their value will be reflected in the determination
of the Cash Amount (as defined below).
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    12. Purchases and redemptions of Creation Units may be made in
whole or in part on a cash basis, rather than in kind, solely under the
following circumstances: (a) To the extent there is a Cash Amount, as
described above; (b) if, on a given Business Day, the Fund announces
before the open of trading that all purchases, all redemptions, or all
purchases and redemptions on that day will be made entirely in cash;
(c) if, upon receiving a purchase or redemption order from an
Authorized Participant (as defined below), the Fund determines to
require the purchase or redemption, as applicable, to be made entirely
in cash; (d) if, on a given Business Day, the Fund requires all
Authorized Participants purchasing or redeeming Shares on that day to
deposit or receive (as applicable) cash in lieu of some or all of the
Deposit Instruments or Redemption Instruments, respectively, solely
because: (i) Such instruments are not eligible for transfer through
either the NSCC or the DTC; or (ii) in the case of Foreign or Global
Funds, such instruments are not eligible for trading due to local
trading restrictions, local restrictions on securities transfers or
other similar circumstances; or (e) if the Fund permits an Authorized
Participant to deposit or receive (as applicable) cash in lieu of some
or all of the Deposit Instruments or Redemption Instruments,
respectively, solely because: (i) Such instruments are, in the case of
the purchase of a Creation Unit, not available in sufficient quantity;
(ii) such instruments are not eligible for trading by an Authorized
Participant or the investor on whose behalf the Authorized Participant
is acting; or (iii) a holder of Shares of a Foreign or Global Fund
would be subject to unfavorable income tax treatment if the holder
receives redemption proceeds in kind.\11\
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    \11\ A ``custom order'' is any purchase or redemption of Shares
made in whole or in part on a cash basis in reliance on clause
(e)(i) or (e)(ii).
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    13. Each Business Day, before the open of trading on the Stock
Exchange, the Fund will cause to be published through the NSCC the
names and quantities of the instruments comprising the Creation Basket,
as well as the estimated Cash Amount (if any), for that day. The
published Creation Basket will apply until a new Creation Basket is
announced on the following Business Day, and there will be no intra-day
changes to the Creation Basket except to correct errors in the
published Creation Basket. The Stock Exchange will disseminate every 15
seconds during its regular trading hours an amount representing the sum
of the estimated Cash Amount plus the current value of the Deposit
Instruments, on a per Share basis.
    14. Purchasers of Shares in Creation Units may hold such Shares or
may sell such Shares into the secondary market. Shares will be listed
and traded on a Stock Exchange. The price of Shares trading on a Stock
Exchange will be based on a current bid/offer market. Transactions
involving the sale of Shares on a Stock Exchange will be subject to
customary brokerage commissions and charges.
    15. Applicants expect that purchasers of Creation Units will
include arbitrageurs and the lead market makers and/or designated
liquidity providers. Applicants expect that secondary market purchasers
of Shares will include both institutional and retail investors.\12\
Applicants state that arbitrage opportunities created by the ability to
continually purchase or redeem Creation Units at their NAV should
ensure that the Shares will not trade at a material discount or premium
in relation to their NAV. Beneficial owners of Shares may sell their
Shares in the secondary market, but must accumulate enough Shares to
constitute a Creation Unit in order to redeem through a Fund.
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    \12\ Shares will be registered in book-entry form only. DTC or
its nominee will be the registered owner of all outstanding Shares.
Beneficial ownership of Shares will be shown on the records of DTC
or DTC participants (``DTC Participants'').
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    16. Each Fund may impose a purchase or redemption transaction fee
(``Transaction Fee'') to protect existing shareholders from the
dilutive costs associated with the purchase or redemption of Creation
Units.\13\ The Distributor will be responsible for maintaining records
of both the orders placed with it and the confirmations of acceptance
furnished by it. The Distributor will deliver a confirmation and
prospectus (``Prospectus'') to the purchaser.
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    \13\ Where a Fund permits a purchaser to substitute cash in lieu
of depositing a portion of the requisite Deposit Instruments, the
purchaser may be assessed a higher Transaction Fee to offset the
cost to the Fund of purchasing such Deposit Instruments. In all
cases, such Transaction Fees will be limited in accordance with
requirements of the Commission applicable to management investment
companies offering redeemable securities.
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    17. Neither the Trust nor any Fund will be advertised or marketed
or otherwise held out as a traditional open-end investment company or a
mutual fund. Instead, each Fund will be marketed as an ``actively-
managed exchange-traded fund.'' \14\ All marketing materials that
describe the features or method of obtaining, buying or selling
Creation Units, or Shares traded on the Stock Exchange, or refer to

redeemability, will prominently disclose that Shares are not
individually redeemable shares and will disclose that the owners of
Shares may acquire those Shares from the Fund, or tender those Shares
for redemption to the Fund in Creation Units only. The same approach
will be followed in connection with shareholder reports and investor
educational materials issued or circulated in connection with the
Shares. Each Fund will provide copies of its semi-annual and annual
shareholder reports to DTC Participants for distribution to beneficial
owners of Shares.
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    \14\ As noted above, certain Funds may operate as Feeder Funds
in a master-feeder structure. Under such circumstances, the Funds
would operate, and would be marketed, as ETFs. The respective Master
Funds would operate as mutual funds, but would not be publicly
offered or marketed. Applicants do not believe the master-feeder
structure would be confusing to investors because any additional
feeder fund that is a traditional mutual fund or other pooled
investment vehicle would be marketed separately. Applicants state
that they will take steps to ensure that investors will understand
the differences between the Funds and any feeder funds.
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    18. The Trust will maintain a Web site that will be publicly
available and free of charge. The Web site will include each Fund's
Prospectus and other information about each Fund that is updated on a
daily basis, including the prior Business Day's NAV, closing market
price or reported midpoint of ``bid and ask'' at the time of
calculation of such NAV (``Bid/Ask Price''), and a calculation of the
premium or discount of the market closing price or Bid/Ask Price
against such NAV. Prior to the opening of the Stock Exchange on each
Business Day, the Trust will disclose on its Web site the identities
and quantities of the securities (``Fund Securities'') and other assets
held by each Fund, or its respective Master Fund,\15\ that will form
the basis of each Fund's NAV at the end of the Business Day.\16\
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    \15\ For Funds that are part of a master-feeder structure, the
Fund will disclose information about the securities and other assets
held by the Master Fund.
    \16\ Under accounting procedures followed by the Funds, trades
made on the prior Business Day (``T'') will be booked and reflected
in NAV on the current Business Day (``T+1''). Accordingly, the Funds
will be able to disclose at the beginning of the Business Day the
portfolio that will form the basis for the NAV calculation at the
end of the Business Day.
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Applicants' Legal Analysis

    1. Applicants request an order under section 6(c) of 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, 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) of the Act for an exemption from sections
12(d)(1)(A) and 12(d)(1)(B) of the Act.
    2. Section 6(c) of the Act 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, 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.
Section 17(b) of the Act authorizes the Commission to exempt a proposed
transaction from section 17(a) of the Act if evidence establishes that
the terms of the 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, and the proposed transaction is
consistent with the policies of the registered investment company and
the general provisions of the Act. Section 12(d)(1)(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)(1) if the exemption
is consistent with the public interest and the protection of investors.

Sections 5(a)(1) and 2(a)(32) of the Act

    3. Section 5(a)(1) of the Act defines an ``open-end company'' as a
management investment company that is offering for sale or has
outstanding any redeemable security of which it is the issuer. Section
2(a)(32) of the Act defines a redeemable security as any security,
other than short-term paper, under the terms of which the holder, upon
its presentation to the issuer, is entitled to receive approximately a
proportionate share of the issuer's current net assets, or the cash
equivalent. Because Shares will not be individually redeemable,
applicants request an order to permit the Trust to register as an open-
end management investment company and each Fund to issue and redeem
Shares in Creation Units only.\17\ Applicants state that investors may
purchase Shares in Creation Units and redeem Creation Units from each
Fund and that Creation Units are always redeemable in accordance with
the provisions of the Act. Applicants further state that because the
market price of Shares will be disciplined by arbitrage opportunities,
investors should be able to sell Shares in the secondary market at
prices that do not vary materially from their NAV.
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    \17\ The Master Funds will not require relief from sections
2(a)(32) and 5(a)(1) because the Master Funds will issue
individually redeemable securities.
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Section 22(d) of the Act and Rule 22c-1 Under the Act

    4. Section 22(d) of the Act, among other things, prohibits a dealer
from selling a redeemable security, which is currently being offered to
the public by or through a principal underwriter, except at a current
public offering price described in the prospectus. Rule 22c-1 under the
Act generally requires that a dealer selling, redeeming, or
repurchasing a redeemable security do so only at a price based on its
NAV. Applicants state that secondary market trading in Shares will take
place at negotiated prices, rather than at the current offering price
described in the Prospectus, and not at a price based on NAV. Thus,
purchases and sales of Shares in the secondary market will not comply
with section 22(d) of the Act and rule 22c-1 under the Act. Applicants
request an exemption under section 6(c) from these provisions.
    5. Applicants assert that the concerns sought to be addressed by
section 22(d) of the Act and rule 22c-1 under the Act with respect to
pricing are equally satisfied by the proposed method of pricing Shares.
Applicants maintain that while there is little legislative history
regarding section 22(d), its provisions, as well as those of rule 22c-
1, appear to have been designed to (a) Prevent dilution caused by
certain riskless-trading schemes by principal underwriters and contract
dealers, (b) prevent unjust discrimination or preferential treatment
among buyers resulting from sales at different prices, and (c) assure
an orderly distribution of investment company shares by eliminating
price competition from Brokers offering shares at less than the
published sales price and repurchasing shares at more than the
published redemption price.
    6. Applicants believe that none of these purposes will be thwarted
by permitting Shares to trade in the secondary market at negotiated
prices. Applicants state that (a) secondary market trading in Shares
would not cause dilution of an investment in Shares because such
transactions do not involve the Funds as parties, and (b) 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. Therefore, applicants assert that secondary market
transactions in Shares will not lead to discrimination or preferential
treatment among purchasers. Finally, applicants contend that the
proposed distribution system will be orderly because arbitrage activity
should ensure that the difference between NAV and the market price of
Shares remains narrow.

Section 22(e)

    7. Section 22(e) of the Act generally prohibits a registered
investment company from suspending the right of redemption or
postponing the date of payment of redemption proceeds for more than
seven days after the tender of

a security for redemption. Applicants observe that the settlement of
redemptions of Creation Units of the Foreign 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 Foreign or
Global Funds may invest. Applicants have been advised that, under
certain circumstances, the delivery cycles for transferring Redemption
Instruments to redeeming investors, coupled with local market holiday
schedules, will require a delivery process of up to 14 calendar days.
Applicants therefore request relief under section 6(c) of the Act 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 Fund Securities of each Foreign or Global Fund
customarily clear and settle, but in all cases no later than 14 days
following the tender of a Creation Unit.\18\ At all other times and
except as disclosed in the relevant Statement of Information (``SAI''),
applicants expect that each Foreign or Global Fund will be able to
deliver redemption proceeds within seven days. Applicants do not
believe the master-feeder structure would have any impact on the
delivery cycle.
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    \18\ 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.
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    8. Applicants submit that Congress adopted section 22(e) to prevent
unreasonable, undisclosed or unforeseen delays in the actual payment of
redemption proceeds. Applicants state that allowing in-kind redemption
payments for Creation Units of a Foreign or Global Fund, and any
respective Master Fund, to be made within the number of days indicated
above would not be inconsistent with the spirit and intent of section
22(e).\19\ Applicants state that the SAI for each Foreign or Global
Fund will disclose those local holidays (over the period of at least
one year following the date of the SAI), if any, that are expected to
prevent the delivery of in-kind redemption proceeds in seven calendar
days and the maximum number of days, up to 14 calendar days, needed to
deliver the proceeds for each affected Foreign or Global Fund.
Applicants are not seeking relief from section 22(e) with respect to
Foreign Funds or Global Funds effecting redemptions on a cash basis.
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    \19\ Other feeder funds invested in any Master Fund are not
seeking, and will not rely on, the section 22(e) relief requested
herein.
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Section 12(d)(1)

    9. Section 12(d)(1)(A) of the Act prohibits a registered investment
company from acquiring shares of an investment company if the
securities represent more than 3% of the total outstanding voting stock
of the acquired company, more than 5% of the total assets of the
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)(1)(B) of the Act prohibits a
registered open-end investment company, its principal underwriter, or
any other broker or dealer from selling its 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.
    10. Applicants request relief to permit Purchasing Funds to acquire
Shares of a Fund beyond the limits of section 12(d)(1)(A) of the Act.
Applicants also seek an exemption to permit the Funds and/or a Broker
to sell Shares to Purchasing Funds beyond the limits of section
12(d)(1)(B).
    11. Applicants assert that the proposed transactions will not lead
to any of the abuses that section 12(d)(1) was designed to prevent.
Applicants submit that the proposed conditions to the requested relief
address the concerns underlying the limits in section 12(d)(1), which
include concerns about undue influence, excessive layering of fees and
overly complex structures.
    12. Applicants submit that their proposed conditions address any
concerns regarding the potential for undue influence. A Purchasing Fund
or Purchasing Fund Affiliate \20\ will not cause an investment in a
Fund to influence the terms of services or transactions between a
Purchasing Fund or a Purchasing Fund Affiliate and the Fund or Fund
Affiliate.\21\ A Purchasing Fund's Advisory Group or a Purchasing
Fund's Sub-Advisory Group will not control a Fund within the meaning of
section 2(a)(9) of the Act.\22\
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    \20\ A ``Purchasing Fund Affiliate'' is defined as the
Purchasing Fund Adviser, Purchasing Fund Subadviser, Sponsor,
promoter and principal underwriter of a Purchasing Fund and any
person controlling, controlled by or under common control with any
of these entities.
    \21\ A ``Fund Affiliate'' is defined as an investment adviser,
promoter or principal underwriter of a Fund, or its respective
Master Fund, and any person controlling, controlled by or under
common control with any of these entities.
    \22\ A ``Purchasing Fund's Advisory Group'' is the Purchasing
Fund Adviser, or Sponsor, any person controlling, controlled by or
under common control with the Purchasing Fund Adviser or Sponsor,
and any investment company or issuer that would be an investment
company but for section 3(c)(1) or 3(c)(7) of the Act, that is
advised or sponsored by the Purchasing Fund Adviser, the Sponsor, or
any person controlling, controlled by or under common control with
the Purchasing Fund Adviser or Sponsor. A ``Purchasing Fund's Sub-
Advisory Group'' is any Purchasing Fund Subadviser, any person
controlling, controlled by, or under common control with the
Purchasing Fund Subadviser, and any investment company or issuer
that would be an investment company but for section 3(c)(1) or
3(c)(7) of the Act (or portion of such investment company or issuer)
advised or sponsored by the Purchasing Fund Subadviser or any person
controlling, controlled by or under common control with the
Purchasing Fund Subadviser.
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    13. Applicants also propose a condition to ensure that no
Purchasing Fund or Purchasing Fund Affiliate will cause a Fund to
purchase a security from an Affiliated Underwriting. 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 a principal
underwriter in any underwriting or selling syndicate that is an
officer, director, member of an advisory board, Purchasing Fund
Adviser, Purchasing Fund Subadviser, employee or Sponsor of the
Purchasing Fund, or a person of which any such officer, director,
member of an advisory board, Purchasing Fund Adviser, Purchasing Fund
Subadviser, employee or Sponsor 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.
    14. Applicants propose several conditions to address the potential
for layering of fees. Applicants note that the board of directors or
trustees of a Purchasing Management Company, including a majority of
the directors or trustees who are not ``interested persons'' within the
meaning of section 2(a)(19) of the Act (``disinterested directors or
trustees''), will be required to find that the advisory fees charged
under the contract are based on services provided that will be in
addition to, rather than duplicative of, services provided under the
advisory contract of any Fund in which the Purchasing Management
Company may invest. Applicants state that any sales charges and/or
service fees charged with respect to shares of a Purchasing Fund will
not exceed the limits applicable to a fund of

funds set forth in NASD Conduct Rule 2830.\23\
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    \23\ Any references to NASD Conduct Rule 2830 include any
successor or replacement rule that may be adopted by FINRA.
---------------------------------------------------------------------------

    15. Applicants submit that the proposed arrangement will not create
an overly complex fund structure. Applicants note that a Fund (and its
respective Master Fund, if any) will be prohibited from acquiring
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, except to the extent that (i) the Fund
(or its respective Master Fund) acquires securities of another
investment company pursuant to certain exemptive relief from the
Commission, or (ii) the Fund acquires shares of its respective Master
Fund.
    16. To ensure that a Purchasing Fund is aware of the terms and
conditions of the requested order, the Purchasing Fund must enter into
an agreement with the respective Fund (``FOF Participation
Agreement''). The FOF Participation Agreement will include an
acknowledgment from the Purchasing Fund that it may rely on the order
only to invest in the Funds and not in any other investment company.
    17. Applicants also are seeking relief from sections 12(d)(1)(A)
and (B) of the Act to permit the Funds in a master-feeder structure to
perform creations and redemptions of Shares in-kind. Applicants assert
that this structure is substantially identical to traditional master-
feeder structures permitted pursuant to the exception provided in
section 12(d)(1)(E) of the Act. Section 12(d)(1)(E) provides that the
percentage limitations of sections 12(d)(1)(A) and (B) will not apply
to a security issued by an investment company (in this case, the shares
of the applicable master portfolio) if, among other things, that
security is the only investment security held by the Fund. Applicants
believe the proposed master-feeder structure complies with section
12(d)(1)(E) because each Fund will hold only investment securities
issued by its corresponding Master Fund; however, the Funds may receive
securities other than securities of its corresponding Master Fund if a
Fund accepts an in-kind creation. To the extent that a Fund may be
deemed to be holding both shares of the master portfolio and other
securities, applicants request relief from sections 12(d)(1)(A) and
(B). The Funds would operate in compliance with all other provisions of
section 12(d)(1)(E).

Sections 17(a)(1) and (2) of the Act

    18. Sections 17(a)(1) and (2) of the Act generally prohibit an
affiliated person of a registered investment company, or an affiliated
person of such a person (``second tier affiliate''), from selling any
security to or purchasing any security from the company. Section
2(a)(3) of the Act defines ``affiliated person'' to include any person
directly or indirectly owning, controlling, or holding with power to
vote 5% or more of the outstanding voting securities of the other
person and any person directly or indirectly controlling, controlled
by, or under common control with, the other person. Section 2(a)(9) of
the Act provides that a control relationship will be presumed where one
person owns more than 25% of another person's voting securities. 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'').
    19. Applicants request an exemption from section 17(a) under
sections 6(c) and 17(b) to permit in-kind purchases and redemptions by
persons that are affiliated persons or second tier affiliates of the
Funds solely by virtue of one or more of the following: (i) Holding 5%
or more, or more than 25%, of the Shares of the Trust or one or more
Funds; (ii) an affiliation with a person with an ownership interest
described in (i); or (iii) holding 5% or more, or more than 25%, of the
shares of one or more Affiliated Funds. Applicants also request an
exemption in order to permit each Fund to sell Shares to and redeem
Shares from, and engage in the transactions that would accompany such
sales and redemptions with, any Purchasing Fund of which the Fund is an
affiliated person or a second tier affiliate.\24\
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    \24\ Applicants believe that a Purchasing Fund generally will
purchase Shares in the secondary market, which would not require
relief from section 17(a), and will not purchase or redeem Creation
Units directly from a Fund. Nonetheless a Purchasing Fund could seek
to transact in Creation Units directly with a Fund, and the relief
requested pursuant to section 17(a) is intended to cover the
transactions that would accompany such sales and redemptions.
Applicants are not seeking relief from section 17(a) for, and the
requested relief will not apply to, transactions where a Fund could
be deemed an affiliated person, or an affiliated person of an
affiliated person, of a Purchasing Fund because the Adviser or an
entity controlling, controlled by, or under common control with the
Adviser is also an investment adviser to the Purchasing Fund.
---------------------------------------------------------------------------

    20. Applicants contend that no useful purpose would be served by
prohibiting these affiliated persons or second tier affiliates of a
Fund from making in-kind purchases or in-kind redemptions of Shares of
a Fund in Creation Units. The value of the Deposit Instruments and
corresponding Cash Amount delivered by a purchaser or Redemption
Instruments and corresponding Cash Amount given to a redeeming investor
will be the same regardless of the investor's identity, and will be
valued under the same objective standards applied to valuing the Fund
Securities. The method of valuing Fund Securities held by a Fund is the
same as that used for calculating in-kind purchase or redemption
values. Therefore, applicants state that the in-kind purchases and
redemptions will afford no opportunity for the specified affiliated
persons and second tier affiliates of a Fund to effect a transaction
detrimental to other holders of Shares. Applicants do not believe that
in-kind purchases and redemptions will result in abusive self-dealing
or overreaching of the Fund.
    21. Applicants also submit that the sale of Shares to and
redemption of Shares from a Purchasing Fund satisfies the standards for
relief under sections 17(b) and 6(c) of the Act. Any consideration paid
for the purchase or redemption of Shares directly from a Fund will be
based on the NAV of the Fund.\25\ The FOF Participation Agreement will
require any Purchasing Fund that purchases Shares directly from a Fund
to represent that its purchases are permitted under its investment
restrictions and consistent with the investment policies described in
its registration statement.
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    \25\ Applicants acknowledge that the receipt of compensation by
(a) an affiliated person of a Purchasing Fund, or an affiliated
person of such person, for the purchase by the Purchasing Fund of
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 a
Purchasing Fund, may be prohibited by section 17(e)(1) of the Act.
The FOF Participation Agreement also will include this
acknowledgment.
---------------------------------------------------------------------------

    22. To the extent that a Fund operates in a master-feeder
structure, applicants also request relief permitting the Funds to
engage in in-kind creations and redemptions with the applicable master
portfolio. Applicants state that the customary section 17(a)(1) and
17(a)(2) relief would not be sufficient to permit such transactions
because the Funds and the applicable master portfolio could also be
affiliated by virtue of having the same investment adviser. However,
applicants believe that in-

kind creations and redemptions between a Fund and a master portfolio
advised by the same investment adviser do not involve ``overreaching''
by an affiliated person. Such transactions will occur only at the
Fund's proportionate share of the master portfolio's net assets, and
the distributed securities will be valued in the same manner as they
are valued for the purposes of calculating the applicable master
portfolio's NAV. Further, all such transactions will be effected with
respect to pre-determined securities and on the same terms with respect
to all investors. Finally, such transactions would only occur as a
result of, and to effectuate, a creation or redemption transaction
between the Fund and a third-party investor. Applicants believe that
the terms of the proposed transactions are reasonable and fair and do
not involve overreaching on the part of any person concerned and that
the transactions are consistent with the general purposes of the Act.

Applicants' Conditions

    Applicants agree that any order of the Commission granting the
requested relief will be subject to the following conditions:

ETF Relief

    1. As long as the Funds operate in reliance on the requested order,
the Shares of the Funds will be listed on a Stock Exchange.
    2. Neither the Trust nor any Fund will be advertised or marketed as
an open-end investment company or a mutual fund. Any advertising
material that describes the purchase or sale of Creation Units or
refers to redeemability will prominently disclose that the Shares are
not individually redeemable and that owners of the Shares may acquire
those Shares from the Fund and tender those Shares for redemption to
the Fund in Creation Units only.
    3. The Web site for the Funds, which is and will be publicly
accessible at no charge, will contain, on a per Share basis, for each
Fund the prior Business Day's NAV and the market closing price or Bid/
Ask Price of the Shares, and a calculation of the premium or discount
of the market closing price or Bid/Ask Price of the Shares against such
NAV.
    4. On each Business Day, before commencement of trading in Shares
on the Stock Exchange, the Fund (or its respective Master Fund) will
disclose on its Web site the identities and quantities of the Fund
Securities and other assets held by the Fund that will form the basis
for the Fund's calculation of NAV at the end of such Business Day.
    5. The Adviser or Subadviser, directly or indirectly, will not
cause any Authorized Participant (or any investor on whose behalf an
Authorized Participant may transact with the Fund) to acquire any
Deposit Instrument for the Fund through a transaction in which the Fund
could not engage directly.
    6. The requested relief, other than the section 12(d)(1) relief and
the section 17 relief related to a master-feeder structure, will expire
on the effective date of any Commission rule under the Act that
provides relief permitting the operation of actively-managed exchange-
traded funds.

Fund of Funds Relief

    7. The members of the Purchasing Fund's Advisory Group will not
control (individually or in the aggregate) a Fund (or its respective
Master Fund) within the meaning of section 2(a)(9) of the Act. The
members of the Purchasing Fund's Sub-Advisory Group will not control
(individually or in the aggregate) a Fund (or its respective Master
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
Purchasing Fund's Advisory Group or the Purchasing Fund's Sub-Advisory
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 Shares
of the Fund in the same proportion as the vote of all other holders of
the Fund's Shares. This condition does not apply to the Purchasing
Fund's Sub-Advisory Group with respect to a Fund (or its respective
Master Fund) for which the Purchasing Fund Subadviser or a person
controlling, controlled by or under common control with the Purchasing
Fund Subadviser acts as the investment adviser within the meaning of
section 2(a)(20)(A) of the Act.
    8. No Purchasing Fund or Purchasing Fund Affiliate will cause any
existing or potential investment by the Purchasing Fund in a Fund to
influence the terms of any services or transactions between the
Purchasing Fund or a Purchasing Fund Affiliate and the Fund (or its
respective Master Fund) or a Fund Affiliate.
    9. The board of directors or trustees of a Purchasing Management
Company, including a majority of the disinterested directors or
trustees, will adopt procedures reasonably designed to assure that the
Purchasing Fund Adviser and any Purchasing Fund Subadviser are
conducting the investment program of the Purchasing Management Company
without taking into account any consideration received by the
Purchasing Management Company or a Purchasing Fund Affiliate from a
Fund (or its respective Master Fund) or a Fund Affiliate in connection
with any services or transactions.
    10. Once an investment by a Purchasing Fund in the securities of a
Fund exceeds the limit in section 12(d)(1)(A)(i) of the Act, the Board
of a Fund (or of its respective Master Fund), including a majority of
the disinterested Board members, will determine that any consideration
paid by the Fund (or its respective Master Fund) to the Purchasing Fund
or a Purchasing 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 (or its
respective Master Fund); (ii) is within the range of consideration that
the Fund (or its respective Master 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 (or its respective Master Fund)
and its investment adviser(s), or any person controlling, controlled by
or under common control with such investment adviser(s).
    11. The Purchasing Fund Adviser, or trustee (``Trustee'') or
Sponsor, as applicable, will waive fees otherwise payable to it by the
Purchasing Fund in an amount at least equal to any compensation
(including fees received pursuant to any plan adopted by a Fund (or its
respective Master Fund) under rule 12b-1 under the Act) received from a
Fund (or its respective Master Fund) by the Purchasing Fund Adviser, or
Trustee or Sponsor, or an affiliated person of the Purchasing Fund
Adviser, or Trustee or Sponsor, other than any advisory fees paid to
the Purchasing Fund Adviser, or Trustee, or Sponsor, or its affiliated
person by the Fund (or its respective Master Fund), in connection with
the investment by the Purchasing Fund in the Fund. Any Purchasing Fund
Subadviser will waive fees otherwise payable to the Purchasing Fund
Subadviser, directly or indirectly, by the Purchasing Management
Company in an amount at least equal to any compensation received from a
Fund (or its respective Master Fund) by the Purchasing Fund Subadviser,
or an affiliated person of the Purchasing Fund Subadviser, other than
any advisory fees paid to the Purchasing Fund Subadviser or its
affiliated person by the Fund (or its respective Master Fund), in
connection with any investment by the Purchasing Management Company in
the Fund made at the direction of the

Purchasing Fund Subadviser. In the event that the Purchasing Fund
Subadviser waives fees, the benefit of the waiver will be passed
through to the Purchasing Management Company.
    12. No Purchasing Fund or Purchasing Fund Affiliate (except to the
extent it is acting in its capacity as an investment adviser to a Fund
(or its respective Master Fund)) will cause a Fund (or its respective
Master Fund) to purchase a security in an Affiliated Underwriting.
    13. The Board of the Fund (or of its respective Master Fund),
including a majority of the disinterested Board members, will adopt
procedures reasonably designed to monitor any purchases of securities
by the Fund (or its respective Master Fund) in an Affiliated
Underwriting, once an investment by a Purchasing 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 Purchasing 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 (or
its respective Master 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 (or its respective Master Fund) in
Affiliated Underwritings and the amount purchased directly from an
Underwriting Affiliate have changed 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.
    14. Each Fund (or its respective Master 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 a Purchasing 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 Board's determinations were made.
    15. Before investing in a Fund in excess of the limit in section
12(d)(1)(A), a Purchasing Fund will execute a FOF Participation
Agreement with the Fund stating that their respective boards of
directors or trustees and their investment advisers, or Trustee and
Sponsor, 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 shares of a Fund in excess of the limit
in section 12(d)(1)(A)(i), a Purchasing Fund will notify the Fund of
the investment. At such time, the Purchasing Fund will also transmit to
the Fund a list of the names of each Purchasing Fund Affiliate and
Underwriting Affiliate. The Purchasing 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 Purchasing Fund will maintain
and preserve a copy of the order, the FOF Participation 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.
    16. Before approving any advisory contract under section 15 of the
Act, the board of directors or trustees of each Purchasing Management
Company, including a majority of the disinterested directors or
trustees, will find that the advisory fees charged under such 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 (or its respective Master Fund) in which the Purchasing
Management Company may invest. These findings and their basis will be
recorded fully in the minute books of the appropriate Purchasing
Management Company.
    17. Any sales charges and/or service fees charged with respect to
shares of a Purchasing Fund will not exceed the limits applicable to a
fund of funds as set forth in NASD Conduct Rule 2830.
    18. No Fund (or its respective Master 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, except to the extent that (i) the Fund (or its
respective Master Fund) acquires securities of another investment
company pursuant to exemptive relief from the Commission permitting the
Fund (or its respective Master Fund) to acquire securities of one or
more investment companies for short-term cash management purposes, or
(ii) the Fund acquires securities of the Master Fund pursuant to the
Master-Feeder Relief.

    For the Commission, by the Division of Investment Management,
under delegated authority.
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-10299 Filed 4-27-12; 8:45 am]
BILLING CODE 8011-01-P


[Federal Register: October 28, 2009 (Volume 74, Number 207)]
[Notices]
[Page 55606-55610]
[DOCID:fr28oc09-128]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-60851; File No. SR-FINRA-2009-068]

Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Notice of Filing of Proposed Rule Change Relating to
FINRA's Rules Governing Clearly Erroneous Executions

October 21, 2009.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on October 19, 2009, Financial Industry Regulatory Authority, Inc.
(``FINRA'') (f/k/a National Association of Securities Dealers, Inc.
(``NASD'')) filed with the Securities and Exchange Commission
(``Commission'') the proposed rule change as described in Items I, II,
and III below, which Items have been prepared by FINRA. The Commission
is publishing this notice to solicit comments on the proposed rule
change from interested persons.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change

    FINRA is proposing to adopt NASD Rule 11890, IM-11890-1, and IM-
11890-2 into the Consolidated FINRA Rulebook as part of a new FINRA
Rule 11890 Series governing clearly erroneous transactions and to amend
these rules as part of a market-wide effort designed to provide
transparency and finality with respect to clearly erroneous executions.
    The text of the proposed rule change is available on FINRA's Web
site at http://www.finra.org, at the principal office of FINRA and at
the Commission's Public Reference Room.

 II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FINRA included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. FINRA has prepared summaries, set forth in sections A,
B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change

1. Purpose
    As part of the process of developing a new consolidated rulebook
(``Consolidated FINRA Rulebook''),\3\ FINRA is proposing that NASD Rule
11890, IM-11890-1, and IM-11890-2 be moved into the Consolidated FINRA
Rulebook as part of a new FINRA Rule 11890 Series governing clearly
erroneous transactions.\4\ FINRA is also proposing to amend these rules
as part of a market-wide effort designed to provide transparency and
finality with respect to clearly erroneous executions.\5\ This effort
seeks to achieve consistent results for participants across U.S.
equities exchanges while maintaining a fair and orderly market,
protecting investors, and protecting the public interest. Unlike the
rules of the U.S. equities exchanges, FINRA's rules also address
clearly erroneous executions in OTC Equity Securities.\6\ NASD Rule
11890 currently provides that, in the event of a disruption or
malfunction related to the use or operation of any quotation,
communication, or trade reporting system owned or operated by FINRA, or
under extraordinary market conditions, designated officers of FINRA can
review an over-the-counter (``OTC'') transaction arising out of or
reported through any such quotation, communication, or trade reporting
system, and may declare the transaction null and void or modify the
terms if any such officer determines that the transaction is clearly
erroneous or that such action is necessary for the maintenance of a
fair and orderly market or the protection of investors and the public
interest. IM-11890-1 and IM-11890-2 address rulings made by FINRA and
the UPC Committee pursuant to NASD Rule 11890 and the review of those
rulings.
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    \3\ The current FINRA rulebook consists of (1) FINRA Rules; (2)
NASD Rules; and (3) rules incorporated from NYSE (``Incorporated
NYSE Rules'') (together, the NASD Rules and Incorporated NYSE Rules
are referred to as the ``Transitional Rulebook''). While the NASD
Rules generally apply to all FINRA members, the Incorporated NYSE
Rules apply only to those members of FINRA that are also members of
the NYSE (``Dual Members''). The FINRA Rules apply to all FINRA
members, unless such rules have a more limited application by their
terms. For more information about the rulebook consolidation
process, see Information Notice, March 12, 2008 (Rulebook
Consolidation Process).
    \4\ FINRA will transfer the remaining rules in the Uniform
Practice Code into the Consolidated FINRA Rulebook in a separate
filing.
    \5\ See Securities Exchange Act Release No. 60706 (September 22,
2009), 74 FR 49416 (September 28, 2009) (approving SR-NYSEArca-2009-
36).
    \6\ For purposes of the proposed rule change, the term ``OTC
Equity Security'' has the same meaning as defined in FINRA Rule
6420, except that the term does not include any equity security that
is traded on any national securities exchange.
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    NASD Rule 11890 provides important safeguards against market
disruptions caused by trader errors, system malfunctions, or other
extraordinary events that result in erroneous executions affecting
multiple market participants and/or securities. NASD Rule 11890 has
been used both with respect to events affecting a single stock, such as
an extraordinary erroneous order causing a large number of trades
involving multiple market participants in a single stock (single stock
events), and events affecting multiple stocks, such as a system
malfunction resulting in a more widespread problem (multi-stock
events).
    In addition to the substantive changes to the clearly erroneous
provisions described below, the proposed rule change structurally
alters the provisions as well. FINRA is proposing to create a new
clearly erroneous series of rules: FINRA Rule Series 11890. Under this
umbrella would be (1) a general provision (Rule 11891) with
accompanying Supplementary Material; (2) a rule governing clearly
erroneous determinations for transactions in exchange-listed securities
(Rule 11892) with accompanying Supplementary Material; (3) a rule
governing clearly erroneous determinations for transactions in OTC
Equity Securities (Rule 11893) with accompanying Supplementary
Material; and (4) a rule governing review of FINRA staff determinations
by the UPC Committee (Rule 11894).
Definition and General Guidelines
    The proposed rule change creates Rule 11891, which defines the term
``clearly erroneous'' for purposes of the new FINRA Rule 11890 Series.
The proposed rule specifies that ``the terms of a transaction are
`clearly erroneous' when there is an obvious error in any term, such as
price, number of shares, or other unit of trading, or identification of
the security.'' The language in the rule is based on the definition in
the recently approved amendments to NYSE Arca Rule 7.10.\7\
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    \7\ See Securities Exchange Act Release No. 60706 (September 22,
2009), 74 FR 49416 (September 28, 2009) (approving SR-NYSEArca-2009-
36).
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    The proposed rule change also includes four proposed paragraphs of
Supplementary Material to Rule 11891. Proposed Supplementary Material
.01 renumbers current NASD IM-11890-1 regarding a member's failure to
abide by FINRA or UPC Committee rulings. Proposed Supplementary
Material .02 and .03 set forth the general standards applicable to
clearly erroneous determinations and clarify that FINRA generally
considers a transaction to be clearly erroneous when there is a
systemic problem that involves large numbers of parties or trades, or
conditions where it would be in the best interests of the market.
Further, extraordinary market conditions may include situations where
an extraordinary event has occurred or is ongoing that has had a
material effect on the market for a security traded over-the-counter or
has caused major disruption to the marketplace. Supplementary Material
.02 also emphasizes that members are responsible for ensuring that the
appropriate price and type of order are entered into FINRA systems.
    Finally, proposed Supplementary Material .04 specifically addresses
suspicious trading activities such as unauthorized trading activity or
attempts to manipulate stock prices by illegally gaining access to
legitimate accounts or opening new accounts using false information
(often referred to as ``account intrusion''). Although FINRA continues
to be concerned about protecting markets from unauthorized or illegal
activity like account intrusion that could disrupt a fair and orderly
market, FINRA believes that its clearly erroneous authority does not
extend to such suspicious trading activities. Rather, FINRA believes
such activities relate to allegations of fraud and fall outside the
scope of the clearly erroneous rules.\8\ Consequently, FINRA is
proposing the Supplementary Material to clarify this position while

also noting that members should routinely review the adequacy of their
internal controls and ensure that appropriate system safeguards are in
place to minimize or eliminate the potential for account intrusion.
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    \8\ In approving recent amendments to Nasdaq's clearly erroneous
rule, the Commission noted that, ``[g]iven the fact that the Clearly
Erroneous Rule is designed to address trades made in error and the
more difficult factual analysis presented by expanding the rule's
application beyond obvious errors,'' it was appropriate for Nasdaq
to ``retain the original scope of the [clearly erroneous] rule''
rather than extend the rule to address account intrusion. See
Securities Exchange Act Release No. 57826 (May 15, 2008), 73 FR
29802 (May 22, 2008).
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Review of Transactions in Exchange-Listed Securities
    Proposed Rule 11892 and its Supplementary Material set forth the
standards FINRA uses to determine whether a transaction in an exchange-
listed security is clearly erroneous. FINRA believes that coordinating
with other self-regulatory organizations with the goal of having
consistency and transparency regarding the clearly erroneous process is
important to the marketplace and to investors. Consequently, for OTC
transactions in exchange-listed securities that are reported to a FINRA
system, such as a FINRA Trade Reporting Facility (``TRF'') or
Alternative Display Facility (``ADF''), FINRA will generally follow the
determination of a national securities exchange to break a trade (or
multiple trades) when that national securities exchange has broken one
or more trades at or near the price range in question at or near the
time in question (in FINRA staff's sole discretion) such that FINRA
breaking such trade(s) would be consistent with market integrity and
investor protection. When multiple national securities exchanges have
related trades, FINRA will leave a trade(s) unbroken when any of those
national securities exchanges has left a trade(s) unbroken at or near
the price range in question at or near the time in question (in FINRA
staff's sole discretion) such that FINRA breaking such trade(s) would
be inconsistent with market integrity and investor protection.\9\
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    \9\ See proposed Rule 11892, Supplementary Material .01.
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    With respect to OTC transactions in exchange-listed securities for
which there is no corresponding or related on-exchange trading
activity, FINRA believes that the best approach in determining whether
to declare transactions clearly erroneous is to follow the exchanges'
criteria when making a clearly erroneous determination. In this sector
of the market, FINRA believes that consistency in application of
clearly erroneous authority across markets is critical to ensure that
one investor does not receive disparate treatment based solely on the
ultimate execution or reporting venue of his or her order.
Consequently, for OTC transactions in exchange-listed securities that
are reported to a FINRA system, such as a FINRA TRF or the ADF, but for
which there is no corresponding or related on-exchange trading
activity, FINRA will generally make its own clearly erroneous
determination.\10\ However, to ensure that transactions in exchange-
listed securities are treated consistently regardless of where the
trade is executed (i.e., on an exchange or OTC), proposed Rule 11892
replicates the numerical thresholds used by the exchanges to determine
whether a transaction is eligible for consideration as clearly
erroneous. The proposed rule also establishes provisions for the use of
alternative reference prices in unusual circumstances, additional
factors that FINRA may consider when making a clearly erroneous
determination, and numerical guidelines applicable to volatile market
opens. Each of these provisions is modeled on similar provisions in the
recently approved amendments to NYSE Arca Rule 7.10.\11\
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    \10\ Unlike the NYSE Arca rule regarding clearly erroneous
determinations, the FINRA rules do not allow members to initiate
reviews of transactions. All reviews conducted by FINRA are
conducted on FINRA's own motion.
    \11\ See Securities Exchange Act Release No. 60706 (September
22, 2009), 74 FR 49416 (September 28, 2009) (approving SR-NYSEArca-
2009-36).
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Review of Transactions in OTC Equity Securities
    Currently, NASD Rule 11890 governs FINRA's clearly erroneous
process for both exchange-listed securities and OTC Equity Securities.
The core purpose of the clearly erroneous rules is to grant FINRA
authority to determine that a transaction is clearly erroneous with a
goal of maintaining market integrity by declaring a transaction (or
multiple transactions, if necessary) to be null and void if the terms
of the trade are clearly out of line with objective market conditions
for the security.\12\ FINRA is proposing to apply its clearly erroneous
authority somewhat differently depending on whether the security is
listed on a national securities exchange or is an OTC Equity Security.
For that reason, FINRA is proposing to create separate rules for the
treatment of exchange-listed securities, which would be governed by
Rule 11892, and OTC Equity Securities, which would be governed by Rule
11893.
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    \12\ NASD Rule 11890 currently gives FINRA officers the
authority to modify the terms of a transaction, in addition to
declaring the transaction null and void. To conform FINRA's
authority to the other exchanges' in the context of clearly
erroneous determinations, FINRA is proposing to eliminate its
ability to modify a clearly erroneous execution. See id.
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    Proposed Rule 11893 is structured similarly to the provisions for
transactions in exchange-listed securities under proposed Rule 11892,
including numerical guidelines, the use of alternative reference prices
in unusual circumstances, and additional factors FINRA officers may
consider when making a clearly erroneous determination. However, as is
the case today, the proposed numerical guidelines for transactions in
OTC Equity Securities are not the same as the guidelines used for
exchange-listed securities. The proposed rule change would codify the
numerical guidelines currently used by FINRA to determine whether a
transaction is eligible for clearly erroneous consideration. In some
instances, for example, the percentage deviations set forth in the
numerical guidelines are based on a sliding scale where the maximum
percentage deviation applies to the lower execution price in the range
and the minimum percentage deviation applies to the higher execution
price in the range. The sliding scale is applied in a generally linear
fashion (i.e., prices at the lower end of the reference price range are
generally assessed at the higher percentage range) and is intended to
smooth the percentage changes from tier to tier and allow for more
gradual deviations. Because the sliding scale is not applied on a
strictly linear basis, FINRA has more discretion in applying the
guidelines for executions within the reference price range rather than
being strictly a calculation of percentages.
    The following chart summarizes the proposed Numerical Guidelines
for clearly erroneous determinations for OTC Equity Securities:

------------------------------------------------------------------------
                                          Numerical guidelines (Subject
                                             transaction's percentage
            Reference price               difference from the reference
                                                      price)
------------------------------------------------------------------------
$0.9999 and under......................  20%.
$1.0000 and up to and including $4.9999  Low end of range minimum 20%--
                                          High end of range minimum 10%.
$5.0000 and up to and including          10%.
 $74.9999.
$75.0000 and up to and including         Low end of range minimum 10%--
 $199.9999.                               High end of range minimum 5%.

$200.0000 and up to and including        5%.
 $499.9999.
$500.0000 and up to and including        Low end of range minimum 5%--
 $999.9999.                               High end of range minimum 3%.
$1,000.0000 and over...................  3%.
------------------------------------------------------------------------

    For example, a transaction executed at $1.5000 that deviates by
more than $0.30 (or 20%) from the prevailing market price may be
eligible for cancellation as ``clearly erroneous''; whereas a
transaction executed at $4.5000 that deviates by more than $0.45 (or
10%) from the prevailing market price may be eligible for cancellation
as ``clearly erroneous.'' The provisions in proposed Rule 11893
regarding alternative reference prices and additional factors are
substantially similar to those set forth in Rule 11892 for exchange-
listed securities.
    FINRA is also proposing to adopt Supplementary Material to Rule
11893 to emphasize that FINRA has historically exercised its clearly
erroneous authority in very limited circumstances, in particular with
respect to OTC Equity Securities. This more narrow approach for OTC
Equity Securities is due to the differences in the OTC equity and
exchange-listed markets, including the lack of compulsory information
flows in the OTC equity market that come as a result of the listing
process and the fact that aberrant trading in the OTC market is often
due to issues other than systems problems or extraordinary events. The
Supplementary Material explains that FINRA does not expect to use its
clearly erroneous authority in most situations; rather, FINRA expects
the parties to settle any dispute privately.
Review Procedures
Initial Determinations
    As noted above, FINRA is proposing to remove language that
currently allows a FINRA officer to modify one or more of the terms of
a transaction under review. Under the proposed rules, the FINRA officer
will only have the authority to break the trades. This proposed change
is intended to conform with the rules of other exchanges and attempts
to remove the subjectivity from the rule that is necessitated by an
adjustment. The proposed rule governing initial determinations remains
substantially similar to that in current NASD Rule 11890. An Executive
Vice President of FINRA's Market Regulation Department or Transparency
Services Department, or any officer designated by such Executive Vice
President, may, on his or her own motion, review any transaction
arising out of or reported through any FINRA facility. With respect to
determinations involving transactions in exchange-listed securities,
absent extraordinary circumstances, the officer shall take action
generally within 30 minutes after becoming aware of the transaction.
When extraordinary circumstances exist, any such action of the officer
must be taken no later than the start of trading on the day following
the date of execution(s) under review. With respect to determinations
involving transactions in OTC Equity Securities, a FINRA officer must
make a determination as soon as possible after becoming aware of the
transaction, but in all cases by 3:00 p.m., Eastern Time, on the next
trading day following the date of the transaction at issue. If a FINRA
officer declares any transaction null and void, FINRA will notify each
party involved in the transaction as soon as practicable, and any party
aggrieved by the action may appeal such action in accordance with Rule
11894, unless the officer making the determination also determines that
the number of the affected transactions is such that immediate finality
is necessary to maintain a fair and orderly market and to protect
investors and the public interest.
Appeals
    FINRA is proposing to codify in a separate rule (Rule 11894) the
provisions governing the appeal to the UPC Committee of a FINRA
officer's determination to declare an execution clearly erroneous.\13\
IM-11890-2, which concerns review by panels of the UPC Committee, will
be incorporated into the text of the new rule. Under the rule, an
appeal must be made in writing and must be received by FINRA within
thirty minutes after the person making the appeal is given the
notification of the determination being appealed. With respect to
appeals regarding exchange-listed securities, determinations by the UPC
Committee will be rendered as soon as practicable, but generally, on
the same trading day as the execution(s) under review. On requests for
appeal received after 3:00 p.m., Eastern Time, a determination will be
rendered as soon as practicable, but in no case later than the trading
day following the date of the execution(s) under review. With respect
to appeals regarding OTC Equity Securities, determinations by the UPC
Committee will be rendered as soon as practicable, but in no case later
than two trading days following the date of the execution(s) under
review.
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    \13\ As the rule makes clear, a FINRA officer's determination
not to break a trade is not appealable.
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    FINRA will announce the effective date of the proposed rule change
in a Regulatory Notice to be published no later than 60 days following
Commission approval. The effective date will be 30 days following
publication of the Regulatory Notice announcing Commission approval.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the
provisions of Section 15A(b)(6) of the Act,\14\ which requires, among
other things, that FINRA rules must be designed to prevent fraudulent
and manipulative acts and practices, to promote just and equitable
principles of trade, and, in general, to protect investors and the
public interest. FINRA believes that adopting guidelines to explain the
application of the clearly erroneous process will provide clarity and
consistency to the marketplace. In addition, FINRA believes if
consistent standards are applied to this process across markets, then
greater efficiency can be reached.
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    \14\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    FINRA does not believe that the proposed rule change will result in
any burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants or Others

    Written comments were neither solicited nor received.

 III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action

    Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to

90 days of such date if it finds such longer period to be appropriate
and publishes its reasons for so finding or (ii) as to which the self-
regulatory organization consents, the Commission will:
    (A) By order approve such proposed rule change, or
    (B) Institute proceedings to determine whether the proposed rule
change should be disapproved.

 IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to<EMAIL_ADDRESS>Please include
File Number SR-FINRA-2009-068 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090.

All submissions should refer to File Number SR-FINRA-2009-068. This
file number should be included on the subject line if e-mail is used.
To help the Commission process and review your comments more
efficiently, please use only one method. The Commission will post all
comments on the Commission's Internet Web site (http://www.sec.gov/
rules/sro.shtml). Copies of the submission, all subsequent amendments,
all written statements with respect to the proposed rule change that
are filed with the Commission, and all written communications relating
to the proposed rule change between the Commission and any person,
other than those that may be withheld from the public in accordance
with the provisions of 5 U.S.C. 552, will be available for inspection
and copying in the Commission's Public Reference Room, on official
business days between the hours of 10 a.m. and 3 p.m. Copies of the
filing also will be available for inspection and copying at the
principal office of the Exchange. All comments received will be posted
without change; the Commission does not edit personal identifying
information from submissions. You should submit only information that
you wish to make available publicly. All submissions should refer to
File Number SR-FINRA-2009-068 and should be submitted on or before
November 18, 2009.

    For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\15\
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    \15\ 17 CFR 200.30-3(a)(12).
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Elizabeth M. Murphy,
Secretary.
[FR Doc. E9-25873 Filed 10-27-09; 8:45 am]

BILLING CODE 8011-01-P