State Street Bank and Trust Company
February 3, 2004
Jonathan G. Katz, Secretary
RE: File No. S7-26-03 Proposed Rule: Disclosure Regarding Market Timing and Selective Disclosure of Portfolio Holdings
State Street Bank and Trust Company ("State Street") welcomes this opportunity to comment on the U.S. Securities and Exchange Commission's (the "Commission") proposed form amendments requiring certain disclosure regarding market timing and selective disclosure of portfolio holdings (the "Release")1. State Street has been a leader in the ETF marketplace since it partnered with the American Stock Exchange to launch the SPDR Trust, Series 1 in 1993. Therefore, we would like to comment on areas of the Release which we believe would unnecessarily burden exchange-traded funds (“ETFs”).
Given the nature of ETFs, we do not believe the concerns which led to the proposed disclosure changes are applicable to ETFs. As you are aware, unlike most registered investment companies, ETFs are funds which track an index and whose securities are traded freely on an exchange. As a result, except as described below, ETFs do not issue shares to new shareholders or redeem shares from existing shareholders; rather, purchases and sales are transacted among investors on an exchange subject to the rules of the exchange.
The only time an ETF issues shares is when an institutional investor presents the fund with a basket of securities which is comprised of securities which represents the fund’s underlying index. In exchange for this basket of securities, the investor receives a large block of shares, typically, 50,000 shares; this is typically defined as a “Creation Unit.” Further, the only time an investor can redeem shares directly from the fund is when they present the fund with a Creation Unit sized aggregation of shares and receive fund securities in exchange.2
The Release seeks to require open-end management investment companies to disclose in their prospectuses both the risks to shareholders of frequent purchase and redemptions of investment company shares, and the investment company’s policies and procedures with respect to such frequent purchases and redemptions. Market timing is not an issue for ETFs, since ETFs are constantly priced throughout the trading day as a result of market activity. This is different than typical mutual funds which strike one value per day, usually at the end of the day, thereby permitting market timing, especially in funds holding foreign securities where the lag between the pricing of the underlying security and the fund’s shares can be the greatest. At the retail level, all transactions in the ETF shares are effected on an exchange, so that any short-term trading in ETF shares does not involve the ETF at all. At the institutional level, because nearly all purchase and redemption transactions are “in-kind” transactions involving only minimal amounts of cash, none of the ill effects typically associated with market timing in mutual funds, such as trading disruption and widely fluctuating demands on cash flow, can arise.
As a result, we believe that ETFs should be specifically excluded from these proposed disclosure requirements. Please do not hesitate to call Mary Moran Zeven at 617-662-1783 or Stephanie M. Nichols at 617-662-3971 if you have any questions regarding this comment letter.
/s/Mary Moran Zeven
/s/Stephanie M. Nichols
cc: Donald A. Gignac