

[Federal Register: March 15, 2007 (Volume 72, Number 50)]
[Notices]               
[Page 12227-12233]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr15mr07-111]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. IC-27750; 812-13336]

 
Vanguard Bond Index Funds, et al.; Notice of Application

March 9, 2007.
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 (the ``Act'') for exemptions from 
sections 2(a)(32), 18(f)(1), 18(i), 22(d) and 24(d) of the Act and rule 
22c-1 under the Act,

[[Page 12228]]

and under sections 6(c) and 17(b) of the Act for exemptions from 
sections 17(a)(1) and (2) of the Act.

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Summary of Application: Applicants request an order that would permit 
the following: (a) An open-end management investment company, the 
series of which consist of the component securities of certain fixed 
income securities indices, to issue a class of shares (``ETF Shares'') 
that can be purchased from the investment company and redeemed only in 
large aggregations (``Creation Units''); (b) secondary market 
transactions in ETF Shares to occur at negotiated prices on a national 
securities exchange, as defined in section 2(a)(26) of the Act 
(``Exchange''); (c) dealers to sell ETF Shares to purchasers in the 
secondary market unaccompanied by a prospectus when prospectus delivery 
is not required by the Securities Act of 1933 (``Securities Act''); and 
(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.

Applicants: Vanguard Bond Index Funds (``Trust''), The Vanguard Group, 
Inc. (``VGI''), and Vanguard Marketing Corporation (``VMC'').

Filing Dates: The application was filed on October 25, 2006 and amended 
on January 23, 2007. Applicants have agreed to file an amendment during 
the notice period, the substance of which is reflected in the notice.

Hearing or Notification of Hearing: An order granting the application 
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 March 30, 2007, 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 Barry A. 
Mendelson, The Vanguard Group, Inc., P.O. Box 2600, Valley Forge, PA 
19482.

FOR FURTHER INFORMATION CONTACT: Keith A. Gregory, Senior Counsel at 
(202) 551-6815, or Michael W. Mundt, Senior Special Counsel, at (202) 
551-6821 (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 for a fee at the 
Commission's Public Reference Desk, 100 F Street, NE., Washington, DC 
20549-0102, telephone (202) 551-5850.

Applicants' Representations

    1. The Trust is an open-end management investment company 
registered under the Act and organized as a Delaware statutory trust. 
The Trust currently has four series (``Existing Funds''). Each Existing 
Fund currently offers separate classes of shares for retail and 
institutional investors (such classes of shares collectively, 
``Conventional Shares''). In the future, the Trust or another 
registered open-end management investment company may offer other 
series (``Future Funds,'' and together with Existing Funds, ``Funds''). 
Any Future Fund will: (a) Be advised by VGI or an entity controlled by 
or under common control with VGI and (b) comply with the terms and 
conditions of any order granted pursuant to the application.
    2. VGI is a Pennsylvania corporation that is wholly and jointly 
owned by 35 investment companies and the series of those investment 
companies (each series, a ``Vanguard Fund'' and collectively, the 
``Vanguard Fund Complex''). VGI is registered as an investment adviser 
under the Investment Advisers Act of 1940 and as a transfer agent under 
the Securities Exchange Act of 1934 (``Exchange Act''). VGI provides 
each Vanguard Fund with corporate management, administrative, and 
transfer agency services at cost. VGI also provides advisory services 
at cost to certain Vanguard Funds, including each of the Existing 
Funds. VMC, a wholly owned subsidiary of VGI, is registered as a 
broker-dealer under the Exchange Act. VMC provides all distribution and 
marketing services to the Vanguard Funds, including each of the 
Existing Funds.
    3. Each Existing Fund seeks to track as closely as possible the 
performance of a different index that measures the performance of the 
bond market as a whole or a discrete segment of the bond market (the 
``Target Indexes'').\1\ The bond holdings of each Existing Fund are 
selected through a sampling process and at least 80% (and in most cases 
more than 90%) of an Existing Fund's assets will be invested in bonds 
included in the Existing Fund's Target Index.\2\ The remainder is 
typically invested in bonds that are not included in the Existing 
Fund's Target Index, cash and cash equivalents, futures, and swap 
contracts. Unlike the other three Existing Funds, the Vanguard Total 
Bond Market Index Fund (``Total Bond Market Index Fund'') holds 
government mortgage-backed securities (``MBS''), asset backed 
securities (``ABS''), and commercial mortgage-backed securities 
(``CMBS'').\3\ The Total Bond Market Index Fund seeks to track that 
portion of the Lehman Agg. Index devoted to MBS by investing a 
corresponding percentage of its assets either in MBS included in the 
index or in ``to-be-announced'' (``TBA'') transactions on MBS.\4\
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    \1\ The Target Indexes are Lehman Brothers Aggregate Bond Index 
``Lehman Agg. Index''), Lehman Brothers 1-5 Year Government/Credit 
Index, Lehman Brothers 5-10 Year Government/Credit Index and Lehman 
Brothers Long Government/Credit Index.
    \2\ Each Fund invests in a representative sample of bonds from 
its Target Index that will resemble the full index in terms of 
characteristics such as maturity, credit quality, issuer type and 
yield.
    \3\ The Total Bond Market Index Fund will hold MBS, ABS, and 
CMBS in approxiamtely the same percentages as those securities are 
represented in the Lehman Agg. Index. ABS and CMBS will not be among 
the Deposit Securities required to purchase a Creation Unit or among 
the Redemption Securities an investor will receive when redeeming a 
Creation Unit.
    \4\ A ``TBA transaction'' is essentially a purchase or sale of 
an MBS for future settlement at an agreed-upon date. Applicants 
state that most MBS trades are executed as TBA transactions. 
Applicants state that TBA transactions increase the liquidity and 
pricing efficiency of transactions in MBS because they permit 
similar MBS to be traded interchangeably pursuant to commonly 
observed settlement and delivery requirements.
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    4. Applicants state that, historically, the difference between the 
performance of an Existing Fund and the performance of its Target Index 
has rarely exceeded one percentage point and in almost all cases has 
been significantly less than one percentage point. Applicants expect 
that, in the future, both the Existing Funds and Future Funds will 
track their Target Indexes with the same degree of precision, and will 
have a tracking error of less than 5% per annum. No entity that 
creates, compiles, sponsors, or maintains a Target Index is or will be 
an affiliated person, as defined in section 2(a)(3) of the Act, or an 
affiliated person of an affiliated person, of the Funds, VGI, any 
adviser to or promoter of a Fund, or VMC.
    5. Each Fund proposes to create ETF Shares, a class of shares that 
would be listed on an Exchange and trade in the secondary market at 
negotiated prices. Applicants submit that the availability of ETF 
Shares would satisfy market

[[Page 12229]]

demand for investment company securities which would provide intra-day 
liquidity and low cost exposure to an index of bonds. Applicants state 
that, by creating an exchange-traded class of shares, the Funds will 
offer short-term investors an attractive means of investing in the 
Funds.\5\ Applicants state that offering ETF Shares will benefit the 
Funds by reducing the portfolio disruption and transaction costs caused 
by short-term investors.
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    \5\ Applicants expect ETF Shares to appeal to short-term 
investors because they can be bought and sold continuously 
throughout the day at market price rather than at net asset value 
(``NAV''), which is calculated only once per day at the close of 
trading on the New York Stock Exchange (``NYSE''). Transactions in 
Conventional Shares will continue to be priced at NAV.
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    6. The Funds will issue ETF Shares only in Creation Units, 
aggregations of a specified number of shares ranging from 50,000 to 
100,000 shares. The price of a Creation Unit will range from $1,500,000 
to $10,000,000. Orders to purchase Creation Units must be placed with 
VMC by or through an ``Authorized Participant,'' which is a Depository 
Trust Company (``DTC'') participant that has executed a participant 
agreement with VMC. Creation Units will be issued in exchange for an 
in-kind deposit of securities and cash (``Creation Deposit'').\6\ The 
Creation Deposit will consist of a basket of approximately 50 to 100 
fixed income securities selected by VGI (``Deposit Securities'') \7\ 
and a cash payment to equalize any difference between the total 
aggregate market value of the Deposit Securities and the NAV per 
Creation Unit of the Fund (``Purchase Balancing Amount'').\8\ An 
investor purchasing a Creation Unit from a Fund will be charged a fee 
(``Transaction Fee'') to prevent any dilution of the interests of 
remaining shareholders due to the Fund incurring costs in connection 
with the investor's purchase of the Creation Unit(s).\9\ Each purchaser 
of a Creation Unit will receive a prospectus for the ETF Shares (the 
``ETF Prospectus'') that discloses the maximum Transaction Fee, and the 
method of calculating Transaction Fees will be disclosed in the Fund's 
Statement of Additional Information (``SAI''). A Fund's Conventional 
Shares will be covered by a separate prospectus (the ``Conventional 
Prospectus'').
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    \6\ On each business day, prior to the opening of trading on the 
Exchange, VGI will make available through the National Securities 
Clearing Corporation (``NSCC'') (or through some other party if NSCC 
is unwilling or unable to perform this function) the list of the 
names and the required amount of each Deposit Security to be 
included in the Creation Deposit for each Fund. Each Fund reserves 
the right to permit or require the purchaser of a Creation Unit to 
substitute cash or a different security to replace a Deposit 
Security under certain circumstances.
    \7\ Applicants state that it would be impractical to ask an 
Authorized Participant to assemble a basket of several hundred or 
several thousand bonds that replicate the portfolio of a Fund. 
Accordingly, VGI will select a subset of the Fund's portfolio using 
a representative sampling strategy.
    \8\ The Funds must comply with the federal securities laws in 
accepting Deposit Securities and satisfying redemptions with 
Redemption Securities (as defined below), including that the Deposit 
Securities and Redemption Securities are sold in transactions that 
would be exempt from registration under the Securities Act. If at 
any time in the future the Funds accept Deposit Securities or 
satisfy redemptions with Redemption Securities that are restricted 
securities eligible for resale pursuant to rule 144A under the 
Securities Act, the Funds will comply with the conditions of rule 
144A, including in satisfying redemptions with such rule 144A 
eligible restricted Redemption Securities. The prospectus for the 
Funds will state that ``An Authorized Participant that is not a 
`qualified institutional buyer' as defined in rule 144A under the 
Securities Act of 1933 will not be able to receive, as part of the 
redemption basket, restricted securities eligible for resale under 
rule 144A.''
    \9\ When a Fund permits an investor to substitute cash for a 
Deposit Security, the investor may be assessed a higher Transaction 
Fee to offset the increased cost to the Fund of buying the necessary 
Deposit Security for its portfolio.
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    7. The Funds will accept purchase orders only on days that the NYSE 
is open for business. Purchase orders must be received by VMC prior to 
the closing time of the regular trading session of the NYSE. VMC will 
transmit all purchase orders to the Funds, maintain a record of each 
Creation Unit purchaser, and send out an ETF Prospectus and 
confirmation to such purchasers.
    8. The purchaser of a Creation Unit will be able to separate the 
Creation Unit into individual ETF Shares.\10\ ETF Shares will be listed 
on an Exchange and traded in the secondary market in the same manner as 
shares of other exchange-traded funds. One or more Exchange specialists 
(``Specialists'') will be assigned to make a market in the ETF Shares. 
The price of ETF Shares traded on an Exchange will be based on a 
current bid/offer market, and each ETF Share is expected to have an 
initial market value of between $30 and $100. Transactions involving 
the sale of ETF Shares in the secondary market will be subject to 
customary brokerage commissions and charges.
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    \10\ Applicants state that persons purchasing Creation Units 
will be cautioned in the ETF Prospectus that some activities on 
their part may, depending on the circumstances, result in their 
being deemed a statutory underwriter and subject them to the 
prospectus delivery and liability provisions of the Securities Act. 
For example, a broker-dealer firm and/or its client may be deemed a 
statutory underwriter if it purchases Creation Units from a Fund, 
breaks them down into the constituent ETF Shares, and sells ETF 
Shares directly to its customers, or if it chooses to couple the 
purchase of a supply of new ETF Shares with an active selling effort 
involving solicitation of secondary market demand for ETF Shares. 
The ETF Prospectus will state that whether a person is an 
underwriter depends on all the facts and circumstances pertaining to 
that person's activities. The ETF Prospectus also will state that 
broker-dealer firms should note that dealers who are not 
``underwriters'' but are participating in a distribution (as 
contrasted to an ordinary secondary trading transaction), and thus 
dealing with ETF Shares that are part of an ``unsold allotment'' 
within the meaning of section 4(3)(C) of the Securities Act, would 
be unable to take advantage of the prospectus delivery exemption 
provided by section 4(3) of the Securities Act.
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    9. Applicants expect that purchasers of Creation Units will include 
institutional investors and arbitrageurs. A Specialist, in providing 
for a fair and orderly secondary market for ETF Shares, also may 
purchase Creation Units for use in its market making activities on the 
Exchange. Applicants expect that secondary market purchasers of ETF 
Shares will include both institutional and retail investors.\11\ 
Applicants believe that arbitrageurs will purchase or redeem Creation 
Units to take advantage of discrepancies between the ETF Shares' market 
price and the ETF Shares' NAV. Applicants expect that this arbitrage 
activity will provide a market discipline that will result in a close 
correspondence between the price at which the ETF Shares trade and 
their NAV. Applicants do not expect ETF Shares to trade at a 
significant premium or discount to their NAV.\12 \
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    \11\ ETF Shares will be registered in book-entry form only. DTC 
or its nominee will be the registered owner of all outstanding ETF 
Shares. Records reflecting the beneficial owners of ETF Shares will 
be maintained by DTC or its participants.
    \12\ Every 15 seconds throughout the trading day, the Exchange 
will disseminate via the facilities of the Consolidated Tape 
Association the market value of an ETF Share and, separate from the 
consolidated tape, the Exchange or another information provider will 
disseminate a calculation of the approximate NAV of an ETF Share. 
Applicants state that an investor comparing the two figures will be 
able to determine whether, and to what extent, ETF Shares are 
selling at a premium or discount to NAV.
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    10. Applicants will make available an ETF Shares product 
description (``Product Description'') for distribution in accordance 
with an Exchange rule requiring Exchange members and member 
organizations effecting transactions in ETF Shares to deliver a Product 
Description to investors purchasing ETF Shares, whether on or away from 
the Exchange. Applicants state that any other Exchange that applies for 
unlisted trading privileges in ETF Shares will have to adopt a similar 
rule, requiring delivery of the Product Description. The Product 
Description will provide a plain English overview of a Fund, including 
its investment objective and investment strategies, the identity of 
VGI, the material risks of investing in the Fund, and the frequency of 
dividends and capital gains distributions. The Product Description also 
will provide a brief, plain English

[[Page 12230]]

description of the salient features of ETF Shares. The Product 
Description will advise investors that an ETF Prospectus and SAI may be 
obtained, without charge, from the investor's broker or from VMC. The 
Product Description also will identify a Web site address where 
investors can obtain information about the composition and compilation 
methodology of the Target Index. Applicants expect that the number of 
purchases of ETF Shares in which an investor will not receive a Product 
Description will not constitute a significant portion of the market 
activity in ETF Shares.
    11. Except in connection with the liquidation of a Fund (or of a 
Fund's ETF Share class), ETF Shares will only be redeemable in Creation 
Units through each Fund. An investor redeeming a Creation Unit 
generally will receive (a) A basket of securities (``Redemption 
Securities''), which in most cases will be the same as the Deposit 
Securities required of investors purchasing Creation Units on the same 
day, and (b) a cash amount equal to the difference in the value of the 
Redemption Securities and the NAV of a Creation Unit, which in most 
cases will be the same as the Purchase Balancing Amount paid (or 
received) by investors purchasing Creation Units on the same day. A 
Fund may make redemptions partly in cash in lieu of transferring one or 
more Redemption Securities to a redeeming investor, if the Fund 
determines that such alternative is warranted. A Fund may make such a 
determination if, for example, a redeeming investor is unable, by law 
or policy, from owning a particular Redemption Security. In order to 
cover the Fund's transaction costs, redeeming investors will pay a 
Transaction Fee.\13\
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    \13\ Investors who redeem for cash, rather than in kind, may pay 
a higher Transaction Fee.
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Applicants' Legal Analysis

    1. Applicants request an order under section 6(c) of the Act for 
exemptions from sections 2(a)(32), 18(f)(1), 18(i), 22(d) and 24(d) of 
the Act and rule 22c-1 under the Act; and under sections 6(c) and 17(b) 
of the Act for exemptions from sections 17(a)(1) and (2) of the Act.
    2. Section 6(c) 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 or provisions 
of the Act, or any rule or regulation thereunder, 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 2(a)(32) of the Act

    3. Section 2(a)(32) of the Act defines ``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 his proportionate share of the issuer's current net 
assets, or the cash equivalent. Applicants request an order under 
section 6(c) to permit ETF Shares to be redeemed in Creation Units 
only. Applicants note that because of the arbitrage possibilities 
created by the redeemability of Creation Units, it is expected that the 
market price of an ETF Share will not vary much from its NAV.

Section 18(f)(1) and 18(i) of the Act

    4. Section 18(f)(1) of the Act, in relevant part, prohibits a 
registered open-end company from issuing any class of ``senior 
security,'' which is defined in section 18(g) to include any stock of a 
class having a priority over any other class as to the distribution of 
assets or payment of dividends. Section 18(i) of the Act requires that 
every share of stock issued by a registered management company be 
voting stock, with the same voting rights as every other outstanding 
voting stock. Rule 18f-3 permits an open-end fund to issue multiple 
classes of shares representing interests in the same portfolio without 
seeking exemptive relief from section 18(f)(1) and 18(i), provided that 
the fund complies with certain requirements. Applicants state that they 
will comply in all respects with rule 18f-3, except the requirements 
that (a) Each class have the same rights and obligations as each other 
class (other than the differences allowed by the rule), and (b) if a 
class has a different distribution arrangement, the class must pay all 
of the expenses of the arrangement. Because applicants, therefore, may 
not rely on rule 18f-3, they request an exemption under section 6(c) 
from sections 18(f)(1) and 18(i).
    5. Applicants state that there are four ways in which the 
Conventional Shares and ETF Shares of each Fund will have different 
rights: (a) Conventional Shares are individually redeemable, while ETF 
Shares will be redeemable in Creation Units only; (b) ETF Shares will 
be traded on an Exchange, while Conventional Shares will not; (c) 
Conventional Shares declare dividends daily, while ETF Shares will 
declare dividends monthly; and (d) although all shares classes of a 
Fund will pay dividends monthly, the payment date for the Conventional 
Shares will be the same as the ex dividend date (``ex date''), while 
the payment date for the ETF Share will be four days or more after the 
ex date. Applicants assert that different trading and redemption rights 
are necessary if their proposal is to have the desired benefits. 
Applicants note that a Fund's ETF Shares will be tradable on an 
Exchange and redeemable only in large aggregations in order to 
encourage short-term investors to conduct their trading activities in a 
way that does not disrupt the management of the Fund's portfolio. 
Applicants assert that there is no reason to make Conventional Shares 
tradable and that it would be counterproductive to facilitate the 
ability of market timers to disrupt a Fund by making ETF Shares 
individually redeemable.
    6. Applicants state the proposal to declare dividends to the ETF 
Share class on a monthly basis, as opposed to on a daily basis for the 
Conventional Share class, will result in a higher net asset value 
(``NAV'') for the ETF Share class during a monthly period due to the 
presence of accrued but undistributed income.\14\ Applicants submit 
that absent adjustment, this difference would result in a 
disproportionate allocation of a fund's income, realized capital gains 
and losses, and unrealized appreciation and depreciation (``Allocable 
Items'') to the ETF Shares relative to the Conventional Shares because 
such items are allocated among a fund's classes based upon relative net 
assets. Applicants intend to eliminate this potential inequality by 
allocating the Allocable Items on the basis of class-level net assets 
adjusted to factor out the differences introduced by the application of 
the different dividend policies (``Asset Adjustment''). Applicants 
submit that the use of the Asset Adjustment will ensure that the daily 
allocation of Allocable Items to ETF Shares and Conventional Shares is 
not distorted by the classes' differing dividend policies.\15\ 
Applicants state

[[Page 12231]]

that it is industry practice for bond ETFs to declare dividends 
monthly.
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    \14\ When dividends are declared monthly, as opposed to daily, 
each day's accrued income is reflected as an increase in the shares' 
NAV. At the end of the month, when dividends are declared, the NAV 
drops by the amount of the dividend. By contrast, when dividends are 
declared daily, the amount of the daily income accrual is offset by 
a corresponding distribution payable liability. As a result, the net 
effect on the shares' NAV typically is zero.
    \15\ Applicants will not rely on the requested order until the 
board of trustees (``Board'') of each Fund has formally determined 
that, after applying the Asset Adjustment, the annualized rates of 
return of the ETF and Conventional Share classes generally will 
differ only by the expense differentials among the classes, as 
required by rule 18f-3(c)(1)(v) under the Act.
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    7. Applicants state that the accrual of dividends in the NAV of the 
ETF Shares but not the Conventional Shares will have an effect on the 
voting power of the respective classes because the shareholders of the 
Funds are given voting rights proportionate to the NAV of their shares. 
Applicants assert that such effects on voting power will be minor and 
that this treatment of voting rights meets the standards of section 
18(i) because every share issued by the Funds will have equal voting 
rights in that each share will be entitled to one vote per dollar of 
NAV and a fractional vote per fractional dollar of NAV.
    8. Applicants state that although Conventional Shares and ETF 
Shares both pay dividends monthly, another difference between the 
classes is that the holders of Conventional Shares are able to reinvest 
dividends immediately when paid, while the ETF Shareholders would have 
to wait a few days to receive their payments through their brokers. As 
a result, holders of Conventional Shares of the Funds who reinvest will 
be continuously invested, while ETF Shareholders who reinvest will be 
``out of the market'' for four days with respect to the amount of the 
dividend.\16\ Applicants state that the four day difference will affect 
the relative performance of the classes because during the time the 
dividend is out of the market, ETF Shareholders will not receive income 
or experience appreciation or depreciation on the amount of the 
dividend. Applicants do not expect this economic difference to be 
significant.
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    \16\ Applicants assert that the delay between the ex date and 
the payment/reinvestment date occurs for all ETFs, whether they are 
stand-alone ETFs or part of a multi-class structure, and regardless 
of whether an ETF Shareholder elects to reinvest dividends.
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    9. Applicants assert that the different rights do not implicate the 
concerns underlying section 18 of the Act, including excessive 
leverage, conflicts of interest and investor confusion. With respect to 
the potential for investor confusion, applicants will take a variety of 
steps to ensure that investors understand the key differences between 
Conventional Shares and ETF Shares. Applicants state that the ETF 
Shares will not be marketed as a mutual fund investment. Marketing 
materials may refer to ETF Shares as an interest in an investment 
company or fund, but will not make reference to an ``open-end fund'' or 
``mutual fund,'' except to compare or contrast the ETF Shares with the 
shares of a conventional open-end management investment company. Any 
marketing or advertising materials addressed primarily to prospective 
investors will emphasize that (a) ETF Shares are not redeemable from a 
Fund other than in Creation Units, (b) ETF Shares, other than in 
Creation Units, may be sold only through a broker, and the shareholder 
may have to pay brokerage commissions in connection with the sale, and 
(c) a selling shareholder may receive less than NAV in connection with 
the sale of ETF Shares. The same type of disclosure will be provided in 
the Conventional Prospectus, ETF Prospectus, Product Description, SAI, 
and any document addressed primarily to prospective investors. The 
prospectus for the Fund's Conventional Shares will disclose that 
dividends are declared daily and paid monthly. The prospectus and 
Product Description for the ETF Shares will disclose that dividends are 
declared monthly and paid monthly and that the reinvestment of 
dividends (if elected), will not occur until approximately four days 
after the ex date. The applicants also note that (a) All references to 
a Fund's exchange-traded class of shares will use a form of the name 
``ETF Shares'' rather than the Fund name, (b) the cover and summary 
page of the ETF Prospectus will state that the ETF Shares are listed on 
an Exchange and are not individually redeemable, (c) VMC will only 
market Conventional Shares and ETF Shares in the same advertisement or 
marketing material when the advertisement or marketing material 
contains appropriate disclosure explaining the relevant features of 
each class of shares and highlighting the differences between the share 
classes, and (d) applicants have prepared educational materials 
describing the ETF Shares.
    10. Applicants currently allocate distribution expenses among funds 
in the Vanguard Fund Complex according to a cost-sharing formula 
approved by the Commission in 1981 as part of an order allowing the 
Vanguard Fund Complex to internalize its distribution services (``1981 
Order'').\17\ For those funds in the Vanguard Fund Complex offering 
multiple classes of shares, applicants apply the formula in the 1981 
Order by treating each class as a separate fund (``Multi-Class 
Distribution Formula'').
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    \17\ Investment Company Act Release No. 11645 (Feb. 25, 1981) 
(Opinion of the Commission and Final Order). Under the formula, each 
Vanguard Fund's contribution is based 50% on its average month-end 
net assets during the preceding quarter relative to the average 
month-end net assets of the other Vanguard Funds, and 50% on its 
sales of new shares relative to the sales of new shares of the other 
Vanguard Funds during the preceding 24 months. So that a new fund is 
not unduly burdened, the formula caps each Vanguard Fund's 
contribution at 125% of the average expenses of the Vanguard Funds 
collectively, with any amounts above the cap redistributed among the 
other Vanguard Funds. In addition, no fund may pay more than 0.2% of 
its average month-end net assets for distribution.
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    11. Applicants propose to apply the Multi-Class Distribution 
Formula to each Fund's class of ETF Shares. Applicants acknowledge 
that, because ETF Shares may have a distribution arrangement that 
differs from that for Conventional Shares, the proposed allocation 
method is inconsistent with rule 18f-3. Applicants contend, however, 
that the Multi-Class Distribution Formula is a fundamental feature of 
Vanguard's unique, internally-managed structure, and that the proposed 
allocation method is consistent with the method approved by the 
Commission in the 1981 Order. The Multi-Class Distribution Formula has 
been approved by the Board of each Fund, and the Board of each Fund, 
including a majority of the trustees who are not interested persons, as 
defined in section 2(a)(19) of the Act (``Disinterested Trustees''), 
will review the application of the Multi-Class Distribution Formula on 
an annual basis and determine that the proposed allocation is in the 
best interests of each class of shareholders and of the Fund as a 
whole.

Section 22(d) of the Act and Rule 22c-1 Under the Act

    12. Section 22(d), among other things, prohibits a dealer from 
selling a redeemable security that is currently being offered to the 
public by or through an underwriter, except at a current public 
offering price described in the prospectus. Rule 22c-1 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 ETF Shares will take place at negotiated 
prices, not at a current offering price described in the ETF 
Prospectus, and not at a price based on NAV. Thus, purchases and sales 
of ETF Shares in the secondary market will not comply with section 
22(d) and rule 22c-1. Accordingly, applicants request exemptions from 
these provisions under section 6(c) of the Act.
    13. Applicants assert that the sale of ETF Shares at negotiated 
prices does not present the opportunity for any of the abuses that 
section 22(d) and rule 22c-1 were designed to prevent. 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

[[Page 12232]]

principal underwriters and contract dealers, (b) prevent unjust 
discrimination or preferential treatment among buyers resulting from 
sales at different prices, and (c) ensure an orderly distribution of 
investment company shares by eliminating price competition from dealers 
offering shares at less than the published sales price and repurchasing 
shares at more than the published redemption price. Applicants state 
that secondary market trading in ETF Shares would not cause dilution 
for existing Fund shareholders because such transactions would not 
directly or indirectly affect the Fund's assets. Applicants further 
state that secondary market trading in ETF Shares would not lead to 
discrimination or preferential treatment among purchasers because, to 
the extent that different prices exist during a given trading day or 
from day to day, these variances will occur as a result of market 
forces. Finally, applicants contend that the proposed distribution 
system will be orderly because, among other things, arbitrage activity 
will ensure that the difference between the market price of ETF Shares 
and their NAV remains narrow.

Section 24(d) of the Act

    14. Section 24(d) provides, in relevant part, that the prospectus 
delivery exemption provided to dealer transactions by section 4(3) of 
the Securities Act does not apply to transactions in a redeemable 
security issued by an open-end investment company. Applicants request 
an exemption under section 6(c) of the Act from section 24(d) to permit 
dealers selling ETF Shares to rely on the prospectus delivery exemption 
provided by section 4(3) of the Securities Act.\18\
---------------------------------------------------------------------------

    \18\ Applicants do not seek relief from the prospectus delivery 
requirement for non-secondary market transactions, including 
purchases of Creation Units or those involving an underwriter.
---------------------------------------------------------------------------

    15. Applicants state that ETF Shares will be listed on an Exchange 
and will be traded in a manner similar to other equity securities, 
including the shares of closed-end investment companies. Applicants 
note that dealers selling shares of closed-end investment companies in 
the secondary market generally are not required to deliver a prospectus 
to the purchaser. Applicants contend that ETF Shares, as a listed 
security, merit similar treatment, reducing compliance costs and 
regulatory burdens that result from the imposition of a prospectus 
delivery requirement on secondary market transactions. Applicants state 
that because ETF Shares will be exchange-listed, prospective investors 
will have access to several types of market information about the ETF 
Shares. Applicants state that information regarding market price and 
volume will be continually available on a real-time basis throughout 
the day on brokers' computer screens and other electronic services. The 
previous day's price and volume information also will be published 
daily in the financial section of newspapers.
    16. Applicants further state that investors that purchase ETF 
Shares in the secondary market will receive a Product Description, 
describing the Fund and its ETF Shares. Applicants state that, while 
not intended as a substitute for a prospectus, the Product Description 
will contain information about ETF Shares that is tailored to meet the 
needs of investors purchasing ETF Shares in the secondary market.

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

    17. Sections 17(a)(1) and (2) generally prohibit an affiliated 
person of a registered investment company, or an affiliated person of 
an affiliated person, acting as principal, from selling any security 
to, or purchasing any security from, the company. Sections 2(a)(3)(A) 
and (C) of the Act define ``affiliated person,'' respectively, as any 
person who owns 5% or more of an issuer's outstanding voting securities 
and any person who controls the fund. Section 2(a)(9) of the Act 
provides that a control relationship will be presumed where one person 
owns 25% or more of another person's voting securities. Applicants 
state that a large institutional investor or the Specialist could own 
5% or more, or more than 25%, of a Fund's outstanding voting securities 
and, as a result, be deemed to be an affiliated person of the Fund 
under section 2(a)(3)(A) or (C). Applicants further state that, because 
purchases and redemptions of Creation Units would be in-kind, rather 
than for cash, those investors would be precluded by sections 17(a)(1) 
and (2) from purchasing or redeeming Creation Units from the Fund. 
Accordingly, applicants request an exemption under sections 6(c) and 
17(b) of the Act to permit these affiliated persons, and affiliated 
persons of such affiliated persons who are not otherwise affiliated 
with the Fund, to purchase and redeem Creation Units through in-kind 
transactions.
    18. Section 17(b) of the Act authorizes the Commission to exempt a 
proposed transaction from section 17(a) 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, and 
the proposed transaction is consistent with the policies of the 
registered investment company involved and the general purposes of the 
Act. Applicants contend that no useful purpose would be served by 
prohibiting persons affiliated with a Fund, as described above, from 
purchasing or redeeming Creation Units from the Fund. Applicants 
represent that Fund affiliates making in-kind purchases and redemptions 
would be treated no differently from non-affiliates making the same 
types of transactions. Applicants state that all purchases and 
redemptions of Creation Units would be at the Fund's next calculated 
NAV. Applicants also state that, in all cases, Deposit Securities and 
Redemption Securities will be valued in the same manner and using the 
same standards as those securities are valued for purposes of 
calculating the Fund's NAV. Applicants assert that, for these reasons, 
the requested relief meets the standards of sections 6(c) and 17(b).

Applicants' Conditions

    Applicants agree that the order granting the requested relief will 
be subject to the following conditions:
    1. The ETF Shares Prospectus and the Product Description for each 
Fund will clearly disclose that, for purposes of the Act, ETF Shares 
are issued by the Fund and the acquisition of ETF Shares by investment 
companies is subject to the restrictions of section 12(d)(1) of the 
Act, except as permitted by an exemptive order that permits registered 
investment companies to invest in a Fund beyond the limits of section 
12(d)(1), subject to certain terms and conditions.
    2. As long as a Fund operates in reliance on the requested order, 
the ETF Shares will be listed on an Exchange.
    3. The ETF Shares of a Fund will not be advertised or marketed as 
shares of an open-end investment company or mutual fund. The ETF Shares 
Prospectus of each Fund will prominently disclose that ETF Shares are 
not individually redeemable and will disclose that holders of ETF 
Shares may acquire the shares from the Fund and tender the shares for 
redemption to the Fund in Creation Unit aggregations only. Any 
advertising material that describes the purchase or sale of Creation 
Units or refers to redeemability will prominently disclose that ETF 
Shares are not individually redeemable and that holders of ETF Shares 
may acquire the shares from the Fund and tender the shares for 
redemption to the Fund in Creation Unit aggregations only.

[[Page 12233]]

    4. Before a Fund may rely on the order, the Commission will have 
approved, pursuant to rule 19b-4 under the Exchange Act, an Exchange 
rule requiring Exchange members and member organizations effecting 
transactions in ETF Shares to deliver a Product Description to 
purchasers of ETF Shares.
    5. On an annual basis the Board of each Fund, including a majority 
of Disinterested Trustees, must determine, for each Fund, that the 
allocation of distribution expenses among the classes of Conventional 
Shares and ETF Shares in accordance with the Multi-Class Distribution 
Formula is in the best interests of each class and of the Fund as a 
whole. Each Fund will preserve for a period of not less than six years 
from the date of a Board determination, the first two years in an 
easily accessible place, a record of the determination and the basis 
and information upon which the determination was made. This record will 
be subject to examination by the Commission and its staff.
    6. Applicants' Web site, which is and will be publicly accessible 
at no charge, will contain the following information, on a per ETF 
Share basis, for each Fund: (a) The prior business day's closing NAV 
and the midpoint of the bid-asked spread at the time the Fund's NAV is 
calculated (``Bid-Asked Price'') and a calculation of the premium or 
discount of the Bid-Asked Price in relation to the closing NAV; and (b) 
data for a period covering at least the four previous calendar quarters 
(or the life of a Fund, if shorter) indicating how frequently each 
Fund's ETF Shares traded at a premium or discount to NAV based on the 
Bid-Asked Price and closing NAV, and the magnitude of such premiums and 
discounts. In addition, the Product Description for each Fund will 
state that applicants' Web site has information about the premiums and 
discounts at which the Fund's ETF Shares have traded.
    7. The ETF Shares Prospectus and annual report will include, for 
each Fund: (a) The information listed in condition 6(b), (i) In the 
case of the ETF Shares Prospectus, for the most recently completed 
calendar year (and the most recently completed quarter or quarters, as 
applicable), and (ii) in the case of the annual report, for no less 
than the immediately preceding five fiscal years (or the life of the 
Fund, if shorter); and (b) the cumulative total return and the average 
annual total return for one, five and ten year periods (or the life of 
the Fund, if shorter) of (i) an ETF Share based on NAV and the Bid-
Asked Price and (ii) the Fund's Target Index.

    For the Commission, by the Division of Investment Management, 
pursuant to delegated authority.
Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7-4721 Filed 3-14-07; 8:45 am]

BILLING CODE 8010-01-P
