Exchange Traded Funds: A White Paper         Page 4
MID-CAP SPDR

In 1995, the SEC issued an Order covering the MidCap SPDR that was essentially similar to the 1992 SPDR Order except that the MidCap SPDR tracked the S&P MidCap 400 Index. This ETF had a tax flaw that would cause additional tax distributions. The flaw would not be fixed until 1999.

WEBS Add Another Round of Innovations

In 1996, Morgan Stanley wanted to offer investments similar to OPALS to retail investors in the United States. Morgan Stanley joined forces with Barclays Global Investments and the American Stock Exchange to create World Equity Benchmark Shares (WEBS) that are similar to OPALS, but are SEC registered. Morgan Stanley drew on its OPALS experience to organize WEBS as an Investment Company, rather than a Unit Investment Trust. This innovation allowed Barclays, the investment manager for WEBS, some of the additional investment management discretion that Morgan Stanley enjoys with OPALS.

WEBS are responsible for other innovations as well. While the SuperFund and SPDR pioneered the concept of exchanging shares, WEBS made a specific advance in the method of exchanging shares that acts to reduce the tax liabilities generated by the ETFs. (The SPDR and MidCap SPDR did not have this feature and this would cause a tax problem for the MidCap SPDR in particular later on.) The tax aspects of ETFs are detailed below. WEBS also used the term "index fund" in relation to their ETFs, a term previously associated only with open-ended mutual funds.

Dow Jones Joins In

In 1997, the SEC issued an Order covering the Diamonds ETF which is based on the Dow Jones Industrial Index. Diamonds are sponsored by the same group that sponsors the SPDRs. The Diamonds incorporated the tax benefits in the WEBS Investment Company but remained a unit investment trust. While the mechanism used to achieve tax benefit in the WEBS was implied, it was specifically stated during the creation of Diamonds.

Sector SPDRs

In 1998, the organizations responsible for the SPDRs and Diamonds abandoned the unit investment trust structure and applied to the SEC for authority to organize Select SPDRs as an investment company. The SEC issued the SPDR Order that same year containing the favorable tax language. Merrill Lynch played a key role in the development of the Select SPDRs helping to expand the marketing force behind ETFs.
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