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S&P Asks SEC to Block New Vanguard Viper Fund

Standard & Poor's has asked the Securities and Exchange Commission to stop Vanguard from rolling out its new Vipers exchange-traded fund that would track the S&P 500 index.

S&P and Vanguard have been locked in a trademark dispute since Vanguard first announced the creation of Vipers in May. In a lawsuit, S&P claims Vanguard's license to use the S&P 500 index does not cover Vipers. (Vanguard plans to launch as many as nine Vipers funds.) Vanguard claims Vipers are simply a new share class of its existing (VFINX) and are covered under their current licensing agreement with S&P.

Unlike traditional mutual funds, exchange-traded funds are priced throughout the trading day and can be bought and sold like stocks. They have proven popular with many index-fund investors because of their low expense ratios and tax efficiency. Because of their unique structure, exchange-traded funds can't be offered without an SEC order exempting them from certain securities laws. This week, S&P filed a request for a public hearing on Vanguard's application for such an order.

S&P's hearing request employs a strategy used by two consumer groups last May to force Barclays Global Fund Advisers to provide more disclosure about its exchange-traded funds. The groups withdrew their requests when Barclays met their demands.

If S&P's trademark suit is really what's behind the hearing request, then what's really behind the trademark suit?

S&P also has licensed the S&P 500 trademark to other exchange-traded funds, including State Street Global Advisors', S&P 500 SPDRs (SPY) (also known as Spiders) and Barclays' iShares S&P 500 (IVV). According to the SPDR's financial statements, it pays S&P 0.04% of the fund's assets annually for the license -- more than four times what Vanguard pays. The licensing fee accounts for one-third of the SPDR's total annual expense ratio of 0.12%.

Barclays, which introduced iShares after State Street launched SPDRs, was apparently able to cut a better deal. The iShares S&P 500 fund's annual expense ratio is only 0.09%. Other expenses for iShares and SPDRs should be about the same, which means Barclays is probably paying only about 0.01% of assets for the S&P license. Because iShares S&P 500 is a mutual fund that is permitted to hide its S&P license expenses in its management fee (SPDRs are unit investment trusts that must break out the license expense separately), it's not possible to determine exactly how much iShares is paying. But it appears its fees are about the same as those Vanguard is paying.

But the key issue may be exclusivity rather than fees. S&P may have granted Barclays exclusive rights to put the S&P 500 trademark on an exchange-traded fund. Barclays could have insisted on exclusivity to protect itself against the likelihood that Vanguard, Fidelity and other established fund complexes would roll out their own S&P 500 exchange-traded funds and bury lesser-known Barclays along the way.

It's also possible SPDRs have exclusive rights of their own, but only for exchange-traded funds structured as unit investment trusts.

The upshot is that if S&P loses its trademark suit against Vanguard, and Vipers are offered under the S&P 500 brand, then Barclays may want to renegotiate its deal, which could lead to lower fees on iShares. And State Street would undoubtedly put more pressure on S&P to renegotiate its deal for SPDRs. This could result in shareholders paying less in annual expenses for the S&P 500 indices, and S&P could be out of a pretty penny. Officials for Barclays, State Street and S&P all declined to comment.

In its SEC filing, S&P says its hearing request is motivated by the "public interest and protection of investors." It argues that if Vanguard loses the trademark lawsuit, "a potentially chaotic situation could develop in which many investors might be left holding orphaned shares or perhaps shares that were subject to an unwieldy recall."

S&P doesn't explain how this "chaotic situation" might evolve, but promises to do so at a public hearing. Such a hearing could delay the launch of Vipers for months, if not years, and pressure Vanguard into paying the higher license fee or dropping the S&P 500 name altogether. Barry Mendelson, associate counsel and principal at Vanguard, had no immediate comment but said the company would respond to the S&P's hearing request in a few days

S&P's move appears to assume that Vanguard needs its index more than the index needs Vanguard. But the S&P 500 brand owes much of its value to Vanguard's success at promoting the concept of index funds. The S&P 500 index was relatively unknown in 1985 when Vanguard licensed the trademark for its fund. Today, it's the world's biggest mutual fund, with more than $100 billion in assets.

If Vanguard loses the trademark suit, it could opt to do without the S&P 500 name and replace it with another index that has a recognizable brand name and invests in essentially the same stocks comprising the S&P 500. But Vanguard officials say they expect to prevail in the trademark suit, and they believe S&P's hearing request will probably amount to little more than a speed bump.

Indeed, the SEC has already informally considered and rejected S&P's position. It had the benefit of nonpublic letters from both parties on the dispute before it issued an Oct. 6 notice of its intent to permit Vanguard to offer Vipers. The SEC is likely to rule on S&P's request next week.
Mercer Bullard, a former assistant chief counsel at the SEC (and former branch chief in the SEC office that reviews exemptive applications), is the founder and CEO of Fund Democracy, a mutual fund shareholder's advocacy group in Chevy Chase, Maryland.

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