In a situation with parallels to the post-election presidential contest, the Vanguard Group of Malvern, Pa., moved a step closer late last month to issuing its VIPER's exchange-traded share class by winning SEC approval to issue the shares. But the product's final approval still hinged on a pending lawsuit.

The dispute between Vanguard and S&P began last May when Vanguard announced it would issue an exchange-traded share class on five of its index funds, including its popular S&P 500 Index fund. Soon after, McGraw-Hill Companies of New York filed a lawsuit in U.S. District Court alleging Vanguard had breached its licensing agreement that covered the use of the name and index of its subsidiary, Standard & Poor's of New York, by extending the agreement to include VIPER shares.

Despite Vanguard's attempt to have the complaint dismissed, the suit remains in court and a trial date has not been set, according to spokespeople from both sides.

In the most recent developments, Vanguard won SEC approval late last month to launch its VIPER share class and McGraw-Hill's request to the SEC for a public hearing on the matter - which would have delayed approval of the product - was thrown out.

Despite the pending lawsuit, Vanguard responded to the decision as if obstacles to introducing the shares had nearly been eliminated.

"We're gratified and pleased the SEC granted us final approval for the new class ... we fully expect to launch the new shares sometime in the first quarter," said John Demming, a spokesperson for Vanguard. "I think this is the next step in the final approval process."

McGraw-Hill, for its part, downplayed the SEC's decision, even though the commission threw out its request for a public hearing on the matter.

"We didn't expect [the SEC] to grant us a hearing," said Bill Jordan, a spokesperson for McGraw-Hill. Rather, the company filed the hearing request in what he called a successful attempt to make the SEC aware of the potential problems that could develop if Vanguard loses its lawsuit, he said.

In October, McGraw-Hill filed the hearing request stating it was concerned "chaos" could ensue if Vanguard sold VIPER shares and then lost the lawsuit.

"If Vanguard were to issue VIPERs, but then an unfavorable [to Vanguard] court ruling were to [be issued], 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," the hearing request said.

In fact, McGraw-Hill's hearing request would have delayed SEC approval of the VIPER share class and was perceived by at least one industry observer to be a last gasp effort to avoid defeat in court.

"Traditionally, the SEC likes to avoid these types of issues," said Geoff Bobroff, president of Bobroff Consulting of East Greenwich, R.I. (MFMN 11/13/00). "To some extent, this may be trying to do in a regulatory setting what you don't believe you're going to be able to do in a court setting."

The SEC denied the hearing because the issues it raised posed no substantial threat to investors, according to the SEC. Also, the outcome of a pending lawsuit over the licensing agreement between Vanguard and McGraw-Hill is not relevant to the criteria the SEC uses in granting approval to launch exchange-traded funds or share classes, the SEC said.

Vanguard's lawsuit with McGraw-Hill represents the final hurdle it faces in issuing its VIPER share class, said Mercer Bullard, president and founder of Fund Democracy LLC of Chevy Chase Md., and a former assistant chief counsel at the SEC's division of investment management.

Although Demming said Vanguard was expecting to issue the shares sometime in the first quarter, he declined to comment on whether his firm would issue the shares while its lawsuit with McGraw-Hill was still pending.

Vanguard can legally issue VIPERS regardless of the lawsuit because it has the SEC's approval, said Bullard. However, Vanguard will probably wait for a decision before it issues the share class, he said. If Vanguard launches the class before then, the move could appear to usurp the court's authority and Vanguard would run the risk of offending the judge hearing the case, Bullard said.

The outcome of the lawsuit will determine whether Vanguard has the right to use S&P's name and index with its VIPER share class on the S&P 500 Index fund. While it is unlikely Vanguard would scrap its plans should it lose the lawsuit, the stakes riding on the case are high, according to Bullard. A loss would mean Vanguard would either have to renegotiate its licensing contract with S&P and pay additional fees to use its index and name, or be forced to use a different index altogether, he said. Currently, Vanguard pays S&P $50,000 a year to use its name, according to Daniel P. Wiener, editor of The Independent Adviser, a newsletter that covers Vanguard.

"This [deal] was done when indexing

wasn't believed to be such a big deal," he said.

For McGraw-Hill's part, losing the lawsuit would mean a loss of potentially millions in additional licensing fees and could force it to renegotiate the licensing agreements it has with Barclays Global Investors of San Francisco and State Street Global Advisors of Boston, Bullard said. He believes both firms negotiated deals giving them exclusive use of the S&P name with an exchange-traded product in an effort to eliminate the threat of competition from a larger S&P index fund, namely Vanguard's. If the court determines Vanguard's existing licensing agreement with S&P covers its exchange-traded share class, Barclays and State Street will most likely sue for a new agreement, Bullard said.

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