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THE MCGRAW-HILL COMPANIES, INC. v. VANGUARD INDEX TRUST

April 25, 2001

THE MCGRAW-HILL COMPANIES, INC., PLAINTIFF,
v.
VANGUARD INDEX TRUST AND THE VANGUARD GROUP, INC., DEFENDANTS.



The opinion of the court was delivered by: Hellerstein, District Judge.

MEMORANDUM AND ORDER GRANTING PLAINTIFF'S MOTION FOR JUDGMENT AND DENYING DEFENDANTS' MOTION FOR JUDGMENT

This case involves trademark and other intellectual property rights to famous financial service indices: the Standard & Poor's 500 Composite Stock Price Index and two related S & P indices. Plaintiff, The McGraw-Hill Companies, Inc., owns the property rights to the relevant trademarks and indices. For more than fifteen years, Defendants, Vanguard Index Trust and the Vanguard Group, Inc., have been using the S & P trademarks, and the index data symbolized by the trademarks, in the sales and marketing of Vanguard's open-end mutual funds based on those indices. Recently, Vanguard has developed a new class of securities for its index mutual funds, a class of exchange-traded securities called VIPERs that will be issued to broker-dealers to enable trading in large blocks upon securities exchanges throughout the trading day. The issue before me is whether the agreements between McGraw-Hill and Vanguard by which Vanguard has the right to use the S & P trademarks and indices extend to VIPERs, or whether, as an unlicensed use, Vanguard's proposed use would infringe on McGraw-Hill's property rights.*fn1

McGraw-Hill and Vanguard both have filed motions for judgment pursuant to Federal Rule of Civil Procedure 52(c), on papers after discovery and as if after a full trial.*fn2 For the reasons set forth below, I grant Plaintiff's motion and deny Defendant's motion. This memorandum constitutes my findings of fact and conclusions of law.

I. Factual Background

Plaintiff, McGraw-Hill, is an industry leader in business publications, financial information and media services. Its Standard & Poor's ("S & P") division designs, maintains and publishes financial indices, including the S & P 500 Composite Stock Price Index ("S & P 500") and other such indices. The S & P 500 is a statistical index based on stock prices of selected and weighted samplings of common stocks of leading United States public companies in a variety of industries. McGraw-Hill owns the trademarks "S & P" and "S & P 500," which have been registered with the United States Patent and Trademark Office, and the unregistered trademarks "Standard & Poor's," "Standard & Poor's 500," and "500." S & P also designs and publishes comparable indices based on other groupings of stocks, relating to other segments of the securities markets.

Financial services companies, analysts and investors regularly refer to S & P indices, including the S & P 500, as bench-marks for measuring the performance of investments, and also may obtain licenses from McGraw-Hill for more active use of the S & P indices and trademarks. The licenses entail two categories of related intellectual property rights: the right to use the data — that is, the shifting composite of common stocks — that make up the S & P index, and the right to use the S & P trademarks symbolizing the data.

Defendant The Vanguard Group, Inc. is a leading manager and seller of mutual funds. Vanguard, through its affiliate, Vanguard Index Trust, also a Defendant in this case, and Vanguard Index Funds, the Index Trust's successor, has been a leader in popularizing index funds: funds designed to hold a portfolio of stocks that mirror the composition of a financial index, for example, the S & P 500. In that connection, Vanguard has been a licensee of Standard & Poor's for sixteen years.

Generally, investment companies may be closed- or open-end funds. A closed-end fund has a fixed number of outstanding shares, traded throughout the day on the stock exchanges where they are listed or over-the-counter, through broker-dealers and at prices determined by market forces, generally at a discount from the fund's overall net asset value. In contrast, shares of an open-end fund are continuously issued and redeemed at prices determined by the fund's net asset value, generally as of the close of business of the day of redemption. Open-end shares typically do not trade in the secondary market.

Beginning in 1993, a hybrid form of investment company, an exchange-traded fund ("ETF"), was developed. As with all investment companies, purchasers of shares in an ETF gain an undivided interest in the portfolio of securities held and managed by the fund. While technically open-end funds, ETFs trade in the secondary market, typically on an exchange and at prices determined by the market, in the same manner as closed-end funds. However, because ETF shares may be created and redeemed by market makers at net asset value, albeit in large denominations commonly known as creation units, ETF shares typically do not trade at prices that vary greatly from their net asset values.

Vanguard now proposes to issue a new type of ETF, not as a separate fund, but as a new classification of shares in three existing Vanguard mutual funds based on S & P indices. The new product is to be called VIPERs, an acronym for Vanguard Index Participation Equity Receipts. By this action, McGraw-Hill seeks to enjoin Vanguard from issuing that product, claiming that Vanguard's issuance of VIPERs would improperly enlarge, and thus violate, the terms of a January 1, 1988 license agreement between the parties by which McGraw-Hill licensed Vanguard to use its S & P trademarks and indices in connection with Vanguard's Index Trust as it then had been operating, as an open-end mutual fund. Vanguard contends, in defense, that the 1988 license agreement authorized it to use the S & P trademarks and indices for the relevant Vanguard funds generally, and that the license grant thus encompasses its proposal to market and sell VIPERs.

The 1988 license agreement succeeded an earlier agreement dated April 24, 1985. Pursuant to the 1985 agreement, McGraw-Hill licensed Vanguard to use "the S & P 500 and the data included in the S & P 500 . . . and S & P's trademarks and trade names solely in connection with the operation and management of the Vanguard Index Trust," as described in a Prospectus of the Index Trust dated April 30, 1985 and attached to the 1985 agreement. McGraw-Hill contends that the scope of the license was thus limited by the terms of the Prospectus and its description of the product offered by the Index Trust: shares of an open-end mutual fund designed to provide investment results corresponding to the performance of the S & P 500 index. The Prospectus stated that Vanguard's purpose was to "attempt[] to duplicate the investment results of the [S & P 500] Index" by using the fund's capital to buy and sell stock weighted and regularly adjusted to correlate with the composition of the S & P 500 index.

The Trust's capital will be invested in no fewer than the 200 stocks having the largest weighings in the Index. . . . The management of the Trust generally selects stocks for the Trust's portfolio in the order of their weighings in the Index, beginning with the heaviest weighted stocks. The percentage of the Trust's assets to be invested in each stock is approximately the same as the percentage it represents in the Index. Temporary cash balances, normally not expected to exceed 1% of net assets, may be invested in short-term money market instruments.

The composition of the portfolio was to be regularly adjusted to achieve a correlation with the composition of the S & P 500 index.

The 1988 agreement incorporated and attached the 1985 agreement, but provided also that the 1988 agreement was the "entire agreement," and "supersede[d]" all prior agreements, including the 1985 agreement, "with respect to the subject matter of [the 1988] Agreement." Since January 1, 1988, Vanguard has created at least seven additional open-end mutual funds that track other S & P indices for various segments of the stock market, each time under specific license from McGraw-Hill reflected in separate written agreements or amendments.

In May 1999, Vanguard submitted an application to the United States Securities and Exchange Commission ("SEC") seeking exemptive relief from the Investment Company Act of 1940 in connection with its proposed issuance of VIPERs. The SEC granted the requested exemption conditionally, requiring Vanguard to agree not to advertise or market VIPERs "as a mutual fund investment," or "as shares of an open-end investment company or mutual fund," or to "make reference to an `open-end fund' or `mutual fund'" except that it could compare or contrast VIPERs with the shares of a conventional open-end management investment company. Vanguard also agreed to use a separate Prospectus and separate marketing materials to sell VIPERs. On May 12, 2000, a year after its application to the SEC, Vanguard received approval and filed a registration statement with the SEC, publicly announcing its plans to market and sell VIPERs.

McGraw-Hill alleges that ETFs generally, and VIPERs particularly, were not in existence and were not contemplated by the parties at the time of the 1985 and 1988 contracts and that VIPERs are a separate and distinct financial product, not simply another conventional class of shares within an existing mutual fund. McGraw-Hill contends that Vanguard's issuance of VIPERs would be an unlicensed use of the S & P trademarks and data, breaching the parties' license agreements. Vanguard disputes McGraw-Hill's contentions, alleging that its license from McGraw-Hill ran, not to particular classes or categories of shares, but to its funds, and that VIPERs, no less than open-end shares, are within the license grant. Hence, the opposing motions for judgment.*fn3

II. The License Agreements in Greater Detail

The disputed licenses for use of the S & P 500 trademarks and indices appear in two documents: a letter agreement effective as of May 15, 1985 and an agreement effective as of January 1, 1988.

The first contract, dated April 24, 1985, is a two-page letter agreement executed by Standard & Poor's Corporation, Vanguard Index Trust, and The Vanguard Group. Pursuant to the letter agreement, and effective May 15, 1985, Vanguard acquired the right to use the S & P 500 index data and the S & P marks for an annual license fee of $5,000, "solely in connection with the operation and management of the Vanguard Index Trust, as described [in an attached Prospectus]." The body of the letter agreement reads as follows:

This will confirm the agreement, effective as of May 15, 1985, between Standard & Poor's Corporation ("S & P") and the Vanguard Index Trust and The Vanguard Group, Inc., for themselves and the Vanguard Group of Investment Companies (collectively, "Vanguard") regarding the use by Vanguard of the S & P 500 Stock Index ("S & P 500") in connection with the Vanguard Index Trust as described more fully in the attached Prospectus ...

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