[Federal Register Volume 77, Number 145 (Friday, July 27, 2012)]
[Notices]
[Pages 44291-44294]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-18311]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-67485; File No. SR-NYSEArca-2012-50]


Self-Regulatory Organizations; NYSE Arca, Inc.; Order Granting 
Approval of Proposed Rule Change Relating to Listing and Trading of the 
First Trust CBOE VIX Tail Hedge Index Fund Under NYSE Arca Equities 
Rule 5.2(j)(3)

July 23, 2012.

I. Introduction

    On May 25, 2012, NYSE Arca, Inc. (``Exchange'' or ``NYSE Arca'') 
filed with the Securities and Exchange Commission (``Commission''), 
pursuant

[[Page 44292]]

to Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act'' or 
``Exchange Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed rule 
change to list and trade shares (``Shares'') of the First Trust CBOE 
VIX Tail Hedge Index Fund (``Fund'') under NYSE Arca Equities Rule 
5.2(j)(3). The proposed rule change was published in the Federal 
Register on June 8, 2012.\3\ The Commission received no comments on the 
proposal. This order grants approval of the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 67107 (June 4, 
2012), 77 FR 34102 (``Notice'').
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II. Description of the Proposal

    The Exchange proposes to list and trade the Shares of the Fund 
under NYSE Arca Equities Rule 5.2(j)(3), the Exchange's listing 
standards for Investment Company Units (``Units''). The Shares will be 
offered by First Trust Exchange-Traded Fund (``Trust''), which is 
organized as a Massachusetts business trust and is registered with the 
Commission as an open-end management investment company.\4\ The 
investment adviser to the Fund will be First Trust Advisors L.P. 
(``Adviser''). First Trust Portfolios L.P. will be the principal 
underwriter and distributor of the Fund's Shares. The Bank of New York 
Mellon Corporation will serve as administrator, custodian, and transfer 
agent for the Fund.
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    \4\ The Trust is registered under the Investment Company Act of 
1940 (``1940 Act''). On October 17, 2011, the Trust filed with the 
Commission an amendment to the Trust's registration statement on 
Form N-1A under the Securities Act of 1933 and under the 1940 Act 
relating to the Fund (File Nos. 333-125751 and 811-21774) 
(``Registration Statement''). In addition, the Commission has issued 
an order granting exemptive relief to the Trust under the 1940 Act. 
See Investment Company Act Release No. 27068 (September 20, 2005) 
(File No. 812-13000) (``Exemptive Order'').
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Description of the Fund

    The Fund will seek investment results that correspond generally to 
the price and yield, before the Fund's fees and expenses, of an equity 
index called the CBOE S&P VIX Tail Hedge Index (``Index''). The Fund 
will normally invest at least 90% of its net assets (plus the amount of 
any borrowings for investment purposes) in common stocks included in 
the Index. In addition, the Fund will normally invest 0.0% to 1.0% of 
its net assets in VIX call options, as described below.
    The Exchange submitted this proposed rule change because the Index 
for the Fund does not meet all of the ``generic'' listing requirements 
of Commentary .01(a)(A) to NYSE Arca Equities Rule 5.2(j)(3) applicable 
to the listing of Units based upon an index of US Component Stocks.\5\ 
Specifically, Commentary .01(a)(A) to NYSE Arca Equities Rule 5.2(j)(3) 
\6\ sets forth the requirements to be met by components of an index or 
portfolio of US Component Stocks. As described further below, the Index 
consists of an S&P 500 Index stock portfolio and a position in 
specified VIX Index (``VIX'') call options.\7\ The Index meets all 
requirements of NYSE Arca Equities Rule 5.2(j)(3) and Commentary 
.01(a)(A) thereto, except that the Index includes VIX call options, 
which are not NMS Stocks as defined in Rule 600 of Regulation NMS. As 
described below, the Index is predominately S&P 500 companies and 
includes an exposure to VIX call options ranging from 0.00% to 1.00% of 
the weight of the Index. All securities in the S&P 500 Index are listed 
and traded on a national securities exchange. Options on the VIX are 
traded on the Chicago Board Options Exchange (``CBOE''). 
Notwithstanding that the Index does not meet all of the generic listing 
requirements of Commentary .01(a)(A) to NYSE Arca Equities Rule 
5.2(j)(3), the Exchange believes that the Index is sufficiently broad-
based to deter potential manipulation in that the S&P 500 Index stocks 
are among the most actively traded, highly capitalized stocks traded in 
the U.S. In addition, the Exchange states that VIX call options are 
highly liquid, with trading volume on the CBOE during the first quarter 
of 2012 of 257,220 contracts per day. VIX call options would represent, 
at most, only 1% of the total weight of the Index. All Index components 
are traded on exchanges that are members of the Intermarket 
Surveillance Group (``ISG''), and the Exchange, therefore, would be 
able to share surveillance information with such exchanges with respect 
to trading in all Index components.
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    \5\ NYSE Arca Equities Rule 5.2(j)(3) provides that the term 
``US Component Stock'' shall mean an equity security that is 
registered under Sections 12(b) or 12(g) of the Exchange Act or an 
American Depositary Receipt, the underlying equity security of which 
is registered under Sections 12(b) or 12(g) of the Exchange Act.
    \6\ Commentary .01(a)(A) to NYSE Arca Equities Rule 5.2(j)(3) 
states, in relevant part, that the components of an index of US 
Component Stocks, upon the initial listing of a series of Units 
pursuant to Rule 19b-4(e) under the Exchange Act, shall be NMS 
Stocks as defined in Rule 600 of Regulation NMS under the Exchange 
Act. See 17 CFR 242.600(b)(47) (defining ``NMS Stock'' as any NMS 
Security other than an option).
    \7\ The VIX Index is a measure of estimated near-term future 
volatility based upon the weighted average of the implied 
volatilities of near-term put and call options on the S&P 500.
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The CBOE S&P VIX Tail Hedge Index

    The Index is rules-based and is owned and was developed by Standard 
& Poor's Financial Services LLC (``Index Provider'').\8\ The Index 
Provider will calculate and maintain the Index. The Index is designed 
to provide a benchmark for investors interested in hedging tail risk in 
an S&P 500 portfolio.\9\ Index components are reviewed quarterly for 
eligibility, and the weights are re-set according to that distribution. 
As of the Index rebalance on March 21, 2012, the Index was comprised of 
99.0% S&P 500 stocks and 1.00% VIX call options. The Index consists of 
an S&P 500 stock portfolio (with dividends reinvested), and an amount 
of one-month, 30-delta VIX call options that is determined by the level 
of forward volatility. On the day of the monthly expiration of VIX call 
options, previously purchased VIX call options are cash-settled, and 
new VIX call options are purchased at the 10 a.m., Central Time asking 
price. The percent of money allocated to VIX call options depends on 
the level of forward volatility at the next call expiration as measured 
by the opening price of VIX futures with the same expiration as the VIX 
call options as follows:
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    \8\ The Index Provider is not a broker-dealer and has 
implemented procedures designed to prevent the use and dissemination 
of material, non-public information regarding the Index.
    \9\ Tail hedging, in the context used by the Index Provider, is 
the practice of trying to hedge the portfolio from extreme market 
moves that are the result of random, unexpected, and unpredictable 
events. Unexpected events of this nature often result in rapid 
increases in market volatility, both realized and implied 
volatility. The Fund will utilize a tail hedging strategy which 
attempts to profit from the sudden rise in implied volatility due to 
any unexpected event. The gains from the ``tail hedge'' would then 
hopefully offset some of the losses incurred in the common stock 
portfolio due to the unexpected events.
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     VIX futures price less than or equal to 15,\10\ no VIX 
call options are purchased;
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    \10\ VIX futures represent the level of expected future 30-day 
volatility as measured in standard deviation units, expressed in 
percent terms (expected volatility multiplied by 100). For example, 
assume that on September 21, 2011, the September VIX call options 
expired and new call options expiring on October 19, 2011 were 
included within the Index. The amount or weighting assigned to the 
October VIX call options within the Index would have been determined 
by the opening price on September 21 of the October 2011 VIX futures 
contract. CBOE data indicate that the opening price was 31.15. 
Because the opening price of the October VIX futures contract was 
greater than 30.00 but less than or equal to 50.00, the allocation 
to VIX call options within the Index would have been equal to 0.50%, 
and the S&P 500 weighting would have been 99.50%. If the opening 
futures price had been equal to or below 15.0 or greater than 50.0, 
the allocation to the call options would have been 0% and the 
Index's composition would have been equal to the S&P 500's 
weightings. If the opening futures price had been greater than 15.0 
but less than or equal to 30.0, the allocation to VIX call options 
within the Index would have been equal to 1.0%, and the S&P 500 
weighting would have been equal to 99.0%.

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[[Page 44293]]

     VIX futures price greater than 15 and less than or equal 
to 30, 1% Index weight in VIX call options;
     VIX futures price greater than 30 and less than or equal 
to 50, 0.50% Index weight in VIX call options; and
     VIX futures price above 50, no VIX call options are 
purchased.
    This dynamic allocation to VIX call options is designed to reduce 
hedging costs by limiting the number of VIX call options that are 
purchased during periods of expected low volatility, and also has the 
effect of taking VIX call option profits when extreme volatility levels 
are reached. The Index is reconstituted and rebalanced monthly.
    The Index Provider will, in most cases, use the quantitative 
ranking and screening system described herein. However, subjective 
screening based on fundamental analysis or other factors may be used, 
if, in the opinion of the Index Provider, certain components should be 
included or excluded from the Index.
    The Fund intends to qualify annually and to elect to be treated as 
a Regulated Investment Company under Subchapter M of the Internal 
Revenue Code.
    Additional information regarding the Trust, the Fund, and the 
Shares, including investment strategies, risks, creation and redemption 
procedures, fees, portfolio holdings disclosure policies, 
distributions, and taxes, among other things, is included in the Notice 
and Registration Statement, as applicable.\11\
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    \11\ See Notice and Registration Statement, supra notes 3 and 4, 
respectively.
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III. Discussion and Commission's Findings

    The Commission has carefully reviewed the proposed rule change and 
finds that it is consistent with the requirements of Section 6 of the 
Act \12\ and the rules and regulations thereunder applicable to a 
national securities exchange.\13\ In particular, the Commission finds 
that the proposal is consistent with Section 6(b)(5) of the Act,\14\ 
which requires, among other things, that the Exchange's rules be 
designed to promote just and equitable principles of trade, to remove 
impediments to and perfect the mechanism of a free and open market and 
a national market system, and, in general, to protect investors and the 
public interest. The Commission notes that the Fund and the Shares must 
comply with the requirements of NYSE Arca Equities Rules 5.2(j)(3) and 
5.5(g)(2) to be listed and traded on the Exchange.
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    \12\ 15 U.S.C. 78f.
    \13\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \14\ 17 U.S.C. 78f(b)(5).
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    The Commission finds that the proposal to list and trade the Shares 
on the Exchange is consistent with Section 11A(a)(1)(C)(iii) of the 
Act,\15\ which sets forth Congress' finding that it is in the public 
interest and appropriate for the protection of investors and the 
maintenance of fair and orderly markets to assure the availability to 
brokers, dealers, and investors of information with respect to 
quotations for, and transactions in, securities. Quotation and last-
sale information for the Shares will be available via the Consolidated 
Tape Association (``CTA'') high-speed line and, for the securities, 
including VIX call options, held by the Fund, will be available from 
the exchange on which they are listed.\16\ The Index value will be 
widely disseminated at least every 15 seconds during the Core Trading 
Session by one or more major market data vendors, such as Bloomberg, 
and additional information regarding the Index and the underlying 
components (S&P 500 stock portfolio and the allocation of VIX call 
options) will be available at CBOE's Web site. In addition, an Intraday 
Indicative Value (``IIV'') for the Shares and the Index value will be 
widely disseminated at least every 15 seconds during the Core Trading 
Session (9:30 a.m. to 4 p.m., Eastern Time) by one or more major market 
data vendors.\17\ On each business day, before commencement of trading 
in Shares in the Core Trading Session on the Exchange, the Fund will 
disclose on its Web site the portfolio of securities and financial 
instruments that will form the basis for the Fund's calculation of NAV 
at the end of the business day.\18\ The Fund's NAV will be determined 
as of the close of trading (normally 4 p.m., Eastern Time) on each day 
the New York Stock Exchange is open for business. A basket composition 
file, which includes the security names and share quantities required 
to be delivered in exchange for the Fund's Shares, together with 
estimates and actual cash components, will be publicly disseminated 
daily prior to the opening of the New York Stock Exchange via the 
National Securities Clearing Corporation. Information regarding market 
price and trading volume of the Shares will be continually available on 
a real-time basis throughout the day on brokers' computer screens and 
other electronic services, and information regarding the previous day's 
closing price and trading volume information for the Shares will be 
published daily in the financial section of newspapers. The Fund's Web 
site will also include a form of the prospectus for the Fund, 
information relating to NAV (updated daily), and other quantitative and 
trading information.
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    \15\ 15 U.S.C. 78k-1(a)(1)(C)(iii).
    \16\ The intra-day, closing, and settlement prices of the 
portfolio securities will also be readily available from the 
securities exchanges trading such securities, automated quotation 
systems, published or other public sources, or on-line information 
services, such as Bloomberg or Reuters.
    \17\ See NYSE Arca Equities Rule 5.2(j)(3), Commentaries 
.01(b)(2) and .01(c). According to the Exchange, several major 
market data vendors widely disseminate IIVs taken from the CTA or 
other data feeds. See Notice, supra note 3, at 34104.
    \18\ On a daily basis, the Adviser will disclose for each 
portfolio security and other financial instrument of the Fund the 
following information on the Fund's Web site: ticker symbol (if 
applicable), name of security and financial instrument, number of 
shares or dollar value of financial instruments held in the 
portfolio, and percentage weighting of the security and financial 
instrument in the portfolio.
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    The Commission further believes that the proposal to list and trade 
the Shares is reasonably designed to promote fair disclosure of 
information that may be necessary to price the Shares appropriately and 
to prevent trading when a reasonable degree of transparency cannot be 
assured. The Commission notes that the Exchange will obtain a 
representation from the issuer of the Shares that the NAV per Share 
will be calculated daily and will be made available to all market 
participants at the same time.\19\ If the IIV or the Index value is not 
being disseminated as required, the Exchange may halt trading during 
the day in which the interruption to the dissemination of the 
applicable IIV or Index value occurs. If the interruption to the 
dissemination of the applicable IIV or Index value persists past the 
trading day in which it occurred, the Exchange will halt trading.\20\ 
In addition, if the Exchange becomes aware that the NAV is not being 
disseminated to all market participants at the same time, it will halt 
trading in the Shares on the Exchange

[[Page 44294]]

until such time as the NAV is available to all market participants. The 
Exchange states that it has a general policy prohibiting the 
distribution of material, non-public information by its employees. The 
Exchange further states that the Index Provider is not a broker-dealer 
and has implemented procedures designed to prevent the use and 
dissemination of material, non-public information regarding the 
Index.\21\ The Commission notes that the Exchange would be able to 
obtain information with respect to the equity securities and VIX call 
options comprising the Index and which will be held by the Fund because 
such equity securities and VIX call options will trade in markets that 
are ISG members or are parties to comprehensive surveillance sharing 
agreements with the Exchange.
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    \19\ See NYSE Arca Equities Rule 5.2(j)(3)(A)(v).
    \20\ With respect to trading halts, the Exchange may consider 
all relevant factors in exercising its discretion to halt or suspend 
trading in the Shares of the Fund. Trading in Shares of the Fund 
will be halted if the circuit breaker parameters in NYSE Arca 
Equities Rule 7.12 have been reached. Trading also may be halted 
because of market conditions or for reasons that, in the view of the 
Exchange, make trading in the Shares inadvisable. These may include: 
(1) The extent to which trading is not occurring in the securities 
and/or the financial instruments comprising the Fund's portfolio; or 
(2) whether other unusual conditions or circumstances detrimental to 
the maintenance of a fair and orderly market are present.
    \21\ The Commission also notes that an investment adviser to an 
open-end fund is required to be registered under the Investment 
Advisers Act of 1940 (``Advisers Act''). As a result, the Adviser 
and its personnel are subject to the provisions of Rule 204A-1 under 
the Advisers Act relating to codes of ethics. This Rule requires 
investment advisers to adopt a code of ethics that reflects the 
fiduciary nature of the relationship to clients as well as 
compliance with other applicable securities laws. Accordingly, 
procedures designed to prevent the communication and misuse of non-
public information by an investment adviser must be consistent with 
Rule 204A-1 under the Advisers Act. In addition, Rule 206(4)-7 under 
the Advisers Act makes it unlawful for an investment adviser to 
provide investment advice to clients unless such investment adviser 
has (i) Adopted and implemented written policies and procedures 
reasonably designed to prevent violation, by the investment adviser 
and its supervised persons, of the Advisers Act and the Commission 
rules adopted thereunder; (ii) implemented, at a minimum, an annual 
review regarding the adequacy of the policies and procedures 
established pursuant to subparagraph (i) above and the effectiveness 
of their implementation; and (iii) designated an individual (who is 
a supervised person) responsible for administering the policies and 
procedures adopted under subparagraph (i) above.
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    The Exchange represents that the Shares are deemed to be equity 
securities, thus rendering trading in the Shares subject to the 
Exchange's existing rules governing the trading of equity securities. 
In support of this proposal, the Exchange has made representations, 
including:
    (1) The continued listing standards under NYSE Arca Equities Rules 
5.2(j)(3) and 5.5(g)(2) applicable to Units shall apply to the Shares.
    (2) In addition, the Fund and the Shares will comply with all other 
requirements applicable to Units including, but not limited to, 
requirements relating to the dissemination of key information such as 
the value of the Index, IIV, and NAV, rules governing the trading of 
equity securities, trading hours, trading halts, surveillance, 
information barriers, and Information Bulletin to Equity Trading Permit 
(``ETP'') Holders (each as described in more detail herein and in the 
Notice and Registration Statement, as applicable), as set forth in 
Exchange rules applicable to Units and prior Commission orders 
approving the generic listing rules applicable to the listing and 
trading of Units.
    (3) The Exchange has appropriate rules to facilitate transactions 
in the Shares during all trading sessions.
    (4) The Exchange's surveillance procedures applicable to derivative 
products, which include Units, are adequate to properly monitor 
Exchange trading of the Shares in all trading sessions and to deter and 
detect violations of Exchange rules and applicable federal securities 
laws. All Index components are traded on exchanges that are members of 
ISG.
    (5) Prior to the commencement of trading, the Exchange will inform 
its ETP Holders in an Information Bulletin of the special 
characteristics and risks associated with trading the Shares. 
Specifically, the Information Bulletin will discuss the following: (a) 
The procedures for purchases and redemptions of Shares in Creation Unit 
Aggregations (as defined in the Notice) and that Shares are not 
individually redeemable; (b) NYSE Arca Equities Rule 9.2(a), which 
imposes a duty of due diligence on its ETP Holders to learn the 
essential facts relating to every customer prior to trading the Shares; 
(c) the risks involved in trading the Shares during the Opening and 
Late Trading Sessions when an updated IIV will not be calculated or 
publicly disseminated; (d) how information regarding the IIV is 
disseminated; (e) the requirement that ETP Holders deliver a prospectus 
to investors purchasing newly issued Shares prior to or concurrently 
with the confirmation of a transaction; and (f) trading and other 
information.
    (6) For initial and/or continued listing, the Fund will be in 
compliance with Rule 10A-3 under the Act,\22\ as provided by NYSE Arca 
Equities Rule 5.3.
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    \22\ See 17 CFR 240.10A-3.
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    (7) The Fund will normally invest at least 90% of its net assets 
(plus the amount of any borrowings for investment purposes) in S&P 500 
common stocks, which are listed and traded on a national securities 
exchange, and 0.0% to 1.0% of its net assets in VIX call options, which 
are traded on CBOE.
    (8) VIX call options would represent, at most, 1.0% of the total 
weight of the Index, and the VIX options components of the Index, if 
any, must remain listed and traded on a national securities exchange.
    (9) A minimum of 100,000 Shares of the Fund will be outstanding at 
the commencement of trading on the Exchange.
    This approval order is based on all of the Exchange's 
representations, including those set forth above and in the Notice, and 
the Exchange's description of the Fund.
    For the foregoing reasons, the Commission finds that the proposed 
rule change is consistent with Section 6(b)(5) of the Act \23\ and the 
rules and regulations thereunder applicable to a national securities 
exchange.
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    \23\ 15 U.S.C. 78f(b)(5).
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\24\ that the proposed rule change (SR-NYSEArca-2012-50) be, and it 
hereby is, approved.
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    \24\ 15 U.S.C. 78s(b)(2).
    \25\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\25\
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-18311 Filed 7-26-12; 8:45 am]
BILLING CODE 8011-01-P