[Federal Register Volume 79, Number 114 (Friday, June 13, 2014)]
[Notices]
[Pages 33959-33964]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-13822]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-72350; File No. SR-NASDAQ-2014-020]


Self-Regulatory Organizations; The NASDAQ Stock Market LLC; Order 
Instituting Proceedings To Determine Whether To Approve or Disapprove 
Proposed Rule Change Relating To Listing and Trading of Exchange-Traded 
Managed Fund Shares

June 9, 2014.

I. Introduction

    On February 26, 2014, The NASDAQ Stock Market LLC (``Nasdaq'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission''), pursuant 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 adopt Nasdaq Rule 5745, which 
would govern the listing and trading of Exchange-Traded Managed Fund 
Shares (``ETMF Shares'' or ``ETMFs''), and to amend related references 
under Nasdaq Rules 4120, 5615, IM-5615-4, and 5940. The proposed rule 
change was published for comment in the Federal Register on March 12, 
2014.\3\ The Commission received four comments on the proposal.\4\ On 
April 23, 2014, pursuant to Section 19(b)(2) of the Act,\5\ the 
Commission designated a longer period within which to either approve 
the proposed rule change, disapprove the proposed rule change, or 
institute proceedings to determine whether to disapprove the proposed 
rule change.\6\ This order institutes proceedings under Section 
19(b)(2)(B) of the Act \7\ to determine whether to approve or 
disapprove 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. 71657 (Mar. 6, 
2014), 79 FR 14092 (``Notice'').
    \4\ See Letters to the Commission from Christopher Davis, 
President, Money Management Institute, dated March 27, 2014 (``MMI 
Letter''); Robert Tull, President, Robert Tull & Co., dated March 
31, 2014 (``Tull Letter''); Avi Nachmany, Co-Founder, Director of 
Research, E.V.P, Strategic Insight, dated April 1, 2014 (``Strategic 
Insight Letter''); and Eric Noll, President and Chief Executive 
Officer, ConvergEx Group, LLC, dated April 1, 2014 (``ConvergEx 
Letter'').
    \5\ 15 U.S.C. 78s(b)(2).
    \6\ See Securities Exchange Act Release No. 72007, 79 FR 24045 
(Apr. 29, 2014). The Commission determined that it was appropriate 
to designate a longer period within which to take action on the 
proposed rule change so that it has sufficient time to consider the 
proposed rule change. Accordingly, the Commission designated June 
10, 2014 as the date by which it should approve, disapprove, or 
institute proceedings to determine whether to disapprove the 
proposed rule change.
    \7\ 15 U.S.C. 78s(b)(2)(B).
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II. Description of the Proposal

    As described in the Notice, the Exchange proposes to adopt new 
Nasdaq Rule 5745 to permit the listing and trading of ETMF Shares. 
Similar to Managed Fund Shares as defined in Nasdaq Rule 5735,\8\ ETMF 
Shares would be issued in specified aggregate unit quantities in return 
for a deposit of a specified basket of securities and/or a cash amount 
with a value equal to the product of the ETMF's net asset value per 
Share (``NAV'') and the number of Shares issued. When aggregated in the 
same specified unit quantities, ETMF Shares could be redeemed in 
exchange for a specified basket of securities and/or cash with a value 
per Share equal to the ETMF's NAV.
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    \8\ See Securities Exchange Act Release No. 57962 (June 13, 
2008), 73 FR 35175 (June 20, 2008) (SR-NASDAQ-2008-039).
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    Unlike Managed Fund Shares, ETMF Shares would trade on Nasdaq using 
a new trading protocol called ``NAV-Based Trading.'' In NAV-Based 
Trading, all bids, offers, and execution prices would be expressed as a 
premium/discount (which may be zero) to the ETMF's next-determined NAV 
(e.g., NAV-$0.01; NAV+$0.01). An ETMF's NAV would be determined each 
business day, normally as of 4:00 p.m. Eastern Time. Trade executions 
using

[[Page 33960]]

NAV-Based Trading would be binding at the time orders are matched on 
Nasdaq's facilities, with the transaction prices contingent upon the 
determination of the ETMF's NAV at the end of the business day.
    Member firms would utilize existing order types and interfaces to 
transmit ETMF Share bids and offers to Nasdaq, which would process ETMF 
Share trades like trades in shares of conventional ETFs and other 
listed securities. In the systems used to transmit and process 
transactions in ETMF Shares, Nasdaq expects an ETMF's next-determined 
NAV to be represented by a proxy price (e.g., 100.00) and a premium/
discount of a stated amount to the next-determined NAV to be 
represented by the same increment/decrement from the proxy price used 
to denote NAV (e.g., NAV-$0.01 would be represented as 99.99; NAV+$0.01 
as 100.01).\9\
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    \9\ Order transmission and processing systems currently in 
common use by exchanges and member firms are generally not designed 
to accommodate pricing arrangements, such as NAV-Based Trading, in 
which bids, offers and execution prices are determined by reference 
to a price or value that is unknown at the time of trade execution. 
Compared to the alternative of building and maintaining (and 
requiring member firms to build and maintain) a dedicated NAV-Based 
Trading order transmission and processing system, the Exchange 
believes that the proposed approach (using, for processing purposes, 
a proxy price to represent next-determined NAV) offers major 
advantages in terms of cost, efficiency and time to implement. To 
convert proxy prices used to represent intraday bids, offers and 
execution prices into prices expressed in relation to the next-
determined NAV, member firms would subtract from the reported proxy 
price (e.g., 99.99) the proxy for NAV (e.g., 100.00) and insert 
``NAV'' in front of the calculated number expressed in dollars 
(e.g., 99.99-100.00 = -0.01, expressed as ``NAV-$0.01'').
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    To avoid potential investor confusion, Nasdaq would work with 
member firms and providers of market data services to seek to ensure 
that representations of intraday bids, offers and execution prices for 
ETMFs that are made available to the investing public follow the ``NAV-
$0.01/NAV+$0.01'' (or similar) display format, rather than displaying 
proxy prices. Nasdaq expects all ETMFs listed on the Exchange to have a 
unique identifier associated with their ticker symbols, which would 
indicate that their Shares are traded using NAV-Based Trading. Nasdaq 
makes available to member firms and market data services certain 
proprietary data feeds (``Nasdaq Data Feeds'') that are designed to 
supplement the market information disseminated through the consolidated 
tape (``Consolidated Tape''). The Exchange would use a Nasdaq Data Feed 
to disseminate intraday price and quote data for ETMFs in real time in 
the ``NAV-$0.01/NAV+$0.01'' (or similar) display format. Member firms 
could use the Nasdaq Data Feed to source intraday ETMF prices for 
presentation to the investing public in the ``NAV-$0.01/NAV+$0.01'' (or 
similar) display format. Alternatively, member firms could source 
intraday ETMF prices in proxy price format from the Consolidated Tape 
and use a simple algorithm to convert prices into the ``NAV-$0.01/
NAV+$0.01'' (or similar) display format.
    All ETMF bids, offers and trade executions would be reported 
intraday in real time by the Exchange to the Consolidated Tape \10\ and 
separately disseminated to member firms and market data services 
through a Nasdaq Data Feed. The Exchange would also provide the member 
firms participating in each ETMF Share trade with a contemporaneous 
notice of trade execution, indicating the number of ETMF Shares bought 
or sold and the executed premium/discount to NAV.\11\
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    \10\ Due to systems limitations, the Consolidated Tape would 
report intraday execution prices and quotes for ETMFs using a proxy 
price format. As noted, Nasdaq would separately report real-time 
execution prices and quotes to member firms and providers of market 
data services in the ``NAV-$0.01/NAV+$0.01'' (or similar) display 
format, and otherwise seek to ensure that representations of 
intraday bids, offers and execution prices for ETMFs that are made 
available to the investing public follow the same display format.
    \11\ All orders to buy or sell an ETMF Share that are not 
executed on the day the order is submitted would be automatically 
cancelled as of the close of trading on such day.
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    All executed ETMF Share trades would be recorded and stored 
intraday by Nasdaq to await the calculation of the ETMF's end-of-day 
NAV and the determination of final trade pricing. After the Reporting 
Authority calculates an ETMF's NAV and provides this information to the 
Exchange, Nasdaq would price each ETMF Share trade entered into during 
the day at the ETMF's NAV plus/minus the trade's executed premium/
discount. Using the final trade price, each executed ETMF Share trade 
would then be disseminated to member firms and market data services 
through the Nasdaq Data Feed used to report ETMF Share trades, and 
confirmed to the member firms participating in the trade to supplement 
the previously provided information to include final pricing. After the 
pricing is finalized, Nasdaq would deliver the ETMF Share trading data 
to NSCC for clearance and settlement, following the same processes used 
for the clearance and settlement of trades in conventional ETFs and 
other exchange-traded securities.

Proposed Listing Rules for Exchange-Traded Managed Fund Shares

    Proposed Nasdaq Rule 5745(b)(1) provides that Nasdaq will file 
separate proposals under Section 19(b) of the Act before the listing of 
ETMF Shares. Proposed Nasdaq Rule 5745(b)(2) provides that transactions 
in ETMF Shares will occur during Nasdaq's Regular Market Session 
through 4:00 p.m.\12\ Proposed Nasdaq Rule 5745(b)(3) provides that 
ETMF Shares will trade on Nasdaq at market-determined premiums or 
discounts to the next-determined NAV, and that the minimum price 
variation for quoting and entry of orders in ETMF Shares will be $0.01. 
Proposed Rule Nasdaq 5745(b)(4) provides that Nasdaq will implement 
written surveillance procedures for ETMF Shares. Proposed Nasdaq Rule 
5745(b)(5) provides that, for ETMF Shares based on an international or 
global portfolio, the statutory prospectus or the application for 
exemption from provisions of the 1940 Act for such series of ETMF 
Shares must state that such series must comply with the federal 
securities laws in accepting securities for deposit and satisfying 
redemptions with securities, including that the securities accepted for 
deposit and the securities used to satisfy redemption requests are sold 
in transactions that would be exempt from registration under the 
Securities Act of 1933 (``Securities Act'').
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    \12\ Nasdaq Rule 4120(b)(4) defines the Regular Market Session 
as the trading session from 9:30 a.m. to 4:00 p.m. or 4:15 p.m. ETMF 
Shares would trade until 4:00 p.m.
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    Proposed Definitions. Proposed Nasdaq Rule 5745(c)(1) defines the 
term ``ETMF Share'' as a security that: (1) Represents an interest in a 
registered investment company organized as an open-end management 
investment company that invests in a portfolio of securities and other 
assets selected and managed by the ETMF's investment adviser consistent 
with the ETMF's investment objectives and policies; (2) is issued in 
specified aggregate unit quantities in return for a deposit of a 
specified portfolio of securities and/or a cash amount with a value per 
Share equal to the ETMF's NAV; (3) when aggregated in the same 
specified unit quantities, may be redeemed in exchange for a specified 
portfolio of securities and/or cash with a value per Share equal to the 
ETMF's NAV; and (4) is traded on Nasdaq or another national securities 
exchange using NAV-Based Trading, including pursuant to UTP.
    In addition, proposed Nasdaq Rule 5745(c)(2) defines the term 
``Intraday Indicative Value'' (``IIV'') as the

[[Page 33961]]

estimated indicative value of an ETMF Share based on current 
information regarding the value of the securities and other assets held 
by the ETMF. Proposed Nasdaq Rule 5745(c)(3) defines the term 
``Composition File'' as the specified portfolio of securities and/or 
cash that an ETMF will accept as a deposit in issuing ETMF Shares and 
the specified portfolio of securities and/or cash that an ETMF will 
deliver in a redemption of ETMF Shares. The current Composition File 
would be disseminated through the National Securities Clearing 
Corporation (``NSCC'') once each business day before the open of 
trading in ETMF Shares on Nasdaq on such day. To maintain the 
confidentiality of current portfolio trading, an ETMF's Composition 
File generally would not be a pro rata reflection of the ETMF's 
securities positions. Each security included in the Composition File 
would be a current holding of the ETMF, but the Composition File 
generally would not include all of the securities in the ETMF's 
portfolio or match the weightings of the included securities in the 
portfolio. The Composition File also may consist entirely of cash, in 
which case it would not include any of the securities in the ETMF's 
portfolio.
    Proposed Nasdaq Rule 5745(c)(4) defines the term ``Reporting 
Authority'' as Nasdaq, an institution or a reporting service designated 
by Nasdaq as the official source for calculating and reporting 
information relating to such series of ETMF Shares, including, but not 
limited to, the IIV, the amount of any cash distribution to holders of 
ETMF Shares, NAV, the Composition File or other information relating to 
the issuance, redemption or trading of ETMF Shares. A series of ETMF 
Shares may have more than one Reporting Authority, each having 
different functions.
    Initial and Continued Listing. Proposed Nasdaq Rule 5745(d) sets 
forth the initial and continued listing criteria applicable to ETMF 
Shares. Proposed Nasdaq Rule 5745(d)(1)(A) provides that, for each 
series of ETMF Shares, Nasdaq will establish a minimum number of ETMF 
Shares required to be outstanding at the time of commencement of 
trading. In addition, under proposed Nasdaq Rule 5745(d)(1)(B), Nasdaq 
must obtain a representation from the issuer of each series of ETMF 
Shares that the NAV for such series will be calculated on each business 
day that the New York Stock Exchange is open for trading and that the 
NAV will be made available to all market participants at the same time. 
Under proposed Nasdaq Rule 5745(d)(1)(C), the Reporting Authority that 
provides the Composition File must implement and maintain, or be 
subject to, procedures designed to prevent the use and dissemination of 
material non-public information regarding the ETMF's portfolio 
positions and changes in positions.
    Proposed Nasdaq Rule 5745(d)(2)(A) provides that each series of 
ETMF Shares could continue to be listed and traded if the IIV for the 
ETMF Shares is widely disseminated by one or more major market data 
vendors at intervals of not more than 15 minutes during the Regular 
Market Session when the ETMF Shares trade on Nasdaq. According to the 
Exchange, the purpose of IIVs in NAV-Based Trading is to enable 
investors to estimate the next-determined NAV so they can determine the 
number of ETMF Shares to buy or sell if they want to transact in an 
approximate dollar amount (e.g., if an investor wants to acquire 
approximately $5,000 of an ETMF, how many Shares should the investor 
buy?).\13\ For this purpose, Nasdaq believes that dissemination of IIVs 
at intervals of not more than 15 minutes should generally be 
sufficient. The Exchange states that more frequent dissemination of 
IIVs may increase fund costs without apparent benefit and could focus 
unwarranted investor attention on these disclosures. Moreover, for 
certain strategies, more frequent IIV disclosure could provide 
unintended information about current portfolio trading activity to 
market participants who possess the requisite analytical capabilities, 
computation power and motivation to reverse engineer the ETMF's 
portfolio positions. As proposed, an ETMF would be permitted to 
disseminate IIVs at intervals of less than 15 minutes, but would not be 
required to do so to maintain trading on the Exchange.
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    \13\ Because, in NAV-Based Trading, prices of executed trades 
are not determined until the reference NAV is calculated, buyers and 
sellers of ETMF Shares during the trading day would not know the 
final value of their purchases and sales until the end of the 
trading day.
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    Proposed Nasdaq Rule 5745(d)(2)(B) provides that Nasdaq will 
consider the suspension of trading in, or removal from listing of, a 
series of ETMF Shares under any of the following circumstances: (1) If, 
following the initial twelve-month period after commencement of trading 
on the Exchange of a series of ETMF Shares, there are fewer than 50 
beneficial holders of the series of ETMF Shares for 30 or more 
consecutive trading days; (2) if the ETMF's IIV or NAV is no longer 
calculated or if its IIV, NAV or Composition File is no longer 
available to all market participants at the same time; (3) if the ETMF 
has failed to submit any filings required by the Commission or if 
Nasdaq is aware that the ETMF is not in compliance with the conditions 
of any exemptive order or no-action relief granted by the Commission 
with respect to the series of ETMF Shares; or (4) if such other event 
shall occur or condition exists which, in the opinion of Nasdaq, makes 
further dealings on Nasdaq inadvisable.
    Proposed Nasdaq Rule 5745(d)(2)(C) provides that, if the IIV of a 
series of ETMF Shares is not being disseminated as required, Nasdaq may 
halt trading during the day in which the interruption to the 
dissemination of the IIV occurs. If the interruption to the 
dissemination of the IIV persists past the trading day in which it 
first occurred, Nasdaq will halt trading no later than the beginning of 
the trading day following the interruption. In addition, if the 
Exchange becomes aware that the NAV with respect to a series of ETMF 
Shares is not calculated on each business day that the New York Stock 
Exchange is open for trading and disseminated to all market 
participants at the same time, it will halt trading in such series 
until such time as the NAV is available to all market participants. If 
Nasdaq becomes aware that the Composition File with respect to a series 
of ETMF Shares is not disseminated to all market participants at the 
same time, it will halt trading in such series until such time as the 
Composition File is available to all market participants.
    In addition, proposed Nasdaq Rule 5745(d)(2)(D) provides that, upon 
termination of an ETMF, the ETMF Shares issued in connection with such 
entity must be removed from listing on Nasdaq. Proposed Nasdaq Rule 
5745(d)(2)(E) provides that voting rights must be as set forth in the 
applicable ETMF prospectus.
    Additional Provisions. Proposed Nasdaq Rule 5745(e) provides that 
neither Nasdaq, the Reporting Authority nor any agent of Nasdaq shall 
have any liability for damages, claims, losses or expenses caused by 
any errors, omissions or delays in calculating or disseminating any of 
the following: The current portfolio value; the current value of the 
securities and other assets required to be deposited in connection with 
issuance of ETMF Shares; the amount of any dividend-equivalent payment 
or cash distribution to holders of ETMF Shares; NAV; the Composition 
File; or other information relating to the purchase, redemption or 
trading of ETMF Shares, resulting from any negligent act or omission by 
Nasdaq, the

[[Page 33962]]

Reporting Authority or any agent of Nasdaq, or any act, condition or 
cause beyond the reasonable control of Nasdaq, its agent or the 
Reporting Authority, including, but not limited to, an act of God, 
fire, flood, extraordinary weather conditions, war, insurrection, riot, 
strike, accident, action of government, communications or power 
failure, equipment or software malfunction, or any error, omission or 
delay in the reports of transactions in one or more underlying 
securities.
    Proposed Nasdaq Rule 5745(f) applies only to series of ETMF Shares 
that are the subject of an order by the Commission exempting such 
series from certain prospectus delivery requirements under Section 
24(d) of the 1940 Act and are not otherwise subject to prospectus 
delivery requirements under the Securities Act. Nasdaq would inform its 
members regarding application of Proposed Nasdaq Rule 5745(f) to a 
particular series of ETMF Shares by means of an information circular 
prior to commencement of trading in such series. Under the proposed 
rule, Nasdaq requires that members provide to all purchasers of a 
series of ETMF Shares a written description of the terms and 
characteristics of those securities, in a form prepared by the open-end 
management investment company issuing such securities, not later than 
the time a confirmation of the first transaction in such series is 
delivered to such purchaser. In addition, members shall include such a 
written description with any sales material relating to a series of 
ETMF Shares that is provided to customers or the public. Any other 
written materials provided by a member to customers or the public 
making specific reference to a series of ETMF Shares as an investment 
vehicle must include a statement in substantially the following form: 
``A circular describing the terms and characteristics of (the series of 
ETMF Shares) has been prepared by the (open-end management investment 
company name) and is available from your broker. It is recommended that 
you obtain and review such circular before purchasing (the series of 
ETMF Shares).'' A member carrying an omnibus account for a non-member 
broker-dealer is required to inform such non-member that execution of 
an order to purchase a series of ETMF Shares for such omnibus account 
would be deemed to constitute agreement by the non-member to make such 
a written description available to its customers on the same terms as 
are directly applicable to members under this rule. Upon request of a 
customer, a member shall also provide a prospectus for the particular 
series of ETMF Shares.
    Proposed Nasdaq Rule 5745(g) provides that, if the investment 
adviser to an ETMF issuing Shares is a registered broker-dealer or 
affiliated with a broker-dealer, such investment adviser shall erect a 
``fire wall'' between the investment adviser and the broker-dealer 
personnel or broker-dealer affiliate, as applicable, with respect to 
access to information concerning the composition and/or changes to such 
ETMF's portfolio holdings. Personnel who make decisions on the ETMF's 
portfolio composition must be subject to procedures designed to prevent 
the use and dissemination of material nonpublic information regarding 
the applicable ETMF portfolio.

Other Proposed Rule Changes

    The Exchange also proposes to amend: (1) Nasdaq Rule 4120(a)(9) and 
(10) to add provisions applicable to ETMF Shares with respect to 
trading halts; (2) Nasdaq Rule 4120(b)(4)(A) and (E) to modify certain 
defined terms to include references to ETMF Shares; (3) Nasdaq Rule 
5615(a)(5) and IM-5615-4 to add references to ETMFs for purposes of 
certain corporate governance requirements; and (4) Nasdaq Rule 5940(a) 
and (b) to add references to ETMF Shares to those securities already 
covered under the rule relating to both entry fees and annual fees.\14\
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    \14\ The Exchange also proposes to make certain other minor 
technical changes to these rules unrelated to ETMFs. Specifically, 
the Exchange proposes to amend Rule 4120(a)(9), (b)(4)(A), and 
(b)(4)(E) to include appropriate references to various derivative 
securities defined in Rule 5711, and to make certain other 
typographical corrections and clarifications.
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Portfolio Disclosure

    The Exchange states that, as required for traditional open-end 
investment companies, ETMFs would disclose their full portfolio 
positions at least quarterly, with a delay (not to exceed 60 days) to 
limit opportunities for other market participants to engage in 
predatory trading practices that might harm fund shareholders.
    Nasdaq Rule 5735 requires Active ETFs to disclose publicly their 
full portfolio positions at least once daily. According to the 
Exchange, the purpose of this requirement is to provide Active ETF 
market makers with the portfolio information needed to hedge the 
intraday market risk they assume as they take inventory positions in 
connection with their market making activities. Nasdaq states that, in 
conventional ETF trading, a condition to maintaining a tight 
relationship between market trading prices and contemporaneous 
underlying portfolio values is that market makers have sufficient 
information regarding portfolio positions to enable them to earn 
reliable arbitrage profits by entering into long (or short) positions 
in ETF shares and offsetting short (or long) positions in the 
underlying holdings (or a suitable proxy).
    Nasdaq states that, in ETMF trading, by contrast, a market maker 
assumes no intraday market risk in connection with its inventory 
positions because all ETMF Share transaction prices are based on the 
next-determined NAV. According to the Exchange, whether an ETMF's 
underlying value goes up or down over the course of a trading day would 
not affect how much profit a market maker earns by selling (or buying) 
ETMF Shares in the market at a net premium (discount) to NAV, and then 
purchasing (redeeming) an offsetting number of ETMF Shares at the end 
of the day in transactions with the ETMF. The Exchange states that no 
intraday market risk means no requirement for intraday hedging, and 
therefore no associated requirement for portfolio disclosure to 
maintain a tight relationship between ETMF Share trading prices and 
NAV.
    According to the Exchange, the arbitrage that connects ETMF trading 
prices to NAV is effected at the end of each trading day when a market 
maker or other arbitrageur purchases (or redeems) Creation Units of 
ETMF Shares through an Authorized Participant to offset the net amount 
of ETMF Shares it has sold (bought) over the course of the trading day, 
and buys (sells) the quantity of Composition File instruments 
corresponding to the number of Creation Units purchased (redeemed). The 
Exchange states that an ETMF market maker that purchases (or redeems) a 
Creation Unit at the end of a trading day to offset its net intraday 
sales (purchases) of a Creation Unit quantity of ETMF Shares would earn 
arbitrage profits to the extent that it either sells (buys) Shares at 
an aggregate premium (discount) to NAV or buys (sells) a Creation Unit-
equivalent quantity of Composition File instruments at an aggregate 
discount (premium) to their end-of-day values, and the net amount of 
ETMF premium (discount) plus Composition File instruments discount 
(premium) exceeds the transaction fee that applies to a purchase 
(redemption) of a Creation Unit of ETMF Shares.\15\
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    \15\ The arbitrage mechanism is simplified for cash creations 
and redemptions. An ETMF market maker that purchases (or redeems) a 
Creation Unit in cash to offset its net intraday sales (purchases) 
of a Creation Unit quantity of ETMF Shares would earn arbitrage 
profits to the extent that it sells (buys) ETMF Shares in the 
secondary market at an aggregate premium (discount) to NAV that 
exceeds the transaction fee that applies to a cash creation 
(redemption) of a Creation Unit of ETMF Shares.

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[[Page 33963]]

    The Exchange states that, different from ETFs trading in 
conventional intraday markets, ETMFs offer market makers an arbitrage 
profit opportunity that does not depend on either corresponding 
intraday adjustments in fund share and underlying portfolio positions 
or the use of a hedge portfolio to manage intraday market risk. 
According to the Exchange, a ``perfect arbitrage'' in an ETMF requires 
only that market makers holding short (or long) positions in ETMF 
Shares accumulated intraday transact with the ETMF to purchase (redeem) 
a corresponding number of Creation Units of ETMF Shares, buy (sell) the 
equivalent quantities of Composition File instruments at market-closing 
or better prices, and offload any remaining sub-Creation Unit ETMF 
Share inventory through secondary market transactions by the market 
close.\16\
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    \16\ According to the Exchange, market makers are expected 
generally to seek to minimize their exposure to price risk in ETMF 
Shares by holding little or no overnight inventory. Establishing 
Creation Unit sizes for ETMFs that are somewhat smaller (i.e., in a 
range of 5,000 to 50,000 Shares) than is customary for ETFs should 
support efficient arbitrage between an ETMF's trading prices and NAV 
by facilitating tighter market maker inventory management. To the 
extent that market makers hold small positions in ETMF Shares 
overnight, they are expected to aggregate such holdings with other 
risk positions and transact at or near the market close to buy or 
sell offsetting positions in appropriate, broad-based hedging 
instruments. Such hedging of overnight inventory risk on a macro 
basis does not require disclosure of non-Composition File portfolio 
positions.
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    According to the Exchange, because the arbitrage mechanism that 
underlies ETMF trading is simpler, more reliable and exposes market 
makers to less risk than ETF arbitrage, market makers should require 
less profit inducement to establish and maintain markets in ETMF Shares 
than in similarly constituted ETFs, thereby enabling ETMFs to routinely 
trade at smaller premiums/discounts and narrower bid-ask spreads. 
Further, because the arbitrage mechanism that underlies efficient 
trading of ETMFs does not involve portfolio positions that are not 
included in the Composition File, the need for full portfolio 
transparency to achieve tight markets in ETMF Shares is eliminated.

Exchange Listing

    Nasdaq intends to enter into a license agreement to allow for the 
listing and trading of ETMF Shares on the Exchange.\17\ According to 
the Exchange, ETMF Shares listed on the Exchange may trade pursuant to 
UTP on other national securities exchanges that have obtained 
appropriate licenses, adopted applicable exchange rules and developed 
systems to support NAV-Based Trading. Nasdaq states that fees collected 
by the Exchange in connection with the listing and trading of ETMF 
Shares would comply with the statutory requirements set forth in the 
Act.
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    \17\ The Exchange states that aspects of ETMFs and NAV-Based 
Trading are protected intellectual property subject to issued and 
pending U.S. patents held by Navigate Fund Solutions LLC 
(``Navigate''), a wholly owned subsidiary of Eaton Vance Corp. 
Nasdaq would enter into a license agreement with Navigate to allow 
for NAV-Based Trading on the Exchange of ETMFs that have themselves 
entered into license agreements with Navigate.
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Trading Rules

    Nasdaq would deem ETMF Shares to be equity securities, thus 
rendering trading in ETMF Shares to be subject to Nasdaq's existing 
rules governing the trading of equity securities.

III. Comment Letters

    The Commission received four comment letters on the proposed rule 
change. All of the commenters supported the proposal. The commenters 
stated their views that ETMFs could offer investment managers and 
investors a tax-efficient alternative to today's mutual funds.\18\ In 
addition to the benefits of tax-efficiency, some commenters stated 
their belief that ETMFs would offer lower cost benefits to investors as 
a result of lower expenses,\19\ and one commenter stated its belief 
that a benefit would be transparency of ETMF transaction costs.\20\ The 
same commenter also stated its view that the non-disclosed nature of 
the ETMF portfolio would serve as a barrier to front-running of 
portfolio trades of actively managed funds and that the proposed ETMFs 
would promote renewed competition in the fund marketplace by 
encouraging investment managers concerned about maintaining the 
confidentiality of their portfolio trading to offer their leading 
strategies in a better performing product structure.\21\
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    \18\ See MMI Letter; Tull Letter; Strategic Insight Letter; and 
ConvergEx Letter at 1, supra note 4.
    \19\ See Tull Letter; Strategic Insight Letter; and ConvergEx 
Letter at 1, supra note 4.
    \20\ See Tull Letter, supra note 4.
    \21\ See id.
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    In addition, several commenters stated their belief about the 
potential positive impact the proposed ETMF product may have on 
arbitrage and pricing. Specifically, one commenter stated its view that 
NAV-Based Trading for ETMFs would permit market makers to offer 
differential arbitrage pricing to investors based on the closing NAV of 
the ETMF, which should expand market maker opportunities as the 
arbitrage moves towards order management control and away from 
sophisticated arbitrage pricing models using real-time pricing that 
makes it difficult for an investor to calculate personal market entry 
and exit costs.\22\ Another commenter stated its view that, because 
ETMFs could promote competition in the fund marketplace, such 
competition might enable ETMFs to trade close to the underlying fund 
value on a consistent basis.\23\ Lastly, one commenter stated its view 
that the promise of ETMFs can be realized if a ``common Chassis'' is 
adopted by multiple fund managers, who would then simultaneously 
educate the marketplace about the benefits of ETMFs.\24\ The same 
commenter also believes that the adoption curve of ETMFs might parallel 
the acceleration in the use of mutual funds triggered by the 
introduction in the early 1990s of the Schwab's Mutual Fund 
OneSource[supreg] supermarket, when numerous fund managers articulated 
the benefit of a common administrative platform.\25\ The commenter 
concluded with its view that ETMFs have the potential to significantly 
improve returns to investors in actively-managed funds, and to 
encourage additional investment and savings by millions of Americans 
over the coming decades.\26\
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    \22\ See id.
    \23\ See ConvergEx Letter at 2, supra note 4.
    \24\ See Strategic Insight Letter, supra note 4.
    \25\ See id.
    \26\ See id.
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IV. Proceedings To Determine Whether To Approve or Disapprove SR-
NASDAQ-2014-020 and Grounds for Disapproval Under Consideration

    The Commission is instituting proceedings pursuant to Section 
19(b)(2)(B) of the Act \27\ to determine whether the proposed rule 
change should be approved or disapproved. Institution of such 
proceedings is appropriate at this time in view of the legal and policy 
issues raised by the proposed rule change, as discussed below. 
Institution of proceedings does not indicate that the Commission has 
reached any conclusions with respect to any of the issues involved. 
Rather, as described below, the Commission seeks and encourages 
interested persons to provide additional comment on the proposed rule 
change.
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    \27\ 15 U.S.C. 78s(b)(2)(B).

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[[Page 33964]]

    As discussed above, the Exchange proposes to adopt new Nasdaq Rule 
5745, which would govern the listing and trading of ETMF Shares. In 
addition, ETMF Shares would trade on Nasdaq using a new trading 
protocol called ``NAV-Based Trading.'' In NAV-Based Trading, all bids, 
offers, and execution prices would be expressed as a premium/discount 
(which may be zero) to the ETMF's next-determined NAV. Trade executions 
using NAV-Based Trading would be binding at the time orders are matched 
on Nasdaq's facilities, with the transaction prices contingent upon the 
determination of the ETMF's NAV at the end of the business day. The 
Commission believes that the proposal, which seeks to permit the 
listing and trading of ETMFs on the Exchange, raises important trading 
issues that warrant further public comment and Commission 
consideration. The proposed rule change would permit the listing and 
trading of ETMFs based on a novel and unique trading protocol, NAV-
Based Trading, and the Commission believes that proceedings are 
appropriate to consider, among other matters, the ability of brokers, 
dealers, investors, and other market participants to fully understand 
NAV-Based Trading, as well as the public availability of information, 
including the differing representations of intraday bids, offers and 
execution prices for ETMFs, for investors and other market 
participants.
    Pursuant to Section 19(b)(2)(B) of the Act,\28\ the Commission is 
providing notice of the grounds for disapproval under consideration. 
The Commission is instituting proceedings to allow for additional 
analysis of the proposed rule change's consistency with Section 6(b)(5) 
of the Exchange Act, which requires, among other things, that the rules 
of a national securities exchange be ``designed to prevent fraudulent 
and manipulative acts and practices, to promote just and equitable 
principles of trade,'' and ``to protect investors and the public 
interest.'' \29\
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    \28\ Id.
    \29\ 15 U.S.C. 78f(b)(5).
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V. Procedure: Request for Written Comments

    The Commission requests that interested persons provide written 
submissions of their views, data, and arguments with respect to the 
concerns identified above, as well as any other concerns they may have 
with the proposal. In particular, the Commission invites the written 
views of interested persons concerning whether the proposal is 
consistent with Section 6(b)(5) or any other provision of the Act, or 
the rules and regulations thereunder. Although there do not appear to 
be any issues relevant to approval or disapproval which would be 
facilitated by an oral presentation of views, data, and arguments, the 
Commission will consider, pursuant to Rule 19b-4, any request for an 
opportunity to make an oral presentation.\30\
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    \30\ Section 19(b)(2) of the Act, as amended by the Securities 
Act Amendments of 1975, Public Law 94-29 (June 4, 1975), grants the 
Commission flexibility to determine what type of proceeding--either 
oral or notice and opportunity for written comments--is appropriate 
for consideration of a particular proposal by a self-regulatory 
organization. See Securities Act Amendments of 1975, Senate Comm. on 
Banking, Housing & Urban Affairs, S. Rep. No. 75, 94th Cong., 1st 
Sess. 30 (1975).
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    Interested persons are invited to submit written data, views, and 
arguments regarding whether the proposal should be approved or 
disapproved by July 7, 2014. Any person who wishes to file a rebuttal 
to any other person's submission must file that rebuttal by July 18, 
2014.
    Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to [email protected]. Please include 
File Number SR-NASDAQ-2014-020 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.

All submissions should refer to File Number SR-NASDAQ-2014-020. This 
file number should be included on the subject line if email is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549, on official business days between the hours of 
10:00 a.m. and 3:00 p.m. Copies of such filings also will be available 
for inspection and copying at the principal office of the Exchange. All 
comments received will be posted without change; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File Number SR-NASDAQ-2014-020 and should 
be submitted on or before July 7, 2014. Rebuttal comments should be 
submitted by July 18, 2014.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\31\
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    \31\ 17 CFR 200.30-3(a)(57).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-13822 Filed 6-12-14; 8:45 am]
BILLING CODE 8011-01-P