[Federal Register Volume 83, Number 237 (Tuesday, December 11, 2018)]
[Notices]
[Pages 63689-63692]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-26735]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-84719; File No. SR-CboeBZX-2018-076]
Self-Regulatory Organizations; Cboe BZX Exchange, Inc.; Order
Granting Approval of a Proposed Rule Change, as Modified by Amendment
Nos. 1 and 2, To List and Trade Shares of the FormulaFolios Sector
Rotation ETF, a Series of the Northern Lights Fund Trust IV, Under Rule
14.11(i), Managed Fund Shares
December 4, 2018.
I. Introduction
On October 2, 2018, Cboe BZX Exchange, Inc. (``Exchange'' or
``BZX'') filed with the Securities and Exchange Commission
(``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a
proposed rule change to list and trade shares (``Shares'') of the
FormulaFolios Sector Rotation ETF (``Fund'') of the Northern Lights
Fund Trust IV (``Trust'') under BZX Rule 14.11(i). The proposed rule
change was published for comment in the Federal Register on October 22,
2018.\3\ On November 8, 2018, the Exchange filed Amendment No. 1 to the
proposed rule change.\4\ On November 30, 2018, the Exchange filed
Amendment No. 2 to the proposed rule change.\5\ The Commission has
received no comments on the proposal. This order grants approval of the
proposed rule change, as modified by Amendment Nos. 1 and 2.
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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. 84438 (October 16,
2018), 83 FR 53343.
\4\ In Amendment No. 1, which amended and replaced the proposed
rule change in its entirety, the Exchange: (a) clarified references
to certain OTC derivatives that the Fund intends to invest; (b)
clarified that, in the event that Sector Swaps (as defined herein)
are unavailable or the pricing for such contracts are unfavorable,
the Fund may attempt to replicate the desired equity exposure by
purchasing some or all of the equity securities that are listed on a
U.S. national securities exchange, including ETFs, comprising the
top four sectors at the time; and (c) made other non-substantive,
technical, and clarifying corrections to the proposal. Because
Amendment No. 1 does not materially alter the substance of the
proposed rule change or raise unique or novel regulatory issues
under the Act, Amendment No. 1 is not subject to notice and comment.
Amendment No. 1 to the proposed rule change is available at: https://www.sec.gov/comments/sr-cboebzx-2018-076/srcboebzx2018076-4716147-176694.pdf.
\5\ In Amendment No. 2, the Exchange: (a) Clarified that the
Fund will meet the requirements of Rule 14.11(i)(4)(C)(vi), which
requires that, to the extent that listed or OTC derivatives are used
to gain exposure to individual equities and/or fixed income
securities, or to indexes of equities and/or indexes of fixed income
securities, the aggregate gross notional value of such exposure
shall meet the criteria set forth in BZX Rule 14.11(i)(4)(C)(i) and
(ii) (including gross notional exposures), respectively; and (b)
made other non-substantive, technical, and clarifying corrections to
the proposal. Because Amendment No. 2 does not materially alter the
substance of the proposed rule change or raise unique or novel
regulatory issues under the Act, Amendment No. 2 is not subject to
notice and comment. Amendment No. 2 to the proposed rule change is
available at: https://www.sec.gov/comments/sr-cboebzx-2018-076/srcboebzx2018076-4716146-176693.pdf.
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II. Exchange's Description of the Proposal, as Modified by Amendment
Nos. 1 and 2
The Exchange proposes to list and trade the Shares of the Fund
under BZX Rule 14.11(i), which governs the listing and trading of
Managed Fund Shares on the Exchange. The Shares will be offered by the
Trust, which was established as a Delaware statutory trust on June 2,
2015. The Exchange represents that Trust is registered with the
Commission as an open-end investment company and has filed a
registration statement on behalf of the Fund on Form N-1A
(``Registration Statement'') with the Commission.\6\ FormulaFolio
Investments, LLC is the investment adviser to the Fund
(``Adviser'').\7\
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\6\ See Registration Statement on Form N-1A for the Trust, dated
July 27, 2018 (File Nos. 333-204808 and 811-23066). According to the
Exchange, the Trust has obtained an order granting certain exemptive
relief under the Investment Company Act of 1940 (``1940 Act''). See
Investment Company Act Release No. 29571 (May 16, 2017) (File No.
812-32367).
\7\ The Exchange represents that the Adviser is not a registered
broker-dealer and is not currently affiliated with any broker-
dealers. In addition, the Exchange represents that Adviser personnel
who make decisions regarding the Fund's portfolio are subject to
procedures designed to prevent the use and dissemination of material
nonpublic information regarding the Fund's portfolio. In the event
that (a) the Adviser becomes registered as a broker-dealer or newly
affiliated with a broker-dealer, or (b) any new adviser or sub-
adviser is a registered broker-dealer or becomes affiliated with a
broker-dealer, it will implement and maintain a fire wall with
respect to its relevant personnel or such broker-dealer affiliate,
as applicable, regarding access to information concerning the
composition of, and/or changes to, the portfolio, and will be
subject to procedures designed to prevent the use and dissemination
of material non-public information regarding such portfolio.
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The Fund will be an actively managed exchange-traded fund that
seeks to provide a long-term total return which exceeds the total
return of its Primary Benchmark Index.\8\ The Fund will seek to achieve
its investment objective, under Normal Market Conditions,\9\ by
utilizing derivatives, or a combination of derivatives and direct
investments, to gain 100% equity exposure. The Exchange submits this
proposal in order to allow the Fund to hold over-the-counter (``OTC'')
derivatives, in a manner that may not comply with BZX Rule
14.11(i)(4)(C)(v), which requires, among other things, that the
aggregate gross notional value of OTC derivatives not exceed 20% of the
weight of the portfolio (including gross notional exposures).\10\
Specifically, the Exchange is proposing that the Fund may hold up to
75% of the weight of its portfolio in OTC derivatives, including gross
notional exposures. Otherwise, the Exchange represents that the Fund
will comply with all other listing requirements on an initial and
continued listing basis under BZX Rule 14.11(i).\11\
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\8\ The Fund's Primary Benchmark Index is the S&P 500 Index.
\9\ As defined in BZX Rule 14.11(i)(3)(E), the term ``Normal
Market Conditions'' includes, but is not limited to, the absence of
trading halts in the applicable financial markets generally;
operational issues causing dissemination of inaccurate market
information or system failures; or force majeure type events such as
natural or man-made disaster, act of God, armed conflict, act of
terrorism, riot or labor disruption, or any similar intervening
circumstance.
\10\ BZX Rule 14.11(i)(4)(C)(v) provides that ``the portfolio
may, on both an initial and continuing basis, hold OTC derivatives,
including forwards, options, and swaps on commodities, currencies
and financial instruments (e.g., stocks, fixed income, interest
rates, and volatility) or a basket or index of any of the foregoing,
however the aggregate gross notional value of OTC derivatives [sic]
shall not exceed 20% of the weight of the portfolio (including gross
notional exposures).''
\11\ In particular, the Exchange notes that the Fund will meet
the requirements of BZX Rule 14.11(i)(4)(C)(vi), which requires
that, to the extent that listed or OTC derivatives are used to gain
exposure to individual equities and/or fixed income securities, or
to indexes of equities and/or indexes of fixed income securities,
the aggregate gross notional value of such exposure shall meet the
criteria set forth in BZX Rule 14.11(i)(4)(C)(i) and (ii) (including
gross notional exposures), respectively.
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[[Page 63690]]
The Adviser will allocate the Fund's assets based on two
proprietary investment models. The Adviser's first investment model
will identify trends for the individual sectors within its Primary
Benchmark Index. Each month, the model will analyze the strength of the
US economy and rank the sectors of its Primary Benchmark Index based on
a blend of various technical momentum indicators, volatility gauges,
and valuation multiples. When the economy appears healthy, sectors with
the highest risk-adjusted returns (lower volatility and higher price
momentum) and the lowest valuations (lower price ratios) are ranked
higher. When the economy appears unhealthy, sectors with more stable
price movements and lower volatility are ranked higher. The Fund will
invest in the top four sectors in an equal weight. In order to achieve
such exposure, the Fund will use OTC swap contracts that reference each
applicable sector index (``Sector Swaps'').\12\ In the event that such
Sector Swaps are unavailable or the pricing for such contracts are
unfavorable, the Fund may attempt to replicate the desired equity
exposure by purchasing some or all of the equity securities that are
listed on a U.S. national securities exchange, including ETFs,\13\
comprising the top four sectors at the time.\14\ If the model indicates
the market is doing poorly, and if not enough sectors pass the
screening criteria, the Fund can invest a portion or all of its assets
in cash or Cash Equivalents.\15\ The Exchange is proposing to allow the
Fund to hold up to 75% of the weight of its portfolio (including gross
notional exposure) in Sector Swaps, collectively, in a manner that may
not comply with 14.11(i)(4)(C)(v).\16\
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\12\ The Fund will attempt to limit counterparty risk in non-
cleared swap contracts by entering into such contracts only with
counterparties the Adviser believes are creditworthy and by limiting
the Fund's exposure to each counterparty. The Adviser will monitor
the creditworthiness of each counterparty and the Fund's exposure to
each counterparty on an ongoing basis. The Sector Swaps will
reference the individual sector indices that underlie the Primary
Benchmark Index, which include S&P 500 Consumer Discretionary, S&P
500 Consumer Staples, S&P 500 Health Care, S&P 500 Industrials, S&P
500 Information Technology, S&P 500 Materials, S&P 500 Real Estate,
S&P 500 Telecommunication Services, S&P 500 Utilities, S&P 500
Financials, and S&P 500 Energy (individually, ``Primary Benchmark
Sector Index,'' and, collectively, ``Primary Benchmark Sector
Indexes''). The Exchange notes that the Primary Benchmark Index and
each Primary Benchmark Sector Index separately meet the generic
listing standards applicable to Index Fund Shares under BZX Rule
14.11(c)(3)(A)(i).
\13\ For purposes of this proposal, the term ETF includes
Portfolio Depositary Receipts, Index Fund Shares, and Managed Fund
Shares as defined in BZX Rules 14.11(b), (c), and (i), respectively,
and their equivalents on other national securities exchanges.
\14\ Such equity securities may include either component
securities of the Primary Benchmark Index, ETFs based on the Primary
Benchmark Index, or ETFs based on the sectors underlying the Primary
Benchmark Index. Any such holdings will meet the listing
requirements for U.S. Component Stocks as provided in BZX Rule
14.11(i)(4)(C)(i)(a).
\15\ As defined in BZX Rule 14.11(i)(4)(C)(iii)(b), Cash
Equivalents are short-term instruments with maturities of less than
three months, which includes only the following: (i) U.S. Government
securities, including bills, notes, and bonds differing as to
maturity and rates of interest, which are either issued or
guaranteed by the U.S. Treasury or by U.S. Government agencies or
instrumentalities; (ii) certificates of deposit issued against funds
deposited in a bank or savings and loan association; (iii) bankers
acceptances, which are short-term credit instruments used to finance
commercial transactions; (iv) repurchase agreements and reverse
repurchase agreements; (v) bank time deposits, which are monies kept
on deposit with banks or savings and loan associations for a stated
period of time at a fixed rate of interest; (vi) commercial paper,
which are short-term unsecured promissory notes; and (vii) money
market funds.
\16\ See supra note 10.
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The Adviser's second investment model is used to manage an active
bond allocation exclusively through holding fixed income ETFs. This
model analyzes various major fixed income asset classes (U.S.
treasuries, investment grade U.S. bonds, high-yield U.S. bonds, high-
yield municipal bonds, and floating rate bonds) based on a blend of
yield spreads, interest rates, and price momentum. Following the
ranking process, the Fund will invest in ETFs based on the highest-
ranked asset classes, with the lowest ranked asset classes left out of
the Fund.\17\ When not enough of the asset classes meet the model's
criteria, the Fund may invest heavily in cash or Cash Equivalents until
more asset classes become favorable for investing.
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\17\ All of the Fund's investments made pursuant to this second
investment model will meet the listing requirements for U.S. equity
securities as provided in BZX Rule 14.11(i)(4)(C)(i)(a).
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III. Discussion and Commission Findings
After careful review, the Commission finds that the Exchange's
proposal to list and trade the Shares, as modified by Amendment Nos. 1
and 2, is consistent with the Act and the rules and regulations
thereunder applicable to a national securities exchange.\18\ In
particular, the Commission finds that the proposed rule change is
consistent with Section 6(b)(5) of the Act,\19\ which requires, among
other things, that the Exchange's rules be designed to prevent
fraudulent and manipulative acts and practices, 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 also 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
\20\ 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.
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\18\ 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).
\19\ 15 U.S.C. 78f(b)(5).
\20\ 15 U.S.C. 78k-1(a)(1)(C)(iii)
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According to the Exchange, apart from the exception to BZX Rule
14.11(i)(4)(C)(v) described above, the Fund's proposed investments will
satisfy, on an initial and continued listing basis, all of the generic
listing standards under BZX Rule 14.11(i)(4)(C) and all other
applicable requirements for Managed Fund Shares under Rule 14.11(i). In
addition, the Exchange represents that the Shares of the Fund will
comply with all other requirements applicable to Managed Fund Shares
including, but not limited to, requirements relating to the
dissemination of key information such as the Disclosed Portfolio, Net
Asset Value (``NAV''), and the Intraday Indicative Value, rules
governing the trading of equity securities, trading hours, trading
halts, surveillance, firewalls, and the information circular, as set
forth in Exchange rules applicable to Managed Fund Shares and the
orders approving such rules.
The Exchange also represents that the intra-day, closing, and
settlement prices of exchange-traded portfolio assets, including equity
securities, will be readily available from the securities exchanges
trading such securities, automated quotation systems, published or
other public sources, or online information services such as Bloomberg
or Reuters. Intraday price quotations on OTC swaps and fixed income
instruments are available from major broker-dealer firms and from
third-parties, which may provide prices free with a time delay or in
real-time for a paid fee. Price information for Cash Equivalents will
be available from major market data vendors. In addition, the Disclosed
Portfolio will be available on the issuer's website free of charge. The
[[Page 63691]]
Fund's website includes a form of the prospectus for the Fund and
additional information related to NAV and other applicable quantitative
information. Information regarding market price and trading volume of
the Shares will be continuously available throughout the day on
brokers' computer screens and other electronic services. Quotation and
last-sale information on the Shares will be available through the
Consolidated Tape Association. Trading in the Shares may be halted for
market conditions or for reasons that, in the view of the Exchange,
make trading inadvisable. The Exchange deems the Shares to be equity
securities, thus rendering trading in the Shares subject to the
Exchange's existing rules governing the trading of equity securities.
The Exchange represents that it has appropriate rules to facilitate
trading in the Shares during all trading sessions.
The Commission notes that, in support of its proposal, the Exchange
has made the following additional representations:
(1) As noted above, the Exchange represents that, apart from the
exception to BZX Rule 14.11(i)(4)(C)(v) relating to holdings in OTC
derivatives, the Fund will meet and be subject to all other
requirements of the generic listing standards and other applicable
continued listing requirements for Managed Fund Shares under BZX Rule
14.11(i), including those requirements regarding the Disclosed
Portfolio and the requirement that the Disclosed Portfolio and the NAV
will be made available to all market participants at the same time,\21\
Intraday Indicative Value,\22\ suspension of trading or removal,\23\
trading halts,\24\ disclosure,\25\ and firewalls.\26\
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\21\ See Rules 14.11(i)(4)(A)(ii) and 14.11(i)(4)(B)(ii).
\22\ See Rule 14.11(i)(4)(B)(i).
\23\ See Rule 14.11(i)(4)(B)(iii).
\24\ See Rule 14.11(i)(4)(B)(iv).
\25\ See Rule 14.11(i)(6).
\26\ See Rule 14.11(i)(7).
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(2) Trading of the Shares through the Exchange will be subject to
the Exchange's surveillance procedures for derivative products,
including Managed Fund Shares. All of the equity securities held by the
Fund will trade on markets that are a member of Intermarket
Surveillance Group (``ISG'') or affiliated with a member of ISG or with
which the Exchange has in place a comprehensive surveillance sharing
agreement. The Exchange, the Financial Industry Regulatory Authority,
Inc. (``FINRA''), on behalf of the Exchange, or both will communicate
regarding trading in the Shares and the underlying equity securities
held by the Fund with the ISG, other markets or entities who are
members or affiliates of the ISG, or with which the Exchange has
entered into a comprehensive surveillance sharing agreement. The
Exchange, FINRA, on behalf of the Exchange, or both may obtain
information regarding trading in the Shares and the underlying equity
securities held by the Fund via the ISG from other markets or entities
who are members or affiliates of the ISG or with which the Exchange has
entered into a comprehensive surveillance sharing agreement.
Additionally, the Exchange or FINRA, on behalf of the Exchange, may
access, as needed, trade information for certain fixed income
instruments reported to FINRA's Trade Reporting and Compliance Engine.
The Exchange has a policy prohibiting the distribution of material non-
public information by its employees.
(3) Prior to the commencement of trading, the Exchange will inform
its members in an Information Circular of the special characteristics
and risks associated with trading the Shares. Specifically, the
Information Circular will discuss the following: (a) The procedures for
purchases and redemptions of Shares in Creation Units (and that Shares
are not individually redeemable); (b) BZX Rule 3.7, which imposes
suitability obligations on Exchange members with respect to
recommending transactions in the Shares to customers; (c) how
information regarding the Intraday Indicative Value and the Disclosed
Portfolio is disseminated; (d) the risks involved in trading the Shares
during the Pre-Opening \27\ and After Hours Trading Sessions \28\ when
an updated Intraday Indicative Value and Underlying Index value will
not be calculated or publicly disseminated; (e) the requirement that
members deliver a prospectus to investors purchasing newly issued
Shares prior to or concurrently with the confirmation of a transaction;
and (f) trading information. In addition, the Information Circular will
advise members, prior to the commencement of trading, of the prospectus
delivery requirements applicable to the Fund. Members purchasing Shares
from the Fund for resale to investors will deliver a prospectus to such
investors. The Information Circular will also discuss any exemptive,
no-action, and interpretive relief granted by the Commission from any
rules under the Act.
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\27\ The Pre-Opening Session is from 8:00 a.m. to 9:30 a.m.
Eastern Time.
\28\ The After Hours Trading Session is from 4:00 p.m. to 5:00
p.m. Eastern Time.
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(4) The Fund's investments, including derivatives, will be
consistent with the 1940 Act, and the Fund's investment objective and
policies and will not be used to enhance leverage (although certain
derivatives and other investments may result in leverage).\29\
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\29\ According to the Exchange, the Fund will include
appropriate risk disclosure in its offering documents, including
leveraging risk, which is the risk that certain transactions of a
fund, including a fund's use of derivatives, may give rise to
leverage, causing a fund to be more volatile than if it had not been
leveraged. The Fund's investments in derivative instruments will be
made in accordance with the 1940 Act and consistent with the Fund's
investment objective and policies. To mitigate leveraging risk, the
Fund will segregate or earmark liquid assets determined to be liquid
by the Adviser in accordance with procedures established by the
Trust's Board and in accordance with the 1940 Act (or, as permitted
by applicable regulations, enter into certain offsetting positions)
to cover its obligations under derivative instruments. These
procedures have been adopted consistent with Section 18 of the 1940
Act and related Commission guidance.
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(5) The Fund's investments will not be used to seek performance
that is the multiple or inverse multiple (i.e., 2Xs and 3Xs) of the
Fund's primary broad-based securities benchmark index (as defined in
Form N-1A).
(6) The Fund will only use those derivatives included in the
defined term ``Sector Swaps.'' The Fund's use of derivative instruments
will be collateralized.
(7) The Trust is required to comply with Rule 10A-3 under the Act
\30\ for the initial and continued listing of the Shares of the Fund,
and at least 100,000 Shares will be outstanding upon the commencement
of trading.
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\30\ See 17 CFR 240.10A-3.
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(8) The Fund will attempt to limit counterparty risk in Sector
Swaps by entering into such contracts only with counterparties the
Adviser believes are creditworthy and by limiting the Fund's exposure
to each counterparty. The Adviser will monitor the creditworthiness of
each counterparty and the Fund's exposure to each counterparty on an
ongoing basis.
(9) All statements and representations made in this filing
regarding the description of the portfolio or reference assets,
limitations on portfolio holdings or reference assets, dissemination
and availability of index, reference asset, and intraday indicative
values, and the applicability of Exchange rules specified in this
filing shall constitute continued listing requirements for the Fund.
The issuer has represented to the Exchange that it will advise the
Exchange of any failure by the Fund or the Shares to comply with the
continued listing requirements, and, pursuant to its
[[Page 63692]]
obligations under Section 19(g)(1) of the Act, the Exchange will
surveil for compliance with the continued listing requirements. If the
Fund or the Shares are not in compliance with the applicable listing
requirements, the Exchange will commence delisting procedures under
Exchange Rule 14.12.
This approval order is based on all of the Exchange's
representations and description of the Shares and the Fund, including
those set forth above and in Amendment Nos. 1 and 2 to the proposed
rule change. Except as described herein, the Commission notes that the
Shares must comply with all applicable requirements of BZX Rule
14.11(i) to be listed and traded on the Exchange on an initial and
continuing basis.
For the foregoing reasons, the Commission finds that the proposed
rule change, as modified by Amendment Nos. 1 and 2, is consistent with
Section 6(b)(5) of the Act \31\ and the rules and regulations
thereunder applicable to a national securities exchange.
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\31\ 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,\32\ that the proposed rule change (SR-CboeBZX-2017-076), as
modified by Amendment Nos. 1 and 2, be, and it hereby is, approved.
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\32\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\33\
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\33\ 17 CFR 200.30-3(a)(12).
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Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2018-26735 Filed 12-10-18; 8:45 am]
BILLING CODE 8011-01-P