[Federal Register Volume 84, Number 50 (Thursday, March 14, 2019)]
[Notices]
[Pages 9395-9397]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-04705]


=======================================================================
-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-85278; File No. SR-CboeBZX-2018-044]


Self-Regulatory Organizations; Cboe BZX Exchange, Inc.; Order 
Disapproving a Proposed Rule Change, as Modified by Amendment No. 1, To 
Amend BZX Rule 14.11(c) (Index Fund Shares)

March 8, 2019.

I. Introduction

    On June 21, 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'' or ``Exchange Act'') \1\ and Rule 19b-4 thereunder,\2\ a 
proposed rule change to amend BZX Rule 14.11(c) to permit either the 
portfolio holdings of a series of Index Fund Shares or the index 
underlying a series of Index Fund Shares to satisfy the listing 
standards under BZX Rules 14.11(c)(3), (4), and (5). The proposed rule 
change was published for comment in the Federal Register on July 11, 
2018.\3\ On August 23, 2018, pursuant to Section 19(b)(2) of the 
Act,\4\ the Commission designated a longer period within which to 
approve the proposed rule change, disapprove the proposed rule change, 
or institute proceedings to determine whether to approve or disapprove 
the proposed rule change.\5\ On September 28, 2018, the Exchange filed 
Amendment No. 1 to the proposed rule change, which amended and replaced 
the proposed rule change as originally filed.\6\ On October 5, 2018, 
the Commission published notice of Amendment No. 1 and instituted 
proceedings pursuant to Section 19(b)(2)(B) of the Act \7\ to determine 
whether to approve or disapprove the proposed rule change, as modified 
by Amendment No. 1.\8\ On December 21, 2018, pursuant to Section 
19(b)(2) of the Act,\9\ the Commission designated a longer period 
within which to issue an order approving or disapproving the proposed 
rule change, as modified by Amendment No. 1.\10\ The Commission has 
received one comment letter on the proposed rule change from the 
Exchange.\11\ This order disapproves the proposed rule change, as 
modified by Amendment No. 1.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 83594 (July 5, 
2018), 83 FR 32158.
    \4\ 15 U.S.C. 78s(b)(2).
    \5\ See Securities Exchange Act Release No. 83919, 83 FR 44083 
(August 29, 2018).
    \6\ Amendment No. 1 is available at: https://www.sec.gov/comments/sr-cboebzx-2018-044/srcboebzx2018044-4468884-175849.pdf.
    \7\ 15 U.S.C. 78s(b)(2)(B).
    \8\ See Securities Exchange Act Release No. 84378, 83 FR 51745 
(October 12, 2018) (``Order Instituting Proceedings'').
    \9\ 15 U.S.C. 78s(b)(2).
    \10\ See Securities Exchange Act Release No. 84948, 83 FR 67785 
(December 31, 2018).
    \11\ See letter from Kyle Murray, Assistant General Counsel, 
Cboe Global Markets, Inc. to Brent J. Fields, Secretary, Commission, 
dated November 16, 2018 (``Exchange Letter'').
---------------------------------------------------------------------------

II. Description of the Proposed Rule Change, as Modified by Amendment 
No. 1 12
---------------------------------------------------------------------------

    \12\ For a full description of the proposal, see Amendment No. 
1, supra note 6.
---------------------------------------------------------------------------

    BZX Rule 14.11(c) sets forth the listing standards for Index Fund 
Shares. Currently, the Exchange determines whether a series of Index 
Fund Shares meets the initial and continued listing standards under BZX 
Rules 14.11(c)(3), (4), and (5) by assessing the underlying index. The 
Exchange now proposes to permit either the portfolio holdings of a 
series of Index Fund Shares or the index underlying a series of Index 
Fund Shares to satisfy the initial and continued listing standards 
under BZX Rules 14.11(c)(3), (4), and (5). As a result, the proposal 
would allow the Exchange to generically list a series of Index Fund 
Shares where the generic listing standards are satisfied by either its 
portfolio holdings or its underlying index.
    The Exchange also proposes to amend BZX Rules 14.11(c)(1)(C),\13\ 
14.11(c)(8),\14\ and 14.11(c)(9)(B)(i)(b) \15\ to eliminate certain 
references to the term portfolio such that the amended provisions would 
refer only to the underlying index.\16\ As proposed, all other 
references to ``index or portfolio'' or ``portfolio or index'' in BZX 
Rule 14.11(c) would mean the index underlying a series of Index Fund 
Shares or the portfolio holdings of a series of Index Fund Shares.
---------------------------------------------------------------------------

    \13\ BZX Rule 14.11(c)(1)(C) currently defines the term 
``Reporting Authority'' to mean, in part, the official source for 
calculating and reporting information relating to a series of Index 
Fund Shares, including, but not limited to, any current index ``or 
portfolio'' value. The Exchange proposes to delete the term ``or 
portfolio'' from this provision.
    \14\ BZX Rule 14.11(c)(8) currently provides, in part, that the 
Exchange may list and trade Index Fund Shares based on one or more 
foreign or domestic indexes ``or portfolios'' and that each issue of 
Index Fund Shares based on each particular index ``or portfolio, or 
combination thereof,'' shall be designated as a separate series and 
shall be identified by a unique symbol. The Exchange proposes to 
delete the terms ``or portfolios'' and ``or portfolio, or 
combination thereof,'' from this provision.
    \15\ BZX Rule 14.11(c)(9)(B)(i)(b) currently provides, in part, 
that the Exchange will consider the suspension of trading in and 
will initiate delisting proceedings for a series of Index Fund 
Shares if the value of the index ``or portfolio'' of securities on 
which the series of Index Fund Shares is based is no longer 
calculated or available, or an interruption to the dissemination of 
the value of the index ``or portfolio'' of securities persists past 
the trading day in which it occurred, or the index ``or portfolio'' 
on which a series of Index Fund Shares is based is replaced with a 
new index ``or portfolio'' unless certain conditions are met. The 
Exchange proposes to delete the terms ``or portfolio'' from this 
provision.
    \16\ According to the Exchange, in these provisions, the term 
``index or portfolio'' currently refers to the index underlying a 
series of Index Fund Shares and is not intended to refer to the 
portfolio holdings of a series of Index Fund Shares. See Amendment 
No. 1, supra note 6, at 11 and Exchange Letter, supra note 11, at 6.
---------------------------------------------------------------------------

    The Exchange represents that it has in place surveillance 
procedures that are adequate to properly monitor trading in Index Fund 
Shares in all trading sessions and to deter and detect violations of 
Exchange rules and applicable federal securities laws.\17\ In addition, 
the Exchange states that it does not believe that the proposal will 
result in any meaningful additional costs associated with regulatory 
review, but to the extent that it does, the Exchange either already has 
or will dedicate sufficient additional resources to perform such 
reviews.\18\
---------------------------------------------------------------------------

    \17\ See Amendment No. 1, supra note 6, at 12.
    \18\ See Amendment No. 1, supra note 6, at 10 and Exchange 
Letter, supra note 11, at 6.
---------------------------------------------------------------------------

III. Discussion

    Under Section 19(b)(2)(C) of the Act, the Commission shall approve 
a proposed rule change of a self-regulatory organization if the 
Commission finds that such proposed rule change is consistent with the 
requirements of the Act and the rules and regulations thereunder that 
are applicable to such organization.\19\ The Commission shall 
disapprove a proposed rule change if it does not make such a 
finding.\20\ Under the Commission's Rules of Practice, the ``burden to 
demonstrate that a proposed rule change is consistent with the Exchange 
Act and the rules and regulations issued thereunder . . . is on the 
self-regulatory organization that proposed the rule change.'' \21\
---------------------------------------------------------------------------

    \19\ 15 U.S.C. 78s(b)(2)(C)(i).
    \20\ 15 U.S.C. 78s(b)(2)(C)(ii).
    \21\ 17 CFR 201.700(b)(3).

---------------------------------------------------------------------------

[[Page 9396]]

    The description of a proposed rule change, its purpose and 
operation, its effect, and a legal analysis of its consistency with 
applicable requirements must all be sufficiently detailed and specific 
to support an affirmative Commission finding, and any failure of a 
self-regulatory organization to provide this information may result in 
the Commission not having a sufficient basis to make an affirmative 
finding that a proposed rule change is consistent with the Act and the 
applicable rules and regulations.\22\
---------------------------------------------------------------------------

    \22\ See id.
---------------------------------------------------------------------------

    For the reasons discussed below, the Commission is disapproving the 
proposed rule change, as modified by Amendment No. 1, because the 
information before the Commission is insufficient to support a finding 
that the proposed rule change is consistent with the requirements of 
the Act and the rules and regulations thereunder applicable to a 
national securities exchange. Specifically, the Commission concludes 
that it does not have sufficient information to determine that the 
proposed rule change is consistent with the requirements of Section 
6(b)(5) of the Act, in particular the requirement that a national 
securities exchange's rules be designed to prevent fraudulent and 
manipulative acts and practices.\23\
---------------------------------------------------------------------------

    \23\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    As discussed above, the Exchange currently determines whether a 
series of Index Fund Shares meets the generic listing standards in BZX 
Rules 14.11(c)(3), (4), and (5) by assessing the underlying index.\24\ 
The proposal would allow the Exchange to assess either the underlying 
index or the portfolio holdings in determining whether a series of 
Index Fund Shares meets the generic listing standards.\25\
---------------------------------------------------------------------------

    \24\ See supra Section II.
    \25\ See id. The generic listing standards for Index Fund Shares 
impose quantitative requirements on the components of the underlying 
index (including, for example, market value requirements, trading 
volume requirements, and concentration limitations) that are 
designed to help ensure that the underlying index is not susceptible 
to manipulation.
---------------------------------------------------------------------------

    The Exchange makes several arguments in support of its proposal. 
First, the Exchange asserts that its proposal would accomplish the 
policy goals underlying the listing standards for Index Fund 
Shares.\26\ The Exchange asserts that, after a series of Index Fund 
Shares is listed on the Exchange, both the index constituents and the 
portfolio holdings are equally viable for evaluating whether the shares 
are susceptible to manipulation.\27\ According to the Exchange, the 
portfolio holdings are arguably a better means for making this 
determination than the underlying index because the portfolio holdings 
reflect the actual assets held by a series of Index Fund Shares, 
whereas the index constituents are just the assets that the series is 
designed to track.\28\
---------------------------------------------------------------------------

    \26\ See Amendment No. 1, supra note 6, at 6 and Exchange 
Letter, supra note 11, at 4.
    \27\ See Amendment No. 1, supra note 6, at 5 and Exchange 
Letter, supra note 11, at 2. The Exchange states that its generic 
listing standards began applying on both an initial and continuous 
basis in January 2018. See Amendment No. 1, supra note 6, at 5. The 
proposal would provide the Exchange with the flexibility to choose 
to apply the generic listing standards to either the portfolio 
holdings or the underlying index (both at the time of initial 
listing and at any time thereafter), even though the Exchange 
acknowledges that for initial listing, the underlying index 
constitutes a better means for determining whether a series of Index 
Fund Shares would be susceptible to manipulation, because the 
underlying index constituents are much more fully developed and less 
theoretical than the portfolio of a yet to be launched fund or a 
sample portfolio, respectively. See Amendment No. 1, supra note 6, 
at 5 and Exchange Letter, supra note 11, at 2.
    \28\ See Amendment No. 1, supra note 6, at 6 and Exchange 
Letter, supra note 11, at 4.
---------------------------------------------------------------------------

    Under the proposal, if the index underlying a series of Index Fund 
Shares fails to meet the generic listing standards, the Exchange could 
still generically list and trade this product as long as the portfolio 
is constructed to comply with the generic listing standards. The 
Exchange acknowledges that allowing the portfolio holdings to satisfy 
the generic listing standards could raise concerns that a series of 
Index Fund Shares may potentially be based on an index that does not 
meet the generic listing standards and therefore may be susceptible to 
manipulation.\29\
---------------------------------------------------------------------------

    \29\ See Amendment No. 1, supra note 6, at 9 and Exchange 
Letter, supra note 11, at 3.
---------------------------------------------------------------------------

    The Exchange has not demonstrated how it would be consistent with 
the Act for the Exchange to generically list and trade a series of 
Index Fund Shares that tracks an index that may be susceptible to 
manipulation. Index Fund Shares are designed to track the performance 
of an index.\30\ If the portfolio meets the generic listing standards 
but the index does not (i.e., a scenario that is not currently 
permissible, but would be permissible under the proposal), and the 
performance of the portfolio tracks the performance of the manipulated 
index, the Exchange did not discuss whether the effects of the index 
manipulation might be reflected in the price of the Index Fund Shares. 
The Exchange also did not explain why the potential (if any) for the 
effects of the index manipulation to be reflected in the price of the 
Index Fund Shares should not be a concern under Section 6(b)(5) of the 
Act, which requires that the rules of the Exchange be designed to 
prevent fraudulent and manipulative acts and practices. As a result, 
based on the information before the Commission, the Commission is 
unable to determine that the proposal is consistent with Section 
6(b)(5) of the Act.
---------------------------------------------------------------------------

    \30\ See Amendment No. 1, supra note 6, at 8 and Exchange 
Letter, supra note 11, at 5.
---------------------------------------------------------------------------

    While the Exchange acknowledges that allowing the portfolio 
holdings to satisfy the generic listing standards could raise concerns 
that a series of Index Fund Shares may potentially be based on an index 
that does not meet the generic listing standards and therefore may be 
susceptible to manipulation, the Exchange argues that, currently, a 
series of Index Fund Shares overlying an index that meets the generic 
listing standards may have portfolio holdings that could theoretically 
be susceptible to manipulation because the portfolio holdings do not 
meet the generic listing standards.\31\ According to the Exchange, if 
the current rule is consistent with the Act, then the inverse (i.e., 
the proposal) would also be consistent with the Act.\32\
---------------------------------------------------------------------------

    \31\ See Amendment No. 1, supra note 6, at 9 and Exchange 
Letter, supra note 11, at 3.
    \32\ See Amendment No. 1, supra note 6, at 9 and Exchange 
Letter, supra note 11, at 3.
---------------------------------------------------------------------------

    The Exchange did not discuss the possible effects of index 
manipulation or portfolio manipulation on the price of Index Fund 
Shares, and correspondingly did not demonstrate that the possible 
consequences of an index manipulation would be the same as, or no worse 
than, the possible consequences of a portfolio manipulation. The 
Commission cannot determine whether the proposal is designed to prevent 
fraudulent and manipulative acts and practices simply based on the 
Exchange's assertion that the current rule is consistent with the Act.
    To support its proposal, the Exchange also compares Index Fund 
Shares to Managed Fund Shares, and notes that the generic listing 
standards for Managed Fund Shares only apply to the portfolio 
holdings.\33\ The Exchange acknowledges the distinction between Index 
Fund Shares and Managed Fund Shares, which is that Index Fund Shares 
are designed to track the performance of an index whereas Managed Fund 
Shares are not.\34\ However, in comparing Index Fund Shares to Managed 
Fund Shares, the Exchange did not address the potential consequences of 
an index manipulation (as discussed above) that

[[Page 9397]]

is associated with Index Fund Shares but not Managed Fund Shares. 
Therefore, based on the information before the Commission, the 
Commission is unable to determine that the proposal is consistent with 
Section 6(b)(5) of the Act.
---------------------------------------------------------------------------

    \33\ See Amendment No. 1, supra note 6, at 8 and Exchange 
Letter, supra note 11, at 5-6.
    \34\ See Amendment No. 1, supra note 6, at 8 and Exchange 
Letter, supra note 11, at 5.
---------------------------------------------------------------------------

    In support of its proposal, the Exchange also argues that any 
series of Index Fund Shares listed on the Exchange must meet all 
requirements applicable under the Investment Company Act of 1940, 
including Rule 35d-1,\35\ which according to the Exchange provides 
assurance that there is significant overlap between the portfolio 
holdings and the underlying index.\36\
---------------------------------------------------------------------------

    \35\ 17 CFR 270.35d-1.
    \36\ See Amendment No. 1, supra note 6, at 9-10 and Exchange 
Letter, supra note 11, at 3-4.
---------------------------------------------------------------------------

    The Exchange did not explain the extent to which generically listed 
Index Fund Shares would have names that are governed by Rule 35d-1 or 
why the Exchange believes any overlap that would result from compliance 
with that rule would be sufficient to satisfy the relevant standard 
under the Exchange Act.
    The Exchange also did not discuss any other specific requirements 
that would assure a significant overlap between the portfolio holdings 
and the underlying index for all current and future generically listed 
Index Fund Shares. Therefore, based on the information before the 
Commission, the Commission is unable to determine whether the portfolio 
composition for all of the Exchange's generically listed Index Fund 
Shares would necessarily have a significant overlap with the index 
composition, such that application of the generic listing standards to 
the portfolio holdings would assure that the index also meets or only 
narrowly misses the generic listing standards.
    Finally, in support of its proposal, the Exchange asserts that the 
index methodology for an index underlying a series of Index Fund Shares 
is out of the control of the issuers of the products, and that it is 
problematic to require an issuer to ensure that the underlying index 
meets listing standards on an ongoing basis.\37\ According to the 
Exchange, the proposal would provide issuers of Index Fund Shares with 
a greater degree of control over whether their products meet their 
ongoing listing obligations.\38\
---------------------------------------------------------------------------

    \37\ See Amendment No. 1, supra note 6, at 7 and Exchange 
Letter, supra note 11, at 4-5.
    \38\ See Amendment No. 1, supra note 6, at 7 and Exchange 
Letter, supra note 11, at 5. In disapproving the proposal, the 
Commission has considered the proposal's impact on efficiency, 
competition, and capital formation, see 15 U.S.C. 78c(f), and the 
Exchange's assertion that its proposal would enhance competition 
among market participants and create greater investor confidence in 
exchange-traded products generally because there will be a greater 
degree of certainty that Index Fund Shares will not be subject to 
regulatory action or delisting. See Amendment No. 1, supra note 6, 
at 10-11 and Exchange Letter, supra note 11, at 6. The Exchange did 
not provide any information to support its assertion that the 
proposal would enhance competition and did not provide any 
information to support its assertion that the proposal would create 
greater investor confidence other than the proposal would provide a 
greater degree of certainty that Index Fund Shares would not be 
subject to regulatory action or delisting. But even if this proposal 
has the potential to enhance competition and create greater investor 
confidence, for the reasons discussed throughout, the Commission 
must disapprove the proposed rule change in light of its inability, 
on the current record, to find that it is consistent with the Act.
---------------------------------------------------------------------------

    The Commission believes that the Exchange has not demonstrated why 
issuers' control over a fund's portfolio composition would be 
responsive to the potential index manipulation issue discussed above. 
In particular, if the portfolio meets the generic listing standards 
(because the issuer has control over the portfolio composition and can 
construct the portfolio to meet the generic listing standards) but the 
index does not, and the performance of the portfolio tracks the 
performance of the manipulated index, the Exchange did not discuss 
whether the effects of the index manipulation might be reflected in the 
price of the Index Fund Shares, and why the potential (if any) for the 
effects of the index manipulation to be reflected in the price of the 
Index Fund Shares should not be a concern under Section 6(b)(5) of the 
Act.
    For the reasons discussed above, the Commission concludes that the 
record before it does not provide a basis to conclude that the Exchange 
has met its burden under the Act and the Commission's Rules of Practice 
to demonstrate that its proposed rule change is consistent with Section 
6(b)(5) of the Act.\39\
---------------------------------------------------------------------------

    \39\ The Order Instituting Proceedings sought comment on several 
specific issues, including the issue of manipulation of the 
underlying index. For the reasons discussed above, the Commission 
does not find that the proposed rule change, as modified by 
Amendment No. 1, is consistent with the requirements of the Act and 
the rules and regulations thereunder applicable to a national 
securities exchange, and therefore the Commission does not believe 
it is necessary to address the other issues raised in the Order 
Instituting Proceedings.
---------------------------------------------------------------------------

IV. Conclusion

    For the reasons set forth above, the Commission does not find, 
pursuant to Section 19(b)(2) of the Act,\40\ that the proposed rule 
change, as modified by Amendment No. 1, is consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to a national securities exchange, and in particular, with 
Section 6(b)(5) of the Act.\41\
---------------------------------------------------------------------------

    \40\ 15 U.S.C. 78s(b)(2).
    \41\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\42\ that the proposed rule change, as modified by Amendment No. 1 
(SR-CboeBZX-2018-044), is disapproved.
---------------------------------------------------------------------------

    \42\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\43\
---------------------------------------------------------------------------

    \43\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Eduardo A. Aleman,
Deputy Secretary.
[FR Doc. 2019-04705 Filed 3-13-19; 8:45 am]
BILLING CODE 8011-01-P