[Federal Register Volume 85, Number 153 (Friday, August 7, 2020)]
[Notices]
[Pages 48012-48017]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-17303]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-89464; File No. SR-NASDAQ-2020-017]


Self-Regulatory Organizations; The Nasdaq Stock Market LLC; 
Notice of Filing of a Proposed Rule Change To Amend Nasdaq Rule 5704

August 4, 2020.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on July 23, 2020, The Nasdaq Stock Market LLC (``Nasdaq'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I and II, below, which Items have been prepared by the Exchange. 
The Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to amend Nasdaq Rule 5704 to remove the 
listing requirement that following twelve months after listing a series 
of Exchange Traded Fund Shares (the ``Fund'') on Nasdaq that the Fund 
has at least 50 beneficial holders and to amend the requirement that 
Nasdaq will establish a minimum number of shares of the Fund to be 
outstanding at the time of initial listing with a requirement that the 
Fund must have a minimum number of shares outstanding to facilitate the 
formation of at least one creation unit on an initial and continued 
listing basis.
    The text of the proposed rule change is available on the Exchange's 
website at https://listingcenter.nasdaq.com/rulebook/nasdaq/rules, at 
the principal office of the Exchange, and at the Commission's Public 
Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the Exchange included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange has prepared summaries, set forth in 
sections A, B, and C below, of the most significant aspects of such 
statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The Exchange proposes to amend Nasdaq Rule 5704 to remove the 
listing requirement that following twelve months after listing a series 
of an Exchange Traded Fund Shares on Nasdaq that the Fund has at least 
50 beneficial holders and to amend the requirement that Nasdaq will 
establish a minimum number of shares of the Fund to be outstanding at 
the time of initial listing with a requirement that the Fund must have 
a minimum number of shares outstanding to facilitate the formation of 
at least one creation unit on an initial and continued listing 
basis.\3\
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    \3\ The term creation unit would have the same meaning as 
defined in Rule 6c-11 (i.e., a specified number of exchange-traded 
fund shares that the exchange-traded fund will issue to (or redeem 
from) an authorized participant in exchange for the deposit (or 
delivery) of a basket and a cash balancing amount, if any.).
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    Nasdaq believes that the requirement that a series of Exchange 
Traded Fund Shares listed pursuant to Nasdaq Rule 5704 must have at 
least 50 beneficial shareholders is no longer necessary. The Exchange 
believes that the conditions of Rule 6c-11 \4\ (``Rule 6c-11'') under 
the Investment Company Act of 1940, as amended,\5\ coupled with the 
existing creation and redemption process, mitigate the potential lack 
of liquidity that the shareholder requirement was intended to 
address.\6\ Nasdaq believes that requiring a sufficient number of 
shares to be outstanding at all times in order to facilitate the 
formation of at least one creation unit, coupled with the daily 
portfolio transparency and other enhanced disclosure requirements of 
Rule 6c-11, will facilitate an effective arbitrage mechanism and 
provide market participants and investors with sufficient transparency 
into the holdings of the underlying portfolio and ensure that the 
trading price in the secondary market remains in line with the value 
per share of the portfolio. The Exchange believes this is consistent 
with prior Commission statements.\7\
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    \4\ A series of Exchange Traded Fund Shares listed pursuant to 
Nasdaq Rule 5704 is required to be eligible to operate pursuant to 
Rule 6c-11. See Nasdaq Rule 5704(b).
    \5\ See Release No. 33-10695; IC-33646; File No. S7-15-18 
(Exchange-Traded Funds) (September 25, 2019), 84 FR 57162 (October 
24, 2019) (``ETF Adopting Release'').
    \6\ As stated in previous rule proposals, Nasdaq believes that 
the shareholder requirement, as it relates to common stock, is a 
measure of liquidity designed to help assure that there will be 
sufficient investor interest and trading to support price discovery 
once a security is listed. See Securities Exchange Act Release No. 
86314 (July 5, 2019), 84 FR 33102 (July 11, 2019) (Notice of Filing 
of Amendment No. 3 and Order Granting Accelerated Approval of a 
Proposed Rule Change, as Modified by Amendment No. 3, To Revise the 
Exchange's Initial Listing Standards Related to Liquidity). However, 
as discussed herein, the pricing, liquidity, trading and valuation 
of Exchange Traded Fund Shares is fundamentally different from that 
of common stock.
    \7\ In the Adopting Release, the Commission stated, ``Further, 
we believe that the conditions we are adopting as part of rule 6c-
11, along with other recent actions that are designed to promote an 
effective arbitrage mechanism, will continue to result in a 
sufficiently close alignment between an ETF's market price and NAV 
per share in most circumstances . . .'' See supra note 6, at pp. 41.
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    For example, Rule 6c-11 requires additional disclosure if the 
premium or discount is in excess of 2% for more than seven consecutive 
days, as well as related website disclosure and discussion 
requirements.\8\ This disclosure provides additional transparency to 
investors in the event that the trading value and the underlying 
portfolio deviate for an extended period of time, which could indicate 
an inefficient arbitrage mechanism.\9\ The arbitrage mechanism relies 
on the fact that shares of the Fund can be created and redeemed and 
that shares of the Fund are able to flow into or out of the market when 
the price of the Fund is not aligned with the net asset value per share 
of the portfolio. The resulting buying and selling of the shares of the 
Fund, as well as the underlying portfolio components, generally causes 
the market price and the net asset value per share to

[[Page 48013]]

converge. The Exchange believes this is consistent with prior 
Commission statements.\10\
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    \8\ See 17 CFR 270.6c-11(c)(1)(vi).
    \9\ The Exchange notes that the Commission discussed the 
importance of an effective and efficient arbitrage mechanism in the 
Rule 6c-11 Release. See supra note 6 at pp. 14-16.
    \10\ In the ETF Adopting Release, the Commission stated, ``The 
combination of the creation and redemption process with secondary 
market trading in ETF shares and underlying securities provides 
arbitrage opportunities that are designed to help keep the market 
price of ETF shares at or close to the NAV per share of the ETF.'' 
See ETF Adopting Release at pp. 12-13.
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    In addition, the proper functioning of the arbitrage mechanism is 
reliant on the presence of authorized participants (``APs'') that are 
eligible to facilitate creations and redemptions with the fund and 
support the liquidity of the fund. The AP facilitates liquidity in the 
ETF primary market by purchasing shares of the underlying portfolio and 
transferring the shares to the ETF issuer in exchange for shares of the 
ETF (creation) or returning shares of the ETF to the issuer and 
receiving shares of the portfolio (redemption). Therefore, the ability 
of the AP to transact in shares of the ETF plays a vital role in the 
liquidity of the ETF and the functioning of the arbitrage mechanism. 
The AP is able to buy and sell shares of the ETF from both the fund and 
investors. Because ETFs can be created and redeemed ``in-kind'' and do 
not have an upper limit of the number of shares that can be 
outstanding, an AP can fulfill customer orders or take advantage of 
arbitrage opportunities regardless of the number of ETF shares 
currently outstanding. Thus, unlike common stock, the liquidity of an 
ETF is not dependent on the number of ETF shares currently outstanding 
or the number of shareholders, but on the availability of AP's to 
transact in the ETF primary market. The Exchange notes that the SEC did 
not adopt a minimum number of APs as part of Rule 6c-11 because funds 
already have enough APs so that a need for such a requirement to ensure 
a sufficient number of APs was unwarranted.\11\
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    \11\ ``Additionally, based upon Form N-CEN data through 
September 5, 2019, we found that out of 1672 funds reviewed that 
could rely on rule 6c-11, only 30 (approximately 1.8% of the funds 
reviewed) reported having fewer than 2 APs. We therefore do not 
believe that it is appropriate at this time to prescribe a minimum 
number of APs that an ETF may use.'' See ETF Adopting Release at p. 
54.
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    ETF liquidity, due to its open-ended structure allowing for 
creations and redemptions, differs from single company stocks because 
the opportunity or market makers to arbitrage between the ETF price and 
the value of the underlying securities exists. Even during market 
conditions marked by large buying or selling imbalances in the ETF, the 
ETF should be expected to trade close to the value of its underlying 
holdings provided that the creation/redemption facility remains open 
and accessible. To demonstrate, the two charts below \12\ compare the 
percentage daily returns of both SPY and QQQ compared to their 
respective benchmark indices the S&P 500 and the Nasdaq 100. SPY and 
QQQ, as passive ETFs, are managed to track the returns of the benchmark 
index by replicating the holdings of the index. As can be seen in the 
two charts below, the returns of both SPY and QQQ are kept close in 
line through the availability of the arbitrage mechanism. It is 
important to note that this dynamic of close tracking was able to occur 
during a period of unprecedented volatility and volumes in both ETFs. 
The observations period was the first two quarters of 2020.
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    \12\ FactSet Research Systems Inc. (2020). SPY vs SP500 Daily 
Returns (Dec. 31, 2019-June 30, 2020) and QQQ vs NDX 100 Daily 
Returns (Dec. 31, 2019-June 30, 2020). Retrieved July 17, 2020, from 
FactSet database.

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[[Page 48014]]

[GRAPHIC] [TIFF OMITTED] TN07AU20.014

    The chart below \13\ maps out daily net flows through creation/
redemption activity in the same observation period to give evidence 
that there likely were significant buy/sell imbalances where market 
makers were able to keep the returns of SPY and QQQ in line with their 
benchmark indices through the availability of arbitrage in the open-
ended ETF structure. This dynamic also works similarly in an ETF with 
little or no daily trading activity, where a market maker can generally 
be expected to provide liquidity in this ETF that is higher than the 
average daily volume through creation/redemption. The market maker will 
consider the availability of the arbitrage mechanism and liquidity of 
the underlying fund securities significantly more than the awareness 
that an ETF has 50 or greater shareholders who may or may not even 
trade on a given trading day.
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    \13\ FactSet Research Systems Inc. (2020). Daily Net Flows SPY & 
QQQ (12/31/19-6/30/20). Retrieved July 17, 2020, from FactSet 
database.

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[[Page 48015]]

[GRAPHIC] [TIFF OMITTED] TN07AU20.015

    To further illustrate how the arbitrage mechanism makes ETF 
liquidity differ from single stock liquidity, the two charts below \14\ 
take the 5 highest weighted stocks from the S&P 500 and Nasdaq 100 
indices and compare their daily percentage returns against the daily 
percentage returns of the index they are constituents of. These stocks 
are some of the largest and most actively held and traded names on a 
daily basis, and the point being made is that these stocks are not 
open-ended and therefore impact how market makers trade them and 
consider the availability and activity of other trading participants. 
The observation period remains the first two quarters of 2020. When 
looking at the relative returns of each of these stocks against the 
``market'' as these indices are commonly referred, we see that there 
are often significant daily return variations between the stock and the 
index. The stocks do not have the open-ended structure to create or 
redeem shares like the ETF; therefore, the market makers in the stocks 
must consider daily buying and selling imbalance activity to reduce 
risk on their balance sheets by quickly adjusting their trading prices 
directly in reaction to large trading imbalances. The expectation of 
other shareholders buying and selling the stock on a daily basis will 
impact how market makers adjust their prices significantly more than in 
an ETF due to their expected ability to quickly and efficiently trade 
out of risk.
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    \14\ FactSet Research Systems Inc. (2020). Daily Return 
Differentials Top 5 Stocks vs. SP500 (Dec 31, 2019-June 30, 2020) 
and QQQ vs NDX 100 Daily Returns (Dec. 31, 2019-June 30, 2020) and 
Daily Return Differentials Top 5 Stocks vs. NDX100 (Dec. 31, 2019-
June 30, 2020). Retrieved July 17, 2020, from FactSet database.
[GRAPHIC] [TIFF OMITTED] TN07AU20.016


[[Page 48016]]


[GRAPHIC] [TIFF OMITTED] TN07AU20.017

    In order for fund redemptions to be executed in support of the 
arbitrage mechanism, Nasdaq believes it is appropriate that in lieu of 
the shareholder requirement that the Fund has a sufficient number of 
shares outstanding in order to facilitate the formation of at least one 
creation unit on an initial and continued listing basis. The existence 
of the creation and redemption process, daily portfolio transparency, 
as well as a sufficient number of shares outstanding to allow for the 
formation of at least one creation unit, ensures that market 
participants are able to redeem shares and, thereby support the proper 
functioning of the arbitrage mechanism. Of the over 350 funds currently 
listed on Nasdaq that would be eligible to be listed under Nasdaq Rule 
5704, only two had a single creation unit outstanding. The remaining 
funds have, on average, shares outstanding equal to approximately 300 
creation units.\15\
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    \15\ Nasdaq internal data as of March 31, 2020.
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    Therefore, the symbiotic relationship between the disclosure 
requirements of Rule 6c-11, the ability of the AP to create and redeem 
shares of a fund, and the functioning of the arbitrage mechanism helps 
to ensure that the trading price in the secondary market is at fair 
value. This renders the need for a shareholder requirement, whose 
original purpose was to support a fair and orderly trading, as 
duplicative and unnecessary. Finally, Nasdaq's surveillance program and 
its ability to halt trading in a fund provides for additional investor 
protections by further mitigating any abnormal trading that would 
affect the Fund's price.\16\
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    \16\ See Nasdaq Rule 4120(a)(10).
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2. Statutory Basis
    The Exchange believes that the proposal is consistent with Section 
6(b) of the Act \17\ in general and Section 6(b)(5) of the Act \18\ in 
particular in that it is 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.
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    \17\ 15 U.S.C. 78f.
    \18\ 15 U.S.C. 78f(b)(5).
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    The Exchange believes that the proposed rule change to amend Nasdaq 
Rule 5704 to remove the 50 beneficial holder requirement and to amend 
the shares outstanding listing requirement, as discussed above, will 
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. As discussed herein, reliance on the conditions of Rule 6c-
11, coupled with the existing creation and redemption process, as well 
as the presence of sufficient shares to support the creation and 
redemption process, serve to mitigate the potential for a lack of 
liquidity that the shareholder requirement was intended to address.\19\ 
By further aligning the listing requirements with the operational 
relationship between investors, market participants and ETF issuers, 
the proposal facilitates greater transparency for investors and issuers 
resulting in a more efficient market and increased investor 
protections.
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    \19\ See supra note 6.
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    For the above reasons, the Exchange believes that the proposed rule 
change is consistent with the requirements of Section 6(b)(5) of the 
Act.

B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition that is not necessary or appropriate 
in furtherance of the purpose of the Act. The Exchange believes that 
the proposed rule change will maintain the integrity of Nasdaq Rule 
5704 on an initial and continued listing basis to the benefit of 
investors and the marketplace.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    No written comments were either solicited or received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period up to 90 days (i) as the 
Commission may designate if it finds such longer period to be 
appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    A. By order approve or disapprove such proposed rule change, or
    B. institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act.

[[Page 48017]]

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-2020-017 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-2020-017. 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 website (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 website 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 the filing also will be available for inspection 
and copying at the principal office of the Exchange. All comments 
received will be posted without change. Persons submitting comments are 
cautioned that we do not redact or edit personal identifying 
information from comment submissions.
    You should submit only information that you wish to make available 
publicly. All submissions should refer to File Number SR-NASDAQ-2020-
017, and should be submitted on or before August 28, 2020.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\20\
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    \20\ 17 CFR 200.30-3(a)(12).
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J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-17303 Filed 8-6-20; 8:45 am]
BILLING CODE 8011-01-P