Document ID: SEC-2013-0138-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: NASDAQ Stock Market LLC
Posted Date: 2013-01-23T05:00Z

[Federal Register Volume 78, Number 15 (Wednesday, January 23, 2013)]
[Notices]
[Pages 4949-4955]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-01225]

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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-68672; File No. SR-NASDAQ-2012-117 ]

Self-Regulatory Organizations; The NASDAQ Stock Market LLC; Order 
Instituting Proceedings To Determine Whether To Approve or Disapprove 
Proposed Rule Change With Respect to INAV Pegged Orders for ETFs

January 16, 2013.

I. Introduction

    On October 2, 2012, 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'') \1\ and Rule 19b-4 thereunder,\2\ a 
proposed rule change to amend NASDAQ Rule 4751(f)(4) to adopt a new 
Intraday Net Asset Value (``INAV'') Pegged Order for Exchange-Traded 
Funds (``ETFs'') where the component stocks underlying the ETFs are 
U.S. Component Stocks (as defined by NASDAQ Rule 5705(a)(1)(C) and 
5705(b)(1)(D)) \3\ (``U.S. Component Stock ETFs''). The proposed rule 
change was published for comment in the Federal Register on October 18, 
2012.\4\ The Commission received one comment letter on the proposal.\5\ 
On November 21, 2012, pursuant to Section 19(b)(2) of the Act,\6\ 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.\7\ On January 15, 2013, the Commission received the 
Exchange's response to the comment letter.\8\ This order institutes 
proceedings under Section 19(b)(2)(B) of the Act \9\ to determine 
whether to approve or disapprove the proposed rule change.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Rule 5705 contains NASDAQ's listing standards for ETFs 
(which include Portfolio Depositary Receipts and Index Fund Shares).
    \4\ See Securities Exchange Act Release No. 68042 (October 12, 
2012), 77 FR 64167 (``Notice'').
    \5\ See Letter from Dorothy Donohue, Deputy General Counsel, 
Investment Company Institute, to Elizabeth M. Murphy, Secretary, 
Commission, dated November 8, 2012 (``ICI Letter'').
    \6\ 15 U.S.C. 78s(b)(2).
    \7\ See Securities Exchange Act Release No. 68279 (November 21, 
2012), 77 FR 70857 (November 27, 2012). See also Securities Exchange 
Act Release No. 68279A (December 4, 2012), 77 FR 73716 (December 11, 
2012) (correcting certain typographical errors). 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 January 16, 2013 as the date 
by which it should approve, disapprove, or institute proceedings to 
determine whether to disapprove the proposed rule change.
    \8\ See Letter from Stephen Matthews, Senior Associate General 
Counsel, NASDAQ OMX, to Elizabeth M. Murphy, Secretary, Commission, 
dated January 15, 2013 (``Response Letter'').
    \9\ 15 U.S.C. 78s(b)(2)(B).
---------------------------------------------------------------------------

II. Description of the Proposal

    The Exchange proposes to amend NASDAQ Rule 4751(f)(4) to establish 
INAV Pegged Orders that would be available only for U.S. Component 
Stock ETFs. The INAV Pegged Order type would be available for all U.S. 
Component Stock ETFs where there is dynamic INAV data. The INAV Pegged 
Order would be priced relative to the INAV of the fund's underlying 
portfolio. According to the Exchange, the INAV is intended to 
approximate the fair value of the securities held in the portfolio by 
an ETF,\10\ and the Exchange represents that the INAV should closely 
represent the value of the fund during the trading

[[Page 4950]]

day.\11\ According to the Exchange, INAVs are typically calculated 
using the last sale prices of the fund's components.\12\ The Exchange 
represents that, pursuant to NASDAQ listing rules, the INAV for NASDAQ-
listed ETFs is disseminated widely to vendors and their subscribers via 
multiple data feeds, including UTP Level 1, NASDAQ Basic, NASDAQ Level 
2, and NASDAQ TotalView, and that INAVs are typically disseminated at 
least once every 15 seconds during the regular market session.\13\
---------------------------------------------------------------------------

    \10\ The Exchange states that investors should note that the 
INAV is only an estimation of a fund's value, and this might differ 
from the end of day net asset value, which is more definitive and 
disseminated on a daily basis at the end of the trading day. See 
Notice, supra note 4, at 64169.
    \11\ See Notice, supra note 4, at 64168. According to the 
Exchange, the term ``INAV,'' as used by the Exchange in its 
proposal, would be synonymous with commonly used terms such as 
Intraday Indicative Value (IIV), Intraday Optimized Portfolio Value 
(IOPV) and Intraday Portfolio Value (IPV), among others. Id.
    \12\ The Exchange states that INAVs can vary from the fund's 
market price and/or can be valued outside of the fund's prevailing 
bid/ask spread as a result of, among other things, the supply and 
demand characteristics of the fund and/or liquidity present in the 
marketplace. See Notice, supra note 4, at 64168. In addition, the 
Exchange states that the INAV may remain unchanged for a certain 
period of time if the underlying values do not change, particularly 
in periods of low volatility, and that the INAV may become stale as 
a result of a compromised data feed or disruption to the calculation 
and/or dissemination agent or other technology related malfunction. 
Id.
    \13\ See id.
---------------------------------------------------------------------------

    Generally, Pegged Orders are orders that, once entered, adjust in 
price automatically in response to changes in factors, such as the 
national best bid or offer, depending upon the type of Pegged Order. An 
INAV Pegged Order would specify that its price will equal (or, to the 
extent an offset is used, be offset from) the prevailing INAV for the 
relevant ETF. As the INAV changes, the INAV Pegged Orders would change 
therewith. In the event that the INAV data feed for a particular ETF 
were to be compromised or temporarily stopped being disseminated, the 
use of the INAV Pegged Order type for that ETF would be suspended 
(i.e., no new INAV Pegged Orders would be accepted into the system) and 
orders utilizing the INAV Pegged Order functionality for that ETF 
already in the system would be cancelled. The suspension of new INAV 
Pegged Orders would remain in effect until such time as the Exchange 
was confident that the integrity of the INAV data feed had been 
restored.
    A Pegged Order may have a limit price beyond which the order shall 
not be executed. In addition, certain Pegged Orders (Primary Peg and 
Market Peg Orders) may establish their pricing relative to the 
appropriate bids or offers by selecting one or more offset amounts that 
will adjust the price of the order by the offset amount selected. The 
Exchange proposes to similarly introduce this functionality for the 
INAV Pegged Order type. Moreover, similar to other Pegged Orders (other 
than a Midpoint Peg Order), the Exchange proposes that an INAV Pegged 
Order may be either displayed or non-displayed. If a market participant 
utilizes the non-displayed order type, its order will be placed lower 
in the priority queue than displayed orders within each price point.
    The Exchange provides the following examples to illustrate how the 
INAV Pegged Order type would operate (note that the price of the order 
updates in response to changes in the INAV):

Example 1

     The best bid is $20.00 and the best offer is $20.06 at 
10:00:00 a.m. INAV is updated and published as $20.03 at 10:00:02.
     An INAV Peg Order to buy entered at 10:00:04 would be 
priced at $20.03.
     The best bid would update to $20.03 (at approximately 
10:00:04).
     The best offer would remain at $20.06.

Example 2

     The best bid is $20.00 and the best offer is $20.06 at 
10:00:00. INAV is updated and published as $19.98 at 10:00:02.
     An INAV Peg Order to sell entered at 10:00:04 would be 
priced at $19.98 and subsequently execute at $20.00 (at approximately 
10:00:04).

Example 3

     The best bid is $20.00 and the best offer is $20.10 at 
10:00:00 a.m. INAV is updated and published as $20.03 at 10:00:02.
     An INAV Peg Order to buy with a +.03 offset entered at 
10:00:04 would be priced at $20.06 ($20.03 +.03) (at approximately 
10:00:04).
     The best bid would update to $20.06 (approximately 
10:00:04).
     The best offer would remain at $20.10.

III. Summary of Comment Letters and the Exchange's Response

    The Commission received one comment letter on the proposed rule 
change.\14\ The commenter raises a number of concerns and requests a 
number of clarifications relating to the proposal, each of which is 
described below. The commenter notes that while it does not necessarily 
object to the creation of a new order type pegged to INAV, it believes 
the Commission should request additional information from the Exchange 
to further explore the questions and concerns it raises, and consider 
the benefits and risks of the proposed INAV Pegged Order, before 
determining whether to approve it.\15\
---------------------------------------------------------------------------

    \14\ See ICI Letter, supra note 5.
    \15\ Id. at 2.
---------------------------------------------------------------------------

A. Questions Regarding the Purpose and Benefits of the Proposal

    First, the commenter states that its members have questioned the 
purpose and benefit to market participants of an order type pegged to 
INAV.\16\ The commenter notes that in its filing the Exchange states 
that ``ETF Sponsors routinely deal with investors that have been 
subject to inferior executions,'' \17\ and that the vast majority of 
these complaints result from people using market orders where the 
prevailing market price either does not correlate to the fund's value, 
or the quoted size does not meet the demand of the order (or both).\18\ 
The commenter believes the use of limit orders generally addresses the 
concerns highlighted by the Exchange, and that investor confusion 
regarding order types likely explains the inopportune use of market 
orders.\19\ The commenter further believes that educating investors on 
the proper use of existing order types may be preferable to the 
creation of another order type.\20\ Moreover, the commenter states that 
the problems with execution typically occur in ETFs that would not be 
covered by the new order type, i.e., those based on fixed income and 
non-US equity securities, and that most ETFs comprised of U.S. equities 
are very liquid and trade with fair price execution.\21\
---------------------------------------------------------------------------

    \16\ Id.
    \17\ See Notice, supra note 4, at 64169.
    \18\ Id.
    \19\ See ICI Letter, supra note 5, at 2.
    \20\ Id. The commenter notes that many ETF sponsors and others 
have undertaken educational efforts aimed at explaining order types 
for investors and cites to www.understandETFs.org, a collaborative 
effort by ETF providers to enhance investor understanding of ETFs, 
as one example. Id.
    \21\ Id.
---------------------------------------------------------------------------

    In response to these comments, the Exchange states its belief that 
fair price executions are currently available for the highest volume, 
most liquid domestic equity products, but not necessarily for the 
majority of products which are less actively traded.\22\ The Exchange 
states that the use of the INAV Pegged Order type would be entirely 
optional, and is meant to offer an additional tool to help investors 
achieve greater transparency and a fair execution price.\23\ The 
Exchange further states its belief that for domestic equity products, 
the published INAV is the best proxy for fair value, as it represents

[[Page 4951]]

the closest calculation of underlying value generally available.\24\
---------------------------------------------------------------------------

    \22\ See Response Letter, supra note 8, at 2.
    \23\ Id.
    \24\ Id.
---------------------------------------------------------------------------

B. Concerns Regarding Investor Understanding of INAV

    The commenter states that its members are concerned about the 
utility of INAV as a reference point for pricing an ETF order because 
market participants may misunderstand INAV.\25\ This commenter states 
that INAV is not a ``fair value'' estimate of the securities underlying 
the ETF, as INAV is typically calculated using the last sales price of 
the fund's components.\26\ The commenter states that, at times, 
particularly for securities that do not trade often, the last sale 
price may not be reflective of the security's value, and unlike a 
fund's end-of-day net asset value, INAV does not attempt to adjust for 
such variations.\27\ Furthermore, the commenter states that INAV is not 
a fair value estimate of the ETF itself, as some U.S. Component Stock 
ETFs may trade at a consistent premium or discount, which is not taken 
into account in the INAV calculation.\28\ The commenter states that 
where an ETF's shares frequently trade at a premium to INAV, an INAV 
Pegged Order to sell at INAV would likely disadvantage the seller.\29\ 
The commenter further states that, although it recognizes that the 
proposed order type could be used with an offset to account for this 
premium, it is concerned that market participants may believe INAV 
represents the fair market value of the ETF, and therefore reflects 
such nuances.\30\
---------------------------------------------------------------------------

    \25\ See ICI Letter, supra note 5, at 3-4.
    \26\ Id. at 4.
    \27\ Id.
    \28\ Id.
    \29\ Id.
    \30\ Id.
---------------------------------------------------------------------------

    In response, the Exchange states its belief that for domestic 
equity products the INAV is a good representation of fair value and the 
only representation of fair value currently available for individual 
investors.\31\ The Exchange disagrees with the commenter that an INAV 
Pegged Order to sell a U.S. Component Stock ETF that trades at a 
consistent premium would disadvantage the seller, noting that in a 
scenario where an INAV Pegged Order to sell was priced below the best 
bid, it would only execute at the best bid, which would be at a premium 
to the INAV to the benefit of the investor.\32\ The Exchange further 
states that, more importantly, a buyer utilizing the INAV Pegged Order 
type would never execute at a premium to INAV.\33\
---------------------------------------------------------------------------

    \31\ See Response Letter, supra note 8, at 2.
    \32\ Id. at 3.
    \33\ Id.
---------------------------------------------------------------------------

    The commenter also is concerned that some market participants may 
not understand that INAV can be an inaccurate reflection of an ETF's 
market value because it can become stale over the course of 15 
seconds.\34\ The commenter believes that establishing an order price 
based on data that is nearly 15 seconds old could result in poor 
execution.\35\
---------------------------------------------------------------------------

    \34\ See ICI Letter, supra note 5, at 4.
    \35\ Id.
---------------------------------------------------------------------------

    In response, the Exchange states that the INAV Pegged Order type 
should lead to a greater level of transparency as it relates to the 
ETF's current value and, as a result, should increase investor 
confidence.\36\ The Exchange states that the INAV is the most up-to-
date data source that is publicly available, and ``is a clear 
improvement over the current state of non-existent data as it relates 
to real time fund valuation.'' \37\ The Exchange states its belief 
that, although the INAV is only updated every 15 seconds, it is still 
of value and beneficial to investors as the execution will still be 
benchmarked against the prevailing published INAV.\38\ The Exchange 
further states that if an investor is uncomfortable with the INAV 
Pegged Order functionality, they would not be required to use the order 
type.\39\
---------------------------------------------------------------------------

    \36\ See Response Letter, supra note 8, at 3.
    \37\ Id.
    \38\ Id.
    \39\ Id.
---------------------------------------------------------------------------

    Further, the commenter also is concerned that investors do not 
understand that INAV calculations are based on the ETF's creation 
basket, which in some cases does not include all of the securities in a 
fund's portfolio.\40\ The commenter notes that in such cases, ETF 
sponsors take great care to publish baskets that mimic the market 
characteristics of the full portfolio, but there may be instances in 
which the INAV, because it is based on the constituents of a sampled 
basket, deviates from the actual intra-day net asset value of the 
ETF.\41\ The commenter is concerned that investors who do not 
understand how INAV is calculated for a particular ETF may be unaware 
that INAV does not always mirror the value of the full portfolio, and 
such investors might have chosen to submit a different type of order 
had they understood the limitations of INAV.\42\
---------------------------------------------------------------------------

    \40\ See ICI Letter, supra note 5, at 4.
    \41\ Id. at 4-5.
    \42\ Id. at 5.
---------------------------------------------------------------------------

C. Concerns Regarding INAV Error

    The commenter also is concerned about the susceptibility of INAV to 
error.\43\ The commenter states that many parties participate in the 
calculation, publication, and dissemination of the INAV (e.g., ETF 
sponsors, calculation agents, exchanges, and/or third party pricing 
vendors), that such a process creates opportunities for errors,\44\ and 
that such errors are not infrequent.\45\ The commenter states that ETF 
sponsors attempt to monitor INAV and correct such errors as soon as 
practicable, but at times INAV Pegged Orders would likely execute 
before these errors are identified.\46\ This commenter further argues 
that if calculation agents and pricing vendors could be held liable by 
investors using INAV Pegged Orders for inaccuracies in INAVs, it is 
possible that firms would cease providing such services, making it 
impossible to disseminate INAVs, or would charge significantly more for 
their services, resulting in increased expenses for ETF investors.\47\
---------------------------------------------------------------------------

    \43\ See ICI Letter, supra note 5, at 3.
    \44\ The commenter provides as examples of such errors that an 
ETF may report a basket inaccurately, a calculation agent may 
receive faulty data from a pricing vendor, or an error may be made 
in the calculation process. Id. at 5.
    \45\ Id. at 5.
    \46\ Id.
    \47\ Id.
---------------------------------------------------------------------------

    In its Response Letter, the Exchange agrees with the commenter that 
an erroneous INAV could be disseminated by a calculation agent.\48\ 
However, the Exchange states its belief that the risk of a poor 
execution is mitigated by existing general safeguards in the market 
place.\49\ The Exchange further states that an execution pursuant to an 
INAV Pegged Order would only ever occur within the prevailing bid-offer 
spread, and that, in the absence of adequate depth of market, an 
aggrieved party could utilize the Exchange's existing clearly erroneous 
procedures.\50\
---------------------------------------------------------------------------

    \48\ See Response Letter, supra note 8, at 3.
    \49\ Id.
    \50\ Id.
---------------------------------------------------------------------------

D. Clarifications About the Operation of the INAV Pegged Order

    The commenter raises a number of questions and requests 
clarifications relating to how the INAV Pegged Order would operate. 
First, the commenter states that far more specificity is necessary to 
explain how the Exchange would suspend the use of and cancel existing 
INAV Pegged Orders for an ETF where the INAV data feed for such ETF 
stops being disseminated or is

[[Page 4952]]

compromised.\51\ The commenter believes that, most importantly, the 
Exchange should clarify what constitutes a ``compromised'' INAV, and 
how the Exchange would identify a compromised INAV and determine 
whether to suspend new orders and cancel existing ones.\52\ The 
commenter also raises questions about the proposed cancellation and 
suspension of INAV Pegged Orders (e.g., how market participants would 
be notified that their orders have been cancelled due to a problem with 
INAV calculation), as well as about INAV Pegged Orders that may be 
executed based on a flawed INAV (e.g., whether such orders would be 
cancellable). The commenter questions the benefit of allowing or 
encouraging the use of an order type that may be subject to 
cancellation due to an independent malfunction (such as an erroneous 
data feed) even when the rest of the market is performing normally.\53\
---------------------------------------------------------------------------

    \51\ See ICI Letter, supra note 5, at 3.
    \52\ Id.
    \53\ Id.
---------------------------------------------------------------------------

    In response to these comments, the Exchange clarifies in its 
Response Letter that it would only suspend use of the INAV Pegged Order 
type if it were to detect a technological problem with the relevant 
INAV data feed.\54\ The Exchange represents that it currently utilizes 
a number of systems and processes aimed at detecting dissemination or 
latency issues with data feeds, and that it has processes in place to 
communicate with market participants in the event of technology issues 
which impact its own systems or those systems of a third party.\55\ The 
Exchange states that it intends to utilize its current processes in 
connection with market communications relating to issues with the INAV 
data feed.\56\ The Exchange further states that it will process clearly 
erroneous executions in accordance with established policies.\57\
---------------------------------------------------------------------------

    \54\ See Response Letter, supra note 8, at 2.
    \55\ Id.
    \56\ Id.
    \57\ Id.
---------------------------------------------------------------------------

IV. Proceedings To Determine Whether To Approve or Disapprove SR-
NASDAQ-2012-117 and Grounds for Disapproval Under Consideration

    The Commission is instituting proceedings pursuant to Section 
19(b)(2)(B) of the Act \58\ 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 significant 
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 in greater detail below, the 
Commission seeks and encourages interested persons to provide 
additional comment on the proposed rule change.
---------------------------------------------------------------------------

    \58\ 15 U.S.C. 78s(b)(2)(B).
---------------------------------------------------------------------------

    Pursuant to Section 19(b)(2)(B) of the Act,\59\ the Commission is 
providing notice of the grounds for disapproval under consideration. In 
particular, Section 6(b)(5) of the Act \60\ 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, 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.
---------------------------------------------------------------------------

    \59\ 15 U.S.C. 78s(b)(2)(B).
    \60\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    As discussed above, the Exchange's proposal would amend NASDAQ Rule 
4751(f)(4) to adopt a new INAV Pegged Order type for U.S. Component 
Stock ETFs. Pursuant to the proposal, an INAV Pegged Order would 
specify that its price will equal (or, to the extent an offset is used, 
be offset from) the prevailing INAV for the relevant U.S. Component 
Stock ETF. Once entered, the INAV Pegged Order would adjust in price 
automatically in response to changes in the INAV. In the event that the 
INAV data feed for a particular ETF were to be compromised or 
temporarily stopped being disseminated, the use of the INAV Pegged 
Order type for that ETF would be suspended until such time as the 
Exchange was confident that the integrity of the INAV data feed had 
been restored (i.e., no new INAV Pegged Orders would be accepted into 
the system and orders utilizing the INAV Pegged Order functionality for 
that ETF already in the system would be cancelled).
    The Commission solicits comment on whether the proposal is 
consistent with the Act and whether the Exchange has met its burden in 
presenting a statutory analysis of how its proposal is consistent with 
the Act. In particular, the grounds for disapproval under consideration 
include whether the Exchange's proposal is consistent with Section 
6(b)(5) of the 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.\61\ As discussed above, one commenter has articulated a 
number of questions and concerns relating to the proposal. Among other 
things, this commenter raises concerns about investor confusion 
relating to what the INAV represents and what it does not represent; 
how INAV is calculated; and the susceptibility of the INAV to 
calculation errors.\62\ In addition, the commenter requests more 
specificity as to how the Exchange would suspend the use of and cancel 
existing INAV Pegged Orders for an ETF where the INAV data feed for 
such ETF stops being disseminated or is compromised.\63\ Further, the 
commenter is concerned that some market participants may not understand 
that INAV can be an inaccurate reflection of an ETF's market value 
because it can become stale over the course of 15 seconds, and believes 
that establishing an order price based on data that is nearly 15 
seconds old could result in poor execution.\64\ As noted, the published 
INAV of an ETF generally is updated every 15 seconds, but the actual 
INAV of an ETF could change significantly during this same 15-second 
period. This fact pattern could potentially result in market 
participants' INAV Pegged Orders being executed at prices that do not 
reflect an up-to-date INAV for the ETF. Investors who may use the INAV 
Pegged Order type may not understand this operational aspect of the 
order type. Moreover, the 15-second period could create opportunities 
for participants with access to real time calculations of the INAV for 
an ETF to take advantage of participants using the INAV Pegged Order 
type that do not have the same information. The Commission also 
questions whether this proposed order type could inherently be 
negatively biased in that INAV Pegged Orders likely would be executed 
when the market is moving against the investor (for example, an 
investor's INAV Pegged Order to buy would be executed only when the 
market price of an ETF is falling).
---------------------------------------------------------------------------

    \61\ Id.
    \62\ See supra Section III.
    \63\ See id. The INAV is not a regulated measurement or 
calculation and is not audited by the Commission or any other 
regulatory or self-regulatory entity. Thus, it is unclear what party 
would be responsible for the integrity and accuracy of the INAV.
    \64\ See id.
---------------------------------------------------------------------------

    In its Response Letter, NASDAQ argues that for U.S. Component Stock 
ETFs, the published INAV represents the closest and most up-to-date 
calculation of underlying value currently generally available, and is a

[[Page 4953]]

good representation of fair value.\65\ NASDAQ further argues that the 
INAV Pegged Order type will offer investors an execution tool which 
should lead to a greater level of transparency and result in increased 
investor confidence.\66\ The Exchange argues that the commenter's 
concerns about poor executions resulting from erroneous or stale INAV 
data are mitigated because, among other things, the INAV Pegged Order 
type will be entirely optional, an execution would only ever occur 
within the prevailing bid-offer spread, and the Exchange's existing 
clearly erroneous procedures would be available to investors using the 
INAV Pegged Order type.\67\
---------------------------------------------------------------------------

    \65\ See Response Letter, supra note 8, at 2.
    \66\ Id. at 3.
    \67\ Id. at 2-3.
---------------------------------------------------------------------------

    After careful consideration, the Commission believes that the 
proposal continues to raise a number of questions, including those 
submitted by the commenter, as to whether the use of the proposed INAV 
Pegged Order type is consistent with the protection of investors and 
the public interest and whether it is designed to promote just and 
equitable principles of trade and prevent fraudulent and manipulative 
acts and practices. The Commission continues to evaluate the issues 
presented by the proposal and the specific concerns articulated by the 
commenter, and the Exchange's response.\68\ In light of these issues 
and concerns, the Commission believes that questions remain as to 
whether NASDAQ's proposal is consistent with the requirements of 
Section 6(b)(5) of the Act, including whether the proposal is designed 
to prevent fraudulent and manipulative acts and practices, promote just 
and equitable principles of trade, and protect investors and the public 
interest.
---------------------------------------------------------------------------

    \68\ See supra Section III.
---------------------------------------------------------------------------

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) \69\ 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.\70\
---------------------------------------------------------------------------

    \69\ 15 U.S.C. 78f(b)(5).
    \70\ 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).
---------------------------------------------------------------------------

    Interested persons are invited to submit written data, views, and 
arguments regarding whether the proposal should be approved or 
disapproved by February 13, 2013. Any person who wishes to file a 
rebuttal to any other person's submission must file that rebuttal by 
February 27, 2013.
    The Commission asks that commenters address the sufficiency and 
merit of the Exchange's statements in support of the proposal, 
including those contained in the Response Letter, and the statements of 
the commenter in response to the proposal, in addition to any other 
comments they may wish to submit about the proposed rule change. In 
particular, the Commission seeks comment on the following:
    1. The commenter states that market participants may misunderstand 
INAV as being the ``fair value'' estimate of the securities underlying 
the ETF.\71\ In its Response Letter, the Exchange states its belief 
that for domestic equity products, the INAV represents the best proxy 
for fair value and the only representation of fair value currently 
available for individual investors, and is the most up-to-date real 
time fund valuation data source that is publicly available.\72\ What 
are commenters' views as to whether the INAV represents a proxy for 
fair value of the assets of an ETF? What are commenters' views as to 
whether market participants could be confused as to what INAV 
represents? Could investors be confused that the INAV is not the same 
as the end-of-day net asset value of the ETF? Do market participants 
currently utilize the published INAV? If so, for what purpose do 
commenters utilize the published INAV? If not, why not?
---------------------------------------------------------------------------

    \71\ See ICI Letter, supra note 5, at 4.
    \72\ See Response Letter, supra note 8, at 2-3.
---------------------------------------------------------------------------

    2. The commenter further states that the INAV calculations are 
based on the ETF's creation basket, which in some cases do not 
represent all of the securities in a fund's portfolio; rather, the INAV 
would reflect baskets that mimic the market characteristics of the full 
portfolio.\73\ Do commenters agree that investors who do not understand 
how INAV is calculated for a particular ETF may not understand that 
INAV does not always mirror the value of the full portfolio of such 
ETF? If not, why not? Are there other aspects of the INAV that 
commenters believe could potentially cause confusion among investors 
and other market participants, particularly with respect to the 
operation of the proposed INAV Pegged Order? If so, what could they be?
---------------------------------------------------------------------------

    \73\ See ICI Letter, supra note 5, at 5.
---------------------------------------------------------------------------

    3. The commenter states that market participants may not understand 
that the INAV can be an inaccurate reflection of an ETF's up-to-date 
market value. As noted, the published INAV of an ETF generally is 
updated every 15 seconds, but the actual INAV of an ETF could change 
significantly during this same 15-second period.\74\ Further, the 
commenter states that the 15-second period could create opportunities 
for participants with access to real time calculations of the INAV for 
an ETF to take advantage of participants using the INAV Pegged Order 
type that do not have the same information.\75\ As a result, the 
commenter asserts that establishing an order price based on data that 
is 15 seconds old could result in poor executions.\76\
---------------------------------------------------------------------------

    \74\ See ICI Letter, supra note 5, at 4.
    \75\ See id.
    \76\ See id.
---------------------------------------------------------------------------

    In response, the Exchange states its belief that, although the INAV 
is only updated every 15 seconds, it is still of value and beneficial 
to investors as the execution will still be benchmarked against the 
prevailing published INAV.\77\
---------------------------------------------------------------------------

    \77\ See Response Letter, supra note 8, at 3. The Exchange 
states that the INAV is the most up-to-date data source that is 
publicly available, and ``is a clear improvement over the current 
state of non-existent data as it relates to real time fund 
valuation.'' Id.
---------------------------------------------------------------------------

    Do commenters agree with the concerns expressed by the commenter? 
If so, why? If not, why not? For instance, do commenters believe that 
the tying of the execution of an INAV Pegged Order to the published 
INAV, which is updated every 15 seconds, could potentially result in 
market participants' INAV Pegged Orders being executed at prices that 
do not reflect an up-to-date INAV for the ETF? Are commenters concerned 
that investors who may use the INAV Pegged Order type may not 
understand this operational aspect of the order type?
    4. The Exchange states that the INAV Pegged Order type should lead 
to a greater level of transparency as it relates to the ETF's current 
value and, as a

[[Page 4954]]

result, should increase investor confidence.\78\ Do commenters agree 
with these views? If so, why? If not, why not? For example, how would 
use of the proposed INAV Pegged Order type lead to greater transparency 
as it relates to the ETF's current value?
---------------------------------------------------------------------------

    \78\ See id.
---------------------------------------------------------------------------

    5. The commenter states that the calculation of INAV may be 
susceptible to errors, based on, for example, inaccurate reporting of 
ETF baskets, faulty data from pricing vendors, or errors in the 
calculation process.\79\ Further, the commenter asserts that such 
errors are not infrequent.\80\ Do commenters agree that INAV is 
susceptible to calculation errors? If not, why not? If so, how so? Do 
commenters believe that a potential for errors in the calculation of 
INAV could undermine the purpose, design, and operation of the proposed 
INAV Pegged Order type? If so, how? If not, why not?
---------------------------------------------------------------------------

    \79\ See ICI Letter, supra note 5, at 5.
    \80\ See id.
---------------------------------------------------------------------------

    In its Response Letter, the Exchange states its belief that the 
risk of a poor execution due to an erroneous INAV is mitigated by 
existing general safeguards in the marketplace.\81\ Do commenters agree 
with the Exchange? If so, what safeguards exist that would mitigate 
such a risk? If not, why not?
---------------------------------------------------------------------------

    \81\ See Response Letter, supra note 8, at 2.
---------------------------------------------------------------------------

    The Commission notes that the INAV is not a regulated measurement 
or calculation and is not audited by the Commission or any other 
regulatory or self-regulatory entity. Thus, it is unclear what party 
would be responsible for the integrity and accuracy of the INAV. Do 
commenters believe that a lack of accountability with respect to those 
parties responsible for the calculation of INAV could undermine the 
purpose, design and operation of the INAV Pegged Order? If not, why 
not?
    6. In addition, the Commission questions whether this proposed 
order type could inherently be negatively biased in that INAV Pegged 
Orders likely would be executed when the market is moving against the 
investor (for example, an investor's INAV Pegged Order to buy would be 
executed only when the market price of an ETF is falling). Do 
commenters agree that the INAV Pegged Order type could be inherently 
biased to the detriment of the investor? If not, why not? In its 
Response Letter, the Exchange states that an execution pursuant to an 
INAV Pegged Order would only ever occur within the prevailing bid-offer 
spread.\82\ Do commenters believe that this mitigates concerns relating 
to whether the INAV Pegged Order type could be inherently biased to the 
detriment of investors? Are there other potential risks that the 
proposed INAV Pegged Order type could pose to investors and other 
market participants? If so, what could they be?
---------------------------------------------------------------------------

    \82\ See Response Letter, supra note 8, at 3.
---------------------------------------------------------------------------

    7. The commenter requests more specificity as to how the Exchange 
would suspend the use of and cancel existing INAV Pegged Orders for an 
ETF where the INAV data feed for such ETF stops being disseminated or 
is ``compromised.'' \83\ The commenter also raises questions about the 
proposed cancellation and suspension of INAV Pegged Orders (e.g., how 
market participants would be notified that their orders have been 
cancelled due to a problem with INAV calculation), as well as about 
INAV Pegged Orders that may be executed based on a flawed INAV (e.g., 
whether such orders would be cancellable).\84\ In its Response Letter, 
the Exchange clarifies that it would only suspend the use of the INAV 
Pegged Order type for a particular U.S. Component Stock ETF if it were 
to detect a technological problem with the relevant INAV data feed, and 
that it would utilize its current systems and processes to detect any 
such problems and to communicate to market participants issues relating 
to the INAV data feed.\85\ Do commenters believe the Exchange has 
provided sufficient detail with respect to when and how an INAV Pegged 
Order would be suspended and cancelled by the Exchange?
---------------------------------------------------------------------------

    \83\ See ICI Letter, supra note 5, at 3.
    \84\ Id.
    \85\ See Response Letter, supra note 8, at 2.
---------------------------------------------------------------------------

    8. The commenter questions the general purpose and benefit of an 
INAV Pegged Order to market participants.\86\ In particular, the 
commenter states that the use of limit orders generally could address 
concerns relating to investors, the vast majority of whom utilize 
market orders and who, as a result, have been subject to inferior 
executions.\87\ As such, the commenter inquires as to whether the 
benefits of the proposed INAV Pegged Order type would outweigh the 
potential risks.\88\ The Exchange states the INAV Pegged Order type 
should help investors achieve greater transparency and a fair execution 
price.\89\ Do commenters agree with the Exchange's assertion? If so, 
why? If not, why not? What other benefits, if any, do commenters 
believe would result from the proposed INAV Pegged Order type? What are 
commenters' views as to how potential benefits that they believe would 
result from use of the proposed INAV Pegged Order would compare to the 
potential risks, as noted above?
---------------------------------------------------------------------------

    \86\ See ICI Letter, supra note 5, at 2.
    \87\ See id.
    \88\ See id.
    \89\ See Response Letter, supra note 8, at 2.
---------------------------------------------------------------------------

    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 rule-comments@sec.gov. Please include 
File Number SR-NASDAQ-2012-117 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-NASDAQ-2012-117. 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 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; 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-2012-117 and should 
be submitted on or before February 13, 2013. Rebuttal comments should 
be submitted by February 27, 2013.

[[Page 4955]]

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\90\
---------------------------------------------------------------------------

    \90\ 17 CFR 200.30-3(a)(57).
---------------------------------------------------------------------------

Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-01225 Filed 1-22-13; 8:45 am]
BILLING CODE 8011-01-P