Document ID: SEC-2020-1805-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: The Nasdaq Stock Market, LLC
Posted Date: 2020-11-12T05:00Z

[Federal Register Volume 85, Number 219 (Thursday, November 12, 2020)]
[Notices]
[Pages 71977-71979]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-24964]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-90355; File No. SR-NASDAQ-2020-017]

Self-Regulatory Organizations; The Nasdaq Stock Market LLC; Order 
Instituting Proceedings To Determine Whether To Approve or Disapprove a 
Proposed Rule Change To Amend Nasdaq Rule 5704

November 5, 2020.
    On July 23, 2020, The Nasdaq Stock Market LLC (``Exchange'' or 
``Nasdaq'') filed with the Securities and Exchange Commission 
(``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Exchange Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to amend certain listing 
requirements relating to maintaining a minimum number of beneficial 
holders and minimum number of shares outstanding. The proposed rule 
change was published for comment in the Federal Register on August 7, 
2020.\3\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 89464 (August 4, 
2020), 85 FR 48012 (``Notice'').
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    On September 10, 2020, pursuant to Section 19(b)(2) of the Exchange 
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 disapprove the 
proposed rule change.\5\ The Commission has received no comments on the 
proposed rule change. The Commission is issuing this order to institute 
proceedings pursuant to Section 19(b)(2)(B) of the Exchange Act \6\ to 
determine whether to approve or disapprove the proposed rule change.
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    \4\ 15 U.S.C. 78s(b)(2).
    \5\ See Securities Exchange Act Release No. 89823, 85 FR 57895 
(September 16, 2020). The Commission designated November 5, 2020 as 
the date by which the Commission shall approve or disapprove, or 
institute proceedings to determine whether to disapprove, the 
proposed rule change.
    \6\ 15 U.S.C. 78s(b)(2)(B).
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I. Description of the Proposal

    The Exchange proposes to amend Nasdaq Rule 5704 to: (1) Remove the 
requirement that, twelve months after the commencement of trading on 
the Exchange, a series of Exchange Traded Fund Shares must have 50 or 
more beneficial holders; and (2) replace its existing minimum number of 
shares requirement with a requirement that each series of Exchange 
Traded Fund Shares have a sufficient number of shares outstanding at 
the commencement of trading to facilitate the formation of at least one 
creation unit.\7\
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    \7\ Currently, Nasdaq Rule 5704(b)(1)(A) provides that the 
Exchange will establish a minimum number of Exchange Traded Fund 
Shares required to be outstanding at the time of commencement of 
trading on the Exchange.
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    The Exchange believes that the requirement that a series of 
Exchange Traded Fund Shares listed on the Exchange must have at least 
50 beneficial shareholders is no longer necessary. The Exchange 
believes that the requirements of Rule 6c-11 under the Investment 
Company Act of 1940 (``1940 Act''), coupled with the existing creation 
and redemption process, mitigate the potential lack of liquidity that, 
according to the Exchange, the shareholder requirement was intended to 
address.\8\ The Exchange further believes that requiring at least one 
creation unit to be outstanding at the commencement of trading, 
together with the daily portfolio transparency and other enhanced 
disclosure requirements of Rule 6c-11 under the 1940 Act,\9\ 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 a 
fund's portfolio.
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    \8\ In contrast, 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 id. at 48012, n.6.
    \9\ As an example, the Exchange notes that Rule 6c-11(c)(1)(vi) 
requires additional disclosure if the premium or discount is in 
excess of 2% for more than seven consecutive days, so that there 
would be 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.
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    Specifically with respect to arbitrage, the Exchange states that 
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 converge. In addition, the Exchange states 
that 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. As a result, the Exchange believes that the AP 
is able to buy and sell Exchange Traded Fund Shares from both the fund 
and investors. Because Exchange Traded Fund Shares 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 
shares currently outstanding. Thus, the Exchange believes that, unlike 
common stock, the liquidity of Exchange Traded Fund Shares is not 
dependent on the number of shares currently outstanding or the number 
of shareholders, but on the availability of APs to transact in the 
Exchange Traded Fund Shares primary market.
    To support these contentions, the Exchange provides information, 
during a two-month observation period, regarding how closely two 
funds--the SPY and QQQ--tracked their respective underlying indexes, as 
well as data regarding creation and redemption activity in those two 
funds during the same observation period. The Exchange asserts that a 
symbiotic relationship exists between the disclosure requirements of 
Rule 6c-11 under the

[[Page 71978]]

1940 Act, the ability of the AP to create and redeem shares of a fund, 
and the functioning of the arbitrage mechanism that helps to ensure 
that the trading price in the secondary market is at fair value. 
According to the Exchange, this renders the need for a shareholder 
requirement as duplicative and unnecessary.
    The Exchange further believes that, in order for fund redemptions 
to be executed in support of the arbitrage mechanism, it is appropriate 
that, in lieu of the minimum number of shareholders requirement, the 
fund have 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 Exchange claims that 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. According to the Exchange, of 
the more than 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.
    In addition, the Exchange states that its surveillance program for, 
and its ability to halt trading in, Exchange Traded Fund Shares provide 
for additional investor protections by further mitigating any abnormal 
trading that would affect the prices of Exchange Traded Fund Shares.

II. Proceedings To Determine Whether To Approve or Disapprove SR-
NASDAQ-2020-017 and Grounds for Disapproval Under Consideration

    The Commission is instituting proceedings pursuant to Section 
19(b)(2)(B) of the Exchange Act \10\ to determine whether the proposed 
rule change should be approved or disapproved. Institution of such 
proceedings is appropriate at this time in view of the legal and policy 
issues raised by the proposed rule change. Institution of proceedings 
does not indicate that the Commission has reached any conclusions with 
respect to any of the issues involved.
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    \10\ 15 U.S.C. 78s(b)(2)(B).
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    Pursuant to Section 19(b)(2)(B) of the Exchange Act,\11\ the 
Commission is providing notice of the grounds for disapproval under 
consideration. The Commission is instituting proceedings to allow for 
additional analysis of and input concerning the proposed rule change's 
consistency with the Exchange Act and, in particular, Section 6(b)(5) 
of the Exchange Act, which requires, among other things, that the rules 
of a national securities exchange be ``designed to prevent fraudulent 
and manipulative acts and practices, to promote just and equitable 
principles of trade, 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; and are not 
designed to permit unfair discrimination between customers, issuers, 
brokers, or dealers.'' \12\
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    \11\ Id.
    \12\ 15 U.S.C. 78f(b)(5).
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    The Commission has consistently recognized the importance of the 
minimum number of holders and other similar requirements in exchange 
listing standards. Among other things, such listing standards help 
ensure that exchange listed securities have sufficient public float, 
investor base, and trading interest to provide the depth and liquidity 
necessary to promote fair and orderly markets.\13\
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    \13\ See, e.g., Securities Exchange Act Release No. 57785 (May 
6, 2008), 73 FR 27597 (May 13, 2008) (SR-NYSE-2008-17) (stating that 
the distribution standards, which includes exchange holder 
requirements ``. . . should help to ensure that the [Special Purpose 
Acquisition Company's] securities have sufficient public float, 
investor base, and liquidity to promote fair and orderly markets''); 
Securities Exchange Act Release No. 86117 (June 14, 2019), 84 FR 
28879 (June 20, 2018) (SR-NYSE-2018-46) (disapproving a proposal to 
reduce the minimum number of public holders continued listing 
requirement applicable to Special Purpose Acquisition Companies from 
300 to 100).
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    As discussed above, the Exchange is proposing to: (1) Remove the 
listing requirement that, following the initial twelve-month period 
after commencement of trading of a series of Exchange Traded Fund 
Shares on the Exchange, such series have at least 50 beneficial 
holders, and (2) replace its existing minimum number of shares 
requirement with a requirement that each series of Exchange Traded Fund 
Shares have a sufficient number of shares outstanding at the 
commencement of trading to facilitate the formation of at least one 
creation unit.\14\ In support of its proposal, the Exchange asserts 
that the minimum number of beneficial holders requirement is no longer 
necessary because the requirements of Rule 6c-11 under the 1940 Act, 
coupled with the existing creation and redemption process, mitigate the 
potential lack of liquidity that Nasdaq believes the beneficial holders 
requirement was intended to address. The Exchange, however, does not 
explain in any detail the basis for this view, particularly if a series 
of Exchange Traded Fund Shares is permitted to have a very small number 
of beneficial holders. For example, while the Exchange provides data 
with respect to two widely-held and highly liquid funds, it does not 
address how the arbitrage mechanism will assure Exchange Traded Fund 
Shares with very few holders or very few active APs will effectively 
support fair and orderly markets. The Exchange also does not discuss 
potential inefficiencies in the arbitrage mechanism that might occur 
with illiquid Exchange Traded Fund Shares that have very few holders, 
and the impact that would have on the ability of the arbitrage 
mechanism to effectively mitigate the risks of manipulation. Further, 
the Exchange does not address the impact of creation unit size on the 
efficiency of the arbitrage mechanism across the spectrum of Exchange 
Traded Fund Shares (e.g., illiquid Exchange Traded Fund Shares with 
very few holders and a large creation unit size). The Exchange provides 
no data or analysis to support its position, other than with respect to 
the SPY and QQQ, two highly liquid and widely held Exchange Traded Fund 
Shares, and the number and size of the creation units for existing 
Exchange Traded Fund Shares.
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    \14\ In support of its proposal, Nasdaq states that it would 
require that a sufficient number of shares to be outstanding at 
``all times'' to facilitate the formation of at least one creation 
unit. See Notice, supra note 3, 85 FR at 48012. However, proposed 
Nasdaq Rule 5704(b)(1)(A) establishes that requirement ``at the time 
of commencement of trading on Nasdaq,'' making it an initial and not 
a continued listing standard.
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    The Exchange provides no specific arguments to support the proposed 
elimination of its existing minimum number of shares requirement. While 
the Exchange proposes to replace that requirement with a requirement 
that each series of Exchange Traded Fund Shares have a sufficient 
number of shares outstanding at the commencement of trading to 
facilitate the formation of at least one creation unit, the Exchange 
does not explain why this is an appropriate substitute for its existing 
standards. Creation unit sizes could be highly variable, since they are 
determined at the discretion of the issuer of Exchange Traded Fund 
Shares. The Exchange has not articulated how this new standard would 
effectively support fair and orderly markets, address the risks of 
manipulation, and otherwise be consistent with Section 6(b)(5) and 
other relevant provisions of the Exchange Act for Exchange Traded

[[Page 71979]]

Fund Shares with only a single and relatively small creation unit 
outstanding. The Exchange also has proposed to limit this requirement 
to a single determination at the commencement of trading, and has not 
explained the impact of fewer shares potentially being outstanding 
thereafter. Further, the Exchange has proposed to require that there be 
a sufficient number of shares outstanding to ``facilitate the formation 
of'' at least one creation unit, and has not explained how this 
standard differs from a requirement that the number of shares 
outstanding at least equals one creation unit.
    Finally, the Exchange takes the position that its surveillance 
procedures and trading halt authority would mitigate any abnormal 
trading that would affect Exchange Traded Fund Shares prices in the 
secondary market. The Exchange, however, does not explain in any detail 
the basis for this view, or how specifically its existing procedures 
would effectively mitigate the risks addressed by the minimum number of 
beneficial holders and minimum number of shares requirements the 
Exchange is proposing to eliminate.
    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 [`SRO'] that proposed the rule change.'' 
\15\ 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 an SRO 
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 Exchange Act and the applicable rules and 
regulations.\16\
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    \15\ Rule 700(b)(3), Commission Rules of Practice, 17 CFR 
201.700(b)(3).
    \16\ See id.
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    For these reasons, the Commission believes it is appropriate to 
institute proceedings pursuant to Section 19(b)(2)(B) of the Exchange 
Act to determine whether the proposal should be approved or 
disapproved.

IV. Commission's Solicitation of Comments

    The Commission requests that interested persons provide written 
submissions of their views, data, and arguments with respect to the 
issues identified above, as well as any other concerns they may have 
with the proposal. In particular, the Commission invites the written 
views of interested persons concerning whether the proposal is 
consistent with Section 6(b)(5) or any other provision of the Exchange 
Act, or the rules and regulations thereunder. Although there do not 
appear to be any issues relevant to approval or disapproval that 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.\17\
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    \17\ Section 19(b)(2) of the Exchange Act, as amended by the 
Securities Act Amendments of 1975, Public Law 94-29 (June 4, 1975), 
grants the Commission flexibility to determine what type of 
proceeding--either oral or notice and opportunity for written 
comments--is appropriate for consideration of a particular proposal 
by a self-regulatory organization. See Securities Act Amendments of 
1975, Senate Comm. on Banking, Housing & Urban Affairs, S. Rep. No. 
75, 94th Cong., 1st Sess. 30 (1975).
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    Interested persons are invited to submit written data, views, and 
arguments regarding whether the proposal should be approved or 
disapproved by December 3, 2020. Any person who wishes to file a 
rebuttal to any other person's submission must file that rebuttal by 
December 17, 2020 The Commission asks that commenters address the 
sufficiency of the Exchange's statements in support of the proposal, 
which are set forth in the Notice,\18\ in addition to any other 
comments they may wish to submit about the proposed rule change.
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    \18\ See supra note 3.
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    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-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 
by December 3, 2020. Rebuttal comments should be submitted by December 
17, 2020.
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    \19\ 17 CFR 200.30-3(a)(57).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\19\
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-24964 Filed 11-10-20; 8:45 am]
BILLING CODE 8011-01-P