
[Federal Register Volume 82, Number 179 (Monday, September 18, 2017)]
[Notices]
[Pages 43621-43627]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-19808]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-81599; File No. SR-BatsBZX-2017-30]


Self-Regulatory Organizations; Bats BZX Exchange, Inc.; Order 
Instituting Proceedings To Determine Whether To Approve or Disapprove a 
Proposed Rule Change To Permit the Listing and Trading of Managed 
Portfolio Shares; and To List and Trade Shares of the Following Under 
Proposed Rule 14.11(k): ClearBridge Appreciation ETF; ClearBridge Large 
Cap ETF; ClearBridge MidCap Growth ETF; ClearBridge Select ETF; and 
ClearBridge All Cap Value ETF

September 13, 2017.
    On June 1, 2017, Bats BZX Exchange, Inc. (``Exchange'' or ``BZX'') 
filed with the Securities and Exchange Commission (``Commission''), 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed rule change to: 
(1) Adopt Rule 14.11(k) (Managed Portfolio Shares); and (2) list and 
trade shares (``Shares'') of the ClearBridge Appreciation ETF; 
ClearBridge Large Cap ETF; ClearBridge MidCap Growth ETF; ClearBridge 
Select ETF; and ClearBridge All Cap Value ETF under proposed Rule 
14.11(k). The proposed rule change was published for comment in the 
Federal Register on June 19, 2017.\3\ On July 28, 2017, 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 
disapprove the proposed rule change.\5\ The Commission has received 
four comments on the proposed rule change.\6\ This order institutes 
proceedings under Section 19(b)(2)(B) of the Act \7\ to determine 
whether to approve or disapprove the proposed rule change.
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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. 80911 (June 13, 
2017), 82 FR 27925 (``Notice'').
    \4\ 15 U.S.C. 78s(b)(2).
    \5\ See Securities Exchange Act Release No. 81247, 82 FR 36031 
(August 2, 2017). The Commission designated September 17, 2017, as 
the date by which the Commission shall approve or disapprove, or 
institute proceedings to determine whether to disapprove, the 
proposed rule change.
    \6\ See Letter from Gary L. Gastineau, President, ETF 
Consultants.com, Inc., to Brent J. Fields, Secretary, Commission, 
dated July 7, 2017 (``Gastineau Letter''); Letter from Todd J. 
Broms, Chief Executive Officer, Broms & Company LLC, to Brent J. 
Fields, Secretary, Commission, dated July 10, 2017 (``Broms 
Letter''); Letter from James J. Angel, Associate Professor of 
Finance, Georgetown University, McDonough School of Business, to the 
Commission, dated July 10, 2017 (``Angel Letter''); and Letter from 
Terence W. Norman, Founder, Blue Tractor Group, LLC, to Brent J. 
Fields, Secretary, Commission, dated August 1, 2017 (``Norman 
Letter''). The comment letters are available on the Commission's Web 
site at: https://www.sec.gov/comments/sr-batsbzx-2017-30/batsbzx201730.htm.
    \7\ 15 U.S.C. 78s(b)(2)(B).
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I. Summary of the Exchange's Description of the Proposed Rule Change 
8
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    \8\ For a complete description of the Exchange's proposal, 
including a description of the Precidian ETF Trust II (``Trust''), 
see the Notice, supra note 3.
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    The Exchange proposes to adopt new Rule 14.11(k), which would 
govern the listing and trading of ``Managed Portfolio Shares.'' \9\ The 
Exchange also proposes to list and trade Shares of the ClearBridge 
Appreciation ETF; ClearBridge Large Cap ETF; ClearBridge MidCap Growth 
ETF; ClearBridge Select ETF; and ClearBridge All Cap Value ETF under 
proposed Rule 14.11(k) (each a ``Fund,'' and collectively the 
``Funds'').
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    \9\ Proposed Rule 14.11(k)(3)(A) defines the term ``Managed 
Portfolio Share'' as a security that (a) is issued by a registered 
investment company (``Investment Company'') organized as an open-end 
management investment company or similar entity, that invests in a 
portfolio of securities selected by the Investment Company's 
investment adviser consistent with the Investment Company's 
investment objectives and policies; and (b) when aggregated in a 
number of shares equal to a Redemption Unit (as defined in proposed 
Rule 14.11(k)(3)(C)) or multiples thereof, may be redeemed at the 
request of an authorized participant (as defined in the Investment 
Company's Form N-1A filed with the Commission), which authorized 
participant will be paid through a confidential account 
(``Confidential Account'') established for its benefit, a portfolio 
of securities and/or cash with a value equal to the next determined 
net asset value (``NAV'').
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A. Description of the Funds

    The portfolio for each Fund will consist primarily of long and/or 
short positions in U.S.-exchange-listed securities and shares issued by 
other U.S. exchange-listed exchange-traded funds (``ETFs'').\10\ All 
exchange-listed equity securities in which the Funds will invest will 
be listed and traded on U.S. national securities exchanges.
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    \10\ The Exchange represents that, for purposes of describing 
the holdings of the Funds, ETFs include Portfolio Depository 
Receipts (as described in Rule 14.11(b)); Index Fund Shares (as 
described in Rule 14.11(c)); and Managed Fund Shares (as described 
in Rule 14.11(i)). The ETFs in which a Fund will invest all will be 
listed and traded on national securities exchanges. While the Funds 
may invest in inverse ETFs, the Funds will not invest in leveraged 
(e.g., 2X, -2X, 3X or -3X) ETFs.
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1. ClearBridge Appreciation ETF
    The ClearBridge Appreciation ETF will seek to provide long-term 
appreciation of shareholders' capital. The Fund will seek to achieve 
its investment objective by investing primarily in U.S. exchange-listed 
equity securities. The Fund will typically invest in medium and large 
capitalization companies, but may also invest in small capitalization 
companies.
2. ClearBridge Large Cap ETF
    The ClearBridge Large Cap ETF will seek long-term capital 
appreciation. The Fund will seek to achieve its investment objective by 
taking long and possibly short positions in equity securities or groups 
of equities that the portfolio managers believe will provide long term 
capital appreciation. The Fund will normally invest at least 80% of its 
net assets (plus borrowings for investment purposes) in stocks included 
in the Russell 1000 Index and ETFs that primarily invest in stocks in 
the Russell 1000 Index. The Fund purchases securities that the Fund's 
sub-adviser, ClearBridge Investments, LLC (``Sub-Adviser''), believes 
are undervalued, and sells short securities that it believes are 
overvalued.
3. ClearBridge Mid Cap Growth ETF
    The ClearBridge Mid Cap Growth ETF will seek long-term growth of 
capital. The Fund will seek to achieve its investment objective by 
investing primarily in U.S. exchange-listed, publicly traded equity and 
equity-related securities of U.S. companies or other instruments with 
similar economic characteristics. The Fund may invest in securities of 
issuers of any market capitalization.
4. ClearBridge Select ETF
    The ClearBridge Select ETF will seek to provide long-term growth of 
capital. The Fund will seek to achieve its investment objective by 
investing primarily in U.S. exchange-listed, publicly traded equity and 
equity-related securities of U.S. companies or other instruments with 
similar economic characteristics. The Fund may invest in securities of 
issuers of any market capitalization.

[[Page 43622]]

5. ClearBridge All Cap Value ETF
    The ClearBridge All Cap Value ETF will seek long-term capital 
growth with current income as a secondary consideration. The Fund will 
seek to achieve its investment objective by investing primarily in 
common stocks and common stock equivalents, such as preferred stocks 
and securities convertible into common stocks, of companies the Sub-
Adviser believes are undervalued in the marketplace. The Fund may 
invest up to 25% of its net assets in equity securities of foreign 
issuers through U.S. exchange-listed depositary receipts.
6. Other Investments
    According to the Exchange, while each Fund, under normal market 
conditions, will invest primarily in U.S. exchange-listed securities, 
as described above, each Fund may invest its remaining assets in other 
securities and financial instruments as follows: (i) Repurchase 
agreements; \11\ (ii) warrants, rights, and options (limited to 5% of 
total assets); (iii) cash or cash equivalents; \12\ and (iv) other 
investment companies (including money market funds).
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    \11\ The Exchange states that it will be the policy of the Trust 
to enter into repurchase agreements only with recognized securities 
dealers, banks, and the Fixed Income Clearing Corporation.
    \12\ The Exchange states that for purposes of the filing, cash 
equivalents include short-term instruments (instruments with 
maturities of less than 3 months) of the following types: (i) U.S. 
Government securities, including bills, notes and bonds differing as 
to maturity and rates of interest, which are either issued or 
guaranteed by the U.S. Treasury or by U.S. Government agencies or 
instrumentalities; (ii) certificates of deposit issued against funds 
deposited in a bank or savings and loan association; (iii) bankers' 
acceptances, which are short-term credit instruments used to finance 
commercial transactions; (iv) repurchase agreements and reverse 
repurchase agreements; (v) bank time deposits, which are monies kept 
on deposit with banks or savings and loan associations for a stated 
period of time at a fixed rate of interest; (vi) commercial paper, 
which are short-term unsecured promissory notes; and (vii) money 
market funds.
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7. Investment Restrictions
    Each Fund may invest up to an aggregate amount of 15% of its net 
assets in illiquid assets (calculated at the time of investment),\13\ 
consistent with Commission guidance. Each Fund will monitor its 
portfolio liquidity on an ongoing basis to determine whether, in light 
of current circumstances, an adequate level of liquidity is being 
maintained, and will consider taking appropriate steps in order to 
maintain adequate liquidity if, through a change in values, net assets, 
or other circumstances, more than 15% of a Fund's net assets are 
invested in illiquid assets. Illiquid assets include securities subject 
to contractual or other restrictions on resale and other instruments 
that lack readily available markets as determined in accordance with 
Commission staff guidance.
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    \13\ In reaching liquidity decisions, the investment adviser to 
the Trust, Precidian Funds LLC (``Adviser''), may consider the 
following factors: The frequency of trades and quotes for the 
security; the number of dealers wishing to purchase or sell the 
security and the number of other potential purchasers; dealer 
undertakings to make a market in the security; and the nature of the 
security and the nature of the marketplace in which it trades (e.g., 
the time needed to dispose of the security, the method of soliciting 
offers and the mechanics of transfer).
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    The Funds will not invest in securities listed on non-U.S. 
exchanges. The Funds also will not invest in futures, forwards, or 
swaps. Further, each Fund's investments will be consistent with its 
investment objective and will not be used to enhance leverage. While a 
Fund may invest in inverse ETFs, a Fund will not invest in leveraged 
(e.g., 2X, -2X, 3X or -3X) ETFs.

B. Key Features of Managed Portfolio Shares

    While Investment Companies issuing Managed Portfolio Shares would 
be actively-managed, and in that respect would be similar to those 
issuing Managed Fund Shares,\14\ Managed Portfolio Shares would differ 
from Managed Fund Shares in the following respects.
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    \14\ Managed Fund Shares are shares of actively-managed 
Investment Companies listed and traded under Rule 14.11(i).
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     First, issues of Managed Fund Shares are required to 
disseminate their ``Disclosed Portfolio'' at least once daily.\15\ By 
contrast, the portfolio for an issue of Managed Portfolio Shares would 
be disclosed only quarterly.\16\
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    \15\ Rule 14.11(i)(3)(B) defines the term ``Disclosed 
Portfolio'' as the identities and quantities of the securities and 
other assets held by the Investment Company that will form the basis 
for the Investment Company's calculation of NAV at the end of the 
business day. Rule 14.11(i)(4)(B)(ii)(a) requires that, for Managed 
Fund Shares, the Disclosed Portfolio will be disseminated at least 
once daily and will be made available to all market participants at 
the same time.
    \16\ The Exchange states that the portfolio for an issue of 
Managed Portfolio Shares would be disclosed quarterly in accordance 
with normal disclosure requirements otherwise applicable to open-end 
investment companies registered under the Investment Company Act of 
1940 (``1940 Act'').
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     Second, in connection with the redemption of shares in 
``Redemption Unit'' size, the delivery of any portfolio securities in 
kind would be effected through a Confidential Account for the benefit 
of the redeeming authorized participant without disclosing the identity 
of the securities to the authorized participant.
     Third, for each series of Managed Portfolio Shares, a 
Verified Intraday Indicative Value (``VIIV'') would be disseminated by 
one or more major market data vendors at least every second during the 
Exchange's Regular Trading Hours (normally, 9:30 a.m. to 4:00 p.m., 
Eastern Time (``E.T.'')).\17\ The Exchange states that dissemination of 
the VIIV will allow investors to determine the estimated intra-day 
value of the underlying portfolio of a series of Managed Portfolio 
Shares and will provide a close estimate of that value throughout the 
trading day.\18\
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    \17\ Proposed Rule 14.11(k)(3)(B) defines the VIIV as the 
estimated indicative value of a Managed Portfolio Share based on all 
of the issuer's holdings as of the close of business on the prior 
business day, priced and disseminated in at least one second 
intervals, and subject to validation by a pricing verification agent 
of the Investment Company that is responsible for comparing multiple 
independent pricing sources to establish the accuracy of the VIIV.
    \18\ According to the Exchange, the VIIV should not be viewed as 
a ``real-time'' update of the NAV per Share of each Fund, because 
the VIIV may not be calculated in the same manner as the NAV, which 
will be computed once a day, generally at the end of the business 
day.
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C. Arbitrage of Managed Portfolio Shares

    The Exchange asserts that market makers will be able to make 
efficient and liquid markets priced near the VIIV, as long as a VIIV is 
disseminated at least every second, market makers have knowledge of a 
Fund's means of achieving its investment objective, and market makers 
are permitted to engage in ``bona fide arbitrage,'' as described below. 
According to the Exchange, market makers would employ bona fide 
arbitrage in addition to risk-management techniques such as 
``statistical arbitrage,'' \19\ which the Exchange states is currently 
used throughout the financial services industry, to make efficient 
markets in ETFs.
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    \19\ According to the Exchange, statistical arbitrage enables a 
trader to construct an accurate proxy for another instrument, 
allowing the trader to hedge the other instrument or buy or sell the 
instrument when it is cheap or expensive in relation to the proxy. 
Statistical analysis permits traders to discover correlations based 
purely on trading data without regard to other fundamental drivers. 
These correlations are a function of differentials, over time, 
between one instrument or group of instruments and one or more other 
instruments. Once the nature of these price deviations has been 
quantified, a universe of securities is searched in an effort to, in 
the case of a hedging strategy, minimize the differential. Once a 
suitable hedging proxy has been identified, a trader can minimize 
portfolio risk by executing the hedging basket. The trader then can 
monitor the performance of this hedge throughout the trade period 
making correction where warranted.
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    According to the Exchange, if an authorized participant believes 
that Shares of a Fund are trading at a price

[[Page 43623]]

that is higher than the value of the underlying portfolio--for example, 
if the market price for the Shares is higher than the VIIV--then the 
authorized participant may sell Shares of the Fund short and instruct 
its ``Trusted Agent'' \20\ to buy portfolio securities for its 
Confidential Account. When the market price of the Shares falls in line 
with the value of the portfolio, the authorized participant can then 
close out its positions in both the Shares and the portfolio 
securities. According to the Exchange, the authorized participant's 
purchase of the portfolio securities into its Confidential Account, 
combined with the sale of Shares, may create downward pressure on the 
price of Shares and/or upward pressure on the price of the portfolio 
securities, bringing the market price of Shares and the value of a 
Fund's portfolio securities closer together. Similarly, according to 
the Exchange, an authorized participant could buy Shares and instruct 
the Trusted Agent to sell the underlying portfolio securities from its 
Confidential Account in an attempt to profit when a Fund's Shares are 
trading at a discount to its portfolio. According to the Exchange, the 
authorized participant's purchase of a Fund's Shares in the secondary 
market, combined with the sale of the portfolio securities from its 
Confidential Account, may create upward pressure on the price of Shares 
and/or downward pressure on the price of portfolio securities, driving 
the market price of Shares and the value of a Fund's portfolio 
securities closer together. The Exchange states that, according to the 
Adviser, this process is identical to how many authorized participants 
currently arbitrage existing traditional ETFs, except for the use of 
the Confidential Account.
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    \20\ Proposed Rule 14.11(k)(2)(D) requires that authorized 
participants redeeming Managed Portfolio Shares sign an agreement 
with an agent (``Trusted Agent'') to establish a Confidential 
Account, for the benefit of such authorized participant, that will 
receive all consideration from the issuer in a redemption. A Trusted 
Agent may not disclose the consideration received in a redemption 
except as required by law or as provided in the Investment Company's 
Form N-1A, as applicable.
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    According to the Exchange, a market participant that is not an 
authorized participant would also be able to establish a Confidential 
Account and could engage in arbitrage activity without using the 
creation or redemption processes described above. The Exchange states 
that if such a market participant believes that a Fund is overvalued 
relative to its underlying assets, the market participant could sell 
Shares short and instruct its Trusted Agent to buy portfolio securities 
in its Confidential Account, wait for the trading prices to move toward 
parity, and then close out the positions in both the Shares and the 
portfolio securities to realize a profit from the relative movement of 
their trading prices. Similarly, according to the Exchange, a market 
participant could buy Shares and instruct the Trusted Agent to sell the 
underlying portfolio securities in an attempt to profit when a Fund's 
Shares are trading at a discount to a Fund's underlying or reference 
assets.

D. The Creation and Redemption Procedures

    The Exchange states that, generally, Shares will be purchased and 
redeemed on an in-kind basis. Accordingly, except where the purchase or 
redemption will include cash under the circumstances described in the 
applicable Fund's registration statement, purchasers will be required 
to purchase ``Creation Units'' by making an in-kind deposit of 
specified instruments (``Deposit Instruments''), and shareholders 
redeeming their Shares will receive an in-kind transfer of specified 
instruments (``Redemption Instruments''). On any given business day, 
the names and quantities of the instruments that constitute the Deposit 
Instruments and the names and quantities of the instruments that 
constitute the Redemption Instruments will be identical, and these 
instruments may be referred to, in the case of either a purchase or a 
redemption, as the ``Creation Basket.''
    In the case of a redemption, a Fund's custodian (``Custodian'') 
will typically deliver securities to the Confidential Account on a pro 
rata basis with a value approximately equal to the value of the Shares 
tendered for redemption at the redemption order cut-off time 
established by the Fund. The Custodian will make delivery of the 
securities by appropriate entries on its books and records transferring 
ownership of the securities to the authorized participant's 
Confidential Account, subject to delivery of the Shares redeemed. The 
Trusted Agent of the Confidential Account will in turn liquidate, 
hedge, or otherwise manage the securities based on instructions from 
the authorized participant.\21\
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    \21\ The Exchange represents that an authorized participant will 
issue execution instructions to the Trusted Agent and be responsible 
for all associated profit or losses. Like a traditional ETF, the 
authorized participant has the ability to sell the basket securities 
at any point during normal trading hours.
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    If the Trusted Agent is instructed to sell all securities received 
at the close on the redemption date, the Trusted Agent will pay the 
liquidation proceeds net of expenses, plus or minus any cash balancing 
amount, to the authorized participant through DTC.\22\ The redemption 
securities that the Confidential Account receives are expected to 
mirror the portfolio holdings of a Fund pro rata.
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    \22\ According to the Exchange, under applicable provisions of 
the Internal Revenue Code, the authorized participant is expected to 
be deemed a ``substantial owner'' of the Confidential Account 
because it receives distributions from the Confidential Account. As 
a result, the Exchange states, all income, gain, or loss realized by 
the Confidential Account will be directly attributed to the 
authorized participant. The Exchange also states that, in a 
redemption, the authorized participant will have a basis in the 
distributed securities equal to the fair market value at the time of 
the distribution, and any gain or loss realized on the sale of those 
Shares will be taxable income to the authorized participant.
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E. Availability of Information

    Each Fund will be required to file with the Commission its complete 
portfolio schedules for the second and fourth fiscal quarters on Form 
N-CSR under the 1940 Act, and to file its complete portfolio schedules 
for the first and third fiscal quarters on Form N-Q under the 1940 Act, 
within 60 days of the end of the quarter. Form N-Q requires funds to 
file the same schedules of investments that are required in annual and 
semi-annual reports to shareholders. The Trust's SAI and each Fund's 
shareholder reports will be available free upon request from the Trust. 
These documents and forms may be viewed on-screen or downloaded from 
the Commission's Web site at www.sec.gov.
    In addition, the VIIV will be widely disseminated by one or more 
major market data vendors at least every second during the Regular 
Trading Hours.\23\ According to the Exchange, the VIIV will include all 
accrued income and expenses of a Fund and will assure that any 
extraordinary expenses, booked during the day, which would be taken 
into account in calculating a Fund's NAV for that day, are also taken 
into account in calculating the VIIV.
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    \23\ The Exchange states that it will disseminate the VIIV for 
each Fund in at least one-second intervals during Regular Trading 
Hours, through the facilities of the Consolidated Tape Association.
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    For purposes of the VIIV, securities held by a Fund will generally 
be valued throughout the day based on the mid-point between the 
disseminated current national best bid and offer. According to the 
Exchange, by utilizing the mid-point pricing for purposes of VIIV 
calculation, stale prices are eliminated and more accurate 
representation of the real-time value of the underlying securities is 
provided to the market. Specifically,

[[Page 43624]]

according to the Exchange, quotations based on the mid-point of bid/ask 
spreads more accurately reflect current market sentiment by providing 
real time information on where market participants are willing to buy 
or sell securities at that point in time. The Exchange also believes 
that the use of quotations will dampen the impact of any momentary 
spikes in the price of a portfolio security.
    According to the Exchange, each Fund will utilize two independent 
pricing sources to provide two independent sources of pricing 
information. Each Fund will also utilize a ``Pricing Verification 
Agent'' and establish a computer-based protocol that will permit the 
Pricing Verification Agent to continuously compare the two data streams 
from the independent pricing sources on a real time basis.\24\ A single 
VIIV will be disseminated publicly for each Fund; however, the Pricing 
Verification Agent will continuously compare the public VIIV against a 
non-public alternative intra-day indicative value to which the Pricing 
Verification Agent has access. If it becomes apparent that there is a 
material discrepancy between the two data streams, the Exchange will be 
notified and have the ability to halt trading in a Fund until the 
discrepancy is resolved.\25\ Each Fund's board of directors will review 
the procedures used to calculate the VIIV and maintain its accuracy as 
appropriate, but not less than annually. The specific methodology for 
calculating the VIIV will be disclosed on each Fund's Web site.
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    \24\ A Fund's Custodian will provide, on a daily basis, the 
constituent basket file comprised of all securities plus any cash to 
the independent pricing agent(s) for purposes of pricing.
    \25\ Proposed Rule 14.11(k)(4)(B)(iii) provides that, upon 
notification to the Exchange by the Investment Company or its agent 
that (i) the prices from the multiple independent pricing sources to 
be validated by the Investment Company's Pricing Verification Agent 
differ by more than 25 basis points for 60 seconds in connection 
with pricing of the VIIV, or (ii) the VIIV of a series of Managed 
Portfolio Shares is not being priced and disseminated in at least 
one-second intervals, as required, the Exchange will halt trading in 
the Managed Portfolio Shares as soon as practicable. The halt in 
trading would continue until the Investment Company or its agent 
notifies the Exchange that the prices from the independent pricing 
sources no longer differ by more than 25 basis points for 60 seconds 
or that the VIIV is being priced and disseminated as required. The 
Investment Company or its agent would be responsible for monitoring 
that the VIIV is being priced and disseminated as required and 
whether the prices to be validated from multiple independent pricing 
sources differ by more than 25 basis points for 60 seconds.
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F. Surveillance

    The Exchange represents that trading of the Shares will be subject 
to its surveillance procedures for derivative products. The Exchange 
believes that its surveillance procedures are adequate to properly 
monitor the trading of the Shares on the Exchange during all trading 
sessions and to deter and detect violations of Exchange rules and the 
applicable federal securities laws.\26\
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    \26\ The Exchange represents that the Exchange or FINRA, on 
behalf of the Exchange, or both, will communicate as needed 
regarding trading in the Shares, underlying stocks, ETFs, and 
exchange-listed options with other markets and other entities that 
are members of the Intermarket Surveillance Group (``ISG''), and the 
Exchange or FINRA, on behalf of the Exchange, or both, may obtain 
trading information regarding such securities from such markets and 
other entities. In addition, the Exchange may obtain information 
regarding trading in the Shares, underlying stocks, ETFs and 
exchange-listed options from markets and other entities that are 
members of ISG or with which the Exchange has in place a 
comprehensive surveillance sharing agreement.
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    The Exchange represents that the Funds' Adviser will make available 
daily to FINRA and the Exchange the portfolio holdings of each Fund in 
order to facilitate the performance of the surveillances referred to 
above. In addition, the Exchange states that it has a general policy 
prohibiting the distribution of material, non-public information by its 
employees.

II. Summary of Comment Letters

    The Commission has received four comment letters on the proposed 
rule change, each of which expresses opposition to the proposed rule 
change.\27\ As of the date of this order instituting proceedings, the 
Exchange has not submitted a response to the comments.
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    \27\ See supra note 6.
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    A. Gastineau Letter.\28\ The commenter opposes approval of the 
proposed rule change and recommends imposition of a number of 
requirements in the event the proposed rule change and exemptive 
application are approved. As an initial matter, the commenter believes 
that the proposed selective disclosure of Fund portfolio holdings 
information to Trusted Agents trading on behalf of Confidential Account 
holders would constitute insider trading and would violate federal 
securities laws.
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    \28\ The Gastineau Letter is available at: https://www.sec.gov/comments/sr-batsbzx-2017-30/batsbzx201730-1852499-155333.pdf.
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    In addition, the commenter asserts that market makers will face 
significant impediments to successfully arbitrage the Shares and 
predicts that this will lead to the Shares trading at wider bid-ask 
spreads and more variable premiums/discounts than actively-managed ETFs 
available today. First, the commenter questions the Exchange's 
assertion that the VIIV will provide an adequate basis for ensuring a 
Fund's ongoing price value alignment and secondary market trading 
efficiency. In evaluating the Exchange's statements regarding VIIVs, 
the commenter asserts that their utility should be compared not to the 
intraday indicative values (``IIVs'') of existing ETFs but rather to 
the independently derived, real-time estimates of underlying fund value 
that ETF market makers use today to identify arbitrage opportunities 
and manage their risks (``MM IIVs''). The commenter asserts that, 
because existing actively-managed ETFs (and most index ETFs) provide 
full daily disclosure of their current portfolio, market makers of 
transparent funds have access to far better information about the 
current value of fund holdings than the proposed VIIVs would provide. 
Moreover, the commenter asserts that VIIVs will be significantly less 
precise than MM IIVs. The commenter also asserts that MM IIVs include 
significant information that would not be reflected in VIIVs, noting as 
follows:
     In calculating VIIVs, Fund securities would be valued 
based on the mid-point between the current national best bid and offer 
quotations. The commenter characterizes the bid-ask midpoint as a 
``fairly crude valuation metric'' that does not capture important 
trading information incorporated into MM IIVs, such as the current bid-
ask spread, the depth of the current order book on the bid and offer 
side of the market, and the predominance of current trading between 
bid-side and offer-side transactions.\29\
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    \29\ The commenter also states that the use of bid-ask midpoints 
can result in flawed intraday valuations for funds holding thinly-
traded stocks, and that bid-ask midpoints may reflect prices at 
which no trading is permitted.
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     VIIVs would be disseminated at least every second, while 
internal valuations used by market makers update continuously (often at 
frequencies higher than once per second) and may be reflected in MM 
IIVs with less time lag.
     The VIIV verification process would leave significant room 
for dissemination of erroneous values. In particular, a Fund's Pricing 
Verification Agent would take no action to address observed 
discrepancies in VIIV input prices until the calculated Fund values 
differ by at least 25 bps for 60 seconds. The commenter characterizes 
that disparity as ``huge,'' asserting that it would be

[[Page 43625]]

wider than the customary bid-ask spread of most domestic equity 
ETFs.\30\
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    \30\ This commenter also expresses concern that if trading in a 
Fund's Shares is frequently interrupted by trading halts, there 
could be severe damage to the Fund's ongoing liquidity and trading 
efficiency. Moreover, the commenter states that the proposal does 
not address the treatment of erroneous Fund Share trades resulting 
from faulty VIIVs.
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     The VIIV process would not address all potential intraday 
valuation errors. The commenter notes that if the constituent basket 
file for a Fund includes material inaccuracies, the VIIVs would be 
erroneous. The commenter also describes that market makers would not be 
able to verify that corporate actions are appropriately reflected in a 
Fund's VIIVs because of the non-transparent portfolio.
     The process for adjusting VIIVs in the event of trading 
halts in portfolio securities is cumbersome and likely to result in 
errors in disseminated VIIVs. The commenter states that, throughout 
this process, which may be protracted, the Fund would continue to 
disseminate VIIVs that do not reflect fair values of the halted 
security, and therefore may vary significantly from the Fund's true 
underlying value at that time. The commenter asserts that the internal 
valuation process of any existing ETF's market makers would almost 
certainly arrive at a fair estimate of a Fund's current underlying 
value far faster than the VIIV adjustment process.
    The commenter asserts that reliance on faulty VIIVs may expose 
market makers to unrecoverable losses, noting that: (1) No liability 
for the timeliness and accuracy of the VIIVs appears to rest with the 
Exchange, its agents, or the Reporting Authority; and (2) the 
circumstances under which the independent pricing sources and the 
Pricing Verification Agent are legally liable for such issues are 
limited. According to the commenter, market makers' forced reliance on 
VIIVs to determine intraday Fund valuations is a source of significant 
incremental risk for them versus making markets in existing ETFs. The 
commenter predicts that this will result in the Shares trading at wider 
bid-ask spreads and more variable premiums and discounts to NAV than 
similar existing ETFs.\31\
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    \31\ The commenter also expresses concerns with respect to VIIV-
related costs and liabilities for the Funds.
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    The commenter also criticizes the Confidential Accounts structure. 
The commenter asserts that, compared to the usual manner in which 
market makers in existing ETFs engage in arbitrage and buy and sell 
creation basket instruments, the Confidential Accounts arrangement 
exposes market makers to significant additional costs, risks, and lost 
opportunities, including:
     Less control over trade execution and trade order 
management when implementing portfolio hedging and Creation Unit 
instrument transactions, which will result in more cost and risk, and 
less profit opportunity.
     No ability for market makers to use their market knowledge 
and their positions in other securities to enhance arbitrage profits 
and minimize costs.
     Reduced incentive for third-party service providers to 
trade expeditiously and with low market impact.
     Little or no ability for market makers to monitor trading 
in Confidential Accounts to ensure best execution or to evaluate 
trading performance.
     Forced pro rata hedging, which is very often not the best 
hedge. Sub-optimal hedging results in less efficient arbitrage.
     Given the more-involved routing of trade instructions and 
trade orders that the Confidential Account structure would necessitate, 
hedging and Creation Unit instrument transactions through Confident 
Accounts will almost certainly take longer, on average, for a market 
maker to execute than similar transactions that the market maker 
executes internally. Slower executions may translate into less 
efficient arbitrage.
     Potentially significant explicit costs to establish and 
maintain Confidential Accounts.
    Additionally, the commenter questions the Exchange's statements 
regarding the efficiency and utility of statistical arbitrage. The 
commenter states that while market makers may be able to gain some 
useful information about a Fund's current composition by knowing the 
Fund's investment objective and tracking performance correlations over 
time versus a known index, the amount of portfolio information that can 
be gleaned using this approach is limited. The commenter states that, 
as a result, any portfolio hedge constructed using this information 
would be subject to meaningful basis risk, especially during times of 
market stress or volatility.
    The commenter expresses concerns regarding data security, and the 
misappropriation and misuse of a Fund's confidential portfolio 
information, in light of the dissemination of this information across a 
potentially broad network of Trusted Agents, affiliated broker-dealers, 
and other Confidential Account service providers. The commenter also 
raises concerns regarding the possibility that market participants 
could reverse-engineer the Funds' portfolio holdings, subjecting the 
Funds to the dilutive effects of front-running. The commenter asserts 
that ``it is far from a settled question that the Funds would not ever 
be susceptible to reverse engineering.''
    Moreover, the commenter raises concerns regarding the ability of 
the Funds, the authorized participants, and the non-authorized 
participant market makers, to comply with various laws, rules, and 
regulations. In addition, the commenter recommends certain limitations 
on the permitted investments of the Funds, and recommends the 
availability of certain information.
    B. Broms Letter.\32\ The commenter opposes the proposed rule 
change. The commenter asserts that the proposed selective disclosure of 
confidential Fund holdings information to Trusted Agents for trading on 
behalf of Confidential Account holders would violate federal securities 
laws. In addition, the commenter believes that the mechanism for 
ensuring secondary market trading efficiency in the Shares is 
``unreliable'' and predicts that the Shares will likely trade at 
significantly wider bid-ask spreads and/or more variable premiums/
discounts than existing ETFs. The commenter also expresses concerns 
regarding the following:
---------------------------------------------------------------------------

    \32\ The Broms Letter is available at: https://www.sec.gov/comments/sr-batsbzx-2017-30/batsbzx201730-1842158-155104.pdf.
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     The likelihood that the Shares' trading performance will 
be especially poor during periods of market stress and volatility.
     The ability to ensure the security of confidential Fund 
information disseminated to Trusted Agents, their affiliates, and 
service providers.
     Potentially significant added Fund costs and risks 
associated with calculating, verifying, and disseminating the VIIV and 
associated Fund warranties.
     The potential for frequent Share trading halts.
     The likely incidence of erroneous Share trades and the 
absence of an Exchange program to detect and remedy such trades.
     The potential for reverse engineering of a Fund's 
portfolio holdings.
     The tax risk due to the Funds' distinctive in-kind 
redemption program.
     The costs, risks, and uncertainties to broker-dealers 
serving as authorized participants and non-authorized participant 
market makers in meeting their compliance obligations with respect to 
securities traded on their behalf through Confidential Accounts.

[[Page 43626]]

    C. Angel Letter.\33\ The commenter opposes the proposal. The 
commenter believes that the opaque nature of the products and the 
inability of arbitrageurs to closely monitor execution quality will 
make arbitrage more difficult and the added costs and risks will lead 
to wider deviations of the market price from the underlying asset 
value. In addition, the commenter raises concerns that the Funds may 
fare worse than traditional ETFs during times of market disruption 
given their opacity and the complexity of the arbitrage relationship 
between the Funds and the underlying securities. The commenter also 
expresses concern that selective disclosure of portfolio information 
could raise issues under Regulation FD and that the use of Confidential 
Accounts could raise issues under Regulation SHO.
---------------------------------------------------------------------------

    \33\ The Angel Letter is available at: https://www.sec.gov/comments/sr-batsbzx-2017-30/batsbzx201730-1843677-155109.pdf.
---------------------------------------------------------------------------

    In addition, the commenter expresses the following concerns:
     It is unclear whether a firm's risk management would have 
access to the contents of Confidential Accounts. If a firm's risk 
management does not have access to such information, the firm would be 
subject to too much risk, but if the firm's risk management does have 
access, information barriers would create compliance complexities.
     Positions held in the Confidential Account not closed out 
by the end of the day would have to be settled, and the settlement 
information would be available to settlement personnel.
     The Trusted Agents would have serious compliance burdens, 
and these burdens could drive up the cost of being a Trusted Agent, 
which would drive up the cost of arbitrage. Higher costs and compliance 
risks would severely limit the number of firms willing to take on the 
burden of becoming Trusted Agents, and less competition could lead to 
higher fees and inferior service. In the event that there were many 
Trusted Agents, the likelihood of data breaches would increase.
    In addition, the commenter believes that the VIIV calculations are 
dangerously flawed because they rely on sometimes flawed bid-ask 
quotes. The commenter believes that the VIIV should instead be based on 
the last trade, and if the underlying market is closed or the 
underlying asset has not traded recently, then a reasonable fair value 
methodology should be used.\34\
---------------------------------------------------------------------------

    \34\ The commenter also states that VIIVs should be disseminated 
over the standard consolidated feeds, not specialized feeds, such 
that they are widely available to all investors.
---------------------------------------------------------------------------

    Moreover, the commenter states that the proposed Funds are very 
different from ETFs and should not be labeled or approved as ETFs.
    D. Norman Letter.\35\ The commenter opposes the proposed rule 
change. The commenter refutes the Trust's statistical analysis that 
purports to demonstrate that the Funds' portfolio compositions could 
not be reverse engineered.\36\ The commenter's analysis concludes that 
reverse engineering of a Fund's portfolio is in fact ``achievable with 
a substantial degree of accuracy.'' \37\ The commenter also asserts 
that, without knowledge of a Fund's underlying stocks, market makers 
may be unable to hedge their risks, which would result in wider and 
more persistent spreads or the market maker choosing not to make a 
market in the Shares. In addition, the commenter questions the 
sufficiency of disseminating the VIIV at one-second intervals, given 
that high frequency trading takes place in milliseconds, and raises 
concerns about potential systems failures that may disrupt the 
dissemination of VIIV. Finally, the commenter believes that selective 
disclosure of portfolio information to Trusted Agents would violate 
federal securities laws, and expresses concern regarding the security 
of confidential portfolio information.
---------------------------------------------------------------------------

    \35\ The Norman Letter is available at: https://www.sec.gov/comments/sr-batsbzx-2017-30/batsbzx201730-2161995-157800.pdf.
    \36\ See Third Amended and Restated Application for an Order for 
exemptions from various provisions of the 1940 Act and rules 
thereunder (File No. 812-14405), dated May 2, 2017, at Exhibit E 
(``Additional Research on the Ability to Reverse Engineer the 
Proposed Precidian ETF,'' by Ricky Alyn Cooper, Ph.D., dated August 
2015).
    \37\ See Norman Letter, Appendix One (``The Reverse Engineering 
of Portfolio Compositions,'' by Dr. Anthony Hayter, dated July 17, 
2017).
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III. Proceedings To Determine Whether To Approve or Disapprove SR-
BatsBZX-2017-30 and Grounds for Disapproval Under Consideration

    The Commission is instituting proceedings pursuant to Section 
19(b)(2)(B) of the Act \38\ 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. Rather, as described below, the 
Commission seeks and encourages interested persons to provide comments 
on the proposed rule change.
---------------------------------------------------------------------------

    \38\ 15 U.S.C. 78s(b)(2)(B).
---------------------------------------------------------------------------

    Pursuant to Section 19(b)(2)(B) of the Act,\39\ the Commission is 
providing notice of the grounds for disapproval under consideration. 
The Commission is instituting proceedings to allow for additional 
analysis of the proposed rule change's consistency 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, . . . 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.'' \40\
---------------------------------------------------------------------------

    \39\ Id.
    \40\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

IV. Procedure: Request for Written 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 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.\41\
---------------------------------------------------------------------------

    \41\ Section 19(b)(2) of the Act, as amended by the Securities 
Acts 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 Acts 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 October 10, 2017. Any person who wishes to file a 
rebuttal to any other person's submission must file that rebuttal by 
October 23, 2017.
    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,\42\ in addition to any other

[[Page 43627]]

comments they may wish to submit about the proposed rule change. 
Specifically, the Commission seeks comment on the statements of the 
Exchange contained in the Notice, the issues raised by the commenters, 
and any other issues raised by the proposed rule change. In addition, 
the Commission seeks comment on whether the trading of the Shares would 
be consistent with the maintenance of fair and orderly markets. In this 
regard, the Commission specifically seeks comment regarding market 
makers' ability to make markets in the Shares and the sufficiency of 
the proposed VIIV as pricing information to market participants. 
Further, the Commission solicits comments on whether the selective 
disclosure of portfolio holdings to a Trusted Agent, as well as the 
non-transparent structure of the Funds, could result in any information 
asymmetry that would be inconsistent with the Act or other federal 
securities laws or rules and regulations thereunder.
---------------------------------------------------------------------------

    \42\ See supra note 3.
---------------------------------------------------------------------------

    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-BatsBZX-2017-30 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-BatsBZX-2017-30. 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-BatsBZX-2017-30 and should 
be submitted on or before October 10, 2017. Rebuttal comments should be 
submitted by October 23, 2017.
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    \43\ 17 CFR 200.30-3(a)(57).

For the Commission, by the Division of Trading and Markets, pursuant 
to delegated authority.\43\
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017-19808 Filed 9-15-17; 8:45 am]
 BILLING CODE 8011-01-P


