[Federal Register Volume 86, Number 2 (Tuesday, January 5, 2021)]
[Notices]
[Pages 332-335]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-29139]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-90819; File No. SR-CboeBZX-2020-036]


Self-Regulatory Organizations; Cboe BZX Exchange, Inc.; Order 
Disapproving a Proposed Rule Change Relating to Rule 14.11, Other 
Securities, To Modify a Continued Listing Criterion for Certain 
Exchange-Traded Products

December 29, 2020.

I. Introduction

    On April 29, 2020, Cboe BZX Exchange, Inc. (``Exchange'' or 
``BZX'') filed with the Securities and Exchange Commission 
(``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Exchange Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to amend one of the continued 
listing requirements relating to certain exchange-traded products 
(``ETPs'') under BZX Rule 14.11. The proposed rule change was published 
for comment in the Federal Register on May 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. 88795 (May 1, 2020), 
85 FR 27254 (``Notice'').
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    On June 16, 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\ On August 4, 2020, the Commission instituted 
proceedings to determine whether to approve or disapprove the proposed 
rule change.\6\ On October 28, 2020, the Commission designated a longer 
period

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for Commission action on the proposed rule change.\7\ The Commission 
has received two comment letters on the proposed rule change.\8\
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    \4\ 15 U.S.C. 78s(b)(2).
    \5\ See Securities Exchange Act Release No. 89076 (June 16, 
2020), 85 FR 37488 (June 22, 2020). The Commission designated August 
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\ See Securities Exchange Act Release No. 89472 (Aug. 4, 
2020), 85 FR 48318 (Aug. 20, 2020) (``OIP'').
    \7\ See Securities Exchange Act Release No. 90277 (Oct. 28, 
2020), 85 FR 69675 (Nov. 3, 2020).
    \8\ Comments on the proposed rule change can be found on the 
Commission's website at: https://www.sec.gov/comments/sr-cboebzx-2020-036/srcboebzx2020036.htm.
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    This order disapproves the proposed rule change because, as 
discussed below, BZX has not met its burden under the Exchange Act and 
the Commission's Rules of Practice to demonstrate that its proposal is 
consistent with the requirements of Exchange Act Section 6(b)(5), and, 
in particular, the requirement that the rules of a national securities 
exchange be designed ``to prevent fraudulent and manipulative acts and 
practices'' and ``to protect investors and the public interest.'' \9\
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    \9\ 15 U.S.C. 78f(b)(5).
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II. Description of the Proposal

    As described in detail in the Notice and OIP, a continued listing 
requirement under BZX Rule 14.11 for certain ETPs \10\ currently 
provides that, following the initial 12-month period after commencement 
of trading on the Exchange, the Exchange will consider the suspension 
of trading in, and will commence delisting proceedings for, shares of 
such ETPs for which there are fewer than 50 beneficial holders for 30 
or more consecutive trading days (``Beneficial Holders Rule''). The 
Exchange is proposing to change the date after which an ETP must have 
at least 50 beneficial holders or be subject to delisting proceedings 
under the Beneficial Holders Rule (``Non-Compliance Period''). 
Specifically, the Exchange seeks to extend the Non-Compliance Period in 
the Beneficial Holders Rule from 12 months after commencement of 
trading on the Exchange to 36 months after commencement of trading on 
the Exchange.
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    \10\ For purposes of the proposal, the term ``ETP'' means 
securities listed pursuant to BZX Rule 14.11(c) (Index Fund Shares), 
BZX Rule 14.11(i) (Managed Fund Shares), and BZX Rule 14.11(l) 
(Exchange-Traded Fund Shares (``ETF Shares'')).
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    The Exchange asserts that it would be appropriate to increase the 
Non-Compliance Period from 12 months to 36 months because: (1) It would 
bring the rule more in line with the life cycle of an ETP; (2) the 
economic and competitive structures in place in the ETP ecosystem 
naturally incentivize issuers to de-list products rather than 
continuing to list products that do not garner investor interest; and 
(3) extending the period from 12 to 36 months will not meaningfully 
impact the manipulation concerns that the Beneficial Holders Rule is 
intended to address.
    According to the Exchange, the ETP space is more competitive than 
it has ever been, with more than 2000 ETPs listed on exchanges. As a 
result, distribution platforms have become more restrictive about the 
ETPs they will allow on their systems, often requiring a minimum track 
record (e.g., twelve months) and a minimum level of assets under 
management (e.g., $100 million). Many larger entities also require a 
one-year track record before they will invest in an ETP. In the 
Exchange's view, this has slowed the growth cycle of the average ETP, 
with the result that the Exchange has seen a significant number of 
deficiencies with respect to the Beneficial Holders Rule over the last 
several years. Specifically, the Exchange states that it has issued 
deficiency notifications to 34 ETPs for non-compliance with the 
Beneficial Holders Rule in the last five years, 27 of which ultimately 
were able to achieve compliance while going through the delisting 
process.
    In addition, the Exchange believes that the economic and 
competitive structures in place in the ETP ecosystem naturally 
incentivize issuers to de-list products with insufficient investor 
interest, and that the Beneficial Holders Rule has resulted in the 
forced termination of ETPs that issuers believed were still 
economically viable. The Exchange states that there are significant 
costs associated with the launch and continued operation of an ETP, and 
notes that the Exchange has had 69 products voluntarily delist in the 
last two years. The Exchange also questions whether the number of 
beneficial holders is a meaningful measure of market interest in an 
ETP, and believes that an ETP issuer is incentivized to have as many 
beneficial holders as possible.
    The Exchange states that the proposal ``does not create any 
significant change in the risk of manipulation for ETPs listed on the 
Exchange.'' The Exchange ``does not believe there is anything 
particularly important about the 50th Beneficial Holder that reduces 
the manipulation risk associated with an ETP as compared to the 49th, 
nor is there any manipulation concern that arises on the 366th day 
after an ETP began trading on the Exchange that didn't otherwise exist 
on the 1st, 2nd, or 365th day.'' \11\ The Exchange also states that it 
has in place a robust surveillance program for ETPs that it believes is 
sufficient to deter and detect manipulation and other violative 
activity, and that the Exchange (or the Financial Industry Regulatory 
Authority on its behalf) communicates as needed with other members of 
the Intermarket Surveillance Group. The Exchange believes that ``these 
robust surveillance procedures will further act to mitigate concerns 
that arise from extending the compliance period for the Beneficial 
Holders [Rule] from 12 months to 36 months.'' \12\ Lastly, the Exchange 
takes the position that other continued listing standards (e.g., with 
respect to the diversity, liquidity and size of an ETP's holdings or 
reference assets) ``are generally sufficient to mitigate manipulation 
concerns associated with the applicable ETP.'' \13\
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    \11\ See Notice, supra note 3, 85 FR at 27256.
    \12\ See id.
    \13\ See id.
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    The Commission received two comments in support of the 
proposal.\14\ One commenter states that the beneficial owner 
requirement disproportionately punishes smaller companies without the 
resources to pay for aggressive distribution, and disincentivizes 
issuers from launching funds that can prove themselves purely by 
investment merit over the long term,\15\ although the commenter 
provides no data to support that assertion. This commenter believes 
that the purpose of the beneficial holder minimum likely is to enforce 
some sort of minimum liquidity, and accordingly suggests alternative 
liquidity measures such as the quality of secondary markets (e.g., 
spreads and depth of book), the liquidity of the underlying basket, and 
the number of potential liquidity providers. In this commenter's view, 
increasing the time period to achieve the minimum number of beneficial 
holders is a positive step, but eliminating the requirement altogether 
``would be far more purposeful.'' \16\
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    \14\ See Letter to Secretary, Commission, from S Phil Bak, 
Founder & CEO, SecLenX (May 13, 2020) (``SecLenX Letter''); and 
letter to Secretary, Commission, from Timothy W. Cameron, Asset 
Management Group--Head, and Lindsey Weber Keljo, Asset Management 
Group--Managing Director and Associate General Counsel, SIFMA AMG 
(Dec. 18, 2020) (``SIFMA Letter'').
    \15\ See SecLenX Letter, supra note 14, at 1.
    \16\ Id. at 2.
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    Another commenter states that the Beneficial Holders Rule ``does 
not appear to provide any meaningful investor-protection benefits.'' 
\17\ Specifically, this commenter expresses the view that the liquidity 
of shares of an exchange-traded fund (``ETF'') is primarily a function 
of the liquidity of the ETF's underlying securities, that the 
marketplace taps into this liquidity

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through the creation and redemption and arbitrage processes, and that 
this mitigates potential price manipulation concerns.\18\ In addition, 
the commenter believes that the enhanced disclosure requirements of 
Rule 6c-11 under the Investment Company Act of 1940,\19\ including 
those relating to an ETF's portfolio holdings and when an ETF's premium 
or discount exceeds 2% for more than seven consecutive days, will help 
facilitate effective arbitrage. The commenter further states that it is 
appropriate to increase the period of time for an ETF to comply with 
the applicable beneficial holders requirement because it may take 
several years for an ETF to gain significant market acceptance and to 
gather assets.\20\ This commenter believes that many investment 
platforms require a three-year track record before making investment 
products available to clients, and the proposal would better align the 
rule with the lifecycle of these ETFs.\21\ This commenter concludes 
from a survey conducted of its members that ETF sponsors often make 
decisions about whether to delist and terminate funds with low levels 
of assets after approximately three years, and that the level of 
assets, number of shareholders, and average daily trading volume often 
improved after three years.\22\
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    \17\ SIFMA Letter, supra note 14, at 3.
    \18\ See id.
    \19\ See id. at 3-4.
    \20\ See id. at 4.
    \21\ See id. The commenter also states that the proposal could 
put newer and smaller sponsors at an unnecessary disadvantage to 
larger sponsors having the enterprise-wide scale and distribution 
reach to gather assets in the months after launch. See id.
    \22\ See id. The commenter also states that data from one large 
ETF sponsor revealed that liquidity tends to build between 12 and 36 
months after launch, and that: (a) The median shareholder count 
increased over ten-fold between 12 and 36 months after launch; (b) 
secondary market liquidity saw a similar growth trajectory between 
12 and 36 months after launch; and (c) median spreads tightened by 3 
basis points between 12 and 36 months after launch. See id., n.10.
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III. Discussion and Commission Findings

    The Commission must consider whether BZX's proposal is consistent 
with Section 6(b)(5) of the Exchange Act, which requires, in relevant 
part, that the rules of a national securities exchange be designed ``to 
prevent fraudulent and manipulative acts and practices'' and ``to 
protect investors and the public interest.'' \23\ 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.'' \24\
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    \23\ 15 U.S.C. 78f(b)(5). Pursuant to Section 19(b)(2) of the 
Exchange Act, 15 U.S.C. 78s(b)(2), the Commission must disapprove a 
proposed rule change filed by a national securities exchange if it 
does not find that the proposed rule change is consistent with the 
applicable requirements of the Exchange Act. Exchange Act Section 
6(b)(5) states that an exchange shall not be registered as a 
national securities exchange unless the Commission determines that 
``[t]he rules of the exchange are designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, to foster cooperation and coordination with 
persons engaged in regulating, clearing, settling, processing 
information with respect to, and facilitating transactions in 
securities, 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, or to regulate by virtue of any authority conferred by 
this title matters not related to the purposes of this title or the 
administration of the exchange.'' 15 U.S.C. 78(f)(b)(5).
    \24\ Rule 700(b)(3), Commission Rules of Practice, 17 CFR 
201.700(b)(3).
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    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,\25\ 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.\26\ Moreover, ``unquestioning reliance'' on an SRO's 
representations in a proposed rule change is not sufficient to justify 
Commission approval of a proposed rule change.\27\
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    \25\ See id.
    \26\ See id.
    \27\ Susquehanna Int'l Group, LLP v. Securities and Exchange 
Commission, 866 F.3d 442, 447 (D.C. Cir. 2017).
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    The Commission has consistently recognized the importance of the 
minimum number of holders and other similar requirements, stating that 
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.\28\ As stated by the Exchange, the minimum number of holders 
requirement also helps to ensure that trading in exchange-listed 
securities is not susceptible to manipulation.\29\
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    \28\ 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).
    \29\ See Notice, supra note 3, 85 FR at 27255.
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    As discussed above, the Exchange is proposing to increase the Non-
Compliance Period from 12 months to 36 months, thereby extending by two 
years the length of time during which an ETP listed on the Exchange 
would have no requirement to have a minimum number of beneficial 
holders. In support of its proposal, the Exchange emphasizes that some 
ETPs have had difficulty complying with the Beneficial Holders Rule. 
The Exchange indicates that non-compliance with the Beneficial Holders 
Rule is increasing because the ETP market has become so competitive, 
and there are so many of them, that it can be difficult to acquire the 
requisite number of beneficial holders within the existing Non-
Compliance Period. The Exchange also believes that the existing 
Beneficial Holders Rule forces the delisting of ETPs that may still be 
economically viable. The Exchange takes the position that the 
manipulation risk would not be materially greater if an ETP had 49 
beneficial holders as opposed to 50, and that no new manipulation 
concerns would arise with a longer Non-Compliance Period than a shorter 
one. The Exchange also asserts that existing surveillances and other 
listing standards are sufficient to mitigate manipulation concerns.\30\
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    \30\ The commenter suggests eliminating the requirement 
altogether, but does not address how increasing the time period to 
achieve the minimum number of beneficial holders is consistent with 
any provision of the Exchange Act.
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    The Exchange takes the position that the highly-competitive ETP 
market has made compliance with the Beneficial Holders Rule difficult 
and has led to the delisting of ETPs that may be economically viable. 
However, the Exchange does not sufficiently support its assertion that 
compliance with the Beneficial Holders Rule is especially difficult for 
ETPs or that any such compliance difficulties have led to the delisting 
of economically viable ETPs. For example, while the Exchange states 
that 22 ETP issues voluntarily delisted within 12 months of commencing 
trading on the Exchange, the Exchange acknowledges that it cannot 
attribute any of those voluntary delistings to non-compliance with the 
Beneficial Holders Rule.\31\
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    \31\ See id. at 27255, n.6.
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    In addition, the Exchange does not sufficiently explain why any 
such

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compliance difficulties justify tripling the Non-Compliance Period for 
this core quantitative listing standard from one year to three years, 
and permitting ETPs to trade on the Exchange for an additional two 
years without the protections, described above, that the Beneficial 
Holders Rule was designed to provide. For example, the Exchange states 
that no new manipulation concerns would arise with a longer Non-
Compliance Period than a shorter one, but does not address why tripling 
the period during which the same regulatory risks posed by a Non-
Compliance Period would be present is consistent with the Exchange Act. 
As discussed above, the Beneficial Holders Rule and other minimum 
number of holders requirements are important to ensure that trading in 
exchange listed securities is fair and orderly and not susceptible to 
manipulation, and the Exchange does not explain why it is consistent 
with the Exchange Act to permit ETPs to trade for two additional years 
without any of the protections of the Beneficial Holders Rule. The 
Exchange also states that the manipulation risk is not materially 
greater with 49 beneficial holders than with 50, but there is no 
minimum number of beneficial holders during the Non-Compliance Period, 
and the Exchange does not sufficiently address why the manipulation and 
other regulatory risks to fair and orderly markets, investor protection 
and the public interest would not be materially greater with a number 
of beneficial holders that is substantially smaller than 49 (e.g., 10 
or 20).
    Finally, while the Exchange asserts that existing surveillances and 
other listing standards are sufficient to mitigate manipulation 
concerns, it does not offer any explanation of the basis for that view 
or provide any supporting information or evidence to support its 
conclusion. Notably, although the Exchange acknowledges that the 
Beneficial Holders Rule helps to ensure that trading in exchange-listed 
securities is not susceptible to manipulation, the Exchange does not 
explain how any of its specific existing surveillances or other listing 
requirements effectively address, in the absence of the Beneficial 
Holders Rule, those manipulation concerns and other regulatory risks to 
fair and orderly markets, investor protection and the public 
interest.\32\ Accordingly, the Commission is unable to assess whether 
the Exchange's assertion has merit.
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    \32\ The Exchange states that its surveillances focus on 
detecting securities trading outside of their normal patterns, 
followed by surveillance analysis and investigations, where 
appropriate, to review the behavior of all relevant parties for all 
relevant trading violations. The Exchange also states that it or the 
Financial Industry Regulatory Authority, on behalf of the Exchange, 
or both, communicate as needed regarding ETP trading with other 
markets and the Intermarket Surveillance Group member entities, and 
may obtain trading information in ETPs from such markets and other 
entities.
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    The Commission identified all of these concerns in the OIP, but the 
Exchange has not responded or provided additional data addressing these 
concerns.\33\ As stated above, 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.'' \34\ 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.\35\ The Commission concludes that, 
because BZX has not demonstrated that its proposal is designed to 
prevent fraudulent and manipulative acts and practices or to protect 
investors and the public interest, the Exchange has not met its burden 
to demonstrate that its proposal is consistent with Section 6(b)(5) of 
the Exchange Act.\36\ For this reason, the Commission must disapprove 
the proposal.
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    \33\ While one commenter suggests alternative liquidity 
standards (see SecLenX Letter, supra note 14), this commenter does 
not explain them with any specificity or explain how they would 
satisfy the requirements of the Exchange Act, and, in any event, the 
Exchange has not proposed them. The other commenter asserts that the 
creation and redemption processes, which tap into the liquidity of 
the underlying holdings, coupled with the enhanced disclosures 
mandated under Rule 6c-11 under the Investment Company Act of 1940, 
mitigate manipulation concerns. See SIFMA Letter, supra note 14, at 
3. However, neither the Exchange nor that commenter explains why 
arbitrage opportunities would sufficiently mitigate manipulation 
concerns for the full range of ETPs, including ETPs overlying a 
portfolio of instruments that are themselves illiquid, or where 
market interest in the ETP is not sufficient to attract effective 
arbitrage activity. While this commenter asserts that certain 
disclosures under Rule 6c-11 under the Investment Company Act of 
1940 provide investors with additional insight into the 
effectiveness of an ETF's arbitrage (see SIFMA Letter, supra note 
14, at 3-4), neither the Exchange nor the commenter explains how 
such disclosures might prevent manipulation.
    \34\ Rule 700(b)(3), Commission Rules of Practice, 17 CFR 
201.700(b)(3).
    \35\ See id.
    \36\ In disapproving this proposed rule change, the Commission 
has considered the proposed rule's impact on efficiency, 
competition, and capital formation. See 15 U.S.C. 78c(f). Although 
one commenter (see SecLenX Letter, supra note 14) asserts that the 
current Beneficial Holders Rule disproportionately punishes smaller 
companies and disincentivizes issuers from launching funds that can 
prove their investment merit over the long term, no data is 
provided--by the commenter or the Exchange--to support these 
conclusions. Similarly, although the other commenter (see SIFMA 
Letter, supra note 14, at 4) asserts that the current Beneficial 
Holders Rule puts newer and smaller sponsors at an unnecessary 
disadvantage to larger sponsors having the enterprise-wide scale and 
distribution reach to gather assets in the months after launch, 
neither the commenter nor the Exchange has provided data to support 
this conclusion.
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IV. Conclusion

    For the reasons set forth above, the Commission does not find, 
pursuant to Section 19(b)(2) of the Exchange Act, that the proposed 
rule change is consistent with the requirements of the Exchange Act and 
the rules and regulations thereunder applicable to a national 
securities exchange, and in particular, with Section 6(b)(5) of the 
Exchange Act.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Exchange Act, that proposed rule change SR-CboeBZX-2020-036 is 
disapproved.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\37\
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    \37\ 17 CFR 200.30-3(a)(12).
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J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-29139 Filed 1-4-21; 8:45 am]
BILLING CODE 8011-01-P


