Cboe Proposes Rule Changes Related to ETF Share Class Relief

On April 15, 2024, Cboe BZX Exchange, Inc. (“Cboe”), a national securities exchange, filed an application (the “Application”) pursuant to Rule 19b-4 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), with the Securities and Exchange Commission (“SEC”) proposing amendments to Cboe Rule 14.11(l).¹ Cboe Rule 14.11(l) currently sets forth the “generic” listing standards applicable to the listing and/or trading on Cboe of exchange-traded funds (“ETFs”) that operate in reliance on Rule 6c-11 under the Investment Company Act of 1940, as amended (the “1940 Act”).²

If approved by the SEC, the proposed amendments to Cboe Rule 14.11(l) would establish a path and set of conditions for Cboe to approve the “generic” listing and/or trading of classes of exchange-traded shares (“ETF Class Shares”) issued by open-end investment companies that also offer non-exchange traded share classes (“Mutual Fund Class Shares”) in reliance on exemptive relief granted by the SEC from certain sections of the 1940 Act and the rules thereunder (“ETF Share Class Relief”).

ETF Share Class Relief

In order to offer both ETF Class Shares and Mutual Fund Class Shares, open-end investment companies require exemptive relief from Sections 18(f)(1) and 18(i) of the 1940 Act, as well as from the same sections and rules from which Rule 6c-11 provides relief to ETFs eligible to rely on that exemptive rule.

Since February 2023, eight applications have been filed with the SEC for ETF Share Class Relief.³ The SEC has not yet granted any exemptive orders with respect to such applications and there is no guarantee that the SEC will grant such exemptive orders.⁴

A catalyst for the filing of these applications was the expiration on May 16, 2023 of the patent obtained by The Vanguard Group, Inc. (“Vanguard”) on the method for implementing an open-end investment company that offers ETF Class Shares and Mutual Fund Class Shares. Currently, Vanguard is the only recipient of ETF Share Class Relief, having been granted a series of exemptive orders by the SEC applicable to index-based investment companies between 2000 and 2007.⁵

Cboe’s Application

The Application sets forth proposed amendments to Cboe Rule 14.11(l) that would, if approved by the SEC, establish a path and set of conditions for Cboe to approve, pursuant to Rule 19b-4(e) under the Exchange Act, the listing and/or trading on Cboe (including pursuant to unlisted trading privileges) of ETF Class Shares issued by open-end investment companies that also offer Mutual Fund Class Shares if such investment companies have been granted ETF Share Class Relief. In addition, under the proposed amendments:

• ETF Class Shares listed and/or trading on Cboe would be required, as a condition of their initial and continued listing, to satisfy the requirements of their ETF Share Class Relief as well as certain other requirements set forth in Cboe Rule 14.11(l); and
• If Cboe becomes aware that the open-end investment company issuing ETF Class Shares listed and/or trading on Cboe is no longer eligible to operate in reliance on its ETF Share Class Relief, Cboe may suspend the trading of or commence delisting proceedings for such ETF Class Shares.

Cboe explains in the Application that it proposed the amendments to prevent any unnecessary delay in listing ETF Share Classes if and when the SEC grants ETF Share Class Relief. In Cboe’s view, ETF Share Class Relief and the proposed amendments in its Application would benefit investors.

Observations

Absent the amendments proposed by Cboe, the path for listing ETF Class Shares for trading would likely be less streamlined and could potentially involve either (i) ETF Class Shares having to rely on existing “generic” listing standards for index-based and managed fund shares (currently set forth in Cboe Rules 14.11(c) and (i), respectively) that impose quantitative and qualitative requirements or (ii) Cboe having to file individual applications pursuant to Rule 19b-4 requesting rule amendments to list ETF Class Shares on the exchange. The listing process involved with these alternatives to Cboe’s proposed amendments may be, in the case of individual applications pursuant to Rule 19b-4, lengthy and uncertain and, in the case of relying on existing “generic” listing standards, relatively complex and difficult to comply with, which could deter some firms from stepping into or expanding their presence in the growing ETF market.

Cboe’s proposed amendments, if approved, would streamline the exchange-listing process for ETF Class Shares to match the process in place for shares issued by ETFs relying on Rule 6c-11 and add certainty and efficiency to the process for launching open-end investment companies with ETF Class Shares and Mutual Fund Class Shares.

That Cboe has pursued SEC approval of the new standards at this stage suggests that it seeks to begin a dialogue with the SEC staff on the standards that should apply to investment companies offering both ETF Class Shares and Mutual Fund Class Shares and, hopefully, to limit the delay and cost of listing such ETF Class Shares in the event ETF Share Class Relief is granted by the SEC.

Next Steps

Once a notice of the Application is available on the SEC’s website and on the Federal Register, it is expected that interested persons will have an opportunity to submit comments on the Application to the SEC. Within 45 days of the date of publication of such notice in the Federal Register, or within such longer period (up to 90 days, as the SEC may designate if it finds such longer period to be appropriate or as to which Cboe consents), the SEC will by order approve or disapprove the proposed rule change or institute proceedings to determine whether the proposed rule change should be disapproved. Section 19(b)(2) of the Exchange Act requires that, after initiating disapproval proceedings, the SEC issue an order approving or disapproving the proposed rule change within 180 days of the publication date of the notice of the proposed rule change. The SEC may extend the period for issuing such order by not more than 60 days if the SEC determines that a longer period is appropriate and publishes the reasons for such determination.

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If you are interested in discussing ETF Share Class Relief or for further information about how the issues described in this Alert may impact your interests, please contact your regular Ropes & Gray contact.