Dissenting Statement Regarding the Commission’s Order Approving a Proposed Rule Change to Adopt New Rule 5713 and List Paired Class Shares Issued by AccuShares® Commodities Trust I
Commissioner Kara M. Stein
Feb. 23, 2015
I dissent from the decision of the majority of the Commission approving NASDAQ Rule 5713, which adopted new listing standards for “Paired Class Shares” in order to list and trade such shares issued by seven new Accushares exchange-traded funds (ETFs) on a national exchange. The approval of these novel and complex products is premature given the substantial concerns about its operations and impact on investors.
In order to approve the rule filing, the Commission must find that it is consistent with the Exchange Act and the rules and regulations thereunder. Among these requirements are those set forth in Section 6(b)(5), which provides that the rules of an exchange must be designed “in general, to protect investors and the public interest.” Unfortunately, the record and analysis presented to date support neither investor protection nor the public interest.
On September 18, 2014, the Commission published the proposed rule change for public comment. The Commission received six comment letters on this proposed rule change – five of which were from commenters affiliated with Accushares or with an economic interest in the funds’ listing. The sole unaffiliated commenter noted that, because of the unusual design of the funds, the arbitrage mechanism essential for these types of products simply cannot function and that the result of these products will be sophisticated entities taking advantage of less sophisticated users.
The products are complex and seek to test an unproven arbitrage mechanism on the market, which has the potential of harming investors. The strategies and operations of these funds are very difficult to explain in plain English, but I will do my best. The funds appear to issue and redeem shares of opposing classes, i.e. Up Shares and Down Shares. The values of each class in theory move in opposite directions depending on the variance in a fund’s underlying benchmark or reference index, such as the S&P GSCI Brent Crude Oil Spot index or the CBOE Volatility index or “VIX.” Up Shares would be correlated positively with the reference index and Down Shares would be negatively correlated. The funds do not own any actual securities, just cash and cash-like instruments.
My concerns are not purely theoretical. The historical record raises significant concerns about the way such products interact with the market. A similarly structured product of paired up and down shares was launched for listing and trading in 2006, and promptly imploded. Has Accushares solved the problem exposed with this product, to the extent it is even solvable? I certainly hope so, but the review process has neither given me comfort that this is the case nor has it alleviated my concerns about investor protection. Accushares believes it has solved the problem via an “innovative” maze of distributions (regular, special, and corrective) that apparently will keep these products from collapsing.
Putting aside whether this distribution mechanism will function as advertised (which appears up for debate), the design of the products with their distributions and concurrent resetting of the value of the Up and Down Shares demands their investors be hyper-vigilant. In essence, investors must track positions and monitor constantly the value of the shares. When the distributions are made, the funds reset the value of both the Up Shares and Down Shares, so an investor may need to reinvest to maintain the desired exposure or sell shares of an undesired share class to re-establish a market position. It is difficult to envision a scenario where even the most sophisticated investors are not exposed to extreme risks.
Disclosure in the prospectus indicates that the funds may not be suitable for all investors and that investments may require active management and monitoring. I take little comfort that this disclosure or suitability concerns will prevent these funds from making their way into the hands of retail investors. Indeed, contrary to any disclosure in the prospectus, the comment letters from those associated with Accushares, or with an economic interest in its listing, explicitly contemplate retail investors owning these products. FINRA recently has brought numerous cases against brokers for pushing leveraged and inverse exchange-traded ETFs on customers for whom such investments were clearly not suitable. My concerns are compounded by the fact that these products appear unlikely to appeal to sophisticated institutional investors given the unfavorable tax ramifications and the ability of such investors to obtain these exposures more efficiently elsewhere.
My concerns are not limited to retail investors. There appears to be little consideration of the impact that these products could have on markets generally, especially if they gain in popularity. During the financial crisis, we witnessed countless complex, opaque products like this collapse. Regulators had little sense of the systemic risks present in those products or the ways in which parties were interconnected through these instruments. It is incumbent on the Commission to keep the lessons of the financial crisis and the 2010 Flash Crash (which had a significant ETF component) in mind, and understand and carefully consider these types of products before they enter the markets. Unfortunately, as I have stated before, these issues have received little attention during the review process.
Quite simply, we need a more thoughtful, transparent, and fulsome review process for these types of ETFs, even if it means disapproving proposed rule changes until we get comfortable with particularly risky and complex products. A more rigorous review process is especially needed here because today’s approval now clears the path for copycat products to enter the market.
The Commission should not approve rule changes for opaque exchange-traded products simply because there is an automatic, statutory deadline hanging over its head. NASDAQ, the self-regulatory organization (SRO), is always able to modify or re-propose a rule change at a later date when the Commission is confident that the products have been fully vetted and understood. Approving ill-considered proposals simply because of a time deadline may well be a violation of our obligation to ensure that the exchange’s rules are designed to protect investors and the public interest.
Additionally, before proceeding with approvals for novel products, I reiterate that we would benefit immensely from public input on these issues, especially regarding broader market and systemic impacts of novel exchange-traded products. The Commission should be taking more affirmative steps to obtain public comment and academic analysis in this space.
As noted above, to approve this rule change, the Commission must satisfy itself that it is consistent with the protection of investors and the public interest. By approving today’s rule change, a majority of the Commission has ignored what I believe are serious concerns that go to the heart of our obligation to protect investors and the public interest and instead rubberstamped opaque, risky products masquerading as financial innovation. For all of these reasons, I must dissent.
 15 U.S.C. 78s(b)(2)(C).
 15 U.S.C. 78f(b)(5) (emphasis added).
 See Comment Letter of Mark Kassner, Esq., on behalf of anonymous client (Oct. 13, 2014), available at http://www.sec.gov/comments/sr-nasdaq-2014-065/nasdaq2014065-4.pdf.
 See Greg Newton, “Crude ETF Critics and the Macroshares Affair,” Seeking Alpha (Jan. 17, 2007), available at http://seekingalpha.com/article/24387-crude-etf-critics-and-the-macroshares-affair.
 See Form S-1, Registration Statement under the Securities Act of 1933 for Accushares Commodities Trust I, available at http://www.sec.gov/Archives/edgar/data/1580167/000089109214002129/e57915s1.htm.
 See Comment Letter of Jack Fonss, CEO and Co-Founder of AccuShares Investment Management LLC (Sept. 25, 2014), available at http://www.sec.gov/comments/sr-nasdaq-2014-065/nasdaq2014065-1.pdf; See Comment Letter of Jurij Trypupenko, Associate General Counsel of NASDAQ (October 28, 2014), available at http://www.sec.gov/comments/sr-nasdaq-2014-065/nasdaq2014065-6.pdf.
 See Suzanne Barlyn and Jessica Toonkel, “FINRA to bring cases over leveraged, inverse ETFs,” Reuters (April 18, 2012), available at http://www.reuters.com/article/2012/04/18/finra-exchange-idUSL2E8FI9XH20120418.
 See, e.g., “Understanding the “Flash Crash”: What Happened, Why ETFs Were Affected, and How to Reduce the Risk of Another,” BlackRock ViewPoint, Nov. 2010, available at www.blackrock.com/corporate/en-us/literature/whitepaper/understanding-the-flash-crash-nov-2010.pdf.
 NASDAQ’s filing of the rule change proposal started a clock whereby the Commission must act within a certain number of days to approve or disapprove of the proposal. If the Commission takes no action, the rule change is automatically approved.
 See Commissioner Kara M. Stein, Keynote Address at Columbia Law School Conference on Current Issues in Securities Regulation: The ‘Hot’ Topics, available at https://www.sec.gov/News/Speech/Detail/Speech/1370543515397.