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SEC Approves Paired Class Shares Rule Change Over Dissent

The SEC recently approved a rule change for NASDAQ that would allow for the listing of “paired class shares.” Funds using the new product would offer two classes of shares, one of which would be positively correlated (“up shares”) and one of which would be negatively correlated (“down shares”) to an underlying benchmark. The shares for the funds would be issued and redeemed by a trust in equal quantities of up and down shares by/to authorized participants. Additionally, the fund would feature several types of distributions. “Regular” distributions are scheduled, “special” distributions would occur when the underlying benchmark changes more than a specified amount in comparison to the previous distribution, and “corrective” distributions would automatically be triggered when the market price of either up or down shares deviates a specified amount from the underlying price for a specified period of time.

Commissioner Kara Stein dissented, arguing that the Commission had not sufficiently studied the impact of such a product. She noted that the Commission only received six letters in response to its request for comment, five of which were from commenters either affiliated with the issuer or with an associated economic interest. She next highlighted the quick “implosion” of a similar product that launched in 2006, and shared her reservations that any proposed features of the current product would resolve the issues encountered by the earlier iteration. Stein also raised suitability issues noting that the complexity of the distributions meant that positions must be monitored constantly and that “[i]t is difficult to envision a scenario where even the most sophisticated investors are not exposed to extreme risks.” Moreover, she argued that the comment letters from interested parties appear to contemplate retail ownership and that sophisticated investors would likely avoid the product due to tax implications and their ability to obtain similar exposure elsewhere. Lastly, Stein questioned how the products would fare in times of market stress, comparing them to “countless complex, opaque products” that collapsed. Stein suggested that the Commission err on the side of denying rule changes that would allow for complex products until the SEC was comfortable with the products. She also indicated her belief that the impending statutory deadline on the rule change application may have meant that the Commission “rubberstamped opaque, risky products masquerading as financial innovation.”