In an effort to reduce the influence of the Apple effect, the NASDAQ OMX Group has announced a ‘Special Rebalance’ to its NASDAQ-100 Index (NDX). The April 5 announcement has sent many investment managers, especially passive ones, into a tizzy. Apple had grown to 21 percent of the index on its burgeoning success since 1998. At that time, its stock was $10 a share. Now it stands at $338 a share.NASDAQ wants to reduce the Job’s effect to 12 percent of the NASDAQ 100 Index. This rebalancing is propelling a series of issues, such as stock valuations, tax effects, and challenges to automated portfolio trading, not to mention a deviation from their stated methodology.Apple has replaced Microsoft as the tech giant on the tech heavy NDX, NASDAQ 100 index. The last time the Special Rebalance was utilised was in 1998 when the Index reduced the weight of Microsoft and the Gates’ effect. As a result of the 2011 rebalance, the weighting of Microsoft will be brought up to 8.3 percent from its current 3.4 percent of the Index. The emphasis on Google is also slated to six percent of the Index from four percent, an increase of 50 percent. Likewise, shares of 16 other companies including Intel, Oracle, and Dell will nearly double in their representation in the NDX, while 82 companies will have their weightings reduced, such as Starbucks and Intuit.This is not just an exercise in methodology. It is having noticeable impacts on the stock values of these companies in the shuffle. Shares of many of those with weightings being peeled have seen their stock prices decline since Tuesday. It is also creating roadblocks for the 140 different asset-based products derived off the NDX. This includes ETFs, mutual funds, options, and futures. NASDAQ notes on the Fact Sheet for the NASDAQ-100 Index (NDX) that over $400 billion in global assets are somehow linked to it, the largest of which is the Invesco Powershares QQQ, or Qube as it is affectionately referred to. The Qube has approximately $24.4 billion in assets.The largest bugaboo of the passive indexes such as Qube is the tax impact of the special rebalancing. With such a large change in weight, it may require the managers to sell out of Apple with a sizeable capital gain. Remember that the stock has risen 300 percent in value in the last 13 or so years. There may be residual capital losses on the stock the managers might have to sell to keep things in balance.Some capital losses might still be available for harvesting from the post tech-bubble fall. Qube’s Trustee is Bank of New York Mellon BK. It is reported that Mellon is conferring with Invesco, the manager of PowerShares, to “mitigate” any possible capital gains. Typically, any normal changes in Index components and weights can be managed within the cash-flow of purchases and redemptions.In order to minimise disorder, the NASDAQ management announced on Tuesday that the changes would be based on the components of the index as of March 31, with the final composition to be effective on Monday, May 2. Traders are going to be on alert from now through that date.Last year in May, the markets witnessed a ‘flash crash’ which sent traders scrambling. It is expected that this year’s Special event with make the flash crash chaos pale in comparison. This week’s glitch with the NASDAQ automated trading system has disrupted things further. There was a 30-minute technical error in their proprietary Global Index Data Service the morning of the announcement, wherein real-time index values were delayed.The NDX is ‘one of the most widely watched indexes in the world’, according to NASDAQ. It was launched in 1985. There are 140 asset-based products derived from the Index and thousands of financial instruments that track it globally. Most of these run on mathematical algorithms that automatically adjust to market changes based on a set of rules. These rules are based on NASDAQ’s stated methodology for managing the indexes. In the case of the NASDAQ-100 index, some say they are breaking the rules in this Special Rebalance.Whereas the respective weight of a company in many indexes is based on the total market value or market capitalisation of the shares listed on the index, the NDX has a ‘modified’ cap-weight approach. It retains an element of cap-weight, whilst providing enhanced diversification. Rules note that this means reducing the representation of stocks that are 24 percent of the NDX or when a selection of separate stocks with weights of 4.5 percent mark up 48 percent of the index. This Special Rebalance must be a pre-emptive bite, in that Apple was at 21 percent.The April 5 press release from the NASDAQ-OMX stated the move will bring the representations of the stocks “closer in line with their actual market capitalisations”. Further, ‘the sector weights will remain the in the same relative order and magnitude’. They refer people to their website for more information: https://indexes.nasdaqomx.com/docs/NDXSpecial–RebalancePresentation.pdf .Rebalancing is not an unusual occurrence for the NDX or other NASDAQ indexes. The listed companies change and the stock values of those listed are dynamic. The NDX is ‘re-ranked’ yearly and rebalanced quarterly on the quadruple witching Fridays of the quarter. This is the date when all the financial instruments expire or are set to reset, such as futures and options. That date was selected to minimise disruptions to the normal trading days. What is typically known as a triple-witching-Friday is usually a chaotic trading day anyway. The most recent regular rebalancing was on March 21.The analysts and management of NASDAQ-OMX have reviewing the indexes and working to expand their empire. The NASDAQ-OMX Group is the largest exchange group in the World, according to their calculations. It trades as NDAQ on the US and Dubai exchanges. The US listing is trading around $29 after recovering from late March dip in the market. Last week the Group along with partner ICE made a $11.3 billion competing bid for the Deutsche Boerse (German Stock Exchange), outbidding the rival NYSE-Euronext $9.53 billion bid.Reports on Wednesday, April 6 suggest that the ICE or Intercontinental Exchange Inc. may withdrawal from the bidding. The ICE and CME Group comprise the world’s largest futures market and own proprietary clearinghouses which might create anti-trust concerns for the US Department of Justice that could block the acquisition. The NYSE and the NASDAQ use the centralised clearinghouse Options Clearing House (OCC) for the exchange-listed equity derivative contracts. Should ICE leave the NASDAQ bidding, the merger will likely land back in NYSE hands. Hopefully the NASDAQ-OMX Group has not bitten off more that it can chew with the proposed merger and Special Rebalancing.Note: In last week’s column the PEG ratio should have read 0.5074. It is normally a PEGs less than one (PEG[Patrice Horner holds an MBA in Finance, a FINRA Series 7 Licence, and is a Certified Financial Planner (CFP-US). Any opinions expressed in this article are not specific recommendations, nor endorsements of any products. Individuals should consult with their banker, insurance agent, lawyer, accountant, or a financial planner for advice to address their personal situations.