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Exchange-Traded Funds
A Small Entity Compliance Guide

Dec. 6, 2019

This compliance guide is divided into the following parts:[1]

Introduction

On September 25, 2019, the Securities and Exchange Commission (the “Commission”) adopted new rule 6c-11 under the Investment Company Act of 1940 (the “Investment Company Act”) that will permit exchange-traded funds (“ETFs”) that satisfy certain conditions to operate without the expense and delay of obtaining an exemptive order. The Commission also adopted certain related amendments to Forms N-1A, N-8B-2, and N-CEN (collectively, the “ETF Rule” or “Rule 6c-11”).

The ETF Rule is designed to create a consistent, transparent, and efficient regulatory framework for ETFs that are organized as registered open-end management investment companies (“open-end funds”) and to facilitate greater competition and innovations among ETFs.

Who is covered by Rule 6c-11?

ETFs that fall within the scope of Rule 6c-11 are:

  • registered open-end management investment companies;
  • that issue (and redeem) creation units to (and from) authorized participants in exchange for a basket and a cash balancing amount (if any); and
  • that issue shares that are listed on a national securities exchange and traded at market-determined prices.

Rule 6c-11 does not include the following types of ETFs and these ETFs will continue to operate pursuant to their exemptive orders:

  • An ETF that that is organized as a unit investment trust (a “UIT”);
  • An ETF that seeks, directly or indirectly, to provide investment returns that correspond to the performance of a market index by a specified multiple or that have an inverse relationship to the performance of a market index, over a predetermined period (a “leveraged or inverse ETF”);
  • An ETF that is structured as a share class of a fund that issues multiple classes of shares representing interests in the same portfolio (a “share class ETF”);
  • An ETF that operates as a feeder fund in a master-feeder structure; and
  • An ETF that is actively managed and does not provide daily portfolio transparency.

All ETFs will be required to provide additional disclosures regarding ETF trading and associated costs.

What exemptive relief does Rule 6c-11 provide?

Rule 6c-11 provides exemptive relief from certain provisions of the Investment Company Act that are necessary for an ETF to operate.

  • Treatment of ETF shares as redeemable securities. If an ETF relies on Rule 6c-11, it will be considered to issue a “redeemable security” within the meaning of section 2(a)(32) of the Investment Company Act, even though its shares cannot be redeemed, except in limited circumstances, other than in creation unit aggregations.
  • Trading of ETF shares at market-determined prices. Rule 6c-11 will provide exemptions from section 22(d) and rule 22c-1 to permit secondary market trading of the ETF’s shares at market-determined prices.
  • Affiliated transactions. Rule 6c-11 will provide exemptions from sections 17(a)(1) and (a)(2) of the Investment Company Act for the deposit and receipt of baskets by an affiliated person of an ETF (or an affiliated person of such a person) only because that person (1) holds with the power to vote 5% or more of the ETF’sshares; or (2) holds with the power to vote 5% or more of any investment company that is an affiliated person of the ETF.
  • Additional time for delivering redemption proceeds. Rule 6c-11 will provide an exemption from section 22(e) of the Investment Company Act to permit an ETF to delay satisfaction of a redemption request in the case of foreign investments for which a local market holiday or the extended delivery cycles of another jurisdiction make timely delivery unfeasible. The ETF must deliver the foreign investment as soon as practicable, but in no event later than 15 days after the tender to the ETF.

What conditions are required to rely on Rule 6c-11?

Rule 6c-11 requires an ETF to comply with certain conditions designed to protect investors and to be consistent with the purposes fairly intended by the policy and provisions of the Investment Company Act. Some of these conditions are outlined below.

  • Website disclosure. Rule 6c-11 will require an ETF to disclose certain information on its website as a condition to the rule. Specifically, it must disclose the following publicly and prominently on its website:
    • The portfolio holdings that will form the basis for each calculation of net asset value per share. They must be the ETF’s portfolio holdings as of the close of business on the prior business day. The disclosure must be available each business day before the opening of regular trading on the primary listing exchange of the ETF’s shares. For each holding, the ETF must disclose the following information (as applicable):
      • ticker symbol;
      • CUSIP or other identifier;
      • description of holding;
      • quantity of each security or other asset; and
      • percentage weight of the holding in the portfolio.
    • The ETF’s current net asset value per share, market price, and premium or discount, each as of the end of the prior business day;
    • A table and line graph showing information regarding the ETF’s premiums and discounts during the most recently completed calendar year and calendar quarters of the current year (or the life of the ETF, if shorter);
    • If the ETF’s premium or discount was greater than 2% for more than seven consecutive trading days, disclosure that the premium or discount was greater than 2%, along with a discussion of the factors that are reasonably believed to have materially contributed to the premium or discount; and
    • Median bid-ask spread over the most recent thirty calendar days.
  • Baskets. An ETF must adopt and implement written policies and procedures governing the construction of baskets and the process that it will use for the acceptance of baskets. Rule 6c-11 provides an ETF with flexibility to use “custom baskets”—such as those composed of a non-representative selection of the ETF’s portfolio holdings— if the ETF has adopted written policies and procedures that: (1) set forth detailed parameters for the construction and acceptance of custom baskets that are in the best interests of the ETF and its shareholders, including the process for any revisions to, or deviations from, those parameters; and (2) specify the titles or roles of employees of its investment adviser who are required to review each custom basket for compliance with those parameters.

What disclosure requirements apply?

Several amendments to Form N-1A, the registration form used by open-end funds, are designed to provide an ETF’s investors with additional information regarding ETF trading and associated costs. These include:

  • Adding the term “selling” to current narrative disclosure requirements to clarify that the fees and expenses reflected in the expense table may be higher for investors if they buy, hold, and sell ETF shares;
  • Requiring streamlined narrative disclosures relating to an ETF’s trading costs, including bid-ask spreads;
  • Requiring ETFs that do not rely on Rule 6c-11 to disclose median bid-ask spread information on their websites or in their prospectus;
  • Excluding ETFs that provide premium/discount disclosures in accordance with Rule 6c-11 from the premium and discount disclosure requirements in Form N-1A; and
  • Eliminating disclosure relating to creation unit size and disclosures applying only to ETFs with creation unit sizes of less than 25,000 shares.

These disclosure requirements apply to certain ETFs that are not included within the scope of Rule 6c-11. The ETF Rule also includes several amendments to Form N-8B-2, the registration form used by UITs, that will mirror the requirements adopted in Form N-1A. Finally, an ETF will be required to indicate, in reports on Form N-CEN, whether it relies on Rule 6c-11.

What recordkeeping requirements apply?

An ETF must preserve and maintain copies of all written agreements between it (or its service provider) and an authorized participant that allow the authorized participant to purchase or redeem creation units. It also must maintain information regarding the baskets exchanged with authorized participants.

Effective date

Eligible ETFs may begin relying on Rule 6c-11 after the effective date, which is December 23, 2019. The compliance date for the form amendments is December 22, 2020. On December 23, 2020, the Commission will also rescind certain portions of prior ETF exemptive orders that grant relief related to the formation and operation of an ETF.

Other resources

The adopting release can be found on the Commission’s website at https://www.sec.gov/rules/final/2019/33-10695.pdf.

The proposing release can be found on the Commission’s website at https://www.sec.gov/rules/proposed/2018/33-10515.pdf.

A related exemptive order providing relief to broker-dealers and certain other persons from certain provisions of the Securities Exchange Act and its rules for transactions involving ETF shares can be found on the Commission’s website at https://www.sec.gov/rules/exorders/2019/34-87110.pdf.

Contacting the Commission

The Commission’s Division of Investment Management is happy to assist small entities with questions regarding the ETF Rule. You may submit a question by email to IMOCC@sec.gov. Additionally, you may contact the Division of Investment Management’s Office of Chief Counsel at (202) 551-6825.


[1] This guide was prepared by the staff of the U.S. Securities and Exchange Commission as a “small entity compliance guide” under Section 212 of the Small Business Regulatory Enforcement Fairness Act of 1996, as amended. The guide summarizes and explains rules and form amendments adopted by the Commission, but is not a substitute for any rule or form itself. Only the rule or form itself can provide complete and definitive information regarding its requirements.

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