On September 25, 2019, the Securities and Exchange Commission (the “SEC”) adopted new Rule 6c-11 under the Investment Company Act of 1940 (the “IC Act”) requiring certain exchange-traded funds (“ETFs”) to operate without exemptive relief if they satisfy conditions designed to promote investor protection.1 In its adopting release, the SEC stated that the rule “will modernize the regulatory framework for ETFs” and that the rule is “designed to further important Commission objectives, including establishing a consistent, transparent, and efficient regulatory framework for ETFs and facilitating greater competition and innovation among ETFs.”2
The new rule will allow eligible ETFs to operate without first receiving an exemptive order from the SEC. Additionally, the rule codifies much of the relief granted in prior exemptive orders and eliminates the distinction between index-based ETFs and actively managed ETFs. The rule will become effective sixty days after it is published in the Federal Register and rescind existing exemptive orders for ETFs eligible to rely on the rule one year later.3
The SEC also issued a new exemptive order related to certain rules promulgated under the Securities Exchange Act of 1934 (“Exchange Act”). This new exemptive order harmonizes prior relief from requirements set forth under Exchange Act Section 11(d)(1) and Rules 10b-10, 15c-1, 15c-16, and 14e-5 for ETF issuers and broker-dealers able to rely on the new rule. However, parties unable to rely on the new rule will still be required to rely on prior relief granted on a class-by-class basis.
Overview of the Rule
Under the rule, certain index-based and actively managed ETFs organized as open-end investment companies under the IC Act will be exempt from certain provisions under the IC Act and thus be permitted to:
- redeem shares in creation unit aggregations
- have their shares purchased and sold at market prices rather than net asset value (“NAV”)
- engage with certain affiliates in in-kind transactions
- in limited circumstances, deliver proceeds from redemptions to authorized participants in more than seven days
As previously mentioned, the ETFs eligible to rely on the rule have one year from the date the rule is published in the Federal Register to transition from complying with individual exemptive relief to the rule’s new compliance requirements. These new compliance requirements include the following:
- Website disclosures. ETFs must disclose the following information each business day before the commencement of trading:
- Portfolio holdings
- Market price
- Premium or discount (including a narrative describing factors that contribute to deviations in the premium or discount that continue for seven consecutive trading days)
- Median bid-ask spread over the last 30 calendar days4
- Creation and redemption basket policies and procedures. ETFs must adopt and implement policies and procedures related to the construction and acceptance of creation and redemption baskets, generally, and further with respect to custom baskets (non-pro rata baskets and/or baskets that differ from other baskets used in other transactions that trading day). Specifically, custom basket policies and procedures must accomplish the following:
- Provide detailed guidelines related to the construction and acceptance of custom baskets when it is in the best interest of the fund shareholders. These guidelines must also specify if and when deviation from guidelines will be allowed.
- Identify specific titles or employees of the ETF’s investment adviser who will be required to review each custom basket for compliance with stated guidelines
- Require the maintenance of records identifying the authorized participant transacting with the fund, the names and quantities of positions comprising each creation and redemption basket, and any cash balancing amount
- Require the identification of any custom baskets and confirm that the custom baskets comply with the policies and procedures
- Amendments to certain registration statement disclosures. Under the rule, all ETFs, regardless of whether they can rely on the rule, will be required to provide additional disclosures on Form N-1A or Form N-8B-2.
ETFs Not Covered by the Rule
While the rule will provide considerable relief for ETFs organized as open-end investment companies, the following ETFs will continue to be subject to the provisions of existing exemptive orders:
- Non-transparent active ETFs5
- Leveraged and inverse ETFs
- Funds organized as unit investment trusts (“UITs”)6
- Funds structured as part of a multi-class fund
As ETF issuers and managers begin to examine the implications of transitioning from exemptive order compliance to complying with the conditions set for in the rule, ACA recommends the following actions:
- Identify funds that will and will not be subject to the rule. ETF issuers and managers should review their fund lineup to determine whether their funds are eligible to rely on the rule. For ETF complexes that have funds subject and not subject to the rule, compliance personnel should be particularly mindful of the diverging compliance requirements for both sets of funds. Where requirements do not align, compliance personnel should ensure compliance can be achieved under the rule and exemptive orders requirements.
- Review existing exemptive orders and requirement to transition to the rule’s conditions. Compliance personnel should review and document existing exemptive order requirements and related controls to identify control changes that will need to be modified to ensure compliance with the rule.
- Adopt new basket policies and procedures. As previously discussed, the rule requires specific policies and procedures governing creation and redemption baskets to be adopted. Compliance personnel should identify relevant internal and external stakeholders early and review the specific requirements outlined in the rule with the stakeholders to ensure new policies and procedures are compliant and operationally feasible.
- Review new disclosure requirements for regulatory filings and ETF websites. Compliance personnel and appropriate operational and legal colleagues should review the amended Forms N 1A, N-8B-2, and N-CSR and identify the parties responsible for new data points in advance of upcoming filing deadlines. They should also consider whether any additional controls or data validation processes should be required as part of these amended filings. Further, such personnel should review the rule’s new website disclosure requirements and identify where information will be gathered from and how it can be validated to ensure accuracy.
ETF issuers, managers, and compliance personnel should conduct a thorough review and assessment of their current exemptive order-related policies and procedures, disclosures to shareholders, and general practices that will be affected by the rule. Because the rule is non-volitional and existing exemptive orders will be rescinded in 2020, it is important to identify areas that require modification early so that changes can be implemented in a timely manner.
How ACA Can Help
ACA is available to assist ETF issuers, advisers, and sub-advisers with understanding the intricacies and requirements of Rule 6c-11. We can assist with reviewing current policies and procedures and with exemptive order compliance. We can also assess what needs to be done to transition into the rule’s new compliance regime. For more information about this rule or to discuss your compliance needs, please contact Erik Olsen or Veronica Popp.
About the Author
Veronica Popp joined ACA Compliance Group in September 2018 through the acquisition of Cordium. As a consultant working out of ACA's Boston office, Veronica works closely with their investment company practice.
Prior to joining Cordium, Veronica held compliance positions at Columbia Threadneedle Investments and State Street Global Advisors. During law school, she interned in the legal department at Eaton Vance for the Honorable Joan N. Feeney of the United States Bankruptcy Court for the District of Massachusetts.
Veronica earned her J.D. degree from Suffolk University Law School and her Bachelor of Arts, Business Administration and Management and Economics from Regis College.
1 See https://www.sec.gov/rules/final/2019/33-10695.pdf (“Adopting Release”).
2See Adopting Release at page 5.
3 The rule does not rescind existing exemptive relief for ETFs ineligible to rely on the rule, relief contained in existing orders pertaining to Section 12(d)(1) of the IC Act, or relief for ETFs operating under a master-feeder structure as of June 28, 2019.
4Note that ETFs that are not subject to the rule will still be required to provide median bid-ask spread for the fund’s most recent fiscal year in their prospectuses or comply with the website disclosure requirement.
5For example, Precidian ETFs Trust, et al. (May 20, 2019).
6It is important to note that while ETFs organized as UITs cannot rely on the rule, UIT ETFs will still be subject to the new disclosure requirements related to ETF trading and related costs under amended Forms N-1A and N 8B 2.