Investment Management and Financial Markets Group
March 27, 2008
SEC Proposes New Exemptive Rule for
Exchange Traded Funds (ETFs)
The Securities and Exchange Commission (SEC) proposed a new rule and various rule amendments to
permit sponsors to offer index-based and actively managed ETFs without obtaining prior SEC relief. If
adopted, the proposed rule and amendments would greatly enhance the ability of ETF sponsors to offer
new products quickly, without having to wait for SEC approval of an exemptive application. The SEC
has asked for comments on various aspects of the proposed new rule and amendments, and all
comments must be submitted by May 19, 2008. The proposed rule and amendments will not be final
until the SEC considers the comments provided and adopts final rules.
Discussion
A.
New Proposed Rule 6c-11
Proposed Rule 6c-11, which essentially codifies the basic terms of the various ETF exemptive
orders the SEC has issued to date, is designed to enable most ETFs to begin operations
without the need to obtain individual exemptive relief. The rule applies to both index-based and
actively managed ETFs, provided that the ETF discloses on its Web site each business day the
identities and weightings of the component securities and other assets held by the index, or for
actively managed ETFs, the identities and weightings of the component securities and other
assets held by the ETF. The proposed rule does not apply to other types of exchange-traded
funds that invest primarily in commodities or commodity-based instruments, such as crude oil
and precious metal (commodity ETFs). Although commodity ETFs are organized as trusts and
issue shares that trade on a securities exchange like other ETFs, they are not “investment
companies” under the Investment Company Act. The proposed rule would not limit the types of
indices that an ETF may track or the types of securities that comprise any index. In this regard,
the SEC asks for comments regarding (i) the effect of ETF portfolio liquidity on the pricing of
ETF shares in the secondary market and (ii) whether actively managed ETFs with fully
transparent portfolios should be able to rely on the proposed rule.
Proposed Rule 6c-11 includes the following conditions, among others, that must be met to rely
on the rule:
Transparency of the ETF’s portfolio: an ETF must either (i) disclose on its Web site each
business day the identities and weightings of the component securities and other assets held by
the fund, or (ii) have a stated investment objective of obtaining returns that correspond to the
returns of a securities index, whose provider discloses on its Web site the identities and
weightings of the component securities and other assets of the index.
CHICAGO ● SAN DIEGO● WASHINGTON
Listing on a national securities exchange: to date, the SEC has required every ETF to list its
shares for trading on a national securities exchange, and the proposed rule includes this
requirement. The SEC seeks comments on whether this requirement should continue.
Disclosure of the ETFs Intraday Value: an ETF could rely on the new rule only if the national
securities exchange on which the ETF is listed disseminates the Intraday Value at regular
intervals during the trading day. The SEC seeks comments on whether the rule should mandate
the frequency and intervals of these disclosures.
Proposed Rule 6c-11 also includes additional requirements related to the marketing and
structure of ETFs, and the SEC seeks comments on the standards noted. For example, the
proposed rule would require each ETF not to market itself as an open-end fund or mutual fund.
Also, the proposed rule would require each ETF to identify itself in any sales literature as an
ETF that does not sell or redeem individual shares (ETFs only issue “creation units” to brokerdealers, who in turn sell ETF shares to individual investors), and to explain that investors may
only purchase or sell individual ETF shares in secondary market transactions that do not involve
the ETF.
Finally, the SEC noted that, although exemptive orders issued to date generally do not require
broker-dealers selling ETF shares to deliver prospectuses in most secondary market
transactions,1 many, if not most, broker-dealers selling ETFs transmit a prospectus to
purchasers. Proposed rule 6c-11 would require that broker-dealers deliver a prospectus to each
investor purchasing an ETF, and the SEC seeks comments regarding the need for this
provision. In this regard, the SEC notes that if it adopts the proposed rules permitting delivery of
summary fund prospectuses, broker-dealers could rely on those rules in meeting ETF
prospectus delivery obligations. The SEC also seeks comments on whether and how the
summary prospectuses should be modified for use by ETFs.
B.
Related Rules and Amendments
Affiliated Index Providers
The SEC noted in its Release that federal securities laws and the rules of national securities
exchanges include sufficient provisions aimed at protecting fund investors against misuse of
non-public information and the abuses that could potentially occur in instances where ETF
sponsors use an affiliated index provider. Accordingly, the proposed rule does not include
provisions similar to the terms of existing exemptive orders designed to prevent the
communication of material non-public information between the ETF and the affiliated index
provider.2
1
These orders simply required broker-dealers to deliver a short “product description” containing basic information about
the ETF and its shares.
2
The terms from existing orders addressing potential conflicts of interest between the ETF adviser and its affiliated index
provider required, among other things, that (i) all of the rules that govern inclusion and weighting of securities in each
index are made publicly available; (ii) the ability to change the rules for index compilation is limited and public notice is
given before any changes are made; (iii) “firewalls” exist between (A) the staff responsible for the creation, development
and modification of the index compilation rules and (B) the portfolio management staff; (iv) the calculation agent, who is
responsible for all index maintenance, calculation, dissemination, and reconstitution activities, is not affiliated with the
index provider, the ETF or any of their affiliates; and (v) the component securities of the index may not be changed more
frequently than on a specified periodic basis.
2
Amendments to Form N-1A
The SEC proposed several amendments to Form N-1A, the registration form used by mutual
funds to register shares with the SEC, to accommodate the use of this form by ETFs. The goal
of these amendments is to make the ETF prospectus better-suited to the retail investors that
purchase ETF shares in the secondary market. Among the suggested changes is a requirement
that each ETF disclose information about the extent to which market prices of fund shares have
tracked the fund’s net asset value.
Registered Investment Companies Investing in ETFs
The SEC also proposed new rule 12d1-4, which would provide an exemption to permit funds,
including a “fund of funds,” to invest in ETFs in excess of current statutory limits, subject to
certain conditions. These conditions are intended to prevent abusive market practices in
connection with the purchase or redemption of ETF shares. Additionally, the proposed rule
would prohibit an acquired ETF from itself being a fund of funds (i.e., the rule would prohibit a
fund of funds of funds, or three-tier fund structure).
Finally, the SEC proposed amendments to rule 12d1-2 to allow an acquiring fund that invests in
an affiliated fund in reliance on section 12(d)(1)(G) to invest in unaffiliated ETFs beyond the
statutory limitations, as long as the fund complies with the conditions of proposed rule 12d1-4.
The SEC also proposed amendments to rule 12d1-2 that would allow funds relying on section
12(d)(1)(G) to invest in assets other than securities, including futures and other financial
instruments that might not be securities under the federal securities laws, and thus may not be
within the scope of rule 12d1-2.
For further information, please contact Cameron Avery 312-807-4302, Kevin Bettsteller 312-807-4442,
Paul Dykstra 312-781-6029, Jennifer Esquibel 312-807-4262, David Glatz 312-807-4295,Alan Goldberg 312-807-4227,
Elizabeth Hudson 312-807-4376, Anna Paglia 312-781-7163, Andrew Pfau 312-807-4386, Paulita Pike 312-781-6027, Eric
Purple 202-955-7081, Bruce Rosenblum 202-955-7087, Donald Weiss 312-807-4303, Gwendolyn Williamson 202-955-7059,
or Stacy Winick 202-955-7040 of Bell, Boyd & Lloyd’s Investment Management and Financial Markets Group or visit our Web
site at www.bellboyd.com.
This publication has been prepared by the Investment Management and Financial Markets Group of Bell, Boyd & Lloyd LLP
for clients and friends of the firm and is for information only. It is not a substitute for legal advice or individual analysis of a
particular legal matter. Readers should not act without seeking professional legal counsel. Transmission and receipt of this
publication does not create an attorney-client relationship.
© 2008 Bell, Boyd & Lloyd LLP All Rights Reserved
www.bellboyd.com
70 West Madison Street
Chicago, Illinois 60602
t. 312-372-1121
f. 312-827-8000
3580 Carmel Mountain Road
San Diego, California 92130
t. 858-509-7400
f. 858-509-7466
1615 L Street, N.W.
Washington, D.C. 20036
t. 202-466-6300
f. 202-463-0678