On March 28, 2016, the SEC’s Division of Investment Management provided a no-action letter to the SPDR S&P Dividend ETF (the “Fund”) permitting the Fund to acquire more than (i) 10% of the total outstanding voting stock of an insurance company notwithstanding Section 12(d)(2) of the 1940 Act and (ii) 5% of an outstanding class of equity securities of a securities-related issuer notwithstanding Rule 12d3-1(b)(1).
The Fund is an “index fund” that seeks to track an independently provided index, which consists of issuers that are either insurance companies or derive a substantial portion of their revenues from securities-related activities, among others. As the Fund has grown, it has encountered the regulatory restrictions of Sections 12(d)(2) and 12(d)(3) of the 1940 Act and Rule 12d3-1 thereunder. Section 12(d)(2) limits to 10% the percentage amount a fund may acquire of the voting stock of an insurance company. Rule 12d3-1(b)(1) limits to 5% the amount that a fund may acquire of the voting stock of an issuer that, in its most recent fiscal year, derived more than 15% of its gross revenues from securities-related activities (i.e., activities as a broker, dealer, underwriter, or registered investment adviser) (a “securities-related issuer”).
With respect to the Section 12(d)(2) limit on fund ownership of an insurance company, the SEC staff agreed with the Fund’s characterization of the purpose of the section – Congress believed that investment companies acquiring controlling blocks of stock of insurance companies would be undesirable because of possible negative effects of fund control of an insurance company. In this case, the Fund represented that the Fund would not own the securities of an insurance company in an amount exceeding the company’s approximate weighting in the index the Fund tracks. The Fund also represented that it would avoid exercising a controlling influence over the management or policies of an insurance company by either (i) voting its shares in an insurance company as directed by an independent third party, or (ii) echo-voting its shares in an insurance company in the same proportion as the votes of all the insurance company’s remaining shareholders. Based on these representations, the SEC staff stated that the Fund’s investment activities would not be inconsistent with the intent of Section 12(d)(2) and, therefore, the staff would not recommend enforcement action if the Fund exceeded Section 12(d)(2)’s 10% limit.
With respect to Rule 12d3-1, the SEC staff agreed that the SEC had identified two apparent Congressional purposes for prohibiting investment company investments in securities-related issuers: (i) limiting a fund’s exposure to the entrepreneurial risks of such issuers, and (ii) preventing potential conflicts of interest and reciprocal practices, such as directed brokerage. The Fund asserted that the concern about exposing funds to the entrepreneurial risk of securities-related issuers is adequately addressed by the Rule 12d3-1(c)’s prohibition on acquiring a general partnership interest of a securities-related issuer because virtually all securities-related issuers are currently organized as corporations and not general partnerships. To address concerns about conflicts of interest and reciprocal practices, the Fund represented that it would not acquire the securities issued by any securities-related issuer in an amount exceeding the issuer’s approximate weighting in the index the Fund tracks. The Fund also represented that it would not use a securities-related issuer as the executing broker for any Fund transactions, and that it would comply with the provisions of Section 17(e) of the 1940 Act and Rule 17e-1 thereunder when using any affiliated person of a securities-related issuer. Based on the Fund’s assertions and representations, the staff agreed that the Fund’s investment activities would not be inconsistent with the concerns that underlie Section 12(d)(3) and Rule 12d3-1 thereunder and, therefore, it would not recommend enforcement action if the Fund exceeded Rule 12d3-1(b)(1)’s 5% limit.