Regulation M. Regulation M is intended to limit the activities of those persons who have a readily identifiable incentive to manipulate the market during an offering. Regulation M exempts from its application redeemable securities issued by an open-end management investment company, and an ETF is an open-end management investment company. However, because of the limited redeemability of ETF Shares, it is not clear that the exemption for open-end investment companies is applicable to ETFs. As a result, ETFs have sought, and the SEC has been willing to grant, no-action positions confirming:
- Persons who may be deemed to be participating in a distribution of ETF Shares may bid for or purchase such ETF Shares during their participation in such distribution
- The receipt of securities comprising the basket of securities received in connection with the redemption of ETF Shares does not constitute an “attempt to induce any person to bid for or purchase a covered security, during the applicable restricted period” within the meaning of Regulation M
- ETFs may redeem ETF Shares during the continuous offering of such ETF Shares
- Tender Offers. Rule 14e-5, among other things, prohibits a person who makes a cash tender offer or exchange offer for an equity security from purchasing, directly or indirectly, such security other than pursuant to the offer. Rule 14e-5 could be read as restricting the ability of a dealer manager of a tender offer for a particular security included in the ETF's portfolio from purchasing and redeeming ETF Shares during the offer period. That would be the case to the extent that purchases and redemptions of ETF Shares are viewed as an indirect purchase or sale of the security subject to the tender offer. To obviate concerns in this regard, ETFs have sought, and the SEC has been willing to grant, exemptive relief from Rule 14e-5 to permit dealer-managers of tender offers of securities comprising the basket of securities tendered or received in connection with a purchase or redemption of ETF Shares to purchase and redeem ETF Shares during the pendency of the offer.
- Broker Confirmations. Rule 10b-10 requires a broker-dealer who effects a transaction on behalf of a customer to provide the customer a written confirmation at or before completion of the transaction. The confirmation must contain certain specified information, including the identity, price, and number of shares or units (or principal amount) of the security purchased or sold.
Compliance with Rule 10b-10 would be extremely burdensome to the extent that all of its requirements were viewed as applicable to all securities comprising the basket of securities tendered or received in connection with a purchase or redemption of ETF Shares. For this reason, ETFs have sought, and the SEC has been willing to grant, exemptive relief to permit broker-dealers to omit information respecting the identity, price, and number of shares of each individual security tendered or received. The SEC has been willing to grant such relief conditioned upon the representation that the confirmation furnished by the broker-dealer to its customer will state that all information required by Rule 10b-10 will be furnished upon request and all such requests will be fulfilled in a timely manner.
- Margin. Pursuant to Section 11(d)(1) of the Securities Exchange Act, a broker-dealer generally may not extend credit in connection with the purchase of any security that is part of a new issue if the broker-dealer was a member of the selling syndicate within the prior 30 days. Because ETFs are continuously offered and traded in the secondary market, the restrictions on margin in connection with purchases in a public offering could be viewed as applicable to ETFs. To obviate this concern, ETFs have sought and obtained no-action relief from the SEC to permit margin credit to be extended, in connection with the purchase of ETF Shares on an exchange, by broker-dealers who engage exclusively in secondary market transactions in ETF Shares. The SEC also has extended this relief to broker-dealers who transact directly with the ETF. In both cases, the relief is subject to the condition that the broker-dealer not receive — from the ETF or an affiliated person of the ETF — any payment, compensation, or other economic incentive to promote the shares of the ETF.
ETFs also have received confirmation that ETF Shares may be treated by broker-dealers as shares issued by an open-end investment company and therefore, pursuant to Rule 11d1-2 of the Securities Exchange Act, broker-dealers are able to extend credit or maintain or arrange for the extension or maintenance of credit on ETF Shares that have been owned for more than 30 days by the persons to whom credit is to be extended.
- Disclosure of Broker Relationships. A broker-dealer is required, under Rule 15c1-5 of the Securities Exchange Act, to disclose to its customers any control relationship between the broker-dealer and the issuer of the security being purchased or sold. Similarly, a broker-dealer that effects a transaction with a customer in connection with any distribution in which the broker-dealer is interested is required, under Rule 15c1-16 of the Securities Exchange Act, to disclose to its customer, the existence of such interest. ETFs have obtained no-action relief from the SEC to confirm that the foregoing rules do not require disclosure of a broker-dealer's relationship with any issuer of a security held in the ETF's portfolio.
- Advance Notice of Corporate Actions. Rule 10b-17 requires a public company to give advance notice of certain specified actions (for example, dividends, stock splits, rights offerings). Paragraph (c) of the Rule, however, states that the Rule does not apply to redeemable securities issued by open-end investment companies. However, because of the limited redeemability of ETF Shares, it is not clear that the exemption for open-end investment companies is applicable. As a result, ETFs have sought, and the SEC has been willing to grant, no-action positions confirming that this exemption applies to ETFs.
- Sections 13(d) and 16(a). Section 13(d) requires beneficial owners of more than five percent of an issuer's outstanding securities to file reports with the SEC. Section 16(a) requires each officer, director, and beneficial owner of more than 10 percent of a public company's outstanding shares (insiders) to file reports with the SEC disclosing the number of shares beneficially owned, and reports regarding changes in ownership. The SEC has granted no action relief to ETFs with respect to the reporting obligations under Sections 13(d) and 16(a) to the effect that: (1) owners of more than five percent of the ETF Shares are not required to file reports under Section 13(d); and (2) insiders are not required to file reports under Section 16(a).
The no-action relief with respect to sections 13(d) and 16(a) is based primarily on representations that the ETF Shares trade at prices that do not deviate materially from NAV. The letters caution, in this regard, that if the ETF Shares begin to trade at prices that materially deviate from NAV, the no-action relief would no longer be available.