On September 26, 2019, the US Securities and Exchange Commission (SEC) announced that it has adopted the eagerly awaited new rule 6c-11 (the Rule) under the Investment Company Act of 1940 (the 1940 Act) that allows most exchange-traded funds that are structured as open-end management investment companies (ETFs) to register with the SEC and commence operations without the delay or expense of first obtaining an individual exemptive order, as has been required to date.1 In announcing the Rule’s adoption, the SEC stated that “[t]he adoption will facilitate greater competition and innovation in the ETF marketplace, leading to more choice for investors. It also will allow ETFs to come to market more quickly without the time or expense of applying for individual exemptive relief.” 2
Who can rely on the Rule?
The Rule applies to:
- actively managed ETFs
- index-based ETFs
The Rule does not apply to the following types of ETFs, which means that these types of ETFs will still need to obtain individual exemptive orders:
- inverse ETFs
- leveraged ETFs
- nontransparent ETFs
- ETFs that operate as a share class of a multi-class fund
- ETFs that are organized as unit investment trusts
When does the Rule go into effect?
- The Rule is effective 60 days after publication in the Federal Register.
- One year after the effective date of the Rule, most previously granted ETF exemptive orders will be rescinded (this will likely be sometime in early December 2020), meaning that ETFs in operation will need to rely on the Rule.
What are the key aspects of the Rule?
- No individual exemptive orders needed. Most ETFs will no longer need to seek individual exemptive relief in order to operate. Rule 6c-11 provides ETFs with the exemptions necessary to operate under the 1940 Act. In addition, the SEC also issued an exemptive order that harmonizes relief needed for ETFs to operate under the Securities Exchange Act of 1934, as amended, and the rules thereunder.
- Custom Baskets. The Rule will allow ETFs to utilize custom creation and redemption baskets for the purchase and redemption of their shares by authorized participants if the ETF’s investment adviser establishes policies and procedures to ensure that such custom baskets will be created in the best interest of the ETF and its shareholders.
- Website Disclosure. The Rule will require an ETF to disclose certain information on its website, including:
- median bid-ask spread over the most recent 30 days
- premium and discount information
- daily portfolio holdings
Eversheds Sutherland’s Quick Observations
- Custom Baskets. The Rule will go a long way toward leveling the playing field between those ETFs that have older exemptive relief and those that are newer entrants to the market. Exemptive orders granted between 1996 and 2006 did not require pro rata baskets; however, since 2006, orders have placed an increasing number of restrictions on the composition of such baskets. As a result, fund families that obtained exemptive relief after 2006 generally either lacked the ability to create custom baskets or were restricted in when they could do so. This Rule will allow an ETF to create a custom basket, instead of requiring baskets to reflect a pro rata representation of the ETF’s holdings. This Rule will ultimately allow ETFs to manage their holdings more efficiently, which may assist the ETFs with minimizing capital gains. In order to take advantage of this portion of the Rule, existing ETFs that could continue to rely on their post-2006 individual exemptive orders for an additional year may wish to come into compliance with the Rule prior to the order’s expiration.
- The Rule’s bid-ask requirements differ significantly from the proposal and should be welcomed by the industry. The proposal would have required an ETF to: (i) disclose both in its prospectus and on its website the median bid-ask spreads for the most recent fiscal year and bid-ask spread examples in the summary section of the prospectus; and (ii) provide an interactive calculator on its website that allows investors to calculate hypothetical bid-ask spreads under specific conditions. This aspect of the proposal was met with substantial opposition. As adopted, the Rule will require disclosure of the bid-ask spread on an ETF’s website only (i.e. not in the ETF prospectus), and will require such disclosure for a much shorter time period (30 days, as compared to one year in the proposal). In addition, as adopted, the Rule does not include a requirement for ETFs to provide an interactive calculator on its website, or include a requirement to disclose bid-ask spread examples in the prospectus.
- Fund of funds relief. Although individual exemptive orders permitting ETFs to operate as such will be rescinded one year after the effective date of the Rule, the portions of those orders that permit other investment companies to invest in ETFs in excess of the statutory limits will not be rescinded. That individual relief will presumably be rescinded when and if the SEC adopts rule 12d1-4 (the Fund of Funds Rule), which was proposed in December 2018.
- Active vs. index. The Rule eliminates the distinction between actively managed and index-based ETFs, which currently exists within individual exemptive orders.
- Intraday indicative value. The Rule does not require ETFs to disseminate an intraday estimate of their net asset value per share (the intraday indicative value, or IIV). According to the SEC, the IIV dissemination was not required due to the SEC’s concerns regarding the accuracy and purported benefits of the IIV information. However, because exchange listing standards currently require the dissemination of the IIV, ETFs will still need to do so.