Since shares of exchange-traded funds (ETF Shares) are continuously offered and also are traded in secondary markets, various issues arise under the Securities Exchange Act of 1934. Issues also arise under the Securities Exchange Act because most ETF Shares are purchased and redeemed in-kind. The following is a brief summary of issues under the Securities Exchange Act that are applicable to ETF Shares. It does not provide comprehensive advice or identify each rule, regulation, document, or action that an exchange-traded fund (ETF) should consider in addressing issues under the Securities Exchange Act.
Description of ETFs. ETF is an acronym for “exchange-traded fund.” ETFs are open-ended investment companies whose securities are traded on national securities exchanges. Like mutual funds, they invest in a variety of securities or other financial instruments to form a pool of investments. Unlike mutual funds, whose securities are traded by investors with the fund once a day at the fund's net asset value (NAV) at the end of the trading day, ETF Shares are traded with other investors in the open market continually during the trading day at varying prices. Because the value of ETF Shares is not tied to the NAV of its portfolio, ETF Shares may trade at a premium to NAV if demand for the shares is high and at a discount to NAV if demand is low.
ETFs sell and redeem their shares directly with investors only in large blocks of shares called “Creation Units.” These investors, who are referred to as Authorized Participants (APs), must enter into a contract with the ETFs and are typically large institutional investors. APs typically purchase and redeem Creation Units in-kind, meaning that the APs acquire the securities comprising the ETF's portfolio and contribute them to the ETF in exchange for ETF Shares, or that the APs receive the securities comprising the ETF's portfolio when the APs redeem ETF Shares rather than cash.
After the Creation Units are purchased, the APs may sell the ETF Shares comprising their Creation Units in the open market, thereby permitting a secondary market to develop for ETF Shares. An investor who accumulates sufficient ETF Shares to comprise a Creation Unit may have the Creation Unit redeemed by the ETF under limited circumstances. However, most trading of ETF Shares occurs in the secondary market. So, unlike mutual funds, the ETF does not buy or sell ETF Shares directly with all of its security holders.
Available No-Action Relief. At the outset, it should be noted that the SEC has issued generic no-action relief that obviates the need for index ETFs to obtain their own no-action relief for items related to Regulation M, tender offers, broker confirmations, margin, disclosure of broker relationships, and advance notice of corporate actions, as discussed below. See The American Stock Exchange, No-Action Letter (publicly available August 17, 2001). In addition, the SEC has consistently granted equivalent no-action relief to ETFs that are not tied to an index, and has indicated that such ETFs no longer need to submit requests for no-action relief with respect to broker confirmations, margin, and disclosure of broker relationships unless novel or unusual issues are present. See WisdomTree Trust, No-Action Letter (publicly available May 9, 2008).
The SEC also has granted no action relief to ETFs with respect to compliance with Section 13(d) and Section 16 of the Securities Exchange Act, and has indicated that ETFs no longer need to submit requests for no-action relief unless novel or unusual issues are present. See Select Sector SPDR Trust, No-Action Letter (publicly available May 6, 1999), and PDR Services Corporation, No-Action Letter (publicly available December 14, 1998).