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Tuesday,

March 18, 2008

Part III

Securities and
Exchange
Commission
17 CFR Parts 239, 270, and 274
Exchange-Traded Funds; Proposed Rule
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14618 Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules

SECURITIES AND EXCHANGE if e-mail is used. To help us process and 3. Marketing


COMMISSION review your comments more efficiently, 4. Conflicts of Interest
please use only one method. The 5. Affiliated Index Providers
17 CFR Parts 239, 270, and 274 C. Exemptive Relief
Commission will post all comments on
1. Issuance of ‘‘Redeemable Securities’’
[Release Nos. 33–8901; IC–28193; File No. the Commission’s Internet Web site 2. Trading of ETF Shares at Negotiated
S7–07–08] (http://www.sec.gov/rules/ Prices
proposed.shtml). Comments are also 3. In-Kind Transactions Between ETFs and
RIN 3235–AJ60 available for public inspection and Certain Affiliates
copying in the Commission’s Public 4. Additional Time for Delivering
Exchange-Traded Funds Reference Room, 100 F Street, NE., Redemption Proceeds
Washington, DC 20549, on official D. Disclosure Amendments
AGENCY: Securities and Exchange 1. Delivery of Prospectuses to Investors
Commission. business days between the hours of 10 2. Amendments to Form N–1A
ACTION: Proposed rule. a.m. and 3 p.m. All comments received E. Amendment of Previously Issued
will be posted without change; we do Exemptive Orders
SUMMARY: The Securities and Exchange not edit personal identifying IV. Exemption for Investment Companies
Commission (‘‘Commission’’ or ‘‘SEC’’) information from submissions. You Investing in ETFs
is proposing a new rule under the should submit only information that A. Background
Investment Company Act of 1940 that you wish to make available publicly. B. Proposed Rule 12d1–4 Conditions
1. Control
would exempt exchange-traded funds FOR FURTHER INFORMATION CONTACT: 2. Redemptions
(‘‘ETFs’’) from certain provisions of that With respect to proposed rule 6c–11 and 3. Complex Structures
Act and our rules. The rule would amendments to Form N–1A, Dalia 4. Layering of Fees
permit certain ETFs to begin operating Osman Blass, Senior Counsel, or C. Scope of Proposed Rule 12d1–4
without the expense and delay of Penelope Saltzman, Acting Assistant 1. Acquiring Funds and ETFs Eligible for
obtaining an exemptive order from the Director, (202) 551–6792, with respect Relief
Commission. The rule is designed to to proposed rule 12d1–4 and proposed 2. Investments in Affiliated ETFs Outside
eliminate unnecessary regulatory amendments to rule 12d1–2, Adam the Fund Complex
burdens, and to facilitate greater 3. Use of Affiliated Broker To Effect Sales
Glazer, Senior Counsel, or Penelope V. Exemption for Affiliated Fund of Funds
competition and innovation among Saltzman, Acting Assistant Director, Investments
ETFs. The Commission also is (202) 551–6792, Office of Regulatory A. Affiliated Fund of Funds Investments in
proposing amendments to our Policy, Division of Investment ETFs
disclosure form for open-end Management, Securities and Exchange B. Affiliated Fund of Funds Investments in
investment companies, Form N–1A, to Commission, 100 F Street, NE., Other Assets
provide more useful information to Washington, DC 20549–5041. VI. Request for Comment
investors who purchase and sell ETF VII. Paperwork Reduction Act
SUPPLEMENTARY INFORMATION: The
shares on national securities exchanges. VIII. Cost-Benefit Analysis
Commission is proposing for public IX. Consideration of Promotion of Efficiency,
In addition, the Commission is comment new rules 6c–11 [17 CFR Competition and Capital Formation
proposing a new rule to allow mutual 270.6c–11] and 12d1–4 [17 CFR X. Initial Regulatory Flexibility Analysis
funds (and other types of investment 270.12d1–4] and amendments to rule XI. Statutory Authority
companies) to invest in ETFs to a greater 12d1–2 [17 CFR 270.12d1–2] under the Text of Proposed Rules and Form
extent than currently permitted under Investment Company Act of 1940 Amendments
the Investment Company Act. (‘‘Investment Company Act’’ or ‘‘Act’’),1 I. Introduction
DATES: Comments should be received on and amendments to Form N–1A 2 under
or before May 19, 2008. Exchange-traded funds are an
the Investment Company Act and the
increasingly popular investment
ADDRESSES: Comments may be Securities Act of 1933 (the ‘‘Securities
vehicle.4 Last year, the number of ETFs
submitted by any of the following Act’’).3
methods: 4 When we refer to an ETF in this release, we refer
Table of Contents
to an ETF that meets the definition of ‘‘investment
Electronic Comments I. Introduction company’’ and is registered under the Investment
• Use the Commission’s Internet II. Operation of Exchange-Traded Funds Company Act generally because it issues securities
III. Exemptions Permitting Funds to Form and is primarily engaged or proposes to primarily
comment form (http://www.sec.gov/ engage in the business of investing in securities.
and Operate as ETFs
rules/proposed.shtml); or Some other types of exchange-traded funds, which
A. Scope of Proposed Rule 6c–11
• Send an e-mail to rule- 1. Index-Based ETFs we will not discuss in this release, invest primarily
comments@sec.gov. Please include File in commodities or commodity-based instruments,
2. Actively Managed ETFs such as crude oil and precious metal (‘‘commodity
Number S7–07–08 on the subject line; 3. Organization as an Open-End Investment ETFs’’). Commodity ETFs are typically organized as
or Company trusts, and issue shares that trade on a securities
• Use the Federal eRulemaking Portal B. Conditions exchange like other ETFs, but they are not
(http://www.regulations.gov). Follow the 1. Transparency of Index and Portfolio ‘‘investment companies’’ under the Investment
instructions for submitting comments. Holdings Company Act. See section 3(a)(1) (defining the term
2. Listing on a National Securities ‘‘investment company’’ as a company that ‘‘(A) is
Paper Comments Exchange and Dissemination of Intraday or holds itself out as being engaged primarily, or
Value proposes to engage primarily, in the business of
• Send paper comments in triplicate investing, reinvesting, or trading in securities; (B)
to Nancy M. Morris, Secretary, is engaged or proposes to engage in the business of
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1 15 U.S.C. 80a. Unless otherwise noted, all


issuing face-amount certificates of the installment
Securities and Exchange Commission, references to rules under the Investment Company type, or has been engaged in such business and has
100 F Street, NE., Washington, DC Act will be to Title 17, Part 270 of the Code of any such certificate outstanding; or (C) is engaged
20549–1090. Federal Regulations [17 CFR 270], and all references or proposes to engage in the business of investing,
to statutory sections are to the Investment Company reinvesting, owning, holding, or trading in
All submissions should refer to File Act. securities, and owns or proposes to acquire
Number S7–07–08. This file number 2 17 CFR 239.15A, 17 CFR 274.11A.
investment securities having a value exceeding 40
should be included on the subject line 3 15 U.S.C. 77a. per centum of the value of such issuer’s total assets

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Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules 14619

traded in U.S. markets increased by 67 Since they were first developed in the investors (including mutual funds) and
percent, from 357 to 601, and the assets early 1990s, ETFs have evolved. The other investors as part of sophisticated
held by ETFs increased by about 42 first ETFs held a basket of securities that trading and hedging strategies.15 Shares
percent, to approximately $580 billion.5 replicated the component securities of of ETFs can be bought and held
Although aggregate ETF assets are less broad-based stock market indexes, such (sometimes as a core component of a
than seven percent of assets held by as the S&P 500.10 Many of the newer portfolio),16 or they can be traded
traditional mutual funds (i.e., open-end ETFs are based on more specialized frequently as part of an active trading
investment companies),6 they are indexes,11 including indexes that are strategy.17
growing more rapidly.7 designed specifically for a particular Like money market funds first offered
ETFs offer public investors an ETF,12 bond indexes,13 and in the 1970s, ETFs represent a new type
undivided interest in a pool of securities international indexes.14 Originally of registered investment company
and other assets and thus are similar in marketed as opportunities for investors (‘‘fund’’). And like money market funds,
many ways to traditional mutual funds, to participate in tradable portfolio or they have required exemptions from
except that shares in an ETF can be basket products, ETFs are held today in certain provisions of the Act before they
bought and sold throughout the day like increasing amounts by institutional can commence operations.18 Since
stocks on an exchange through a broker-
1992, the Commission has issued 61
dealer.8 ETFs therefore possess shares short, write options on them, and set market,
limit, and stop-loss orders on them. The shares of orders to ETFs and their sponsors.19
characteristics of traditional mutual
funds, which issue redeemable shares, many ETFs often trade on the secondary market at In this release, we propose a new rule
prices close to the net asset value (‘‘NAV’’) of the that would codify the exemptive orders
and of closed-end investment shares, rather than at discounts or premiums.
companies, which generally issue shares 10 See, e.g., SPDR Trust, Series 1, Investment we have issued to ETFs. Proposed rule
that trade at negotiated market prices on Company Act Release Nos. 18959 (Sept. 17, 1992) 6c–11 would allow new competitors
a national securities exchange and are [57 FR 43996 (Sept. 23, 1992)] (notice) and 19055 (i.e., those sponsors who do not already
(Oct. 26, 1992) (order) (‘‘SPDR Order’’); Diamonds have exemptive orders) to enter the
not redeemable.9 Trust, Investment Company Act Release Nos. 22927
(Dec. 5, 1997) [62 FR 65453 (Dec. 12, 1997)] (notice) market more easily. We also are
(exclusive of Government securities and cash items) and 22979 (Dec. 30, 1997) (order). The S&P 500 proposing amendments to our
on an unconsolidated basis.’’). 15 U.S.C. 80a– stands for the Standard & Poor’s 500 Composite registration form for open-end funds,
3(a)(1). Stock Price Index. Form N–1A, to provide more useful
5 Investment Company Institute (‘‘ICI’’), Outline 11 ETF providers offer ETFs that track the

of Supplemental Tables for Exchange-Traded Fund performance of indexes related to particular


information to individual investors who
Report (http://members.ici.org/stats/etfdata.xls industries or market sectors. In 2007, domestic purchase and sell ETF shares on
(‘‘ICI ETF Statistics 2007’’)), Exchange-Traded Fund sector/industry ETFs increased by 62% from 135 to national securities exchanges. Finally,
Assets December 2007, Jan. 30, 2008 (‘‘ICI ETF 219. ICI ETF Assets 2007, supra note 5. we are proposing a new rule to allow
Assets 2007’’). ICI statistics cited in this release may 12 Many of these indexes are essentially portfolios

be found at: http://www.ici.org/stats/etf/index.html of assets that are compiled (and change) on the
funds to invest in ETFs to a greater
and exclude commodity ETFs. By comparison, 153 basis of criteria that the index provider has extent than currently permitted under
ETFs were introduced in 2006, 50 were introduced designed for the particular ETF. Some indexes, for the Act and our rules.
in 2005, and 32 ETFs were introduced in 2004. ICI, example, are ‘‘fundamental’’ indexes or rules-based
2007 Investment Company Fact Book, May 2007. indexes, in which the securities are chosen on 15 David Hoffman, Funds’ grip loosens as ETFs
6 In 2007, net new investment in ETFs was criteria such as dividends and core earnings. See,
approximately $142 billion compared to $212 e.g., PowerShares Exchange-Traded Fund Trust, gain, InvestmentNews, Apr. 28, 2006 (reporting that
billion in traditional mutual funds, or 67 percent of Investment Company Act Release Nos. 25961 (Mar. in 2004, 44% of 821 advisory firms polled by
net new investment in traditional mutual funds. ICI 4, 2003) [68 FR 11598 (Mar. 11, 2003)] (notice) Financial Research Corp. of Boston said they
ETF Statistics 2007, supra note 5; ICI, Trends in (‘‘PowerShares 2003 Notice’’) and 25985 (Mar. 28, collectively allocated an average of 12% of total
Mutual Fund Investing December 2007, Jan. 30, 2003) (order) (‘‘PowerShares 2003 Order’’) assets under management to ETFs as compared with
2008 (‘‘ICI Trends December 2007’’). (PowerShares offers ETFs that mirror custom-built 2003, in which only 34% used ETFs and
7 ICI ETF Assets 2007, supra note 5. As of indexes based on ‘‘Intellidexes,’’ which were collectively allocated an average of 8% of assets
December 2007, assets held by traditional equity created by a quantitative unit of the American Stock under management).
16 See, e.g., iShares Trust, Investment Company
and bond mutual funds were $8.9 trillion. ICI Exchange). A few of the index providers that
Trends December 2007, supra note 6. In 2007, ETF compile and revise the indexes are affiliated with Act Release No. 25969 (Mar. 21, 2003) [68 FR 15010
assets grew 42 percent (from $407.9 billion to the sponsor of the ETF. See, e.g., WisdomTree (Mar. 27, 2003)].
$579.5 billion) while traditional equity and bond Investments, Investment Company Act Release Nos. 17 See Gary L. Gastineau, Exchange-Traded Funds

mutual fund assets grew 9.7 percent (from $8.06 27324 (May 18, 2006) [71 FR 29995 (May 24, 2006)] Manual, 2 (2002) (‘‘Gastineau’’) (ascribing the
trillion to $8.9 trillion). See ICI ETF Statistics 2007, (notice) (‘‘WisdomTree Notice’’) and 27391 (June popularity of ETFs among active traders to high
supra note 5; ICI Trends December 2007, supra note 12, 2006) (order) (‘‘WisdomTree Order’’) trading volume, competitive market makers, and
6. (WisdomTree’s ETFs seek to track the price and active arbitrage pricing.). Morgan Stanley,
8 ETF shares represent an undivided interest in yield performance of domestic and international Exchange-Traded Funds Quarterly Report, Nov. 16,
the portfolio of assets held by the fund. ETFs are equity securities indexes provided by an affiliate). 2006, at 13 (‘‘They can be used by market timers
registered with the Commission and are organized 13 As of December 2007, 49 ETFs track bond wishing to gain or reduce exposure to entire
either as open-end investment companies or unit indexes. ICI, Exchange-Traded Fund Assets markets or sectors throughout the trading day.’’).
investment trusts (‘‘UITs’’). See section 5(a)(1) of December 2007, Jan. 30, 2008. See, e.g., Ameristock 18 See rule 2a–7 under the Act, which codified the

the Investment Company Act (defining ‘‘open-end ETF Trust, Investment Company Act Release Nos. standards for granting the applications filed by
company’’ as a management company that is 27847 (May 30, 2007) [72 FR 31113 (June 5, 2007)] money market funds for exemptions from the
offering for sale or has outstanding any redeemable (notice) (‘‘Ameristock Notice’’) and 27874 (June 26, pricing and valuation provisions of the Act. For a
security of which it is the issuer); section 4(2) of 2007) (order); Vanguard Bond Index Funds, discussion of the administrative history of rule 2a–
the Act (defining ‘‘unit investment trust’’ as an Investment Company Act Release Nos. 27750 (Mar. 7, see Valuation of Debt Instruments and
investment company that (A) is organized under a 9, 2007) [72 FR 12227 (Mar. 15, 2007)] (notice) and Computation of Current Price per Share by Certain
trust indenture, contract of custodianship or 27773 (Apr. 2, 2007) (order); Barclays Global Fund Open-End Investment Companies (Money Market
agency, or similar instrument, (B) does not have a Advisors, Investment Company Act Release Nos. Funds), Investment Company Act Release No.
board of directors, and (C) issues only redeemable 27608 (Dec. 21, 2006) [71 FR 78235 (Dec. 28, 2006)] 12206 (Feb. 1, 1982) [47 FR 5428 (Feb. 5, 1982)].
securities, each of which represents an undivided (notice) (‘‘Barclays High Yield Notice’’) and 27661 19 Since 2000, the Commission has provided ETF
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interest in a unit of specified securities, but does (Jan. 17, 2007) (order). sponsors relief for any ETFs created in the future
not include a voting trust). 15 U.S.C. 80a–5(a)(1). 14 The first international equity ETFs were in connection with their exemptive orders so that
9 ETFs today have certain characteristics that introduced in 1996. As of December 2007, there the sponsors can introduce new ETFs if the ETFs
have made them attractive to investors. Many have were 159 ETFs that provide exposure to meet the terms and conditions contained in the
lower expense ratios and certain tax efficiencies international equity markets. ICI, Exchange-Traded exemptive orders. See, e.g., Barclays Global Fund
compared to traditional mutual funds, and they Fund Assets December 2007, Jan. 30, 2008. Advisors, Investment Company Act Release Nos.
allow investors to buy and sell shares at intra-day International index-based ETFs increased by 87% 24394 (Apr. 17, 2000) [65 FR 21219 (Apr. 20, 2000)]
market prices. Moreover, investors can sell ETF from 85 in 2006 to 159 in 2007. Id. (notice) and 24451 (May 12, 2000) (order).

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14620 Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules

II. Operation of Exchange-Traded The redemption process is the reverse Arbitrage activity in ETF shares is
Funds of the purchase process. The financial facilitated by the transparency of the
All ETFs trading today operate in a institution acquires (through purchases ETF’s portfolio. Each day, the ETF
similar way.20 Unlike traditional mutual on national securities exchanges, publishes the identities of the securities
funds, ETFs do not sell or redeem their principal transactions, or private in the purchase and redemption baskets,
transactions) the number of ETF shares which are representative of the ETF’s
individual shares (‘‘ETF shares’’) at net
that comprise a creation unit, and portfolio.27 Each exchange on which the
asset value (‘‘NAV’’). Instead, financial
redeems the creation unit from the ETF ETF shares are listed typically discloses
institutions purchase and redeem ETF
in exchange for a ‘‘redemption basket’’ an approximation of the current value of
shares directly from the ETF, but only
of securities and other assets.24 An the basket on a per share basis
in large blocks called ‘‘creation
investor holding fewer ETF shares than (‘‘Intraday Value’’) 28 at 15 second
units.’’ 21 A financial institution that
the amount needed to constitute a intervals throughout the day and, for
purchases a creation unit of ETF shares
creation unit (most retail investors) may index-based ETFs, disseminates the
first deposits with the ETF a ‘‘purchase
dispose of those ETF shares by selling current value of the relevant index.29
basket’’ of certain securities and other
them on the secondary market. The This transparency can contribute to the
assets identified by the ETF that day,
investor receives market price for the efficiency of the arbitrage mechanism
and then receives the creation unit in ETF shares, which may be higher or because it helps arbitrageurs determine
return for those assets. The basket lower than the NAV of the shares, and whether to purchase or redeem creation
generally reflects the contents of the pays customary brokerage commissions units based on the relative values of ETF
ETF’s portfolio and is equal in value to on the sale. shares in the secondary market and the
the aggregate NAV of the ETF shares in The ability of financial institutions to securities contained in the ETF’s
the creation unit. After purchasing a purchase and redeem creation units at portfolio.
creation unit, the financial institution each day’s NAV creates arbitrage Arbitrage activity in ETF shares also
may hold the ETF shares, or sell some opportunities that may help keep the appears to be affected by the liquidity of
or all in secondary market market price of ETF shares near the the securities in an ETF’s portfolio.
transactions.22 NAV per share of the ETF. For example, Most ETFs represent in their
Like operating companies and closed- if ETF shares begin trading on national applications for exemptive relief that
end funds, ETFs register offerings and securities exchanges at a price below the they invest in highly liquid securities.30
sales of ETF shares under the Securities fund’s NAV per share, financial
Act and list their shares for trading institutions can purchase ETF shares in domestic indexes is generally less than 2%. See,
under the Securities Exchange Act of secondary market transactions and, after e.g., Vanguard U.S. Stock ETFs, Prospectus 56–59
1934 (‘‘Exchange Act’’).23 As with any (Apr. 27, 2007). ETFs that track foreign indexes may
accumulating enough shares to have a more significant deviation. See, e.g., iShares
listed security, investors may trade ETF comprise a creation unit, redeem them FTSE/Xinhua China 25 Index Fund, Prospectus 19
shares at market prices. ETF shares from the ETF in exchange for the more (Dec. 1, 2006).
purchased in secondary market valuable securities in the ETF’s 27 With respect to index-based ETFs, portfolio

transactions are not redeemable from transparency is enhanced by the transparency of the
redemption basket. Those purchases underlying index. Index providers publicly
the ETF except in creation units. create greater market demand for the announce the components of their indexes. Because
ETF shares, and thus tend to drive up an index-based ETF seeks to track the performance
20 Until recently, all ETFs had an investment
the market price of the shares to a level of an index, often by replicating the component
objective of seeking returns that are correlated to securities of the index, the transparency of the
the returns of a securities index, and in this respect closer to NAV.25 Conversely, if the underlying index results in a high degree of
operated much like traditional index funds. market price for ETF shares exceeds the transparency in the ETF’s investment operations.
Recently, we issued orders approving actively NAV per share of the ETF itself, a Similarly, each of the actively managed ETFs
managed ETFs. See WisdomTree Trust, et al., financial institution can deposit a basket operating under the recent exemptive orders
Investment Company Act Release Nos. 28147 (Feb. approved by the Commission is required to make
6, 2008) [73 FR 7776 (Feb. 11, 2008)] (notice) of securities in exchange for the more public each day the securities and other assets in
(‘‘WisdomTree Actively Managed ETF Notice’’) and valuable creation unit of ETF shares, its portfolio. See Actively Managed ETF Orders,
28174 (Feb. 27, 2008) (order) (‘‘WisdomTree and then sell the individual shares in supra note 20.
Actively Managed ETF’’); Barclays Global Fund the market to realize its profit. These 28 The Intraday Value also is referred to as the
Advisors, et al., Investment Company Act Release Intraday Indicative Value, Indicative Optimized
Nos. 28146 (Feb. 6, 2008) [73 FR 7771 (Feb. 11, sales would increase the supply of ETF Portfolio Value, Indicative Fund Value, Indicative
2008)] (notice) and 28173 (Feb. 27, 2008) (order) shares in the secondary market, and Trust Value, or Indicative Partnership Value.
(‘‘Barclays Actively Managed ETF’’); Bear Sterns thus tend to drive down the price of the 29 National securities exchanges are permitted to
Asset Management, Inc., et al., Investment ETF shares to a level closer to the NAV disseminate this information at 60 second intervals
Company Act Release Nos. 28143 (Feb. 5, 2008) [73 for ETFs that track non-U.S. indexes. See, e.g.,
FR 7768 (Feb. 11, 2008)] (notice) and 28172 (Feb. of the ETF share.26
Commentary .01(b)(2) to NYSE Acra Equities Rule
27, 2008) (order) (‘‘Bear Sterns Actively Managed 5.2(j)(3); Commentary 0.2(a)(C)(c) to American
ETF’’); PowerShares Capital Management LLC, et 24 ETFs sometimes provide cash-in-lieu payments
Stock Exchange Constitution and Rules &
al., Investment Company Act Release Nos. 28140 on some (or all) purchases or redemptions. See infra Arbitration Awards Rule 1000A.
(Feb. 1, 2008) [73 FR 7328 (Feb. 7, 2008)] (notice) notes 120–121 and accompanying text. 30 Index-based ETFs track indexes that have
(‘‘PowerShares Actively Managed ETF Notice’’) and 25 The purchase of the ETF shares on the
specified methodologies for selecting their
28171 (Feb. 27, 2008) (order) (‘‘PowerShares secondary market combined with the sale of the component securities. The methodologies generally
Actively Managed ETF’’ and collectively, ‘‘Actively redemption basket securities also may create ensure that an index consists of securities that will
Managed ETF Orders’’). upward pressure on the price of ETF shares and/ be highly liquid. See, e.g., Barclays High Yield
21 As discussed further below, creation units or downward pressure on the price of redemption Notice, supra note 13 (‘‘The Underlying Index is a
typically consist of at least 25,000 ETF shares. See basket securities, driving the market price and ETF rules-based index designed to reflect the 50 most
infra note 113. NAV closer together. liquid U.S. dollar-denominated high-yield corporate
22 We note that depending on the facts and 26 The institution’s purchase of the purchase
bonds registered for sale in the U.S. or exempt from
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circumstances, broker-dealers that purchase a basket securities combined with the sale of ETF registration.’’). Because index-based ETFs either
creation unit and sell the shares may be deemed to shares also may create downward pressure on the replicate or sample the indexes, their portfolio
be participants in a distribution, which could price of ETF shares and/or upward pressure on the securities also should possess these characteristics.
render them statutory underwriters and subject price of purchase basket securities, driving the The actively managed ETFs also appear to invest in
them to the prospectus delivery and liability market price and the ETF’s NAV closer together. highly liquid securities. See WisdomTree Actively
provisions of the Securities Act. See 15 U.S.C. ETF sponsors and market participants report that Managed ETF, supra note 20 (investing in U.S. and
77b(a)(11). the average deviation between the daily closing foreign money market securities); Barclays Actively
23 15 U.S.C. 78a. price and the daily NAV of ETFs that track Managed ETF, supra note 20 (investing in foreign

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Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules 14621

Effective arbitrage depends in part on rule would codify our previous investment objectives? 35 We note that
the ability of financial institutions to exemptive orders. Our experience is that currently there is substantially more
readily assemble the basket for the conditions included in the index- market interest in ETFs that track broad-
purchases of creation units and to sell based ETF orders have effectively based indexes that are comprised of
securities received upon redemption of preserved the statutory purposes of the highly liquid securities than ETFs that
creation units, and liquidity appears to Act. track more specialized indexes.36 How
be a factor in this process. An ETF’s would liquidity or illiquidity of
The proposed rule would not limit the
investment in less liquid securities may securities or other assets in an ETF’s
types of indexes that an ETF may track
reduce arbitrage efficiency and thereby portfolio affect the ability of financial
or the types of securities that comprise
increase both the likelihood that a institutions to assemble securities for a
deviation between ETF share market any index. Thus, the rule would not
purchase basket and thus the arbitrage
price and NAV per share may occur and limit the exemption to ETFs investing in
mechanism and operation of the ETF?
the amount of any deviation that does liquid securities or assets, although
Would liquidity requirements preclude
occur. existing ETFs generally have
the development of specialty ETFs that
represented to us that their portfolios
III. Exemptions Permitting Funds To serve narrow investment purposes but
are comprised of highly liquid
Form and Operate as ETFs which may satisfy particular investment
securities,33 and, as open-end funds, are
needs of certain investors?
Today we are proposing for public required to comply with the liquidity
comment a new rule that would codify guidelines applicable to all open-end 2. Actively Managed ETFs
much of the relief and many of the funds.34
We recently issued exemptive orders
conditions of orders that we have issued We request comment regarding the to several actively managed ETFs and
to index-based ETFs in the past, and effect of portfolio liquidity on the their sponsors.37 Like our orders,
more recently to certain actively potential for deviation between ETF proposed rule 6c–11 would provide an
managed ETFs. The proposed rule is share market price and NAV and the exemption for an actively managed ETF
designed to enable most ETFs to begin amount of any deviation. In addition to that discloses on its Internet Web site
operations without the need to obtain the liquidity guidelines applicable to all each business day the identities and
individual exemptive relief from the open-end funds, should the Commission weightings of the component securities
Commission. include additional liquidity and other assets held by the ETF.38
A. Scope of Proposed Rule 6c–11 requirements as a condition of the Unlike index-based ETFs, an actively
exemptions? If so, what additional managed ETF does not seek to track the
1. Index-Based ETFs
requirements and why? Should the return of a particular index. Instead, an
Proposed rule 6c–11, like our orders, chance (or likelihood) that substantial actively managed ETF’s investment
would provide exemptions for ETFs that discounts or premiums may occur if an adviser, like an adviser to any
have a stated investment objective of ETF portfolio contains less liquid traditional actively managed mutual
maintaining returns that correspond to securities or assets be a regulatory fund, generally selects securities
the returns of a securities index whose concern for the Commission, or should consistent with the ETF’s investment
provider discloses on its Internet Web it be treated as a material risk to be objectives and policies without regard to
site the identities and weightings 31 of disclosed to prospective investors, a corresponding index.
the component securities and other permitting them to evaluate whether the In 2001, we sought comment on the
assets of the index.32 In this respect, the risk makes the ETF an appropriate concept of an actively managed ETF
investment in light of the investor’s (‘‘2001 Concept Release’’).39 We
money market securities); Bear Sterns Actively
Managed ETF, supra note 20 (investing primarily in requested comment on a broad number
investment-grade fixed income securities); by acquiring a subset of the component securities of questions that we felt were important
PowerShares Actively Managed ETF, supra note 20 of the underlying index, and possibly some to consider before expanding the scope
(investing in large cap companies or U.S. securities that are not included in the
government and corporate debt securities). corresponding index that are designed to help the of the exemptive orders we had issued.
31 Proposed rule 6c–11(e)(9) defines ‘‘weighting of ETF track the performance of the index. See, e.g., We wanted to know how investors
the component security’’ as ‘‘the percentage of the id. would use an actively managed ETF
index’s value represented, or accounted for, by such 33 See supra note 30 and accompanying and
because it seemed that, unlike an
component security.’’ following text. See also WisdomTree Notice, supra
32 Proposed rule 6c–11(e)(4)(v)(B) (defining note 12 at n.8 and accompanying text.
investment in an index-based ETF, an
‘‘exchange-traded fund’’); see infra Section III.B.1 34 Long-standing Commission guidelines have investment in an actively managed ETF
for a discussion of this index transparency required open-end funds to hold no more than 15% could not be used, for example, to
requirement. Index-based ETFs obtain returns that of their net assets in illiquid securities and other implement a hedging strategy. We
correspond to those of an underlying index by illiquid assets. See Statement Regarding ‘‘Restricted questioned whether an actively
replicating or sampling the component securities of Securities,’’ Investment Company Act Release No.
the index. An ETF that uses a replicating strategy 5847 (Oct. 21, 1969) [35 FR 19989 (Dec. 31, 1970)]; managed ETF would provide investors
generally invests in the component securities of the Revisions of Guidelines to Form N–1A, Investment with the same or similar benefits as
underlying index in the same approximate Company Act Release No. 18612 (Mar. 12, 1992) [57
proportions as in the underlying index. See, e.g., FR 9828 (Mar. 20, 1992)]. A fund’s portfolio 35 The Commission is proposing an amendment to
First Trust Exchange-Traded Fund, Investment security is illiquid if it cannot be disposed of in the
Form N–1A that would codify the condition in our
Company Act Release No. 27051 (Aug. 26, 2005) [70 ordinary course of business within seven days at
orders that ETFs disclose the extent and frequency
FR 52450 (Sept. 2, 2005)] (‘‘First Trust Notice’’) at approximately the value ascribed to it by the ETF.
with which market prices have tracked their NAV.
n.1. If, however, there are practical difficulties or See Acquisition and Valuation of Certain Portfolio
See infra notes 169–170 and accompanying text.
substantial costs involved in holding every security Instruments by Registered Investment Companies, 36 See ICI ETF Statistics 2007, supra note 5.
in the underlying index, the ETF may use a Investment Company Act Release No. 14983 (Mar.
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37 See Actively Managed ETF Orders, supra note


representative sampling strategy pursuant to which 12, 1986) [51 FR 9773 (Mar. 21, 1986)] (adopting
it will invest in some but not all of the relevant amendments to rule 2a–7 under the Act); Resale of 20.
38 Proposed rule 6c–11(e)(4)(v)(A); see infra
component securities. An ETF that uses a sampling Restricted Securities; Changes to Method of
strategy includes in its portfolio securities that are Determining Holding Period of Restricted Securities Section III.B.1 for a discussion of this requirement.
designed, in the aggregate, to reflect the underlying under Rules 144 and 145, Investment Company Act 39 See Actively Managed Exchange-Traded Funds,

index’s capitalization, industry, and fundamental Release No. 17452 (Apr. 23, 1990) [55 FR 17933 Investment Company Act Release No. 25258 (Nov.
investment characteristics, and to perform like the (Apr. 30, 1990)] (adopting Rule 144A under the 8, 2001) [66 FR 57614 (Nov. 15, 2001)] (‘‘2001
index. The ETF implements the sampling strategy Securities Act). Concept Release’’).

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14622 Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules

index-based ETFs, including potential could potentially serve as short-term or ETFs with share prices that significantly
tax efficiencies and low expense ratios. long-term investment vehicles, allow deviate from NAV would likely not
Our 2001 Concept Release also asked investors to gain exposure to an asset attract the interest of investors and
more focused questions about the category such as value, growth or would ultimately fail if they did not
structural and operational differences income, and play a significant role in an provide information necessary for
between the two types of ETFs and how investor’s hedging strategies.44 market participants to make
those differences might affect the market Commenters also asserted that actively knowledgeable investment decisions.49
value of ETF shares. We inquired managed ETFs have the potential for Other commenters asserted that it is
whether as a matter of public policy an providing investors benefits similar to important to require that ETFs provide
ETF must be designed to enable efficient index-based ETFs, including low all investors with the same information
arbitrage and thereby minimize the expense ratios and intra-day exchange about portfolio holdings 50 and to
probability that ETF shares would trade trading.45 Other commenters, however, require clear fund disclosures regarding
at a material premium or discount.40 We questioned whether some of the investor the risks associated with the level of
asked, for example, whether actively benefits traditionally associated with transparency provided.51 These
managed ETFs must have the same index-based ETFs would be present commenters stressed the need, however,
degree of portfolio transparency as with actively managed ETFs.46 for sufficient market information to
index-based ETFs, a factor that appeared Commenters agreed that actively
to contribute significantly to arbitrage managed ETFs should be designed, like
would retard efficiency, competition, and capital
efficiency.41 It was unclear to us at that index-based ETFs, with an arbitrage formation.’’); Comment Letter of State Street Bank
time whether an adviser to actively mechanism intended to minimize the and Trust Company, File No. S7–20–01 (Jan. 14,
managed ETFs would be willing to potential deviation between market 2002) (‘‘* * *[A] non-transparent actively managed
provide the same degree of transparency price and NAV of ETF shares.47 Not all ETF will be no worse off than closed-end funds
trading today. In fact, the premium/discount of a
as an adviser to index-based ETFs commenters agreed, however, on non-transparent ETF should be narrower due to the
because, for example, disclosure could whether we should be concerned with ETF’s open-ended qualities.’’); Comment Letter of
allow market participants to access the the extent of premiums or discounts the Vanguard Group, File No. S7–20–01 (Feb. 14,
fund’s investment strategy.42 We were and, therefore, whether we should 2002) (‘‘While [spreads] may be higher for actively
managed ETFs than for index ETFs, we do not
concerned that reduced transparency require full portfolio transparency. believe that the discounts between market price and
could expose arbitrageurs to greater Some asserted that the amount of any NAV will approach those seen in closed-end
investment risk and result in a less discount or premium that might develop funds.’’).
efficient arbitrage mechanism, which in ought not to be a consideration for us in 49 See Comment Letter of State Street Bank and

determining whether to grant exemptive Trust Company, File No. S7–20–01 (Jan. 14, 2002);
turn could lead to more significant see also Comment Letter of the American Bar
premiums and discounts than relief.48 One commenter argued that Association, Committee on Federal Regulation of
experienced by index-based ETFs. Securities, File No. S7–20–01 (Feb. 1, 2002)
44 See, e.g., Comment Letter of the American (‘‘Ultimately it is in the interest of the sponsor and
We received 20 comments from
Stock Exchange LLC, File No. S7–20–01 (Mar. 5, investment adviser to provide for effective arbitrage
market participants, many of which 2002) (‘‘For example, an investor may find that a opportunities. It is unlikely that an actively
supported the introduction of actively particular actively managed ETF more closely managed ETF sponsor would be able to convince
managed ETFs.43 Many commenters tracks his securities holdings, and therefore may be the critical market participants such as specialists,
stated that actively managed ETFs a more effective hedge.’’); Comment Letter of State market makers, arbitragers and other Authorized
Street Bank and Trust Company, File No. S7–20– Participants to support a product that contained
would have the potential to provide 01 (Jan. 14, 2002). One commenter asserted, illiquid securities to a degree that would affect the
investors with uses and benefits similar however, that actively managed ETFs would be of liquidity of the ETF, making it difficult to price,
to index-based ETFs. For example, greater interest to retail investors; institutional trade and hedge, ultimately leading to its failure in
commenters maintained that, like index- investors would not use active fund products for the marketplace.’’).
hedging, cash equitization or other strategies. 50 See, e.g., Comment Letter of the Vanguard
based ETFs, actively managed ETFs Comment Letter of Barclays Global Investors, File Group, File No. S7–20–01 (Feb. 14, 2002)
No. S7–20–01 (Jan. 11, 2002). (‘‘Sponsors of actively managed ETFs should not be
40 Id. at text following n.35. 45 See, e.g., Comment Letter of the American
permitted to provide more information about
41 See supra note 27 and accompanying text. Stock Exchange LLC, File No. S7–20–01 (Mar. 5, portfolio holdings to the exchange specialist and
42 We also noted concerns that full disclosure 2002); Comment Letter of State Street Bank and market makers than they provide to other investors.
could permit market participants to ‘‘front-run’’ Trust Company, File No. S7–20–01 (Jan. 14, 2002). Vanguard believes, as a matter of fundamental
46 One commenter, for example, asserted that an
portfolio trades. See infra text accompanying and fairness, that all investors in a fund must be treated
preceding note 84. In addition, because actively actively managed ETF would likely not experience equally. Providing information only to a favored
managed portfolios likely would change more similar tax efficiency because that is predominantly few is inconsistent with the foundation of our
frequently and in less foreseeable ways than a a function of the low portfolio turnover of index- capital markets—full and fair disclosure to all
portfolio of index-based ETFs, we were unclear how based ETFs. The commenter also noted that actively investors.’’).
or whether an actively managed ETF would managed ETFs are unlikely to have the low 51 See, e.g., Comment Letter of Morgan Stanley &
communicate intra-day portfolio changes to expenses associated with index-based ETFs, which Co., File No. S7–20–01 (May 3, 2002) (‘‘Even if the
investors. See generally, Russ Wermers, The result primarily from lower advisory fees associated Commission were to determine that new forms of
Potential Effects of More Frequent Portfolio with the passive management of those funds. ETFs do pose a significant risk of trading at a
Disclosure on Mutual Fund Performance, Comment Letter of the Vanguard Group, File No. discount or premium to NAV, we do not believe
Investment Company Institute Perspective, June S7–20–01 (Feb. 14, 2002). that the Commission should delay approval of the
2001, Vol. 7, No. 3, at http://www.ici.org/ 47 See, e.g., Comment Letter of the Vanguard
product for this reason. Instead, we would urge the
perspective/per07-03.pdf. (examining the potential Group, File No. S7–20–01 (Feb. 14, 2002); Comment Commission to address any perceived investor risks
effects of more frequent portfolio disclosure on the Letter of Barclays Global Investors, File No. S7–20– by requiring additional risk disclosure.’’); Comment
performance of mutual funds and concluding that, 01 (Jan. 11, 2002). Letter of the Vanguard Group, File No. S7–20–01
with more frequent disclosure, shareholders would 48 See, e.g., Comment Letter of the American Bar (Feb. 14, 2002) (‘‘Investors in an actively managed
likely receive lower total returns on their Association, Committee on Federal Regulation of ETF must receive adequate disclosure about the
investments due to, among other things, front- Securities, File No. S7–20–01 (Feb. 1, 2002) (‘‘We risks associated with the level of the ETF’s
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running and free-riding). believe that the Commission should not mandate transparency (and other risks unique to actively
43 The comment letters to the 2001 Concept the level of transparency in ETFs’ portfolios, but managed ETFs) * * * if the ETF has limited
Release are available for public inspection and rather should allow fully informed demand in the transparency, the fund’s disclosure documents
copying in the Commission’s Public Reference financial markets to determine the proper levels. should discuss the possibility that the spreads
Room, 100 F Street, NE., Washington, DC 20549 Different segments of the market with different between bid and asked prices and between the
(File No. S7–20–01), and are available on the needs might demand investment vehicles with market price and NAV of the fund’s exchange-
Commission’s Internet Web site: (http:// different variation. To prevent market demand from traded shares may be higher than is typically the
www.sec.gov/rules/concept/s72001.shtml.) determining the structure of investment vehicles case of index ETFs.’’).

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Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules 14623

value the fund’s portfolio.52 Others have issued orders approving several of transparent portfolios to rely on the
argued that portfolio transparency is these ETFs.57 As described in these exemptions provided by the proposed
essential to support effective arbitrage.53 applications, an actively managed ETF rule. We only recently approved orders
One commenter asserted that any lack of would operate in the same manner as an to allow certain actively managed ETFs
transparency would negatively impact index-based ETF.58 Each would be and have not had the opportunity to
an ETF’s arbitrage mechanism and registered under the Act as an open-end observe how they operate in the markets
would likely result in ETF shares fund and would redeem shares in over a significant period of time. Should
trading at secondary market prices that creation units in exchange for basket we wait until we have gained greater
do not reflect the value of the ETF’s assets. Each would be listed on a experience with the operation of
underlying portfolio.54 The commenter national securities exchange, and actively managed ETFs before adopting
noted that to the extent an ETF operates investors would trade the ETF shares a final rule applicable to them? Is there
with less than full transparency during throughout the day at market prices in any concern that a fully transparent
periods of market volatility, this would the secondary market.59 The national actively managed ETF would not
likely result in some individual securities exchange typically would facilitate an efficient arbitrage
investors buying or selling ETF shares at disseminate the Intraday Value of ETF mechanism? Would actively managed
secondary market prices moving in the shares at 15-second intervals throughout ETFs provide investors with uses and
opposite direction of the ETF’s NAV. the trading day,60 thereby providing benefits similar to or different than their
The commenter urged us to consider institutional investors and other index-based counterparts? Do these or
carefully the consequence of granting an arbitrageurs the information necessary any other concerns regarding the
exemption that might yield such a to engage in ETF share purchases and operation of a fully transparent actively
result.55 The Investment Company sales on the secondary market, and managed ETF warrant limiting the rule
Institute asserted that to the extent that purchases and redemptions with the to index-based ETFs and considering
all or part of an ETF’s portfolio is not fund, which should help keep ETF exemptions for actively managed ETFs
transparent, it could raise significant share prices from trading at a significant on a case by case basis through the
investor protection concerns including discount or premium.61 Finally, the exemptive applications process? Should
the potential for disparate treatment of actively managed ETFs represent that we consider exemptions for other types
investors and the potential for the ETF they would provide ETF investors with of actively managed ETFs? If so, how
to trade at significant premiums and uses and benefits similar to index-based would the arbitrage mechanism work in
discounts.56 ETFs.62 these ETFs? What kinds of conditions
Today we propose exemptions We believe that permitting fully should we consider in order to facilitate
applicable to both index-based and transparent, actively managed ETFs an arbitrage mechanism?
actively managed ETFs that provide would provide additional investment
portfolio transparency to market 3. Organization as an Open-End
choices for investors and that
participants. The comments we Investment Company
exemptions necessary to permit the
received, together with subsequent operation of these ETFs would be in the Our proposed rule would be available
developments, address the principal public interest and consistent with the only to ETFs that are organized as open-
concerns we raised in the 2001 Concept policies and purposes of the Act. By end funds.63 We have provided similar
Release with respect to actively proposing this rule we are not, however, exemptions to unit investment trusts
managed ETFs. We have received a suggesting that we will not consider (‘‘UITs’’) in the past.64 However,
number of applications from actively applications for exemptive orders for because we have not received an
managed ETFs whose sponsors are actively managed ETFs that do not exemptive application for a new ETF to
interested in offering fully transparent, satisfy the proposed rule’s transparency be organized as a UIT since 2002, there
actively managed ETFs, and recently we requirements. Rather, we are at this time does not appear to be a need to include
proposing to permit fully transparent, UIT relief in the proposed rule.65 We
52 See, e.g., Comment Letter of the American
actively managed ETFs to be offered understand that ETF sponsors prefer the
Stock Exchange LLC, File No. S7–20–01 (Mar. 5,
2002) (asserting that non-transparent actively without first seeking individual open-end fund structure because it
managed ETFs need not disclose the full contents exemptive orders from the Commission. allows more investment flexibility.66 In
of their portfolios ‘‘so long as there is sufficient We request comment on allowing
market information available to value the portfolio 63 Proposed rule 6c–11(e)(4).
or a creation unit (or if different, the Redemption
actively managed ETFs with fully 64 See, e.g., SPDR Order, supra note 10. See supra
Basket) on an intra-day basis so as to facilitate note 8 for a definition of UITs.
57 See Actively Managed ETF Orders, supra note
secondary market trading and hedging.’’); Comment 65 Although two exemptive applications for ETFs
Letter of State Street Bank and Trust Co., File No. 20.
organized as UITs were filed in 2007, the
S7–20–01 (‘‘While the importance of an effective 58 See id. applications were occasioned by the transfer of the
arbitrage mechanism is clear, there are potential 59 See infra notes 88–94 and accompanying text sponsorship from Nasdaq Financial Products
ways to achieve an effective arbitrage mechanism for a discussion of the proposed rule’s condition Services, Inc. to PowerShares Capital Management,
with less than full transparency, and, potentially, that ETF shares be approved for listing and trading LLC and did not result in new ETFs. See BLDRs
with no portfolio transparency. This may be on a national securities exchange. Index Funds Trust, Investment Company Act
accomplished with proper disclosure of an actively 60 See infra notes 92–94 and accompanying text
Release No. 27745 (Feb. 28, 2007) [72 FR 9787 (Mar.
managed ETF’s investment strategy and portfolio for a discussion of the proposed rule’s condition 5, 2007)] (‘‘BLDRs Notice’’); Nasdaq-100 Trust,
characteristics.’’). that ETFs be listed on an exchange that Series 1, Investment Company Act Release No.
53 See, e.g., Comment Letter of Barclays Global
disseminates the Intraday Value of ETF shares on 27740 (Feb. 27, 2007) [72 FR 9594 (Mar. 2, 2007)].
Investors, File No. S7–20–01 (Jan. 11, 2002) (‘‘It is a regular basis. 66 A UIT portfolio is fixed, and substitution of
generally accepted that portfolio transparency is the 61 See supra notes 27–29 and accompanying and
securities may take place only under certain
key to effective arbitrage. Therefore, the most following text. See also Actively Managed ETF circumstances. As a result, an ETF organized as a
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significant issue for the Commission * * * is Orders supra note 20. UIT typically replicates the holdings of the index
whether [actively managed ETFs] would provide 62 See, e.g., In re PowerShares Capital it tracks. By contrast, existing ETFs organized as
the necessary level and frequency of portfolio Management LLC, et al., Fifth Amendment, File No. open-end funds may employ investment advisers
disclosure to support efficient arbitrage.’’). 812–13386, filed Jan. 7, 2008 (‘‘PowerShares and use a ‘‘sampling’’ strategy to track the index.
54 Id.
Actively Managed ETF Application’’), at 12–13 Using a sampling strategy, an investment adviser
55 Id.
(available for public inspection and copying in the can construct a portfolio that is a subset of the
56 Comment Letter of the Investment Company Commission’s Public Reference Room, 100 F Street, component securities in the corresponding index,
Institute, File No. S7–20–01 (Jan. 14, 2002). NE., Washington, DC 20549). Continued

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14624 Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules

addition, unlike an ETF that is a UIT, an when buying and selling their fund Intraday Value, and listing on a national
open-end fund ETF may participate in shares.72 securities exchange.
securities lending programs and has ETFs seeking to register as open-end 1. Transparency of Index and Portfolio
greater flexibility in reinvesting funds under the Act require exemptions Holdings
dividends received from portfolio from these provisions because certain
securities. Of the 601 ETFs in existence To take advantage of the proposed
investors may purchase and sell
as of December 2007, 593 were exemption, an ETF must either (i)
individual ETF shares on the secondary
organized as open-end funds.67 disclose on its Internet Web site each
market at current market prices, i.e., at
business day the identities and
We request comment on whether we prices other than those described in the
weightings of the component securities
should include ETFs organized as UITs ETF’s prospectus or based on NAV. As
and other assets held by the fund, or (ii)
in the definition of ETF under the discussed above, investors (typically
have a stated investment objective of
proposed rule. If so, should they be financial institutions) can purchase and
obtaining returns that correspond to the
subject to the same conditions set forth redeem shares from the ETF at NAV
returns of a securities index, whose
in the proposed rule? only in creation units.73 Because these
provider discloses on its Internet Web
financial institutions can take advantage
B. Conditions site the identities and weightings of the
of disparities between the market price
component securities and other assets of
of ETF shares and NAV, they may be in
ETF sponsors have sought exemptions the index.77 The Web page of the ETF
a different position than investors who
from certain provisions of the Act and or the index provider, as the case may
buy and sell individual ETF shares only
our rules so that they may register ETFs be, must be publicly accessible at no
on the secondary market.74 The
as open-end funds. The principal charge.78 Thus, the proposed rule would
disparities in market price and NAV,
distinguishing feature of open-end allow for an actively managed ETF
however, provide those institutional
funds is that they offer for sale provided that the actively managed ETF
investors with opportunities for
redeemable securities.68 The Act defines discloses its portfolio assets each
arbitrage that would tend to drive the
‘‘redeemable security’’ as any security business day.79
market price in the direction of the We seek comment on these
that allows the holder to receive his or ETF’s NAV to the benefit of retail
her proportionate share of the issuer’s transparency conditions. In particular,
investors.75 we request comment on the proposed
current net assets upon presentation to
Today, we propose a rule with certain provision requiring that an ETF that
the issuer.69
conditions that may permit the ETF tracks an index and does not disclose its
Section 22(d) of the Act prohibits any structure to operate within the scope of portfolio each business day must track
dealer in redeemable securities from the Act without sacrificing appropriate an index whose provider discloses on
selling open-end fund shares at a price investor protection, and is designed to an Internet Web site the component
other than a current offering price be consistent with the purposes fairly securities and other assets of the index
described in the fund’s prospectus.70 intended by the policy and provisions of it tracks.80 Is it necessary for the rule to
Rule 22c–1 under the Act requires the Act.76 Our orders have provided include this option instead of simply
funds, their principal underwriters, and exemptions from the definition of requiring daily portfolio disclosure by
dealers to sell and redeem fund shares ‘‘redeemable security’’ and section 22(d) the ETF? What circumstances, if any,
at a price based on the current NAV and rule 22c–1 for ETFs with an would prevent an index-based ETF from
next computed after receipt of an order arbitrage mechanism that helps disclosing its portfolio holdings? 81
to buy or redeem.71 Together, these maintain the equilibrium between Would Internet Web site disclosure of
provisions are designed to require that market price and NAV. Our proposed portfolio holdings be sufficient? If not,
fund shareholders are treated equitably rule would codify these exemptions what other means of disclosure should
subject to three conditions that appear the ETF or the index provider use?
rather than a replication of the index. The to have facilitated the arbitrage We also seek comment on whether we
investment adviser also may invest a specific mechanism: Transparency of the ETF’s should require ETFs to disclose daily on
portion of the ETF’s portfolio in securities and other
financial instruments that are not included in the
portfolio, disclosure of the ETF’s their Internet Web sites liabilities (as
corresponding index if the adviser believes the well as portfolio holdings) to permit
investment will help the ETF track its underlying 72 See generally, H.R. Rep. No. 2639, 76th Cong., investors, particularly arbitrageurs, to
index. See, e.g., First Trust Notice, supra note 32, 3d Sess., 8 (1940). See also Investment Trusts and evaluate the impact of leverage from
at. n.1. Investment Companies, Report of the Securities and
67 The number of ETFs organized as UITs is based Exchange Commission, H.R. Doc. No. 279, 76th
borrowings on the fund’s portfolio.82
on information in the Commission’s database of Cong., 1st Sess., pt. 3, at 860–874 (1939).
77 Proposed rule 6c–11(e)(4)(v).
Form N-SAR filings. 73 See supra Section II for a discussion on the
68 15 U.S.C. 80a–5(a)(1); see infra notes 109–121 78 Id.
operation of ETFs.
and accompanying text. 74 See, e.g., Comment Letter of Barclays Global 79 See supra discussion at Section III.A.2. An
69 15 U.S.C. 80a–2(a)(32). Investors, File No. S7–20–01 (Jan. 11, 2002) index-based ETF that has the investment objective
70 15 U.S.C. 80a–22(d). (‘‘[D]uring periods of market volatility * * * it is of obtaining returns that correspond to the returns
71 17 CFR 270.22c–1(a). The rule requires that not unreasonable to assume that some retail of multiple securities indexes may rely on the
funds calculate their NAV at least once daily investors would buy or sell ETF shares at secondary proposed rule provided that it discloses its portfolio
Monday through Friday (with certain exceptions, market prices moving in the opposite direction of in the same manner as a fully transparent actively
including days on which no securities are tendered a fund’s NAV.’’). managed ETF.
75 See supra notes 25–26 and accompanying text. 80 The proposed rule defines an ‘‘index provider’’
for redemption and the fund receives no orders to
purchase or sell securities). See 17 CFR 270.22c– 76 Section 6(c) of the Act permits the Commission, to mean the person that determines the securities
1(b)(1). Today, most funds calculate NAV as of the conditionally or unconditionally, to exempt by rule and other assets that comprise a securities index.
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time the major U.S. stock exchanges close (typically any person, security, or transaction (or classes of See proposed rule 6c–11(e)(7).
81 See supra note 27.
at 4 p.m. Eastern Time). Thus, a fund’s NAV persons, securities, or transactions) from any
generally reflects the closing prices of the securities provision of the Act ‘‘if and to the extent that such 82 For example, if an ETF enters into a written call

it holds. Under rule 22c–1, an investor who submits exemption is necessary or appropriate in the public to hedge the fair value exposure of an equity
an order before the 4:00 p.m. pricing time receives interest and consistent with the protection of security in its portfolio, it would sacrifice any
that day’s price, and an investor who submits an investors and the purposes fairly intended by the unrealized gains caused by the price of the equity
order after the pricing time receives the next day’s policy and provisions’’ of the Act. 15 U.S.C. 80a– security increasing above the price at which the call
price. 6(c). may be exercised (i.e. the strike price). Unless the

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Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules 14625

Should we limit such a requirement to Should the proposed rule prohibit enables market makers to engage in the
certain kinds of ETFs that may have advance portfolio disclosure? Would arbitrage activities that determine the
significant liabilities? If so, how should advance portfolio disclosure increase market price for ETF shares.94
we identify the ETFs that would be the likelihood of free-riding or front- We request comment on these two
subject to the condition? running? If so, should the risk that conditions. Should the rule require that
One of the issues we discussed in the participants may engage in these ETF shares be listed on a national
2001 Concept Release was that full activities be treated as a material risk to securities exchange? Should the rule
portfolio transparency could give be disclosed to prospective investors make allowance for shares that are
market participants an ability to access permitting them to evaluate whether the
delisted for a short time, or for
the fund’s market strategies (i.e., ‘‘free- risk makes the ETF an appropriate
riding’’) and, in some cases, the ability suspensions in listing? If an ETF’s
investment in light of the particular
to trade ahead of the ETF (i.e., ‘‘front- shares were not listed for trading on a
investor’s investment objectives? How
running’’).83 Those commenters who national securities exchange (even on a
would advance disclosure affect the
addressed the issue generally agreed arbitrage mechanism? If the portfolio temporary basis), would the ETF
that intra-day or advance portfolio disclosed in advance differed from the structure permit the arbitrage
disclosure may be detrimental to an actual portfolio acquired, would that mechanism to function appropriately?
actively managed ETF because it could affect the market’s ability to price the Should the rule require an ETF to
enable third parties to front-run the ETF’s shares? liquidate or take other steps in the event
fund.84 Therefore, the proposed rule of delisting? Should the proposed rule
2. Listing on a National Securities condition relief on listing exchanges
does not require disclosure of intra-day
Exchange and Dissemination of Intraday disseminating the Intraday Value? If not,
changes in the portfolio of the ETF,
Value are there other means for market makers
because currently, intra-day changes do
not affect the composition of the ETF’s An ETF that relies on rule 6c–11 to receive the Intraday Value? Are there
basket assets until the next trading would need to satisfy two additional alternatives to using the basket as the
day.85 The proposed rule also does not conditions set forth in the paragraph basis for the Intraday Value calculation?
require advance disclosure of portfolio defining ‘‘exchange-traded fund.’’ 88 For example, should the rule require the
trades.86 First, shares issued by the ETF would entity calculating the Intraday Value to
We request comment on these aspects have to be approved for listing and use the ETF’s portfolio (as opposed to
of the proposal. Should the rule require trading on a national securities the basket)? Should the calculation
disclosure of portfolio changes more exchange.89 We have premised our method be prescribed?
often than once a day? How would more previous exemptive orders on the ETF The proposed rule does not require
frequent disclosure affect the arbitrage listing its shares for trading on a the dissemination of an ETF’s Intraday
mechanism? Would more frequent national securities exchange.90 Listing Value at specific intervals because the
disclosure increase the likelihood of on an exchange would provide an rules of national securities exchanges, as
free-riding or front-running? The rule organized and continuous trading approved by the Commission, establish
does not limit ETFs to tracking market for the ETF shares at negotiated the frequency of disclosure.95 Should
specialized indexes that change their prices. Applicants for exemptive relief the rule specify a minimal frequency?
assets at or below a specified frequency. have noted that this intra-day trading, For example, should the rule prohibit an
How might this affect the transparency combined with the arbitrage mechanism ETF from relying on the exemption if it
of the portfolios of ETFs that would rely inherent in the ETF structure, should is listed on an exchange that permits
on index rather than portfolio prevent significant premiums and dissemination at intervals longer than
disclosure? 87 discounts between the market price of the current 15 or 60-second intervals?
ETF shares and the Intraday Value.91
ETF discloses the presence of these and similar
Second, an ETF could rely on the rule 3. Marketing
liabilities, investors may not be able to evaluate the only if a national securities exchange
impact of leverage on the NAV of the ETF. disseminates the Intraday Value at Our exemptive orders included a
83 Market participants could trade ahead of an
regular intervals during the trading condition requiring each ETF to agree
ETF if it disclosed portfolio assets in advance of the day.92 Applications for exemptive relief not to market or advertise the ETF as an
trades, rather than after the assets were acquired. open-end fund or mutual fund and to
84 See, e.g., Comment Letter of the Vanguard
have noted that exchanges typically
Group, File No. S7–20–01 (Feb. 14, 2002); Comment disseminate the Intraday Value every 15 explain that ETF shares are not
Letter of the Investment Company Institute, File No. seconds during trading hours.93 They individually redeemable.96 This
S7–20–01 (Jan. 14, 2002). have also asserted that this regular condition was designed to help prevent
85 Applicants seeking exemptions for actively
dissemination of the Intraday Value retail investors from confusing ETFs
managed ETFs noted that under accounting with traditional mutual funds.
procedures followed by the funds, portfolio trades
made on the prior business day (‘‘T’’) would be
88 Proposed rule 6c–11(e)(4) (defining ‘‘exchange- Similarly, the proposed rule would
booked and reflected in the fund’s NAV on the traded fund’’). require each ETF relying on the rule to
89 Proposed rule 6c–11(e)(4)(iii).
current business day (‘‘T+1’’). See, e.g., identify itself in any sales literature as
WisdomTree Actively Managed ETF Notice, supra 90 See, e.g., HealthShares, Inc., Investment

Company Act Release No. 27553 (Nov. 16, 2006) [71


an ETF that does not sell or redeem
note 20, at n.5. As a result, these funds will not
have to announce trades before they are made. In FR 67404, 67408 (Nov. 21, 2006)] (‘‘HealthShares individual shares, and explain that
addition, the funds will be able to disclose at the Notice’’). investors may purchase or sell
beginning of each trading day the portfolio that will 91 See, e.g., Amended and Restated Application of
individual ETF shares in secondary
form the basis of the NAV calculation at the end Ziegler Exchange Traded Trust, File No. 812–13224, market transactions that do not involve
of the day. Id. filed Dec. 19, 2006 (‘‘Ziegler Application’’), at 10;
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86 See proposed rule 6c–11(e)(4)(v)(A). Under the PowerShares Actively Managed ETF Notice, supra
proposed rule, an ETF could disclose its portfolio note 20. 94 See, e.g., Ziegler Application, supra note 91, at

at the end of the day on which relevant portfolio 92 Proposed rule 6c–11(e)(4)(i). 26–27.
trades occurred (i.e., after the portfolio assets are 93 See, e.g., Van Eck, Van Eck Associates Corp., 95 An ETF’s Intraday Value is disseminated every

acquired) or the beginning of the following day, Investment Company Act Release No. 27283 (Apr. 15 seconds (or 60 seconds in the case of ETFs that
which would eliminate the potential for front- 7, 2006) [71 FR 19214 (Apr. 13, 2006)], at n.3; track foreign indexes). See supra note 29 and
running. PowerShares Actively Managed ETF Notice, supra accompanying text.
87 See supra note 77 and accompanying text. note 20, at n.2. 96 See, e.g., WisdomTree Order, supra note 12.

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14626 Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules

the ETF.97 This condition, like the prior the basket assets, a greater potential for transaction in which the ETF could not
condition in our orders, is designed to conflicts appears to exist. engage directly.104
help prevent retail investors from Commenters generally stated that We request comment on whether it
confusing ETFs with traditional mutual actively managed ETFs would not be would be useful to include a condition
funds. faced with conflicts that are different in the proposed rule reminding ETFs
from those that currently exist for relying on the rule of the prohibitions
We request comment on whether the
actively managed mutual funds.100 One contained in section 48(a) of the Act.
proposed condition is likely to provide
commenter, however, recommended We also request comment on potential
a benefit for investors with respect to
that the Commission impose any conflicts of interest for an ETF’s
ETF marketing and advertising
prohibitions or conditions under the Act investment adviser. Does an adviser to
materials. Are investors confused about that would apply to transactions a fully transparent, actively managed
the distinction between ETFs and directly effected by the adviser on any ETF face different conflicts of interest
traditional mutual funds? Should any transactions effected at the adviser’s from the conflicts of an adviser to a
confusion be addressed through rule discretion.101 The commenter noted traditional mutual fund? If so, what are
requirements? Should the rule require that, for example, an ETF that is those conflicts and how could the rule
ETFs to identify themselves as either prohibited from acquiring a security in address them?
index-based or actively managed ETFs? certain underwritings (under section
5. Affiliated Index Providers
4. Conflicts of Interest 10(f) of the Act) 102 should be prohibited
from circumventing this prohibition by Federal securities laws and the rules
Section 1(b)(2) of the Investment including the security in the ETF’s of national securities exchanges require
Company Act states that the public basket assets. Similarly, an adviser funds and their advisers to adopt
interest and the interest of investors are could attempt to circumvent section measures reasonably designed to
adversely affected when investment 17(a) restrictions on principal prevent misuse of non-public
companies are organized, operated, transactions between a registered fund information.105 Funds are likely to be in
managed, or their portfolio securities are and its affiliates by designating a a position to well understand the
selected, in the interest of directors, security for the basket assets that a potential circumstances and
officers, investment advisers, or other creation unit purchaser would have to relationships that could give rise to the
affiliated persons, and underwriters, purchase from an affiliate of the misuse of non-public information, and
brokers, or dealers rather than in the adviser.103 can develop appropriate measures to
interest of shareholders.98 The operation We have not included a condition in address them. We believe these
of an ETF—specifically, the process in the proposed rule prohibiting an requirements should be sufficient to
which a creation unit is purchased by actively managed ETF’s adviser, directly protect against the abuses addressed by
delivering basket assets to the ETF, and or indirectly, from causing a creation the terms in the exemptive applications
redeemed in exchange for basket unit purchaser to acquire a security for
104 See Lessler v. Little, 857 F.2d 866, 873–874
assets—may lend itself to certain the ETF through a transaction in which
(1st Cir. 1988) (reversing dismissal of a claim that
conflicts for the ETF’s investment the ETF could not engage directly. An principals of a registered investment company and
adviser, which has discretion to specify adviser to an actively managed ETF its adviser had violated sections 17(a)(2) and 48(a)
the securities included in the baskets. already is subject to section 48(a) of the of the Act by purchasing the fund’s assets indirectly
For example, the adviser could direct Act, which prohibits a person from by arranging for sale of the fund to a third party in
conjunction with an arrangement whereby the
creation unit purchasers to purchase doing indirectly, through another adviser obtained excessive interest in the
securities from affiliates of the adviser person, what that person is prohibited transferred assets); SEC v. Commonwealth Chemical
for subsequent presentation to the ETF. by the Act from doing directly. An Securities, 410 F. Supp 1002, 1018 (S.D.N.Y. 1976)
As we noted in the 2001 Concept adviser, therefore, would be prohibited (finding violations of sections 17(a) and 48(a) of the
Act by directors of a registered investment company
Release, these conflicts would appear to from causing an institution that who caused a third party to purchase shares in an
be minimized in the case of an index- transacts directly with the ETF (or any offering underwritten by an affiliated broker-dealer
based ETF because the universe of investor on whose behalf the institution and sold the shares to the registered investment
securities that may be included in the may transact with the ETF) to acquire company).
105 See rule 38a–1 (requiring funds to adopt
ETF’s portfolio generally is restricted by any security for the ETF through a
policies and procedures reasonably designed to
the composition of its corresponding prevent violation of federal securities laws); rule
100 See, e.g., Comment Letter of the American
index.99 We also noted that the same 17j–1 (requiring funds to adopt a code of ethics
Stock Exchange LLC, File No. S7–20–01 (Mar. 5, containing provisions designed to prevent certain
would not appear to be the case for an 2002); Comment Letter of State Street Bank and fund personnel (‘‘access persons’’) from misusing
actively managed ETF. Because the Trust Company, File No. S7–20–01 (Jan. 14, 2002); information regarding fund transactions); Section
adviser to an actively managed ETF Comment Letter of Nuveen Investments, File No. 204A of the Investment Advisers Act of 1940
would have greater discretion to S7–20–01 (Jan. 14, 2002). (‘‘Advisers Act’’) (15 U.S.C. 80b–204A) (requiring
101 Comment Letter of the Investment Company
designate securities to be included in an adviser to adopt policies and procedures that are
Institute, File No. S7–20–01 (Jan. 14, 2002). reasonably designed, taking into account the nature
102 Section 10(f) of the Act prohibits a fund from of its business, to prevent the misuse of material,
97 Proposed rule 6c–11(e)(4)(ii). The term sales
purchasing any security during an underwriting or non-public information by the adviser or any
literature is defined in the proposed rule to mean selling syndicate if a principal underwriter of the associated person, in violation of the Advisers Act
any advertisement, pamphlet, circular, form letter, security is an officer, director, member of an or the Exchange Act, or the rules or regulations
or other sales material addressed to or intended for advisory board, investment adviser, or employee of thereunder); Section 15(f) of the Exchange Act (15
distribution to prospective investors other than a the fund or if any of these persons is an affiliate U.S.C. 78o(f)) (requiring a registered broker or
registration statement filed with the Commission of the principal underwriter. 15 U.S.C. 80a–10(f). dealer to adopt policies and procedures reasonably
under section 8 of the Act. Proposed rule 6c– This section protects fund shareholders by designed, taking into account the nature of the
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11(e)(8). An ETF would have to make similar preventing an affiliated underwriter from placing or broker’s or dealer’s business, to prevent the misuse
disclosures in its prospectus under the proposed ‘‘dumping’’ unmarketable securities in the fund. of material, nonpublic information by the broker or
amendments to Form N–1A. See proposed Item 103 Section 17(a) generally prohibits affiliated dealer or any person associated with the broker or
6(h)(3) of Form N–1A, and infra text accompanying persons of a registered fund (‘‘first-tier affiliates’’) dealer, in violation of the Exchange Act or the rules
note 159. or affiliated persons of the fund’s affiliated persons or regulations thereunder).
98 15 U.S.C. 80a–1(b)(2).
(‘‘second-tier affiliates’’) from selling securities or See, e.g. Rule Commentary .02(b)(i) of American
99 See 2001 Concept Release, supra note 39, at other property to the fund (or any company the Stock Exchange Rule 1000A (requiring ‘‘firewalls’’
Section IV.E.2. fund controls). 15 U.S.C. 80a–17(a). between an ETF and an affiliated index provider).

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Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules 14627

of ETF sponsors that represented they redeemable in creation units only.109 In the same time as practicable for the
would use an affiliated index provider. support of the relief, ETF sponsors have purpose of taking advantage of a
The proposed rule, therefore, does not noted that because the market price of difference in the Intraday Value and the
include terms from previous ETF shares is disciplined by arbitrage current market price of the shares.115
applications that are designed to opportunities, investors in ETF shares The proposed rule also would require
prevent the communication of material generally should be able to sell the an ETF to disclose in its prospectus and
non-public information between the shares in secondary market transactions any sales literature the number of ETF
ETF and the affiliated index provider.106 at approximately their NAV.110 shares for which it will issue or redeem
We request comment on our proposal Proposed rule 6c–11 would deem an a creation unit to alert investors that
to eliminate these terms. Should the equity security issued by an ETF to be they cannot purchase or redeem
rule include any of the terms included a ‘‘redeemable security’’ for purposes of individual ETF shares directly from or
in previous exemptive applications for section 2(a)(32) of the Act.111 This with the ETF.116
affiliated index providers? If so, which provision would permit an ETF to The proposed condition regarding
terms and why? register with the Commission as an creation unit size is intended to require
open-end fund, which the Act defines as ETFs that rely on the proposed rule to
C. Exemptive Relief an investment company that issues choose creation unit sizes that promote
The unique structure of ETFs has redeemable securities,112 even though an arbitrage mechanism and to preclude
required ETF sponsors to seek relief ETF shares are issued and redeemed in ETFs from setting very low or high
from certain provisions of the Act and creation unit aggregations.113 This thresholds, such as one ETF share per
our rules in order to form and operate. approach would provide ETFs with the creation unit or one million ETF shares
Proposed Rule 6c–11 would permit an same relief contained in our exemptive per creation unit. A low creation unit
ETF that meets the conditions of the orders without exempting ETFs from size could, as a practical matter, make
rule to redeem shares in creation unit other requirements imposed under the the use of creation unit redemption
aggregations, to trade at current market Act and our rules that apply to funds irrelevant. The ETF would, in effect, be
prices, to engage in in-kind transactions that issue redeemable securities.114 issuing and redeeming ETF shares like
with certain affiliates and, in certain We request comment on this aspect of a traditional mutual fund, but the shares
circumstances, to pay the proceeds from the proposed rule. Are there differences would trade on an exchange.
the redemption of shares in more than in ETFs and other funds that would Conversely, a high creation unit size
seven days. The proposed exemptions justify not applying any provision of the could reduce the willingness or ability
Act or our rules that applies to funds of institutional arbitrageurs to engage in
would be subject to certain conditions
that issue redeemable securities? creation unit purchases or redemptions.
that are designed to address the
As discussed above, ETFs today Impeding the ability of arbitrageurs to
concerns underlying the statute and
operate with an arbitrage mechanism purchase and redeem ETF shares could
thereby satisfy the requirement that
designed to minimize the potential disrupt the arbitrage pricing discipline,
exemptions from statutory provisions
deviation between the market price and which could lead to more frequent
are in the public interest and consistent
NAV of ETF shares. The proposed rule occurrences of pricing premiums or
with the protection of investors and the
would require that an ETF establish discounts.
purposes fairly intended by the policy We request comment on the proposed
of the Act.107 creation unit sizes the number of shares
requirement for creation unit size,
of which are reasonably designed to
1. Issuance of ‘‘Redeemable Securities’’ which is included in the proposed rule’s
facilitate arbitrage, which is described
definition of ‘‘creation unit.’’ Does the
Our exemptive orders have provided in the proposed definition of creation
requirement that an ETF establish
ETFs with relief from sections 2(a)(32) unit as the purchase (or redemption) of creation unit sizes the number of which
and 5(a)(1) 108 of the Act so that they shares from the ETF with an offsetting is reasonably designed to facilitate
may register under the Act as open-end sale (or purchase) of shares on a arbitrage provide the sponsor or adviser
funds while issuing shares that are national securities exchange at as nearly of the ETF with sufficient guidance in
109 These exemptions are granted under section
setting appropriate thresholds? Should
106 The terms are intended to address the
6(c) of the Act. See supra note 76. we include other elements in our
potential conflicts of interest between the ETF
adviser and its affiliated index provider, and
110 See, e.g., Ziegler Exchange Traded Trust, description of arbitrage, which is
include: (i) All of the rules that govern inclusion Investment Company Act Release No. 27610 (Dec. included in the definition of creation
and weighting of securities in each index are made 22, 2006) [72 FR 163 (Jan. 3, 2007)] (‘‘Ziegler
publicly available; (ii) the ability to change the rules Notice’’); PowerShares Actively Managed ETF 115 Proposed rule 6c–11(e)(3). We note that the
for index compilation is limited and public notice Notice, supra note 20, at text following n.5. Board of Governors of the Federal Reserve defines
111 Proposed rule 6c–11(a). Our orders provided
is given before any changes are made; (iii) ‘‘arbitrage’’ in a similar manner in section 220.6(b)
‘‘firewalls’’ exist between (A) the staff responsible an exemption from sections 2(a)(32) and 5(a)(1) to of Regulation T (‘‘Arbitrage. A creditor may effect
for the creation, development and modification of allow ETFs to redeem securities in creation unit and finance for any customer bona fide arbitrage
the index compilation rules and (B) the portfolio aggregations rather than individually. transactions. For the purpose of this section, the
management staff; (iv) the calculation agent, who is 112 See 15 U.S.C. 80a–5(a)(1).
term ‘‘bona fide arbitrage’’ means: (1) A purchase
responsible for all index maintenance, calculation, 113 ETF creation units have ranged from 25,000 to or sale of a security in one market together with an
dissemination, and reconstitution activities, is not 200,000 ETF shares. See, e.g., PowerShares Actively offsetting sale or purchase of the same security in
affiliated with the index provider, the ETF or any Managed ETF Notice, supra note 20 (creation units a different market at as nearly the same time as
of their affiliates; and (v) the component securities are blocks of 50,000 to 100,000 ETF shares); practicable for the purpose of taking advantage of
of the index may not be changed more frequently ProShares Trust, Investment Company Act Release a difference in prices in the two markets; or (2) A
than on a specified periodic basis. See HealthShares No. 27323 (May 18, 2006) [71 FR 29991 (May 24, purchase of a security which is, without restriction
Notice, supra note 90; WisdomTree Notice, supra 2006)] (notice) (‘‘ProShares Notice’’) (creation units other than the payment of money, exchangeable or
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note 12. are blocks of 25,000 to 50,000 ETF shares); convertible within 90 calendar days of the purchase
107 See 15 U.S.C. 80a–6(c). WisdomTree Notice, supra note 12 (creation units into a second security together with an offsetting
108 15 U.S.C. 80a–2(a)(32) (defining ‘‘redeemable are blocks of 25,000 to 200,000 ETF shares). sale of the second security at or about the same
security’’ as any security the terms of which permit 114 See, e.g., 15 U.S.C. 80a–22; 17 CFR 270.22c– time, for the purpose of taking advantage of a
the holder upon presentation to receive the holder’s 1. In addition, the rules under the Exchange Act concurrent disparity in the prices of the two
proportionate share of the issuer’s current net that apply to redeemable securities issued by a securities.’’). 12 CFR 220.6.
assets, or the cash equivalent); 15 U.S.C. 80a– mutual fund would apply to ETFs. See, e.g., 17 CFR 116 Proposed rule 6c–11(e)(4)(ii); Proposed Item

5(a)(1). 240.15c3–1. 6(h)(3) to Form N–1A.

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14628 Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules

unit? If so, what elements? Should the or delivery of a basket of securities and conditions for when an ETF may require
proposed rule instead require the board other assets. The proposed rule defines or permit cash substitutions? If so, what
of directors of the ETF to make a finding ‘‘basket assets’’ to mean the securities or conditions should be included? Should
that the ETF is structured in a manner other assets specified each business day the rule specify how the ETF would
reasonably intended to facilitate in name and number by the ETF as the announce the composition of the
arbitrage? This finding could require the securities or assets in exchange for basket? For example, should the rule
board, for example, to look at the which it will issue, or in return for mandate that the ETF post the
number of shares in each creation unit which it will redeem, ETF shares.119 information on its Internet Web site?
and the liquidity of the portfolio The rule does not require that the basket Should the rule specify the frequency
securities and other assets. What other mirror the portfolio of the ETF because with which the ETF must announce the
elements, if any, should the board be in some circumstances it may not be composition of the basket? If so, how
required to review in making this practicable, convenient or operationally often?
finding? possible for the ETF to operate on an in-
The proposed rule does not include kind basis.120 The rule, like our orders, 2. Trading of ETF Shares at Negotiated
numerical thresholds for the number of allows an ETF to require or permit a Prices
ETF shares in each creation unit. purchasing or redeeming shareholder to As noted above, section 22(d), among
Should the proposed rule include substitute cash for some or all of the other things, prohibits a dealer from
minimum or maximum numerical securities in the basket assets.121 selling a redeemable security that is
thresholds? If so, what would be We request comment on the proposed being offered currently to the public by
appropriate thresholds and why? For definition of basket assets. Are there any or through an underwriter, except at a
example, should the rule set a minimum reasons why an ETF should not be current public offering price described
of 100 ETF shares, and/or a maximum permitted to substitute cash for some or in the prospectus.122 Rule 22c–1
of 500,000 ETF shares, per creation all of the assets in the basket? Should generally requires that a dealer selling,
unit? Are our concerns with respect to the proposed rule include any redeeming, or repurchasing a
smaller-or larger-sized creation units redeemable security do so only at a
addressed by requiring ETFs to establish 119 Proposed rule 6c–11(e)(1). Under the proposed
price based on its NAV.123 Because
creation unit sizes that facilitate rule, the term ‘‘business day’’ with respect to an
ETF would mean any day that the fund is open for secondary market trading in ETF shares
arbitrage? If the rule does not include business, including any day on which it is required takes place at current market prices, and
any thresholds, would any of the to make payment under section 22(e) of the Act. not at the current offering price
exemptions provided by the proposed Section 22(e) of the Act prohibits registered funds
described in the prospectus or based on
rule be inappropriate for an ETF with from suspending the right of redemption or
postponing the date of payment upon redemption NAV, ETFs have obtained exemptions
smaller-or larger-sized creation units? If of any redeemable security for more than seven from section 22(d) and rule 22c–1.
so, which exemptions? days except for certain periods specified in the The provisions of section 22(d), as
ETF applicants represent that ETF provision. See 15 U.S.C. 80a–22(e). Proposed rule
well as rule 22c–1, are designed to
share prices are disciplined by arbitrage 6c–11(e)(2).
120 The ETF and its adviser may decide to permit prevent dilution caused by certain
opportunities created by the ability to
cash-only purchases of creation units to minimize riskless trading schemes by principal
purchase and redeem creation units at transaction costs or enhance the ETF’s operational underwriters and dealers, and to
NAV on a daily basis.117 Would this efficiency. For example, on a day when a prevent unjust discrimination or
pricing mechanism function differently substantial rebalancing of an index-based ETF’s
portfolio is required, the adviser might prefer to preferential treatment among investors
for smaller-or larger-sized creation
receive cash rather than in-kind securities so that purchasing and redeeming fund
units? Because ETFs charge transaction it has the liquid resources at hand to make the shares.124 The proposed rule would
fees for direct purchases and necessary purchases. If the ETF received in-kind
redemptions from the fund, ETF exempt a dealer in ETF shares from
securities on that day, it might have to sell some
applicants have asserted that the securities and acquire new ones to properly track section 22(d) of the Act and rule 22c–
interests of long-term shareholders its underlying index, incurring transaction costs 1(a) with regard to purchases, sales and
should not be diluted by frequent
that could have been avoided if the ETF had repurchases of ETF shares in secondary
received cash instead. See, e.g., Ziegler Application, market transactions at current market
traders, if those transaction fees supra note 91, at 21–22. For some ETFs that track
accurately reflect the costs to the country-specific equity securities indexes, it is prices.125 As discussed above, we have
fund.118 Are smaller-sized creation units operationally necessary to engage in cash-only provided exemptions from section 22(d)
likely to cause the transaction fees
transactions because of local law restrictions on and rule 22c–1 in our orders because the
transferability of securities. See iShares, Inc., arbitrage function appears to address the
charged by ETFs to be insufficient to Investment Company Act Release Nos. 25595 (May
protect the long-term shareholders in 29, 2002) [67 FR 38684 (June 5, 2002)] (notice) and potential concerns regarding
the event of more frequent purchases 25623 (June 25, 2002) (order) (certain iShares ETFs shareholder dilution and unjust
and redemptions? If so, should an ETF that invest in certain foreign markets currently discrimination that these provisions
effect purchases and redemptions through cash
relying on the proposed exemption be transactions).
122 15 U.S.C. 80a–22(d).
required to take additional measures 121 Proposed rule 6c–11(e)(1). Though the
123 17 CFR 270.22c–1.
designed to protect long-term standard operations of most existing ETFs involve
124 For a complete legislative history of section
shareholder interests from being diluted in-kind purchases and redemptions, the
Commission has consistently permitted the 22(d), see Exemption from Section 22(d) to Permit
by frequent traders? If so, what substitution of cash for certain securities in the the Sale of Redeemable Securities at Prices that
measures? basket assets. See, e.g., WisdomTree Notice, supra Reflect Different Sales Loads, Investment Company
As discussed above, ETFs issue and note 12 at text preceding n.9. In addition, the Act Release No. 13183 (Apr. 22, 1983) [44 FR 19887
redeem shares in creation unit Commission has permitted ETFs that primarily hold (May 10, 1983)]. See also Adoption of Rule 22c–1
financial instruments, cash and cash equivalents in under the Investment Company Act of 1940
aggregations in exchange for the deposit
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their portfolios to operate on a cash-only basis Prescribing the Time of Pricing Redeemable
because of the limited transferability of financial Securities for Distribution, Redemption, and
117 See, e.g., Zeigler Application, supra note 91,
instruments. See, e.g., ProShares Notice, supra note Repurchase and Amendment of Rule 17a–3(a)(7)
at 52–53; see also supra notes 25–26 and 113, at n.2 and accompanying text. See also SPDR under the Securities Exchange Act of 1934
accompanying and preceding text. Lehman Municipal Bond ETF, Prospectus 19–22 Requiring Dealers to Time Stamp Orders,
118 See Zeigler Application, supra note 91, at 23; (Sept. 10, 2007) (ETF generally sells creation units Investment Company Act Release No. 5519 (Oct. 16,
PowerShares Actively Managed ETF Application, for cash only and redeems creation units in-kind 1968) [33 FR 16331 (Nov. 7, 1968)].
supra note 62, at 17–18. only). 125 Proposed rule 6c–11(b).

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were designed to address.126 In We have granted exemptions from reliance on proposed rule 12d1–4 from
addition, secondary market trading sections 17(a)(1) and (a)(2) 130 of the Act relying on proposed rule 6c–11(d) to
should not cause dilution for ETF to allow these first- and second-tier redeem those ETF shares in kind.135
shareholders because those transactions affiliates of the ETF to purchase and We request comment on this proposed
do not directly involve ETF portfolio redeem creation units through in-kind exemption. Does the proposed
assets (the transactions are with other transactions.131 In seeking this relief, exemption raise any risks with regard to
investors, not the ETF), and thus have applicants have submitted that because affiliated transactions with the ETF? If
no direct impact on the NAV of ETF the first- and second-tier affiliates are so, should the exemption include any
shares held by other investors. not treated differently from non- conditions to minimize those risks?
Moreover, to the extent that different affiliates when engaging in purchases Should the relief extend to parties that
prices for ETF shares exist during a and redemptions of creation units, there are affiliated persons of an ETF for other
given trading day, or from day to day, is no opportunity for these affiliated reasons? For example, should a broker-
these variations occur as a result of persons to effect a transaction dealer that is affiliated with the ETF’s
third-party market forces, such as detrimental to the other ETF adviser be allowed to transact in-kind
supply and demand, and not as a result shareholders. The securities to be with the ETF?
of discrimination or preferential deposited for purchases of creation
treatment among purchasers. units and to be delivered for 4. Additional Time for Delivering
We request comment on this proposed redemptions of creation units are Redemption Proceeds
relief. Should the relief also apply to announced at the beginning of each day. Section 22(e) of the Act generally
parties other than dealers in ETF shares? All purchases and redemptions of prohibits a registered open-end
If so, which other parties require similar creation units are at an ETF’s next- investment company from suspending
relief, and why? Do dealers (or others) calculated NAV (pursuant to rule 22c– the right of redemption, or postponing
need relief from other provisions to 1), and the securities deposited or the date of satisfaction of redemption
facilitate transactions in ETF shares on delivered upon redemption are valued requests more than seven days after the
the secondary market? in the same manner, using the same tender of a security for redemption.136
standards, as those securities are valued Some ETFs that track foreign indexes
3. In-Kind Transactions Between ETFs for purposes of calculating the ETF’s
and Certain Affiliates have stated that local market delivery
NAV. cycles for transferring foreign securities
Section 17(a) of the Act generally The proposed rule would permit first-
to redeeming investors, together with
prohibits an affiliated person of a and second-tier affiliates of the ETF to
local market holiday schedules, require
registered investment company, or an purchase and redeem creation units
a delivery process in excess of seven
affiliated person of such person, from through in-kind transactions.132 The
proposed exemption would not, days. These ETFs have requested, and
selling any security to or purchasing any we have granted, relief from section
security from the company.127 however, apply to a specific category of
redemptions that would be addressed in 22(e) so that they may satisfy
Purchases and redemptions of ETF redemptions up to a specified maximum
creation units are typically in-kind new rule 12d1–4, which we also are
proposing today. Section 12(d)(1) of the number of calendar days depending
rather than cash transactions,128 and upon specific circumstances in the local
section 17(a) prohibits these in-kind Act imposes substantial limitations on
the ability of investment companies to markets, as disclosed in the ETF’s
purchases and redemptions by persons prospectus or statement of additional
who are affiliated with the ETF, invest in other investment
companies.133 As discussed in Section information (‘‘SAI’’). Other than in the
including those affiliated because they disclosed situations, these ETFs satisfy
own 5 percent or more, and in some IV of this release, proposed rule 12d1–
4 would permit investment companies redemptions within seven days.137
cases more than 25 percent, of the ETF’s
to acquire shares of ETFs in excess of Section 22(e) of the Act is designed to
outstanding securities (‘‘first-tier
the limitations on those investments prevent unreasonable delays in the
affiliates’’), and by persons who are
under section 12(d)(1) of the Act subject satisfaction of redemptions, and ETF
affiliated with the first-tier affiliates or
to certain conditions intended to sponsors have asserted that the
who own 5 percent or more, and in
address the concerns underlying those requested relief will not lead to the
some cases more than 25 percent, of the
limitations. One of the proposed problems that section 22(e) was
outstanding securities of one or more
funds advised by the ETF’s investment conditions would prohibit investment
adviser (‘‘second-tier affiliates’’).129 companies from redeeming certain ETF 135 The proposed rule would not permit an

shares acquired in reliance on proposed investment company that has acquired ETF shares
in excess of the limits in section 12(d)(1)(A)(i) of the
126 See supra notes 71–7573 and accompanying rule 12d1–4.134 In order to make Act in reliance on proposed rule 12d1–4(a) to rely
text. proposed rule 6c–11 consistent with the on proposed rule 6c–11(d) with regard to the
127 15 U.S.C. 80a–17(a). conditions in proposed rule 12d1–4, we purchase of basket assets (i.e., the purchase of
128 ETFs must comply with the federal securities propose to exclude investment securities identified in the basket when redeeming
laws in accepting and satisfying redemptions with ETF shares). Proposed rule 6c–11(d).
companies that acquire ETF shares in
basket assets, including the registration provisions 136 15 U.S.C. 80a–22(e).

of the Securities Act. See, e.g., Ameristock Notice, 137 In their applications, ETFs acknowledge that
supra note 13, at n.3. than 25 percent of another person’s outstanding no relief obtained from the requirements of section
129 An affiliated person of a fund includes, among voting securities. 15 U.S.C. 80a–2(a)(9). 22(e) will affect any obligations that they may
130 15 U.S.C. 80a–17(a)(1), 80a–17(a)(2).
others: (i) Any person directly or indirectly owning, otherwise have under rule 15c6–1 under the
131 See, e.g., HealthShares Notice, supra note 90,
controlling, or holding with power to vote, five Exchange Act. See, e.g., In re Barclays Global Fund
percent or more of the outstanding voting securities at text following n.10. Advisors, Second Amended and Restated
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132 Proposed rule 6c–11(d).


of the fund; (ii) any person five percent or more of Application, File No. 812–11598, filed May 11,
whose outstanding voting securities are directly or 133 See infra note 194 and accompanying text. 2000 (‘‘Barclays Foreign Application’’), at 76
indirectly owned, controlled, or held with power to 134 As discussed in Section IV.B.2, infra, this (available for public inspection and copying in the
vote by the fund; and (iii) any person directly or condition is designed to prevent a fund that relies Commission’s Public Reference Room, 100 F Street,
indirectly controlling, controlled by, or under on the proposed rule to acquire ETF shares in NE., Washington, DC 20549). Rule 15c6–1 requires
common control with such other person. 15 U.S.C. excess of the limits of section 12(d)(1)(A)(i) from that most securities transactions be settled within
80a–2(a)(3)(A), (B) and (C). A control relationship unduly influencing the ETF by the threat of a large- three business days of the trade date. 17 CFR
will be presumed where one person owns more scale redemption. 240.15c6–1.

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14630 Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules

designed to prevent.138 They have the disclosure be included in any sales in periodic reports. Accordingly, the
represented that the ETF’s SAI would literature of the ETF? Securities Act requires delivery of a
disclose those local holidays (over the The rule would provide relief if the prospectus meeting the requirements of
period of at least one year following the ETF’s basket assets include a foreign section 10(a) to each investor in a
date of the SAI) that are expected to security. Should the rule also provide registered offering.142 The Securities Act
prevent the satisfaction of redemptions relief if an ETF has foreign securities also requires dealers in a security, for a
in seven days and the maximum included in its portfolio and, if so, why? specified period of time after the
number of days needed to satisfy Would actively managed ETFs present registration statement for the security
redemption requests with respect to the any issues with respect to this becomes effective, to deliver a final
foreign securities at issue.139 exemption that do not exist with respect prospectus to purchasers, including to
The delay in satisfying redemption to index-based ETFs? Could the most persons purchasing shares in
requests seems reasonable under the investment adviser to an actively secondary market transactions.143 The
circumstances described by the ETF managed ETF manage the ETF so as to Investment Company Act, however,
sponsors because it is for a limited comply with section 22(e)? requires dealers to continue prospectus
period of time and disclosed to The proposed rule defines ‘‘foreign delivery to investors in open-end funds,
investors. The proposed rule, therefore, security’’ to mean any security issued by including ETFs, which continuously
would codify the relief from section a government or any political offer their securities to the public.144
22(e) of the Act previously provided to subdivision of a foreign country, a
ETFs. If an ETF has a foreign security in national of any foreign country, or a 1. Delivery of Prospectuses to Investors
its basket assets and a foreign holiday corporation or other organization Our orders generally have exempted
prevents timely delivery of the foreign incorporated or organized under the broker-dealers selling ETF shares from
security, the ETF would be exempt from laws of any foreign country, and for the obligation to deliver prospectuses in
the prohibition in section 22(e) against which there is no established United most secondary market transactions.145
postponing the date of satisfaction upon States public trading market as that term
redemption for more than seven days. is used in Item 201 of Regulation S–K 142 15 U.S.C. 77j(a). This is known as a ‘‘final

To rely on this exemption, the ETF under the Exchange Act. Use of the prospectus.’’ In 2005, the Commission adopted rule
phrase ‘‘established United States 172 under the Securities Act which generally deems
would be required to disclose in its SAI final prospectus delivery satisfied when the
the foreign holidays it expects to public trading market’’ is designed to prospectus is filed with the Commission (‘‘access
prevent timely delivery of the foreign limit this relief to ETFs that invest in equals delivery’’). 17 CFR 230.172. The
securities and the maximum number of securities that do not have an active Commission, however, specifically excluded
days it anticipates it would need to trading market in the United States. The registered investment companies from rule 172. See
Securities Offering Reform, Securities Act Release
deliver the foreign securities. Finally, rule does not rely on registration status No. 8591 (July 19, 2005) [70 FR 44722 (Aug. 3,
the delivery would have to take place no because an unregistered large foreign 2005)]. For a detailed discussion on the prospectus
more than 12 calendar days after the private issuer may have an active U.S. delivery requirements and related liabilities with
tender of ETF shares (in a creation market for its securities, in which case respect to open-end investment companies, see
Enhanced Disclosure and New Prospectus Delivery
unit).140 the ETF should be able to meet Option for Registered Open-End Management
We request comment on this relief in redemption requests in a timely Investment Companies, Investment Company Act
the proposed exemption. Is the relief manner.141 Release No. 28064 (Nov. 21, 2007) [72 FR 67790
necessary? We specifically request We request comment on the definition (Nov. 30, 2007)] (‘‘Enhanced Disclosure Proposing
of ‘‘foreign security.’’ Should the Release’’) at sections II.B.1 and II.B.4.
comment from ETFs regarding the 143 Under section 4(3) of the Securities Act,
frequency with which they have relied definition provide any additional dealers must deliver a prospectus in connection
on this exemption. Could an ETF pay exceptions? with original sales by the dealer of securities
cash (as part of the basket assets) in lieu D. Disclosure Amendments
obtained from or through an underwriter, and
of foreign securities in the case of delays resales by the dealer occurring during the 40 days
Congress enacted the federal (90 days for first-time issuers) after the effective
in settlement? Should the relief be date of the registration statement (or, under certain
limited to ETFs that satisfy redemptions securities laws to promote fair and circumstances, a different date). This aftermarket
entirely through in-kind transactions? Is honest securities markets, and an delivery obligation applies to all dealers, whether
the number of days in the proposed rule important purpose of these laws is to or not they participated in the offering itself. 15
sufficient or is it too long? Should the promote full and fair disclosure of U.S.C. 77d(3). See also rule 174 under the Securities
important information by issuers of Act, which provides an exception from the
rule refer to the applicable local requirement in section 4(3) that a prospectus be
market’s settlement cycle without securities to the investing public. The delivered prior to the expiration of the applicable
specifying a number of days? Should the Securities Act and the Exchange Act, as 40-day or 90-day period. 17 CFR 230.174.
disclosure be included in the prospectus implemented by Commission rules and 144 Section 24(d) of the Act eliminates the dealer’s

regulations, provide for systems of exception with respect to securities issued by funds
of the ETF instead of the SAI, which is and UITs on the theory that, because those issuers
only delivered upon request? Should mandatory disclosure of certain material continuously offer their securities to the public, all
information in securities offerings and dealers should be compelled to use the statutory
138 See Investment Trusts and Investment prospectus. See H.R. Rep. No. 1542, 83d Cong., 2d
Companies: Hearings on S. 3580 Before a 141 See Termination of a Foreign Private Issuer’s Sess. 29–30 (1954).
Subcomm. of the Senate Comm. on Banking and Registration of a Class of Securities Under Section 145 Most of the orders have granted exemptions

Currency, 76th Cong., 3d Sess. 291–293 (statements 12(g) and Duty To File Reports Under Section 13(a) from section 24(d) of the Act, which makes
of David Schenker). or 15(d) of the Securities Exchange Act of 1934, inapplicable the dealer exception in section 4(3) of
139 See, e.g., Barclays Foreign Application, supra Securities Exchange Act Release No. 55540 (Mar. the Securities Act to transactions in redeemable
note 137, at 76–84. 27, 2007) [72 FR 16934 (Apr. 5, 2007)] (adopting securities issued by an open-end fund. 15 U.S.C.
140 Proposed rule 6c–11(c). Applicants requesting rule 12h–6 under the Exchange Act, which permits 80a–24(d); 15 U.S.C. 77(d)(3); see, e.g., WisdomTree
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this exemptive relief generally have represented a foreign issuer to terminate its Exchange Act Notice, supra note 12, at n.14. ETFs that have this
that they would be able to deliver redemption registration and reporting obligations regarding a relief continue to be subject to prospectus delivery
proceeds within 12 calendar days. See, e.g., class of equity securities if the average daily trading requirements in connection with sales of creation
WisdomTree Notice, supra note 12. An ETF relying volume (‘‘ADTV’’) of the securities in the United units and other non-secondary market transactions.
on this exemption would disclose the information States has been 5 percent or less of the ADTV of Our most recent orders permitting certain actively
in the SAI. See Item 18 of Form N–1A (requiring that class of securities in the issuer’s principal managed ETFs do not, however, provide this
disclosures regarding purchase, redemption, and trading market during a recent 12-month period, exemption. See Actively Managed ETF Orders,
pricing of shares). regardless of the size of its U.S. public float). supra note 20.

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Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules 14631

Applicants have represented that summary prospectus in secondary exemptive orders to ETFs, they had
broker-dealers would instead deliver a market transactions. We believe the basic investment objectives (to track a
‘‘product description’’ containing basic summary prospectus would contain widely-followed index) and simple
information about the ETF and its material information that may not be investment techniques (investment in
shares.146 Proposed rule 6c–11 would included in a product description, but, all, or a representative sample of, the
not include a similar exemption, and like the product description, would be securities of a widely followed
thus broker-dealers would be required in a form that would be easy to use and index).155 Soon, however, some ETFs
to deliver a prospectus meeting the readily accessible. will be actively managed and have
requirements of section 10(a) of the We request comment on this portfolio managers whose role is
Securities Act to investors purchasing approach. Are we correct in our important to the success of the fund.156
ETF shares.147 understanding that many, if not most, ETF operations, investment objectives,
We understand that many, if not most, broker-dealers deliver a prospectus expenses, and other characteristics may
broker-dealers selling ETF shares in instead of a product description in become more varied as well. Because
secondary market transactions do, in connection with sales of ETF shares in prospectuses contain information in a
fact, transmit a prospectus to secondary market transactions? If so, standardized form prescribed by the
purchasers, and thus they have not why? Commission, the use of these disclosure
relied on the exemptions we have If we were to adopt rule 6c–11 before forms could promote greater uniformity
provided in our orders. More important, the amendments proposed in the in the content and level of disclosure
we believe an exemption allowing Enhanced Disclosure Proposing Release, among ETFs.157 In addition, as
dealers to deliver product descriptions we would expect to permit delivery of discussed below, we are proposing to
would be unnecessary given our a product description in lieu of a amend Form N–1A to include
proposal regarding summary prospectus prospectus, pending final determination additional information relevant to a
disclosure. As discussed below,148 we of that proposal by the Commission. We retail investor in an ETF, who does not
recently proposed amendments to Form request comment on this approach. typically buy or redeem individual
N–1A and to rule 498 under the Should we permit all ETFs, including shares directly from the fund.
Securities Act,149 in order to enhance actively managed ETFs and index-based If we were to retain the prospectus
the disclosures that are provided to ETFs that rely on the rule instead of an delivery exemption for broker-dealers,
mutual fund investors (‘‘Enhanced exemptive order to deliver product should the exemption be limited to
Disclosure Proposing Release’’).150 The descriptions? Should we prescribe the index-based ETFs or only to certain
proposed amendments, if adopted, form of the product description? For index-based ETFs, such as those that
would require key information to appear example, should we propose specific replicate the components of a broad-
in plain English in a standardized order requirements for product descriptions based stock market index? If we were to
at the front of the mutual fund that would provide ETF investors with retain the exemption, should we require
prospectus (‘‘summary section’’).151 A information similar to that received by broker-dealers to deliver prospectuses
person could satisfy its mutual fund traditional mutual fund investors, such instead of product descriptions to
prospectus delivery obligations under as the fee table, name and length of purchasers of actively managed ETF
section 5(b)(2) of the Securities Act by service of the portfolio manager, and shares?
sending or giving this key information return information, as noted above?
directly to investors in the form of a Alternatively, should the product 2. Amendments to Form N–1A
summary prospectus and providing a description conform to the disclosures We are proposing several
prospectus that meets the requirements in the summary section as proposed in amendments to Form N–1A, the
of section 10(a) of the Securities Act Section III.D.2 below? 153 If so, are there registration form used by open-end
(‘‘statutory prospectus’’) on an Internet any additional disclosures to those in management investment companies to
Web site.152 If adopted, broker-dealers the proposed summary section that register under the Act and to offer their
selling ETF shares could deliver a ETFs should be required to include in securities under the Securities Act, to
a product description? Are there any accommodate the use of this form by
146 See, e.g., Ziegler Notice, supra note 110. The disclosures in the proposed summary ETFs. The proposed amendments for
product description provides a summary of the section that ETFs should not be required
salient features of the ETF and its shares, including ETF prospectuses are designed to meet
the investment objectives of the fund, the manner to include in the product description? the needs of investors (including retail
in which ETF shares trade on the secondary market, If we do not adopt the amendments investors) who purchase shares in
and the manner in which creation units are proposed in the Enhanced Disclosure secondary market transactions rather
purchased and redeemed. National securities Proposing Release, we would anticipate
exchanges on which ETFs are listed have adopted than financial institutions purchasing
rules requiring the delivery of product descriptions. that dealers in ETF shares will creation units directly from the ETF.
See, e.g., American Stock Exchange Rules 1000 and nevertheless continue their current We request comment on our proposal
1000A. practice of delivering prospectuses to to amend Form N–1A to meet the needs
147 15 U.S.C. 77j(a). This prospectus delivery
investors. We request comment on of secondary market investors. Is this
requirement would apply to all ETFs, including
ETFs operating under current exemptive orders. whether the rule should require dealers
Therefore, we propose to amend orders we issued to deliver prospectuses instead of 155 See supra note 10 and accompanying text.
to open-end ETFs to exclude the section 24(d) product descriptions.154 ETFs are 156 The investment objectives and techniques of
exemption we have issued to existing ETFs. See becoming more like traditional mutual index-based ETFs also have become more complex.
infra Section III.E for a discussion of this proposed Some ETFs today follow specialized or custom-
amendment to existing orders. funds in several respects. As discussed
designed indexes; others are leveraged through use
148 See infra notes 176–185 and accompanying above, when we began issuing of futures contracts and other types of derivative
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text. instruments.
149 17 CFR 230.498. 153 See infra notes 175–189 and accompanying 157 Certain disclosures required by Form N–1A
150 See Enhanced Disclosure Proposing Release,
text. that generally are not included in product
supra note 142. 154 For a discussion of the additional burdens descriptions may be important to some investors
151 See id., at Section II.A.
associated with the requirement that broker-dealers given the evolution of ETFs. Product descriptions
152 15 U.S.C. 77j(a). The fund also would be deliver prospectuses in secondary market do not, for example, include a fee table itemizing
required to provide additional information on its transactions involving ETF shares, see infra the ETF’s expenses, or the name and length of
Web site. See Proposed rule 498(c). discussion at Section VIII. service of the portfolio manager.

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14632 Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules

distinction we propose to draw between Item 6 currently requires and which we the fund’s NAV and better relate to an
purchasers of shares in secondary propose to eliminate. Should we amend ETF investor’s experience in the fund.
market transactions and purchasers of the SAI to include the disclosure We request comment on whether use
creation units from the fund requirements we are proposing to of market prices, in addition to NAV,
appropriate? Should we instead revise eliminate from Item 6? Should we would provide secondary market
Form N–1A to include the additional require that the information in the SAI purchasers of ETF shares with
disclosure (as discussed below) we are regarding the purchase of creation units meaningful information on their
proposing today for secondary market also specify associated fees and investments. Alternatively, should we
investors without eliminating (as expenses? As an alternative, should we require returns to be computed solely
discussed below) certain disclosures require purchase and redemption using market prices? Would investors
relevant to creation unit purchasers? information and associated fees and find it confusing to have fund returns
Would secondary market investors be expenses to remain in Item 3 and Item presented using both market price and
confused if Form N–1A included 6 only for prospectuses provided to NAV? Should we limit this amendment
disclosure relevant to both types of investors purchasing creation units, to ETFs with creation units of 25,000
investors? such as in the form of a supplementary shares or more because more retail
Purchasing and Redeeming Shares. prospectus? investors may be able to transact
We propose to amend Item 6 of Form N– The proposed alternative disclosures directly with the ETF in the event of
1A to eliminate the requirement that in Items 3 and 6 would not be available, smaller creation units?
ETF prospectuses disclose information however, to ETFs with creation units of For purposes of determining ETF
on how to buy and redeem shares of the less than 25,000 shares because more returns, we would define ‘‘market
ETF because it is not relevant to retail investors would be able to transact price’’ as the last price at which ETF
secondary market purchasers of ETF directly with an ETF that has smaller- shares trade on their principal U.S.
shares.158 Instead ETF prospectuses sized creation units. trading market during a regular trading
would simply state the number of shares We request comment on whether the session (i.e. closing price).164 Is this an
contained in a creation unit (i.e. the exemptions we are providing from Items appropriate definition for market price,
amount of shares necessary to redeem 3 and 6 of Form N–1A should be based or should we instead (or in addition)
with the ETF) and that individual shares on the size of the creation unit, and define the market price as the mid-point
can only be bought and sold on the whether 25,000 shares per creation unit price between the highest bid and the
secondary market through a broker- is an appropriate threshold. Should it be lowest offer on the principal U.S.
dealer.159 Similarly, we also would higher or lower? Should we instead market on which the ETF shares are
amend Item 3 to exclude from the fee adopt a threshold based on the value of traded, at the time the fund’s NAV is
table fees and expenses for purchases or shares rather than the number of shares? calculated? 165
sales of creation units.160 Instead, the Total Return. We propose to modify Premium/Discount Information. We
proposed amendment would require an instructions to several items that require propose to require that each ETF
ETF to modify the narrative explanation the use of the ETF’s NAV to determine disclose to investors information about
preceding the example in the fee table its return. In addition to returns based the extent and frequency with which
to state that individual ETF shares are on NAV, ETFs also would be required market prices of fund shares have
sold on the secondary market rather to include returns based on the market tracked the fund’s NAV.166 This
than redeemed at the end of the periods price of fund shares.163 As discussed disclosure, which would be required on
indicated, and that investors in ETF above, returns based on market price the fund’s Internet Web site and
shares may be required to pay brokerage may be different than returns based on included in its prospectus, is a
commissions that are not reflected in condition to relief in ETF exemptive
the fee table.161 163 We propose to amend the average annual orders.167 Proposed rule 6c–11 also
We request comment on our return table to include a separate line item for would require each ETF to disclose on
assumption that investors (including returns based on the market price of ETF shares. its Internet Web site the prior business
most individual investors) purchasing Proposed Instruction 5(a) to Item 2(c)(2) of Form N– day’s last determined NAV, the market
their shares in secondary market 1A. This would codify, with modifications, a
condition in ETF exemptive orders. See, e.g.,
transactions do not need to know Ziegler Notice, supra note 110. The condition in our
164 Proposed definition of ‘‘Market Price’’ in

information on how creation units are exemptive orders did not specify the location of the General Instruction A of Form N–1A. We consider
purchased and redeemed, or the disclosure in the prospectus. As a result, ETFs the closing price to be the strongest indicator of
include an additional table in the prospectus, rather market value. See Codification of Financial
payment of transaction fees by investors Reporting Policies, Section 404.03.b.ii, ‘‘Valuation
than including market price returns in the average
purchasing or redeeming creation units. annual returns table required by Item 2. In addition, of Securities—Securities Listed for Trading on a
If they do need this information, why? ETFs use different time periods for the disclosure, National Securities Exchange,’’ reprinted in SEC
ETFs would still be required to with some using calendar years and others fiscal Accounting Rules (CCH) ¶ 38,221 (‘‘ASR 118’’), at
years. The proposed amendment would eliminate 38, 424–38, 425. See also Fair Value Measurements,
include disclosure on how creation Statement of Financial Accounting Standards No.
use of a second table, which may confuse investors.
units are offered to the public in the It also would standardize the reporting period by 157, § 24 (Fin. Accounting Standards Bd. 2006)
SAI.162 We are not proposing to amend requiring all ETFs to present the information using (‘‘FASB 157’’) (‘‘[A] quoted price in an active
this disclosure to include information calendar years. market provides the most reliable evidence of fair
value and shall be used to measure fair value
on creation unit redemption, which We also propose to amend the financial
whenever available.’’).
highlights table to require ETFs to calculate total
165 In circumstances where closing price may be
158 Proposed return at market prices in addition to returns at
Item 6(h)(1) of Form N–1A. less accurate because the last trade occurred at a
159 Proposed
NAV. This proposed amendment would provide
Item 6(h)(3) of Form N–1A. secondary market investors with more pertinent much earlier point in the day than NAV calculation,
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160 Proposed Instruction 1(e)(i) to Item 3 of Form some ETFs have used the mid-point price, rather
information as to the effect of market price
N–1A. movements on their investments. Proposed than the closing price. See, e.g., Claymore
161 Proposed Instruction 1(e)(ii) to Item 3 of Form
Instruction 3(f) to Item 8(a) of Form N–1A. Under Exchange-Traded Fund Trust, Investment Company
N–1A. We also are proposing a conforming the proposed amendment, ETFs would be required Act Release No. 27469 (Aug. 28, 2006) [71 FR 51869
amendment to the fee table in ETF annual and to include two bar charts under Item 2 of the form; (Aug. 31, 2006)].
semi-annual reports. Proposed Instruction 1(e) to one using market price returns and one using NAV 166 Proposed Item 6(h)(4) to Form N–1A.

Item 22(d) of Form N–1A. returns. See Instruction 1(a) to Item 2(c)(2) of Form 167 See, e.g., WisdomTree Notice supra note 12;
162 Item 18(a) of Form N–1A. N–1A. Zeigler Notice supra note 110.

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closing price of its shares and the intervals during trading hours. We rather than a benchmark index.173 This
premium/discount of the closing price request ETF sponsors commenting on amendment would permit use of a
to NAV.168 This disclosure is designed this condition of the rule to provide us narrow-based or affiliated index and
to alert investors to the current with data regarding the frequency with eliminate the opportunity for an index-
relationship between NAV and the which visitors to their Internet Web based ETF to select an index different
market price of the ETF’s shares, and sites access this information. In addition from its underlying index which should
that they may sell or purchase ETF to current premium/discount better reflect whether the ETF’s
shares at prices that do not correspond information, should we also require ETF performance corresponds to the index
to the NAV of the fund. Web sites to provide historical the performance of which it seeks to
Proposed Item 6(h)(4) of Form N–1A premium/discount information as is track.174
would require disclosure in the ETF currently required by exemptive orders? We request comment on whether it is
prospectus of the number of trading If the Web site includes historical appropriate to require an index-based
days, during the most recently premium/discount information, should ETF to compare its performance to its
completed calendar year and quarters the rule also require historical underlying index. Should an index-
since that year, on which the market information in Form N–1A? If so, over based ETF that tracks an index
price of the ETF shares was greater than what periods? compiled by an affiliated index provider
the fund’s NAV and the number of days Periodic Report Information. We are use a benchmark index instead of, or in
it was less than the fund’s NAV proposing conforming amendments to addition to, its underlying index?
(premium/discount information).169 In ETF return information in ETF annual Should an index-based ETF that tracks
addition to alerting investors that the reports. The proposed amendments a fundamental or other custom-designed
ETF’s NAV and share price may differ, would require each ETF to use the index use a benchmark index instead of,
this disclosure also would provide market price of fund shares in addition or in addition to, its underlying index?
historical information regarding the to NAV to determine its return,171 and Summary Prospectus. As noted above,
frequency of these deviations. In light of include a table with premium/discount we recently issued the Enhanced
the historical premium/discount information for the five recently Disclosure Proposing Release, which
disclosure in the ETF prospectus and in completed fiscal years.172 would require key information to appear
order to avoid duplicative disclosures We request comment on whether it is in plain English in a summary section
that may result in additional regulatory necessary to include similar disclosure of the prospectus.175 In addition, a
burdens, proposed rule 6c–11, unlike in both the prospectus and annual person could satisfy its mutual fund
the exemptive orders, would not require report of an ETF. Should ETFs that delivery obligations under section
ETFs to include historical premium/ provide this information on their 5(b)(2) of the Securities Act by
discount information on their Internet Internet Web sites be exempt from this delivering the summary prospectus to
Web sites. annual report requirement? Is it investors and providing a statutory
We request comment on whether necessary for the ETF to provide prospectus on an Internet Web site.
daily and historical premium/discount premium/discount data for the most Upon request, a fund also would be
information, which ETFs currently recently completed five fiscal years? required to send the statutory
provide, is useful to investors. One Should the reporting period conform to prospectus to the investor.176
commenter to the 2001 Concept Release that proposed under Item 6 of the form As proposed, the summary section
suggested that investors need not (i.e., one calendar year and most recent would include certain key information,
receive premiums/discounts against quarters since that year)? which also would comprise the
NAV disclosure because the more useful We also are proposing to amend the information in the summary prospectus.
information is the Intraday Value of the prospectus and annual report This key information would include: (i)
fund’s basket as disseminated by requirements of Form N–1A to require Investment objectives; 177 (ii) costs; 178
national securities exchanges at regular an index-based ETF to compare its
intervals.170 This information, according performance to its underlying index 173 Proposed Instruction 5(b) to Item 2(c)(2) of

to the commenter, provides investors Form N–1A; Proposed Instruction 12(c) to Item
with contemporaneous pricing of the 171 Proposed Instruction 12(b) to Item 22(b)(7) of 22(b)(7) of Form N–1A.
174 Item 2(c)(2)(iii) of Form N–1A; Instruction
fund’s portfolio and enables the investor Form N–1A. This proposed disclosure would be
12(c) to Item 22(b)(7) of Form N–1A. The form
to see, at the time his order is entered, identical to proposed Instruction 5(a) to Item 2(c)(2)
of Form N–1A. See supra note 163. We also are requires use of a broad-based index and prohibits
whether the Intraday Value is close to proposing to require ETFs to include a new line use of affiliated indexes unless widely used and
(or between) the bid-asked price. graph comparing the initial and subsequent account recognized. Our amendment would require ETFs
We request comment on whether values using market price, following the line graph that track narrow, custom indexes or affiliated
using NAV required by Item 22(b)(7)(ii)(A) of Form indexes, to use the underlying index when
investors need premium/discount presenting this return information.
N–1A. Proposed Instruction 12(a) to Item 22(b)(7)
disclosure in light of the dissemination of Form N–1A. Consistent with the amendments
175 See supra notes 148–152 and accompanying

of the ETF’s Intraday Value at regular proposed above, this proposed amendment also is text. References to Form N–1A amendments in the
designed to provide individual investors with the Enhanced Disclosure Proposing Release, supra note
168 Proposed rule 6c–11(e)(4)(iv). effect of market price fluctuations on their 142, are to the ‘‘proposed summary prospectus.’’
176 See Enhanced Disclosure Proposing Release,
169 Consistent with current orders, ETFs would be investment.
required to present premiums or discounts as a 172 Proposed Item 22(b)(7)(iv) of Form N–1A. supra note 142, at Section II.B (proposed rule 498
percentage of NAV. They also would be required to Although similar to the proposed disclosure under the Securities Act).
177 See id., at n.43 and accompanying text
explain that shareholders may pay more than NAV amendment to the shareholder information in Item
when purchasing shares and receive less than NAV 6 of the form, this proposed disclosure would span (proposed summary prospectus Item 2 of Form N–
when selling, because shares are bought and sold a longer, and different, reporting period: five fiscal 1A). This is the same information required by
at market prices. Proposed Instructions 2, 3 to Item years instead of the most recent calendar year and current Item 2(a) of Form N–1A.
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6(h)(4) of Form N–1A. In addition, the amendments quarter(s). See Proposed Item 6(h)(4) of Form N–1A. 178 See id., at nn.44–55 and accompanying text

also would require each ETF to identify the trading The proposed amendment would require fiscal year (proposed summary prospectus Item 3 of Form N–
symbol(s) and principal U.S. market(s) on which disclosure to conform to currently required 1A). This information would be substantially the
the shares are traded. Proposed Item 6(h)(2) of Form disclosure in Item 22(b)(7). We are also proposing same as that required by current Item 3 of Form N–
N–1A. to include instructions similar to those proposed in 1A (the risk/return summary fee table and
170 See Comment Letter of Nuveen Investments, Item 6 to assist funds in meeting this proposed example), except for proposed amendments that
File No. S7–20–01 (Jan. 14, 2002). See also disclosure obligation. Proposed Instructions to Item would: (i) Require funds that offer discounts on
Gastineau, supra note 17, at 230–241. 22(b)(7)(iv) of Form N–1A. Continued

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14634 Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules

(iii) principal investment strategies, information is drawn largely from the proposed summary prospectus Item 4,
risks, and performance; 179 (iv) the current risk/return summary and rule which includes the risk/return
fund’s top ten portfolio holdings as of 498 fund profile.184 In addition, the summary, bar chart and table; 187 and
the end of its most recent calendar summary prospectus would be required (iii) premium/discount information
quarter; 180 (v) identity of investment to include on the cover page or at the would be included in proposed
advisers and portfolio managers; 181 (vi) beginning: (i) The fund’s name and the summary prospectus Item 7 (purchase
brief purchase and sale and tax share classes to which the summary and sale information).188 We also would
information; 182 and (vii) financial prospectus relates; (ii) a statement permit ETFs to exclude proposed
intermediary compensation.183 This identifying the document as a information regarding the purchase and
‘‘summary prospectus’’; (iii) the sale of creation units consistent with
front-end sales charges for volume purchases (i.e. approximate date of the summary our proposal today.189
breakpoints) to include a brief narrative disclosure prospectus’s first use; and (iv) the We request comment on whether
alerting investors to the availability of those ETFs should send or give the proposed
discounts; (ii) revise the parenthetical following the
following legend:
heading ‘‘Annual Fund Operating Expenses’’ to Before you invest, you may want to review additional items in the summary
read ‘‘ongoing expenses that you pay each year as the Fund’s prospectus, which contains more prospectus. If so, should any
a percentage of the value of your investment’’ in information about the Fund and its risks. You information from the statutory
place of ‘‘expenses that are deducted from Fund can find the Fund’s prospectus and other prospectus, in addition to the items that
assets’’; (iii) require funds to add brief disclosure
information about the Fund online at [_____]. we are proposing today, be included in
regarding portfolio turnover immediately following
the fee table example; and (iv) permit funds to You can also get this information at no cost the summary section of an ETF’s
include additional captions directly below the by calling [_____] or by sending an e-mail prospectus and, therefore, in its
‘‘Total Annual Fund Operating Expenses’’ caption request to [_____ ].185
summary prospectus? Should ETFs not
in cases where there were expense reimbursement If adopted, the amendments to Form
or fee waiver arrangements that reduced fund
be required to include certain items in
operating expenses and that will continue to reduce N–1A and rule 498 proposed in the the summary section? For example, in
them for no less than one year from the effective Enhanced Disclosure Proposing Release light of the transparency of portfolio
date of the fund’s registration statement. would require open-end ETFs to include holdings of an ETF, should ETFs not
179 See id., at nn.56–57 and accompanying text
the summary section in their have to include the top ten portfolio
(proposed summary prospectus Item 4 of Form N–
1A). This would include the same information
prospectuses and permit persons to holdings? Should ETFs be permitted or
required by current Items 2(b) and (c) of Form N– satisfy their prospectus delivery required to locate any of the specific
1A. obligations by sending or giving the disclosures proposed in this release or
180 See id., at nn.58–66 and accompanying text
summary prospectus and providing the in the Enhanced Disclosure Proposing
(proposed summary prospectus Item 5 of Form N– statutory prospectus on an Internet Web Release elsewhere in the prospectus
1A). This information currently is not required in
a fund’s prospectus. The proposal would allow site in the manner set forth in the outside the summary section?
funds to list an amount not exceeding five percent proposed rules. Today, we also propose
E. Amendment of Previously Issued
of the total value of the portfolio holdings in one that, if the Enhanced Disclosure
amount as ‘‘Miscellaneous securities’’ provided Exemptive Orders
Proposing Release is adopted, ETFs
certain specified conditions are met. Id. at n.66 and As discussed above, our orders have
accompanying text (proposed Instruction 3 to include in the summary section of their
proposed summary prospectus Item 5 of Form N– prospectuses, and in their summary exempted ETFs from compliance with
1A). prospectuses, the additional proposed section 24(d) of the Act to relieve
181 See id., at nn.67–72 and accompanying text
disclosures discussed above. dealers from delivering prospectuses to
(proposed summary prospectus Item 6 of Form N– investors in secondary market
1A) (proposing that a fund disclose the name of
Specifically, we would modify the
each investment adviser and sub-adviser of the amendments proposed in the Enhanced transactions. We are proposing today
fund, followed by the name, title, and length of Disclosure Proposing Release to include not to include such an exemption in
service of the fund’s portfolio managers). This our proposed amendments to ETF rule 6c–11 to ensure that broker-dealers
information is similar to disclosures required by
disclosures as follows: (i) Our proposed are subject to the same delivery
current Item 5 of Form N–1A. Certain additional requirements with respect to all
disclosures regarding investment advisers and amendments regarding disclosures
portfolio managers that are currently required in the about creation units and the purchase ETFs.190 In addition, we are proposing
statutory prospectus would continue to be required and sale of individual ETF shares would amendments to Form N–1A that would
in the statutory prospectus, but not in the summary
section. See id., at n.68.
be included in proposed summary
187 Our proposed instructions 5(a) and (b) to the
182 See id., at nn.73–74 and accompanying text prospectus Item 7, which would require
risk return bar chart and table (current Item 2(c)(2)
(proposed summary prospectus Item 7 of Form N– brief purchase and sale information; 186 of Form N–1A), see note 163 and accompanying
1A) (proposing that a fund disclose minimum (ii) the additional information on market and following text, would be added to the end of
initial or subsequent investment requirements, the price returns would be included in the proposed instructions to proposed summary
fact that the shares are redeemable, and identify the prospectus Item 4.
procedures for redeeming shares (e.g., on any 188 The disclosure in our proposed Item 6(h)(4) to
business day by written request, telephone, or wire related services, and state that these payments may Form N–1A, see notes 167–169 and accompanying
transfer)), and nn.75–76 and accompanying text influence the broker-dealer or other intermediary and following text, would be included at the end
(proposed summary prospectus Item 8 of Form N– and the salesperson to recommend the fund over of proposed summary prospectus Item 7 of Form N–
1A) (proposing that a fund state, as applicable, that another investment). 1A. Our proposed amendments to the financial
184 Registrants would not be permitted to include
it intends to make distributions that may be taxed highlights (current Item 8 of Form N–1A) and the
as ordinary income or capital gains or that the fund any additional information in the summary section. financial statements (current Item 22 of Form N–
intends to distribute tax-exempt income, and See id., at n.37 and accompanying text (proposed 1A) would be included in the proposed summary
proposing that a fund that holds itself out as summary prospectus General Instruction C.3.(b) of prospectus Items 14 and 28 of Form N–1A,
investing in securities generating tax-exempt Form N–1A). respectively.
income provide, as applicable, a general statement 185 See id., at n.98 and accompanying text 189 ETFs would be permitted to exclude from the
to the effect that a portion of the fund’s (proposed rule 498(b)(1) under the Securities Act). fee table (current Item 3 and proposed summary
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distributions may be subject to federal income tax). 186 The disclosures in our proposed Items 6(a)(1), prospectus Item 3 of Form N–1A) the fees and
183 See id., at nn.77–78 and accompanying text 6(h)(2) and 6(h)(3) to Form N–1A would be expenses associated with creation unit purchases
(proposed summary prospectus Item 9 of Form N– included in proposed summary prospectus Item 7 and redemptions and would be permitted to
1A) (proposing that a fund provide disclosure that, of Form N–1A. As noted, our proposed exclude the disclosure required by proposed
if an investor purchases the fund through a broker- amendments also would require the ETF to modify summary prospectus Items 7(a) and 7(b) of Form N–
dealer or other financial intermediary (such as a the narrative explanation preceding the example in 1A. See supra notes 158–160 and accompanying
bank), the fund and its related companies may pay the fee table, see supra note 160, which would text.
the intermediary for the sale of fund shares and remain in current Item 3 of Form N–1A. 190 See supra Section III.D.1.

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Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules 14635

revise the prospectus requirements in ability to invest in ETFs, however, is redemptions).196 Congress also was
that form in order to provide more limited because section 12(d)(1) of the concerned about the potential for
useful information to investors in ETF Act prohibits a fund (and companies or excessive fees when one fund invested
shares. Therefore, pursuant to our funds it controls) (‘‘acquiring fund’’) in another,197 and the formation of
authority under section 38(a) of the Act, from: overly complex structures that could be
we propose to amend the exemptive (i) Acquiring more than three percent confusing to investors.198 Congress
orders we have issued to ETFs that are of any other investment company’s imposed these limits, in part, based on
open-end funds to eliminate the section outstanding voting securities (‘‘acquired our conclusion in 1966 that fund of
24(d) exemptions and require ETFs to fund’’); funds structures served little or no
satisfy their statutory prospectus (ii) Investing more than five percent of economic purpose.199
delivery requirements.191 its total assets in any one acquired fund; Our views and those of Congress
The consequence of the amendment or regarding the economic value of fund of
to these orders, if adopted, would be to (iii) Investing more than ten percent funds arrangements have changed over
put ETFs that have received exemptive of its total assets in all acquired the years as fund of funds arrangements
orders on the same footing as ETFs that funds.194 have been created that serve new,
may in the future rely solely on rule 6c– Section 12(d)(1) was enacted to limit legitimate purposes. Recognizing this, in
11, and thus eliminate any competitive so-called ‘‘fund of funds’’ arrangements. 1996, Congress granted us specific
advantage they might otherwise obtain Congress was concerned about authority to provide exemptions
by having obtained orders before ‘‘pyramiding,’’ a practice under which allowing fund of funds arrangements,
adoption of the rule.192 The amendment investors could use a limited investment and directed that we use it ‘‘in a
would be limited to orders issued to in an acquiring fund to gain control of progressive way.’’ 200 Pursuant to this
ETFs seeking to operate as open-end another (and potentially much larger)
management companies. fund and use the assets of the acquired
196 Large-scale redemptions may disrupt portfolio

We are not proposing to rescind the management or increase transaction fees if fund
fund to enrich themselves at the managers must hold cash or sell portfolio securities
orders we have issued because we do expense of acquired fund at an inopportune time to meet redemptions. Large-
not believe rescission would be shareholders.195 Control could be scale redemptions also may be threatening to a fund
necessary to eliminate competitive exercised either directly (such as manager because they decrease the fund’s assets
advantages for ETFs that have already under management, on which the manager’s fee is
through holding a controlling interest) based.
received exemptive orders. With the or indirectly (such as by coercion 197 Pyramiding schemes resulted in fund
exception of the section 24(d) through the threat of large-scale shareholders paying excessive charges due to
exemption (and the related prospectus duplicative fees at the acquiring and acquired fund
disclosure requirements), the proposed levels. See SEC, Investment Trusts and Investment
194 See 15 U.S.C. 80a–12(d)(1)(A). Both registered
Companies, H.R. Doc. No. 279, 76th Cong., 1st
rule contains broader exemptive relief and unregistered funds are subject to these limits Sess., pt.3, at 2721–95 (1939) (‘‘Investment Trust
than that provided in our orders and with respect to their investments in a registered Study’’). See also Fund of Funds Investments,
therefore we expect most, if not all, fund. Registered funds are also subject to these Investment Company Act Release No. 26198 (Oct.
same limits with respect to their investments in an 1, 2003) [68 FR 58226 (Oct. 8, 2003)] (‘‘Fund of
ETFs would rely on the rule if and when unregistered fund. Unregistered funds are not Funds Proposing Release’’) at nn.2–6 and
it is adopted. subject to limits on their investments in another accompanying text. For example, from 1927 to
We request comment on whether we unregistered fund. Id. ETFs are registered funds and 1936, it was estimated that the duplication of
should rescind our previous orders. Is therefore both registered and unregistered funds are expenses incurred by funds investing in other funds
our assumption correct that most ETFs subject to section 12(d)(1)(A)’s limits with respect exceeded five percent of the total operating
to investments in ETFs. Section 12(d)(1)(B) expenses for all management funds. See Investment
that have orders would rely on the rule? prohibits a registered open-end fund from selling Trust study, at 2727–2728. Fund of Funds, Ltd. also
any security issued by the fund to any other fund charged duplicative advisory fees at the acquiring
IV. Exemption for Investment (including unregistered funds) if, after the sale, the and acquired fund levels, provided sales loads to
Companies Investing in ETFs acquiring fund would: (i) Together with companies an affiliated broker for each investment the
and funds it controls, own more than three percent acquiring fund made in an acquired fund, and
A. Background of the acquired fund’s voting securities; or (ii) directed brokerage to an affiliate of the fund of
As we discussed above, institutional together with other funds (and companies they funds. See 1966 Study, supra note 195, at 318–320;
control) own more than ten percent of the acquired Arthur Lipper Corp., et al. v. SEC, Securities
investors, including funds, have fund’s voting securities. 15 U.S.C. 80a–12(d)(1)(B). Exchange Act Release No. 11773, 46 S.E.C. 78 (Oct.
invested in ETFs to achieve asset 195 The legislative history of these provisions cites 24, 1975), sanction modified, 547 F.2d 171 (2d Cir.
allocation, diversification, or other examples of controlling investors in an acquiring 1976) (a Fund of Funds, Ltd. affiliated broker-dealer
investment objectives.193 Some funds fund using ‘‘pyramiding schemes’’ to force acquired received commissions under step-out arrangements
funds to purchase securities of companies in which with Arthur Lipper Corp, a registered broker-dealer,
invest primarily in ETFs. A fund’s and other broker-dealers).
the investors had an interest and to direct
198 Pyramiding of funds resulted in complicated
underwriting and brokerage business to broker-
191 Section 38(a) of the Act provides the
dealers they controlled. In an open-end fund, corporate structures that were confusing to
Commission with the authority to amend orders controlling investors were able to exert control and shareholders and made it difficult for shareholders
when necessary or appropriate to the exercise of its influence over acquired funds through the threat of to determine the nature and value of the holdings
powers conferred elsewhere in the Act. We are not large-scale redemptions. In the 1960s, Fund of ultimately underlying each shareholder’s
proposing to amend the orders of UITs that have Funds, Ltd., an unregistered foreign investment investment. See Investment Trust study, supra note
sought and obtained an exemption from section company, acquired controlling interests in several 197, at 2778–93.
24(d) of the Act because those ETFs do not prepare registered U.S. funds and was able to exert undue 199 See id., at 2725–41.
their prospectuses in accordance with Form N–1A. influence over the management of those acquired 200 See National Securities Markets Improvement
192 For the same purpose, we expect all funds
funds by threatening advisers to those funds with Act of 1996, Pub. L. 104–290, § 202(4), 110 Stat.
seeking exemptive orders to operate an ETF after large redemptions. See SEC, Public Policy 3416, 3427 (1996) (‘‘NSMIA’’); H.R. Rep. No. 622,
today to agree as a condition of the order that the Implications of Investment Company Growth, H.R. 104th Cong., 2d Sess., at 43–44 (1996) (‘‘H.R. Rep.
requested order would expire on the effective date Rep. No. 2337, 89th Cong., 2d Sess. at 315–16 No. 622’’) (discussing new section 12(d)(1)(J) of the
rwilkins on PROD1PC63 with PROPOSALS2

of any Commission rule under the Act that provides (1966) (‘‘1966 Study’’). Congress enacted section Act that gives the Commission authority, by rule or
relief permitting the operation of index-based or 12(d)(1) to prevent these abuses and amended the order, to provide exemptions from the limits of
actively managed ETFs. section in 1970 to prevent similar abuses by section 12(d)(1) when it is consistent with the
193 See supra note 15 and accompanying text investors in unregistered acquiring funds. Congress public interest and the protection of investors). In
(funds also use ETFs for hedging purposes). See later amended section 12(d)(1) to give the 1996, Congress also amended the Act to include a
also, e.g., iShares Trust, Investment Company Act Commission specific authority to provide statutory exemption from section 12(d)(1) limits for
Release No. 25969 (Mar. 21, 2003) [68 FR 15010 exemptions from these limitations. See infra notes funds that invest in funds in the same fund group.
(Mar. 27, 2003)]. 200 and 214 and accompanying text. Continued

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14636 Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules

authority, we have provided exemptions limits on certain fees charged to the (iii) limits on the acquired fund’s ability
to permit certain fund of funds acquiring fund and its shareholders; 206 to invest in other funds; 207 (iv) the
arrangements that would otherwise be acquired fund and each acquiring fund
prohibited under section 12(d)(1). For ETF within the meaning of section 2(a)(9) of the must enter into an agreement stating
example, in 2006 we adopted rule Act; (ii) neither the acquiring fund nor certain of its that both funds understand the terms
affiliates cause any existing or potential investment
12d1–1, which allows funds to invest in by the acquiring fund in ETF shares to influence the
and conditions of the order and agree to
money market funds in excess of section terms of any services or transactions between the fulfill their responsibilities under the
12(d)(1) limits.201 We also have issued acquiring fund or its affiliate and the ETF or an ETF order (‘‘participation agreement’’); 208
exemptive orders that allow many funds affiliate; (iii) the board of directors (or trustees) of and (v) the acquiring fund provides a
the acquiring fund, including a majority of the
to invest in unaffiliated traditional independent directors, adopts procedures list of certain of its affiliates to the
funds (‘‘multigroup fund orders’’) and reasonably designed to assure that the acquiring acquired fund.209
that allow the sale of shares issued by fund’s investment adviser(s) is conducting the More recently, sponsors of some ETFs
acquiring fund’s investment program without taking as well as managers of funds investing
several ETFs to unaffiliated funds in into account any consideration received by the
excess of the statutory limits.202 The acquiring fund or an acquiring fund affiliate from
in ETFs have expressed concern to our
exemptions provided under the rule and the ETF or an ETF affiliate in connection with any staff that some of the conditions in the
these orders facilitate the acquiring services or transactions; (iv) the board of directors exemptive orders are burdensome and
of an open-end ETF, including a majority of its unnecessary in the context of a fund
funds’ ability to achieve their independent directors, determines that any
investment objectives by expanding consideration paid by the ETF to the acquiring fund
investment in an ETF, which is less
their investment options to include or an acquiring fund affiliate in connection with likely to be subject to at least some of
investments in unaffiliated funds in a any services or transactions: (a) Is fair and the abuses these conditions were
reasonable in relation to the nature and quality of designed to prevent.210 For example,
manner consistent with the protection the services and benefits received by the ETF; (b)
of investors. These exemptions also is within the range of consideration that the ETF
ETF sponsors have communicated to
increase the potential pool of investors would be required to pay to another unaffiliated our staff that the participation
and assets available for investment in entity in connection with the same services or agreement condition is cumbersome and
transactions; and (c) does not involve overreaching costly because the ETFs must enter into
ETFs and traditional funds. on the part of any person concerned; (v) neither the
ETF applicants have sought acquiring fund nor certain of its affiliates (except to
an agreement with each acquiring fund
exemptive orders similar to those we the extent it is acting in its capacity as an and each acquiring fund seeks to
have issued to funds investing in investment adviser or sponsor to the ETF) causes negotiate different terms in its
the ETF to purchase a security in any affiliated agreement.211 They have suggested that
unaffiliated traditional funds.203 The underwriting (an underwriting in which an affiliate
conditions included in those orders of the acquiring fund is a principal underwriter);
we develop conditions that address the
were designed to prevent the abuses that (vi) the board of directors of an open-end ETF,
including a majority of the independent directors, acquiring fund’s adviser, trustee, or sponsor or an
historically were associated with fund adopts procedures reasonably designed to monitor affiliated person of the acquiring fund’s adviser,
of funds arrangements and that led any purchases of securities by the ETF in an trustee, or sponsor (other than any advisory fees
Congress to enact section 12(d)(1).204 affiliated underwriting, including any purchases paid by the ETF to the adviser, trustee, or sponsor
The conditions include: (i) Limits on the made directly from the affiliate, and the board or its affiliated person) in connection with the
reviews these purchases at least annually to acquiring fund’s investment in the ETF; and (iii)
control and influence an acquiring fund determine whether the purchases were influenced any sales charge and/or service fees charged with
can exert on the acquired fund; 205 (ii) by the acquiring fund’s investment in the ETF, in respect to shares of the acquiring fund do not
its review the board must consider: (a) Whether the exceed the limits applicable to a fund of funds as
NSMIA, section 202(5). See also infra note 214 and purchases were consistent with the ETF’s set forth in Rule 2830 of the NASD Conduct Rules
accompanying text. investment objectives and policies; (b) how the (or with respect to registered separate accounts that
201 See Fund of Funds Investments, Investment performance of the purchased securities compares invest in a fund of funds, no sales load is charged
to the performance of comparable securities at the acquiring fund level or ETF level and other
Company Act Release No. 27399 (June 20, 2006) [71 sales charges and services fees, if any, are only
FR 36640 (June 27, 2006)] (‘‘Fund of Funds purchased during a comparable period of time in
an unaffiliated underwriting or to a benchmark charged at either the acquiring fund level or ETF
Adopting Release’’); 17 CFR 270.12d1–1. level, not both). See, e.g., Healthshares(tm), Inc. and
202 See, e.g., Schwab Capital Trust, et al.,
such as a comparable market index; and (c) whether
the amount of securities purchased has changed XShares Order, supra note 205.
Investment Company Act Release Nos. 24067 (Oct. significantly from prior years; and (vii) the ETF 207 Under the exemptive orders permitting
1, 1999) [64 FR 54939 (Oct. 8, 1999)] (notice) maintains and preserves permanently in an easily investments in ETFs, the ETF may not invest in
(‘‘Schwab Notice’’) and 24113 (Oct. 27, 1999) accessible place a written copy of the procedures shares of other funds (including companies relying
(order) (‘‘Schwab Order’’); First Trust Exchange- designed to monitor purchases made in an affiliated on sections 3(c)(1) and 3(c)(7) of the Act) in excess
Traded Fund, et al., Investment Company Act underwriting and maintains and preserves for at of the limits in section 12(d)(1)(A) of the Act (some
Release Nos. 27812 (Apr. 30, 2007) [72 FR 25795 least six years, the first two in an easily accessible orders allow a few exceptions to this condition, see
(May 7, 2007)] (notice) and 27845 (May 30, 2007) place, a written record of each purchase (and the infra note 225). See, e.g., Healthshares(tm), Inc. and
(order); iShares Trust, et al., Investment Company terms thereof) of securities in an affiliated XShares Order, supra note 205.
Act Release Nos. 25969 (Mar. 21, 2003) [68 FR underwriting and the information or materials upon 208 The exemptive orders require an agreement
15010 (Mar. 27, 2003)] (notice) and 26006 (Apr. 15, which the board’s determinations were made. See, between the acquiring fund and the ETF stating that
2003) (order). e.g., Healthshares(tm), Inc. and XShares Advisors their boards and investment advisers, or their
203 Fifteen orders have been issued to ETFs
LLC, Investment Company Act Release No. 27844 sponsors and trustees, as applicable, understand the
allowing other funds to invest in ETFs beyond the (May 29, 2007) [72 FR 30885 (June 4, 2007)] terms and conditions of the order and agree to
limits of section 12(d)(1). See, e.g., iShares Trust, (‘‘Healthshares(tm), Inc. and XShares Order’’). fulfill their responsibilities under the order (and the
et al., Investment Company Act Release No. 25969 206 The exemptive orders permitting investments acquiring fund transmits to the ETF a list of certain
(Mar. 21, 2003) [68 FR 15010 (Mar. 27, 2003)]. in ETFs contain the following conditions relating to of its affiliates and underwriting affiliates) and the
204 See, e.g., Schwab Notice and Order, supra note
fee limits: (i) Before approving any advisory acquiring fund and ETF maintain and preserve a
202. contract under section 15 of the Act, the board, copy of the exemptive order, participation
205 The exemptive orders permitting investments including a majority of independent directors, finds agreement, and the list of affiliates with any
in ETFs contain the following conditions relating to that the advisory fees charged under the contract updated information for the duration of the
influence and control: (i) The acquiring fund’s are based on services provided that are in addition investment and for at least six years thereafter, the
investment adviser or sponsor, any person in a to, rather than duplicative of, the services provided first two years in an easily accessible place. See,
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control relationship with that investment adviser or under the ETF advisory contract(s) and these e.g., Healthshares(tm), Inc. and XShares Order,
sponsor, any investment company (including a findings and their basis are recorded in the minute supra note 205.
209 See supra note 208.
company that would be an investment company but books of the acquiring fund; (ii) the acquiring fund’s
210 See infra Section IV.B.
for the exceptions provided in sections 3(c)(1) and adviser(s) (or if the acquiring fund is a UIT, its
3(c)(7) of the Act) that is advised or sponsored by trustee or sponsor) waives fees payable to it by the 211 Acquiring funds also have indicated to the

the acquiring fund’s investment adviser or sponsor, acquiring fund in an amount at least equal to any staff that it is burdensome for them to enter into
or any person in a control relationship with that compensation (including fees received pursuant to participation agreements with each ETF in which
investment adviser or sponsor cannot control the any 12b-1 plan) received from the ETF by the the funds want to invest.

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Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules 14637

concerns underlying section 12(d)(1) in ‘‘control’’ an ETF.215 The Act defines controlling influence on the ETF’s
a manner that is more suited to fund ‘‘control’’ to mean ‘‘the power to management and thus lose its
investments in ETFs.212 exercise a controlling influence over the exemption under the proposed rule.219
management or policies of a company, We request comment on the proposed
B. Proposed Rule 12d1–4 Conditions condition. Do ETF sponsors believe that
unless such power is solely the result of
Today, we are proposing a new rule an official position with such it would sufficiently protect the ETF
12d1–4, which would provide an company.’’ 216 The Act also creates from the type of coercive behavior on
exemption to permit acquiring funds to rebuttable presumptions that any person the part of acquiring funds that section
invest in ETFs in excess of the limits of who directly or indirectly beneficially 12(d)(1) was intended to prevent?
section 12(d)(1), subject to four owns more than 25 percent of the voting
conditions that are designed to address 2. Redemptions
securities of a company controls the
the historical abuses that result from company and that one who does not The proposed rule includes two
pyramiding and the threat of large-scale own that amount does not control it.217 provisions that would prevent an
redemptions and may arise in The effect of the proposed rule, if acquiring fund from redeeming shares it
connection with investments in adopted, would be that an acquiring acquired in reliance on the proposed
ETFs.213 The relief we propose is fund’s beneficial ownership of up to 25 rule. First, the rule would prohibit an
subject to fewer conditions than our percent of the voting securities of an acquiring fund that relies on the
exemptive orders but, unlike our orders, ETF, by itself, would not constitute proposed rule to acquire shares in
would limit an acquiring fund’s ability control over the ETF. As a result, a fund excess of section 12(d)(1)(A)(i) limits
to redeem ETF shares.214 relying on the rule could make a (i.e., to acquire more than three percent
substantial investment in an ETF (i.e., of an ETF’s shares) from redeeming
1. Control those shares.220 As a result, acquiring
up to 25 percent of the ETF’s shares)
In order to address the concern that a without seeking further exemption from funds would not be able to threaten
fund could exert control over another us. large-scale redemptions as a means of
fund, the proposed rule would limit the If, however, an acquiring fund uses its coercing an ETF. It is our understanding
exemption to an acquiring fund (and ownership interest in the ETF (even if that most acquiring funds purchase and
any entity in a control relationship with that interest is 25 percent or less) to sell ETF shares in secondary market
the acquiring fund) that does not exercise a controlling influence over the transactions. Accordingly, this
ETF’s management or policies, the fund condition, while precluding one of the
212 Many funds also appear to consider
would not be able to rely on the historical abuses associated with fund of
investments in ETFs to be different than
investments in other investment companies. In proposed rule.218 For example, an funds arrangements, would not prevent
2004, our staff conducted examinations of a number acquiring fund that used its share acquiring funds from taking passive
of mutual fund complexes, which focused on the position to persuade an ETF manager to shareholder positions in ETF shares (in
funds’ investments in ETFs and whether those excess of section 12(d)(1) limits) in
investments were made in accordance with section
enter into a transaction with an affiliate
12(d)(1) of the Act. Most of the examined mutual of the acquiring fund or its adviser order to, for example, gain exposure to
fund complexes treated ETF investments like would almost certainly exercise a a particular market segment.
investments in traditional equity securities and did We request comment on whether the
not identify ETFs as registered funds subject to the 215 Proposed rule 12d1–4(a)(1). The condition condition achieves this purpose. If not,
requirements of section 12(d)(1) of the Act. Thus,
those that acquired more than three percent of the
would provide that: (i) an acquiring fund and any are there other conditions that would
of its investment advisers or depositors, and any better address the concern?
voting securities of an ETF or invested more than company in a control relationship with the
five percent of the acquiring fund’s assets in the acquiring fund or any of its investment advisers or Second, the proposed rule would
voting securities of an ETF were inconsistent with prohibit an ETF, its principal
depositors, each individually or in the aggregate, do
section 12(d)(1). Most of the mutual funds
not control an ETF; and (ii) if, as a result of a
examined invested in ETFs in order to: (i) Hedge
decrease in the outstanding voting securities of an 219 We have long held that ‘‘controlling
the portfolio; (ii) ‘‘equitize’’ cash balances in order
ETF, the acquiring fund, any of its investment influence’’ includes, in addition to voting power, a
to earn returns in excess of money market rates; and
advisers, and any company in a control relationship dominating persuasiveness of one or more persons,
(iii) gain exposure to a specific market and/or
with the acquiring fund or its investment adviser, the act or process that is effective in checking or
industry sector in an efficient manner.
213 We are also proposing related amendments to
either individually or together in the aggregate, directing action or exercising restraint or preventing
become holders of more than 25 percent of the free action, and the latent existence of power to
rule 12d1–2 under the Act to include within its outstanding voting securities of an ETF (i.e., are
exemptive relief investments in ETFs made in exert a controlling influence. See, e.g., Investors
presumed to control the ETF, see infra notes 217– Mutual, Inc., Investment Company Act Release No.
reliance on proposed rule 12d1–4 and investments
218 and accompanying text), each of those 4595 (May 11, 1966) at text accompanying nn.11–
in non-security assets. See infra Section V.
214 In 1996, Congress added section 12(d)(1)(J) to
shareholders must vote its shares of the ETF in the 14 (citing The Chicago Corporation, Investment
same proportion as the vote of all the other ETF Company Act Release No. 1203 (Aug. 24, 1948);
the Act, which gave us specific authority to exempt shareholders. The same condition is in our
any person, security or transaction, or any class or Transit Investment Corporation, Investment
exemptive orders. Company Act Release No. 927 (July 31, 1946); In
classes of transactions, from section 12(d)(1) of the 216 15 U.S.C. 80a–2(a)(9).
Act if the exemption is consistent with the public the Matter of the M.A. Hanna Company, Investment
217 Id. These presumptions continue until the Company Act Release No. 265 (Nov. 26, 1941)).
interest and the protection of investors. NSMIA,
section 202(4) (codified at 15 U.S.C. 80a– Commission makes a final determination to the 220 Proposed rule 12d1–4(a)(2). Under the

12(d)(1)(J)). The House Report accompanying the contrary by order either on its own motion or on proposed rule, an acquiring fund would be deemed
legislation urged the Commission to use the application by an interested person. Id. to have redeemed or sold the most recently
218 A determination of control depends on the acquired ETF shares first. Id. As a result, an
additional exemptive authority under section
12(d)(1)(J) ‘‘in a progressive way as the fund of facts and circumstances of the particular situation. acquiring fund could redeem shares from an ETF
funds concept continues to evolve over time.’’ H.R. ‘‘[N]o person may rely on the presumption that less only when the fund (and companies or funds it
Rep. No. 622, supra note 200, at 43–44 (1996). The than 25 percent ownership is not control when, in controls) holds ETF shares in an amount consistent
House Report explained that, in exercising its fact, a control relationship exists under all the facts with section 12(d)(1)(A)(i) limits. An acquiring fund
exemptive authority, the Commission should and circumstances.’’ Exemption of Transactions by that relies on the proposed rule to invest more than
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consider factors that relate to the protection of Investment Companies with Certain Affiliated five percent of its assets in the acquired ETF
investors, including the extent to which a proposed Persons, Investment Company Act Release No. (prohibited by section 12(d)(1)(A)(ii)) and/or to
arrangement is subject to conditions that are 10698 (May 16, 1979) [44 FR 29908 (May 23, 1979)] invest more than 10 percent of its assets in all funds
designed to address conflicts of interest and at n.2. (citing Fundamental Investors, Inc., 41 SEC (including the acquired ETF) (prohibited by section
overreaching by a participant in the arrangement, so 285 (1962)) (‘‘Fundamental Investors’’) 12(d)(1)(A)(iii)) but that does not acquire more than
as to avoid the abuses that gave rise to the initial (Commission order noting that rebutting three percent of the acquired ETF’s outstanding
adoption of the Act’s restrictions against funds presumption of control can have retrospective as securities would not be prohibited from redeeming
investing in other funds. Id. at 44. well as prospective effect). shares of the ETF under the proposed rule.

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14638 Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules

underwriter, and a broker or a dealer ETFs redeem their shares or sell them in We request comment on the exclusion
that relies on the rule to sell ETF shares secondary market transactions? Would of these conditions from the proposed
in excess of section 12(d)(1)(B) limits the prohibition on redemption impede rule. Is there a concern that if the
from redeeming (or submitting an order the ability of acquiring funds to dispose acquiring fund and ETF do not take
to redeem) those shares acquired by of ETF shares? Do acquiring funds particular measures to prevent the
another fund that exceed the three realize significant benefits from the acquiring fund from unduly influencing
percent limit in section 12(d)(1)(A)(i).221 ability to redeem ETF shares? the ETF, acquiring funds may be able
We recognize that it may be difficult in The proposed conditions limiting more easily to coerce the ETF?
all circumstances for an ETF, its redemptions of ETF shares are designed Notwithstanding the prohibition on
principal underwriter, a broker or a to eliminate the threat of redemption control and redemption, should we be
dealer to know whether a redemption that an acquiring fund could otherwise concerned about particular transactions
order is submitted by an acquiring fund use to coerce an ETF. Accordingly, the between an acquiring fund (or an
that acquired more than three percent of proposed rule does not include the acquiring fund affiliate) and an ETF, or
the ETF’s shares in reliance on the conditions in our exemptive orders that an ETF’s purchase of securities during
proposed rule. Accordingly, we are require the ETF 223 and the acquiring an underwriting in which a principal
proposing to include a safe harbor for fund to take measures to prevent the underwriter is an affiliate of the
each of those entities if it has: (i) acquiring fund from unduly influencing acquiring fund or its adviser? If there is
Received a representation from the the ETF.224 reason for concern about ETF purchases
acquiring fund that none of the ETF’s of securities in an affiliated
shares the acquiring fund is redeeming 223 The orders require that: (i) The board of
underwriting, is that concern limited to
directors of an ETF, including a majority of its purchases from an affiliate of the
includes any shares that it acquired in independent directors, determines that any
excess of three percent of the ETF’s consideration paid by the ETF to the acquiring fund acquiring fund or its adviser? Should
shares in reliance on proposed rule or any investment adviser, depositor, or principal any specific conditions in the exemptive
12d1–4(a); and (ii) no reason to believe underwriter of the acquiring fund and any person orders be included in the proposed rule
controlling, controlled by, or under common in addition to or in place of the
that the acquiring fund is redeeming control with an investment adviser, depositor, or
ETF shares that the acquiring fund principal underwriter of the acquiring fund, (but proposed conditions to prevent an
acquired in excess of three percent of not including any investment adviser of the ETF or acquiring fund or an acquiring fund
the ETF’s shares in reliance on the any person controlling, controlled by, or under affiliate from unduly influencing an
common control with the investment adviser of the ETF?
proposed rule.222 If an acquiring fund ETF) (‘‘acquiring fund affiliate’’) in connection with
attempts to redeem ETF shares in any services or transactions: (a) Is fair and 3. Complex Structures
connection with a threat to coerce the reasonable in relation to the nature and quality of
ETF, the ETF would know of the the services and benefits received by the ETF; (b) To prevent the formation of overly
is within the range of consideration that the ETF complex multi-tiered fund structures,
attempt. In those circumstances, or if would be required to pay to another unaffiliated
the principal underwriter, broker or entity in connection with the same services or
the proposed rule would prohibit an
dealer knows or has reason to know of transactions; and (c) does not involve overreaching acquired ETF from itself being a fund of
the threat, the entity could not redeem on the part of any person concerned; (ii) the ETF funds (i.e., the rule would prohibit a
board of directors, including a majority of the fund of funds of funds, or three-tier
(or submit for redemption) the ETF independent directors, adopts procedures
fund, structure).225 A fund of ETFs has
shares held by the acquiring fund. We reasonably designed to monitor any purchases of
believe that the proposed condition securities by the ETF in an underwriting in which
a principal underwriter is an officer, director, control relationship with the acquiring fund) could
prohibiting acquiring funds from member of an advisory board, acquiring fund not ‘‘control’’ the ETF. See supra note 215 and
redeeming ETF shares acquired in investment adviser, acquiring fund depositor, or an accompanying text.
reliance on the proposed rule should acquiring fund employee or an affiliated person of 225 Proposed rule 12d1–4(a)(4) (‘‘The exchange-

sufficiently prevent an acquiring fund any such person (‘‘affiliated underwriting’’), and the traded fund has a disclosed policy that prohibits it
board reviews these purchases at least annually to from investing more than 10 percent of its assets in:
from threatening redemptions as a determine whether the purchases were influenced (i) Other investment companies in reliance on
means of coercing an ETF adviser. by the acquiring fund’s investment in the ETF; and section 12(d)(1)(F) or section 12(d)(1)(G) of the Act
We request comment on these (iii) the ETF maintains and preserves a copy of the or [rule 12d1–4]; and (ii) Any other company that
conditions. Do most funds that invest in procedures designed to monitor purchases made in would be an investment company under section
an affiliated underwriting and maintains a written 3(a) of the Act but for the exceptions to that
record of each purchase of securities in an affiliated definition provided in sections 3(c)(1) and 3(c)(7) of
221 Proposed rule 12d1–4(b)(1). Under the
underwriting and the information or materials upon the Act (15 U.S.C. 80a–3(c)(1) and 80a–3(c)(7)).’’).
proposed rule, an exchange-traded fund, any which the board’s determinations were made. See Section 12(d)(1)(A)(iii) of the Act limits an
principal underwriter thereof, and a broker or a supra note 205. acquiring fund’s total investment in other funds to
dealer may sell or otherwise dispose of exchange- 224 The orders require that: (i) Neither the no more than 10 percent of the acquiring fund’s
traded fund shares if the exchange-traded fund does acquiring fund nor any acquiring fund affiliate assets. An ETF would still be able to make limited
not redeem, or the principal underwriter, broker or cause any existing or potential investment by the investments in other funds, including other ETFs.
dealer does not submit for redemption any of the acquiring fund in an ETF to influence the terms of This is similar to a condition in section 12(d)(1)(G)
exchange-traded fund’s shares that were acquired any services or transactions between the acquiring of the Act that provides an exemption from section
by an acquiring fund in excess of the limits of fund or an acquiring fund affiliate and the ETF (or 12(d)(1) limits for funds to invest in other funds in
section 12(d)(1)(A)(i) in reliance on proposed rule certain affiliates of the ETF); (ii) neither the the same group provided, among other things, the
12d1–4(a). Id. An acquiring fund would be deemed acquiring fund nor an acquiring fund affiliate acquired fund has a policy that it will not rely on
to have redeemed or sold the most recently causes the ETF to purchase a security in any exemptions allowing it to be a fund of funds. See
acquired exchange-traded fund shares first. Id. See affiliated underwriting; and (iii) the acquiring fund 15 U.S.C. 80a–12(d)(1)(G)(i)(IV). The exemptive
also supra note 220. board of directors, including a majority of its orders generally prohibit an acquired ETF from
We note that our adoption of proposed rule 12d1– independent directors, adopts procedures investing in other funds beyond section 12(d)(1)(A)
4 would not preclude an acquiring fund from reasonably designed to assure that the acquiring limits. Many of the orders have provided exceptions
continuing to rely on exemptive orders we have fund’s investment adviser(s) is conducting the to this general prohibition, which permit the ETF
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previously issued that permit funds to invest in acquiring fund’s investment program without taking to invest in money market funds beyond the limits
ETFs in excess of the limits of section 12(d)(1) but into account any consideration received by the of section 12(d)(1)(A) either in reliance on another
which do not restrict their ability to redeem ETF acquiring fund or an acquiring fund affiliate from exemptive order allowing the ETF to do so or in
shares, subject to the conditions set forth in the the ETF (or certain affiliates of the ETF). See supra reliance on rule 12d1–1. In addition, some of the
orders and described above. Moreover, we intend to note 205. orders permit the ETF to invest in another fund
continue to issue such orders and may consider As discussed above, the proposed rule would beyond the limits of section 12(d)(1)(A) to the
their codification in a rule in the future. however include the condition from our exemptive extent permitted by section 12(d)(1)(E) of the Act.
222 Proposed rule 12d1–4(b)(2). orders that an acquiring fund (and any entity in a An acquiring fund relying on any of these

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the potential to become a complicated percent of its assets in other ETFs in excessive distribution or service
corporate structure of the kind that reliance on proposed rule 12d1–4? fees? 234 Are there any special concerns
concerned Congress when section 4. Layering of Fees as to how to apply the proposed fee
12(d)(1) was enacted.226 If an acquiring limits to an acquiring fund when a
fund invests in an ETF that in turn As discussed above, one of Congress’ separate account invests in an acquiring
invests in other funds (including other concerns regarding fund of funds fund? Do our disclosure requirements
ETFs), an acquiring fund shareholder arrangements was that acquiring fund provide sufficient information to
could find it difficult to determine the shareholders might pay excessive investors to allow them to determine
charges due to duplicative fees at the whether the total fees imposed on a
nature and value of the holdings
acquiring and acquired fund levels.230 fund of ETFs are consistent with their
ultimately underlying his or her
To prevent duplicative fees at the investment objectives?
investment. The proposed rule is acquiring and acquired fund levels, the
designed to allow an ETF the flexibility proposed rule would limit sales charges C. Scope of Proposed Rule 12d1–4
to invest in other funds in order to meet and service fees charged by the
its investment objectives while 1. Acquiring Funds and ETFs Eligible
acquiring fund to those set forth in the
preventing shareholder confusion as to for Relief
Financial Industry Regulatory
the nature of their investment in an Authority’s (‘‘FINRA’’) sales charge rule, Proposed rule 12d1–4 would permit
acquiring fund by limiting the extent of which takes into consideration fees open-end and closed-end management
those ETF investments.227 charged at both levels of a fund of funds companies (including business
We request comment on the proposed arrangement.231 In addition, like all development companies) 235 and
limits on an ETF itself being a fund of acquiring funds, funds that invest in UITs 236 that comply with the rule’s
funds. Are the proposed limits on an ETFs would be subject to our disclosure conditions to invest in ETFs beyond the
underlying ETF’s investments in other rules for fund investments in other
funds sufficient to prevent investor funds. These rules require all registered 234 The proposed rule would not include the

confusion? If not, what limits should the funds to disclose in their prospectus fee condition from our orders requiring the acquiring
proposed rule include to prevent tables expenses paid by both the fund adviser (or sponsor or trustee) to waive its fee
acquiring and acquired funds so that in an amount at least equal to any compensation
shareholder confusion? Should the (including fees received pursuant to any 12b–1 plan
proposed rule include the same limit shareholders can evaluate the costs of but excluding advisory fees) received from the ETF
investing in a fund that invests in other by the acquiring fund’s adviser, trustee, or sponsor
(and exceptions to the limit) as in our
funds, including ETFs.232 These rules or an affiliated person of the acquiring fund’s
exemptive orders? 228 Are there reasons adviser, trustee, or sponsor in connection with the
and the proposed fee limit may fully
not to restrict the ability of an acquired acquiring fund’s investment in the ETF. The
address congressional concerns with the proposed rule also does not include the condition
ETF itself to invest in other funds,
duplication and layering of fees that from our orders that requires the board of the
including ETFs, beyond the limits of
hide the real cost of investing in an acquiring fund to find that the advisory fees
section 12(d)(1)(A)? 229 Does the fact investment company.233 charged under an advisory contract are based on
that ETF shares trade more like a typical We request comment on the proposed services provided that will be in addition to, rather
equity security make it less likely that than duplicative of, the services provided by an
condition limiting the fees charged by adviser to an acquired ETF. As we noted in the
investors would be confused if we were an acquiring fund. Would the proposed proposing and adopting releases for rule 12d1–1
to allow an acquiring fund to invest in fee limits adequately prevent acquiring explaining our exclusion of a similar condition
an ETF that itself invests more than ten fund shareholders from paying from rule 12d1–1, an acquiring fund board is
already obligated to protect the fund from being
overcharged for services provided to the fund
exceptions may have difficulty determining 230 See supra note 197 and accompanying text. regardless of any special findings we might require.
whether an acquired ETF would itself be 231 Proposed rule 12d1–4(a)(3). The proposed rule See Fund of Funds Adopting Release, supra note
considered a fund of funds because the acquiring would limit the sales charge (including any 12b–1 201, nn.51–52 and accompanying text; Fund of
fund might not be able to ascertain easily if the ETF fee) or service fee charged in connection with the Funds Proposing Release, supra note 197, at nn.65–
is relying on an order, section 12(d)(1)(E) of the Act, purchase, sale, or redemption of securities issued 67 and accompanying text.
or rule 12d1–1 to invest in other funds beyond the by the acquiring fund to the FINRA fee limits for 235 A business development company is any
limits of section 12(d)(1)(A) of the Act. The orders fund of funds set forth in NASD Conduct Rule closed-end company that: (i) Is organized under the
also do not anticipate any future exemptive relief 2830(d)(3). Some ETFs charge a 12b–1 fee. See, e.g., laws of, and has its principal place in, any state or
the Commission might provide to allow acquired Select Sector SPDRs, Prospectus 20,28 (Jan. 31, states; (ii) is operated for the purpose of investing
ETFs to invest in other non-money market funds in 2008). FINRA does not, however, apply Conduct in securities described in section 55(a)(1)–(3) of the
excess of section 12(d)(1)(A) limits. Limiting Rule 2830 to variable annuity contracts. See NASD Act and makes available ‘‘significant managerial
exemptive relief to investments in ETFs with Conduct Rule 2820(a) (rule 2820 applies exclusively assistance’’ to the issuers of those securities, subject
disclosed policies would allow an acquiring fund and in lieu of rule 2830 to the activities of members to certain conditions; and (iii) has elected under
to determine easily if it could invest in a particular in connection with variable contracts to the extent section 54(a) of the Act to be subject to the sections
ETF. the activities are subject to federal securities law addressing activities of business development
226 See supra note 198 and accompanying text.
regulation). To address the potential for excessive companies under the Act. See 15 U.S.C. 80a–
227 Under the proposed rule, an acquiring fund layering of fees in a separate account that invests 2(a)(48). Section 60 of the Act extends the limits of
could invest in an ETF that invests up to 10 percent in an acquiring fund, proposed rule 12d1–4(a)(3)(ii) section 12(d) to a business development company
of its assets in other ETFs. would: (i) Prohibit an acquiring fund in which a to the same extent as if it were a registered closed-
228 As discussed above, the orders generally separate account invests and any ETF in which the end fund. Section 6(f) of the Act exempts business
prohibit an acquired ETF from investing in other acquiring fund invests from charging a sales load development companies that have made the
funds beyond the limits of section 12(d)(1)(A). and would allow only the acquiring fund or ETF, election under section 54 of the Act from
Some of the orders include a few exceptions to this but not both, to impose asset-based sales charges or registration and other provisions of the Act. We
general prohibition. See supra note 225. service fees; and (ii) require the aggregate fees similarly included business development
229 The proposed rule would allow an acquired associated with the variable insurance contract and companies within the scope of rule 12d1–1 to allow
ETF to invest in other funds, including ETFs, the sales charges and service fees charged by the then to invest in money market funds beyond the
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beyond the limits of section 12(d)(1)(A) in reliance acquiring fund and the ETF to be reasonable in limits of section 12(d)(1). See Fund of Funds
on sections 12(d)(1)(F) and 12(d)(1)(G) and to invest relation to the services rendered, the expenses Adopting Release, supra note 201, at nn.44–46 and
in other ETFs beyond the limits of section expected to be incurred and, with respect to the accompanying text.
12(d)(1)(A) in reliance on the proposed rule. variable insurance contract, the risks assumed by 236 Because an ETF can be organized either as an

However, the proposed rule would limit an the insurance company. open-end management company or UIT, see supra
232 See Item 3(f) to Form N–1A; Fund of Funds
acquired ETF’s aggregate investment in these funds note 8, it could rely on the proposed rule to invest
to no more than 10 percent of the acquired ETF’s Adopting Release, supra note 201, at Section II.D. in other ETFs beyond the limits contained in
assets. Proposed rule 12d1–4(a)(4). 233 See supra note 197. section 12(d)(1).

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14640 Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules

limits of section 12(d)(1).237 Our orders provisions would otherwise effectively Allowing the ETF to acquire securities
to date have provided exemptions only preclude a fund that acquires five identified in a creation basket from an
for investments in ETFs by registered percent or more of the securities of an affiliated acquiring fund on the same
management funds and UITs.238 We do ETF in another fund complex from basis as any other investor also would
not anticipate that providing a similar making any additional purchases of not seem to implicate the concerns
exemption for business development shares from the ETF.241 They also underlying section 17(a). Accordingly,
companies would raise particular would prohibit an affiliated acquiring we believe that exemptions from
concerns that section 12(d)(1) was fund from depositing (i.e., ‘‘selling’’) sections 17(a)(1), 17(a)(2), 57(a)(1), and
designed to address. securities identified in the creation 57(a)(2) of the Act for these transactions
We request comment on the inclusion basket. Permitting an acquiring fund to would be appropriate, in the public
of business development companies purchase additional ETF shares from the interest, and consistent with the
within the scope of proposed rule 12d1– ETF at NAV on the same basis as any protection of investors and the purposes
4. Would these entities benefit from this other purchaser of a creation unit, by of the Act.243
exemption? Are there reasons not to itself, seems to provide little We seek comment on these
extend the exemption to these opportunity for the acquiring fund to exemptions. Are there risks other than
companies? Do any special concerns manage the ETF for its own benefit.242 the concerns we addressed with respect
arise with respect to extending the to section 12(d)(1) limitations, regarding
exemption to these companies? Subcomm. of the Senate Comm. On Banking and the potential that the acquiring fund
Currency, 76th Cong., 3d Sess. 37 (1940) (Statement could manage the ETF, that would arise
2. Investments in Affiliated ETFs of Commissioner Healy). Section 17 also would
from the proposed exception allowing a
Outside the Fund Complex restrict an acquiring fund from investing in an ETF
that is affiliated with the acquiring fund because fund to acquire more than five percent
In addition to providing an exemption both funds have a common investment adviser or of the shares of an affiliated ETF in
from section 12(d)(1) of the Act, the other person exercising a controlling influence over another complex?
proposed rule would provide the management or policies of the funds. See 15
U.S.C. 80a–2(a)(3)(C). The determination of whether 3. Use of Affiliated Broker to Effect
exemptions from sections 17(a)(1), a fund is under the control of its adviser, officers,
17(a)(2), 57(a)(1) and 57(a)(2) of the Act. or directors depends on all the relevant facts and
Sales
These provisions restrict a fund’s ability circumstances. See Investment Company Mergers, In order to allow acquiring funds to
to enter into transactions with affiliated Investment Company Act Release No. 25259 (Nov. take full advantage of the exemptive
8, 2001) [66 FR 57602 (Nov. 15, 2001)], at n.11. For
persons.239 They are designed to purposes of this release, we presume that funds relief, proposed rule 12d1–4 also would
prevent affiliated persons from with a common investment adviser are under provide limited relief from section
managing the fund’s assets for their own common control because funds that are not 17(e)(2) of the Act. If an investment
affiliated persons would not require, and thus not
benefit, rather than for the benefit of the rely on, the exemptions from section 17(a). company in one complex acquired more
fund’s shareholders.240 These Although funds in the same group of investment than five percent of the assets of an ETF
companies generally are under common control of in another complex, any broker-dealer
237 Section 12(d)(1)(B)’s limits on sales of an an investment adviser or other person exercising a affiliated with that ETF would become
acquired fund’s securities apply only to shares of controlling interest, these funds may rely on section
an ETF organized as an open-end investment 12d(1)(G) of the Act to invest in an ETF in the same a (second-tier) affiliated person of the
company. group. See infra note 249 and accompanying text. acquiring fund.244 As a result of the
238 We have not had the opportunity to consider 241 An ETF would be prohibited under section
affiliation, the broker-dealer’s fee for
a request for an individual exemptive order for 17(a)(1) from selling its shares to an affiliated effecting the sale of securities to (or by)
other types of investment companies. Our orders acquiring fund and under section 17(a)(2) from
also have permitted funds to invest in ETFs purchasing securities (i.e., securities designated in the acquiring fund would be subject to
organized as UITs (and as open-end funds). the creation basket) from the affiliated acquiring the conditions set forth in rule 17e–1,
Proposed rule 12d1–4 would include relief for fund in exchange for ETF shares. An acquiring fund including the quarterly board review
investments in ETFs that are organized as UITs as would be prohibited under section 17(a)(1) from
selling any securities (i.e., securities identified in
and recordkeeping requirements with
long as the UITs satisfy the criteria enumerated in
proposed rule 6c–11(e)(4). Proposed rule 12d1– the creation basket) to an affiliated ETF in exchange respect to certain securities transactions
4(d)(2). As noted above, proposed rule 6c–11 would for the ETF’s shares. An acquiring fund also would involving the affiliated broker-dealer.245
not include a UIT within its relief because we have be prohibited under section 17(a)(2) from
not received an exemptive application for a new purchasing (creation basket) securities from an 243 Our proposal would not provide an exemption
ETF to be organized as a UIT in a number of years. affiliated ETF for the redemption of ETF shares. The
for any transactions other than the sale of securities
See supra note 65 and accompanying text. ETF would be prohibited under section 17(a)(1)
by an acquiring fund to an affiliated ETF for a
239 Section 17 of the Act limits transactions from selling the affiliated acquiring fund (creation
basket) securities in exchange for ETF shares creation unit of ETF shares. The proposed rule also
between a fund and its affiliated persons. Section would not provide an exemption for any other
17(a) of the Act generally prohibits affiliated redeemed and under section 17(a)(2) from acquiring
the ETF shares submitted for redemption by the transactions between a business development
persons of a registered fund (‘‘first-tier affiliates’’) company and an affiliated ETF that would be
or affiliated persons of the fund’s affiliated persons affiliated acquiring fund
242 The exemptive orders provide similar relief subject to section 57 limitations.
(‘‘second-tier affiliates’’) from selling securities or 244 See supra notes 239–240.
other property to or purchasing securities or other from sections 17(a)(1) and 17(a)(2) of the Act,
245 Section 17(e)(2) of the Act prohibits an
property from the fund (or any company the fund including relief to allow the acquiring fund to
controls). Section 57 of the Act restricts certain redeem shares of an affiliated ETF. The proposed affiliated person (or second-tier affiliate) of a fund
transactions between business development rule would not, however, provide an acquiring fund from receiving compensation for acting as a broker,
companies and certain of their affiliates. An relief from sections 17(a)(2) and 57(a)(2) of the Act in connection with the sale of securities to or by
affiliated person of a fund includes: (i) Any person in order to redeem shares in excess of the three the fund if the compensation exceeds limits
directly or indirectly owning, controlling, or percent limit in section 12(d)(1)(A)(i) from an prescribed by the section. Rule 17e–1 sets forth a
holding with power to vote, five percent or more affiliated ETF. In addition, proposed rule 6c–11, conditional exemption under which a commission,
of the outstanding voting securities of the fund; and which would permit persons affiliated with an ETF fee or other remuneration shall be deemed as not
(ii) any person five percent or more of whose solely because they own five percent or more of the exceeding the ‘‘usual and customary broker’s
outstanding voting securities are directly or ETF’s shares, to purchase and sell ETF shares in- commission’’ for purposes of section 17(e)(2)(A) of
indirectly owned, controlled, or held with power to kind (i.e., in exchange for securities designated in the Act. Rule 17e–1(b)(3) requires the fund’s board
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vote by the fund. See 15 U.S.C. 80a–2(a)(3)(A), (B). the creation basket) would not extend relief to of directors, including a majority of the directors
Thus, if an acquiring fund holds five percent or certain redemptions by acquiring funds consistent who are not interested persons under section
more of the outstanding voting shares of the ETF, with proposed rule 12d1–4(a). See supra Section 2(a)(19) of the Act, to determine at least quarterly
the acquiring fund is an affiliated person of the ETF III.C.3 and proposed rule 6c–11(d). As noted above, that all transactions effected in reliance on the rule
and the ETF is an affiliated person of the acquiring no orders have been issued to business have complied with procedures which are
fund. development companies therefore no order includes reasonably designed to provide that the brokerage
240 See Investment Trusts and Investment relief from sections 57(a)(1) and 57(a)(2) of the Act. compensation is consistent with the rule’s
Companies: Hearings on S. 3580 Before a See supra note 238 and accompanying text. standards. Rule 17e–1(d)(2) specifies the records

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We believe that it is unlikely that a limits.248 One of these exceptions— When it added section 12(d)(1)(G) to
broker-dealer would be in a position to section 12(d)(1)(G)—permits a registered the Act, Congress also gave us specific
take advantage of the acquiring fund open-end investment company or UIT to authority to provide certain exemptions
merely because that fund owned a invest in other registered open-end from the limitations of section 12(d)(1)
position in an ETF affiliated with the investment companies or UITs if the exemption is consistent with the
broker-dealer.246 Accordingly, the (including ETFs) that are in the ‘‘same public interest and the protection of
proposed rule would permit an group of investment companies’’ investors.252 In conjunction with the
acquiring fund to pay commissions, (‘‘affiliated funds’’) beyond the section adoption of rule 12d1–1 in 2006
fees, or other remuneration to a (second- 12(d)(1) limits.249 A fund that invests in (allowing funds to invest in money
tier) affiliated broker-dealer without unaffiliated ETFs (i.e., ETFs in other market funds beyond the limits of
complying with the quarterly board fund groups) in many cases, however, is section 12(d)(1)), we adopted rule 12d1–
review and recordkeeping requirements still subject to the section 12(d)(1) 2, which allows funds relying on section
set forth in rules 17e–1(b)(3) and 17e– limits.250 Section 12(d)(1)(G) restricts 12(d)(1)(G) also to invest in: (i)
1(d)(2).247 This relief would be available the other investments an acquiring fund Unaffiliated money market funds when
only if the broker-dealer and the investing in affiliated funds can make to the acquisition is in reliance on rule
acquiring fund are affiliated solely government securities and short-term 12d1–1; (ii) securities issued by
because of the acquiring fund’s paper.251 unaffiliated funds (including ETFs),
investment in the ETF. subject to the investment limits in
We request comment on the proposed 248 For a full discussion of section 12(d)(1) sections 12(d)(1)(A) and 12(d)(1)(F) of
exemptions. Is the scope of the limitations and the exceptions under sections the Act; 253 and (iii) securities not issued
proposed exemptions from section 17 12(d)(1)(E), 12(d)(1)(F), and 12(d)(1)(G) of the Act, by an investment company. Under rule
see Fund of Funds Proposing Release, supra note 12d1–2, therefore, a fund that invests in
limitations sufficiently broad to allow 197, at Section I.
funds to take full advantage of the 249 See 15 U.S.C. 80a–12(d)(1)(G). Section
affiliated funds in reliance on section
proposed relief? Are the proposed 12(d)(1)(G)(ii) of the Act defines ‘‘same group of 12(d)(1)(G) and desires to invest in
exemptions from board review and investment companies’’ to mean ‘‘any 2 or more unaffiliated ETFs is subject to these
registered investment companies that hold statutory limitations (e.g., to acquiring
recordkeeping requirements with themselves out to investors as related companies for
respect to transactions with an affiliated no more than three percent of the
purposes of investment and investor services.’’
broker-dealer necessary? Do funds Section 12(d)(1)(G) imposes the following acquired ETF’s shares). There seems no
engage in these transactions with conditions on funds relying on this exception: (i) reason, however, to maintain the
broker-dealer affiliates of acquired other investments are limited to short-term paper statutory limitations on investments in
and government securities; (ii) acquired funds must ETFs in these circumstances when we
ETFs? Is there additional section 17 have a policy against investing in shares of other
relief that would be helpful in order for funds in reliance on sections 12(d)(1)(F) or are proposing to permit other types of
acquiring funds to take full advantage of 12(d)(1)(G) (to prevent multi-tiered structures); and funds to invest in ETFs in excess of
the proposed exemption for investments (iii) overall distribution expenses are limited. section 12(d)(1) limits. No special issues
250 A fund could invest in unaffiliated funds in
in ETFs? If so, please be specific appear to arise in connection with an
reliance on two other statutory exemptions. Under
regarding the transactions that would section 12(d)(1)(E) an investment company may
acquiring fund’s investments in an
prevent funds from relying on the acquire securities issued by another investment unaffiliated ETF simply because the
proposed rule. company provided that (i) the acquiring fund’s acquiring fund also invests in affiliated
depositor or principal underwriter is a broker or funds. Accordingly, we propose to
V. Exemption for Affiliated Fund of dealer registered under the Securities Exchange Act amend rule 12d1–2 to allow acquiring
of 1934, (or a person the broker-dealer controls), (ii)
Funds Investments the security is the only investment security the funds that invest in affiliated funds in
A. Affiliated Fund of Funds Investments acquiring fund holds (or the securities are the only reliance on section 12(d)(1)(G) to invest
in ETFs
investment securities the acquiring investment in unaffiliated ETFs beyond the
company holds if it is a registered UIT that issues statutory limitations as long as the funds
As noted above, Congress recognized two or more classes or series of securities, each of
which provides for the accumulation of shares of comply with the conditions of proposed
that the investment limits in section a different investment company), and (iii) the rule 12d1–4.254 This is similar to the
12(d)(1) might restrict certain legitimate acquiring investment company is obligated (a) to relief we provided to affiliated funds of
fund of funds arrangements, and seek instructions from its shareholders with regard funds to allow them to acquire shares in
included three exceptions to those to voting the acquired investment company’s
securities or to vote the acquired investment money market funds, if the acquisition
company’s shares in the same proportion as the is in reliance on rule 12d1–1.255
that must be maintained by each fund with respect vote of all other acquired investment company We request comment on the proposed
to any transaction effected pursuant to rule 17e–1. shareholders, and (b) if unregistered, to obtain
246 We expect that the ETF’s adviser would have
amendment. Are there reasons not to
Commission approval before substituting the
no influence over the decisions made by the investment security. A fund relying on section extend the proposed relief to affiliated
acquiring fund’s adviser. In addition, because the 12(d)(1)(F) of the Act (and its affiliated persons) funds of funds? Do investments by an
interests of the adviser to the ETF and the adviser may acquire no more than three percent of another acquiring fund that invests in affiliated
to the acquiring fund are directly aligned with their investment company’s outstanding stock, cannot funds raise any special concerns if the
respective funds, transactions between the charge a sales load greater than 11⁄2 percent; is
acquiring fund and a broker-dealer affiliate of the restricted in its ability to redeem shares of the acquiring fund also invests in
ETF are likely to be at arm’s length. acquired investment company; and must vote unaffiliated ETFs? Are these concerns
247 Proposed rule 12d1–4(c). The proposed relief shares of an acquired investment company either by different than any other fund’s
is similar to relief we have provided in rule 12d1– seeking instructions from the acquiring fund’s investment in unaffiliated ETFs?
1, which permits funds to invest in money market shareholders, or voting the shares in the same
funds in excess of section 12(d)(1) limits. See Fund proportion as the vote of all other shareholders of
252 Section 12(d)(1)(J) of the Act authorizes the
of Funds Adopting Release, supra note 201, at the acquired investment company.
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nn.32–36 and accompanying text. An acquiring 251 Congress imposed this limitation to restrict the Commission to exempt any person, security or
fund relying on this exemption would be required use of the exemption provided by section transaction, or any class or classes of transactions,
to comply with all of the provisions of rule 17e– 12(d)(1)(G) to a ‘‘bona fide’’ fund of funds. Congress from section 12(d)(1) of the Act if the exemption is
1, except for those in paragraphs (b)(3) and (d)(2). permitted other investments to include only consistent with the public interest and the
It does not appear that having to comply with the government securities and short-term paper, which protection of investors. See supra note 214.
253 See supra note 250.
other provisions contained in rule 17e–1 would provide the fund with a source of liquidity to
254 Proposed rule 12d1–2(a)(4).
deter acquiring funds from taking full advantage of redeem shares. See H.R. Rep. No. 622, supra note
the exemption provided by proposed rule 12d1–4. 200, at 42. 255 See 17 CFR 270.12d1–2(a)(3).

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14642 Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules

B. Affiliated Fund of Funds Investments investments would, of course, have to is mandatory. Responses to the
in Other Assets be consistent with the fund’s investment disclosure requirements are not kept
We also are proposing an amendment policies.261 confidential.
to rule 12d1–2 that would allow funds We seek comment on this proposal. Finally, proposed rule 12d1–4 would
relying on section 12(d)(1)(G) to invest Would any concerns arise if a fund result in a new ‘‘collection of
in assets other than securities. As relying on section 12(d)(1)(G) could information’’ requirement within the
discussed above, in 2006 we adopted invest directly in non-securities? Do meaning of the PRA. The Commission is
rule 12d1–2 to permit affiliated funds of these concerns differ from a traditional therefore submitting the proposal for
funds to acquire securities issued by fund that can invest in such assets and rule 12d1–4 to OMB for review. The
other unaffiliated investment invests in other funds subject to the title for the collection of information
companies, as well as ‘‘securities (other limits of section 12(d)(1)? requirements is ‘‘Rule 12d1–4 under the
than securities issued by an investment Investment Company Act of 1940,
VI. Request for Comment ‘Exemption for investments in
company).’’ 256 The rule was intended to
The Commission requests comment exchange-traded funds.’ ’’ If adopted,
allow an acquiring fund greater
on the rules, rule amendments, and this collection would not be mandatory,
flexibility to meet investment objectives
Form N–1A amendments proposed in but would be a condition that an
that may not be met as well by
this release. The Commission also acquiring fund would have to satisfy in
investments in affiliated funds. We
noted that these investments would not requests suggestions for additional order for an ETF, its principal
seem to present any additional concerns changes to existing rules or forms, and underwriter, a broker, or a dealer to rely
that section 12(d)(1)(G) was intended to comments on other matters that might on the safe harbor if an acquiring fund
address.257 have an effect on the proposals redeems ETF shares. Responses to the
Since we adopted the rule, it has been contained in this release. Commenters collection of information requirements
brought to our attention that funds are requested to provide empirical data of proposed rule 12d1–4 would not be
relying on section 12(d)(1)(G) wish to to support their views. kept confidential.
invest in other types of financial assets, An agency may not conduct or
VII. Paperwork Reduction Act sponsor, and a person is not required to
including futures and other financial
Certain provisions of proposed rule respond to, a collection of information
instruments that might not be securities
6c–11 would result in new ‘‘collection unless it displays a currently valid
under the Act and thus may not be
of information’’ requirements within the control number. OMB has not yet
within the scope of rule 12d1–2.258
Investments in these types of assets may meaning of the Paperwork Reduction assigned control numbers to the new
allow an acquiring fund greater Act of 1995 (‘‘PRA’’).262 The collections for proposed rules 6c–11 and
flexibility to meet investment objectives Commission is therefore submitting this 12d1–4. The approved collection of
that may not be met as well by proposal to the Office of Management information associated with Form N–
investments in securities. In addition, and Budget (‘‘OMB’’) for review in 1A, which would be revised by the
like investments in securities, accordance with 44 U.S.C. 3507(d) and proposed amendments, displays control
investments in these assets do not 5 CFR 1320.11. The title for the number 3235–0307.
appear to raise concerns that the collection of information requirements
A. Proposed Rule 6c–11
investment limits on fund of funds is ‘‘Rule 6c–11 under the Investment
Company Act of 1940, ‘Exchange-traded Proposed rule 6c7–11 would exempt
arrangements contained in section
funds.’ ’’ If adopted, this collection ETFs from certain provisions of the Act,
12(d)(1) were intended to address.
would not be mandatory, but would be permitting them to begin operating
Accordingly, we propose to amend rule
necessary for ETFs that seek to form and without obtaining an exemptive order
12d1–2 to allow funds relying on
operate as open-end management from the Commission. The proposed
section 12(d)(1)(G) to invest in assets or
companies without seeking individual rule also would expand the relief we
instruments other than securities.259
exemptive orders. Responses to the have issued in the past to index-based
Under the proposed rule, funds relying
collection of information requirements ETFs, and to transparent, actively
on the exemptive relief in section
of proposed rule 6c–11 would not be managed ETFs. Each ETF seeking to rely
12(d)(1)(G) would be able to invest in,
among other things, real estate, futures kept confidential. on the proposed rule would have to
contracts, and other financial In addition, the Commission is disclose on a daily basis specific
instruments that do not qualify as a proposing amendments to an existing information to market participants: (i)
security under the Act.260 Those collection of information requirement The contents of its basket assets; (ii) the
titled ‘‘Form N–1A under the identities and weightings of the
256 See 17 CFR 270.12d1–2(a)(1), 17 CFR Investment Company Act of 1940 and component securities and other assets in
270.12d1–2(a)(2). Securities Act of 1933, Registration its portfolio if it does not track an index
257 See Fund of Funds Proposing Release, supra
Statement for Open-End Management whose provider discloses its
note 197, at n.80 and accompanying text. Companies.’’ Compliance with the composition daily; and (iii) the prior
258 See 15 U.S.C. 80a–2(a)(36) (defining
disclosure requirements of Form N–1A business day’s NAV, market closing
‘‘security’’). If a future or other financial instrument
in which a fund relying on section 12(d)(1)(G) price for its ETF shares and premium/
proposes to invest is included within the Act’s (Dec. 19, 2007) [72 FR 74372 (Dec. 31, 2007)] discount information.263 In addition,
definition of ‘‘security,’’ investments in such an (notice) and 28122 (Jan. 16, 2008) (order); Vanguard each ETF would have to disclose in its
instrument would be permitted under current rule Star Funds, et al., Investment Company Act Release
Nos. 28009 (Sept. 28, 2007) [72 FR 56813 (Oct. 4,
registration statement: (i) the number of
12d1–2(a)(2).
259 Proposed rule 12d1–2(a)(5). 2007)] (notice) and 28024 (Oct. 24, 2007) (order) shares that comprise a creation unit; and
(ii) the foreign holidays that would
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260 We have issued exemptive orders to funds that (permitting funds relying on section 12(d)(1)(G) and
rely on section 12(d)(1)(G) to allow those funds to rule 12d1–2 under the Act to invest in financial prevent timely satisfaction of
invest in futures contracts and other financial instruments that may not be securities within the
meaning of section 2(a)(36) of the Act).
redemption with respect to foreign
instruments. See, e.g., Schroder Series Trust, et al.,
Investment Company Act Release Nos. 28133 (Jan. 261 See Item 4 of Form N–1A (requiring disclosure securities in its basket assets.264 An ETF
24, 2008) [73 FR 5603 (Jan. 30, 2008)] (notice) and of funds’ investment objectives and principal
28167 (Feb. 25, 2008) (order); The UBS Funds, et investment strategies). 263 263 Proposed rule 6c–11.
al., Investment Company Act Release Nos. 28080 262 44 U.S.C. 3501–3520. 264 264 Id.

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that chooses not to disclose its portfolio Internet Web page daily with this We seek comments on these
would have to track an index whose information, at a cost of $42,000.267 The estimates. If commenters believe these
provider discloses the identities and staff also estimates that each new ETF estimates are not reasonable, we request
weightings of the securities and other initially would spend 100 hours to they provide data that would allow us
assets that constitute the index in order develop the Web page for this to make more accurate estimates.
to rely on the proposed rule. In disclosure. Staff estimates the initial Third, in any sales literature each ETF
addition, each ETF seeking to rely on cost would be $22,520 for internal ETF must identify itself as an ETF that does
the proposed rule also would have to, in staff time to develop the Web page and not sell or redeem individual shares,
any sales literature (as defined in the $12,600 for an external Web site and explain that investors may purchase
rule), identify itself as an ETF, which developer, for a total of $35,120.268 or sell individual shares only on
does not sell or redeem individual We seek comments on these national securities exchanges. This
shares, and explain that investors may estimates. If commenters believe these condition is similar to the condition in
purchase or sell individual shares on estimates are not reasonable, we request our exemptive orders, which requires
national securities exchanges. they provide data that would allow us each ETF to agree not to market or
Two of the disclosure conditions in to make more accurate estimates. advertise the ETF as an open-end fund
proposed rule 6c–11 would not result in Second, the proposed rule also would or mutual fund and to explain that the
a burden for purposes of the PRA. require each ETF to disclose its prior ETF shares are not individually
Disclosure of the contents of the basket business day’s NAV, market price for its redeemable. Based on conversations
assets that comprise a creation unit and shares, and premium/discount with ETF representatives, Commission
the number of shares in each creation information, which would provide staff estimates that an ETF each year
unit does not result in a burden because investors with information on the spends approximately 30 hours at a cost
ETFs must disclose this information in deviation, if any, between the price of of $1704 to comply with the condition
the normal course of business.265 ETF shares and the NAV of the in our exemptive orders.271 Because the
Similarly, disclosure by an index underlying portfolio. Commission staff condition in the proposed rule is
provider of the identities and estimates that an ETF each year spends similar, the staff estimates that each new
weightings of the component securities approximately 206 hours of professional ETF also would spend 30 hours at a cost
and other assets that comprise the index time to update the relevant Internet Web of $1704 to comply with the condition
would not result in a burden because page daily with this information. Based in the proposed rule.
index providers disclose this on staff estimates, we estimate the We seek comment on this estimate. If
information in the normal course of annual cost would be $43,466 for commenters believe this estimate is not
business. internal ETF staff time to update the reasonable, we request they provide
The remaining four disclosure Web page and $6,000 to acquire the data data that would allow us to make a more
requirements are collections of from external data providers.269 The accurate estimate.
information. First, the proposed rule staff also estimates that each new ETF Finally, some ETFs that track foreign
would require an ETF that does not initially would spend 75 hours to indexes have stated that local market
track an index whose provider discloses develop the Web page for these delivery cycles for transferring foreign
its composition daily to provide daily disclosures. Based on staff estimates, we securities to redeeming investors,
disclosure of the identities and estimate the initial cost would be together with local market holiday
weightings of the component securities $16,890 for internal ETF staff time to schedules, require a delivery process in
and other assets in the ETF’s portfolio. develop the Web page and $9,540 for an excess of the statutory seven days
Currently, two ETF registrants are external Web site developer, for a total required by section 22(e) of the Act. The
required to disclose their portfolios of $26,430.270 proposed rule would codify the
daily under the terms of their exemptive disclosure requirement in existing
orders.266 The Commission staff 267 Estimates on the number of burden hours and
exemptive orders that requires ETFs to
estimates that an ETF each year would external costs associated with the collections of disclose in their registration statements
information are based on informal conversations
spend approximately 200 hours of between Commission staff and representatives of the foreign holidays that would prevent
professional time to update the relevant ETFs. The staff estimates the cost would be 200 timely satisfaction of redemption.272
hours for an internal Web site developer (at $211 The collection of information burden for
265 See Section II of this release for a discussion per hour) (200 × $211 = $42,200). Hourly wages this disclosure is discussed in the PRA
on the operation of ETFs. Disclosure of the contents used for purposes of this PRA analysis are from the
Securities Industry Association (now named analysis of proposed Form N–1A
of the basket assets and the number of shares that
comprise a creation unit are critical to investors Securities Industry and Financial Markets amendments in section VI.B below.
who seek to purchase or redeem creation units from Association), SIA Report on Management & As of December 2007, there were 601
the ETF and, therefore, to the operation of an ETF. Professional Earnings in the Securities Industry ETFs.273 The Commission staff
To purchase a creation unit, an investor would need 2006, modified to account for an 1800-hour work-
to know the securities and other assets that must year and multiplied by 5.35 to account for bonuses,
be deposited with the ETF in exchange for a firm size, employee benefits and overhead. hours for Web site managers (at $282 per hour) to
creation unit. To redeem a creation unit, an investor 268 Commission staff estimates the cost would review the Web page ((60 hours × $211) + (15 hours
would need to know the number of ETF shares that equal 80 hours for Web site developers at the ETF × $282) = $16,890). In addition, based on
comprise a creation unit in order to compile enough (at $211 per hour) to develop the Web page and 20 discussions with industry representatives, the staff
shares to redeem from the ETF. Disclosure of the hours for internal Web site managers (at $282 per estimates that each fund would spend an additional
contents of the basket assets also is important to the hour) to review the Web page ((80 hours × $211) $9540 to external Web site developers ($16,890 +
arbitrage mechanism of the ETF. Arbitrageurs + (20 hours time × $282) = $22,520). In addition, $9540 = $26,430).
compare the NAV of the basket to the NAV of ETF based on discussions with industry representatives, 271 Commission staff estimates the cost would

shares to determine whether to purchase or redeem the staff estimates that each ETF initially would equal 2 hours for the ETF’s internal counsel (at
rwilkins on PROD1PC63 with PROPOSALS2

creation units based on the relative values of ETF spend an additional $12,600 to external Web site $292 per hour) to draft the disclosure and 28 hours
shares in the secondary market and the securities developers ($22,520 + 12,600 = $35,120). for clerical staff (at $40 per hour) to input and copy
contained in the basket. 269 Commission staff estimates the cost would check the marketing materials ((2 × $292) + (28 ×
266 ProShares Notice, supra note 113; Rydex ETF equal 206 hours for internal Web site developers at $40) = $1704).
Trust, Investment Company Act Release No. 27703 ($211 per hour) (206 × $211 = $43,466). 272 See supra notes 136–141 and accompanying

(Feb. 20, 2007) [72 FR 8810 (Feb. 27, 2007)]. 270 Commission staff estimates the cost would text for a discussion of the proposed exemption
Together, these registrants offer 64 ETFs that are equal 60 hours for internal Web site developers (at from section 22(e) of the Act.
required to disclose their portfolios daily. $211 per hour) to develop the Web page and 15 273 ICI ETF Statistics 2007, supra note 5.

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estimates that each year 150 new ETFs B. Form N–1A in Item 2 of the Form.283 This would
will form and operate.274 The staff We are proposing amendments to codify, with modifications, a condition
estimates that each ETF each year Form N–1A to provide more useful in ETF exemptive orders. The
would spend approximately 236 hours information to investors who purchase amendments also would require ETFs to
to comply with the conditions of and sell ETF shares on national calculate total return at market prices in
proposed rule 6c–11. Each new ETF securities exchanges. addition to returns at NAV for their
would spend an additional 75 hours to Creation Units. The proposed financial highlights tables.284 One
develop the Web sites for daily amendments would permit an ETF to consequence of this proposed
disclosure of its prior business day’s exclude certain information from its amendment is that ETFs would be
NAV, market closing price for its shares, prospectus that is not pertinent to required to include two bar charts under
and premium/discount information. In investors purchasing individual ETF Item 2 of Form N–1A; one using market
addition, ETFs that provide the shares. Specifically, an ETF that has price returns and one using NAV
identities and weightings of the creation units of 25,000 shares or more returns.285 We do not believe these
securities and other assets in their may exclude from its prospectus: (i) added disclosures would increase the
portfolios if they do not track an index Information on how to purchase and hourly burdens of ETFs. ETFs are
whose provider discloses its redeem shares of the ETF; 280 and (ii) fee currently required by our orders to
composition daily would spend an table fees and expenses for purchases calculate and present market price
additional 100 hours to develop the and redemptions of creation units.281 returns in the prospectus and, therefore,
Web sites for this disclosure. Each of Based on conversations with industry this disclosure would not present a new
those ETFs also would spend an representatives, Commission staff substantive requirement. The proposal
estimated 200 hours each year to update estimates that this proposed amendment would eliminate industry practice of
the disclosures of portfolio assets on its would decrease the information including this disclosure in a
Web site. For purposes of this PRA, the collection burdens of an ETF that has supplemental section rather than the
staff estimates that one-half of all new creation units of 25,000 shares or more main body of the prospectus and,
ETFs (75 ETFs) would provide this by an average of 1.4 hours per fund per therefore, would integrate the disclosure
disclosure. Based on staff estimates, we filing of an initial registration statement within current Form N–1A
estimate that ETFs would, in the or post-effective amendment to a requirements.286 Staff estimates that the
registration statement. time it takes to prepare the new line
aggregate, spend 205,036 hours each
The proposed amendment also would items and the additional bar chart
year to comply with the requirements of
require disclosures designed to include would be the same as the amount of
proposed rule 6c–11.275 We estimate
important information for purchasers of time ETFs currently spend preparing the
further that ETFs would spend 18,750
individual ETF shares, as described market price return disclosure that is
hours initially to develop the Web page
below. An ETF would have to modify included in the supplemental section.
for these disclosures, amortized over
the narrative explanation preceding the Based on discussions with industry
three years for an annual burden of 6250
example in the fee table in its representatives, the staff estimates that
hours.276 Thus, the estimated total
prospectus and periodic reports to state each ETF currently spends
annual burden is 211,286 hours.277 We
that fund shares are sold on the approximately 0.6 hours of professional
estimate the annual internal costs of time to prepare the market price returns
secondary market rather than redeemed
ongoing compliance with these disclosure required by our exemptive
at the end of the periods indicated, and
disclosure requirements would be $40 orders.
that investors in ETF shares may be
million and external costs would be We request comment on this estimate.
required to pay brokerage commissions
$4.5 million.278 We further estimate that If commenters believe the estimate is
that are not reflected in the fee table.282
initial internal costs to develop the Web not reasonable, we request they provide
We believe that the added information
page for these disclosures would be $4.2 specific data that would allow us to
collection burdens associated with this
million and external costs would be make a more accurate estimate.
statement, if any, would be negligible.
$2.3 million, or $1.4 million and $0.8 We request comment on these Premium/Discount Information. The
million, respectively, amortized over estimates. If commenters believe these amendments also would require ETFs to
three years.279 estimates are not reasonable, we request include premium/discount information
they provide data that would allow us in both the prospectus and annual
274 To estimate the number of new ETFs each year

for purposes of this PRA, the staff has used the to make more accurate estimates. report of each ETF. This proposed
approximate average of the number of new ETFs for Total Returns. The proposed amendment codifies an existing
the past three years ((50 + 153 + 244)/3 =149). ICI, amendments would require each ETF to exemptive order requirement. Based on
Exchange-Traded Fund Assets December 2006, Jan. include a separate line item for returns discussions with industry
31, 2007; ICI ETF Statistics 2007, supra note 5.
275 Assuming all existing ETFs would rely on the
based on the market price of ETF shares representatives, the staff estimates that
proposed rule, these estimates are based on the in the average annual total returns table each ETF currently spends an average of
following calculations: ((206 hours + 30) × 612 0.5 hours per filing of an initial
(existing plus estimated new index-based ETFs)) + × 75) = $4,222,500; ($9540 × 75) + (($9540 + registration statement or a post-effective
(436 hours × 139 (existing plus estimated new $12,600) × 75) = $2,376,000. amendment to a registration statement
actively managed ETFs) = 205,036). 280 Proposed Item 6(h)(1) of Form N–1A.
276 This estimate is based on the following
to include this disclosure.287 The staff
281 Proposed Instruction 1(e)(i) to Item 3 of Form
calculation: (75 hours × 75 (estimated new index- N–1A.
based ETFs)) + (175 hours × 75 (estimated new 282 Proposed Instruction 1(e)(ii) to Item 3 of Form
283 Proposed Instruction 5(a) to Item 2(c)(2) of

actively managed ETFs)) = 18,750. Form N 1A.


N–1A; Proposed Instruction 1(e)(ii) to Item 22(d) of
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277 This estimate is based on the following 284 Proposed Instruction 3(f) to Item 8(a) of Form
Form N–1A. The proposal also would require each
calculation: 205,036 + 6250 = 211,286. ETF to identify the principal U.S. market on which N–1A.
278 These estimates are based on the following 285 See Item 2(c)(2)(i) of Form N 1A.
its shares are traded and include a statement to the
calculations: (($43,466 + $1704) × 612) + ($42,000 effect that ETF shares are bought and sold on 286 See supra note 163.

× 139) = $39,760,670; ($6000 × 612) + ($6000 × 139) national securities exchanges. We believe that the 287 This estimate is based on discussions with
= $4,506,000. added information collection burdens associated representatives of ETFs, which include premium/
279 These estimates are based on the following with these very brief and specific statements, if any, discount information as required by their exemptive
calculations: ($16,890 × 75) + (($16,890 + $22,520) would be negligible. orders.

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further estimates that each ETF also C. Proposed Rule 12d1–4 specific data that would allow us to
would spend 0.5 hours per annual Proposed rule 12d1–4 would permit make a more accurate estimate.
report to include this disclosure. an acquiring fund to acquire ETF shares There were 601 ETFs as of the end of
We request comment on this estimate. in excess of the limits of section 12(d)(1) December 2007.294 Based on our
If commenters believe the estimate is estimate, two acquiring funds each year
of the Act, subject to certain
not reasonable, we request they provide would provide a representation to an
conditions.289 In order to rely on the
specific data that would allow us to ETF, its principal underwriter, a broker,
proposed rule for an exemption from
make a more accurate estimate. or a dealer with respect to each ETF, for
Foreign Holidays. As noted above, section 12(d)(1)(B) limits, an ETF may
a total of 1202 representations. We
proposed rule 6c–11 would require not redeem and its principal
estimate that each representation would
certain ETFs to disclose in their underwriter, a broker, or dealer may not
take, on average no more than 0.2 hours
registration statements the foreign submit for redemption any of the ETF’s
to prepare and submit to the ETF,
holidays that would prevent timely shares that were acquired by an
principal underwriter, broker, or
satisfaction of redemption. As of July acquiring fund in excess of the limits of
dealer.295 Accordingly, we believe that
2007, there were 125 ETFs that provide section 12(d)(1)(A)(i) of the Act in the total annual collection of
exposure to international equity reliance on proposed rule 12d1–4.290 information burden for proposed rule
markets. Based on discussions with ETF The proposed rule provides a safe 12d1–4 would be 240 hours at a cost of
representatives, the staff estimates that harbor for these entities if the entity has $70,080.296
approximately 10% of these ETFs may (i) received a representation from the We request comment on these
need to delay satisfaction of redemption acquiring fund that none of the ETF estimates. If commenters believe these
requests, and that each of those ETFs shares it is redeeming was acquired in estimates are not reasonable, we request
would spend approximately 0.3 hours to excess of the limits of section they provide specific data that would
include the required information in its 12(d)(1)(A)(i) in reliance on the rule, allow us to make more accurate
registration statement. and (ii) no reason to believe that the estimates.
We request comment on these acquiring fund is redeeming any ETF
shares that the acquiring fund acquired D. Request for Comments
estimates. If commenters believe these
estimates are not reasonable, we request in excess of the limits of section We request comment on whether
they provide specific data that would 12(d)(1)(A)(i) in reliance on the rule.291 these estimates are reasonable. Pursuant
allow us to make more accurate The representation required for the safe to 44 U.S.C. 3506(c)(2)(B), the
estimates. harbor would be a collection of Commission solicits comments in order
The current burden for preparing an information for purposes of the PRA. to: (i) Evaluate whether the proposed
initial Form N–1A filing is 830.47 hours Our understanding is that acquiring collections of information are necessary
per portfolio. The current burden for funds that invest in ETFs generally do for the proper performance of the
preparing a post-effective amendment not redeem their shares from the ETF, functions of the Commission, including
on Form N–1A is 111 hours per but rather sell them in secondary market whether the information will have
portfolio. The total annual hour burden transactions. We also believe that an practical utility; (ii) evaluate the
approved for Form N–1A is 1,575,184. acquiring fund that would not rely on accuracy of the Commission’s estimate
Based on Commission filings, proposed rule 12d1–4 to acquire ETF of the burden of the proposed
Commission staff estimates that on an shares (i.e., an acquiring fund that collections of information; (iii)
annual basis, ETFs file initial acquires 3 percent or less of an ETF’s determine whether there are ways to
registration statements covering 98 ETF outstanding voting securities) would be enhance the quality, utility, and clarity
portfolios, and post-effective less likely to redeem shares because it of the information to be collected; and
amendments covering 1441 ETF would be less likely to have a sufficient (iv) minimize the burden of the
portfolios on Form N–1A. Based on staff number of shares to permit the collections of information on those who
estimates, we estimate that the proposed acquiring fund to redeem its shares.292 are to respond, including through the
amendments would not increase the We estimate that ETFs, their principal use of automated collection techniques
hour burden per ETF per filing on an underwriters, and brokers and dealers in or other forms of information
initial registration or post-effective the aggregate would choose to rely on technology.
amendment to a registration the safe harbor to redeem or submit a Persons wishing to submit comments
statement.288 Therefore, if the proposed redemption order with respect to ETF on the collection of information
amendments to Form N–1A were shares that were not acquired in reliance requirements of the proposed
adopted, we estimate that the total on proposed rule 12d1–4 on average two amendments should direct them to the
annual hour burden for all ETFs for times each year with respect to each Office of Management and Budget,
preparation and filing of initial ETF.293 Attention Desk Officer for the Securities
registration statements would remain We request comment on this estimate. and Exchange Commission, Office of
the same. If commenters believe this estimate is
294 ICI ETF Assets 2007, supra note 5.
We request comment on these not reasonable, we request they provide
295 The proposed rule does not specify language
estimates. If commenters believe these that must appear in the representation. It simply
289 See discussion in Section IV.A–B supra.
estimates are not reasonable, we request requires the acquiring fund to represent that the
290 See proposed rule 12d1–4(b)(1).
they provide specific data that would shares submitted for redemption are not shares
289 See proposed rule 12d1–4(b)(2).
acquired in excess of the limits of section
allow us to make more accurate 292 ETF shares are redeemed only in creation unit 12(d)(1)(A)(i) of the Act in reliance on proposed
estimates. aggregations. A creation unit typically consists of at rule 12d1–4. Accordingly, we expect that while
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least 25,000 shares. See supra note 113. initial representations might take half an hour to
288 The proposed amendments would add 293 We recognize that some ETFs may receive draft, these representations would soon conform to
approximately 1.4 hours (0.6 hours (total returns), more redemption requests from acquiring funds and an industry standard that would take no more than
0.5 hours (premium/discount information), and 0.3 may rely on the safe harbor more often, while other a few minutes to produce.
hours (foreign holidays)), which staff estimates ETFs may receive no redemption requests or may 296 These estimates are based on the following

would be offset by approximately 1.4 hours not choose to rely on the safe harbor when they calculations: 1202 representations × 0.2 hours =
(elimination of description of creation units and receive a redemption request from an acquiring 240.4 hours; 240 hours × $292 (hourly rate for a
associated fees). fund. fund attorney) = $70,080.

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14646 Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules

Information and Regulatory Affairs, exemptive orders that we have issued to result in additional benefits to ETFs or
Room 10102, New Executive Office ETFs in the past.298 Proposed rule 6c– their investors. Are there other costs of
Building, Washington, DC 20503, and 11 would require an ETF that relies on the proposed rule that would offset any
should send a copy to Nancy M. Morris, the proposed rule either to (i) disclose cost savings resulting from not having to
Secretary, Securities and Exchange on its Internet Web site each business file an exemptive application?
Commission, 100 F Street, NE., day the identities and weightings of the The exemptive application process
Washington, DC 20549–1090, with component securities and other assets also involves other indirect costs. ETFs
reference to File No. S7–07–08. OMB is held by the fund, or (ii) have a stated and their sponsors that apply for an
required to make a decision concerning objective of obtaining results that order forgo potential market
the collections of information between correspond to the returns of a securities opportunities until they receive the
30 and 60 days after publication of this index whose index provider discloses order, while others forgo the market
Release; therefore a comment to OMB is on its Internet Web site the identities opportunity entirely rather than seek an
best assured of having its full effect if and weightings of the component exemptive order because they have
OMB receives it within 30 days after securities and other assets of the concluded that the cost of seeking an
publication of this Release. Requests for index.299 An ETF that meets one of exemptive order would exceed the
materials submitted to OMB by the these requirements could redeem shares anticipated benefit of the market
Commission with regard to these in creation unit aggregations, have its opportunity.302 These direct and
collections of information should be in shares traded at current market prices, indirect costs currently may prevent
writing, refer to File No. S7–07–08, and engage in in-kind transactions with smaller ETFs and their sponsors from
be submitted to the Securities and certain affiliates, and in certain coming to market because they have
Exchange Commission, Public Reference circumstances, redeem shares in more determined that the cost of an
Room, 100 F Street, NE., Washington, than seven days.300 exemptive application may exceed the
DC 20549–1520. Elimination of Exemptive Order Costs. potential benefit. Eliminating these
We anticipate that ETFs, their sponsors, costs may allow more ETFs, particularly
VIII. Cost-Benefit Analysis and ETF investors would benefit from smaller ETFs, to come to market.
The Commission is sensitive to the the proposed rule. ETFs and their We seek comment this analysis.
costs and benefits imposed by its rules. sponsors increasingly have sought Would removing the regulatory burdens
As discussed above, the proposed rules exemptive orders (which the facilitate greater innovation in the ETF
and rule amendments would permit Commission has granted) to form and market place, particularly with respect
funds to engage in activities and operate as open-end management to smaller ETFs?
transactions that are otherwise companies under the Act. The Increased Investment Options. We
prohibited under the Act without the application process involved in expect that the proposed rule also
expense and delay of obtaining an obtaining exemptive orders imposes would benefit ETF investors to the
individual exemptive order. direct costs on ETFs and their sponsors, extent it would remove a possible
Specifically, proposed rule 6c–11 would including preparation and revision of an disincentive for some ETFs and their
permit ETFs to form and operate. application, as well as consultations sponsors to form and operate as open-
Proposed rule 12d1–4 would permit a with Commission staff. The proposed end funds and provide investors with
fund to invest in ETFs beyond the limits rule would benefit ETFs and their additional investment choices. As noted
of section 12(d)(1) of the Act, and sponsors by eliminating the direct costs above, the direct and indirect costs of
proposed amendments to rule 12d1–2 of applying to the Commission for an the exemptive application process may
would expand the investment options exemptive order to form and operate as discourage potential sponsors,
available to funds that rely on the permitted under the rule.301 The rule particularly smaller sponsors interested
exemptive relief in section 12(d)(1)(G) of would further benefit ETFs and their in offering smaller, more narrowly
the Act. The proposed amendments to sponsors by eliminating the uncertainty focused ETFs which may serve the
Form N–1A are designed to provide that a particular applicant might not particular investment needs of certain
more useful information to investors obtain relief to form and operate as investors. By eliminating the need for
who purchase and sell ETF shares on permitted under the rule. We anticipate individual exemptive relief, we
national securities exchanges, while that the elimination of the direct costs anticipate that the proposed rule would,
simplifying the form by permitting of exemptive applications also may over time, lead to an increase in ETFs.
most, if not all, ETFs to exclude benefit ETF investors by enabling ETFs In those circumstances, the proposed
information related to the purchase and to lower their costs as a result of lower rule would provide ETF investors with
redemption of creation units.297 This start-up costs. greater investment choices, while also
cost-benefit analysis examines the costs We seek comment on whether the providing them with the protections
and benefits to ETFs, acquiring funds, elimination of these direct costs would afforded by the Investment Company
and investors that would result from Act.
reliance on the proposed exemptive 298 The proposed rule does not codify exemptions We seek comment on this analysis.
rules and rule and form amendments, in previously provided to ETFs organized as UITs Would the proposed rule result in
because the Commission has not received an increased investment options?
comparison to the costs and benefits exemptive application for a new ETF to be
associated with obtaining an exemptive organized as a UIT since 2002. See discussion in Elimination of Certain Exemptive
order from the Commission. Section III.A.3 of this release. Order Terms. Proposed rule 6c–11 also
299 Proposed rule 6c–11(e)(4)(v); see also may benefit ETFs and their sponsors by
A. Rule 6c–11 discussion in Section III.B.1 of this release for a eliminating certain terms contained in
discussion of these conditions.
1. Benefits exemptive orders that we believe may
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300 Proposed rule 6c–11(a)–(d); see also

discussion in Section III.C. of this release. be addressed by other provisions of the


Proposed rule 6c–11 would codify 301 The cost to an ETF for submitting an
much of the relief and conditions of application ranges from approximately $75,000 to 302 The time involved in obtaining an order from

$350,000. These figures are based on conversations the Commission ranges from several months to
297 As noted above, information on how creation with attorneys and ETF employees who have been several years depending on the nature, complexity,
units are offered to the public is required to be involved in submitting applications to the and de novo consideration of the exemptions
disclosed in the SAI. Item 18(a) of Form N–1A. Commission. sought.

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federal securities laws. We propose to as or greater than the costs associated may be costs associated with printing
eliminate the terms designed to prevent with the proposed rule. and delivering prospectuses to
the communication of material non- We request comment on this analysis. secondary market purchasers, we expect
public information between the ETF and Would ETFs that currently rely on an these costs to be minimal. We
its affiliated index provider because we order bear lower costs if they relied on understand that many, if not most,
believe that there are sufficient the proposed rule? Would an ETF have broker-dealers selling ETF shares in
requirements under federal securities to change its operation in any way to secondary market transactions, in fact,
laws and the rules of national securities comply with the proposed rule? transmit a prospectus to purchasers, and
exchanges to protect against the abuses Prospectus Delivery. The proposed thus they may not have relied on the
the terms were intended to address.303 rule does not provide an exemption exemptions provided in the orders. In
We anticipate that eliminating these from prospectus delivery that most ETFs addition, we anticipate these costs
regulatory burdens may reduce costs of and their sponsors have requested and could be offset by the fact that the ETFs
operating an ETF and thereby facilitate we have provided in our orders. Most of would not have to prepare product
greater competition and innovation our orders have exempted broker- descriptions and by the simplified
among ETFs. dealers selling ETF shares from the prospectus disclosure in this
We request comment on this analysis. obligation to deliver prospectuses in proposal.308
Are there any costs associated with most secondary market transactions.304 We anticipate that any cost associated
eliminating these terms? Those applicants have represented that with this requirement may be justified
broker-dealers would instead deliver a by the benefits to ETF investors.
2. Costs
Prospectuses provide ETF investors
We do not expect the proposed rule ‘‘product description’’ containing basic
with standardized information about an
would impose mandatory costs on any information about the ETF and its
investment in an ETF and the
ETF. As discussed above, the proposed shares.305 Because proposed rule 6c–11
differences between an ETF and a
rule is exemptive, and we expect that a would not contain a similar exemption,
traditional mutual fund. Because
fund would not operate as an ETF in broker-dealers would be required to
prospectuses are standardized forms the
reliance on the rule if the anticipated deliver a prospectus meeting the
content of which has been prescribed by
benefits did not justify the costs. We requirements of section 10 of the
the Commission, their delivery could
expect the costs of relying on the Securities Act to investors purchasing
promote greater uniformity in the
proposed rule are likely to be the same ETF shares.306 We believe an exemption
content and level of disclosure among
as or less than the costs to an ETF that allowing broker dealers to deliver existing and future ETFs. Finally, our
relies on an existing exemptive order product descriptions would be proposed amendments to the prospectus
because the proposed rule includes the unnecessary given our proposal should provide more useful information
same or fewer conditions than existing regarding summary prospectus to investors who purchase and sell ETF
orders that provide equivalent disclosure. If we adopt the Enhanced shares on a national securities exchange,
exemptive relief. Disclosure Proposing Release, broker- while simplifying prospectuses by
The proposed rule would affect dealers selling ETF shares could deliver permitting ETFs to exclude information
different types of ETFs and their a summary prospectus in secondary related to the purchase and redemption
sponsors in different ways. A sponsor or market transactions.307 Although there of creation units.
adviser that has not sought and would We request comment on this analysis.
304 The orders have granted exemptions from
not seek exemptive relief to form and section 24(d) of the Act, which makes inapplicable
Are we correct in assuming that
operate an ETF registered under the Act the dealer exception in section 4(3) of the Securities prospectus delivery costs would be
would not be affected by the rule. For Act to transactions in redeemable securities issued offset by the elimination of product
an ETF and its sponsor that currently by an open-end investment company. 15 U.S.C. descriptions?
80a–24(d); 15 U.S.C. 77d(3); see, e.g., WisdomTree Conditions. All ETFs seeking to rely
rely on an exemptive order, there may Order, supra note 12. ETFs that have this
be one-time ‘‘learning costs’’ in exemption, however continue to be subject to on the rule would have to be listed on
determining the differences between the prospectus delivery requirements in connection an exchange that disseminates the per
order and rule. After making this with sales of creation units and other non- share NAV of the ETFs’ baskets at
secondary market transactions. Our most recent regular intervals. This condition was
determination, we expect that the costs orders, however, do not provide an exemption from
for this ETF would be the same as or prospectus delivery requirements. See Actively
included in our exemptive orders and,
less than the costs of relying on its Managed ETF Orders, supra note 20. therefore, should not result in an
exemptive order because the rule 305 See, e.g., Ziegler Notice, supra note 110. The increased cost to existing ETFs. Each
contains the same or fewer conditions product description provides a summary of the ETF also must, in any sales literature (as
salient features of the ETF and its shares, including defined in the rule), identify itself as an
than existing orders. In addition, an ETF the investment objectives of the fund, the manner
and its sponsor that currently rely on an in which ETF shares trade on the secondary market, ETF, which does not sell or redeem
exemptive order could generally satisfy and the manner in which creation units are individual shares, and explain that
all the conditions of the rule that purchased and redeemed. National securities investors may purchase or sell
exchanges on which ETFs are listed have adopted individual shares on national securities
provide similar exemptive relief without rules requiring the delivery of product descriptions.
changing its operation. Finally, a See, e.g., American Stock Exchange Rules 1000 and
exchanges. This condition is similar to
sponsor that has not relied on an 1000A. one included in our exemptive orders
exemptive order and that intends to rely 306 15 U.S.C. 77j. We also are proposing to amend and, therefore, should not result in an
on the proposed rule would bear the our orders to exclude the section 24(d) exemption increased cost to existing ETFs. In
we have issued to existing ETFs. Accordingly, the addition, the ETF would be required
same or lower continuing costs of prospectus delivery requirement would apply to all
either to (i) disclose on its Internet Web
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complying with conditions that it would ETFs, including ETFs operating under current
have borne had it obtained an exemptive orders. See supra Section III.E for a
discussion of this proposed amendment to existing would be in a form that would be easy to use and
exemptive order. In that case, its total orders. readily accessible.
costs are likely to have been the same 307 See supra notes 145–152 and accompanying 308 The preparation of a product description can

text. The summary prospectus would contain cost approximately $360 to $11,000 per ETF. These
303 See Section III.B.4 of this release for a material information that may not appear in a figures are based on conversations with attorneys
discussion of this condition. product description, but like a product description, and ETF employees.

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14648 Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules

site each business day the identities and amendments to Form N–1A, and the this information must be located in the
weightings of the component securities summary prospectus, designed to meet prospectus. As a result, ETFs have
and other assets held by the fund, or (ii) the needs of investors (including retail included an additional table in the
have a stated objective of obtaining investors) who purchase shares in the prospectus, rather than including
results that correspond to the returns of secondary market rather than market price returns in the average
a securities index whose index provider institutional investors purchasing annual returns table required by Item 2
discloses on its Internet Web site the creation units from the ETF. of the Form. The lack of specificity also
identities and weightings of the Material Information to ETF Investors. resulted in ETFs using different time
component securities and other assets of We expect that the primary benefit of periods for the disclosure, with some
the index.309 Index-based ETFs comply our proposed amendments would be to using calendar years and others fiscal
with the latter requirement and, provide ETF investors purchasing years. The proposed amendment would
therefore, this condition should not shares in the secondary market with eliminate use of a second table, which
result in an increased cost to ETFs that information on the investment that may confuse investors. It also would
would track a transparent index. ETFs currently is not included in product require all ETFs to present the
that choose to rely on the former descriptions, such as the fund’s fee table information using calendar years,
condition, including the actively and the name and length of service of standardizing the reporting period used
managed ETFs subject to the recent the portfolio manager. This should by ETFs. The proposed amendments
exemptive orders we issued, would provide ETF investors with information would mandate uniform disclosure in
incur costs in connection with necessary to understand an investment the prospectus, which should benefit
developing a Web page for this in an ETF. This information also may be investors by allowing them to compare
disclosure and updating the disclosure helpful to investors in making portfolio ETFs more easily.
daily.310 We expect these costs to be of allocation decisions. Similarly, our exemptive orders
the same magnitude as the costs borne Simplified Disclosure. Our proposed required ETFs to include in their
by index providers in making their amendments are designed to simplify prospectuses and annual reports
indexes transparent. Although this may prospectus and periodic report premium/discount information to alert
be a reallocation of costs from index disclosure in two ways. First, the investors of the extent and frequency
providers to those ETFs that choose to proposal would allow ETFs to exclude with which market prices deviated from
fully disclose their portfolios, we do not from the prospectus information on how the fund’s NAV.313 ETFs have generally
believe that this change would to purchase and redeem creation units, included this information in a
significantly affect the costs borne by including information on fees and supplemental section of the prospectus
ETF investors. The new disclosure costs expenses associated with creation unit and annual report.314 The proposed
for ETFs that choose to disclose their sales or purchases. Current ETF amendments would incorporate this
portfolios rather than track a transparent prospectuses and periodic reports disclosure in the Shareholder
index would be offset by the lack of include detailed information on how to Information section (Item 6 of Form N–
index licensing fees that are generally purchase and redeem creation units. 1A) of the prospectus and the
charged to index-based ETFs. The fee table and example include Management’s Discussion of Fund
We request comment on whether information on transaction fees payable Performance (Item 22(b)(7) of the annual
investors in an actively managed ETF only by creation unit purchasers. Our report). We anticipate that this would
would incur any additional costs as a proposed amendments would permit benefit ETF investors by simplifying the
result of the portfolio disclosure. We ETFs with creation units of at least prospectuses and annual reports of ETFs
also request comment on our analysis. 25,000 shares to exclude this while codifying important disclosures
information because it is not relevant mandated by our exemptive orders.
B. Amendments to Form N–1A (and potentially confusing) to investors
2. Costs
1. Benefits purchasing in secondary market
transactions.311 This proposed provision The primary goal of our proposed
As discussed above, most of our should simplify ETF prospectuses amendments is to provide investors in
orders have exempted broker-dealers without compromising the disclosure ETF shares with more valuable
selling ETF shares from the obligation to provided to investors who purchase ETF information regarding an investment in
deliver prospectuses in secondary shares in secondary market transactions. an ETF. We do not expect that the
market transactions. Applicants for Second, the proposed amendment proposed amendments would result in
those orders have represented that they would incorporate current disclosure significant additional costs to ETFs.315
would instead require that broker- requirements mandated by our As noted above, our proposed
dealers deliver a product description exemptive orders into the prospectus disclosure amendments generally would
containing basic information about the instead of in a supplemental section codify disclosure requirements in
ETF and its shares. We are not including where ETFs currently locate it. Our existing ETF exemptive orders. To the
a similar exemption in proposed rule exemptive orders require ETFs to extent the proposed amendments
6c–11, and thus a broker-dealer would include in their prospectuses and
be required to deliver a prospectus annual reports returns based on market 313 See supra notes 166–170 and accompanying

meeting the requirements of section 10 price in addition to returns based on text for a discussion of this proposed amendment.
of the Securities Act to investors NAV, which as discussed above, may be
314 See e.g., iShares MSCI Series, Prospectus 62–

purchasing ETF shares. In light of this 65 (Jan. 1, 2007); iShares MSCI Series, 2006
different than the fund’s NAV and better Shareholders Annual Report 130–136 (Aug. 31,
requirement, we also are proposing relate to an ETF investor’s experience in 2006).
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315 Existing ETFs would face a one-time ‘‘learning


309 Proposed
the fund.312 The condition in our
rule 6c–11(e)(4)(iv). cost’’ to determine the difference between the
310 For purposes of the Paperwork Reduction Act,
exemptive orders did not specify where current Form N–1A requirements as modified by
the staff estimated that each ETF would spend their exemptive orders and the proposed
311 See supra notes 158–161 and accompanying
approximately $22,520 to develop the Web site. The amendments. We do not anticipate that this cost
staff also estimates that each ETF would spend 200 text for a discussion of this proposed amendment. would be significant given the similarity of the
hours annually to update the site daily. See supra 312 See supra notes 163–165 and accompanying amendments to the conditions in existing
notes 267–268 and accompanying text. text for a discussion of this proposed amendment. exemptive orders.

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contain new disclosure requirements, commissions.319 Including these reliance on proposed rule 12d1–4; and
such as, for example, the requirement additional statements should present (ii) no reason to believe that the shares
that ETFs include market price returns minimal, if any, printing costs. to be redeemed were acquired in excess
in addition to NAV returns in Item 8 of As noted above, any additional costs of the limits of section 12(d)(1)(A)(i) in
Form N–1A, any costs related to these incurred by an ETF in complying with reliance on the proposed rule.326
additional disclosures should be offset these additional disclosures should be We anticipate that acquiring funds,
by our proposal to exempt ETFs with offset by the cost-savings of our acquired ETFs, investment advisers, and
creation units of 25,000 or more shares proposal, which would allow most, if shareholders of both acquiring funds
from including creation unit purchase not all, ETFs to exclude creation unit and acquired ETFs would benefit from
and redemption information in their purchase and redemption information the proposed rule. Acquiring funds
prospectuses and annual reports. Most, in their prospectuses.320 would be able to purchase and ETFs
if not all ETFs, would be able to rely on would be able to sell ETF shares beyond
C. Rule 12d1–4
this exemption.316 We anticipate that the limits of section 12(d)(1) without
future ETFs would offer creation units 1. Benefits obtaining an exemptive order, which
of 25,000 shares or more. Proposed rule 12d1–4 would codify can be costly to ETFs and their
We request comment on this much of the relief in orders that we have shareholders.327 The exemptive
assumption. If ETFs are likely to offer issued permitting funds to invest in application process also involves other
smaller creation units, what is the ETFs beyond the limits of section indirect costs. ETFs that apply for an
fewest number of shares likely to be 12(d)(1), while eliminating most of the order to permit other funds to make
offered in a creation unit? conditions included in the orders. additional investments in the ETFs
In addition to codifying disclosure Proposed rule 12d1–4 would permit beyond the limits of section 12(d)(1) and
requirements of existing exemptive fund investments in ETFs beyond the funds that would rely on the order
orders, we are proposing several new limits of section 12(d)(1) if: (i) The issued to the ETF forgo potentially
disclosure requirements in Form N–1A. acquiring fund (and any entity in a beneficial investments until the ETFs
First, we propose to require that ETFs control relationship with the acquiring receive the order,328 while other ETFs
include an additional total return fund) could not control the ETF; 321 (ii) (and funds that would rely on the order
calculation under Item 8 using market the acquiring fund does not redeem if issued to the ETF) forgo the
price returns, which would result in an certain shares acquired in reliance on investment entirely rather than seek an
additional bar chart under Item 2(c)(2)(i) the rule; 322 (iii) the fees charged by the exemptive order because they have
of Form N–1A.317 Because most ETFs acquiring fund do not exceed the FINRA concluded that the cost of seeking an
currently calculate and present market sales charge limits; 323 and (iv) the exemptive order would exceed the
price returns in the prospectus pursuant acquired ETF is not itself a fund of anticipated benefit of the investment.
to their exemptive orders, this funds (i.e., the rule would prohibit a Unlike the orders, proposed rule
additional bar chart should result in fund of funds of funds, or three-tier 12d1–4 would not provide an
minimal additional costs because it only fund, structure).324 In addition, an ETF exemption permitting acquiring funds to
requires duplicating the presentation of could not redeem and its principal redeem ETF shares acquired in excess of
information in another location. Second, underwriter, a broker or a dealer could the three percent limit in section
we would require an index-based ETF to not submit an order for redemption of 12(d)(1)(A)(i) of the Act in reliance on
compare its performance to its certain shares acquired by an acquiring the proposed rule. This was designed to
underlying index rather than a fund in reliance on proposed rule 12d1– limit the potential for an acquiring fund
benchmark index.318 This amendment 4.325 The rule provides a safe harbor for to threaten large-scale redemptions as a
would permit use of a narrow-based or any of those entities if it has: (i) A means of coercing an ETF.329
affiliated index and eliminate the representation from an acquiring fund Accordingly, the conditions in the
opportunity for an index-based ETF to that none of the shares to be redeemed proposed rule differ from those in the
select an index different from its was acquired in excess of the limits of exemptive orders. The proposed rule
underlying index, which would better section 12(d)(1)(A)(i) of the Act in would not include: (i) The participation
reflect whether the ETF’s performance agreement requirement; (ii) the
corresponds to the index which 319 See supra note 161 and note 282 and transmission by an acquiring fund of a
performance it seeks to track. This accompanying text.
amendment replaces the type of index 320 For purposes of our Paperwork Reduction Act 326 Proposed rule 12d1–4(b)(2). See supra note

used to present performance data analysis, we have estimated that our proposed 222 and accompanying text for a discussion of the
currently required under Form N–1A amendments would not change the current Form proposed safe harbor.
N–1A compliance costs. See supra discussion at 327 We estimate, based on discussions with fund
and, therefore, should not increase the Section VII of this release. representatives, that the cost of obtaining an
compliance burden for ETFs. Finally, 321 Proposed rule 12d1–4(a)(1). See supra notes
exemptive order permitting an acquiring fund to
we would require each ETF to identify 215–219 and accompanying text for a discussion of invest in an ETF beyond the limits of section
the principal U.S. market on which its the proposed condition. 12(d)(1) ranges from approximately $75,000 to
322 Proposed rule 12d1–4(a)(2) See supra note 220
shares are traded and include a $200,000.
and accompanying and following text for a 328 Although these applications for relief are
statement to the effect that ETF shares discussion of the proposed condition. typically processed expeditiously, Commission staff
are bought and sold on national 323 Proposed rule 12d1–4(a)(3). See supra notes
estimates, based on orders issued in the past, that
securities exchanges and that ETF 230–233 and accompanying text for a discussion of the exemptive application process (from initial
investors trading in these exchanges the proposed condition. Unlike the orders, filing to issuance of order) has taken on average
however, the proposed rule would not require about 15 months. During that time, Commission
may be required to pay brokerage directors to make any special findings that investors staff review and comment on applications,
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are not paying multiple advisory fees for the same applicants submit responses to comments, and the
316 Existing ETFs typically offer creation units of services. completed application is summarized in a notice to
50,000 or more shares, and the lowest number of 324 Proposed rule 12d1–4(a)(4). See supra notes the public. If an application contains a request for
shares permitted under current exemptive orders is 225–229 and accompanying text for a discussion of relief in addition to the relief from section 12(d)(1)
25,000 the proposed condition. of the Act, the application process has often taken
317 See supra note 163. 325 Proposed rule 12d1–4(b)(1). See supra note longer than 15 months.
318 See supra notes 173–174 and accompanying 221 and accompanying text for a discussion of the 329 See supra note 220 and accompanying and

text. proposed condition. following text.

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14650 Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules

list of certain of its affiliates to the ETF; 1(d)(2).333 This relief would be available redeem its shares.336 We estimate that
(iii) certain policies and procedures only if the broker-dealer and the ETFs, their principal underwriters, and
designed to limit the influence an acquiring fund became affiliated solely brokers and dealers in the aggregate
acquiring fund can exert on the ETF; because of the acquiring fund’s would choose to rely on the safe harbor
and (iv) limits on certain fees. investment in the ETF. We believe that to redeem or submit a redemption order
Elimination of these conditions would this relief would enable more funds to with respect to ETF shares that were not
reduce regulatory burdens and the cost take advantage of the exemption acquired in reliance on proposed rule
of compliance for funds that seek to provided by the proposed rule. 12d1–4 on average two times each year
invest in ETFs, facilitating greater with respect to each ETF.337 We believe
2. Costs
participation by funds in the purchase that the total annual cost for making this
and sale of ETF shares both directly We do not believe that the rule will representation would be $70,080.338
with the ETF and in secondary market impose mandatory costs on any fund. We request comment on these
transactions.330 Although the proposed As discussed above, the rule is estimates. If commenters believe these
rule would not allow acquiring funds to exemptive, and we believe that a fund estimates are not reasonable, we request
redeem certain shares from the ETF, we would not rely on it if the anticipated they provide specific data that would
understand that acquiring funds benefits did not justify the costs. We allow us to make more accurate
generally sell ETF shares in secondary believe the costs of relying on the rule estimates.
market transactions, rather than redeem would be less than the costs to an The rule would affect different types
them. Accordingly, we believe that this acquiring fund (and ETF) that relies on of sponsors or advisers in different
prohibition would have minimal impact an existing exemptive order to invest in ways. A sponsor or adviser that has not
on acquiring funds. Moreover, the (or sell) ETF shares because the rule sought and would not seek exemptive
adoption of proposed rule 12d1–4 includes substantially fewer conditions relief to permit another fund to invest in
would not preclude an acquiring fund than existing orders that provide similar its shares beyond the limits of section
from continuing to rely on exemptive exemptive relief with respect to 12(d)(1) of the Act would not be affected
orders we have previously issued or purchases and sales of ETF shares. by the rule. The cost for a sponsor or
In order to rely on the proposed rule adviser that currently relies on
seeking new orders to permit funds to
for an exemption from section exemptive relief covered by the rule
invest in ETFs in excess of the limits of
12(d)(1)(B) limits, an ETF may not would be less than the costs of relying
section 12(d)(1) but which do not
redeem and its principal underwriter, or on its exemptive order because the
restrict their ability to redeem ETF
a broker or dealer may not submit for proposed rule contains substantially
shares, subject to the conditions set
redemption any of the ETF’s shares that fewer conditions than existing orders. In
forth in the orders and described above.
were acquired by an acquiring fund in addition, a sponsor or adviser that
In order to allow acquiring funds to excess of the limits of section currently relies on an exemptive order
take full advantage of the exemptive 12(d)(1)(A)(i) of the Act in reliance on could satisfy all the conditions of the
relief, proposed rule 12d1–4 also would proposed rule 12d1–4.334 The proposed proposed rule that provides similar
provide limited relief from rule 17e–1 rule provides a safe harbor for these exemptive relief with respect to
under the Act. If an investment entities if the entity has (i) received a purchases and sales of ETF shares
company in one complex acquired more representation from the acquiring fund without changing its operation. Finally,
than five percent of the assets of an ETF that none of the ETF shares it is a sponsor or adviser that has not relied
in another complex, any broker-dealer redeeming was acquired in excess of the on an exemptive order and that intends
affiliated with that ETF would become limits of section 12(d)(1)(A)(i) in to rely on the proposed rule would
a (second-tier) affiliated person of the reliance on the rule, and (ii) no reason avoid the cost of obtaining an exemptive
acquiring fund.331 As a result of the to believe that the acquiring fund is order and would incur lower continuing
affiliation, the broker-dealer’s fee for redeeming any ETF shares that the costs to comply with the conditions
effecting the sale of securities to (or by) acquiring fund acquired in excess of the included in the proposed rule than it
the acquiring fund would be subject to limits of section 12(d)(1)(A)(i) in would have borne had it obtained an
the conditions set forth in rule 17e–1, reliance on the rule.335 exemptive order.
including the quarterly board review As noted above, we understand that
and recordkeeping requirements with D. Amendments to Rule 12d1–2
acquiring funds that invest in ETFs
respect to certain securities transactions generally do not redeem their shares 1. Benefits
involving the affiliated broker-dealer.332 from the ETF, but rather sell them in
The proposed rule would permit an The proposed amendments to rule
secondary market transactions. We also 12d1–2 would expand the type of
acquiring fund to pay commissions, believe that an acquiring fund that
fees, or other remuneration to a (second- investments that funds relying on the
would not rely on proposed rule 12d1– exemptive relief in section 12(d)(1)(G) of
tier) affiliated broker-dealer without 4 to acquire ETF shares (i.e., an the Act could make. The proposed
complying with the quarterly board acquiring fund that acquires 3 percent amendments would allow acquiring
review and recordkeeping requirements or less of an ETF’s outstanding voting funds that invest in affiliated funds in
set forth in rules 17e–1(b)(3) and 17e– securities) would be less likely to
redeem shares because it would be less 336 ETF shares are generally redeemed only in
330 Based on discussions with fund likely to have a sufficient number of creation unit aggregations. A creation unit typically
representatives, we estimate that the cost of consists of at least 25,000 shares. See supra note
negotiating and entering into a participation shares to permit the acquiring fund to
113.
agreement (and for an acquiring fund preparing the 337 We recognize that some ETFs may receive
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initial list of affiliates) required by our exemptive 333 See supra note 247 and accompanying text. more redemption requests from acquiring funds and
orders ranges from approximately $5,000 to 334 See proposed rule 12d1–4(b)(1). may rely on the safe harbor more often, while other
$10,000. We estimate that the cost to an acquiring 335 See proposed rule 12d1–4(b)(2). We believe ETFs may receive no redemption requests or may
fund to review and update its list of affiliates each that the costs associated with this safe harbor would not choose to rely on the safe harbor when they
year as required by our exemptive orders ranges not be significant. Only acquiring funds that intend receive a redemption request from an acquiring
from approximately $4,000 to $15,000. to redeem less than three percent of an ETF’s shares fund.
331 See supra note 239.
could provide the representations required under 338 See supra notes 294–296 and accompanying
332 See supra note 245. the safe harbor. text.

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reliance on section 12(d)(1)(G) to invest A. Proposed Rules 6c–11 ETF’s NAV and the number of days it
in unaffiliated ETFs beyond the Proposed rule 6c–11 would codify was less than the ETF’s NAV (premium/
statutory limitations as long as the funds much of the relief and conditions of discount information). This information
comply with the conditions of proposed exemptive orders that we have issued to should promote more efficient
rule 12d1–4.339 We also propose to ETFs. The rule would provide relief to allocation of investments by investors
amend rule 12d1–2 to allow funds ETFs by permitting an ETF to operate and more efficient allocation of assets
relying on section 12(d)(1)(G) to invest without first obtaining an exemptive among competing ETFs because
in assets other than securities.340 Under order from the Commission. As noted investors may compare and choose ETFs
the proposed rule, funds relying on the above, the direct and indirect costs of based on their market returns and
exemptive relief in section 12(d)(1)(G) the exemptive application process may deviations from NAV more easily. These
would be able to invest in, among other discourage potential ETF sponsors. The amendments also should improve
things, futures contracts, options, proposed rule also would not include competition because they may prompt
swaps, other derivative investments, conditions contained in exemptive sponsors to launch ETFs that provide
and other financial instruments that do orders designed to address particular improved market price returns or lesser
not qualify as a security under the Act. concerns that we now believe are premiums/discounts. We do not believe
Those investments would, of course, addressed by other provisions of the the proposed amendments would have
have to be consistent with the fund’s federal securities laws.344 Eliminating an adverse impact on capital formation.
investment policies.341 We believe that the need for individual exemptive relief C. Proposed Rule 12d1–4 and
including these types of investment and compliance with specific Amendments to Rule 12d1–2
opportunities would permit funds to conditions may reduce costs of
allocate their investments more introducing and operating an ETF, and Proposed rule 12d1–4 and the
efficiently. may permit additional opportunities for proposed amendments to rule 12d1–2
2. Costs sponsors to introduce new ETFs, would expand the circumstances in
particularly smaller sponsors interested which funds can invest in ETFs without
Rule 12d1–2 (and the proposed in offering smaller, more narrowly the ETF first obtaining an exemptive
amendments to the rule) does not focused ETFs which may serve order from the Commission, which can
impose any conditions on its reliance particular investment needs of certain be costly and time-consuming. We
and thus a fund would not incur any investors. We therefore anticipate that anticipate that the proposed rule and
costs in relying on the rule. the proposed rule would, over time, amendments would promote efficiency
E. Request for Comment lead to an increase in ETFs. and competition. Proposed rule 12d1–4
We expect that the proposal is likely would permit funds to acquire shares of
The Commission requests comment to increase competition and efficiency. ETFs in excess of the limitations in
on the potential costs and benefits of the By making it easier for sponsors, section 12(d)(1) of the Act. This
proposed rules and rule amendments. particularly smaller sponsors, to exemption should allow acquiring funds
We also request comment on the introduce ETFs, the proposal should to allocate their investments more
potential costs and benefits of any allow more sponsors to enter the efficiently by expanding their
alternatives suggested by commenters. marketplace, thereby increasing investment options to include holdings
We encourage commenters to identify, competition among ETF sponsors. The in ETFs beyond the limits of section
discuss, analyze, and supply relevant resulting increase in ETFs that we 12(d)(1) in order to meet the funds’
data regarding any additional costs and expect also should increase competition investment objectives. We also
benefits. For purposes of the Small and innovation among funds. The anticipate that the proposed rule would
Business Regulatory Enforcement Act of proposal also should promote efficiency promote efficiency because permitting
1996,342 the Commission also requests because the increase in ETFs should funds to buy creation units might
information regarding the potential provide investors with more benefit other ETF investors buying and
annual effect of the proposals on the investments that may be specifically selling ETF shares in secondary market
U.S. economy. Commenters are tailored to their particular investment transactions by increasing the number of
requested to provide empirical data to objectives. We do not expect the institutional investors participating in
support their views. proposed rule would have an adverse the arbitrage process. The proposed rule
impact on capital formation. might promote competition by
IX. Consideration of Promotion of
Efficiency, Competition and Capital B. Amendments to Form N–1A increasing the pool of ETFs that accept
Formation investments by other funds beyond
The proposed amendments to Form
section 12(d)(1) limits. Proposed rule
Section 2(c) of the Investment N–1A are designed to provide more
12d1–4 would eliminate the need for
Company Act requires the Commission, useful information to investors
ETFs to obtain an exemptive order from
when engaging in rulemaking that (including retail investors) who
purchase shares in the secondary the Commission, the cost of which
requires it to consider or determine might discourage ETFs, particularly
whether an action is consistent with the market, rather than institutional
investors purchasing creation units from smaller ETFs, from accepting or seeking
public interest, to consider, in addition fund investments beyond section
to the protection of investors, whether the ETF. The proposed amendments
would require ETFs, in addition to 12(d)(1) limits.345
the action will promote efficiency,
competition, and capital formation.343 providing returns based on NAV, to 345 As noted above, the proposed rule also would
include returns based on the market not incorporate many of the conditions contained
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339 Proposed
price of fund shares, and to disclose in in our exemptive orders. The compliance costs of
rule 12d1–2(a)(4).
340 Proposed rule 12d1–2(a)(5).
the ETF prospectus the number of such conditions might otherwise discourage ETFs,
trading days on which the market price particularly small ETFs, from accepting or seeking
341 See Item 4 of Form N–1A (requiring disclosure
fund investments beyond section 12(d)(1) limits.
of funds’ investment objectives and principal of the ETF shares was greater than the See supra note 330 and accompanying and
investment strategies). following text. By eliminating most of the
342 Pub. L. 104–121, Title II, 110 Stat. 857 (1996). 344 See supra Section III.B.5. of this release for a conditions from our exemptive orders, more ETFs
343 15 U.S.C. 80a–2(c). discussion of these conditions. Continued

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The proposed rule would provide purchase and sell ETF shares on a C. Legal Basis
relief from section 17(e) for funds that securities exchange. The statutory authority for proposed
execute transactions with certain rules 6c–11 and 12d1–4 and the
broker-dealers affiliated with ETFs in 2. Investment Company Investments in
ETFs proposed amendments to rule 12d1–2
which the acquiring funds invest. This and Form N–1A is set forth in Section
relief, which is not included in our As described more fully in sections I XI of this release.
exemptive orders, should allow more and IV of this release, we are proposing
funds to take full advantage of the D. Small Entities Subject to the
new rule 12d1–4 to permit funds to Proposed Rule and Amendments
exemption provided by the rule, thereby invest in shares of ETFs beyond the
increasing the potential that the limits of section 12(d)(1)(A) without A small business or small
proposed rule would promote efficiency first obtaining an exemptive order from organization (collectively, ‘‘small
and competition.346 entity’’) for purposes of the Regulatory
the Commission. The proposed rule
The proposed amendments to rule Flexibility Act 349 is a fund that,
would codify exemptions provided in
12d1–2 expand the investment options together with other funds in the same
orders we have issued permitting funds
for funds that rely on the exemption in group of related investment companies,
section 12(d)(1)(G) of the Act to include to invest in ETFs beyond the Act’s
has net assets of $50 million or less as
investments in unaffiliated ETFs beyond limits. We also are proposing
of the end of its most recent fiscal
the section 12(d)(1) limits and assets amendments to rule 12d1–2, as year.350 Of approximately 601 ETFs (593
other than securities. This expansion of described more fully in section V of this registered open-end investment
investment opportunities could permit release, to expand the investment companies and 8 registered UITs), only
funds to allocate their investments more options available to funds that rely on 1 (an open-end fund) is a small
efficiently. This may allow a fund to section 12(d)(1)(G) of the Act. entity.351 There are approximately 145
compete more effectively. We do not B. Objectives of the Proposed Actions fund complexes 352 and 43 business
expect that proposed rule 12d1–4 or the development companies 353 that are
proposed amendments to rule 12d1–2 1. ETFs small entities that could choose to rely
would have an adverse impact on on proposed rule 12d1–4 to invest in
capital formation.347 As described more fully in sections I ETFs beyond the limits of section
and III of this release, the objectives of 12(d)(1).
X. Initial Regulatory Flexibility the proposed rule 6c–11 are to allow
Analysis new ETF competitors to enter the 1. ETFs
This Initial Regulatory Flexibility market more easily and eliminate Commission staff expects proposed
Analysis (‘‘IRFA’’) has been prepared in certain conditions contained in the rule 6c–11 and amendments to Form N–
accordance with 5 U.S.C. 603. It relates outstanding orders that we now believe 1A would have little impact on small
to proposed new rules 6c–11 and 12d1– may be unnecessary. As described more entities. Like other funds, small entities
4 and proposed amendments to rule fully in sections I and III.D of this would be affected by proposed rule 6c–
12d1–2 under the Investment Company release, the objective of the proposed 11 and the proposed amendments to
Act, and to Form N–1A under the amendments to Form N–1A is to Form N–1A only if they determine to
Investment Company Act and the provide more useful information to rely on rule 6c–11 to operate as an ETF.
Securities Act. individual investors who purchase and Small entities that are open-end ETFs
sell ETF shares on national securities and currently rely on an exemptive
A. Reasons for the Proposed Actions exchanges. order also would be affected by the
1. ETFs proposed amendments to Form N–1A.
2. Investment Company Investments in Commission staff estimates that only
As described more fully in sections I ETFs one of the 61 orders permitting funds to
and III of this release, we are proposing operate as ETFs was issued to a small
rule 6c–11 to allow new ETFs to enter As more fully described in sections I
and IV of this release, proposed rule entity. The staff anticipates that the
the market without first obtaining an number of funds, including small funds,
exemptive order from the 12d1–4 is intended to allow funds to
that would operate as an ETF under
Commission.348 The proposed rule invest more easily in ETFs beyond the
proposed rule 6c–11 and also therefore
would codify and expand upon the limits of section 12(d)(1) of the Act
be subject to the disclosure
exemptive orders we have issued to subject to certain conditions designed to
requirements contained in the proposed
ETFs allowing them to form and protect investors. As more fully
amendments to Form N–1A would
operate. In conjunction with proposed described in Section V of this release,
rule 6c–11, we also are proposing the proposed amendments to rule 12d1– 349 5 U.S.C. 601–612.
amendments to Form N–1A, as 2 are intended to expand the 350 17 CFR 270.0–10.
described more fully in sections I and investments options available to funds 351 For purposes of this IRFA, any series or

III.D of this release, to provide more that rely on section 12(d)(1)(G) to portfolio of an ETF is considered a separate ETF.
useful information to investors who include: (i) Investments in unaffiliated Therefore, there are 601 portfolios or series of
registered investment companies operating as ETFs.
ETFs beyond the limits of section For purposes of determining whether a fund is a
may accept and seek fund investments in their 12(d)(1) of the Act consistent with small entity under the Regulatory Flexibility Act,
shares. proposed rule 12d1–4; and (ii) other however, the assets of funds (including each
346 See supra Section IV.C.3 for a discussion of portfolio and series of a fund) in the same group
non-securities assets, which do not
the proposed exemption. of related investment companies are aggregated.
appear to raise concerns that the
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347 While proposed rule 12d1–4 may result in 352 The 145 fund complexes contain in the

additional investments in ETFs, we do not investment limits of section 12(d)(1)(G) aggregate 160 funds that are small entities. This
anticipate that the rule would have a significant were intended to address. The proposed estimate is derived from data reported on Forms N–
impact on capital formation. amendments to rule 12d1–2 would SAR and N–CSR filed with the Commission for the
348 Our exemptive orders have provided ETFs period ending June 30, 2007.
with relief from a number of sections in the Act in
provide funds relying on section 353 This estimate is based on data reported on

order to allow them to operate. See supra Section 12(d)(1)(G) with greater flexibility to Forms 10–K and 10–Q filed with the Commission
III.C. meet their investment objectives. for the period ending June 30, 2007.

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Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules 14653

increase as compared with the number relying on the rule would have to price of its shares; 363 (ii) the number of
of applicants. Nevertheless, the staff disclose: (i) The foreign holidays that trading days on which the market price
believes that the proportion of small would prevent timely satisfaction of a of its shares was greater than its NAV
entities compared to the total number of redemption request; 356 (ii) the basket and the number of days it was less than
funds that operate as ETFs would assets; 357 (iii) the number of shares in its NAV (premium/discount
remain small. a creation unit; 358 (iv) the fund’s NAV, information); 364 and (iii) a comparison
the market closing price for its shares, of its performance, if it is an index-
2. Investment Company Investments in
and the premium/discount between its based ETF, to its underlying index
ETFs
NAV and the market closing price daily rather than a benchmark index.365 The
Commission staff expects proposed on its Internet Web site; 359 and (v) the proposed amendments also would
rule 12d1–4 and the proposed identities and weightings of the require the ETF to disclose in its
amendments to rule 12d1–2 to have component securities and other assets prospectus the trading symbol(s) and
little impact on small entities. Like held by the fund.360 The proposed rule principal U.S. market(s) on which its
other funds, small entities would only also would impose compliance shares are traded.366
be affected by the rule and the requirements on ETFs that are essential The proposed amendments to Form
amendments if they determine to rely to the operation of an ETF. A fund that N–1A also would eliminate some
on the exemptions provided by the chose to rely on the proposed rule disclosure requirements for ETFs with
proposed rule and amendments.354 would be required to have (i) its shares creation units of 25,000 or more shares
Commission staff estimates that none of approved for listing and trading on a and replace them with fewer
the approximately 15 exemptive orders national securities exchange,361 and (ii) disclosures. Under the proposed
issued to ETFs allowing other funds to the Intraday Value of the basket assets amendments, those ETFs would not
invest in the ETFs beyond the limits of disseminated at regular intervals during have to: (i) Disclose information on how
section 12(d)(1) was issued to a small the day by a national securities to buy and redeem shares of ETF; 367 or
entity. Similarly, none of the exchange.362 (ii) include in its fee table in its
applications that has sought to allow a Proposed rule 6c–11 may benefit fund prospectus or annual and semi-annual
fund that relied on section 12(d)(1)(G) of shareholders by allowing funds to reports fees and expenses for purchases
the Act to invest in securities other than operate as ETFs without incurring the or sales of creation units.368
funds in the same complex, government costs and delays associated with the The amendments to Form N–1A are
securities, and short-term paper was a exemptive application process and designed to accommodate the use of the
small entity. The staff anticipates that without having to comply with some of
the number of funds, including small the conditions included in the 363 Proposed Instruction 5(a) to Item 2(c)(2) of

exemptive orders. While the rule would Form N–1A; Proposed Instruction 3(f) to Item 8(a)
funds, that would rely on the proposed of Form N–1A; Proposed Instruction 12(b) to Item
rule and rule amendments would be require ETFs to comply with reporting 22(b)(7) of Form N–1A. Form N–1A currently only
greater than the number of funds that and compliance requirements, these requires an ETF to disclose in its prospectus its
currently rely on exemptive orders. requirements would not involve any return based on its NAV. The annual reports also
would have to contain a new line graph comparing
Nevertheless, the staff believes that the new costs for ETFs because these the initial and subsequent account values using
proportion of small entities compared to requirements (as well as additional market price, following the line graph using NAV
the total number of funds that would requirements) are included in the ETF required by Item 22(b)(7)(ii)(A) of Form N–1A.
rely on the proposed rule and rule exemptive orders. Proposed Instruction 12(a) to Item 22(b)(7) of Form
The proposed amendments to Form N–1A.
amendments would be small. 364 Proposed Item 6(h)(4) of Form N–1A
N–1A would impose reporting (requiring proposed premium/discount information
E. Reporting, Recordkeeping, and Other requirements on open-end funds that in the prospectus to span the most recently
Compliance Requirements operate as ETFs. The proposed completed calendar year and quarters since that
amendments would require an ETF to year); Proposed Item 22(b)(7)(iv) of Form N–1A
1. ETFs (requiring proposed premium/discount information
Proposed rule 6c–11 would not disclose in its prospectus and annual disclosed in annual reports to span five fiscal
impose any recordkeeping requirements reports: (i) Returns based on the market years). The ETF would be required to present
premiums or discounts as a percentage of NAV and
on any person and would not materially to explain that shareholders may pay more than
We understand that many, if not most, broker-
increase other compliance requirements. dealers selling ETF shares in secondary market NAV when purchasing shares and receive less than
Proposed rule 6c–11 would impose transactions, in fact, transmit a prospectus to NAV when selling, because shares are bought and
sold at market prices. Proposed Instructions 2,3 to
reporting requirements on funds that purchasers. Therefore, we anticipate that the
Item 6(h)(4) of Form N–1A; Proposed Instruction
choose to rely on the rule.355 Funds proposed amendment to the ETF orders would have
little if any impact on ETFs, including small ETFs. (b), (c) to Item 22(b)(7)(iv).
365 Proposed Instruction 5(b) to Item 2(c)(2) of
356 Proposed rule 6c–11(c)(1). Funds would have
354 Small acquiring funds could choose to rely on Form N–1A; Proposed Instruction 12(c) to Item
to disclose this information in their registration
the proposed rule to invest in ETFs beyond the 22(b)(7) of Form N–1A.
statements (Form N–1A) and in any sales literature.
limits of section 12(d)(1)(A) of the Act, and small 357 Proposed rule 6c–11(e)(1).
366 Proposed Item 6(h)(2) of Form N–1A.

ETFs could choose to rely on the rule to sell their 358 Proposed rule 6c–11(e)(3). Funds would have
367 Proposed Item 6(h)(1) of Form N–1A. Instead
shares to other funds beyond the limits of section ETF prospectuses could simply state that individual
12(d)(1)(B) of the Act. Small acquiring funds that to disclose this information in their registration
fund shares can only be bought and sold on the
rely on section 12(d)(1)(G) of the Act could choose statements (Form N–1A) and in any sales literature.
359 Proposed rule 6c–11(e)(4)(iii), (iv).
secondary market through a broker-dealer. Proposed
to rely on the proposed amendments to rule 12d1– Item 6(h)(3) of Form N–1A.
360 Proposed rule 6c–11(e)(4)(iv)(A). If the fund
2 to invest in ETFs in reliance on proposed rule 368 Proposed Instruction 1(e)(i) to Item 3 of Form
12d1–4 and to invest in assets other than securities. has a stated investment objective of obtaining N–1A; Proposed Instruction 1(e)(i) to Item 22(d) of
355 In addition to the reporting requirements, the returns that correspond to the returns of a securities Form N–1A. An ETF would instead modify the
proposed rule, unlike most of the ETF exemptive index, reliance on the proposed rule would be narrative explanation preceding the example in the
rwilkins on PROD1PC63 with PROPOSALS2

orders, would not include relief from section 24(d) conditioned on the ETF tracking an index whose fee table to state that fund shares are sold on the
of the Act and thus broker-dealers would be provider discloses on its Internet Web site the secondary market rather than redeemed at the end
required to deliver prospectuses to investors in identities and weightings of the component of the periods indicated, and that investors in its
secondary market transactions. We also propose to securities and other assets of the index in lieu of shares may be required to pay brokerage
amend the existing ETF exemptive orders issued to disclosure on the fund’s Internet Web site. Proposed commissions that are not reflected in the fee table.
open-end funds to eliminate the section 24(d) rule 6c–11(e)(4)(iv)(B). Proposed Instruction 1(e)(ii) to Item 3 of Form N–
361 Proposed rule 6c–11(e)(4)(iii).
exemptions and require ETFs relying on the orders 1A; Proposed Instruction 1(e)(ii) to Item 22(d) of
to satisfy their prospectus delivery requirements. 362 Proposed rule 6c–11(e)(4)(i). Form N–1A.

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14654 Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules

form by ETFs and to meet the needs of of section 12(d)(1). We do not anticipate the proposed rule might have on small
investors (including retail investors) that the additional conditions entities.
who purchase ETF shares in secondary prohibiting redemptions would impose The proposed amendments to Form
market transactions rather than significant, if any, new costs on N–1A would only apply to funds that
institutional investors purchasing acquiring funds or ETFs because we choose to rely on proposed rule 6c–11
creation units directly from the ETF. We understand that most funds do not or that rely on an exemptive order to
believe that the amendments would redeem shares with ETFs, but sell their operate as an ETF. As discussed above,
have a negligible impact (if any) on the shares in secondary market transactions. the proposed amendments to Form N–
disclosure burdens on ETFs while 1A are designed to accommodate the
providing necessary information to ETF F. Duplicative, Overlapping, or use of the form by ETFs and to meet the
investors. We do not believe that the Conflicting Federal Rules needs of investors (including retail
proposed amendments to Form N–1A The Commission has not identified investors) who purchase ETF shares in
would disproportionately impact small any federal rules that duplicate, overlap, secondary market transactions rather
funds. or conflict with the proposed rules or than institutional investors purchasing
rule amendments. creation units directly from the ETF.
2. Investment Company Investments in Therefore, we believe that any further
ETFs G. Significant Alternatives clarification, consolidation, or
Proposed rule 12d1–4 and the simplification of the proposed
The Regulatory Flexibility Act directs
proposed amendments to rule 121–2 amendments would not be consistent
the Commission to consider significant
would not impose any reporting or with the protection of investors. An
alternatives that would accomplish the
recordkeeping requirements. The exemption for small entities also would
stated objective, while minimizing any
proposed amendments to rule 12d1–2 defeat the purposes of the amendments.
significant adverse impact on small
also would not impose any new
entities. In connection with the 2. Investment Company Investments in
compliance requirements on any
proposed rules and amendments, the ETFs
person. Proposed rule 12d1–4 would
Commission considered the following Proposed rule 12d1–4 and the
impose compliance requirements on
alternatives: (i) The establishment of proposed amendments to rule 12d1–2
funds that choose to rely on it. Proposed
differing compliance or reporting are exemptive and compliance with
rule 12d1–4 would permit fund
requirements or timetables that take into proposed rule 12d1–4 and the proposed
investments in ETFs beyond the limits
account the resources available to small amendments to rule 12d1–2 would be
of section 12(d)(1) if: (i) The acquiring
entities; (ii) the clarification, voluntary. We therefore do not believe
fund (and any entity in a control
consolidation, or simplification of that special compliance, timetable, or
relationship with the acquiring fund)
compliance and reporting requirements reporting requirements, or an exemption
does not control the ETF; 369 (ii) the
under the rule for small entities; (iii) the from coverage of the proposed rule or
acquiring fund does not redeem certain
use of performance rather than design the proposed amendments to rule 12d1–
shares acquired in reliance on the
standards; and (iv) an exemption from 2 for small entities would be
proposed rule; 370 (iii) the fees charged
coverage of the rule, or any part thereof, appropriate. The Commission believes
by the acquiring fund do not exceed the
for small entities. that proposed rule 12d1–4 and the
FINRA sales charge limits; 371 and (iv)
the acquired ETF is not itself a fund of 1. ETFs proposed amendments to rule 12d1–2
funds (i.e., the rule would prohibit a would decrease burdens on small
Proposed rule 6c–11 is exemptive and entities by making it unnecessary for
fund of funds of funds, or three-tier
compliance with the rule would be them to seek an exemptive order from
fund, structure).372 In addition, an ETF
voluntary. We therefore do not believe the Commission allowing them to sell
could not redeem, and its principal
that special compliance, timetable, or their shares to other funds beyond the
underwriter, a broker or a dealer could
reporting requirements, or an exemption limits in section 12(d)(1)(B) of the Act
not submit for redemption ETF shares
from coverage of the proposed rule for or to allow small entities that rely on
acquired in reliance on proposed rule
small entities would be appropriate. In section 12(d)(1)(G) to invest in assets
12d1–4.373 These compliance
addition, as discussed above, only one other than securities and ETFs beyond
requirements, however, would not
fund that meets the definition of a small the limits of section 12(d)(1). In
impose any new costs on acquiring
entity currently relies on an exemptive addition, proposed rule 12d1–4 has a
funds or ETFs. Most of these conditions
order to operate as an ETF. Therefore, limited number of conditions, most of
(as well as number of other conditions
few of the entities that would be which are included in the exemptive
which are not included in the proposed
affected by the proposed rule would be orders. The proposed amendments to
rule) are included in the exemptive
considered to be small entities. The rule 12d1–2 do not impose any
orders that currently permit fund
Commission also believes that proposed compliance requirements. As a result
investments in ETFs beyond the limits
rule 6c–11 would decrease burdens on the potential impact of the proposed
369 Proposed rule 12d1–4(a)(1). See supra notes small entities by making it unnecessary rule and amendments on small entities
215–219 and accompanying text for a discussion of for them to seek an exemptive order should not be significant. For these
the proposed condition. from the Commission allowing them to reasons, alternatives to the proposed
370 Proposed rule 12d1–4(a)(2). See supra note
operate as ETFS and by eliminating rule and amendments seem unnecessary
220 and accompanying and following text for a some of the conditions included in the
discussion of the proposed condition. and, in any event, unlikely to minimize
371 Proposed rule 12d1–4(a)(3). See supra notes exemptive orders from the proposed any impact that the proposed rule and
rule. As a result, we do not anticipate
rwilkins on PROD1PC63 with PROPOSALS2

230–233 and accompanying text for a discussion of amendments might have on small
the proposed condition. the potential impact of the proposed entities.
372 Proposed rule 12d1–4(a)(4). See supra notes
rule on small entities would be
225–229 and accompanying text for a discussion of significant. For these reasons, H. Solicitation of Comments
the proposed condition.
373 Proposed rule 12d1–4(b)(1). See supra note alternatives to the proposed rule appear The Commission encourages the
221 and accompanying text for a discussion of the unnecessary and in any event are submission of comments with respect to
proposed condition. unlikely to minimize any impact that any aspect of this IRFA. Comment is

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Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules 14655

specifically requested on the number of Text of Proposed Rules and Form after the tender of a redeemable
small entities that would be affected by Amendments security, if:
the proposed rules and amendments, For reasons set out in the preamble, (1) The exchange-traded fund
and the likely impact of the proposals Title 17, Chapter II of the Code of discloses in its registration statement
on small entities. Commenters are asked Federal Regulations is proposed to be the foreign holidays that it expects may
to describe the nature of any impact and amended as follows: prevent timely delivery of foreign
provide empirical data supporting its securities, and the maximum number of
extent. These comments will be PART 239—FORMS PRESCRIBED days that it anticipates it will need to
considered in connection with any UNDER THE SECURITIES ACT OF 1933 deliver the foreign securities; and
adoption of the proposed rule and (2) Foreign securities are delivered no
amendments, and reflected in a Final 1. The authority citation for part 239
continues to read, in part, as follows: later than 12 calendar days after the
Regulatory Flexibility Analysis. tender of the exchange-traded fund
Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s,
Comments should be submitted in shares.
77z–2, 77z–3, 77sss, 78c, 78l, 78m, 78n,
triplicate to Nancy M. Morris, Secretary, 78o(d), 78u–5, 78w(a), 78ll, 78mm, 80a–2(a), (d) Affiliated transactions. A person
Securities and Exchange Commission, 80a–3, 80a–8, 80a–9, 80a–10, 80a–13, 80a– who is an affiliated person of an
100 F Street, NE., Washington, DC 24, 80a–26, 80a–29, 80a–30, and 80a–37, exchange-traded fund solely by reason
20549–1090. Comments also may be unless otherwise noted. of holding with the power to vote 5
submitted electronically to the * * * * * percent or more, or more than 25
following e-mail address: rule- percent, of securities issued by the
comments@sec.gov. All comment letters PART 270—RULES AND exchange-traded fund (or who is an
should refer to File No. S7–07–08, and REGULATIONS, INVESTMENT affiliated person of such a person), or
this file number should be included on COMPANY ACT OF 1940 issued by an investment company under
the subject line if e-mail is used.374 common control with the exchange-
2. The authority citation for part 270
Comment letters will be available for traded fund, is exempt from sections
is amended by adding a specific
public inspection and copying in the 17(a)(1) and 17(a)(2) of the Act (15
authority citation for § 270.6c–11 and
Commission’s Public Reference Room, U.S.C. 80a–17(a)(1) and (a)(2)) with
revising the specific authority citation
100 Fifth Street, NE., Washington, DC regard to the deposit and delivery of
for §§ 270.12d1–1, 270.12d1–2 and
20549–1520, on official business days basket assets. An investment company
12d1–3 to read as follows:
between the hours of 10 a.m. and 3 p.m. that has acquired exchange-traded fund
Electronically submitted comment Authority: 15 U.S.C. 80a–1 et seq., 80a–
34(d), 80a–37, and 80a–39, unless otherwise
shares in reliance on § 270.12d1–4 may
letters also will be posted on the not rely on this paragraph with regard
noted.
Commission’s Internet Web site (http:// to the purchase of basket assets.
www.sec.gov). * * * * *
Section 270.6c–11 is also issued under 15 (e) Definitions. For purposes of this
XI. Statutory Authority U.S.C. 80a–6(c) and 80a–37(a). section:
* * * * * (1) Basket assets are the securities or
The Commission is proposing rule Sections 270.12d1–1, 270.12d1–2, other assets specified each business day
6c–11 pursuant to the authority set forth 270.12d1–3, and 12d1–4 are also issued in name and number by an exchange-
in sections 6(c) and 38(a) of the under 15 U.S.C. 80a–6(c), 80a–12(d)(1)(J), traded fund as the securities or assets in
Investment Company Act [15 U.S.C. and 80a–37(a). exchange for which it will issue or in
80a–6(c) and 80a–37(a)]. The * * * * * return for which it will redeem
Commission is proposing amendments 3. Section 270.6c–11 is added to read exchange-traded fund shares; provided
to rule 12d1–2 and new rule 12d1–4 as follows: that the fund may require or permit a
pursuant to the authority set forth in purchaser (or redeemer) of a creation
sections 6(c), 12(d)(1)(J), and 38(a) of the § 270.6c–11 Exchange-traded funds.
unit to substitute cash for some or all of
Investment Company Act [15 U.S.C. (a) Redeemable securities. Exchange-
the securities in the basket assets.
80a–6(c), 80a–12(d)(1)(J), and 80a– traded fund shares are considered
‘‘redeemable securities’’ for purposes of (2) Business day means, with respect
37(a)]. The Commission is proposing
section 2(a)(32) of the Act (15 U.S.C. to an exchange-traded fund, any day
amendments to registration form N–1A
80a–2(a)(32)). that the fund is open for business,
under the authority set forth in sections
(b) Pricing. A dealer in exchange- including any day on which it is
6, 7(a), 10 and 19(a) of the Securities Act
traded fund shares is exempt from required to make payment under section
of 1933 [15 U.S.C. 77f, 77g(a), 77j,
section 22(d) of the Act (15 U.S.C. 80a– 22(e) of the Act (15 U.S.C. 80a–22(e)).
77s(a)], and sections 8(b), 24(a), and 30
of the Investment Company Act [15 22(d)) and § 270.22c–1(a) with regard to (3) Creation unit is a specified number
U.S.C. 80a–8(b), 80a–24(a), and 80a–29]. purchases, sales and repurchases of of exchange-traded fund shares
exchange-traded fund shares in the disclosed in the exchange-traded fund’s
List of Subjects secondary market at the current market prospectus that the fund will issue (or
17 CFR Part 239 price. redeem) in exchange for the deposit (or
(c) Postponement of redemption. If an delivery) of basket assets. The creation
Reporting and recordkeeping exchange-traded fund includes a foreign unit must be reasonably designed to
requirements, Securities. security in its basket assets and a foreign facilitate the purchase (or redemption)
holiday prevents timely delivery of the of shares from the exchange-traded fund
17 CFR Parts 270 and 274 foreign security in response to a with an offsetting sale (or purchase) of
rwilkins on PROD1PC63 with PROPOSALS2

Investment companies, Reporting and redemption request, the fund is exempt, shares on a national securities exchange
recordkeeping requirements, Securities. with respect to the foreign security, at as nearly the same time as practicable
from the prohibition in section 22(e) of for the purpose of taking advantage of a
374 Comments on the IRFA will be placed in the the Act (15 U.S.C. 80a–22(e)) against difference in the current value of basket
same public file that contains comments on the postponing the date of satisfaction upon assets on a per share basis and the
proposed rules and amendments. redemption for more than seven days current market price of the shares.

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14656 Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules

(4) Exchange-traded fund is a letter, or other sales material addressed vote its shares of the exchange-traded
registered open-end management to or intended for distribution to fund in the manner prescribed by
company that: prospective investors other than a section 12(d)(1)(E) of the Act (15 U.S.C.
(i) Issues (or redeems) creation units registration statement filed with the 80a–12(d)(1)(E)).
in exchange for the deposit (or delivery) Commission under section 8 of the Act (2) No redemption. An acquiring fund
of basket assets the current value of (15 U.S.C. 80a–8). that relies on paragraph (a) of this
which is disseminated on a per share (9) Weighting of the component section to acquire exchange-traded fund
basis by a national securities exchange security is the percentage of the index’s shares in excess of the limits of section
at regular intervals during the trading value represented, or accounted for, by 12(d)(1)(A)(i) of the Act (15 U.S.C. 80a–
day; such component security. 12(d)(1)(A)(i)) does not redeem any of
(ii) In any sales literature, identifies 4. Section 270.12d1–2 is amended by: those shares. For purposes of this
itself as an exchange-traded fund, which a. Revising the heading to paragraph paragraph, an acquiring fund will be
does not sell or redeem individual (a); deemed to have redeemed or sold the
shares, and explains that investors may b. Removing ‘‘and’’ at the end of most recently acquired exchange-traded
purchase or sell individual exchange- paragraph (a)(2); fund shares first.
traded fund shares on a national c. Removing the period at the end of (3) Fees. (i) Any sales charge, as
securities exchange; paragraph (a)(3) and adding a ‘‘;’’; defined in rule 2830(b)(8) of the
(iii) Issues shares that are approved d. Adding paragraphs (a)(4) and (a)(5); Conduct Rules of the NASD (‘‘sales
for listing and trading on a national and charge’’), or service fee, as defined in
securities exchange under section 12(d) e. Revising paragraph (b). rule 2830(b)(9) of the Conduct Rules of
(15 U.S.C. 78l(d)) of the Securities The additions and revisions read as the NASD (‘‘service fee’’), charged in
Exchange Act of 1934 and rule 12d1–1 follows: connection with the purchase, sale, or
(17 CFR 240.12d1–1) thereunder; redemption of securities issued by the
(iv) Discloses each business day on its § 270.12d1–2 Exemptions for investment acquiring fund does not exceed the
Internet Web site, which is publicly companies relying on section 12(d)(1)(G) of
limits set forth in rule 2830(d)(3) of the
accessible at no charge, the prior the Act.
Conduct Rules of the NASD; and
business day’s net asset value and (a) Exemption to acquire other (ii) With respect to a separate account
closing market price of the fund’s securities and assets. * * * that invests in an acquiring fund:
shares, and the premium or discount of (4) Securities issued by an exchange- (A) The acquiring fund and exchange-
the closing market price against the net traded fund, when the acquisition is in traded fund do not charge a sales load;
asset value of the fund’s shares as a reliance on § 270.12d1–4; and (B) Any asset-based sales charge, as
percentage of net asset value; and (5) Other assets. defined in rule 2830(b)(8)(A) of the
(v) Either: (b) Definitions. For purposes of this Conduct Rules of the NASD, or service
(A) Discloses each business day on its section, ‘‘exchange-traded fund’’ has the fee is charged only by the acquiring
Internet Web site, which is publicly same meaning as in § 270.12d1–4(d)(2) fund or the exchange-traded fund; and
accessible at no charge, the identities and ‘‘money market fund’’ has the same (C) The fees associated with a variable
and weightings of the component meaning as in § 270.12d1–1(d)(2). insurance contract that invests in the
securities and other assets held by the 5. Section 270.12d1–4 is added to acquiring fund and the sales charges
fund, or read as follows: and service fees charged by the
(B) Has a stated investment objective acquiring fund and the exchange-traded
of obtaining returns that correspond to § 270.12d1–4 Exemptions for investments
fund, in the aggregate, must be
in exchange-traded funds.
the returns of a securities index reasonable in relation to the services
specified in the fund’s registration (a) Exemptions for acquisition of rendered, the expenses expected to be
statement, and the index provider exchange-traded fund shares. incurred and, with respect to the
discloses on its Internet Web site, which Notwithstanding sections 12(d)(1)(A), variable insurance contract, the risks
is publicly accessible at no charge, the 17(a)(1), and 57(a)(1) of the Act (15 assumed by the insurance company.
identities and weightings of the U.S.C. 80a–12(d)(1)(A), 15 U.S.C. 80a– (4) Complex fund structures. The
component securities and other assets of 17(a)(1), and 15 U.S.C. 80a–56(a)(1)), an exchange-traded fund has a disclosed
the index. investment company (‘‘acquiring fund’’) policy that prohibits it from investing
(5) Exchange-traded fund share is an may acquire exchange-traded fund more than 10 percent of its assets in:
equity security issued by an exchange- shares if: (i) Other investment companies in
traded fund. (1) Control. No acquiring fund or any reliance on section 12(d)(1)(F) or section
(6) Foreign security is any security of its investment advisers or depositors, 12(d)(1)(G) of the Act (15 U.S.C. 80a–
issued by a government or any political and any company controlling, 12(d)(1)(F) or 15 U.S.C. 80a–12(d)(1)(G))
subdivision of a foreign country, a controlled by or under common control or this section; and
national of any foreign country, or a with the acquiring fund, or any of its (ii) Any other company that would be
corporation or other organization investment advisers or depositors, each an investment company under section
incorporated or organized under the individually or together in the aggregate: 3(a) of the Act (15 U.S.C. 80a–3(a)) but
laws of any foreign country, and for (i) Controls the exchange-traded fund; for the exceptions to that definition
which there is no established United and provided in sections 3(c)(1) and 3(c)(7)
States public trading market as that term (ii) If, as a result of a decrease in the of the Act (15 U.S.C. 80a–3(c)(1) and
is used in Item 201 of Regulation S–K outstanding voting securities of the 80a–3(c)(7)).
under the Securities Exchange Act of exchange-traded fund, any of those (b) Exemptions for sale of exchange-
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1934 (17 CFR 229.201). persons, each individually or together in traded fund shares. (1) Notwithstanding
(7) Index provider is the person that the aggregate, become holders of more sections 12(d)(1)(B), 17(a)(1), 17(a)(2),
determines the securities and other than 25 percent of the outstanding 57(a)(1), and 57(a)(2) of the Act (15
assets that comprise a securities index. voting securities of the exchange-traded U.S.C. 80a–12(d)(1)(B), 15 U.S.C. 80a–
(8) Sales literature means any fund, each of those holders of shares 17(a)(1), 15 U.S.C. 80a–56(a)(1), and 15
advertisement, pamphlet, circular, form issued by the exchange-traded fund will U.S.C. 80a–56(a)(2)), an exchange-traded

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Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules 14657

fund, any principal underwriter thereof, affairs of the trust, and the sponsor or Item 2. Risk/Return Summary:
and a broker or a dealer may sell or manager of the trust. Investments, Risks, and Performance
otherwise dispose of exchange-traded (2) Exchange-traded fund has the
* * * * *
fund shares if the exchange-traded fund same meaning as in § 270.6c–11(e)(4) (c) Principal risks of investing in the
does not redeem, or the principal and also includes a registered unit Fund.
underwriter, broker or dealer does not investment trust that satisfies the
submit for redemption any of the criteria set forth in § 270.6c–11(e)(4). * * * * *
(3) Exchange-traded fund share has (2) Risk/Return Bar Chart and Table.
exchange-traded fund’s shares that were
acquired by an acquiring fund in excess the same meaning as in § 270.6c– * * * * *
of the limits of section 12(d)(1)(A)(i) of 11(e)(5). Instructions
the Act (15 U.S.C. 80a–12(d)(1)(A)(i)) in
reliance on paragraph (a) of this section. PART 239—FORMS PRESCRIBED * * * * *
UNDER THE SECURITIES ACT OF 1933 5. Exchange-Traded Funds.
For purposes of this paragraph, an
(a) Add a caption in the ‘‘Average
acquiring fund will be deemed to have
PART 274—FORMS PRESCRIBED Annual Total Returns’’ table directly
redeemed or sold the most recently
UNDER THE INVESTMENT COMPANY above the caption titled ‘‘Index’’. Title
acquired exchange-traded fund shares
ACT OF 1940 the caption ‘‘Returns—Market Price’’.
first.
(2) An exchange-traded fund, a Disclose in the caption the Fund’s
6. The authority citation for part 274 average annual total return based on the
principal underwriter thereof, or broker continues to read in part as follows:
or dealer will be deemed to have Market Price for the periods indicated.
complied with the condition in Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, In a footnote to the caption, explain how
paragraph (b)(1) of this section if it has: 78c(b), 78l, 78m, 78n, 78o(d), 80a–8, 80a–24, Market Price returns are calculated and
(i) Received a representation from the 80a–26, and 80a–29, unless otherwise noted. how they differ from NAV returns.
acquiring fund that none of the * * * * * (b) If the Fund has an investment
exchange-traded fund shares it is 7. Form N–1A (referenced in objective of obtaining returns that
redeeming was acquired in excess of the §§ 239.15A and 274.11A) is amended correspond to the returns of a securities
limits of section 12(d)(1)(A)(i) of the Act by: index, the table must show the average
(15 U.S.C. 80a–12(d)(1)(A)(i)) in reliance a. Adding the definitions ‘‘Exchange- annual total returns of the securities
on paragraph (a) of this section; and Traded Fund’’ and ‘‘Market Price’’ in index specified in its registration
(ii) No reason to believe that the alphabetical order to General statement for the same periods. The
acquiring fund is redeeming any Instructions A; Fund may exclude the returns of an
exchange-traded fund shares that the b. Adding paragraph 5 to the appropriate broad-based securities
acquiring fund acquired in excess of the Instructions to Item 2 paragraph (c)(2); market index as defined in Instruction
limits of section 12(d)(1)(A)(i) of the Act c. Adding paragraph 1(e) to the 5 to Item 22(b)(7) for the same periods.
(15 U.S.C. 80a–12(d)(1)(A)(i)) in reliance Instructions to Item 3;
d. Revising paragraph 1(a) and adding Item 3. Risk/Return Summary: Fee
on paragraph (a) of this section. Table
(c) Exemption from certain paragraph (h) to Item 6;
monitoring and recordkeeping e. Adding paragraph 3(f) to the * * * * *
requirements under § 270.17e–1. Instructions to Item 8(a); and
f. Adding paragraph 12 to the Instructions
Notwithstanding the requirements of
Instructions to paragraphs (b)(7)(i) and 1. General.
§§ 270.17e–1(b)(3) and 270.17e–1(d)(2),
the payment of a commission, fee, or (ii), paragraph (iv) to paragraph (b)(7), * * * * *
other remuneration to a broker shall be and paragraph 1(e) to the Instructions to (e)(i) If the Fund is an Exchange-
deemed as not exceeding the usual and paragraph (d) of Item 22. Traded Fund and issues or redeems
The additions and revisions read as shares in creation units of not less than
customary broker’s commission for
follows: 25,000 shares each, exclude any fees
purposes of section 17(e)(2)(A) of the
Act (15 U.S.C. 80a–17(e)(2)(A)) if: Note: The text of Form N–1A does not, and charged for the purchase and
(1) The commission, fee, or other this amendment will not, appear in the Code redemption of the Fund’s creation units.
remuneration is paid in connection with of Federal Regulations. (ii) Modify the narrative explanation
the sale of securities to or by an to state that Fund shares are sold on a
acquiring fund; Form N–1A national securities exchange at the end
(2) The broker and the acquiring fund * * * * * of the time periods indicated, and that
are affiliated persons because each is an brokerage commissions for buying and
affiliated person of the same exchange- General Instructions selling Fund shares through a broker are
traded fund; and A. Definitions not reflected.
(3) The acquiring fund is an affiliated * * * * *
* * * * *
person of the exchange-traded fund
‘‘Exchange-Traded Fund’’ means a Item 6. Shareholder Information
solely because the acquiring fund owns,
Fund whose shares are traded on a (a) * * *
controls, or holds with power to vote
national securities exchange and (1) An explanation that the price of
five percent or more of the outstanding
satisfies the criteria set forth in rule 6c– Fund shares is based on the Fund’s net
securities of the exchange-traded fund.
(d) Definitions. For purposes of this 11(e)(4) (17 CFR 270.6c–11(e)(4)). asset value and the method used to
section: * * * * * value Fund shares (market price, fair
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(1) Depositor includes the person ‘‘Market Price’’ refers to the last price value, or amortized cost); except that if
primarily responsible for the at which Exchange-Traded Fund shares the Fund is an Exchange-Traded Fund,
organization of the unit investment trade on the principal U.S. market on an explanation that the price of Fund
trust, the person who has continuing which the Fund’s shares are traded shares is based on Market Price.
functions or responsibilities with during a regular trading session. * * * * *
respect to the administration of the * * * * * (h) Exchange-Traded Funds.

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14658 Federal Register / Vol. 73, No. 53 / Tuesday, March 18, 2008 / Proposed Rules

(1) If the Fund issues or redeems (f) Exchange-Traded Funds. (i) shares was greater than the Fund’s net
Fund shares in creation units of not less Change the caption ‘‘Total Return’’ to asset value and the number of days it
than 25,000 shares each, the Fund may ‘‘Total Return—NAV’’. was less than the Fund’s net asset value
omit from the prospectus the (ii) Add a caption following ‘‘Total for the most recently completed five
information required by Items 6(a)(2), Return—NAV’’ titled ‘‘Total Return— fiscal years (or the life of the Fund if
(b) and (c). Market Price’’. Disclose in the caption shorter), but only for periods subsequent
(2) Identify the principal U.S. market the Fund’s total return using Market to the effective date of the Fund’s
or markets on which the Fund shares Price, assuming a purchase of Fund registration statement.
are traded and the trading symbol(s) for shares at the Market Price on the first
those shares, unless the information Instructions
day and a sale of the shares on the last
appears on the front cover page. day of each period shown. (a) Provide the information in tabular
(3) Specify the number of Fund shares * * * * * form.
that the Fund will issue (or redeem) in (b) Express the information as a
exchange for the deposit (or delivery) of Item 22. Financial Statements
percentage of the net asset value of the
basket assets as defined in rule 6c-11 [17 * * * * * Exchange-Traded Fund, using separate
CFR 270.6c-11] (i.e., a creation unit) and (b) Annual Report. * * * columns for the number of days the
explain that individual Fund shares (7) Management’s Discussion of Fund Market Price was greater than the
may only be purchased and sold on a Performance. * * * Fund’s net asset value and the number
national securities exchange through a of days it was less than the Fund’s net
broker-dealer. Instructions
asset value. Round all percentages to the
(4) Premium/Discount Information. 12. Exchange-Traded Funds. nearest hundredth of one percent.
Provide a table showing the number of (a) Include a second line graph (c) Adjacent to the table, provide a
days the Market Price of the Fund immediately following the line graph brief explanation that: Shareholders
shares was greater than the Fund’s net required by paragraph (b)(7)(ii)(A) of may pay more than net asset value when
asset value and the number of days it this Item, assume an initial investment they buy Fund shares and receive less
was less than the Fund’s net asset value of $10,000 was made at the Market Price than net asset value when they sell
for the most recently completed on the business day before the first day those shares, because shares are bought
calendar year, and the most recently of the first fiscal year, and base the and sold at current market prices.
completed calendar quarters since that subsequent account values on the
year, or the life of the Fund (if shorter). (d) Include a statement that the data
Market Price on the last business day of presented represents past performance
Instructions the first and each subsequent fiscal year. and cannot be used to predict future
Calculate the final account value by results.
1. Provide the information in tabular assuming the investor sold all
form. Exchange-Traded Fund shares at the * * * * *
2. Express the information as a Market Price on the last business day of (d) Annual and Semi-Annual Reports.
percentage of the net asset value of the the most recent fiscal year. * * *
Fund, using separate columns for the (b) For purposes of the table required
number of days the Market Price was Instructions
by paragraph (b)(7)(ii)(B) of this Item,
greater than the Fund’s net asset value add a caption titled ‘‘Returns—Market 1. General.
and the number of days it was less than Price’’. Disclose in the caption the * * * * *
the Fund’s net asset value. Round all Fund’s average annual total return based (e) (i) If the Fund is an Exchange-
percentages to the nearest hundredth of on Market Price for the periods Traded Fund and issues or redeems
one percent. indicated. In a footnote to the caption,
3. Adjacent to the table, provide a shares in creation units of not less than
explain how Market Price returns are 25,000 shares each, exclude from the
brief explanation that: Shareholders
calculated and how they differ from narrative explanation and the Example
may pay more than net asset value when
returns based on net asset value. any fees charged for the purchase and
they buy Fund shares and receive less
(c) If the Fund has an investment redemption of the Fund’s creation units.
than net asset value when they sell
objective of obtaining returns that (ii) Modify the narrative explanation
those shares, because shares are bought
correspond to the returns of a securities to state that Fund shares are sold on a
and sold at current market prices.
4. Include a statement that the data index, the table must show the average national securities exchange at the end
presented represents past performance annual total returns of the securities of the time periods indicated, and that
and cannot be used to predict future index specified in its registration brokerage commissions for buying and
results. statement for the same periods. The selling Fund shares through a broker are
Fund may exclude the returns of an not reflected.
* * * * * appropriate broad-based securities * * * * *
Item 8. Financial Highlights market index as defined in Instruction
Information 5 to paragraph (b)(7)(i) and (ii) of this Dated: March 11, 2008.
Item for the same periods. By the Commission.
(a) * * *
* * * * * Nancy M. Morris,
Instructions (iv) Premium/Discount Information. Secretary.
* * * * * Provide a table showing the number of [FR Doc. E8–5239 Filed 3–17–08; 8:45 am]
3. Total Return. * * * days the Market Price of the Fund BILLING CODE 8011–01–P
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