The SEC voted to propose a new rule that would completely overhaul the fund-of-funds rules. Instead of relying on exemptive orders, the new rule would allow fund-of-funds structures that meet specified conditions including: (i) limitations on voting to avoid control of the underlying fund, (ii) redemption limits within 30 days of purchasing the underlying fund, (iii) evaluations to avoid excessive aggregate fees, and (iv) prohibitions on 3-tier fund-of-funds arrangements. The SEC would rescind all current fund-of-funds exemptive orders, thereby requiring all fund-of-funds arrangements to comply with the new rule. Proposed Rule 12d1-4 would provide an exemption from Section 12(d)(1) of the Investment Company Act which limits an acquiring fund from acquiring (a) more than 3% of an underlying fund, (b) an underlying fund that would represent more than 5% of the acquiring company, and (c) underlying funds that in the aggregate exceed 10% of the acquiring company. The SEC has provided a 90-day comment period.
We love the idea of an exemptive rule to allow plain vanilla fund-of-funds structures to quickly get to market without an SEC exemptive order. We hate that the SEC will rescind all current orders, which could force many current fund-of-funds into restructuring time-tested products. Since this is such a significant regulatory change, we expect a vigorous comment period.
The SEC proposed a new rule that would allow exchange-traded funds to launch without obtaining an individualized exemptive order, a discretionary process that can take several months. Proposed rule 6c-11 would allow ETFs structured as open-end funds to operate so long as they provide daily portfolio transparency on their websites, disclose historical premium, discount and bid-ask spread information, and adopt policies and procedures about the use of custom baskets. Other conditions may be included in the full proposal once it is released. The proposed rule would rescind current exemptive relief granted to ETFs that could rely on the new rule. Since 1992, the SEC has issued more than 300 ETF exemptive orders, creating a $3.4 trillion market that includes over 1,900 ETFs representing nearly 15% of total investment company assets.
OUR TAKE: The SEC already went down this road back in 2008. Let’s hope that the Commission adopts a rule and ends the costs and delay associated with requiring formulaic exemptive orders.
A large ETF adviser agreed to pay a $1.5 Million fine for operating a fund without obtaining the required exemptive relief. According to the SEC, from 2010 to 2015, the adviser relied on exemptive relief for a separate ETF trust even though the SEC staff had opined that the relief did not apply to the fund at issue. The SEC asserts that both internal and outside counsel advised (incorrectly, according to the SEC) that the firm could rely on the pre-existing exemptive relief. The SEC did acknowledge that the fund complied with exemptive order requirements even though it did not obtain its own, specific relief. The offending fund was merged out of existence in 2015. An exemptive order is required to operate an ETF because it would otherwise violate various pricing provisions of the Investment Company Act.
OUR TAKE: Why would the SEC take action against a fund that no longer exists and an adviser that complied with conditions that would have been applicable to a fund where no investor harm was alleged? The answer is that the SEC is very serious about compliance with exemptive orders and ensuring that ETF sponsors strictly follow the conditions. Just because you are driving safely doesn’t mean you can drive without a license.