On September 26, 2019, the U.S. Securities and Exchange Commission announced the adoption of Rule 6c-11 under the Investment Company Act of 1940, which will allow exchange-traded funds that satisfy certain standardized conditions to operate without first obtaining individual exemptive relief.¹ In connection with the adoption of Rule 6c-11, the SEC adopted related amendments to Form N-1A, Form N‑8B-2 and Form N-CEN (Form Amendments). In addition, the SEC issued conditional exemptive relief from certain provisions of the Securities Exchange Act of 1934 to broker-dealers and other market participants engaged in certain transactions with respect to shares of ETFs relying on Rule 6c-11 (Exchange Act Relief).²

Notable Differences from the Proposal

The SEC originally proposed Rule 6c-11 and certain form amendments on June 28, 2018 (Proposal).³ While Rule 6c-11 and the Form Amendments are largely consistent with the Proposal, there are certain key differences, including:

• Median Bid-Ask Spread Disclosures – As adopted, Rule 6c-11 requires the disclosure and calculation of an ETF’s median bid-ask spread over the past 30 days to be published on an ETF’s website. Under the Proposal, ETFs would have been required to calculate bid-ask spread information for the prior fiscal year and to include such disclosure in the ETF’s prospectus. In addition and as opposed to the Proposal, Rule 6c-11 does not require ETFs to include a specified question-and-answer (Q&A) section giving examples of bid-ask spreads in the prospectus or to include an interactive calculator on the ETF’s website for calculating spreads
• T-1 Orders – The Proposal would have precluded ETFs from utilizing “T-1” creation or redemption orders (where an ETF creation or redemption order is placed the day before the order is processed, to enable corresponding transactions to be placed in certain non-U.S. markets while those markets are open) by requiring daily holdings to be posted before the ETF accepts creation or redemption orders. Rule 6c-11, by contrast, requires holdings to be posted prior to the commencement of trading on the ETF’s primary listing exchange, thus allowing for T-1 orders.
• ETF shares as “redeemable securities” – The Adopting Release provides that shares of all ETFs, whether or not eligible to rely on Rule 6c-11, are considered “redeemable securities” for purposes of relying on the exceptions to Rules 101(c)(4) and 102(d)(4) of Regulation M and Rules 10b-17(c) and 11d1-2 under the Exchange Act. The Proposal would have granted that status only to ETFs relying on Rule 6c-11.
• Section 22(e) Relief – Unlike the Proposal, Rule 6c-11 does not contain a 10-year sunset provision with respect to relief from Section 22(e) of the 1940 Act.
• Presentation of Holdings Disclosure Information – Under the Proposal, an ETF’s daily holdings disclosure would have been required to be presented in the manner prescribed in Article 12 of Regulation S-X. Rule 6c-11, as adopted, requires disclosure of more streamlined information relating to each portfolio holding on a daily basis, in response to comments that the Regulation S‑X requirements are unduly burdensome or unnecessary in this context.

As under the Proposal, the following ETFs are ineligible to rely on Rule 6c-11: (i) ETFs organized as unit investment trusts; (ii) ETFs structured as share classes of multi-class funds; (iii) leveraged or inverse ETFs; and (iv) non-transparent actively managed ETFs.

Custom Baskets

Rule 6c-11 provides ETFs flexibility to use “custom baskets.” Under Rule 6c-11, a custom basket is a basket used for creation and redemption transactions that (i) does not correspond pro rata to the ETF’s portfolio holdings, or (ii) is a representative basket that differs from the initial basket used by the ETF in transactions that business day. In order to utilize custom baskets under Rule 6c-11, an ETF must adopt written policies and procedures describing in detail the circumstances under which custom baskets would be utilized in the best interests of the ETF and its shareholders, and implement certain recordkeeping requirements related to custom basket transactions. These requirements concerning custom baskets generally correspond to those in the Proposal. However, in the Adopting Release, the SEC provided additional guidance regarding the topics that such policies and procedures should cover.

Exchange Act Relief

In addition to adopting Rule 6c-11, the SEC also issued an order granting conditional relief from Section 11(d)(1) of the Exchange Act and Rules 10b-10, 15c1-5, 15c1-6, and 14e-5 thereunder, to broker-dealers and other market participants engaged in certain securities transactions involving ETF shares. Unlike the SEC's interpretation of “redeemable securities” discussed above, the Exchange Act Relief extends only to ETFs that rely on Rule 6c-11.

The Exchange Act Relief is subject to certain conditions, some of which vary based on the particular Exchange Act section or rule. Among other conditions, certain relief is available only with respect to ETFs that meet the diversification requirement applicable to regulated investment companies under the Internal Revenue Code.

Compliance Dates; Impact of Rule 6c-11 on Existing Exemptive Relief

Rule 6c-11, the Form Amendments and the Exchange Act Relief will become effective 60 days after publication in the Federal Register. The compliance date for the Form Amendments is one year following their effective date, and existing exemptive relief relating to ETFs eligible to rely on Rule 6c-11 will be rescinded one year after the effective date of Rule 6c-11. Likewise, the Adopting Release provides that exemptive orders that are set to “automatically expire on the effective date of a rule permitting the operations of ETFs” are amended to provide for expiration one year after the effective date.

Rule 6c-11 does not rescind existing exemptive relief for ETFs that are ineligible to rely on Rule 6c-11, nor does it rescind exemptive relief contained in ETF exemptive orders permitting certain investments in an ETF in excess of the limits set forth in Section 12(d)(1) of the 1940 Act. Notably, the Adopting Release provides that ETFs that rely on Rule 6c-11 and that do not have Section 12(d)(1) relief may enter into fund of funds arrangements in accordance with the conditions of recent ETF exemptive orders, until the effective date of a new SEC rule permitting registered funds to invest in other funds in excess of the Section 12(d)(1) limits (including Rule 12d1-4, if adopted).

An upcoming OnPoint will provide further analysis of these matters.

Footnotes

1) See Exchange-Traded Funds, SEC Rel. No. IC-33646 (Sept. 25, 2019) (Adopting Release).

2) See SEC Rel. No. 34-87110 (Sept. 25, 2019).

3) See Exchange-Traded Funds, SEC Rel. No. IC-33140 (June 28, 2018)