Corp Fin has issued a few new CDIs—two relating to Section 16 and one relating to beneficial ownership under Rule 13d-3. The new CDIs address issues in connection with exchange-traded funds, or ETFs, and the use of “informational barriers.”
Exchange Act Section 16
Section 109. Rule 16a-1 ― Definition of Terms
109.02 This CDI addresses the issue, for purposes of Rule 16a-1(a)(1), of whether an authorized participant (“AP”) in an ETF can “rely on informational barriers to determine whether the AP is a greater than 10% beneficial owner of the ETF’s portfolio securities that are acquired on its behalf in a Confidential Account on a disaggregated basis from other accounts of the AP.” The CDI posits a situation where an ETF does not disclose on each trading day the identities and quantities of its portfolio securities, and, to maintain confidentiality, the AP effects creation and redemption transactions through a confidential brokerage account (“Confidential Account”) with an agent (“AP Representative”), for the AP’s benefit. The AP will not know the identities and quantities of the ETF’s portfolio securities, but it will have some control over the timing of the purchases and sales as a result of its ability to place creation and redemption orders with the ETF. According to Corp Fin, the AP can rely on informational barriers to determine whether it is a greater than 10% beneficial owner of the ETF’s portfolio securities for purposes of Section 16 if the arrangement is consistent with SEC guidance regarding the calculation and reporting of beneficial ownership status set forth in Release No. 34-39538 (Jan. 12, 1998), including the following conditions:
- “the agreements governing the Confidential Account contain confidentiality provisions that operate as an effective informational barrier between the AP and the AP Representative and other persons with knowledge of the composition of the ETF’s portfolio;
- the AP, AP Representative, and the ETF’s custodian are unaffiliated entities that do not share officers, directors, or employees with investment discretion over the Confidential Account and their respective directors, officers, and employees do not participate in common compensation pools; and
- the AP obtains an annual, independent assessment of the operation of the policies and procedures established to prevent the flow of information related to the Confidential Account.”
209.06 This CDI relates to how, under certain circumstances, an AP can avoid being deemed to have a pecuniary interest in an ETF’s creation or redemption basket. Where APs in an ETF have directors or officers, or the directors or officers of the AP’s parent holding company, that serve as a director of an issuer of securities purchased or sold as part of the ETF’s in-kind creation or redemption baskets, the AP or its parent holding company may be deemed to be a director of that issuer for the purposes of Section 16 based on expressly or impliedly “deputizing” that individual to serve as its representative on the issuer’s board of directors. For the AP and its parent holding company to avoid being deemed to have a pecuniary interest in a security in the creation or redemption basket for the purposes of Rule 16a-1(a)(2), the ETF could substitute cash for that basket security, so that neither the AP, nor anyone transacting on the AP’s behalf, would purchase, receive or sell the security.
Exchange Act Sections 13(d) and 13(g) and Regulation 13D-G Beneficial Ownership Reporting
Section 105. Rule 13d-3 ― Determination of Beneficial Ownership
105.07 This CDI posits the same factual situation as in CDI 109.02 above, but addresses the issue of whether the AP can rely on informational barriers to calculate and report its Rule 13d-3 beneficial ownership of the ETF’s portfolio securities that are acquired on its behalf in a Confidential Account on a disaggregated basis from other accounts of the AP. Corp Fin advised that the AP may rely on informational barriers so long as the arrangement is consistent with the SEC’s guidance set forth in Release No. 34-39538, including the conditions described under the Section 16 CDI 109.02 above.
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