[Federal Register Volume 83, Number 147 (Tuesday, July 31, 2018)]
[Proposed Rules]
[Pages 37332-37411]
[FR Doc No: 2018-14370]

Vol. 83

Tuesday,

No. 147

July 31, 2018

Part IV

Securities and Exchange Commission

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17 CFR Parts 239, 270 and 274

Exchange-Traded Funds; Proposed Rule

Federal Register / Vol. 83 , No. 147 / Tuesday, July 31, 2018 /
Proposed Rules

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 239, 270, and 274

[Release Nos. 33-10515; IC-33140; File No. S7-15-18]
RIN 3235-AJ60

Exchange-Traded Funds

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission (the ``Commission'') is
proposing a new rule under the Investment Company Act of 1940 (the
``Investment Company Act'' or the ``Act'') that would permit exchange-
traded funds (``ETFs'') that satisfy certain conditions to operate
without the expense and delay of obtaining an exemptive order. In
connection with the proposed exemptive rule, the Commission proposes to
rescind certain exemptive orders that have been granted to ETFs and
their sponsors. The Commission also is proposing certain disclosure
amendments to Form N-1A and Form N-8B-2 to provide investors who
purchase and sell ETF shares on the secondary market with additional
information regarding ETF trading costs, regardless of whether such
ETFs are structured as registered open-end management investment
companies (``open-end funds'') or unit investment trusts (``UITs'').
Finally, the Commission is proposing related amendments to Form N-CEN.
The proposed rule and form amendments are designed to create a
consistent, transparent, and efficient regulatory framework for ETFs
and to facilitate greater competition and innovation among ETFs.

DATES: Comments should be received on or before October 1, 2018.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's internet comment form (http://www.sec.gov/rules/proposed.shtml); or
     Send an email to [email protected]. Please include
File Number S7-15-18 on the subject line.

Paper Comments

     Send paper comments to Brent J. Fields, Secretary,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549-1090.

All submissions should refer to File Number S7-15-18. This file number
should be included on the subject line if email is used. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's
internet website (http://www.sec.gov/rules/proposed.shtml). Comments
are also available for website viewing and printing in the Commission's
Public Reference Room, 100 F Street NE, Washington, DC 20549, on
official business days between the hours of 10:00 a.m. and 3:00 p.m.
Persons submitting comments are cautioned that we do not redact or edit
personal identifying information from comment submissions. You should
submit only information that you wish to make available publicly.
    Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any such materials
will be made available on the Commission's website. To ensure direct
electronic receipt of such notifications, sign up through the ``Stay
Connected'' option at www.sec.gov to receive notifications by email.

FOR FURTHER INFORMATION CONTACT: Zeena Abdul-Rahman (Senior Counsel),
Joel Cavanaugh (Senior Counsel), John Foley (Senior Counsel), Jacob D.
Krawitz (Branch Chief), Melissa S. Gainor (Senior Special Counsel), and
Brian McLaughlin Johnson (Assistant Director), Investment Company
Regulation Office, at<PHONE_NUMBER>, Sumeera Younis (Branch Chief) and
Christian Sandoe (Assistant Director), Disclosure Review and Accounting
Office, at<PHONE_NUMBER>, Division of Investment Management,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549.

SUPPLEMENTARY INFORMATION: The Commission is proposing for public
comment 17 CFR 270.6c-11 (new rule 6c-11) under the Investment Company
Act [15 U.S.C. 80a-1 et seq.]; amendments to Form N-1A [referenced in
17 CFR 274.11A] under the Investment Company Act and the Securities Act
of 1933 [15 U.S.C. 77a et seq.] (``Securities Act''); and amendments to
Forms N-8B-2 [referenced in 17 CFR 274.12] and N-CEN [referenced in 17
CFR 274.101] under the Investment Company Act.\1\
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    \1\ Unless otherwise noted, all references to statutory sections
are to the Investment Company Act, and all references to rules under
the Investment Company Act are to title 17, part 270 of the Code of
Federal Regulations [17 CFR part 270].
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Table of Contents

I. Introduction
    A. Overview of Exchange-Traded Funds
    B. Operation of Exchange-Traded Funds
II. Discussion
    A. Scope of Proposed Rule 6c-11
    1. Organization as Open-End Funds
    2. Index-Based ETFs and Actively Managed ETFs
    3. Leveraged ETFs
    B. Exemptive Relief Under Proposed Rule 6c-11
    1. Treatment of ETF Shares as ``Redeemable Securities''
    2. Trading of ETF Shares at Market-Determined Prices
    3. Affiliated Transactions
    4. Additional Time for Delivering Redemption Proceeds
    C. Conditions for Reliance on Proposed Rule 6c-11
    1. Issuance and Redemption of Shares
    2. Listing on a National Securities Exchange
    3. Intraday Indicative Value
    4. Portfolio Holdings
    5. Baskets
    6. Website Disclosure
    7. Marketing
    D. Recordkeeping
    E. Share Class ETFs
    F. Master-Feeder ETFs
    G. Effect of Proposed Rule 6c-11 on Prior Orders
    H. Amendments to Form N-1A
    1. Definitions
    2. Item 3 of Form N-1A
    3. Item 6 of Form N-1A
    4. Item 11 of Form N-1A
    5. Potential Alternatives to Current ETF Registration Forms
    I. Amendments to Form N-8B-2
    J. Amendments to Form N-CEN
III. Economic Analysis
    A. Introduction
    B. Economic Baseline
    1. ETF Industry Growth and Trends
    2. Exemptive Order Process
    3. Market Participants
    4. Secondary Market Trading, Arbitrage, and ETF Liquidity
    C. Benefits and Costs of Proposed Rule 6c-11 and Amendments to
Forms N-1A and N-8B-2
    1. Proposed Rule 6c-11
    2. Disclosure (Amendments to Forms N-1A and N-8B-2)
    D. Effects on Efficiency, Competition, and Capital Formation
    1. Efficiency
    2. Competition
    3. Capital Formation
    E. Reasonable Alternatives
    1. Treatment of Existing Exemptive Relief
    2. ETFs Organized as UITs
    3. Basket Flexibility
    4. Website Disclosure of Every Basket Used by an ETF
    5. The Use of a Structured Format for Additional Website
Disclosures and the Filing of Additional Website Disclosures in a
Structured Format on EDGAR
    6. Treatment of Leveraged ETFs
    F. Request for Comments
IV. Paperwork Reduction Act
    A. Introduction

    B. Proposed Rule 6c-11
    1. Website Disclosures
    2. Recordkeeping
    3. Policies and Procedures
    4. Estimated Total Burden
    C. Rule 0-2
    D. Form N-1A
    E. Disclosure Amendments to Forms N-8B-2 and S-6
    F. Form N-CEN
    G. Request for Comments
V. Initial Regulatory Flexibility Analysis
    A. Reasons for and Objectives of the Proposed Actions
    B. Legal Basis
    C. Small Entities Subject to the Rule
    D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
    1. Rule 6c-11
    2. Disclosure and Reporting Requirements
    E. Duplicative, Overlapping or Conflicting Federal Rules
    F. Significant Alternatives
    G. General Request for Comment
VI. Consideration of Impact on the Economy
VII. Statutory Authority

I. Introduction

    The Commission is proposing rule 6c-11 under the Investment Company
Act to permit ETFs that satisfy certain conditions to operate without
the expense and delay of obtaining an exemptive order from the
Commission under the Act. This rule would modernize the regulatory
framework for ETFs to reflect our 26 years of experience with these
investment products. It is designed to create a consistent,
transparent, and efficient regulatory framework for ETFs and to
facilitate greater competition and innovation among ETFs.
    The Commission approved the first ETF in 1992. Since then, ETFs
registered with us have grown to $3.4 trillion in total net assets.\2\
They now account for approximately 15% of total net assets managed by
investment companies,\3\ and are projected to continue to grow.\4\ ETFs
currently rely on exemptive orders, which permit them to operate as
investment companies under the Act, subject to representations and
conditions that have evolved over time.\5\ We have granted over 300 of
these orders over the last quarter century, resulting in differences in
representations and conditions that have led to some variations in the
regulatory structure for existing ETFs.\6\
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    \2\ This figure is based on data obtained from Bloomberg. As of
December 2017, there were 1,900 ETFs registered with the Commission.
See id.
    \3\ ICI, 2018 Investment Company Fact Book (58th ed., 2018)
(``2018 ICI Fact Book''), available at https://www.ici.org/pdf/2018_factbook.pdf, at 96. When the Commission first proposed a rule
for ETFs in 2008, aggregate ETF assets were less than 7% of total
net assets held by mutual funds. See Exchange-Traded Funds,
Investment Company Act Release No. 28193 (Mar. 11, 2008) [73 FR
14618 (Mar. 18, 2008)] (``2008 ETF Proposing Release'').
    \4\ See Greg Tusar, The evolution of the ETF industry, Pension &
Investments (Jan. 31, 2017), available at http://www.pionline.com/article/20170131/ONLINE/170139973/the-evolution-of-the-etf-industry
(describing projections that ETF assets could double to $6 trillion
by 2020).
    \5\ As the orders are subject to the terms and conditions set
forth in the applications requesting exemptive relief, references in
this release to ``exemptive relief'' or ``exemptive orders'' include
the terms and conditions described in the related application. See,
e.g., infra footnote 6.
    \6\ Since 2000, our ETF exemptive orders have provided relief
for future ETFs. See, e.g., Barclays Global Fund Advisors,
Investment Company Act Release Nos. 24394 (Apr. 17, 2000) [65 FR
21215 (Apr. 20, 2000)] (notice) and 24451 (May 12, 2000) (order) and
related application (``Barclays Global 2000''). This relief has
allowed ETF sponsors to form ETFs without filing new applications to
the extent that the new ETFs meet the terms and conditions set forth
in the exemptive order. Applications granted before 2000, unless
subsequently amended, did not include this relief.
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    Proposed rule 6c-11 would simplify this regulatory framework by
eliminating conditions included within our exemptive orders that we no
longer believe are necessary for our exemptive relief and removing
historical distinctions between actively managed and index-based ETFs.
In connection with the proposed rule, we also propose to rescind
certain exemptive orders that have been granted to ETFs and their
sponsors. As a result, proposed rule 6c-11 would level the playing
field for ETFs that are organized as open-end funds and pursue the same
or similar investment strategies.\7\ The proposed rule also would
assist the Commission with regulating ETFs, as funds covered by the
rule would no longer be subject to the varying provisions of exemptive
orders granted over time, and instead would be subject to a consistent
regulatory framework. Furthermore, creating an efficient regulatory
framework for ETFs would allow Commission staff and industry resources
to focus the exemptive order process on products that do not fall
within the scope of our proposed rule.
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    \7\ As discussed below, the scope of proposed rule 6c-11 does
not include ETFs that: (i) Are organized as UITs; (ii) seek to
exceed the performance of a market index by a specified multiple or
to provide returns that have an inverse relationship to the
performance of a market index, over a fixed period of time
(``leveraged ETFs''); or (iii) are structured as a share class of a
fund that issues multiple classes of shares representing interests
in the same portfolio (``share class ETFs''). These ETFs would
continue to operate pursuant to the terms of their exemptive orders.
See infra sections II.A.1 (UIT ETFs), II.A.3 (leveraged ETFs), and
II.E (share class ETFs).
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    In addition, we are proposing certain disclosure amendments to
provide additional information to investors who purchase and sell ETF
shares in the secondary markets, and to provide investors who purchase
UITs with the same disclosures that we propose to require of ETFs
organized as open-end funds. The proposed amendments would include new
disclosures regarding certain unique costs associated specifically with
ETFs, such as the bid-ask spread and premiums and discounts from the
ETF's net asset value (``NAV'').
    Our proposal takes into account the comments we received in
response to our 2008 ETF proposal, which was designed to codify the
exemptive relief that had been issued to ETFs at that time.\8\
Developments in the ETF industry since the 2008 proposal and interim
Commission actions also have informed the parameters of proposed rule
6c-11 and the related disclosure amendments that we are proposing.\9\
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    \8\ See 2008 ETF Proposing Release, supra footnote 3. Comment
letters on the 2008 ETF Proposing Release are available at http://www.sec.gov/comments/s7-07-08/s70708.shtml.
    \9\ See, e.g., Request for Comment on Exchange-Traded Products,
Exchange Act Release No. 75165 (June 12, 2015) [80 FR 34729 (June
17, 2015)] (``2015 ETP Request for Comment''), at section I.A;
Report of the Staffs of the CFTC and SEC to the Joint Advisory
Committee on Emerging Regulatory Issues, Findings Regarding the
Market Events of May 6, 2010 (Sept. 30, 2010) (``Final May 6
Report''), available at http://www.sec.gov/news/studies/2010/marketevents-report.pdf. Comment letters on the 2015 ETP Request for
Comment are available at https://www.sec.gov/comments/s7-11-15/s71115.shtml.
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A. Overview of Exchange-Traded Funds

    ETFs are a type of exchange-traded product (``ETP'').\10\ ETFs
possess characteristics of both mutual funds, which issue redeemable
securities, and closed-end funds, which generally issue shares that
trade at market-determined prices on a national securities exchange and
are not redeemable.\11\ Because ETFs

have characteristics that distinguish them from the types of investment
companies contemplated by the Act, they require exemptions from certain
provisions of the Investment Company Act in order to operate. The
Commission (and Commission staff under delegated authority) now
routinely grants exemptive orders permitting ETFs to operate as
investment companies under the Investment Company Act, generally
subject to the provisions of the Act applicable to open-end funds (or
UITs).\12\ These exemptive orders reflect our determination that, based
on the factual representations offered by the applicants and the
conditions to which the applicants have agreed, the requested relief is
necessary or appropriate in the public interest and consistent with the
protection of investors and the purposes fairly intended by the policy
and provisions of the Investment Company Act.\13\ The Commission also
has approved the standards of national securities exchanges, under
which ETF shares are listed and traded.\14\
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    \10\ ETFs are investment companies registered under the
Investment Company Act. See 15 U.S.C. 80a-3(a)(1). Other types of
ETPs are pooled investment vehicles with shares that trade on a
securities exchange, but they are not ``investment companies'' under
the Act because they do not invest primarily in securities. Such
ETPs may invest primarily in assets other than securities, such as
futures, currencies, or physical commodities (e.g., precious
metals). Still other ETPs are not pooled investment vehicles. For
example, exchange-traded notes are senior, unsecured, unsubordinated
debt securities that are linked to the performance of a market index
and trade on securities exchanges.
    \11\ The Act defines ``redeemable security'' as any security
that allows the holder to receive his or her proportionate share of
the issuer's current net assets upon presentation to the issuer. 15
U.S.C. 80a-2(a)(32). While closed-end fund shares are not
redeemable, certain closed-end funds may elect to repurchase their
shares at periodic intervals pursuant to 17 CFR 270.23c-3 (rule 23c-
3) under the Act (``interval funds''). Based on staff analysis,
there were 39 interval funds, representing approximately $21 billion
in assets, in 2017. Other closed-end funds may repurchase their
shares in tender offers pursuant to 17 CFR 240.13e-4 (rule 13e-4)
under the Securities Exchange Act of 1934 (the ``Exchange Act'').
    \12\ Historically, ETFs have been organized as open-end funds or
UITs. See 15 U.S.C. 80a-5(a)(1) (defining the term ``open-end
company'') and 15 U.S.C. 80a-4(2) (defining the term ``unit
investment trust''). Some fund groups have multiple orders covering
different types of ETFs (e.g., one order covering ETFs organized as
UITs and another covering ETFs organized as open-end funds or one
order covering index-based ETFs and another covering actively
managed ETFs).
    \13\ See 15 U.S.C. 80a-6(c).
    \14\ Additionally, ETFs regularly request relief from 17 CFR
242.101 and 242.102 (rules 101 and 102 of Regulation M); section
11(d)(1) of the Exchange Act and 17 CFR 240.11d1-2 (``rule 11d1-2''
under the Exchange Act); certain other rules under the Exchange Act
(i.e., 17 CFR 240.10b-10, 240.10b-17, 240.14e-5, 240.15c1-5, and
240.15c1-6 (rules 10b-10, 10b-17, 14e-5, 15c1-5, and 15c1-6)); and
17 CFR 242.200(g) (rule 200(g) of Regulation SHO). See 2015 ETP
Request for Comment, supra footnote 9, at section I.D.2 (discussing
the exemptive and no-action relief granted to ETPs under the
Exchange Act and the listing process for ETP securities for trading
on a national securities exchange).
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    As discussed above, ETFs have become an increasingly popular
investment vehicle over the last 26 years. They also have become a
popular trading tool, making up a significant portion of secondary
market equities trading. During the first quarter of 2018, for example,
trading in U.S.-listed ETFs made up approximately 18.75% of U.S. equity
trading by share volume and 28.2% of U.S. equity trading by dollar
volume.\15\
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    \15\ These estimates are based on trade and quote data from the
New York Stock Exchange and Trade Reporting Facility data from
FINRA.
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    Investors can buy and hold shares of ETFs (sometimes as a core
component of a portfolio) or trade them frequently as part of an active
trading or hedging strategy.\16\ ETF investors can sell ETF shares
short, write options on them, and set market, limit, and stop-loss
orders on them. Moreover, because certain costs are either absent in
the ETF structure or are otherwise partially externalized, many ETFs
have lower operating expenses than mutual funds.\17\ ETFs also may
offer certain tax efficiencies compared to other pooled investment
vehicles because redemptions from ETFs are often made in kind (that is,
by delivering certain assets from the ETF's portfolio, rather than in
cash), thereby avoiding the need for the ETF to sell assets and
potentially realize capital gains that are distributed to its
shareholders.
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    \16\ See, e.g., Chris Dieterich, Are You An ETF `Trader' Or An
ETF `Investor'?, Barrons (Aug. 8, 2017), available at https://www.barrons.com/articles/are-you-an-etf-trader-or-an-etf-investor-1470673638; Greenwich Associates, Institutions Find New,
Increasingly Strategic Uses for ETFs (May 2012) (``More than one-in-
five asset managers that use [ETFs] report employing ETFs for active
exposures in domestic equities and commodities, and about 17% note
using them for active exposures in international equities.''); Joe
Renninson, Institutional Investors Boost Ownership of ETFs,
Financial Times (Apr. 13, 2017), available at https://www.ft.com/content/c70113ac-ab83-33ac-a624-d2d874533fb0?mhq5j=e7.
    \17\ For instance, ETFs typically do not bear distribution or
shareholder servicing fees. In addition, ETFs that transact on an
in-kind basis can execute changes in the ETF's portfolio without
incurring brokerage costs, leading to transaction cost savings.
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    ETFs today provide investors with a diverse set of investment
options. While the first ETFs held portfolios of securities that
replicated the component securities of broad-based domestic stock
market indexes, some ETFs now track more specialized indexes, including
international equity indexes, fixed-income indexes, or indexes focused
on particular industry sectors such as telecommunications or
healthcare.\18\ Some ETFs seek to track highly customized or bespoke
indexes, while others seek to provide a level of leveraged or inverse
exposure to an index over a fixed period of time.\19\ Investors also
have the ability to invest in ETFs that do not track a particular index
and are actively managed.\20\
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    \18\ The Commission historically has referred to ETFs that have
stated investment objectives of maintaining returns that correspond
to the returns of a securities index as ``index-based'' ETFs. See,
e.g., Parker Global Strategies, LLC, et al., Investment Company Act
Release Nos. 32528 (Mar. 10, 2017) [82 FR 14043 (Mar. 16, 2017)]
(notice) and 32595 (Apr. 5, 2017) (order) and related application
(``Parker Global Strategies'').
    \19\ Inverse ETFs are often marketed as a way for investors to
profit from, or at least hedge their exposure to, downward moving
markets. See infra section II.A.3.
    \20\ An actively managed ETF's investment adviser, like an
adviser to any actively managed mutual fund, generally selects
securities consistent with the ETF's investment objectives and
policies without trying to track the performance of a corresponding
index. Actively managed ETFs represent approximately 1.3% of total
ETF assets as of September 2017. Based on data obtained from the
Market Information Data Analytics System (``MIDAS''), Bloomberg, and
Morningstar Direct.
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B. Operation of Exchange-Traded Funds

    An ETF issues shares that can be bought or sold throughout the day
in the secondary market at a market-determined price. Like other
investment companies, an ETF pools the assets of multiple investors and
invests those assets according to its investment objective and
principal investment strategies. Each share of an ETF represents an
undivided interest in the underlying assets of the ETF. Similar to
mutual funds, ETFs continuously offer their shares for sale.
    Unlike mutual funds, however, ETFs do not sell or redeem individual
shares. Instead, ``authorized participants'' that have contractual
arrangements with the ETF (or its distributor) purchase and redeem ETF
shares directly from the ETF in blocks called ``creation units.'' \21\
An authorized participant may act as a principal for its own account
when purchasing or redeeming creation units from the ETF. Authorized
participants also may act as agent for others, such as market makers,
proprietary trading firms, hedge funds or other institutional
investors, and receive fees for processing creation units on their
behalf.\22\ Market makers, proprietary trading firms, and hedge funds
provide additional liquidity to the ETF market through their trading
activity. Institutional investors may engage in primary market
transactions with an ETF through an authorized participant as a way to
efficiently hedge a portion of their portfolio or balance sheet or to

gain exposure to a strategy or asset class.\23\
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    \21\ Our exemptive orders typically contain a representation by
the applicant that an authorized participant will be either: (a) A
broker or other participant in the continuous net settlement system
of the National Securities Clearing Corporation, a clearing agency
registered with the Commission and affiliated with the Depository
Trust Company (``DTC''), or (b) a DTC participant, which has
executed a participant agreement with the ETF's distributor and
transfer agent with respect to the creation and redemption of
creation units. See, e.g., Emerging Global Advisors, LLC, et al.,
Investment Company Act Release Nos. 30382 (Feb. 13, 2013) [78 FR
11909 (Feb. 20, 2013)] (notice) and 30423 (Mar. 12, 2013) (order)
and related application. Proposed rule 6c-11(a) would define
``authorized participant'' as a member or participant of a clearing
agency registered with the Commission, which has a written agreement
with the ETF or one of its service providers that allows the
authorized participant to place orders for the purchase and
redemption of creation units.
    \22\ See David J. Abner, The ETF Handbook: How to Value and
Trade Exchange Traded Funds, 2nd ed. (2016) (``ETF Handbook'').
    \23\ Id.
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    An authorized participant that purchases a creation unit of ETF
shares directly from the ETF deposits with the ETF a ``basket'' of
securities and other assets identified by the ETF that day, and then
receives the creation unit of ETF shares in return for those
assets.\24\ The basket is generally representative of the ETF's
portfolio \25\ and, together with a cash balancing amount, equal in
value to the aggregate NAV of the ETF shares in the creation unit.\26\
After purchasing a creation unit, the authorized participant may hold
the individual ETF shares, or sell some or all of them in secondary
market transactions.\27\ Investors then purchase individual ETF shares
in the secondary market. The redemption process is the reverse of the
purchase process: The authorized participant redeems a creation unit of
ETF shares for a basket of securities and other assets.
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    \24\ An ETF may impose fees in connection with the purchase or
redemption of creation units that are intended to defray operational
processing and brokerage costs to prevent possible shareholder
dilution (``transaction fees'').
    \25\ The basket might not reflect a pro rata slice of an ETF's
portfolio holdings. Subject to the terms of the applicable exemptive
relief, an ETF may substitute other securities or cash in the basket
for some (or all) of the ETF's portfolio holdings. Restrictions
related to flexibility in baskets have varied over time. See infra
section II.C.5.
    \26\ An open-end fund is required by law to redeem its
securities on demand from shareholders at a price approximating
their proportionate share of the fund's NAV at the time of
redemption. See 15 U.S.C. 80a-22(d). Title 17 CFR 270.22c-1 (``rule
22c-1'') generally requires that funds calculate their NAV per share
at least once daily Monday through Friday. See rule 22c-1(b)(1).
Today, most funds calculate NAV per share as of the time the major
U.S. stock exchanges close (typically at 4:00 p.m. Eastern Time).
Under rule 22c-1, an investor who submits an order before the 4:00
p.m. pricing time receives that day's price, and an investor who
submits an order after the pricing time receives the next day's
price. See also 17 CFR 270.2a-4 (``rule 2a-4'') (defining ``current
net asset value'').
    \27\ ETFs register offerings of shares under the Securities Act,
and list their shares for trading under the Exchange Act. Depending
on the facts and circumstances, authorized participants that
purchase a creation unit and sell the shares may be deemed to be
participants in a distribution, which could render them statutory
underwriters and subject them to the prospectus delivery and
liability provisions of the Securities Act. See 15 U.S.C. 77b(a)(11)
(defining the term ``underwriter'').
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    The combination of the creation and redemption process with
secondary market trading in ETF shares provides arbitrage opportunities
that are designed to help keep the market price of ETF shares at or
close to the NAV per share of the ETF.\28\ For example, if ETF shares
are trading on national securities exchanges at a ``discount'' (a price
below the NAV per share of the ETF), an authorized participant can
purchase ETF shares in secondary market transactions and, after
accumulating enough shares to compose a creation unit, redeem them from
the ETF in exchange for the more valuable securities in the ETF's
redemption basket. The authorized participant's purchase of an ETF's
shares on the secondary market, combined with the sale of the ETF's
basket assets, may create upward pressure on the price of the ETF
shares, downward pressure on the price of the basket assets, or both,
bringing the market price of ETF shares and the value of the ETF's
portfolio holdings closer together.\29\ Alternatively, if ETF shares
are trading at a ``premium'' (a price above the NAV per share of the
ETF), the transactions in the arbitrage process are reversed and, when
arbitrage is working effectively, keep the market price of the ETF's
shares close to its NAV.
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    \28\ To date, the arbitrage mechanism has been dependent on
daily portfolio transparency.
    \29\ As part of this arbitrage process, authorized participants
are likely to hedge their intraday risk. For example, when ETF
shares are trading at a discount to an estimated intraday NAV per
share of the ETF, an authorized participant may short the securities
composing the ETF's redemption basket. After the authorized
participant returns a creation unit of ETF shares to the ETF in
exchange for the ETF's baskets, the authorized participant can then
use the basket assets to cover its short positions.
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    Market participants also can engage in arbitrage activity without
using the creation or redemption processes. For example, if a market
participant believes that an ETF is overvalued relative to its
underlying or reference assets (i.e., trading at a premium), the market
participant may sell ETF shares short and buy the underlying or
reference assets, wait for the trading prices to move toward parity,
and then close out the positions in both the ETF shares and the
underlying or reference assets to realize a profit from the relative
movement of their trading prices. Similarly, a market participant could
buy ETF shares and sell the underlying or reference assets short in an
attempt to profit when an ETF's shares are trading at a discount to the
ETF's underlying or reference assets. As with the creation and
redemption process, the trading of an ETF's shares and the ETF's
underlying or reference assets may bring the prices of the ETF's shares
and its portfolio assets closer together through market pressure.\30\
---------------------------------------------------------------------------

    \30\ Some studies have found the majority of all ETF-related
trading activity takes place on the secondary market. See, e.g.,
Rochelle Antoniewicz & Jane Heinrichs, Understanding Exchange-Traded
Funds: How ETFs Work, ICI Research Perspective 20, No. 5 (Sept.
2014) (``Antoniewicz''), available at https://www.ici.org/pdf/per20-05.pdf, at 2 (``On most trading days, the vast majority of ETFs do
not have any primary market activity--that is, they do not create or
redeem shares.'').
---------------------------------------------------------------------------

    The arbitrage mechanism is important because it provides a means to
maintain a close tie between market price and NAV per share of the ETF,
thereby helping to ensure ETF investors are treated equitably when
buying and selling fund shares. In granting relief under section 6(c)
of the Act for ETFs to operate, the Commission has relied on this close
tie between what retail investors pay (or receive) in the secondary
market and the ETF's approximate NAV to find that the required
exemptions are necessary or appropriate in the public interest and
consistent with the protection of investors and the purposes fairly
intended by the policy and provisions of the Act. Investors also have
come to expect that an ETF's market price will maintain a close tie to
the ETF's NAV per share, which may lead some investors to view ETFs
more favorably than similar closed-end funds.\31\ On the other hand,
this expectation may lead investors to view ETFs as a less attractive
investment option or cause them to sell ETF shares if market price and
NAV per share diverge, particularly during periods of market
stress.\32\
---------------------------------------------------------------------------

    \31\ Scott W. Barnhart & Stuart Rosenstein, Exchange-Traded Fund
Introductions and Closed-End Fund Discounts and Volume, 45 The
Financial Review 4 (Nov. 2010) (within a year of the introduction of
a similar ETF, the average discount widens significantly and volume
falls significantly in U.S. domestic equity, international equity,
and U.S. bond closed-end funds, which may indicate that closed-end
funds lose some desirability when a substitute ETF becomes
available). As of December 31, 2017, total net assets of ETFs were
$3.4 trillion compared to $275 billion for closed-end funds. See
2018 ICI Fact Book, supra footnote 3.
    \32\ See Staff of the Office of Analytics and Research, Division
of Trading and Markets, Research Note: Equity Market Volatility on
August 24, 2015 (Dec. 2015) (``August 24 Staff Report''), available
at https://www.sec.gov/marketstructure/research/equity_market_volatility.pdf (discussing spikes in ETF trading
volume on August 24, 2015 when U.S. equity markets experienced
unusual price volatility). See also infra section II.B.2 (discussing
intraday deviations between market price and NAV as well as
contemporaneous deviations between market price and the intraday
value of the ETF's portfolio).
---------------------------------------------------------------------------

II. Discussion

    Given the growth in the ETF market, ETFs' popularity among retail
and institutional investors, and our long experience regulating this
investment and trading vehicle, we believe that it is appropriate to
propose a rule that would allow most ETFs to operate without first
obtaining an exemptive order from the Commission under the Act. We
believe that such a rule would create a consistent, transparent and
efficient regulatory framework for the regulation of most ETFs and
level the playing field for these market participants. Proposed

rule 6c-11 includes several conditions designed to address the concerns
underlying the relevant statutory provisions and to support a
Commission finding that the exemptions necessary to allow ETFs to
operate are in the public interest and consistent with the protection
of investors and the purposes fairly intended by the policy and
provisions of the Act. The proposed conditions are based upon the
existing exemptive relief for ETFs, which we believe have served to
support an efficient arbitrage mechanism, but reflect several
modifications based on our experience regulating this product.

A. Scope of Proposed Rule 6c-11

    Proposed rule 6c-11 would define an ETF as a registered open-end
management investment company that: (i) Issues (and redeems) creation
units to (and from) authorized participants in exchange for a basket
and a cash balancing amount (if any); and (ii) issues shares that are
listed on a national securities exchange and traded at market-
determined prices.\33\
---------------------------------------------------------------------------

    \33\ See proposed rule 6c-11(a) (defining ``exchange-traded
fund''). Under the proposed rule, the term ``basket'' would be
defined to mean the securities, assets, or other positions in
exchange for which an ETF issues (or in return for which it redeems)
creation units. The term ``exchange-traded fund'' thus would include
ETFs that transact on an in-kind basis, on a cash basis, or both.
---------------------------------------------------------------------------

1. Organization as Open-End Funds
    Proposed rule 6c-11 would be available only to ETFs that are
organized as open-end funds. The vast majority of ETFs currently in
operation are organized as open-end funds, although the earliest ETFs
were organized as UITs (``UIT ETFs'').\34\ These early UIT ETFs
represent a significant amount of assets within the ETF industry.\35\
For example, two of the largest ETFs by total net assets and estimated
dollar trading volume (SPDR S&P 500 ETF Trust (SPY) and PowerShares QQQ
Trust, Series 1 (QQQ)) are organized as UITs.
---------------------------------------------------------------------------

    \34\ See, e.g., SPDR Trust, Series 1, Investment Company Act
Release Nos. 18959 (Sept. 17, 1992) [57 FR 43996 (Sept. 23, 1992)]
(notice) and 19055 (Oct. 26, 1992) (order) and related application
(``SPDR'').
    \35\ As of Dec. 31, 2017, for example, the eight existing UIT
ETFs had total assets of approximately $379 billion, representing
approximately 11.3% of total assets invested in ETFs (based on data
obtained from MIDAS, Bloomberg, and Morningstar Direct).
---------------------------------------------------------------------------

    A UIT is an investment company organized under a trust indenture or
similar instrument that issues redeemable securities, each of which
represents an undivided interest in a unit of specified securities.\36\
By statute, a UIT is unmanaged and its portfolio is fixed. Substitution
of securities may take place only under certain pre-defined
circumstances.\37\ A UIT does not have a board of directors, corporate
officers, or an investment adviser to render advice during the life of
the trust. By contrast, ETFs organized as open-end funds are managed by
investment advisers and, in addition to replicating an index, can be
actively managed or use a ``sampling'' strategy to track an index.\38\
Unlike an ETF structured as a UIT, an open-end fund ETF may participate
in securities lending programs and has greater flexibility to reinvest
dividends from portfolio securities.\39\ ETFs structured as open-end
funds also may invest in derivatives, which typically require a degree
of management that is not provided for in the UIT structure.\40\ As a
result, we understand that most ETF sponsors now prefer the open-end
fund structure over the UIT structure given the increased investment
flexibility the open-end structure affords. Indeed, we have received
very few exemptive applications for new UIT ETFs since 2002 and no new
UIT ETFs have come to market in that time.\41\
---------------------------------------------------------------------------

    \36\ See section 4(2) of the Act [15 U.S.C. 80a-4]. A UIT has a
fixed life--a termination date for the trust is established when the
trust is created.
    \37\ The exemptive relief granted to UIT ETFs does not provide
relief from the portion of section 4(2) that requires that UIT
securities represent an undivided interest in a unit of specified
securities. Because a UIT must invest in ``specified securities,''
the investment strategies that a UIT ETF can pursue are limited. All
UIT ETFs today seek to track the performance of an index by
investing in the component securities of the index in the same
approximate proportions as in the index (i.e., ``replicating'' the
index). The trustee of an UIT ETF may make adjustments to the ETF's
portfolio only to reflect changes in the composition of the
underlying index. See Actively Managed Exchange-Traded Funds,
Investment Company Act Release No. 25258 (Nov. 8. 2001) [66 FR 57614
(Nov. 15, 2001)] (``2001 Concept Release''), at n.11.
    \38\ An ETF that uses a sampling strategy includes assets in its
portfolio that are designed, in the aggregate, to reflect the
underlying index's capitalization, industry, and fundamental
investment characteristics, and to perform like the index. The ETF
implements the strategy by acquiring a subset of the underlying
index's component securities and may invest a portion of the ETF's
portfolio in securities and other financial instruments (including
derivatives) that are not included in the corresponding index if the
adviser believes the investment will help the ETF track the
underlying index. See 2008 ETF Proposing Release, supra footnote 3.
    \39\ UIT dividends are held in a non-interest bearing account
and paid out quarterly. The inability to reinvest dividends can have
a cash drag on the tracking performance of a UIT ETF. See A. Seddik
Meziani, Exchange-Traded Funds: Investment Practices and Tactical
Approaches (2016), at 22.
    \40\ See Use of Derivatives by Registered Investment Companies
and Business Development Companies, Investment Company Act Release
No. 31933 (Dec. 11, 2015) [80 FR 80883 (Dec. 28, 2015)]
(``Derivatives Proposing Release''), at n.139.
    \41\ The Commission has received applications for ETFs
structured as a UIT, but with features that are different from
typical UIT-structured ETFs. See Application of Elkhorn Securities,
LLC and Elkhorn Unit Trust (Mar. 6, 2017) (``Elkhorn Application'');
Application of Precidian ADRs LLC (Aug. 1, 2014) (``Precidian ADR
Application''). The Commission has not taken any action on the
Elkhorn Application, and the Precidian ADR Application was withdrawn
by the applicant. Two orders modifying relief for existing ETFs
organized as UITs were issued in 2007. See NASDAQ-100 Trust, Series
1, et al., Investment Company Act Release Nos. 27740 (Feb. 27, 2007)
[72 FR 9594 (Mar. 2, 2007)] (notice) and 27753 (Mar. 20, 2007)
(order) and related application; BLDRS Index Funds Trust, et al.,
Investment Company Act Release Nos. 27745 (Feb. 28, 2007) [72 FR
9787 (Mar. 5, 2007)] (notice) and 27768 (Mar. 21, 2007) (order) and
related application.
---------------------------------------------------------------------------

    The rule we proposed in 2008 would not have included UIT ETFs
within its scope.\42\ Comments on the 2008 ETF Proposing Release were
mixed with regard to providing relief to UITs, with two commenters
supporting the exclusion of UITs.\43\ On the other hand, two commenters
argued that the Commission should expand the rule to include UITs,
contending that sponsors in the future may choose the UIT structure for
some reason unforeseen today.\44\ Some commenters also stated that
existing UIT ETFs should be able to rely on the rule, which may provide
broader relief than provided by their exemptive orders.\45\
---------------------------------------------------------------------------

    \42\ See 2008 ETF Proposing Release, supra footnote 3, at text
accompanying nn.63-67 (noting that the Commission had not received
an exemptive application for a new ETF to be organized as a UIT
since 2002 and, as a result, there did not appear to be a need to
include UIT relief in the proposed rule).
    \43\ See Comment Letter of Xshares Advisors LLC (May 20, 2008)
(``Xshares 2008 Comment Letter''); Comment Letter of the Investment
Company Institute (May 19, 2008) (``ICI 2008 Comment Letter'').
    \44\ See Comment Letter of Katten Muchin Rosenman LLP (May 30,
2008) (``Katten 2008 Comment Letter''); Comment Letter of the
Federal Regulation of Securities Committee, Section of Business Law,
American Bar Association (May 29, 2008) (``ABA 2008 Comment
Letter'').
    \45\ See Comment Letter of State Street Global Advisors (May 19,
2008) (``SSgA 2008 Comment Letter''); Comment Letter of NYSE Arca
(May 29, 2008) (``NYSE Arca 2008 Comment Letter''); Katten 2008
Comment Letter.
---------------------------------------------------------------------------

    While we acknowledge that excluding UIT ETFs would result in a
segment of ETF assets that are outside the regulatory framework of
proposed rule 6c-11, we do not believe there is a need to include ETF
UITs within the scope of the proposed rule given the limited sponsor
interest in developing ETFs organized as UITs. In addition, even if we
were to include UIT ETFs within the scope of the rule, we believe that
the unmanaged nature of the UIT structure would require conditions that
differ from the conditions applicable to ETFs

organized as open-end funds, requiring a regulatory framework that
would be different than our proposed structure for open-end ETFs. The
exemptive relief that has been granted to UIT ETFs, for example,
provides that the trustee will make adjustments to the ETF's portfolio
only pursuant to the specifications set forth in the trust formation
documents in order to track changes in the ETF's underlying
indexes.\46\ The trustee does not have discretion when making these
portfolio adjustments.\47\ In most cases, therefore, a UIT ETF uses
baskets that correspond pro rata to the ETF's portfolio holdings.\48\
The rule we are proposing would allow ETFs the flexibility to use
baskets that differ from a pro rata representation of the ETF's
portfolio if certain conditions are met.\49\ Because the conditions we
are proposing related to basket flexibility require ongoing management
and board oversight, we do not believe that extending such basket
flexibility to UIT ETFs would be appropriate given the unmanaged nature
of a UIT.
---------------------------------------------------------------------------

    \46\ See, e.g., SPDR, supra footnote 34.
    \47\ See id.
    \48\ See id. (permitting baskets accepted by UIT ETF for
purchases of creation units to include the cash equivalent of a
component security of the underlying index only where: (i) The
trustee determines that the index security is likely to be
unavailable or available in insufficient quantity; or (ii) a
particular investor is restricted from investing or transacting in
such index security).
    \49\ See infra section II.C.5.
---------------------------------------------------------------------------

    Instead, we believe that UIT ETFs should continue to operate
pursuant to their exemptive orders, which include terms and conditions
that are appropriately tailored to address the unique features of a
UIT.\50\ The exemptive relief granted to UIT ETFs includes relief from
sections of the Act that govern key aspects of a UIT's operations.\51\
For example, because UITs are prohibited from paying fees beyond those
necessary to cover the costs of administrative and bookkeeping
services, UIT ETFs require exemptive relief from section 26(a)(2)(C) of
the Act to allow the ETF to pay certain enumerated expenses.\52\
However, because UITs are unmanaged and are not overseen by boards, the
exemptive order for each UIT ETF contains its own list of permissible
capped expenses that vary among the different UIT ETFs.\53\
---------------------------------------------------------------------------

    \50\ Unlike the exemptive relief we have granted to certain ETFs
organized as open-end funds (see supra footnote 6), the relief we
have granted to ETFs organized as UITs does not provide relief for
future ETFs formed pursuant to the same order.
    \51\ See, e.g., SPDR, supra footnote 34.
    \52\ Section 26(a)(2)(C) of the Act requires that the trust
indenture for a UIT prohibit payments to the depositor or to any
affiliated person thereof, except payments for performing
bookkeeping and other administrative services of a character
normally performed by the trustee or custodian itself. 15 U.S.C.
80a-26(a)(2)(C).
    \53\ See, e.g., NASDAQ-100 Trust, Series 1, Investment Company
Act Release Nos. 23668 (Jan. 27, 1999) [64 FR 5082 (Feb. 2, 1999)]
(notice) and 23702 (Feb. 22, 1999) (order) and related application
(exemption from section 26(a)(2)(C) to permit UIT to reimburse the
sponsor up to a maximum of 20 basis points) (``NASDAQ 100''); Midcap
SPDR Trust, Series 1, Investment Company Act Release Nos. 20797
(Dec. 23, 1994) [60 FR 163 (Jan. 3, 1995)] (notice) and 20844 (Jan.
18, 1995) (order) and related application (30 basis points).
---------------------------------------------------------------------------

    To the extent that ETF sponsors develop unforeseen, novel UIT ETFs,
we believe that the Commission should review such products as part of
its exemptive process to determine whether the relief is necessary or
appropriate in the public interest and consistent with the protection
of investors. We therefore are not proposing to include ETFs structured
as UITs within the scope of proposed rule 6c-11.\54\
---------------------------------------------------------------------------

    \54\ While we do not propose to include ETFs organized as UITs
within the scope of proposed rule 6c-11, we are proposing amendments
to Form N-8B-2 to require them to provide certain additional
disclosures regarding trading costs. See infra section II.I.
---------------------------------------------------------------------------

    We request comment on whether proposed rule 6c-11 should be
available only to ETFs structured as open-end funds.
     Should the rule provide exemptive relief for both ETFs
organized as open-end funds and ETFs organized as UITs? Are we correct
that ETF sponsors will likely prefer the open-end structure to the UIT
structure when forming ETFs in the future? If not, why?
     If UIT ETFs were included in the scope of the proposed
rule, should they be subject to the same proposed conditions or should
we tailor particular conditions in light of the unmanaged nature of a
UIT? For example, how should the proposed rule address basket
composition for UIT ETFs? Should UIT ETFs only be permitted to
replicate their index, or should we allow them to engage in
representative sampling on a pro rata basis? Should a UIT ETF only be
permitted to substitute cash (instead of other securities) for
particular basket assets? Should we allow a UIT ETF to substitute
basket assets only in certain enumerated circumstances (e.g., only when
the basket asset is not eligible for trading by an authorized
participant or is not available in sufficient quantity for delivery to
or from the authorized participant)?
     If UIT ETFs were included within the scope of the rule,
should we expressly limit the types of indexes that such ETFs may track
given the unmanaged nature of the UIT structure and the potential for
specialized or bespoke indexes to be inconsistent with a fixed
portfolio? For example, should we provide that ETFs structured as UITs
may only track broad-based securities indexes? Should we limit the
derivatives holdings of UIT ETFs or restrict them from tracking indexes
that include certain types of derivatives? If so, what types of
derivatives should be permitted?
     If we were to include UIT ETFs within the scope of rule
6c-11, should we provide an exemption from section 26(a)(2)(C),
consistent with our exemptive orders, to permit the payment of certain
expenses associated with the creation and maintenance of the ETF? If
so, should we limit the amount of expenses that may be reimbursed? What
should the limit be, and why? Should we limit the reimbursement to no
more than 20 basis points of the ETF's NAV per share on an annualized
basis, consistent with some of the exemptive orders granted to UIT
ETFs? Should this limit be higher (e.g., 30 basis points) or lower
(e.g., 10 basis points)? Should the rule enumerate the expenses that
may be reimbursed? For example, should the rule permit the
reimbursement of any or all of the following: (i) Annual index
licensing fees; (ii) annual federal and state fees for the registration
of newly issued creation units; and (iii) expenses of the sponsor
relating to the development, printing, and distribution of marketing
materials? Are there other expenses that should be permissible
reimbursements under such an exemption?
     Our exemptive orders for UIT ETFs also include relief from
section 14(a) of the Act, which provides that no registered investment
company may make an initial public offering of its securities unless it
has a net worth of at least $100,000 or is assured, via private
subscriptions, of issuing at least $100,000 in securities in the
offering.\55\ If UIT ETFs were included within the scope of the rule,
would they need relief from section 14(a) of the Act consistent with
our prior exemptive relief? If so, what conditions should we consider
as part of the rule? Alternatively, should we consider amending rule
14a-3 under the Act, which provides an exemption from section 14(a) for
UITs that invest in ``eligible trust securities?'' \56\ If so, how
should we define ``eligible trust securities''? For example, should
equity securities be added to the definition of ``eligible trust
securities''? Should we

include other types of securities within that definition? For example,
should we include FLEX options within the definition? \57\
---------------------------------------------------------------------------

    \55\ See NASDAQ 100, supra footnote 53.
    \56\ Eligible trust securities under rule 14a-3 include
corporate debt securities (including nonconvertible preferred
stock), government and municipal securities, and units of a
previously issued series of a UIT. The term does not include equity
securities. See rule 14a-3(b).
    \57\ FLexible EXchange options (``FLEX options'') are a type of
customized equity or index option contracts. Some traditional UITs
have exemptive relief from section 14(a) to invest in FLEX options
with expiration dates that coincide with UIT's maturity date. See
e.g., Olden Lane Securities LLC, et al., Investment Company Act
Release Nos. 32589 (April 3, 2017) [82 FR 17048 (April 7, 2017)]
(notice) and 32619 (May 1, 2017) (order) and related application.
---------------------------------------------------------------------------

     Are there any other exemptions we should consider for UIT
ETFs?
     If we were to include UIT ETFs in rule 6c-11, are there
any specific disclosures that should be required, other than the ones
proposed herein?
     If we do not include UIT ETFs within the scope of the
rule, should we nonetheless require them to comply with any of the
rule's requirements for ETFs organized as open-end funds?
2. Index-Based ETFs and Actively Managed ETFs
    Proposed rule 6c-11 would provide exemptions for both index-based
ETFs and actively managed ETFs, but would not by its terms establish
different requirements based on whether an ETF's investment objective
is to seek returns that correspond to the returns of an index. We
believe that index-based and actively managed ETFs that comply with the
proposed rule's conditions function similarly with respect to
operational matters, despite different investment objectives or
strategies, and do not present significantly different concerns under
the provisions of the Act from which the proposed rule grants relief.
For example, both index-based and actively managed ETFs register under
the Act, issue and redeem shares in creation unit sizes in exchange for
baskets of assets, list on national securities exchanges, and allow
investors to trade ETF shares throughout the day at market-determined
prices in the secondary market.
    The distinction between index-based ETFs and actively managed ETFs
in our current exemptive orders is largely a product of ETFs'
historical evolution. The Commission did not approve the first actively
managed ETF until nearly 15 years after index-based ETFs were
introduced.\58\ As discussed in a 2001 concept release on actively
managed ETFs, the Commission was initially concerned that actively
managed ETFs would not be able (or willing) to provide portfolio
transparency, potentially hindering the arbitrage mechanism deemed
critical to the operation of an ETF.\59\ Actively managed ETFs were
novel at the time of the 2008 ETF Proposing Release, and the Commission
solicited comment on whether a proposed ETF rule should specifically
include actively managed ETFs.\60\ Six commenters supported this
approach,\61\ while a few commenters questioned whether it was
premature to allow actively managed ETFs to operate using the rule.\62\
---------------------------------------------------------------------------

    \58\ See, e.g., WisdomTree Trust, et al., Investment Company Act
Release Nos. 28147 (Feb. 6, 2008) [73 FR 7776 (Feb. 11, 2008)]
(notice) and 28174 (Feb. 27, 2008) (order) and related application
(``2008 WisdomTree Trust''); Barclays Global Fund Advisors, et al.,
Investment Company Act Release Nos. 28146 (Feb. 6, 2008) [73 FR 7771
(Feb. 11, 2008)] (notice) and 28173 (Feb. 27, 2008) (order) and
related application (``Barclays Global 2008''). Approximately 100
exemptive orders have been issued since 2008 for actively managed,
transparent ETFs.
    \59\ See 2001 Concept Release, supra footnote 37, at n.31 and
accompanying and following text. Comment letters to the 2001 Concept
Release are available at http://www.sec.gov/rules/concept/s72001.shtml.
    \60\ See 2008 ETF Proposing Release, supra footnote 3, at
section III.A.2.
    \61\ See e.g., Comment Letter of the Vanguard Group, Inc. (June
19, 2008) (``Vanguard 2008 Comment Letter''); Xshares 2008 Comment
Letter; Comment Letter of Barclays Global Fund Advisors (May 16,
2008) (``BGFA 2008 Comment Letter''); ICI 2008 Comment Letter; SSgA
2008 Comment Letter; Comment Letter of Mutual Fund Directors Forum
(May 21, 2008).
    \62\ See Comment Letter of Brown & Associates LLC (May 19,
2008); Katten 2008 Comment Letter.
---------------------------------------------------------------------------

    The actively managed ETF market has grown considerably since 2008.
There are now over 200 actively managed ETFs with approximately $45.8
billion in assets.\63\ The Commission has observed how actively managed
ETFs operate during this time, and has not identified any operational
issues that suggest additional conditions for actively managed ETFs are
warranted. As noted below, we believe that the arbitrage mechanism for
existing actively managed ETFs has worked effectively with small
deviations between market price and NAV per share.\64\
---------------------------------------------------------------------------

    \63\ These estimates are based on data obtained from MIDAS,
Bloomberg and Morningstar Direct as of December 31, 2017.
    \64\ See infra section II.B.2.
---------------------------------------------------------------------------

    We believe that permitting index-based and actively managed open-
end ETFs to operate under the proposed rule subject to the same
conditions would provide a level playing field among those market
participants. Furthermore, we believe that it would be unreasonable to
create a meaningful distinction within the rule between index-based and
actively managed ETFs given the evolution of indexes over the last
decade. The proliferation of highly customized, often methodologically
complicated, indexes has blurred the distinction between such
products.\65\ At the same time, ETF industry practices in areas such as
portfolio transparency have converged between these types of funds.\66\
We therefore believe that eliminating the regulatory distinction
between index-based ETFs and actively managed ETFs would help to
provide a more consistent and transparent regulatory framework for ETFs
organized as open-end funds. This approach also would be consistent
with our regulation of other types of open-end funds, which does not
distinguish between actively managed and index-based strategies.
---------------------------------------------------------------------------

    \65\ See, e.g., John Waggoner, Smart-beta ETFs Take in Billions
in New Assets, Investment News (Oct. 11, 2017), available at http://www.investmentnews.com/article/20171011/FREE/171019982/smart-beta-etfs-take-in-billions-in-new-assets); Brendan Conway, New Trend: The
``Bespoke'' ETF, Barron's (Jan. 17, 2014), available at http://www.barrons.com/articles/new-trend-the-aposbespokeapos-etf-1389970766.
    \66\ All ETFs that could rely on the proposed rule currently
provide full portfolio transparency as a matter of market practice,
although only actively managed ETFs and some index-based ETFs with
affiliated index providers are required to do so pursuant to their
exemptive orders. See infra section II.C.4. See also, e.g.,
Guggenheim Funds Investment Advisors, LLC, et al., Investment
Company Act Release Nos. 30560 (June 14, 2013) [78 FR 37614 (June
21, 2013)] (notice) and 30598 (July 10, 2013) (order) and related
application. Earlier relief granted to ETFs with affiliated index
providers did not require full portfolio transparency, but included
conditions that were intended to address potential conflicts of
interest. See, e.g., HealthShares Inc., et al., Investment Company
Act Release Nos. 27916 (July 27, 2007) [72 FR 42447 (Aug. 2, 2007)]
(notice) and 27930 (Aug. 20, 2007) (order) and related application;
WisdomTree Investments, Inc., et al., Investment Company Act Release
Nos. 27324 (May 18, 2006) [71 FR 29995 (May 24, 2006)] (notice) and
27391 (June 12, 2006) (order) and related application (``2006
WisdomTree Investments'').
---------------------------------------------------------------------------

    The rule we proposed in 2008 similarly would not have distinguished
between index-based ETFs and actively managed ETFs, except in one
respect--it would have permitted an index-based ETF to disclose daily
the composition of its index in lieu of disclosing its portfolio
holdings.\67\ However, we believe that distinguishing between index-
based ETFs and actively managed ETFs in this manner is no longer
necessary given that all ETFs that could rely on the proposed rule
currently provide full portfolio transparency.\68\
---------------------------------------------------------------------------

    \67\ For these purposes, an index-based ETF was defined as an
ETF that has a stated investment objective of obtaining returns that
correspond to the returns of a securities index (whose provider
discloses on its internet website the identities and weightings of
the component securities and other assets of that index). See 2008
ETF Proposing Release, supra footnote 3. See also infra section
II.C.4 (discussing proposed condition regarding portfolio
transparency).
    \68\ See 2015 ETP Request for Comment, supra footnote 9.
---------------------------------------------------------------------------

    We request comment on whether proposed rule 6c-11 should provide

exemptions to index-based ETFs and actively managed ETFs subject to the
same conditions.
     Should the rule maintain the historical distinction
between index-based ETFs and actively managed ETFs? Do investors find
this distinction meaningful?
     If the rule maintains the distinction, what conditions of
the rule should differ between index-based and actively managed ETFs?
For example, some applications for index-based ETFs include a
representation that the ETF will invest at least 80% of its assets,
exclusive of collateral held from securities lending, in the component
securities of its underlying index.\69\ Should the rule include a
similar condition?
---------------------------------------------------------------------------

    \69\ There are some variations in this representation for index-
based funds that invest in fixed-income securities and foreign
securities. See, e.g., Destra Exchange-Traded Fund Trust, et al.,
Investment Company Act Release Nos. 33048 (Mar. 14, 2018) [83 FR
12208 (Mar. 20, 2018)] (notice) and 33071 (Apr. 10, 2018) (order)
and related application (``Each Fund . . . will invest at least 80%
of its assets, exclusive of collateral held from securities lending,
in Component Securities of its respective Underlying Index, or in
the case of Fixed Income Funds, in the Component Securities of its
respective Underlying Index and [to-be-announced transactions]
representing Component Securities, and in the case of Foreign Funds,
in Component Securities and depositary receipts representing foreign
securities such as [American Depositary Receipts and Global
Depositary Receipts] representing such Component Securities (or, in
the case of Foreign Funds tracking Underlying Indexes for which
Depositary Receipts are themselves Component Securities, underlying
stocks in respect of such Depositary Receipts.'') (internal
footnotes omitted).
---------------------------------------------------------------------------

     Should the proposed rule include requirements relating to
index-based ETFs with an affiliated index provider? If so, what
requirements and why? For example, should ETFs with affiliated index
providers be required to adopt additional policies and procedures
designed to further limit information sharing between portfolio
management staff and index management staff? How should we define
``index provider'' for these purposes?
     Are there operational differences between index-based and
actively managed ETFs that should be addressed in the proposed rule?
3. Leveraged ETFs
    Although the proposed rule would not distinguish between actively
managed ETFs and index-based ETFs in general, it would take a different
approach with respect to leveraged ETFs, which are a type of index-
based ETF that presents unique considerations.\70\ ``Leveraged ETFs''
refers to ETFs that seek, directly or indirectly, to provide returns
that exceed the performance of a market index by a specified multiple
or to provide returns that have an inverse relationship to the
performance of a market index, over a fixed period of time.\71\ A
leveraged ETF seeks to amplify the returns of its underlying index or
to profit from a decline in the value of its underlying index. It also
typically seeks to deliver the targeted return over a short period of
time, such as a day. This means that investors holding shares over
periods longer than the targeted period may experience performance that
is different, and at times substantially different, from the targeted
returns. Leveraged ETFs seek to achieve their targeted returns by using
financial derivatives. These funds are sometimes referred to as trading
tools because they can be used by investors to hedge against or profit
from short-term market movements without using margin.\72\
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    \70\ We use the term ``leveraged ETFs'' in this release to refer
to ETFs that pursue leveraged strategies (i.e., those that seek to
provide returns that exceed the performance of a market index by a
specified multiple over a period of time) and inverse strategies
(i.e., those that seek to provide returns that have an inverse
relationship to, or provide returns that are an inverse multiple of,
the performance of a market index over a fixed period of time). At
the end of December 2017, 187 ETFs employed leveraged or inverse
investment strategies. All of these ETFs are structured as open-end
funds. In total, these ETFs had total net assets of $35.26 billion
or approximately 1% of all ETF assets. See infra footnote 427 and
following text.
    \71\ See proposed rule 6c-11(c)(4); see also Item C.3.c. of Form
N-CEN (requiring funds to identify if they seek to achieve
performance results that are a multiple of an index or other
benchmark, the inverse of an index or other benchmark, or a multiple
of the inverse of an index or other benchmark).
    \72\ See ETF Handbook, supra footnote 22, at 266.
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    The strategy that leveraged ETFs pursue requires them to rebalance
their portfolios on a daily basis in order to maintain a constant
leverage ratio. This daily reset, and the effects of compounding,\73\
can result in performance that differs significantly from some
investors' expectations of how index investing generally works.\74\
This effect can be more pronounced in volatile markets.\75\ As a
result, buy-and-hold investors in a leveraged ETF with an intermediate
or long-term time horizon--who may not evaluate their portfolios
frequently--may experience large and unexpected losses.\76\
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    \73\ For example, as a result of compounding, leveraged ETFs can
outperform a simple multiple of its index's returns over several
days of consistently positive returns, or underperform a simple
multiple of its index's returns over several days of volatile
returns.
    \74\ See Office of Investor Education and Advocacy, SEC,
Leveraged and Inverse ETFs: Specialized Products with Extra Risks
for Buy-and-Hold Investors Investor Alert and Bulletins (Aug. 1,
2009), available at http://www.sec.gov/investor/pubs/leveragedetfs-alert.htm; FINRA, Non-Traditional ETFs: FINRA Reminds Firms of Sales
Practice Obligations Relating to Leveraged and Inverse Exchange-
Traded Funds, Regulatory Notice 09-31 (June 2009), available at
http://www.finra.org/sites/default/files/NoticeDocument/p118952.pdf
(``FINRA Regulatory Notice 09-31'') (providing an example of a four-
month period where a specified index gained 2%, while an ETF seeking
to deliver twice the daily return of that index fell 6%, and the
related ETF seeking to deliver twice the inverse of the index's
daily return fell 26%).
    \75\ See FINRA Regulatory Notice 09-31, supra footnote 74
(``Using a two-day example, if the index goes from 100 to close at
101 on the first day and back down to close at 100 on the next day,
the two-day return of an inverse ETF will be different than if the
index had moved up to close at 110 the first day but then back down
to close at 100 on the next day. In the first case with low
volatility, the inverse ETF loses 0.02 percent; but in the more
volatile scenario the inverse ETF loses 1.82 percent. The effects of
mathematical compounding can grow significantly over time, leading
to scenarios such as those noted above.'').
    \76\ See id. (reminding member firms of their sales practice
obligations relating to leveraged ETFs and noting that leveraged
ETFs are typically not suitable for retail investors who plan to
hold these products for more than one trading session). See also,
e.g., SEC v. Hallas, No. 1:17-cv-2999 (S.D.N.Y. Sept. 27, 2017);
FINRA News Release, FINRA Sanctions Oppenheimer & Co. $2.9 Million
for Unsuitable Sales of Non-Traditional ETFs and Related Supervisory
Failures (June 8, 2016), available at http://www.finra.org/newsroom/2016/finra-sanctions-oppenheimer-co-29-million-unsuitable-sales-non-traditional-etfs. The Commission also settled an enforcement action
against an investment adviser under section 206(4) of the Investment
Advisers Act of 1940 (the ``Advisers Act'') and rule 206(4)-7,
finding the adviser violated these provisions by failing to
adequately implement written compliance policies that were designed
to ensure that recommendations of single inverse ETFs to non-
discretionary advisory clients were suitable for each individual
client. See In Re Morgan Stanley Smith Barney, LLC, Investment
Advisers Act Release No. 4649 (Feb. 14, 2017) (settled action),
available at https://www.sec.gov/litigation/admin/2017/ia-4649.pdf.
---------------------------------------------------------------------------

    Leveraged ETFs, and their use of derivatives, also may raise issues
under section 18 that we are evaluating as part of our broader
consideration of the use of derivatives by registered funds and
business development companies.\77\ In

2015, for example, we proposed new 17 CFR 270.18f-4 (``rule 18f-4''
under the Act). Proposed rule 18f-4 was designed to address the
investor protection purposes and concerns underlying section 18 of the
Act and to provide an updated and more comprehensive approach to the
regulation of funds' use of derivatives transactions.\78\
---------------------------------------------------------------------------

    \77\ The staff has not supported new exemptive relief for
leveraged ETFs since 2009. The orders issued to current leveraged
ETF sponsors prior to the staff moratorium, as amended over time,
relate to leveraged ETFs that seek investment results of up to 300%
of the return (or inverse of the return) of the underlying index.
Rydex ETF Trust, et al., Investment Company Act Release Nos. 27703
(Feb. 20, 2007) [72 FR 8810 (Feb. 27, 2007)] (notice) and 27754
(Mar. 20, 2007) (order) and related application; Rafferty Asset
Management, LLC, et al., Investment Company Act Release Nos. 28379
(Sept. 12, 2008) [73 FR 54179 (Sept. 18, 2008)] (notice) and 28434
(Oct. 6, 2008) (order) and related application. See also ProShares
Trust, et al., Investment Company Act Release Nos. 28696 (Apr. 14,
2009) [74 FR 18265 Apr. 21, 2009)] (notice) and 28724 (May 12, 2009)
(order) and related application (amending the applicant's prior
order) (``ProShares''); Rafferty Asset Management, LLC, et al.,
Investment Company Act Release Nos. 28889 (Aug. 27, 2009) [74 FR
45495 (Sept. 2, 2009)] (notice) and 28905 (Sept. 22, 2009) (order)
and related application (amending the applicant's prior order)
(``Rafferty'').
    \78\ See Derivatives Proposing Release, supra footnote 40.
Section 18 of the Act limits a fund's ability to obtain leverage or
issue senior securities. 15 U.S.C. 80a-18.
---------------------------------------------------------------------------

    In light of our ongoing consideration, including the potential
staff recommendation of a re-proposal on funds' use of derivatives, we
do not believe it is appropriate to permit additional leveraged ETF
sponsors to form leveraged ETFs and operate under our proposed rule at
this time.\79\ Accordingly, we propose to include a condition that
would prevent leveraged ETFs from relying on proposed rule 6c-11.\80\
ETFs that seek to provide returns that exceed the performance (or
inverse performance) of a market index by a specified multiple over a
fixed period could not operate under our proposed rule.
---------------------------------------------------------------------------

    \79\ See supra footnote 77. As discussed in more detail in
section II.G below, we are not proposing here to rescind the
existing leverage ETF orders. Existing leveraged ETF sponsors would
continue to operate under their exemptive orders. Existing leveraged
ETFs, however, would be subject to the proposed amendments to Form
N-1A discussed below.
    \80\ Proposed rule 6c-11(c)(4).
---------------------------------------------------------------------------

    The daily or other periodic reset, and more particularly the
effects of compounding, are what distinguish a leveraged ETF strategy
from other strategies pursued by ETFs. The proposed condition relating
to leveraged ETFs thus includes a temporal element (i.e., ``over a
fixed period of time'') in order to specifically capture ETFs that seek
to deliver the leveraged or inverse return of a market index over a
fixed period of time, daily or otherwise.\81\ In addition, the proposed
rule's use of the term ``multiple'' includes leverage that is not
evenly divisible by 100, such as a fund that seeks to provide a return
equal to 150% of the performance of an index.\82\ Finally, we believe
it is important to specify that an ETF may not indirectly seek to
provide returns that exceed the performance of a market index by a
specified multiple or to provide returns that have an inverse
relationship to the performance of a market index over a fixed period
of time in order to prevent a fund from circumventing this condition,
such as by embedding inverse leverage in the underlying index.
---------------------------------------------------------------------------

    \81\ The current exemptive orders that allow leveraged ETFs
contemplate a daily reset, because the orders relate to ETFs that
pursue daily investment objectives. See supra footnote 77. For
example, one application describes its leveraged ETFs as ``seek[ing]
to provide daily investment results, before fees and expenses, that
correspond to 300% of the daily performance, or 300% of the inverse
(opposite) daily performance, of its Underlying Index.'' See
Rafferty, supra footnote 77. Another describes its leveraged ETFs as
``attempt[ing], on a daily basis, to achieve its investment
objective by corresponding to a specified multiple of the
performance (either 125%, 150% or 200%), or the inverse performance,
or the inverse multiple (either 125%, 150% or 200% of the opposite)
of the performance of a particular securities index.'' See
ProShares, supra footnote 77.
    \82\ Similarly, an ``inverse ETF'' includes both inverse
strategies (i.e., -100% of an index's performance) and leveraged
inverse strategies (e.g., -125% or -200% of an index's performance).
---------------------------------------------------------------------------

    We request comment on excluding leveraged ETFs from the scope of
funds that may rely on the proposed rule.
     Do commenters agree that it is appropriate for proposed
rule 6c-11 to include a condition that an ETF may not seek, directly or
indirectly, to provide returns that exceed the performance of a market
index by a specified multiple, or to provide returns that have an
inverse relationship to the performance of a market index, over a fixed
period of time?
     Alternatively, do commenters believe that the structure
and operation of leveraged ETFs do not raise issues that warrant our
excluding them from a rule of general applicability related to the
structure and operations of ETFs? If so, are there any conditions
specific to leveraged ETFs that should be part of the rule? For
example, should we permit leveraged ETFs to operate in reliance on the
rule but prohibit a leveraged ETF that exceeds a specific multiple of
the performance, or inverse performance, of a market index? If so, what
multiple should we use? For example, ETFs currently may not seek
investment results over 300% of the return (or inverse of the return)
of the underlying index. Should we maintain the status quo with respect
to the maximum amount of leveraged market exposure that leveraged ETFs
may obtain (i.e., 300%)? Should we limit ETFs to a higher or lower
multiplier? If so, what multiplier and why?
     Does the proposed rule's use of ``a fixed period of time''
effectively describe the daily reset mechanism in leveraged ETFs? Are
there other descriptions we should use? Could an ETF seek to provide
returns that are a multiple, or inverse, of an index without this
limitation? For example, would such an ETF be able to operate without
the daily (or other periodic) reset? Would such an ETF raise the same
investor protection issues as the leveraged ETFs that we are proposing
to exclude from relying on proposed rule 6c-11? Would they raise other
investor protection issues? If so, what issues and why?
     Does the proposed rule prevent an ETF from circumventing
this limitation by embedding leverage in an index or through any other
means? If not, should we consider other conditions or limitations, and
if so, what? For example, should the rule provide that an ETF may not
``obtain'' or ``provide'' leveraged exposure, rather than stating that
an ETF may not ``seek'' to provide leveraged exposure as proposed?
Alternatively, should we define leveraged ETFs as funds currently do in
their applications (i.e., to achieve its investment objective by
corresponding to a specified multiple of the performance (either 125%,
150% or 200%), or the inverse performance, or the inverse multiple
(either 125%, 150% or 200% of the opposite) of the performance of a
particular securities index)? \83\
---------------------------------------------------------------------------

    \83\ See supra footnote 81.
---------------------------------------------------------------------------

     Proposed rule 6c-11 does not seek to address any concerns
raised under section 18 of the Act by leveraged ETFs. Do commenters
agree that this is appropriate? Should we consider additional
conditions in rule 6c-11 for leveraged ETFs designed to address
concerns raised under section 18 or other investor protection concerns
raised by their strategies? If so, what conditions? Should we provide
any relief to these ETFs under section 18 of the Act?
     What types of investors purchase shares of leveraged ETFs?
What is the proportion of volume from retail versus institutional
trading? How do these different types of investors utilize leveraged
ETFs? What is the typical holding period of leveraged ETFs by each type
of investor?
     What types of intermediaries are active with leveraged ETF
investments? Are the current suitability requirements for
intermediaries effective with respect to leveraged ETFs? What specific
methods, if any, are intermediaries using to meet their suitability
obligations for these products? Should we propose as part of a future
rulemaking that leveraged ETFs be subject to additional requirements,
particularly for retail investors? \84\
---------------------------------------------------------------------------

    \84\ See, e.g., NASD, Structured Products: NASD Provides
Guidance Concerning the Sale of Structured Products, Notice to
Members (September 2005), available at http://www.complinet.com/file_store/pdf/rulebooks/nasd_0559ntm.pdf; see also FINRA, Complex
Products: Heightened Supervision of Complex Products, Regulatory
Notice 12-03 (January 2012), available at http://www.finra.org/sites/default/files/NoticeDocument/p125397.pdf.

---------------------------------------------------------------------------

     The Commission understands that leveraged ETFs typically
provide enhanced disclosure of the risks of investing in the ETF.\85\
Do investors understand leveraged ETFs better today than they did when
Commission staff and FINRA jointly issued an investor alert expressing
the concern that individual investors may be confused about the
performance objectives of leveraged ETFs? \86\ For example, are
investors more likely to be aware that leveraged ETFs are typically
designed to achieve their stated performance objectives on a periodic
basis (e.g., daily)? Do investors understand that leveraged ETFs may
not achieve those performance objectives over the long-term? \87\
---------------------------------------------------------------------------

    \85\ This understanding is based on Commission staff review of
registration statements filed with the Commission and ETF websites.
    \86\ See supra footnote 74.
    \87\ See e.g., Paolo Guasoni and Eberhard Mayerhofer, Leveraged
Funds: Robust Replication and Performance Evaluation (2017)
(``Leveraged and inverse exchange-traded funds seek daily returns
equal to fixed multiples of indexes' returns. Trading costs implied
by frequent adjustments of funds' portfolios create a tension
between tracking error, reflecting short-term correlation with the
index, and excess return, the long-term deviation from the leveraged
index's performance.''); Lu Lei, Jun Wang, and Ge Zhang, Long-term
performance of leveraged ETFs, 21 Financial Services Review 1 (2012)
(``Overall our results caution against the use of leveraged ETFs as
long-term investment substitutes for long or short positions of the
benchmark indices.'').
---------------------------------------------------------------------------

     Leveraged ETFs typically include charts in their
disclosures that explain the potential impact of compounding to an
investor's returns. Should we amend Form N-1A to require leveraged ETFs
to include such a chart to better explain the impact of compounding?
Are there other disclosures that we should require leveraged ETFs to
provide? If so, what are they?
     Should we propose rules governing leveraged ETF marketing
materials to address concerns that leveraged ETFs may be marketed to
investors that do not have an appropriate risk tolerance to invest in
these products or that lack understanding of leveraged ETFs' strategies
and risks? For example, should we require leveraged ETFs to include
prescribed cautionary disclosures regarding these strategies and risks?

B. Exemptive Relief Under Proposed Rule 6c-11

    Proposed rule 6c-11 would provide ETFs within the scope of the rule
with exemptions from certain provisions of the Act that are necessary
to allow ETFs to operate. These exemptions are generally consistent
with the relief we have given to ETFs under our exemptive orders.\88\
Proposed rule 6c-11 would permit an ETF that meets the conditions of
the rule to: (i) Redeem shares only in creation unit aggregations; (ii)
permit ETF shares to be purchased and sold at market prices rather than
at NAV per share; (iii) engage in in-kind transactions with certain
affiliates; and (iv) in certain limited circumstances, pay authorized
participants the proceeds from the redemption of shares in more than
seven days. As discussed below in section II.C, the exemptions would be
subject to certain conditions that are designed to address the concerns
underlying the relevant statutory provisions and to support a
Commission finding that the exemptions are in the public interest and
consistent with the protection of investors and the purposes fairly
intended by the policy and provisions of the Act.\89\
---------------------------------------------------------------------------

    \88\ Our exemptive orders also provide relief allowing certain
types of funds to invest in ETFs beyond the limits of section
12(d)(1) of the Act. We are not addressing this relief at this time.
See infra section II.G. However, we are proposing to rescind the
master-feeder relief that we previously granted to ETFs that do not
rely on the relief as of the date of this proposal (June 28, 2018).
We also propose to grandfather existing master-feeder arrangements
involving ETF feeder funds, but prevent the formation of new ones,
by amending relevant exemptive orders. See infra section II.F.
    \89\ See 15 U.S.C. 80a-6(c).
---------------------------------------------------------------------------

1. Treatment of ETF Shares as ``Redeemable Securities''
    Under proposed rule 6c-11, an ETF, as defined in the rule, would be
considered to issue a ``redeemable security'' within the meaning of
section 2(a)(32) of the Act.\90\ As discussed above, ETFs have features
that distinguish them from both traditional open-end and closed-end
funds. A defining feature of open-end funds is that they offer
redeemable securities, which allow the holder to receive his or her
proportionate share of the fund's NAV per share upon presentation of
the security to the issuer. Although individual ETF shares cannot be
redeemed, except in limited circumstances,\91\ they can be redeemed in
creation unit aggregations.\92\ Therefore, we believe that ETF shares
are most appropriately classified under the proposed rule as redeemable
securities within the meaning of section 2(a)(32),\93\ and that ETFs
should be regulated as open-end funds within the meaning of section
5(a)(1) of the Act.\94\
---------------------------------------------------------------------------

    \90\ Proposed rule 6c-11(b)(1).
    \91\ See infra section II.C.1 (discussing circumstances where
ETF shares can be individually redeemed).
    \92\ See proposed rule 6c-11(a) (defining an exchange-traded
fund, in part, as a registered open-end management company that
issues and redeems its shares in creation units). The proposed rule
would define ``creation unit'' to mean a specified number of ETF
shares that the ETF will issue to (or redeem from) an authorized
participant in exchange for the deposit (or delivery) of a basket
and a cash balancing amount (if any). See proposed definition of
``creation unit'' in rule 6c-11(a).
    \93\ If ETF shares were not classified as redeemable securities
within the meaning of section 2(a)(32) of the Act, an ETF would be
subject to the provisions of the Act applicable to closed-end funds.
See 15 U.S.C. 80a-5(a)(2) (defining a ``closed-end company'' as any
management company other than an open-end company).
    \94\ 15 U.S.C. 80a-5(a)(1) (defining ``open-end company''); 15
U.S.C. 80a-2(a)(32) (defining ``redeemable security'').
---------------------------------------------------------------------------

    The arbitrage mechanism that is central to the operation of an ETF
(and the conditions in our relief designed to facilitate an effective
arbitrage mechanism) serves to keep the market price of ETF shares at
or close to the ETF's NAV per share. As a result, even though only
authorized participants may redeem creation units directly from the ETF
at NAV per share, investors are able to sell their ETF shares on the
secondary market at or close to NAV, similar to investors in an open-
end fund that redeem their shares directly from the fund at NAV per
share.\95\ The shares of closed-end funds, on the other hand, generally
trade on the secondary market at a discount or premium to NAV.
---------------------------------------------------------------------------

    \95\ See Robert Engle & Debojyoti Sarkar, Premiums-Discounts and
Exchange Traded Funds, 13 Journal of Derivatives 4 (Summer 2006)
(``Engle Article'') (observing that premiums and discounts for
domestic ETFs are generally small and highly transient, and that
while premiums and discounts are larger and more persistent in
international ETFs, they are smaller and less persistent than the
premiums and discounts of international closed-end funds); but see,
e.g., Bradley Kay, Has the ETF Arbitrage Mechanism Failed?,
Morningstar (Mar. 11, 2009), available at http://news.morningstar.com/articlenet/article.aspx?id=283302 (stating that
market prices for ETFs may deviate significantly from NAV during
periods of market stress); Chris Dieterich, Greece ETF Pacing for
Record Tumble on Huge Volume: Here's What You Need to Know, Barron's
(June 29, 2015), available at https://www.barrons.com/articles/greece-etf-pacing-for-record-tumble-on-huge-volume-heres-what-you-need-to-know-1435597369 (noting that ETFs tied to Greek and Egyptian
stocks traded at significant discounts to NAV when the exchanges on
which the underlying stocks traded were closed).
---------------------------------------------------------------------------

    Our exemptive orders have provided exemptions from sections
2(a)(32) and 5(a)(1) of the Act so that ETFs may register under the Act
as open-end funds while issuing shares redeemable in creation units
only. Unlike our exemptive orders, however, the proposed rule would not
provide an exemption from the definition of ``redeemable security'' in
section 2(a)(32) or from the definition ``open-end company'' in section
5(a)(1). We believe that it is more appropriate for the proposed rule
to address these questions of status by classifying ETF shares as
``redeemable securities.'' Thus,

any ETF operating in compliance with the rule's conditions and
requirements would meet the definition of open-end company.\96\
---------------------------------------------------------------------------

    \96\ Section 5(a)(1) defines an ``open-end company'' as ``a
management company which is offering for sale or has outstanding any
redeemable security of which it is the issuer.'' 15 U.S.C. 80a-
5(a)(1).
---------------------------------------------------------------------------

    ETFs operating in reliance on the proposed rule would be subject to
the requirements imposed under the Act and our rules that apply to all
open-end funds.\97\ We note that our approach is substantially similar
to the 2008 proposal, which was generally supported by commenters.\98\
In addition, in our view the rules under the Exchange Act that apply to
redeemable securities issued by an open-end fund would apply to ETFs
relying on the proposed rule.\99\ Thus, proposed rule 6c-11 would
result in ETFs relying on proposed rule 6c-11 becoming eligible for the
``redeemable securities'' exceptions in 12 CFR 242.101(c)(4) and
242.102(d)(4) (``rules 101(c)(4) and 102(d)(4) of Regulation M'') and
12 CFR 240.10b-17(c) (``rule 10b-17(c) under the Exchange Act'') in
connection with secondary market transactions in ETF shares and the
creation or redemption of creation units. Similarly, we would view ETFs
relying on rule 6c-11 as within the ``registered open-end investment
company'' exemption in rule 11d1-2 under the Exchange Act.\100\
---------------------------------------------------------------------------

    \97\ See, e.g., 15 U.S.C. 80a-22; 17 CFR 270.22c-1.
    \98\ See 2008 ETF Proposing Release, supra footnote 3. See also
ICI 2008 Comment Letter; Xshares 2008 Comment Letter.
    \99\ See, e.g., 17 CFR 240.15c3-1. See also Securities
Transaction Settlement Cycle, Exchange Act Release No. 80295 (Mar.
22, 2017) [82 FR 15564 (Mar. 29, 2017)] (``T+2 Adopting Release'')
(shortening the standard settlement cycle for most broker-dealer
securities transactions to two business days).
    \100\ Cf. Securities Industry Association, SEC Staff No-Action
Letter (Nov. 21, 2005) (treating certain equity index-based ETFs as
registered open-end investment companies for purposes of rule 11d1-
2).
---------------------------------------------------------------------------

    We request comment on this aspect of the proposed rule.
     Are there differences between ETFs and other open-end
funds that would justify not applying certain open-end fund provisions
of the Act or our rules to ETFs? For example, we adopted tailored
liquidity risk management program requirements for ETFs under 17 CFR
270.22e-4 (``rule 22e-4'').\101\ Should we consider tailored
requirements for ETFs in connection with other provisions?
---------------------------------------------------------------------------

    \101\ See Investment Company Liquidity Risk Management Programs,
Investment Company Act Release No. 32315 (Oct. 13, 2016) [81 FR
82142 (Nov. 18, 2016)] (``LRM Adopting Release''), at sections II.A.
and II.J.
---------------------------------------------------------------------------

     As we discussed above, ETFs relying on proposed rule 6c-11
would be able to rely on the ``redeemable securities'' exceptions in
rules 101(c)(4) and 102(d)(4) of Regulation M and rule 10b-17(c) under
the Exchange Act and the ``registered open-end investment company''
exemption in rule 11d1-2 under the Exchange Act. Should the Commission
exempt ETFs relying on proposed rule 6c-11 from any other rules under
the Exchange Act? \102\ If so, which rules and why? For example, ETFs
typically request relief from Exchange Act section 11(d)(1) and rule
11d1-2 thereunder; and 17 CFR 240.10b-10, 240.15c1-5, and 240.15c1-6
(rules 10b-10, 15c1-5, and 15c1-6 under Exchange Act). Should the
Commission provide relief from these provisions under the Exchange Act?
If so, what conditions should apply to such relief, if any, and why?
For example, ETFs currently rely on relief that is conditioned on:
minimum creation unit sizes; \103\ dissemination of the Intraday
Indicative Value (``IIV''); \104\ restrictions on the payment of
certain cash compensation or economic incentives; \105\ minimum levels
of diversification in the ETF's basket; \106\ and whether the ETF is
managed to track an index.\107\ Should we eliminate or modify any or
all of these conditions? We requested comment on exchange listing
standards for ETFs and other ETPs in 2015.\108\ Do commenters have
updated views on those requests for comment?
---------------------------------------------------------------------------

    \102\ See, e.g., supra footnote 14.
    \103\ See, e.g., Letter from James A. Brigagliano, Deputy
Director, Division of Trading and Markets, to W. John McGuire,
Morgan, Lewis & Bockius LLP re: U.S. One Trust Actively-Managed
Exchange Traded Fund of Exchange Traded Funds, dated May 4, 2010
(conditioning relief under Exchange Act Section 11(d)(1) on the ETFs
continuously redeeming, at NAV, creation unit aggregations of 50,000
shares valued at a minimum of $1.25 million).
    \104\ Id. (representing that the ETFs would disseminate the IIV
every 15 seconds throughout the trading day).
    \105\ See, e.g., Letter from Catherine McGuire, Chief Counsel,
Division of Market Regulation to Securities Industry Association,
dated Nov. 21, 2005, at n.3 and accompanying text.
    \106\ Id. (defining, in part, a ``qualifying ETF'' as consisting
of a basket of twenty or more component securities with no one
component security constituting more than 25% of the total value of
the ETF).
    \107\ Id.
    \108\ 2015 ETP Request for Comment, supra footnote 9, at n.106
and accompanying and following text.
---------------------------------------------------------------------------

2. Trading of ETF Shares at Market-Determined Prices
    Section 22(d) of the Act, among other things, prohibits investment
companies, their principal underwriters, and dealers from selling a
redeemable security to the public except at a current public offering
price described in the prospectus.\109\ Rule 22c-1 generally requires
that a dealer selling, redeeming, or repurchasing a redeemable security
do so only at a price based on its NAV.\110\ Together, section 22(d)
and rule 22c-1 are designed to: (i) Prevent dilution caused by certain
riskless trading practices of principal underwriters and dealers; (ii)
prevent unjust discrimination or preferential treatment among investors
purchasing and redeeming fund shares; and (iii) preserve an orderly
distribution of investment company shares.\111\ ETFs seeking to
register under the Act obtain exemptions from these provisions because
investors may purchase and sell individual ETF shares from and to
dealers on the secondary market at market-determined prices (i.e., at
prices other than those described in the prospectus or based on NAV).
Consistent with our prior exemptive orders, proposed rule 6c-11 would
provide exemptions from these provisions.\112\
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    \109\ 15 U.S.C. 80a-22(d).
    \110\ See 17 CFR 270.22c-1.
    \111\ See generally Mutual Fund Distribution Fees;
Confirmations, Investment Company Act Release No. 29367 (July 21,
2010) [75 FR 47064 (Aug. 4, 2010)] (discussing legislative history
of section 22(d)).
    \112\ See proposed rule 6c-11(b)(2). The reference in the
proposed rule to ``repurchases . . . at market-determined prices''
refers to secondary market transactions with dealers. Thus, the rule
would not allow an ETF to repurchase shares from an investor at
market-determined prices.
---------------------------------------------------------------------------

    As discussed above, only authorized participants can purchase and
redeem shares directly from an ETF at NAV per share and only in
creation unit aggregations. Because authorized participants (and other
market participants transacting through an authorized participant) can
take advantage of disparities between the market price of ETF shares
and NAV per share, they may be in a different position than investors
who buy and sell individual ETF shares only on the secondary
market.\113\ However, if the arbitrage mechanism is functioning
effectively, entities taking advantage of these disparities in market
price and NAV per share move the market price to a level at or close to
the NAV per share of the ETF. The proposed rule would provide
exemptions from section 22(d) and rule 22c-1 because we believe this

arbitrage mechanism--and the conditions in this rule designed to
promote a properly functioning arbitrage mechanism--have adequately
addressed, over the significant operating history of ETFs, the
potential concerns regarding shareholder dilution and unjust
discrimination that these provisions were designed to address.
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    \113\ See, e.g., Comment Letter of Barclays Global Investors on
2001 Concept Release (Jan. 11, 2002) (``[D]uring periods of market
volatility . . . it is not unreasonable to assume that some retail
investors would buy or sell ETF shares at secondary market prices
moving in the opposite direction of a fund's NAV.'').
---------------------------------------------------------------------------

    We proposed the same exemptions in 2008 and commenters who
addressed this aspect of the 2008 ETF Proposing Release supported the
Commission's approach.\114\ Commenters on the 2015 ETP Request for
Comment also addressed the existing arbitrage mechanism, generally
arguing that it is effective and efficient in ensuring that an ETF's
market price does not vary substantially from its NAV per share.\115\
On the other hand, one commenter questioned the efficacy of the
arbitrage mechanism, particularly at the close of trading when bid-ask
spreads tend to widen.\116\ One commenter asserted that the arbitrage
mechanism does not work well for ETFs holding securities that do not
trade during U.S. market hours.\117\ Another commenter argued that even
if the arbitrage mechanism corrects price mismatches between market
price and NAV per share, it does so by creating an unfair windfall for
authorized participants who can capitalize on information asymmetries
and operational advantages to extract value from the market.\118\
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    \114\ See ICI 2008 Comment Letter; Xshares 2008 Comment Letter.
    \115\ See, e.g., Comment Letter of KCG Holdings, Inc. on 2015
ETP Request for Comment (Aug. 17, 2015); Comment Letter of Vanguard
on 2015 ETP Request for Comment (Aug. 17, 2015); Comment Letter of
Charles Schwab & Co., Inc. and Charles Schwab Investment Management,
Inc. on 2015 ETP Request for Comment (Aug. 17, 2015) (``Schwab ETP
Comment Letter'') (noting that it had not identified any significant
systemic differences in efficiency across various ETF products,
regardless of ETF's investment strategy).
    \116\ See Comment Letter of ETF Consultants.com, Inc. on 2015
ETP Request for Comment (Aug. 17, 2015); see also infra section II.H
regarding bid-ask spreads.
    \117\ See Comment Letter of James J. Angel, Ph.D., CFA on 2015
ETP Request for Comment (Aug. 17, 2015).
    \118\ See Comment Letter of Occupy the SEC on 2015 ETP Request
for Comment (Aug. 21, 2015).
---------------------------------------------------------------------------

    The arbitrage mechanism is the foundation for why retail and other
secondary market investors generally can buy and sell ETF shares at
prices that are at or close to the prices at which authorized
participants are able to buy and redeem shares directly from the ETF at
NAV. In the Commission's experience, the deviation between the market
price of ETFs and NAV per share, each calculated as of the close of
trading each day, generally has been relatively small.\119\ For
example, during 2016-2017, the closing price of ETFs based on U.S.
equity indexes were within 1% of NAV for 97.9% of trading days and
within 1% of NAV for actively managed ETFs investing in U.S. equities
for 98.5% of trading days. The absolute weighted average of the daily
difference between the NAV and market price during a six-month period
ending in December 2017 was 0.014% for ETFs based on U.S. equities
indexes and 0.074% for actively managed ETFs investing in U.S.
equities.\120\
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    \119\ Figures in this section represent an analysis by
Commission staff of market data obtained from Bloomberg Professional
Services and Morningstar. In preparing this analysis, staff used the
market price of each ETF as of the close of trading each day.
    \120\ An ETF can trade at a premium or discount to its NAV per
share on any given day. When taking an average over many days,
premiums (which have a positive difference) and discounts (which
have a negative difference) may offset each other. Therefore, to
calculate deviation from NAV, we use the absolute value of premiums
and discounts when calculating weighted average differences to
prevent such offsetting.
---------------------------------------------------------------------------

    Other types of ETFs have had a somewhat higher deviation between
NAV per share and market price. During 2016-2017, the closing price for
index-based and actively managed ETFs investing in international
equities, for example, were within 1% of NAV for 87.4% and 86.8% of
trading days, respectively. Similarly, the absolute weighted average of
the daily difference between the NAV and market price during a six-
month period ending in December 2017 for index-based and actively
managed ETFs investing in U.S. fixed-income securities were 0.067% and
0.068%, respectively. The absolute weighted average of daily difference
between NAV per share and market price during the six-month period
studied was 0.206% for ETFs based on international equities indexes and
0.390% for actively managed ETFs investing in international
equities.\121\
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    \121\ International equity ETFs can provide exposure to markets
that do not overlap with U.S. trading hours. In these circumstances,
the deviation between NAV per share and market price may be
attributable in large part to obtaining exposure to those markets
when they are closed.
---------------------------------------------------------------------------

    These numbers represent only broad averages with respect to end-of-
day differences, however, and intraday deviations between market price
and NAV per share may be greater under certain circumstances. These
figures also do not reflect intraday deviations between market prices
and the contemporaneous value of the ETF's portfolio.\122\ However, one
academic paper has shown that deviations between intraday market prices
and estimated intraday values for domestic ETFs also were generally
small.\123\
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    \122\ Most funds calculate NAV per share once per day as of the
time the major U.S. stock exchanges close. See supra footnote 26.
    \123\ Engle Article, supra footnote 95. For domestic ETFs, the
study showed intraday average daily premium of 0.25 basis points
with an average standard deviation of 11.8 basis points. For
international ETFs, the respective figures were 23.7 basis points
and an average standard deviation of 64.8 basis points. The intraday
premium was measured every minute as the percentage difference
between: (i) The average of the bid and the ask of the ETF shares;
and (ii) the intraday indicative value (IIV) of the ETF's portfolio.
See infra sections II.C.3 and II.C.6 for a discussion of the IIV and
the potential problems associated with using the IIV as a tool to
measure the current value of the ETF's portfolio on an ongoing
basis.
---------------------------------------------------------------------------

    The Commission and its staff have observed the operation of the
arbitrage mechanism during periods of market stress when the deviation
between intraday market prices and the next-calculated NAV per share
significantly widened for short periods of time. During periods of
extraordinary volatility in the underlying ETF holdings, it may be
difficult for authorized participants or market makers to confidently
ascribe precise values to an ETF's holdings, thereby making it more
difficult to effectively hedge their positions.\124\ These market
participants may widen their quoted spreads in ETF shares or, in
certain cases, may elect not to transact in or quote ETF shares, rather
than risk loss.\125\
---------------------------------------------------------------------------

    \124\ See generally Itzhak Ben-David, et al., Exchange Traded
Funds (ETFS), National Bureau of Econ., Working Paper No. 22829
(Nov. 2016), available at http://www.nber.org/papers/w22829 (``Ben-
David'') (``Because of sparse liquidity in some exchanges [on the
morning of August 24, 2015], some of the arbitrage programs
diagnosed unreliable price data and withdrew from the market,
leading to a positive feedback loop.'').
    \125\ See also Milan Borkovec, et al., Liquidity and Price
Discovery in Exchange-Traded Funds: One of Several Possible Lessons
from the Flash Crash, 1 The Journal of Index Investing 2 (2010)
(``Borkovec'') (reporting that liquidity of ETFs declined
dramatically during the ``Flash Crash,'' causing spreads to widen
significantly).
---------------------------------------------------------------------------

    Market makers may have already exhibited this behavior in periods
of extraordinary volatility.\126\ For example,

on May 6, 2010, the prices of many U.S.-based equity products
experienced a significant decline and recovery, and many of the
securities that experienced the greatest price changes were equity-
based ETFs.\127\ Significant price volatility on the morning of August
24, 2015 triggered limit up-limit down pauses in many equity
securities, including many ETFs.\128\ In both instances, certain ETFs
saw larger intraday premiums/discounts and wider bid-ask spreads for
portions of the trading day.\129\ Deviations between market price and
NAV per share were closed after relatively short periods, however, as
the arbitrage mechanism resumed its effectiveness.\130\
---------------------------------------------------------------------------

    \126\ See Ben-David, supra footnote 124 (``ETF market makers and
[authorized participants] arguably withdrew from the market after a
trading pause in the futures market, which they used to hedge their
exposure in volatile trading sessions.'') (internal citations
omitted). Many ETFs disclose the risk that ETF shares will trade at
a premium or discount, particularly during times of market
disruptions, in their prospectuses as part of their principal risk
disclosure. See, e.g., iShares Trust rule 485(b) Registration
Statement (Nov. 1, 2017), available at https://www.sec.gov/Archives/edgar/data/1100663/000119312517327588/d486424d485bpos.htm (``Market
Trading Risk: The Fund faces numerous market trading risks,
including the potential lack of an active market for Fund shares,
losses from trading in secondary markets, periods of high volatility
and disruptions in the creation/redemption process. ANY OF THESE
FACTORS, AMONG OTHERS, MAY LEAD TO THE FUND'S SHARES TRADING AT A
PREMIUM OR DISCOUNT TO NAV.'').
    \127\ See Final May 6 Report, supra footnote 9, at n.36 and
accompanying text (noting that ETFs accounted for approximately 70%
of all securities with trades broken pursuant to the clearly
erroneous execution rules on May 6).
    \128\ See August 24 Staff Report, supra footnote 32 (noting that
ETFs as a class accounted for almost all of the 1,279 trading halts
on August 24, 2015, but 80% of ETFs did not experience a single
trading halt).
    \129\ See Borkovec, supra footnote 125; Ben-David, supra
footnote 124.
    \130\ See Borkovec, supra footnote 125, at 40; see also Ananth
Madhavan, Exchange-Traded Funds, Market Structure, and the Flash
Crash, 68 Financial Analysts Journal 20 (2012) (``Madhavan
Article'').
---------------------------------------------------------------------------

    Accordingly, we recognize that under certain circumstances,
including during periods of market stress, the arbitrage mechanism may
work less effectively for a period of time. We also recognize that
secondary market investors who trade in ETF shares during these periods
may be harmed by trading at a price that is not close to the NAV per
share of the ETF (or the contemporaneous value of the ETF's portfolio).
On balance, however, we believe these investors are more likely to
weigh the potential benefits of ETFs (e.g., low cost and intraday
trading) against any potential for market price deviations when
deciding whether to utilize ETFs.\131\ Further, we believe that the
conditions we are proposing as part of rule 6c-11, along with other
recent actions that are designed to promote an effective arbitrage
mechanism,\132\ would continue to result in a sufficiently close
alignment between an ETF's market price and NAV per share in most
circumstances, and provide an appropriate basis for the exemptive
relief we are proposing. We particularly find this to be the case given
the benefits ETFs offer investors, as discussed above.
---------------------------------------------------------------------------

    \131\ The Commission has taken steps to address disruptions in
the arbitrage mechanism. For example, the Commission approved
changes to the limit up-limit down rules following the market events
on August 24, 2015. See Self-Regulatory Organizations; Financial
Industry Regulatory Authority, Inc.; Notice of Filing and Immediate
Effectiveness of a Proposed Rule Change to Clarify the Operation of
the Regulation NMS Plan to Address Extraordinary Market Volatility,
Exchange Release No. 78435 (July 28, 2016) [81 FR 51239 (Aug. 3,
2016)]; Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Notice of Filing and Immediate Effectiveness of a
Proposed Rule Change to Extend the Effective Date of SR-FINRA-2016-
028, Exchange Release No.78660 (Aug. 24, 2016) [81 FR 59676 (Aug.
30, 2016)].
    \132\ For example, rule 22e-4 under the Act requires ETFs to
consider certain additional factors that address the relationship
between the liquidity of the ETF's portfolio and the arbitrage
mechanism in assessing, managing, and periodically reviewing its
liquidity risk. See LRM Adopting Release, supra footnote 101. We
have taken these requirements into consideration in developing the
conditions in this proposal.
---------------------------------------------------------------------------

    Furthermore, to the extent that there are instances where bid-ask
spreads widen, or premiums and discounts persist, the proposed rule and
disclosure amendments would require ETFs to disclose certain
information on their website.\133\ We believe that it is important for
investors to be informed where costs may increase beyond what they
would reasonably expect. Our exemptive orders have required ETFs'
websites to disclose, among other things, the ETF's NAV per share for
the prior business day, the market closing price or the midpoint of the
bid-ask spread at the time of the calculation of NAV, and a calculation
of the premium or discount of the market closing price or midpoint of
the bid-ask spread against NAV per share.\134\ However, the proposed
rule and disclosure amendments would require ETFs to disclose
additional information on their websites that is not currently required
under our exemptive orders.\135\
---------------------------------------------------------------------------

    \133\ See infra section II.C.6.
    \134\ See, e.g., Fidelity Commonwealth Trust, Investment Company
Act Release Nos. 32166 (June 29, 2016) [81 FR 44063 July 6, 2016)]
(notice) and 32191 (July 26, 2016) (order) and related application;
Claymore Exchange-Traded Fund Trust, Investment Company Act Release
Nos. 27469 (Aug. 28, 2006) [71 FR 51869 (Aug. 31, 2006)] (notice)
and 27483 (Sept. 18, 2006) (order) and related application.
    \135\ See infra footnote 278 and accompanying and following text
(noting that, currently, Form N-1A provides an ETF with the option
to omit certain historical information regarding premiums and
discounts from its prospectus and annual report if the disclosure is
provided on its website).
---------------------------------------------------------------------------

    In particular, as discussed in section II.C.6, we are proposing to
require ETFs to disclose on their websites the median bid-ask spread
for the ETF's most recent fiscal year and certain historical
information about the extent and frequency of an ETF's premiums and
discounts. This would allow investors to be more aware of this risk
when deciding whether to invest in ETFs generally or in a particular
ETF. Our proposed amendments to Form N-1A would require additional
disclosure regarding ETF trading information and related costs,
including information relating to high-end (95th percentile) spread
costs.\136\ We also request comment below on whether there are other
ways to calculate premiums and discounts, or other metrics we should
consider, to better inform investors about an ETF's history of
deviations between intraday market prices and (i) the next-calculated
NAV; or (ii) the contemporaneous value of the ETF's portfolio.\137\
---------------------------------------------------------------------------

    \136\ See infra section II.H.
    \137\ See infra section II.C.6.
---------------------------------------------------------------------------

    We request comment on the proposed exemptions from section 22(d) of
the Act and rule 22c-1 thereunder.
     Is the proposed relief sufficient to facilitate
transactions in ETF shares on the secondary market?
     Will the proposed conditions (discussed below) promote the
arbitrage mechanism and support the Commission granting this relief?
Are there other conditions we should consider?
     Under what circumstances could a premium or discount for
an ETF develop or persist? For example, when would a premium or
discount develop due to a break-down in the arbitrage mechanism? Are
there instances where a premium or discount may develop or persist
because of price discovery, such as when the underlying markets for the
ETF's component securities are closed? Are there instances where a
premium or discount may develop or persist because of transaction costs
relating to the ETF's basket securities? How can these circumstances be
distinguished from one another? Should we consider any changes to our
proposal to account for these different circumstances?
     Would the arbitrage mechanism contemplated by the proposed
rule keep ETF market prices at or close to NAV per share under normal
market conditions? How should this be measured? For example, is it
appropriate to assess premiums and discounts solely by comparing ETF
market prices to the ETF's NAV, which typically is calculated at the
end of the day? Should intraday calculations play a larger role when
assessing premiums and discounts? Should we, for example, assess the
efficiency of the arbitrage mechanism by comparing the mean/median of
the market prices on a given trading day against the end of day NAV?
Alternatively, should we compare the mean/median of the market price on
a given trading day against an intraday

measure of the value of an ETF's portfolio?
3. Affiliated Transactions
    Section 17(a) of the Act generally prohibits an affiliated person
of a registered investment company, or an affiliated person of such
person, from selling any security or other property to or purchasing
any security from the company.\138\ Purchases and redemptions of ETF
creation units are typically effected in kind, and section 17(a)
prohibits these in-kind purchases and redemptions by affiliated persons
of the ETF. An affiliated person of an ETF includes, among others: (i)
Any person directly or indirectly owning, controlling, or holding with
power to vote, 5% or more of the outstanding voting securities of the
ETF; (ii) any person 5% or more of whose outstanding voting securities
are directly or indirectly owned, controlled, or held with power to
vote by the ETF; and (iii) any person directly or indirectly
controlling, controlled by, or under common control with the ETF.\139\
---------------------------------------------------------------------------

    \138\ 15 U.S.C. 80a-17(a).
    \139\ 15 U.S.C. 80a-2(a)(3)(A), (B) and (C). A control
relationship is presumed when one person owns more than 25% of
another person's outstanding voting securities. 15 U.S.C. 80a-
2(a)(9).
---------------------------------------------------------------------------

    ETF applicants have requested, and we have granted, exemptive
relief from section 17(a) of the Act for: (i) Persons affiliated with
the ETF based on their ownership of 5% or more of the ETF's outstanding
securities (``first-tier affiliates''); and (ii) affiliated persons of
the first-tier affiliates or persons who own 5% or more of the
outstanding securities of one or more funds advised by the ETF's
investment adviser (``second-tier affiliates'').\140\ In seeking this
relief, applicants have stated that first- and second-tier affiliates
are not treated differently from non-affiliates when engaging in
purchases and redemptions of creation units.\141\ All purchases and
redemptions of creation units are at an ETF's next-calculated NAV
pursuant to rule 22c-1. Additionally, the securities deposited or
delivered upon redemption are valued in the same manner, using the same
standards, as those securities are valued for purposes of calculating
the ETF's NAV per share.
---------------------------------------------------------------------------

    \140\ See, e.g., Barclays Global 2000, supra footnote 6
(``Because purchases and redemptions of Creation Units may be `in-
kind' rather than cash transactions, section 17(a) may prohibit
affiliated persons of an [ETF] from purchasing or redeeming Creation
Units.'').
    \141\ See e.g., Barclays Global 2008, supra footnote 58.
---------------------------------------------------------------------------

    Proposed rule 6c-11 similarly would provide exemptions from
sections 17(a)(1) and (a)(2) of the Act with regard to the deposit and
receipt of baskets to a person who is an affiliated person of an ETF
(or who is an affiliated person of such a person) solely by reason of:
(i) Holding with the power to vote 5% or more of an ETF's shares; or
(ii) holding with the power to vote 5% or more of any investment
company that is an affiliated person of the ETF.\142\ We believe that
this relief is necessary to facilitate the efficient functioning of the
arbitrage mechanism. Without it, an authorized participant or other
market participant that becomes an affiliated person of the ETF due to
its holdings would be prevented from engaging in arbitrage using an in-
kind basket. This, in turn, could have the adverse effect of limiting
the pool of market participants that could engage in arbitrage.
Ultimately, it could result in the deviation between market price and
NAV per share widening in cases where there are very few authorized
participants or other market participants actively engaged in
transactions with the ETF. The arbitrage mechanism for newly launched
ETFs could be particularly challenged without this relief because every
purchaser of a creation unit would be considered an affiliated person
of the ETF so long as there are fewer than twenty creation units
outstanding. We also believe that this relief is appropriate because
all purchases and redemptions of creation units are at an ETF's next-
calculated NAV, and the securities deposited or delivered upon
redemption would be valued in the same manner, using the same
standards, as those securities are valued for purposes of calculating
the ETF's NAV.
---------------------------------------------------------------------------

    \142\ See proposed rule 6c-11(b)(3).
---------------------------------------------------------------------------

    The exemption in proposed rule 6c-11(b)(3) is similar to the
section 17(a) exemption we proposed in 2008, although the relief would
be subject to certain additional conditions related to custom
baskets.\143\ Commenters who addressed the proposed relief in 2008
supported it.\144\ Several commenters, however, requested that the
relief be expanded to cover additional types of affiliated
relationships, such as broker-dealers that are affiliated with the
ETF's adviser.\145\ These commenters noted that any Commission concern
of undue influence by the affiliate would be addressed by the federal
securities laws and regulations that prohibit manipulative practices
and misuse of nonpublic information, and that ETFs would benefit from
an increase in entities eligible to transact with the ETF.\146\ An
increase in the number of authorized participants could also help to
reduce the potential for an ETF to be reliant on one or more particular
authorized participants.\147\
---------------------------------------------------------------------------

    \143\ See id. To utilize custom baskets, proposed rule 6c-
11(c)(3) would require an ETF to adopt and implement written
policies and procedures that: (i) Set forth detailed parameters for
the construction and acceptance of custom baskets that are in the
best interests of the ETF and its shareholders, including the
process for any revisions to, or deviations from, those parameters;
and (ii) specify the titles or roles of the employees of the ETF's
investment adviser who are required to review each custom basket for
compliance with those parameters.
    \144\ See, e.g., Comment Letter of Barclays Capital Inc. (May 8,
2008); ICI 2008 Comment Letter; SSgA 2008 Comment Letter.