the form of the product description? For example, should we propose
specific requirements for product descriptions that would provide ETF
investors with information similar to that received by traditional
mutual fund investors, such as the fee table, name and length of
service of the portfolio manager, and return information, as noted
above? Alternatively, should the product description conform to the
disclosures in the summary section as proposed in Section III.D.2
below? \153\ If so, are there any additional disclosures to those in
the proposed summary section that ETFs should be required to include in
a product description? Are there any disclosures in the proposed
summary section that ETFs should not be required to include in the
product description?
---------------------------------------------------------------------------

    \153\ See infra notes 175-189 and accompanying text.
---------------------------------------------------------------------------

    If we do not adopt the amendments proposed in the Enhanced
Disclosure Proposing Release, we would anticipate that dealers in ETF
shares will nevertheless continue their current practice of delivering
prospectuses to investors. We request comment on whether the rule
should require dealers to deliver prospectuses instead of product
descriptions.\154\ ETFs are becoming more like traditional mutual funds
in several respects. As discussed above, when we began issuing
exemptive orders to ETFs, they had basic investment objectives (to
track a widely-followed index) and simple investment techniques
(investment in all, or a representative sample of, the securities of a
widely followed index).\155\ Soon, however, some ETFs will be actively
managed and have portfolio managers whose role is important to the
success of the fund.\156\ ETF operations, investment objectives,
expenses, and other characteristics may become more varied as well.
Because prospectuses contain information in a standardized form
prescribed by the Commission, the use of these disclosure forms could
promote greater uniformity in the content and level of disclosure among
ETFs.\157\ In addition, as discussed below, we are proposing to amend
Form N-1A to include additional information relevant to a retail
investor in an ETF, who does not typically buy or redeem individual
shares directly from the fund.
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    \154\ For a discussion of the additional burdens associated with
the requirement that broker-dealers deliver prospectuses in
secondary market transactions involving ETF shares, see infra
discussion at Section VIII.
    \155\ See supra note 10 and accompanying text.
    \156\ The investment objectives and techniques of index-based
ETFs also have become more complex. Some ETFs today follow
specialized or custom-designed indexes; others are leveraged through
use of futures contracts and other types of derivative instruments.
    \157\ Certain disclosures required by Form N-1A that generally
are not included in product descriptions may be important to some
investors given the evolution of ETFs. Product descriptions do not,
for example, include a fee table itemizing the ETF's expenses, or
the name and length of service of the portfolio manager.
---------------------------------------------------------------------------

    If we were to retain the prospectus delivery exemption for broker-
dealers, should the exemption be limited to index-based ETFs or only to
certain index-based ETFs, such as those that replicate the components
of a broad-based stock market index? If we were to retain the
exemption, should we require broker-dealers to deliver prospectuses
instead of product descriptions to purchasers of actively managed ETF
shares?
2. Amendments to Form N-1A
    We are proposing several amendments to Form N-1A, the registration
form used by open-end management investment companies to register under
the Act and to offer their securities under the Securities Act, to
accommodate the use of this form by ETFs. The proposed amendments for
ETF prospectuses are designed to meet the needs of investors (including
retail investors) who purchase shares in secondary market transactions
rather than financial institutions purchasing creation units directly
from the ETF.
    We request comment on our proposal to amend Form N-1A to meet the
needs of secondary market investors. Is this

distinction we propose to draw between purchasers of shares in
secondary market transactions and purchasers of creation units from the
fund appropriate? Should we instead revise Form N-1A to include the
additional disclosure (as discussed below) we are proposing today for
secondary market investors without eliminating (as discussed below)
certain disclosures relevant to creation unit purchasers? Would
secondary market investors be confused if Form N-1A included disclosure
relevant to both types of investors?
    Purchasing and Redeeming Shares. We propose to amend Item 6 of Form
N-1A to eliminate the requirement that ETF prospectuses disclose
information on how to buy and redeem shares of the ETF because it is
not relevant to secondary market purchasers of ETF shares.\158\ Instead
ETF prospectuses would simply state the number of shares contained in a
creation unit (i.e. the amount of shares necessary to redeem with the
ETF) and that individual shares can only be bought and sold on the
secondary market through a broker-dealer.\159\ Similarly, we also would
amend Item 3 to exclude from the fee table fees and expenses for
purchases or sales of creation units.\160\ Instead, the proposed
amendment would require an ETF to modify the narrative explanation
preceding the example in the fee table to state that individual ETF
shares are sold on the secondary market rather than redeemed at the end
of the periods indicated, and that investors in ETF shares may be
required to pay brokerage commissions that are not reflected in the fee
table.\161\
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    \158\ Proposed Item 6(h)(1) of Form N-1A.
    \159\ Proposed Item 6(h)(3) of Form N-1A.
    \160\ Proposed Instruction 1(e)(i) to Item 3 of Form N-1A.
    \161\ Proposed Instruction 1(e)(ii) to Item 3 of Form N-1A. We
also are proposing a conforming amendment to the fee table in ETF
annual and semi-annual reports. Proposed Instruction 1(e) to Item
22(d) of Form N-1A.
---------------------------------------------------------------------------

    We request comment on our assumption that investors (including most
individual investors) purchasing their shares in secondary market
transactions do not need to know information on how creation units are
purchased and redeemed, or the payment of transaction fees by investors
purchasing or redeeming creation units. If they do need this
information, why?
    ETFs would still be required to include disclosure on how creation
units are offered to the public in the SAI.\162\ We are not proposing
to amend this disclosure to include information on creation unit
redemption, which Item 6 currently requires and which we propose to
eliminate. Should we amend the SAI to include the disclosure
requirements we are proposing to eliminate from Item 6? Should we
require that the information in the SAI regarding the purchase of
creation units also specify associated fees and expenses? As an
alternative, should we require purchase and redemption information and
associated fees and expenses to remain in Item 3 and Item 6 only for
prospectuses provided to investors purchasing creation units, such as
in the form of a supplementary prospectus?
---------------------------------------------------------------------------

    \162\ Item 18(a) of Form N-1A.
---------------------------------------------------------------------------

    The proposed alternative disclosures in Items 3 and 6 would not be
available, however, to ETFs with creation units of less than 25,000
shares because more retail investors would be able to transact directly
with an ETF that has smaller-sized creation units.
    We request comment on whether the exemptions we are providing from
Items 3 and 6 of Form N-1A should be based on the size of the creation
unit, and whether 25,000 shares per creation unit is an appropriate
threshold. Should it be higher or lower? Should we instead adopt a
threshold based on the value of shares rather than the number of
shares?
    Total Return. We propose to modify instructions to several items
that require the use of the ETF's NAV to determine its return. In
addition to returns based on NAV, ETFs also would be required to
include returns based on the market price of fund shares.\163\ As
discussed above, returns based on market price may be different than
returns based on the fund's NAV and better relate to an ETF investor's
experience in the fund.
---------------------------------------------------------------------------

    \163\ We propose to amend the average annual return table to
include a separate line item for returns based on the market price
of ETF shares. Proposed Instruction 5(a) to Item 2(c)(2) of Form N-
1A. This would codify, with modifications, a condition in ETF
exemptive orders. See, e.g., Ziegler Notice, supra note 110. The
condition in our exemptive orders did not specify the location of
the disclosure in the prospectus. As a result, ETFs include an
additional table in the prospectus, rather than including market
price returns in the average annual returns table required by Item
2. In addition, ETFs use different time periods for the disclosure,
with some using calendar years and others fiscal years. The proposed
amendment would eliminate use of a second table, which may confuse
investors. It also would standardize the reporting period by
requiring all ETFs to present the information using calendar years.
    We also propose to amend the financial highlights table to
require ETFs to calculate total return at market prices in addition
to returns at NAV. This proposed amendment would provide secondary
market investors with more pertinent information as to the effect of
market price movements on their investments. Proposed Instruction
3(f) to Item 8(a) of Form N-1A. Under the proposed amendment, ETFs
would be required to include two bar charts under Item 2 of the
form; one using market price returns and one using NAV returns. See
Instruction 1(a) to Item 2(c)(2) of Form N-1A.
---------------------------------------------------------------------------

    We request comment on whether use of market prices, in addition to
NAV, would provide secondary market purchasers of ETF shares with
meaningful information on their investments. Alternatively, should we
require returns to be computed solely using market prices? Would
investors find it confusing to have fund returns presented using both
market price and NAV? Should we limit this amendment to ETFs with
creation units of 25,000 shares or more because more retail investors
may be able to transact directly with the ETF in the event of smaller
creation units?
    For purposes of determining ETF returns, we would define ``market
price'' as the last price at which ETF shares trade on their principal
U.S. trading market during a regular trading session (i.e. closing
price).\164\ Is this an appropriate definition for market price, or
should we instead (or in addition) define the market price as the mid-
point price between the highest bid and the lowest offer on the
principal U.S. market on which the ETF shares are traded, at the time
the fund's NAV is calculated? \165\
---------------------------------------------------------------------------

    \164\ Proposed definition of ``Market Price'' in General
Instruction A of Form N-1A. We consider the closing price to be the
strongest indicator of market value. See Codification of Financial
Reporting Policies, Section 404.03.b.ii, ``Valuation of Securities--
Securities Listed for Trading on a National Securities Exchange,''
reprinted in SEC Accounting Rules (CCH) ] 38,221 (``ASR 118''), at
38, 424-38, 425. See also Fair Value Measurements, Statement of
Financial Accounting Standards No. 157, Sec.  24 (Fin. Accounting
Standards Bd. 2006) (``FASB 157'') (``[A] quoted price in an active
market provides the most reliable evidence of fair value and shall
be used to measure fair value whenever available.'').
    \165\ In circumstances where closing price may be less accurate
because the last trade occurred at a much earlier point in the day
than NAV calculation, some ETFs have used the mid-point price,
rather than the closing price. See, e.g., Claymore Exchange-Traded
Fund Trust, Investment Company Act Release No. 27469 (Aug. 28, 2006)
[71 FR 51869 (Aug. 31, 2006)].
---------------------------------------------------------------------------

    Premium/Discount Information. We propose to require that each ETF
disclose to investors information about the extent and frequency with
which market prices of fund shares have tracked the fund's NAV.\166\
This disclosure, which would be required on the fund's Internet Web
site and included in its prospectus, is a condition to relief in ETF
exemptive orders.\167\ Proposed rule 6c-11 also would require each ETF
to disclose on its Internet Web site the prior business day's last
determined NAV, the market

closing price of its shares and the premium/discount of the closing
price to NAV.\168\ This disclosure is designed to alert investors to
the current relationship between NAV and the market price of the ETF's
shares, and that they may sell or purchase ETF shares at prices that do
not correspond to the NAV of the fund.
---------------------------------------------------------------------------

    \166\ Proposed Item 6(h)(4) to Form N-1A.
    \167\ See, e.g., WisdomTree Notice supra note 12; Zeigler Notice
supra note 110.
    \168\ Proposed rule 6c-11(e)(4)(iv).
---------------------------------------------------------------------------

    Proposed Item 6(h)(4) of Form N-1A would require disclosure in the
ETF prospectus of the number of trading days, during the most recently
completed calendar year and quarters since that year, on which the
market price of the ETF shares was greater than the fund's NAV and the
number of days it was less than the fund's NAV (premium/discount
information).\169\ In addition to alerting investors that the ETF's NAV
and share price may differ, this disclosure also would provide
historical information regarding the frequency of these deviations. In
light of the historical premium/discount disclosure in the ETF
prospectus and in order to avoid duplicative disclosures that may
result in additional regulatory burdens, proposed rule 6c-11, unlike
the exemptive orders, would not require ETFs to include historical
premium/discount information on their Internet Web sites.
---------------------------------------------------------------------------

    \169\ Consistent with current orders, ETFs would be required to
present premiums or discounts as a percentage of NAV. They also
would be required to explain that shareholders may pay more than NAV
when purchasing shares and receive less than NAV when selling,
because shares are bought and sold at market prices. Proposed
Instructions 2, 3 to Item 6(h)(4) of Form N-1A. In addition, the
amendments also would require each ETF to identify the trading
symbol(s) and principal U.S. market(s) on which the shares are
traded. Proposed Item 6(h)(2) of Form N-1A.
---------------------------------------------------------------------------

    We request comment on whether daily and historical premium/discount
information, which ETFs currently provide, is useful to investors. One
commenter to the 2001 Concept Release suggested that investors need not
receive premiums/discounts against NAV disclosure because the more
useful information is the Intraday Value of the fund's basket as
disseminated by national securities exchanges at regular
intervals.\170\ This information, according to the commenter, provides
investors with contemporaneous pricing of the fund's portfolio and
enables the investor to see, at the time his order is entered, whether
the Intraday Value is close to (or between) the bid-asked price.
---------------------------------------------------------------------------

    \170\ See Comment Letter of Nuveen Investments, File No. S7-20-
01 (Jan. 14, 2002). See also Gastineau, supra note 17, at 230-241.
---------------------------------------------------------------------------

    We request comment on whether investors need premium/discount
disclosure in light of the dissemination of the ETF's Intraday Value at
regular intervals during trading hours. We request ETF sponsors
commenting on this condition of the rule to provide us with data
regarding the frequency with which visitors to their Internet Web sites
access this information. In addition to current premium/discount
information, should we also require ETF Web sites to provide historical
premium/discount information as is currently required by exemptive
orders? If the Web site includes historical premium/discount
information, should the rule also require historical information in
Form N-1A? If so, over what periods?
    Periodic Report Information. We are proposing conforming amendments
to ETF return information in ETF annual reports. The proposed
amendments would require each ETF to use the market price of fund
shares in addition to NAV to determine its return,\171\ and include a
table with premium/discount information for the five recently completed
fiscal years.\172\
---------------------------------------------------------------------------

    \171\ Proposed Instruction 12(b) to Item 22(b)(7) of Form N-1A.
This proposed disclosure would be identical to proposed Instruction
5(a) to Item 2(c)(2) of Form N-1A. See supra note 163. We also are
proposing to require ETFs to include a new line graph comparing the
initial and subsequent account values using market price, following
the line graph using NAV required by Item 22(b)(7)(ii)(A) of Form N-
1A. Proposed Instruction 12(a) to Item 22(b)(7) of Form N-1A.
Consistent with the amendments proposed above, this proposed
amendment also is designed to provide individual investors with the
effect of market price fluctuations on their investment.
    \172\ Proposed Item 22(b)(7)(iv) of Form N-1A. Although similar
to the proposed disclosure amendment to the shareholder information
in Item 6 of the form, this proposed disclosure would span a longer,
and different, reporting period: five fiscal years instead of the
most recent calendar year and quarter(s). See Proposed Item 6(h)(4)
of Form N-1A. The proposed amendment would require fiscal year
disclosure to conform to currently required disclosure in Item
22(b)(7). We are also proposing to include instructions similar to
those proposed in Item 6 to assist funds in meeting this proposed
disclosure obligation. Proposed Instructions to Item 22(b)(7)(iv) of
Form N-1A.
---------------------------------------------------------------------------

    We request comment on whether it is necessary to include similar
disclosure in both the prospectus and annual report of an ETF. Should
ETFs that provide this information on their Internet Web sites be
exempt from this annual report requirement? Is it necessary for the ETF
to provide premium/discount data for the most recently completed five
fiscal years? Should the reporting period conform to that proposed
under Item 6 of the form (i.e., one calendar year and most recent
quarters since that year)?
    We also are proposing to amend the prospectus and annual report
requirements of Form N-1A to require an index-based ETF to compare its
performance to its underlying index rather than a benchmark index.\173\
This amendment would permit use of a narrow-based or affiliated index
and eliminate the opportunity for an index-based ETF to select an index
different from its underlying index which should better reflect whether
the ETF's performance corresponds to the index the performance of which
it seeks to track.\174\
---------------------------------------------------------------------------

    \173\ Proposed Instruction 5(b) to Item 2(c)(2) of Form N-1A;
Proposed Instruction 12(c) to Item 22(b)(7) of Form N-1A.
    \174\ Item 2(c)(2)(iii) of Form N-1A; Instruction 12(c) to Item
22(b)(7) of Form N-1A. The form requires use of a broad-based index
and prohibits use of affiliated indexes unless widely used and
recognized. Our amendment would require ETFs that track narrow,
custom indexes or affiliated indexes, to use the underlying index
when presenting this return information.
---------------------------------------------------------------------------

    We request comment on whether it is appropriate to require an
index-based ETF to compare its performance to its underlying index.
Should an index-based ETF that tracks an index compiled by an
affiliated index provider use a benchmark index instead of, or in
addition to, its underlying index? Should an index-based ETF that
tracks a fundamental or other custom-designed index use a benchmark
index instead of, or in addition to, its underlying index?
    Summary Prospectus. As noted above, we recently issued the Enhanced
Disclosure Proposing Release, which would require key information to
appear in plain English in a summary section of the prospectus.\175\ In
addition, a person could satisfy its mutual fund delivery obligations
under section 5(b)(2) of the Securities Act by delivering the summary
prospectus to investors and providing a statutory prospectus on an
Internet Web site. Upon request, a fund also would be required to send
the statutory prospectus to the investor.\176\
---------------------------------------------------------------------------

    \175\ See supra notes 148-152 and accompanying text. References
to Form N-1A amendments in the Enhanced Disclosure Proposing
Release, supra note 142, are to the ``proposed summary prospectus.''
    \176\ See Enhanced Disclosure Proposing Release, supra note 142,
at Section II.B (proposed rule 498 under the Securities Act).
---------------------------------------------------------------------------

    As proposed, the summary section would include certain key
information, which also would comprise the information in the summary
prospectus. This key information would include: (i) Investment
objectives; \177\ (ii) costs; \178\

(iii) principal investment strategies, risks, and performance; \179\
(iv) the fund's top ten portfolio holdings as of the end of its most
recent calendar quarter; \180\ (v) identity of investment advisers and
portfolio managers; \181\ (vi) brief purchase and sale and tax
information; \182\ and (vii) financial intermediary compensation.\183\
This information is drawn largely from the current risk/return summary
and rule 498 fund profile.\184\ In addition, the summary prospectus
would be required to include on the cover page or at the beginning: (i)
The fund's name and the share classes to which the summary prospectus
relates; (ii) a statement identifying the document as a ``summary
prospectus''; (iii) the approximate date of the summary prospectus's
first use; and (iv) the following legend:
---------------------------------------------------------------------------

    \177\ See id., at n.43 and accompanying text (proposed summary
prospectus Item 2 of Form N-1A). This is the same information
required by current Item 2(a) of Form N-1A.
    \178\ See id., at nn.44-55 and accompanying text (proposed
summary prospectus Item 3 of Form N-1A). This information would be
substantially the same as that required by current Item 3 of Form N-
1A (the risk/return summary fee table and example), except for
proposed amendments that would: (i) Require funds that offer
discounts on front-end sales charges for volume purchases (i.e.
breakpoints) to include a brief narrative disclosure alerting
investors to the availability of those discounts; (ii) revise the
parenthetical following the heading ``Annual Fund Operating
Expenses'' to read ``ongoing expenses that you pay each year as a
percentage of the value of your investment'' in place of ``expenses
that are deducted from Fund assets''; (iii) require funds to add
brief disclosure regarding portfolio turnover immediately following
the fee table example; and (iv) permit funds to include additional
captions directly below the ``Total Annual Fund Operating Expenses''
caption in cases where there were expense reimbursement or fee
waiver arrangements that reduced fund operating expenses and that
will continue to reduce them for no less than one year from the
effective date of the fund's registration statement.
    \179\ See id., at nn.56-57 and accompanying text (proposed
summary prospectus Item 4 of Form N-1A). This would include the same
information required by current Items 2(b) and (c) of Form N-1A.
    \180\ See id., at nn.58-66 and accompanying text (proposed
summary prospectus Item 5 of Form N-1A). This information currently
is not required in a fund's prospectus. The proposal would allow
funds to list an amount not exceeding five percent of the total
value of the portfolio holdings in one amount as ``Miscellaneous
securities'' provided certain specified conditions are met. Id. at
n.66 and accompanying text (proposed Instruction 3 to proposed
summary prospectus Item 5 of Form N-1A).
    \181\ See id., at nn.67-72 and accompanying text (proposed
summary prospectus Item 6 of Form N-1A) (proposing that a fund
disclose the name of each investment adviser and sub-adviser of the
fund, followed by the name, title, and length of service of the
fund's portfolio managers). This information is similar to
disclosures required by current Item 5 of Form N-1A. Certain
additional disclosures regarding investment advisers and portfolio
managers that are currently required in the statutory prospectus
would continue to be required in the statutory prospectus, but not
in the summary section. See id., at n.68.
    \182\ See id., at nn.73-74 and accompanying text (proposed
summary prospectus Item 7 of Form N-1A) (proposing that a fund
disclose minimum initial or subsequent investment requirements, the
fact that the shares are redeemable, and identify the procedures for
redeeming shares (e.g., on any business day by written request,
telephone, or wire transfer)), and nn.75-76 and accompanying text
(proposed summary prospectus Item 8 of Form N-1A) (proposing that a
fund state, as applicable, that it intends to make distributions
that may be taxed as ordinary income or capital gains or that the
fund intends to distribute tax-exempt income, and proposing that a
fund that holds itself out as investing in securities generating
tax-exempt income provide, as applicable, a general statement to the
effect that a portion of the fund's distributions may be subject to
federal income tax).
    \183\ See id., at nn.77-78 and accompanying text (proposed
summary prospectus Item 9 of Form N-1A) (proposing that a fund
provide disclosure that, if an investor purchases the fund through a
broker-dealer or other financial intermediary (such as a bank), the
fund and its related companies may pay the intermediary for the sale
of fund shares and related services, and state that these payments
may influence the broker-dealer or other intermediary and the
salesperson to recommend the fund over another investment).
    \184\ Registrants would not be permitted to include any
additional information in the summary section. See id., at n.37 and
accompanying text (proposed summary prospectus General Instruction
C.3.(b) of Form N-1A).

    Before you invest, you may want to review the Fund's prospectus,
which contains more information about the Fund and its risks. You
can find the Fund's prospectus and other information about the Fund
online at [----------]. You can also get this information at no cost
by calling [----------] or by sending an e-mail request to [--------
-- ].\185\
---------------------------------------------------------------------------

    \185\ See id., at n.98 and accompanying text (proposed rule
498(b)(1) under the Securities Act).

    If adopted, the amendments to Form N-1A and rule 498 proposed in
the Enhanced Disclosure Proposing Release would require open-end ETFs
to include the summary section in their prospectuses and permit persons
to satisfy their prospectus delivery obligations by sending or giving
the summary prospectus and providing the statutory prospectus on an
Internet Web site in the manner set forth in the proposed rules. Today,
we also propose that, if the Enhanced Disclosure Proposing Release is
adopted, ETFs include in the summary section of their prospectuses, and
in their summary prospectuses, the additional proposed disclosures
discussed above. Specifically, we would modify the amendments proposed
in the Enhanced Disclosure Proposing Release to include our proposed
amendments to ETF disclosures as follows: (i) Our proposed amendments
regarding disclosures about creation units and the purchase and sale of
individual ETF shares would be included in proposed summary prospectus
Item 7, which would require brief purchase and sale information; \186\
(ii) the additional information on market price returns would be
included in proposed summary prospectus Item 4, which includes the
risk/return summary, bar chart and table; \187\ and (iii) premium/
discount information would be included in proposed summary prospectus
Item 7 (purchase and sale information).\188\ We also would permit ETFs
to exclude proposed information regarding the purchase and sale of
creation units consistent with our proposal today.\189\
---------------------------------------------------------------------------

    \186\ The disclosures in our proposed Items 6(a)(1), 6(h)(2) and
6(h)(3) to Form N-1A would be included in proposed summary
prospectus Item 7 of Form N-1A. As noted, our proposed amendments
also would require the ETF to modify the narrative explanation
preceding the example in the fee table, see supra note 160, which
would remain in current Item 3 of Form N-1A.
    \187\ Our proposed instructions 5(a) and (b) to the risk return
bar chart and table (current Item 2(c)(2) of Form N-1A), see note
163 and accompanying and following text, would be added to the end
of the proposed instructions to proposed summary prospectus Item 4.
    \188\ The disclosure in our proposed Item 6(h)(4) to Form N-1A,
see notes 167-169 and accompanying and following text, would be
included at the end of proposed summary prospectus Item 7 of Form N-
1A. Our proposed amendments to the financial highlights (current
Item 8 of Form N-1A) and the financial statements (current Item 22
of Form N-1A) would be included in the proposed summary prospectus
Items 14 and 28 of Form N-1A, respectively.
    \189\ ETFs would be permitted to exclude from the fee table
(current Item 3 and proposed summary prospectus Item 3 of Form N-1A)
the fees and expenses associated with creation unit purchases and
redemptions and would be permitted to exclude the disclosure
required by proposed summary prospectus Items 7(a) and 7(b) of Form
N-1A. See supra notes 158-160 and accompanying text.
---------------------------------------------------------------------------

    We request comment on whether ETFs should send or give the proposed
additional items in the summary prospectus. If so, should any
information from the statutory prospectus, in addition to the items
that we are proposing today, be included in the summary section of an
ETF's prospectus and, therefore, in its summary prospectus? Should ETFs
not be required to include certain items in the summary section? For
example, in light of the transparency of portfolio holdings of an ETF,
should ETFs not have to include the top ten portfolio holdings? Should
ETFs be permitted or required to locate any of the specific disclosures
proposed in this release or in the Enhanced Disclosure Proposing
Release elsewhere in the prospectus outside the summary section?

E. Amendment of Previously Issued Exemptive Orders

    As discussed above, our orders have exempted ETFs from compliance
with section 24(d) of the Act to relieve dealers from delivering
prospectuses to investors in secondary market transactions. We are
proposing today not to include such an exemption in rule 6c-11 to
ensure that broker-dealers are subject to the same delivery
requirements with respect to all ETFs.\190\ In addition, we are
proposing amendments to Form N-1A that would

revise the prospectus requirements in that form in order to provide
more useful information to investors in ETF shares. Therefore, pursuant
to our authority under section 38(a) of the Act, we propose to amend
the exemptive orders we have issued to ETFs that are open-end funds to
eliminate the section 24(d) exemptions and require ETFs to satisfy
their statutory prospectus delivery requirements.\191\
---------------------------------------------------------------------------

    \190\ See supra Section III.D.1.
    \191\ Section 38(a) of the Act provides the Commission with the
authority to amend orders when necessary or appropriate to the
exercise of its powers conferred elsewhere in the Act. We are not
proposing to amend the orders of UITs that have sought and obtained
an exemption from section 24(d) of the Act because those ETFs do not
prepare their prospectuses in accordance with Form N-1A.
---------------------------------------------------------------------------

    The consequence of the amendment to these orders, if adopted, would
be to put ETFs that have received exemptive orders on the same footing
as ETFs that may in the future rely solely on rule 6c-11, and thus
eliminate any competitive advantage they might otherwise obtain by
having obtained orders before adoption of the rule.\192\ The amendment
would be limited to orders issued to ETFs seeking to operate as open-
end management companies.
---------------------------------------------------------------------------

    \192\ For the same purpose, we expect all funds seeking
exemptive orders to operate an ETF after today to agree as a
condition of the order that the requested order would expire on the
effective date of any Commission rule under the Act that provides
relief permitting the operation of index-based or actively managed
ETFs.
---------------------------------------------------------------------------

    We are not proposing to rescind the orders we have issued because
we do not believe rescission would be necessary to eliminate
competitive advantages for ETFs that have already received exemptive
orders. With the exception of the section 24(d) exemption (and the
related prospectus disclosure requirements), the proposed rule contains
broader exemptive relief than that provided in our orders and therefore
we expect most, if not all, ETFs would rely on the rule if and when it
is adopted.
    We request comment on whether we should rescind our previous
orders. Is our assumption correct that most ETFs that have orders would
rely on the rule?

IV. Exemption for Investment Companies Investing in ETFs

A. Background

    As we discussed above, institutional investors, including funds,
have invested in ETFs to achieve asset allocation, diversification, or
other investment objectives.\193\ Some funds invest primarily in ETFs.
A fund's ability to invest in ETFs, however, is limited because section
12(d)(1) of the Act prohibits a fund (and companies or funds it
controls) (``acquiring fund'') from:
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    \193\ See supra note 15 and accompanying text (funds also use
ETFs for hedging purposes). See also, e.g., iShares Trust,
Investment Company Act Release No. 25969 (Mar. 21, 2003) [68 FR
15010 (Mar. 27, 2003)].
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    (i) Acquiring more than three percent of any other investment
company's outstanding voting securities (``acquired fund'');
    (ii) Investing more than five percent of its total assets in any
one acquired fund; or
    (iii) Investing more than ten percent of its total assets in all
acquired funds.\194\
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    \194\ See 15 U.S.C. 80a-12(d)(1)(A). Both registered and
unregistered funds are subject to these limits with respect to their
investments in a registered fund. Registered funds are also subject
to these same limits with respect to their investments in an
unregistered fund. Unregistered funds are not subject to limits on
their investments in another unregistered fund. Id. ETFs are
registered funds and therefore both registered and unregistered
funds are subject to section 12(d)(1)(A)'s limits with respect to
investments in ETFs. Section 12(d)(1)(B) prohibits a registered
open-end fund from selling any security issued by the fund to any
other fund (including unregistered funds) if, after the sale, the
acquiring fund would: (i) Together with companies and funds it
controls, own more than three percent of the acquired fund's voting
securities; or (ii) together with other funds (and companies they
control) own more than ten percent of the acquired fund's voting
securities. 15 U.S.C. 80a-12(d)(1)(B).
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    Section 12(d)(1) was enacted to limit so-called ``fund of funds''
arrangements. Congress was concerned about ``pyramiding,'' a practice
under which investors could use a limited investment in an acquiring
fund to gain control of another (and potentially much larger) fund and
use the assets of the acquired fund to enrich themselves at the expense
of acquired fund shareholders.\195\ Control could be exercised either
directly (such as through holding a controlling interest) or indirectly
(such as by coercion through the threat of large-scale
redemptions).\196\ Congress also was concerned about the potential for
excessive fees when one fund invested in another,\197\ and the
formation of overly complex structures that could be confusing to
investors.\198\ Congress imposed these limits, in part, based on our
conclusion in 1966 that fund of funds structures served little or no
economic purpose.\199\
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    \195\ The legislative history of these provisions cites examples
of controlling investors in an acquiring fund using ``pyramiding
schemes'' to force acquired funds to purchase securities of
companies in which the investors had an interest and to direct
underwriting and brokerage business to broker-dealers they
controlled. In an open-end fund, controlling investors were able to
exert control and influence over acquired funds through the threat
of large-scale redemptions. In the 1960s, Fund of Funds, Ltd., an
unregistered foreign investment company, acquired controlling
interests in several registered U.S. funds and was able to exert
undue influence over the management of those acquired funds by
threatening advisers to those funds with large redemptions. See SEC,
Public Policy Implications of Investment Company Growth, H.R. Rep.
No. 2337, 89th Cong., 2d Sess. at 315-16 (1966) (``1966 Study'').
Congress enacted section 12(d)(1) to prevent these abuses and
amended the section in 1970 to prevent similar abuses by investors
in unregistered acquiring funds. Congress later amended section
12(d)(1) to give the Commission specific authority to provide
exemptions from these limitations. See infra notes 200 and 214 and
accompanying text.
    \196\ Large-scale redemptions may disrupt portfolio management
or increase transaction fees if fund managers must hold cash or sell
portfolio securities at an inopportune time to meet redemptions.
Large-scale redemptions also may be threatening to a fund manager
because they decrease the fund's assets under management, on which
the manager's fee is based.
    \197\ Pyramiding schemes resulted in fund shareholders paying
excessive charges due to duplicative fees at the acquiring and
acquired fund levels. See SEC, Investment Trusts and Investment
Companies, H.R. Doc. No. 279, 76th Cong., 1st Sess., pt.3, at 2721-
95 (1939) (``Investment Trust Study''). See also Fund of Funds
Investments, Investment Company Act Release No. 26198 (Oct. 1, 2003)
[68 FR 58226 (Oct. 8, 2003)] (``Fund of Funds Proposing Release'')
at nn.2-6 and accompanying text. For example, from 1927 to 1936, it
was estimated that the duplication of expenses incurred by funds
investing in other funds exceeded five percent of the total
operating expenses for all management funds. See Investment Trust
study, at 2727-2728. Fund of Funds, Ltd. also charged duplicative
advisory fees at the acquiring and acquired fund levels, provided
sales loads to an affiliated broker for each investment the
acquiring fund made in an acquired fund, and directed brokerage to
an affiliate of the fund of funds. See 1966 Study, supra note 195,
at 318-320; Arthur Lipper Corp., et al. v. SEC, Securities Exchange
Act Release No. 11773, 46 S.E.C. 78 (Oct. 24, 1975), sanction
modified, 547 F.2d 171 (2d Cir. 1976) (a Fund of Funds, Ltd.
affiliated broker-dealer received commissions under step-out
arrangements with Arthur Lipper Corp, a registered broker-dealer,
and other broker-dealers).
    \198\ Pyramiding of funds resulted in complicated corporate
structures that were confusing to shareholders and made it difficult
for shareholders to determine the nature and value of the holdings
ultimately underlying each shareholder's investment. See Investment
Trust study, supra note 197, at 2778-93.
    \199\ See id., at 2725-41.
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    Our views and those of Congress regarding the economic value of
fund of funds arrangements have changed over the years as fund of funds
arrangements have been created that serve new, legitimate purposes.
Recognizing this, in 1996, Congress granted us specific authority to
provide exemptions allowing fund of funds arrangements, and directed
that we use it ``in a progressive way.'' \200\ Pursuant to this

authority, we have provided exemptions to permit certain fund of funds
arrangements that would otherwise be prohibited under section 12(d)(1).
For example, in 2006 we adopted rule 12d1-1, which allows funds to
invest in money market funds in excess of section 12(d)(1) limits.\201\
We also have issued exemptive orders that allow many funds to invest in
unaffiliated traditional funds (``multigroup fund orders'') and that
allow the sale of shares issued by several ETFs to unaffiliated funds
in excess of the statutory limits.\202\ The exemptions provided under
the rule and these orders facilitate the acquiring funds' ability to
achieve their investment objectives by expanding their investment
options to include investments in unaffiliated funds in a manner
consistent with the protection of investors. These exemptions also
increase the potential pool of investors and assets available for
investment in ETFs and traditional funds.
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    \200\ See National Securities Markets Improvement Act of 1996,
Pub. L. 104-290, Sec.  202(4), 110 Stat. 3416, 3427 (1996)
(``NSMIA''); H.R. Rep. No. 622, 104th Cong., 2d Sess., at 43-44
(1996) (``H.R. Rep. No. 622'') (discussing new section 12(d)(1)(J)
of the Act that gives the Commission authority, by rule or order, to
provide exemptions from the limits of section 12(d)(1) when it is
consistent with the public interest and the protection of
investors). In 1996, Congress also amended the Act to include a
statutory exemption from section 12(d)(1) limits for funds that
invest in funds in the same fund group. NSMIA, section 202(5). See
also infra note 214 and accompanying text.
    \201\ See Fund of Funds Investments, Investment Company Act
Release No. 27399 (June 20, 2006) [71 FR 36640 (June 27, 2006)]
(``Fund of Funds Adopting Release''); 17 CFR 270.12d1-1.
    \202\ See, e.g., Schwab Capital Trust, et al., Investment
Company Act Release Nos. 24067 (Oct. 1, 1999) [64 FR 54939 (Oct. 8,
1999)] (notice) (``Schwab Notice'') and 24113 (Oct. 27, 1999)
(order) (``Schwab Order''); First Trust Exchange-Traded Fund, et
al., Investment Company Act Release Nos. 27812 (Apr. 30, 2007) [72
FR 25795 (May 7, 2007)] (notice) and 27845 (May 30, 2007) (order);
iShares Trust, et al., Investment Company Act Release Nos. 25969
(Mar. 21, 2003) [68 FR 15010 (Mar. 27, 2003)] (notice) and 26006
(Apr. 15, 2003) (order).
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    ETF applicants have sought exemptive orders similar to those we
have issued to funds investing in unaffiliated traditional funds.\203\
The conditions included in those orders were designed to prevent the
abuses that historically were associated with fund of funds
arrangements and that led Congress to enact section 12(d)(1).\204\ The
conditions include: (i) Limits on the control and influence an
acquiring fund can exert on the acquired fund; \205\ (ii) limits on
certain fees charged to the acquiring fund and its shareholders; \206\
(iii) limits on the acquired fund's ability to invest in other funds;
\207\ (iv) the acquired fund and each acquiring fund must enter into an
agreement stating that both funds understand the terms and conditions
of the order and agree to fulfill their responsibilities under the
order (``participation agreement''); \208\ and (v) the acquiring fund
provides a list of certain of its affiliates to the acquired fund.\209\
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    \203\ Fifteen orders have been issued to ETFs allowing other
funds to invest in ETFs beyond the limits of section 12(d)(1). See,
e.g., iShares Trust, et al., Investment Company Act Release No.
25969 (Mar. 21, 2003) [68 FR 15010 (Mar. 27, 2003)].
    \204\ See, e.g., Schwab Notice and Order, supra note 202.
    \205\ The exemptive orders permitting investments in ETFs
contain the following conditions relating to influence and control:
(i) The acquiring fund's investment adviser or sponsor, any person
in a control relationship with that investment adviser or sponsor,
any investment company (including a company that would be an
investment company but for the exceptions provided in sections
3(c)(1) and 3(c)(7) of the Act) that is advised or sponsored by the
acquiring fund's investment adviser or sponsor, or any person in a
control relationship with that investment adviser or sponsor cannot
control the ETF within the meaning of section 2(a)(9) of the Act;
(ii) neither the acquiring fund nor certain of its affiliates cause
any existing or potential investment by the acquiring fund in ETF
shares to influence the terms of any services or transactions
between the acquiring fund or its affiliate and the ETF or an ETF
affiliate; (iii) the board of directors (or trustees) of the
acquiring fund, including a majority of the independent directors,
adopts procedures reasonably designed to assure that the acquiring
fund's investment adviser(s) is conducting the acquiring fund's
investment program without taking into account any consideration
received by the acquiring fund or an acquiring fund affiliate from
the ETF or an ETF affiliate in connection with any services or
transactions; (iv) the board of directors of an open-end ETF,
including a majority of its independent directors, determines that
any consideration paid by the ETF to the acquiring fund or an
acquiring fund affiliate in connection with any services or
transactions: (a) Is fair and reasonable in relation to the nature
and quality of the services and benefits received by the ETF; (b) is
within the range of consideration that the ETF would be required to
pay to another unaffiliated entity in connection with the same
services or transactions; and (c) does not involve overreaching on
the part of any person concerned; (v) neither the acquiring fund nor
certain of its affiliates (except to the extent it is acting in its
capacity as an investment adviser or sponsor to the ETF) causes the
ETF to purchase a security in any affiliated underwriting (an
underwriting in which an affiliate of the acquiring fund is a
principal underwriter); (vi) the board of directors of an open-end
ETF, including a majority of the independent directors, adopts
procedures reasonably designed to monitor any purchases of
securities by the ETF in an affiliated underwriting, including any
purchases made directly from the affiliate, and the board reviews
these purchases at least annually to determine whether the purchases
were influenced by the acquiring fund's investment in the ETF, in
its review the board must consider: (a) Whether the purchases were
consistent with the ETF's investment objectives and policies; (b)
how the performance of the purchased securities compares to the
performance of comparable securities purchased during a comparable
period of time in an unaffiliated underwriting or to a benchmark
such as a comparable market index; and (c) whether the amount of
securities purchased has changed significantly from prior years; and
(vii) the ETF maintains and preserves permanently in an easily
accessible place a written copy of the procedures designed to
monitor purchases made in an affiliated underwriting and maintains
and preserves for at least six years, the first two in an easily
accessible place, a written record of each purchase (and the terms
thereof) of securities in an affiliated underwriting and the
information or materials upon which the board's determinations were
made. See, e.g., Healthshares(tm), Inc. and XShares Advisors LLC,
Investment Company Act Release No. 27844 (May 29, 2007) [72 FR 30885
(June 4, 2007)] (``Healthshares(tm), Inc. and XShares Order'').
    \206\ The exemptive orders permitting investments in ETFs
contain the following conditions relating to fee limits: (i) Before
approving any advisory contract under section 15 of the Act, the
board, including a majority of independent directors, finds that the
advisory fees charged under the contract are based on services
provided that are in addition to, rather than duplicative of, the
services provided under the ETF advisory contract(s) and these
findings and their basis are recorded in the minute books of the
acquiring fund; (ii) the acquiring fund's adviser(s) (or if the
acquiring fund is a UIT, its trustee or sponsor) waives fees payable
to it by the acquiring fund in an amount at least equal to any
compensation (including fees received pursuant to any 12b-1 plan)
received from the ETF by the acquiring fund's adviser, trustee, or
sponsor or an affiliated person of the acquiring fund's adviser,
trustee, or sponsor (other than any advisory fees paid by the ETF to
the adviser, trustee, or sponsor or its affiliated person) in
connection with the acquiring fund's investment in the ETF; and
(iii) any sales charge and/or service fees charged with respect to
shares of the acquiring fund do not exceed the limits applicable to
a fund of funds as set forth in Rule 2830 of the NASD Conduct Rules
(or with respect to registered separate accounts that invest in a
fund of funds, no sales load is charged at the acquiring fund level
or ETF level and other sales charges and services fees, if any, are
only charged at either the acquiring fund level or ETF level, not
both). See, e.g., Healthshares(tm), Inc. and XShares Order, supra
note 205.
    \207\ Under the exemptive orders permitting investments in ETFs,
the ETF may not invest in shares of other funds (including companies
relying on sections 3(c)(1) and 3(c)(7) of the Act) in excess of the
limits in section 12(d)(1)(A) of the Act (some orders allow a few
exceptions to this condition, see infra note 225). See, e.g.,
Healthshares(tm), Inc. and XShares Order, supra note 205.
    \208\ The exemptive orders require an agreement between the
acquiring fund and the ETF stating that their boards and investment
advisers, or their sponsors and trustees, as applicable, understand
the terms and conditions of the order and agree to fulfill their
responsibilities under the order (and the acquiring fund transmits
to the ETF a list of certain of its affiliates and underwriting
affiliates) and the acquiring fund and ETF maintain and preserve a
copy of the exemptive order, participation agreement, and the list
of affiliates with any updated information for the duration of the
investment and for at least six years thereafter, the first two
years in an easily accessible place. See, e.g., Healthshares(tm),
Inc. and XShares Order, supra note 205.
    \209\ See supra note 208.
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    More recently, sponsors of some ETFs as well as managers of funds
investing in ETFs have expressed concern to our staff that some of the
conditions in the exemptive orders are burdensome and unnecessary in
the context of a fund investment in an ETF, which is less likely to be
subject to at least some of the abuses these conditions were designed
to prevent.\210\ For example, ETF sponsors have communicated to our
staff that the participation agreement condition is cumbersome and
costly because the ETFs must enter into an agreement with each
acquiring fund and each acquiring fund seeks to negotiate different
terms in its agreement.\211\ They have suggested that we develop
conditions that address the

concerns underlying section 12(d)(1) in a manner that is more suited to
fund investments in ETFs.\212\
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    \210\ See infra Section IV.B.
    \211\ Acquiring funds also have indicated to the staff that it
is burdensome for them to enter into participation agreements with
each ETF in which the funds want to invest.
    \212\ Many funds also appear to consider investments in ETFs to
be different than investments in other investment companies. In
2004, our staff conducted examinations of a number of mutual fund
complexes, which focused on the funds' investments in ETFs and
whether those investments were made in accordance with section
12(d)(1) of the Act. Most of the examined mutual fund complexes
treated ETF investments like investments in traditional equity
securities and did not identify ETFs as registered funds subject to
the requirements of section 12(d)(1) of the Act. Thus, those that
acquired more than three percent of the voting securities of an ETF
or invested more than five percent of the acquiring fund's assets in
the voting securities of an ETF were inconsistent with section
12(d)(1). Most of the mutual funds examined invested in ETFs in
order to: (i) Hedge the portfolio; (ii) ``equitize'' cash balances
in order to earn returns in excess of money market rates; and (iii)
gain exposure to a specific market and/or industry sector in an
efficient manner.
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B. Proposed Rule 12d1-4 Conditions

    Today, we are proposing a new rule 12d1-4, which would provide an
exemption to permit acquiring funds to invest in ETFs in excess of the
limits of section 12(d)(1), subject to four conditions that are
designed to address the historical abuses that result from pyramiding
and the threat of large-scale redemptions and may arise in connection
with investments in ETFs.\213\ The relief we propose is subject to
fewer conditions than our exemptive orders but, unlike our orders,
would limit an acquiring fund's ability to redeem ETF shares.\214\
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    \213\ We are also proposing related amendments to rule 12d1-2
under the Act to include within its exemptive relief investments in
ETFs made in reliance on proposed rule 12d1-4 and investments in
non-security assets. See infra Section V.
    \214\ In 1996, Congress added section 12(d)(1)(J) to the Act,
which gave us specific authority to exempt any person, security or
transaction, or any class or classes of transactions, from section
12(d)(1) of the Act if the exemption is consistent with the public
interest and the protection of investors. NSMIA, section 202(4)
(codified at 15 U.S.C. 80a-12(d)(1)(J)). The House Report
accompanying the legislation urged the Commission to use the
additional exemptive authority under section 12(d)(1)(J) ``in a
progressive way as the fund of funds concept continues to evolve
over time.'' H.R. Rep. No. 622, supra note 200, at 43-44 (1996). The
House Report explained that, in exercising its exemptive authority,
the Commission should consider factors that relate to the protection
of investors, including the extent to which a proposed arrangement
is subject to conditions that are designed to address conflicts of
interest and overreaching by a participant in the arrangement, so as
to avoid the abuses that gave rise to the initial adoption of the
Act's restrictions against funds investing in other funds. Id. at
44.
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1. Control
    In order to address the concern that a fund could exert control
over another fund, the proposed rule would limit the exemption to an
acquiring fund (and any entity in a control relationship with the
acquiring fund) that does not ``control'' an ETF.\215\ The Act defines
``control'' to mean ``the power to exercise a controlling influence
over the management or policies of a company, unless such power is
solely the result of an official position with such company.'' \216\
The Act also creates rebuttable presumptions that any person who
directly or indirectly beneficially owns more than 25 percent of the
voting securities of a company controls the company and that one who
does not own that amount does not control it.\217\ The effect of the
proposed rule, if adopted, would be that an acquiring fund's beneficial
ownership of up to 25 percent of the voting securities of an ETF, by
itself, would not constitute control over the ETF. As a result, a fund
relying on the rule could make a substantial investment in an ETF
(i.e., up to 25 percent of the ETF's shares) without seeking further
exemption from us.
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    \215\ Proposed rule 12d1-4(a)(1). The condition would provide
that: (i) an acquiring fund and any of its investment advisers or
depositors, and any company in a control relationship with the
acquiring fund or any of its investment advisers or depositors, each
individually or in the aggregate, do not control an ETF; and (ii)
if, as a result of a decrease in the outstanding voting securities
of an ETF, the acquiring fund, any of its investment advisers, and
any company in a control relationship with the acquiring fund or its
investment adviser, either individually or together in the
aggregate, become holders of more than 25 percent of the outstanding
voting securities of an ETF (i.e., are presumed to control the ETF,
see infra notes 217-218 and accompanying text), each of those
shareholders must vote its shares of the ETF in the same proportion
as the vote of all the other ETF shareholders. The same condition is
in our exemptive orders.
    \216\ 15 U.S.C. 80a-2(a)(9).
    \217\ Id. These presumptions continue until the Commission makes
a final determination to the contrary by order either on its own
motion or on application by an interested person. Id.
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    If, however, an acquiring fund uses its ownership interest in the
ETF (even if that interest is 25 percent or less) to exercise a
controlling influence over the ETF's management or policies, the fund
would not be able to rely on the proposed rule.\218\ For example, an
acquiring fund that used its share position to persuade an ETF manager
to enter into a transaction with an affiliate of the acquiring fund or
its adviser would almost certainly exercise a controlling influence on
the ETF's management and thus lose its exemption under the proposed
rule.\219\
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    \218\ A determination of control depends on the facts and
circumstances of the particular situation. ``[N]o person may rely on
the presumption that less than 25 percent ownership is not control
when, in fact, a control relationship exists under all the facts and
circumstances.'' Exemption of Transactions by Investment Companies
with Certain Affiliated Persons, Investment Company Act Release No.
10698 (May 16, 1979) [44 FR 29908 (May 23, 1979)] at n.2. (citing
Fundamental Investors, Inc., 41 SEC 285 (1962)) (``Fundamental
Investors'') (Commission order noting that rebutting presumption of
control can have retrospective as well as prospective effect).
    \219\ We have long held that ``controlling influence'' includes,
in addition to voting power, a dominating persuasiveness of one or
more persons, the act or process that is effective in checking or
directing action or exercising restraint or preventing free action,
and the latent existence of power to exert a controlling influence.
See, e.g., Investors Mutual, Inc., Investment Company Act Release
No. 4595 (May 11, 1966) at text accompanying nn.11-14 (citing The
Chicago Corporation, Investment Company Act Release No. 1203 (Aug.
24, 1948); Transit Investment Corporation, Investment Company Act
Release No. 927 (July 31, 1946); In the Matter of the M.A. Hanna
Company, Investment Company Act Release No. 265 (Nov. 26, 1941)).
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    We request comment on the proposed condition. Do ETF sponsors
believe that it would sufficiently protect the ETF from the type of
coercive behavior on the part of acquiring funds that section 12(d)(1)
was intended to prevent?
2. Redemptions
    The proposed rule includes two provisions that would prevent an
acquiring fund from redeeming shares it acquired in reliance on the
proposed rule. First, the rule would prohibit an acquiring fund that
relies on the proposed rule to acquire shares in excess of section
12(d)(1)(A)(i) limits (i.e., to acquire more than three percent of an
ETF's shares) from redeeming those shares.\220\ As a result, acquiring
funds would not be able to threaten large-scale redemptions as a means
of coercing an ETF. It is our understanding that most acquiring funds
purchase and sell ETF shares in secondary market transactions.
Accordingly, this condition, while precluding one of the historical
abuses associated with fund of funds arrangements, would not prevent
acquiring funds from taking passive shareholder positions in ETF shares
(in excess of section 12(d)(1) limits) in order to, for example, gain
exposure to a particular market segment.
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    \220\ Proposed rule 12d1-4(a)(2). Under the proposed rule, an
acquiring fund would be deemed to have redeemed or sold the most
recently acquired ETF shares first. Id. As a result, an acquiring
fund could redeem shares from an ETF only when the fund (and
companies or funds it controls) holds ETF shares in an amount
consistent with section 12(d)(1)(A)(i) limits. An acquiring fund
that relies on the proposed rule to invest more than five percent of
its assets in the acquired ETF (prohibited by section
12(d)(1)(A)(ii)) and/or to invest more than 10 percent of its assets
in all funds (including the acquired ETF) (prohibited by section
12(d)(1)(A)(iii)) but that does not acquire more than three percent
of the acquired ETF's outstanding securities would not be prohibited
from redeeming shares of the ETF under the proposed rule.
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    We request comment on whether the condition achieves this purpose.
If not, are there other conditions that would better address the
concern?
    Second, the proposed rule would prohibit an ETF, its principal

underwriter, and a broker or a dealer that relies on the rule to sell
ETF shares in excess of section 12(d)(1)(B) limits from redeeming (or
submitting an order to redeem) those shares acquired by another fund
that exceed the three percent limit in section 12(d)(1)(A)(i).\221\ We
recognize that it may be difficult in all circumstances for an ETF, its
principal underwriter, a broker or a dealer to know whether a
redemption order is submitted by an acquiring fund that acquired more
than three percent of the ETF's shares in reliance on the proposed
rule. Accordingly, we are proposing to include a safe harbor for each
of those entities if it has: (i) Received a representation from the
acquiring fund that none of the ETF's shares the acquiring fund is
redeeming includes any shares that it acquired in excess of three
percent of the ETF's shares in reliance on proposed rule 12d1-4(a); and
(ii) no reason to believe that the acquiring fund is redeeming ETF
shares that the acquiring fund acquired in excess of three percent of
the ETF's shares in reliance on the proposed rule.\222\ If an acquiring
fund attempts to redeem ETF shares in connection with a threat to
coerce the ETF, the ETF would know of the attempt. In those
circumstances, or if the principal underwriter, broker or dealer knows
or has reason to know of the threat, the entity could not redeem (or
submit for redemption) the ETF shares held by the acquiring fund. We
believe that the proposed condition prohibiting acquiring funds from
redeeming ETF shares acquired in reliance on the proposed rule should
sufficiently prevent an acquiring fund from threatening redemptions as
a means of coercing an ETF adviser.
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    \221\ Proposed rule 12d1-4(b)(1). Under the proposed rule, an
exchange-traded fund, any principal underwriter thereof, and a
broker or a dealer may sell or otherwise dispose of exchange-traded
fund shares if the exchange-traded fund does not redeem, or the
principal underwriter, broker or dealer does not submit for
redemption any of the exchange-traded fund's shares that were
acquired by an acquiring fund in excess of the limits of section
12(d)(1)(A)(i) in reliance on proposed rule 12d1-4(a). Id. An
acquiring fund would be deemed to have redeemed or sold the most
recently acquired exchange-traded fund shares first. Id. See also
supra note 220.
    We note that our adoption of proposed rule 12d1-4 would not
preclude an acquiring fund from continuing to rely on exemptive
orders we have previously issued that permit funds to invest in ETFs
in excess of the limits of section 12(d)(1) but which do not
restrict their ability to redeem ETF shares, subject to the
conditions set forth in the orders and described above. Moreover, we
intend to continue to issue such orders and may consider their
codification in a rule in the future.
    \222\ Proposed rule 12d1-4(b)(2).
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    We request comment on these conditions. Do most funds that invest
in ETFs redeem their shares or sell them in secondary market
transactions? Would the prohibition on redemption impede the ability of
acquiring funds to dispose of ETF shares? Do acquiring funds realize
significant benefits from the ability to redeem ETF shares?
    The proposed conditions limiting redemptions of ETF shares are
designed to eliminate the threat of redemption that an acquiring fund
could otherwise use to coerce an ETF. Accordingly, the proposed rule
does not include the conditions in our exemptive orders that require
the ETF \223\ and the acquiring fund to take measures to prevent the
acquiring fund from unduly influencing the ETF.\224\
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    \223\ The orders require that: (i) The board of directors of an
ETF, including a majority of its independent directors, determines
that any consideration paid by the ETF to the acquiring fund or any
investment adviser, depositor, or principal underwriter of the
acquiring fund and any person controlling, controlled by, or under
common control with an investment adviser, depositor, or principal
underwriter of the acquiring fund, (but not including any investment
adviser of the ETF or any person controlling, controlled by, or
under common control with the investment adviser of the ETF)
(``acquiring fund affiliate'') in connection with any services or
transactions: (a) Is fair and reasonable in relation to the nature
and quality of the services and benefits received by the ETF; (b) is
within the range of consideration that the ETF would be required to
pay to another unaffiliated entity in connection with the same
services or transactions; and (c) does not involve overreaching on
the part of any person concerned; (ii) the ETF board of directors,
including a majority of the independent directors, adopts procedures
reasonably designed to monitor any purchases of securities by the
ETF in an underwriting in which a principal underwriter is an
officer, director, member of an advisory board, acquiring fund
investment adviser, acquiring fund depositor, or an acquiring fund
employee or an affiliated person of any such person (``affiliated
underwriting''), and the board reviews these purchases at least
annually to determine whether the purchases were influenced by the
acquiring fund's investment in the ETF; and (iii) the ETF maintains
and preserves a copy of the procedures designed to monitor purchases
made in an affiliated underwriting and maintains a written record of
each purchase of securities in an affiliated underwriting and the
information or materials upon which the board's determinations were
made. See supra note 205.
    \224\ The orders require that: (i) Neither the acquiring fund
nor any acquiring fund affiliate cause any existing or potential
investment by the acquiring fund in an ETF to influence the terms of
any services or transactions between the acquiring fund or an
acquiring fund affiliate and the ETF (or certain affiliates of the
ETF); (ii) neither the acquiring fund nor an acquiring fund
affiliate causes the ETF to purchase a security in any affiliated
underwriting; and (iii) the acquiring fund board of directors,
including a majority of its independent directors, adopts procedures
reasonably designed to assure that the acquiring fund's investment
adviser(s) is conducting the acquiring fund's investment program
without taking into account any consideration received by the
acquiring fund or an acquiring fund affiliate from the ETF (or
certain affiliates of the ETF). See supra note 205.
    As discussed above, the proposed rule would however include the
condition from our exemptive orders that an acquiring fund (and any
entity in a control relationship with the acquiring fund) could not
``control'' the ETF. See supra note 215 and accompanying text.
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    We request comment on the exclusion of these conditions from the
proposed rule. Is there a concern that if the acquiring fund and ETF do
not take particular measures to prevent the acquiring fund from unduly
influencing the ETF, acquiring funds may be able more easily to coerce
the ETF? Notwithstanding the prohibition on control and redemption,
should we be concerned about particular transactions between an
acquiring fund (or an acquiring fund affiliate) and an ETF, or an ETF's
purchase of securities during an underwriting in which a principal
underwriter is an affiliate of the acquiring fund or its adviser? If
there is reason for concern about ETF purchases of securities in an
affiliated underwriting, is that concern limited to purchases from an
affiliate of the acquiring fund or its adviser? Should any specific
conditions in the exemptive orders be included in the proposed rule in
addition to or in place of the proposed conditions to prevent an
acquiring fund or an acquiring fund affiliate from unduly influencing
an ETF?
3. Complex Structures
    To prevent the formation of overly complex multi-tiered fund
structures, the proposed rule would prohibit an acquired ETF from
itself being a fund of funds (i.e., the rule would prohibit a fund of
funds of funds, or three-tier fund, structure).\225\ A fund of ETFs has

the potential to become a complicated corporate structure of the kind
that concerned Congress when section 12(d)(1) was enacted.\226\ If an
acquiring fund invests in an ETF that in turn invests in other funds
(including other ETFs), an acquiring fund shareholder could find it
difficult to determine the nature and value of the holdings ultimately
underlying his or her investment. The proposed rule is designed to
allow an ETF the flexibility to invest in other funds in order to meet
its investment objectives while preventing shareholder confusion as to
the nature of their investment in an acquiring fund by limiting the
extent of those ETF investments.\227\
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    \225\ Proposed rule 12d1-4(a)(4) (``The exchange-traded fund has
a disclosed policy that prohibits it from investing more than 10
percent of its assets in: (i) Other investment companies in reliance
on section 12(d)(1)(F) or section 12(d)(1)(G) of the Act or [rule
12d1-4]; and (ii) Any other company that would be an investment
company under section 3(a) of the Act but for the exceptions to that
definition provided in sections 3(c)(1) and 3(c)(7) of the Act (15
U.S.C. 80a-3(c)(1) and 80a-3(c)(7)).''). Section 12(d)(1)(A)(iii) of
the Act limits an acquiring fund's total investment in other funds
to no more than 10 percent of the acquiring fund's assets. An ETF
would still be able to make limited investments in other funds,
including other ETFs. This is similar to a condition in section
12(d)(1)(G) of the Act that provides an exemption from section
12(d)(1) limits for funds to invest in other funds in the same group
provided, among other things, the acquired fund has a policy that it
will not rely on exemptions allowing it to be a fund of funds. See
15 U.S.C. 80a-12(d)(1)(G)(i)(IV). The exemptive orders generally
prohibit an acquired ETF from investing in other funds beyond
section 12(d)(1)(A) limits. Many of the orders have provided
exceptions to this general prohibition, which permit the ETF to
invest in money market funds beyond the limits of section
12(d)(1)(A) either in reliance on another exemptive order allowing
the ETF to do so or in reliance on rule 12d1-1. In addition, some of
the orders permit the ETF to invest in another fund beyond the
limits of section 12(d)(1)(A) to the extent permitted by section
12(d)(1)(E) of the Act. An acquiring fund relying on any of these
exceptions may have difficulty determining whether an acquired ETF
would itself be considered a fund of funds because the acquiring
fund might not be able to ascertain easily if the ETF is relying on
an order, section 12(d)(1)(E) of the Act, or rule 12d1-1 to invest
in other funds beyond the limits of section 12(d)(1)(A) of the Act.
The orders also do not anticipate any future exemptive relief the
Commission might provide to allow acquired ETFs to invest in other
non-money market funds in excess of section 12(d)(1)(A) limits.
Limiting exemptive relief to investments in ETFs with disclosed
policies would allow an acquiring fund to determine easily if it
could invest in a particular ETF.
    \226\ See supra note 198 and accompanying text.
    \227\ Under the proposed rule, an acquiring fund could invest in
an ETF that invests up to 10 percent of its assets in other ETFs.
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    We request comment on the proposed limits on an ETF itself being a
fund of funds. Are the proposed limits on an underlying ETF's
investments in other funds sufficient to prevent investor confusion? If
not, what limits should the proposed rule include to prevent
shareholder confusion? Should the proposed rule include the same limit
(and exceptions to the limit) as in our exemptive orders? \228\ Are
there reasons not to restrict the ability of an acquired ETF itself to
invest in other funds, including ETFs, beyond the limits of section
12(d)(1)(A)? \229\ Does the fact that ETF shares trade more like a
typical equity security make it less likely that investors would be
confused if we were to allow an acquiring fund to invest in an ETF that
itself invests more than ten percent of its assets in other ETFs in
reliance on proposed rule 12d1-4?
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    \228\ As discussed above, the orders generally prohibit an
acquired ETF from investing in other funds beyond the limits of
section 12(d)(1)(A). Some of the orders include a few exceptions to
this general prohibition. See supra note 225.
    \229\ The proposed rule would allow an acquired ETF to invest in
other funds, including ETFs, beyond the limits of section
12(d)(1)(A) in reliance on sections 12(d)(1)(F) and 12(d)(1)(G) and
to invest in other ETFs beyond the limits of section 12(d)(1)(A) in
reliance on the proposed rule. However, the proposed rule would
limit an acquired ETF's aggregate investment in these funds to no
more than 10 percent of the acquired ETF's assets. Proposed rule
12d1-4(a)(4).
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4. Layering of Fees
    As discussed above, one of Congress' concerns regarding fund of
funds arrangements was that acquiring fund shareholders might pay
excessive charges due to duplicative fees at the acquiring and acquired
fund levels.\230\ To prevent duplicative fees at the acquiring and
acquired fund levels, the proposed rule would limit sales charges and
service fees charged by the acquiring fund to those set forth in the
Financial Industry Regulatory Authority's (``FINRA'') sales charge
rule, which takes into consideration fees charged at both levels of a
fund of funds arrangement.\231\ In addition, like all acquiring funds,
funds that invest in ETFs would be subject to our disclosure rules for
fund investments in other funds. These rules require all registered
funds to disclose in their prospectus fee tables expenses paid by both
the acquiring and acquired funds so that shareholders can evaluate the
costs of investing in a fund that invests in other funds, including
ETFs.\232\ These rules and the proposed fee limit may fully address
congressional concerns with the duplication and layering of fees that
hide the real cost of investing in an investment company.\233\
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    \230\ See supra note 197 and accompanying text.
    \231\ Proposed rule 12d1-4(a)(3). The proposed rule would limit
the sales charge (including any 12b-1 fee) or service fee charged in
connection with the purchase, sale, or redemption of securities
issued by the acquiring fund to the FINRA fee limits for fund of
funds set forth in NASD Conduct Rule 2830(d)(3). Some ETFs charge a
12b-1 fee. See, e.g., Select Sector SPDRs[supreg], Prospectus 20,28
(Jan. 31, 2008). FINRA does not, however, apply Conduct Rule 2830 to
variable annuity contracts. See NASD Conduct Rule 2820(a) (rule 2820
applies exclusively and in lieu of rule 2830 to the activities of
members in connection with variable contracts to the extent the
activities are subject to federal securities law regulation). To
address the potential for excessive layering of fees in a separate
account that invests in an acquiring fund, proposed rule 12d1-
4(a)(3)(ii) would: (i) Prohibit an acquiring fund in which a
separate account invests and any ETF in which the acquiring fund
invests from charging a sales load and would allow only the
acquiring fund or ETF, but not both, to impose asset-based sales
charges or service fees; and (ii) require the aggregate fees
associated with the variable insurance contract and the sales
charges and service fees charged by the acquiring fund and the ETF
to be reasonable in relation to the services rendered, the expenses
expected to be incurred and, with respect to the variable insurance
contract, the risks assumed by the insurance company.
    \232\ See Item 3(f) to Form N-1A; Fund of Funds Adopting
Release, supra note 201, at Section II.D.
    \233\ See supra note 197.
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    We request comment on the proposed condition limiting the fees
charged by an acquiring fund. Would the proposed fee limits adequately
prevent acquiring fund shareholders from paying excessive distribution
or service fees? \234\ Are there any special concerns as to how to
apply the proposed fee limits to an acquiring fund when a separate
account invests in an acquiring fund? Do our disclosure requirements
provide sufficient information to investors to allow them to determine
whether the total fees imposed on a fund of ETFs are consistent with
their investment objectives?
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    \234\ The proposed rule would not include the condition from our
orders requiring the acquiring fund adviser (or sponsor or trustee)
to waive its fee in an amount at least equal to any compensation
(including fees received pursuant to any 12b-1 plan but excluding
advisory fees) received from the ETF by the acquiring fund's
adviser, trustee, or sponsor or an affiliated person of the
acquiring fund's adviser, trustee, or sponsor in connection with the
acquiring fund's investment in the ETF. The proposed rule also does
not include the condition from our orders that requires the board of
the acquiring fund to find that the advisory fees charged under an
advisory contract are based on services provided that will be in
addition to, rather than duplicative of, the services provided by an
adviser to an acquired ETF. As we noted in the proposing and
adopting releases for rule 12d1-1 explaining our exclusion of a
similar condition from rule 12d1-1, an acquiring fund board is
already obligated to protect the fund from being overcharged for
services provided to the fund regardless of any special findings we
might require. See Fund of Funds Adopting Release, supra note 201,
nn.51-52 and accompanying text; Fund of Funds Proposing Release,
supra note 197, at nn.65-67 and accompanying text.
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C. Scope of Proposed Rule 12d1-4

1. Acquiring Funds and ETFs Eligible for Relief
    Proposed rule 12d1-4 would permit open-end and closed-end
management companies (including business development companies) \235\
and UITs \236\ that comply with the rule's conditions to invest in ETFs
beyond the

limits of section 12(d)(1).\237\ Our orders to date have provided
exemptions only for investments in ETFs by registered management funds
and UITs.\238\ We do not anticipate that providing a similar exemption
for business development companies would raise particular concerns that
section 12(d)(1) was designed to address.
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    \235\ A business development company is any closed-end company
that: (i) Is organized under the laws of, and has its principal
place in, any state or states; (ii) is operated for the purpose of
investing in securities described in section 55(a)(1)-(3) of the Act
and makes available ``significant managerial assistance'' to the
issuers of those securities, subject to certain conditions; and
(iii) has elected under section 54(a) of the Act to be subject to
the sections addressing activities of business development companies
under the Act. See 15 U.S.C. 80a-2(a)(48). Section 60 of the Act
extends the limits of section 12(d) to a business development
company to the same extent as if it were a registered closed-end
fund. Section 6(f) of the Act exempts business development companies
that have made the election under section 54 of the Act from
registration and other provisions of the Act. We similarly included
business development companies within the scope of rule 12d1-1 to
allow then to invest in money market funds beyond the limits of
section 12(d)(1). See Fund of Funds Adopting Release, supra note
201, at nn.44-46 and accompanying text.
    \236\ Because an ETF can be organized either as an open-end
management company or UIT, see supra note 8, it could rely on the
proposed rule to invest in other ETFs beyond the limits contained in
section 12(d)(1).
    \237\ Section 12(d)(1)(B)'s limits on sales of an acquired
fund's securities apply only to shares of an ETF organized as an
open-end investment company.
    \238\ We have not had the opportunity to consider a request for
an individual exemptive order for other types of investment
companies. Our orders also have permitted funds to invest in ETFs
organized as UITs (and as open-end funds). Proposed rule 12d1-4
would include relief for investments in ETFs that are organized as
UITs as long as the UITs satisfy the criteria enumerated in proposed
rule 6c-11(e)(4). Proposed rule 12d1-4(d)(2). As noted above,
proposed rule 6c-11 would not include a UIT within its relief
because we have not received an exemptive application for a new ETF
to be organized as a UIT in a number of years. See supra note 65 and
accompanying text.
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    We request comment on the inclusion of business development
companies within the scope of proposed rule 12d1-4. Would these
entities benefit from this exemption? Are there reasons not to extend
the exemption to these companies? Do any special concerns arise with
respect to extending the exemption to these companies?

2. Investments in Affiliated ETFs Outside the Fund Complex

    In addition to providing an exemption from section 12(d)(1) of the
Act, the proposed rule would provide exemptions from sections 17(a)(1),
17(a)(2), 57(a)(1) and 57(a)(2) of the Act. These provisions restrict a
fund's ability to enter into transactions with affiliated persons.\239\
They are designed to prevent affiliated persons from managing the
fund's assets for their own benefit, rather than for the benefit of the
fund's shareholders.\240\ These provisions would otherwise effectively
preclude a fund that acquires five percent or more of the securities of
an ETF in another fund complex from making any additional purchases of
shares from the ETF.\241\ They also would prohibit an affiliated
acquiring fund from depositing (i.e., ``selling'') securities
identified in the creation basket. Permitting an acquiring fund to
purchase additional ETF shares from the ETF at NAV on the same basis as
any other purchaser of a creation unit, by itself, seems to provide
little opportunity for the acquiring fund to manage the ETF for its own
benefit.\242\ Allowing the ETF to acquire securities identified in a
creation basket from an affiliated acquiring fund on the same basis as
any other investor also would not seem to implicate the concerns
underlying section 17(a). Accordingly, we believe that exemptions from
sections 17(a)(1), 17(a)(2), 57(a)(1), and 57(a)(2) of the Act for
these transactions would be appropriate, in the public interest, and
consistent with the protection of investors and the purposes of the
Act.\243\
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    \239\ Section 17 of the Act limits transactions between a fund
and its affiliated persons. Section 17(a) of the Act generally
prohibits affiliated persons of a registered fund (``first-tier
affiliates'') or affiliated persons of the fund's affiliated persons
(``second-tier affiliates'') from selling securities or other
property to or purchasing securities or other property from the fund
(or any company the fund controls). Section 57 of the Act restricts
certain transactions between business development companies and
certain of their affiliates. An affiliated person of a fund
includes: (i) Any person directly or indirectly owning, controlling,
or holding with power to vote, five percent or more of the
outstanding voting securities of the fund; and (ii) any person five
percent or more of whose outstanding voting securities are directly
or indirectly owned, controlled, or held with power to vote by the
fund. See 15 U.S.C. 80a-2(a)(3)(A), (B). Thus, if an acquiring fund
holds five percent or more of the outstanding voting shares of the
ETF, the acquiring fund is an affiliated person of the ETF and the
ETF is an affiliated person of the acquiring fund.
    \240\ See Investment Trusts and Investment Companies: Hearings
on S. 3580 Before a Subcomm. of the Senate Comm. On Banking and
Currency, 76th Cong., 3d Sess. 37 (1940) (Statement of Commissioner
Healy). Section 17 also would restrict an acquiring fund from
investing in an ETF that is affiliated with the acquiring fund
because both funds have a common investment adviser or other person
exercising a controlling influence over the management or policies
of the funds. See 15 U.S.C. 80a-2(a)(3)(C). The determination of
whether a fund is under the control of its adviser, officers, or
directors depends on all the relevant facts and circumstances. See
Investment Company Mergers, Investment Company Act Release No. 25259
(Nov. 8, 2001) [66 FR 57602 (Nov. 15, 2001)], at n.11. For purposes
of this release, we presume that funds with a common investment
adviser are under common control because funds that are not
affiliated persons would not require, and thus not rely on, the
exemptions from section 17(a). Although funds in the same group of
investment companies generally are under common control of an
investment adviser or other person exercising a controlling
interest, these funds may rely on section 12d(1)(G) of the Act to
invest in an ETF in the same group. See infra note 249 and
accompanying text.
    \241\ An ETF would be prohibited under section 17(a)(1) from
selling its shares to an affiliated acquiring fund and under section
17(a)(2) from purchasing securities (i.e., securities designated in
the creation basket) from the affiliated acquiring fund in exchange
for ETF shares. An acquiring fund would be prohibited under section
17(a)(1) from selling any securities (i.e., securities identified in
the creation basket) to an affiliated ETF in exchange for the ETF's
shares. An acquiring fund also would be prohibited under section
17(a)(2) from purchasing (creation basket) securities from an
affiliated ETF for the redemption of ETF shares. The ETF would be
prohibited under section 17(a)(1) from selling the affiliated
acquiring fund (creation basket) securities in exchange for ETF
shares redeemed and under section 17(a)(2) from acquiring the ETF
shares submitted for redemption by the affiliated acquiring fund.
    \242\ The exemptive orders provide similar relief from sections
17(a)(1) and 17(a)(2) of the Act, including relief to allow the
acquiring fund to redeem shares of an affiliated ETF. The proposed
rule would not, however, provide an acquiring fund relief from
sections 17(a)(2) and 57(a)(2) of the Act in order to redeem shares
in excess of the three percent limit in section 12(d)(1)(A)(i) from
an affiliated ETF. In addition, proposed rule 6c-11, which would
permit persons affiliated with an ETF solely because they own five
percent or more of the ETF's shares, to purchase and sell ETF shares
in-kind (i.e., in exchange for securities designated in the creation
basket) would not extend relief to certain redemptions by acquiring
funds consistent with proposed rule 12d1-4(a). See supra Section
III.C.3 and proposed rule 6c-11(d). As noted above, no orders have
been issued to business development companies therefore no order
includes relief from sections 57(a)(1) and 57(a)(2) of the Act. See
supra note 238 and accompanying text.
    \243\ Our proposal would not provide an exemption for any
transactions other than the sale of securities by an acquiring fund
to an affiliated ETF for a creation unit of ETF shares. The proposed
rule also would not provide an exemption for any other transactions
between a business development company and an affiliated ETF that
would be subject to section 57 limitations.
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    We seek comment on these exemptions. Are there risks other than the
concerns we addressed with respect to section 12(d)(1) limitations,
regarding the potential that the acquiring fund could manage the ETF,
that would arise from the proposed exception allowing a fund to acquire
more than five percent of the shares of an affiliated ETF in another
complex?
3. Use of Affiliated Broker to Effect Sales
    In order to allow acquiring funds to take full advantage of the
exemptive relief, proposed rule 12d1-4 also would provide limited
relief from section 17(e)(2) of the Act. If an investment company in
one complex acquired more than five percent of the assets of an ETF in
another complex, any broker-dealer affiliated with that ETF would
become a (second-tier) affiliated person of the acquiring fund.\244\ As
a result of the affiliation, the broker-dealer's fee for effecting the
sale of securities to (or by) the acquiring fund would be subject to
the conditions set forth in rule 17e-1, including the quarterly board
review and recordkeeping requirements with respect to certain
securities transactions involving the affiliated broker-dealer.\245\

We believe that it is unlikely that a broker-dealer would be in a
position to take advantage of the acquiring fund merely because that
fund owned a position in an ETF affiliated with the broker-dealer.\246\
Accordingly, the proposed rule would permit an acquiring fund to pay
commissions, fees, or other remuneration to a (second-tier) affiliated
broker-dealer without complying with the quarterly board review and
recordkeeping requirements set forth in rules 17e-1(b)(3) and 17e-
1(d)(2).\247\ This relief would be available only if the broker-dealer
and the acquiring fund are affiliated solely because of the acquiring
fund's investment in the ETF.
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    \244\ See supra notes 239-240.
    \245\ Section 17(e)(2) of the Act prohibits an affiliated person
(or second-tier affiliate) of a fund from receiving compensation for
acting as a broker, in connection with the sale of securities to or
by the fund if the compensation exceeds limits prescribed by the
section. Rule 17e-1 sets forth a conditional exemption under which a
commission, fee or other remuneration shall be deemed as not
exceeding the ``usual and customary broker's commission'' for
purposes of section 17(e)(2)(A) of the Act. Rule 17e-1(b)(3)
requires the fund's board of directors, including a majority of the
directors who are not interested persons under section 2(a)(19) of
the Act, to determine at least quarterly that all transactions
effected in reliance on the rule have complied with procedures which
are reasonably designed to provide that the brokerage compensation
is consistent with the rule's standards. Rule 17e-1(d)(2) specifies
the records that must be maintained by each fund with respect to any
transaction effected pursuant to rule 17e-1.
    \246\ We expect that the ETF's adviser would have no influence
over the decisions made by the acquiring fund's adviser. In
addition, because the interests of the adviser to the ETF and the
adviser to the acquiring fund are directly aligned with their
respective funds, transactions between the acquiring fund and a
broker-dealer affiliate of the ETF are likely to be at arm's length.
    \247\ Proposed rule 12d1-4(c). The proposed relief is similar to
relief we have provided in rule 12d1-1, which permits funds to
invest in money market funds in excess of section 12(d)(1) limits.
See Fund of Funds Adopting Release, supra note 201, at nn.32-36 and
accompanying text. An acquiring fund relying on this exemption would
be required to comply with all of the provisions of rule 17e-1,
except for those in paragraphs (b)(3) and (d)(2). It does not appear
that having to comply with the other provisions contained in rule
17e-1 would deter acquiring funds from taking full advantage of the
exemption provided by proposed rule 12d1-4.
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    We request comment on the proposed exemptions. Is the scope of the
proposed exemptions from section 17 limitations sufficiently broad to
allow funds to take full advantage of the proposed relief? Are the
proposed exemptions from board review and recordkeeping requirements
with respect to transactions with an affiliated broker-dealer
necessary? Do funds engage in these transactions with broker-dealer
affiliates of acquired ETFs? Is there additional section 17 relief that
would be helpful in order for acquiring funds to take full advantage of
the proposed exemption for investments in ETFs? If so, please be
specific regarding the transactions that would prevent funds from
relying on the proposed rule.

V. Exemption for Affiliated Fund of Funds Investments

A. Affiliated Fund of Funds Investments in ETFs

    As noted above, Congress recognized that the investment limits in
section 12(d)(1) might restrict certain legitimate fund of funds
arrangements, and included three exceptions to those limits.\248\ One
of these exceptions--section 12(d)(1)(G)--permits a registered open-end
investment company or UIT to invest in other registered open-end
investment companies or UITs (including ETFs) that are in the ``same
group of investment companies'' (``affiliated funds'') beyond the
section 12(d)(1) limits.\249\ A fund that invests in unaffiliated ETFs
(i.e., ETFs in other fund groups) in many cases, however, is still
subject to the section 12(d)(1) limits.\250\ Section 12(d)(1)(G)
restricts the other investments an acquiring fund investing in
affiliated funds can make to government securities and short-term
paper.\251\
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    \248\ For a full discussion of section 12(d)(1) limitations and
the exceptions under sections 12(d)(1)(E), 12(d)(1)(F), and
12(d)(1)(G) of the Act, see Fund of Funds Proposing Release, supra
note 197, at Section I.
    \249\ See 15 U.S.C. 80a-12(d)(1)(G). Section 12(d)(1)(G)(ii) of
the Act defines ``same group of investment companies'' to mean ``any
2 or more registered investment companies that hold themselves out
to investors as related companies for purposes of investment and
investor services.'' Section 12(d)(1)(G) imposes the following
conditions on funds relying on this exception: (i) other investments
are limited to short-term paper and government securities; (ii)
acquired funds must have a policy against investing in shares of
other funds in reliance on sections 12(d)(1)(F) or 12(d)(1)(G) (to
prevent multi-tiered structures); and (iii) overall distribution
expenses are limited.
    \250\ A fund could invest in unaffiliated funds in reliance on
two other statutory exemptions. Under section 12(d)(1)(E) an
investment company may acquire securities issued by another
investment company provided that (i) the acquiring fund's depositor
or principal underwriter is a broker or dealer registered under the
Securities Exchange Act of 1934, (or a person the broker-dealer
controls), (ii) the security is the only investment security the
acquiring fund holds (or the securities are the only investment
securities the acquiring investment company holds if it is a
registered UIT that issues two or more classes or series of
securities, each of which provides for the accumulation of shares of
a different investment company), and (iii) the acquiring investment
company is obligated (a) to seek instructions from its shareholders
with regard to voting the acquired investment company's securities
or to vote the acquired investment company's shares in the same
proportion as the vote of all other acquired investment company
shareholders, and (b) if unregistered, to obtain Commission approval
before substituting the investment security. A fund relying on
section 12(d)(1)(F) of the Act (and its affiliated persons) may
acquire no more than three percent of another investment company's
outstanding stock, cannot charge a sales load greater than 1\1/2\
percent; is restricted in its ability to redeem shares of the
acquired investment company; and must vote shares of an acquired
investment company either by seeking instructions from the acquiring
fund's shareholders, or voting the shares in the same proportion as
the vote of all other shareholders of the acquired investment
company.
    \251\ Congress imposed this limitation to restrict the use of
the exemption provided by section 12(d)(1)(G) to a ``bona fide''
fund of funds. Congress permitted other investments to include only
government securities and short-term paper, which provide the fund
with a source of liquidity to redeem shares. See H.R. Rep. No. 622,
supra note 200, at 42.
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    When it added section 12(d)(1)(G) to the Act, Congress also gave us
specific authority to provide certain exemptions from the limitations
of section 12(d)(1) if the exemption is consistent with the public
interest and the protection of investors.\252\ In conjunction with the
adoption of rule 12d1-1 in 2006 (allowing funds to invest in money
market funds beyond the limits of section 12(d)(1)), we adopted rule
12d1-2, which allows funds relying on section 12(d)(1)(G) also to
invest in: (i) Unaffiliated money market funds when the acquisition is
in reliance on rule 12d1-1; (ii) securities issued by unaffiliated
funds (including ETFs), subject to the investment limits in sections
12(d)(1)(A) and 12(d)(1)(F) of the Act; \253\ and (iii) securities not
issued by an investment company. Under rule 12d1-2, therefore, a fund
that invests in affiliated funds in reliance on section 12(d)(1)(G) and
desires to invest in unaffiliated ETFs is subject to these statutory
limitations (e.g., to acquiring no more than three percent of the
acquired ETF's shares). There seems no reason, however, to maintain the
statutory limitations on investments in ETFs in these circumstances
when we are proposing to permit other types of funds to invest in ETFs
in excess of section 12(d)(1) limits. No special issues appear to arise
in connection with an acquiring fund's investments in an unaffiliated
ETF simply because the acquiring fund also invests in affiliated funds.
Accordingly, we propose to amend rule 12d1-2 to allow acquiring funds
that invest in affiliated funds in reliance on section 12(d)(1)(G) to
invest in unaffiliated ETFs beyond the statutory limitations as long as
the funds comply with the conditions of proposed rule 12d1-4.\254\ This
is similar to the relief we provided to affiliated funds of funds to
allow them to acquire shares in money market funds, if the acquisition
is in reliance on rule 12d1-1.\255\
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    \252\ Section 12(d)(1)(J) of the Act authorizes the Commission
to exempt any person, security or transaction, or any class or
classes of transactions, from section 12(d)(1) of the Act if the
exemption is consistent with the public interest and the protection
of investors. See supra note 214.
    \253\ See supra note 250.
    \254\ Proposed rule 12d1-2(a)(4).
    \255\ See 17 CFR 270.12d1-2(a)(3).
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    We request comment on the proposed amendment. Are there reasons not
to extend the proposed relief to affiliated funds of funds? Do
investments by an acquiring fund that invests in affiliated funds raise
any special concerns if the acquiring fund also invests in unaffiliated
ETFs? Are these concerns different than any other fund's investment in
unaffiliated ETFs?

B. Affiliated Fund of Funds Investments in Other Assets

    We also are proposing an amendment to rule 12d1-2 that would allow
funds relying on section 12(d)(1)(G) to invest in assets other than
securities. As discussed above, in 2006 we adopted rule 12d1-2 to
permit affiliated funds of funds to acquire securities issued by other
unaffiliated investment companies, as well as ``securities (other than
securities issued by an investment company).'' \256\ The rule was
intended to allow an acquiring fund greater flexibility to meet
investment objectives that may not be met as well by investments in
affiliated funds. We noted that these investments would not seem to
present any additional concerns that section 12(d)(1)(G) was intended
to address.\257\
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    \256\ See 17 CFR 270.12d1-2(a)(1), 17 CFR 270.12d1-2(a)(2).
    \257\ See Fund of Funds Proposing Release, supra note 197, at
n.80 and accompanying text.
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    Since we adopted the rule, it has been brought to our attention
that funds relying on section 12(d)(1)(G) wish to invest in other types
of financial assets, including futures and other financial instruments
that might not be securities under the Act and thus may not be within
the scope of rule 12d1-2.\258\ Investments in these types of assets may
allow an acquiring fund greater flexibility to meet investment
objectives that may not be met as well by investments in securities. In
addition, like investments in securities, investments in these assets
do not appear to raise concerns that the investment limits on fund of
funds arrangements contained in section 12(d)(1) were intended to
address. Accordingly, we propose to amend rule 12d1-2 to allow funds
relying on section 12(d)(1)(G) to invest in assets or instruments other
than securities.\259\ Under the proposed rule, funds relying on the
exemptive relief in section 12(d)(1)(G) would be able to invest in,
among other things, real estate, futures contracts, and other financial
instruments that do not qualify as a security under the Act.\260\ Those
investments would, of course, have to be consistent with the fund's
investment policies.\261\
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    \258\ See 15 U.S.C. 80a-2(a)(36) (defining ``security''). If a
future or other financial instrument in which a fund relying on
section 12(d)(1)(G) proposes to invest is included within the Act's
definition of ``security,'' investments in such an instrument would
be permitted under current rule 12d1-2(a)(2).
    \259\ Proposed rule 12d1-2(a)(5).
    \260\ We have issued exemptive orders to funds that rely on
section 12(d)(1)(G) to allow those funds to invest in futures
contracts and other financial instruments. See, e.g., Schroder
Series Trust, et al., Investment Company Act Release Nos. 28133
(Jan. 24, 2008) [73 FR 5603 (Jan. 30, 2008)] (notice) and 28167
(Feb. 25, 2008) (order); The UBS Funds, et al., Investment Company
Act Release Nos. 28080 (Dec. 19, 2007) [72 FR 74372 (Dec. 31, 2007)]
(notice) and 28122 (Jan. 16, 2008) (order); Vanguard Star Funds, et
al., Investment Company Act Release Nos. 28009 (Sept. 28, 2007) [72
FR 56813 (Oct. 4, 2007)] (notice) and 28024 (Oct. 24, 2007) (order)
(permitting funds relying on section 12(d)(1)(G) and rule 12d1-2
under the Act to invest in financial instruments that may not be
securities within the meaning of section 2(a)(36) of the Act).
    \261\ See Item 4 of Form N-1A (requiring disclosure of funds'
investment objectives and principal investment strategies).
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    We seek comment on this proposal. Would any concerns arise if a
fund relying on section 12(d)(1)(G) could invest directly in non-
securities? Do these concerns differ from a traditional fund that can
invest in such assets and invests in other funds subject to the limits
of section 12(d)(1)?

VI. Request for Comment

    The Commission requests comment on the rules, rule amendments, and
Form N-1A amendments proposed in this release. The Commission also
requests suggestions for additional changes to existing rules or forms,
and comments on other matters that might have an effect on the
proposals contained in this release. Commenters are requested to
provide empirical data to support their views.

VII. Paperwork Reduction Act

    Certain provisions of proposed rule 6c-11 would result in new
``collection of information'' requirements within the meaning of the
Paperwork Reduction Act of 1995 (``PRA'').\262\ The Commission is
therefore submitting this proposal to the Office of Management and
Budget (``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5
CFR 1320.11. The title for the collection of information requirements
is ``Rule 6c-11 under the Investment Company Act of 1940, `Exchange-
traded funds.' '' If adopted, this collection would not be mandatory,
but would be necessary for ETFs that seek to form and operate as open-
end management companies without seeking individual exemptive orders.
Responses to the collection of information requirements of proposed
rule 6c-11 would not be kept confidential.
---------------------------------------------------------------------------

    \262\ 44 U.S.C. 3501-3520.
---------------------------------------------------------------------------

    In addition, the Commission is proposing amendments to an existing
collection of information requirement titled ``Form N-1A under the
Investment Company Act of 1940 and Securities Act of 1933, Registration
Statement for Open-End Management Companies.'' Compliance with the
disclosure requirements of Form N-1A is mandatory. Responses to the
disclosure requirements are not kept confidential.
    Finally, proposed rule 12d1-4 would result in a new ``collection of
information'' requirement within the meaning of the PRA. The Commission
is therefore submitting the proposal for rule 12d1-4 to OMB for review.
The title for the collection of information requirements is ``Rule
12d1-4 under the Investment Company Act of 1940, `Exemption for
investments in exchange-traded funds.' '' If adopted, this collection
would not be mandatory, but would be a condition that an acquiring fund
would have to satisfy in order for an ETF, its principal underwriter, a
broker, or a dealer to rely on the safe harbor if an acquiring fund
redeems ETF shares. Responses to the collection of information
requirements of proposed rule 12d1-4 would not be kept confidential.
    An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a
currently valid control number. OMB has not yet assigned control
numbers to the new collections for proposed rules 6c-11 and 12d1-4. The
approved collection of information associated with Form N-1A, which
would be revised by the proposed amendments, displays control number
3235-0307.

A. Proposed Rule 6c-11

    Proposed rule 6c7-11 would exempt ETFs from certain provisions of
the Act, permitting them to begin operating without obtaining an
exemptive order from the Commission. The proposed rule also would
expand the relief we have issued in the past to index-based ETFs, and
to transparent, actively managed ETFs. Each ETF seeking to rely on the
proposed rule would have to disclose on a daily basis specific
information to market participants: (i) The contents of its basket
assets; (ii) the identities and weightings of the component securities
and other assets in its portfolio if it does not track an index whose
provider discloses its composition daily; and (iii) the prior business
day's NAV, market closing price for its ETF shares and premium/discount
information.\263\ In addition, each ETF would have to disclose in its
registration statement: (i) the number of shares that comprise a
creation unit; and (ii) the foreign holidays that would prevent timely
satisfaction of redemption with respect to foreign securities in its
basket assets.\264\ An ETF

that chooses not to disclose its portfolio would have to track an index
whose provider discloses the identities and weightings of the
securities and other assets that constitute the index in order to rely
on the proposed rule. In addition, each ETF seeking to rely on the
proposed rule also would have to, in any sales literature (as defined
in the rule), identify itself as an ETF, which does not sell or redeem
individual shares, and explain that investors may purchase or sell
individual shares on national securities exchanges.
---------------------------------------------------------------------------

    \263\ 263 Proposed rule 6c-11.
    \264\ 264 Id.
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    Two of the disclosure conditions in proposed rule 6c-11 would not
result in a burden for purposes of the PRA. Disclosure of the contents
of the basket assets that comprise a creation unit and the number of
shares in each creation unit does not result in a burden because ETFs
must disclose this information in the normal course of business.\265\
Similarly, disclosure by an index provider of the identities and
weightings of the component securities and other assets that comprise
the index would not result in a burden because index providers disclose
this information in the normal course of business.
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    \265\ See Section II of this release for a discussion on the
operation of ETFs. Disclosure of the contents of the basket assets
and the number of shares that comprise a creation unit are critical
to investors who seek to purchase or redeem creation units from the
ETF and, therefore, to the operation of an ETF. To purchase a
creation unit, an investor would need to know the securities and
other assets that must be deposited with the ETF in exchange for a
creation unit. To redeem a creation unit, an investor would need to
know the number of ETF shares that comprise a creation unit in order
to compile enough shares to redeem from the ETF. Disclosure of the
contents of the basket assets also is important to the arbitrage
mechanism of the ETF. Arbitrageurs compare the NAV of the basket to
the NAV of ETF shares to determine whether to purchase or redeem
creation units based on the relative values of ETF shares in the
secondary market and the securities contained in the basket.
---------------------------------------------------------------------------

    The remaining four disclosure requirements are collections of
information. First, the proposed rule would require an ETF that does
not track an index whose provider discloses its composition daily to
provide daily disclosure of the identities and weightings of the
component securities and other assets in the ETF's portfolio.
Currently, two ETF registrants are required to disclose their
portfolios daily under the terms of their exemptive orders.\266\ The
Commission staff estimates that an ETF each year would spend
approximately 200 hours of professional time to update the relevant
Internet Web page daily with this information, at a cost of
$42,000.\267\ The staff also estimates that each new ETF initially
would spend 100 hours to develop the Web page for this disclosure.
Staff estimates the initial cost would be $22,520 for internal ETF
staff time to develop the Web page and $12,600 for an external Web site
developer, for a total of $35,120.\268\
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    \266\ ProShares Notice, supra note 113; Rydex ETF Trust,
Investment Company Act Release No. 27703 (Feb. 20, 2007) [72 FR 8810
(Feb. 27, 2007)]. Together, these registrants offer 64 ETFs that are
required to disclose their portfolios daily.
    \267\ Estimates on the number of burden hours and external costs
associated with the collections of information are based on informal
conversations between Commission staff and representatives of ETFs.
The staff estimates the cost would be 200 hours for an internal Web
site developer (at $211 per hour) (200 x $211 = $42,200). Hourly
wages used for purposes of this PRA analysis are from the Securities
Industry Association (now named Securities Industry and Financial
Markets Association), SIA Report on Management & Professional
Earnings in the Securities Industry 2006, modified to account for an
1800-hour work-year and multiplied by 5.35 to account for bonuses,
firm size, employee benefits and overhead.
    \268\ Commission staff estimates the cost would equal 80 hours
for Web site developers at the ETF (at $211 per hour) to develop the
Web page and 20 hours for internal Web site managers (at $282 per
hour) to review the Web page ((80 hours x $211) + (20 hours time x
$282) = $22,520). In addition, based on discussions with industry
representatives, the staff estimates that each ETF initially would
spend an additional $12,600 to external Web site developers ($22,520
+ 12,600 = $35,120).
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    We seek comments on these estimates. If commenters believe these
estimates are not reasonable, we request they provide data that would
allow us to make more accurate estimates.
    Second, the proposed rule also would require each ETF to disclose
its prior business day's NAV, market price for its shares, and premium/
discount information, which would provide investors with information on
the deviation, if any, between the price of ETF shares and the NAV of
the underlying portfolio. Commission staff estimates that an ETF each
year spends approximately 206 hours of professional time to update the
relevant Internet Web page daily with this information. Based on staff
estimates, we estimate the annual cost would be $43,466 for internal
ETF staff time to update the Web page and $6,000 to acquire the data
from external data providers.\269\ The staff also estimates that each
new ETF initially would spend 75 hours to develop the Web page for
these disclosures. Based on staff estimates, we estimate the initial
cost would be $16,890 for internal ETF staff time to develop the Web
page and $9,540 for an external Web site developer, for a total of
$26,430.\270\
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    \269\ Commission staff estimates the cost would equal 206 hours
for internal Web site developers at ($211 per hour) (206 x $211 =
$43,466).
    \270\ Commission staff estimates the cost would equal 60 hours
for internal Web site developers (at $211 per hour) to develop the
Web page and 15 hours for Web site managers (at $282 per hour) to
review the Web page ((60 hours x $211) + (15 hours x $282) =
$16,890). In addition, based on discussions with industry
representatives, the staff estimates that each fund would spend an
additional $9540 to external Web site developers ($16,890 + $9540 =
$26,430).
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    We seek comments on these estimates. If commenters believe these
estimates are not reasonable, we request they provide data that would
allow us to make more accurate estimates.
    Third, in any sales literature each ETF must identify itself as an
ETF that does not sell or redeem individual shares, and explain that
investors may purchase or sell individual shares only on national
securities exchanges. This condition is similar to the condition in our
exemptive orders, which requires each ETF to agree not to market or
advertise the ETF as an open-end fund or mutual fund and to explain
that the ETF shares are not individually redeemable. Based on
conversations with ETF representatives, Commission staff estimates that
an ETF each year spends approximately 30 hours at a cost of $1704 to
comply with the condition in our exemptive orders.\271\ Because the
condition in the proposed rule is similar, the staff estimates that
each new ETF also would spend 30 hours at a cost of $1704 to comply
with the condition in the proposed rule.
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    \271\ Commission staff estimates the cost would equal 2 hours
for the ETF's internal counsel (at $292 per hour) to draft the
disclosure and 28 hours for clerical staff (at $40 per hour) to
input and copy check the marketing materials ((2 x $292) + (28 x
$40) = $1704).
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    We seek comment on this estimate. If commenters believe this
estimate is not reasonable, we request they provide data that would
allow us to make a more accurate estimate.
    Finally, some ETFs that track foreign indexes have stated that
local market delivery cycles for transferring foreign securities to
redeeming investors, together with local market holiday schedules,
require a delivery process in excess of the statutory seven days
required by section 22(e) of the Act. The proposed rule would codify
the disclosure requirement in existing exemptive orders that requires
ETFs to disclose in their registration statements the foreign holidays
that would prevent timely satisfaction of redemption.\272\ The
collection of information burden for this disclosure is discussed in
the PRA analysis of proposed Form N-1A amendments in section VI.B
below.
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    \272\ See supra notes 136-141 and accompanying text for a
discussion of the proposed exemption from section 22(e) of the Act.
---------------------------------------------------------------------------

    As of December 2007, there were 601 ETFs.\273\ The Commission staff

estimates that each year 150 new ETFs will form and operate.\274\ The
staff estimates that each ETF each year would spend approximately 236
hours to comply with the conditions of proposed rule 6c-11. Each new
ETF would spend an additional 75 hours to develop the Web sites for
daily disclosure of its prior business day's NAV, market closing price
for its shares, and premium/discount information. In addition, ETFs
that provide the identities and weightings of the securities and other
assets in their portfolios if they do not track an index whose provider
discloses its composition daily would spend an additional 100 hours to
develop the Web sites for this disclosure. Each of those ETFs also
would spend an estimated 200 hours each year to update the disclosures
of portfolio assets on its Web site. For purposes of this PRA, the
staff estimates that one-half of all new ETFs (75 ETFs) would provide
this disclosure. Based on staff estimates, we estimate that ETFs would,
in the aggregate, spend 205,036 hours each year to comply with the
requirements of proposed rule 6c-11.\275\ We estimate further that ETFs
would spend 18,750 hours initially to develop the Web page for these
disclosures, amortized over three years for an annual burden of 6250
hours.\276\ Thus, the estimated total annual burden is 211,286
hours.\277\ We estimate the annual internal costs of ongoing compliance
with these disclosure requirements would be $40 million and external
costs would be $4.5 million.\278\ We further estimate that initial
internal costs to develop the Web page for these disclosures would be
$4.2 million and external costs would be $2.3 million, or $1.4 million
and $0.8 million, respectively, amortized over three years.\279\
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    \273\ ICI ETF Statistics 2007, supra note 5.
    \274\ To estimate the number of new ETFs each year for purposes
of this PRA, the staff has used the approximate average of the
number of new ETFs for the past three years ((50 + 153 + 244)/3
=149). ICI, Exchange-Traded Fund Assets December 2006, Jan. 31,
2007; ICI ETF Statistics 2007, supra note 5.
    \275\ Assuming all existing ETFs would rely on the proposed
rule, these estimates are based on the following calculations: ((206
hours + 30) x 612 (existing plus estimated new index-based ETFs)) +
(436 hours x 139 (existing plus estimated new actively managed ETFs)
= 205,036).
    \276\ This estimate is based on the following calculation: (75
hours x 75 (estimated new index-based ETFs)) + (175 hours x 75
(estimated new actively managed ETFs)) = 18,750.
    \277\ This estimate is based on the following calculation:
205,036 + 6250 = 211,286.
    \278\ These estimates are based on the following calculations:
(($43,466 + $1704) x 612) + ($42,000 x 139) = $39,760,670; ($6000 x
612) + ($6000 x 139) = $4,506,000.
    \279\ These estimates are based on the following calculations:
($16,890 x 75) + (($16,890 + $22,520) x 75) = $4,222,500; ($9540 x
75) + (($9540 + $12,600) x 75) = $2,376,000.
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B. Form N-1A

    We are proposing amendments to Form N-1A to provide more useful
information to investors who purchase and sell ETF shares on national
securities exchanges.
    Creation Units. The proposed amendments would permit an ETF to
exclude certain information from its prospectus that is not pertinent
to investors purchasing individual ETF shares. Specifically, an ETF
that has creation units of 25,000 shares or more may exclude from its
prospectus: (i) Information on how to purchase and redeem shares of the
ETF; \280\ and (ii) fee table fees and expenses for purchases and
redemptions of creation units.\281\ Based on conversations with
industry representatives, Commission staff estimates that this proposed
amendment would decrease the information collection burdens of an ETF
that has creation units of 25,000 shares or more by an average of 1.4
hours per fund per filing of an initial registration statement or post-
effective amendment to a registration statement.