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Federal Register › Vol. 73 › 73 FR 14618

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SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 239, 270, and 274 [Release Nos. 33-8901; IC-28193; File No. S7-07-08] RIN 3235-AJ60 Exchange-Traded Funds AGENCY:

Securities and Exchange Commission.

ACTION:

Proposed rule.

SUMMARY:

The Securities and Exchange Commission (“Commission” or “SEC”) is proposing a new rule under the Investment Company Act of 1940 that would exempt exchange-traded funds (“ETFs”) from certain provisions of that Act and our rules. The rule would permit certain ETFs to begin operating without the expense and delay of obtaining an exemptive order from the Commission. The rule is designed to eliminate unnecessary regulatory burdens, and to facilitate greater competition and innovation among ETFs. The Commission also is proposing amendments to our disclosure form for open-end investment companies, Form N-1A, to provide more useful information to investors who purchase and sell ETF shares on national securities exchanges. In addition, the Commission is proposing a new rule to allow mutual funds (and other types of investment companies) to invest in ETFs to a greater extent than currently permitted under the Investment Company Act.

DATES:

Comments should be received on or before May 19, 2008.

ADDRESSES:

Comments may be submitted by any of the following methods:

Electronic Comments

• Use the Commission's Internet comment form ( http://www.sec.gov/rules/proposed.shtml ); or

• Send an e-mail to rule-comments@sec.gov. Please include File Number S7-07-08 on the subject line; or

• Use the Federal eRulemaking Portal ( http://www.regulations.gov ). Follow the instructions for submitting comments.

Paper Comments

• Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.

All submissions should refer to File Number S7-07-08. This file number should be included on the subject line if e-mail is used

al eRulemaking Portal ( http://www.regulations.gov ). Follow the instructions for submitting comments.

Paper Comments

• Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.

All submissions should refer to File Number S7-07-08. This file number should be included on the subject line if e-mail is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site ( http://www.sec.gov/rules/proposed.shtml ). Comments are also available for public inspection and copying in the Commission's Public Reference Room, 100 F Street, NE., Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. FOR FURTHER INFORMATION CONTACT:

With respect to proposed rule 6c-11 and amendments to Form N-1A, Dalia Osman Blass, Senior Counsel, or Penelope Saltzman, Acting Assistant Director, (202) 551-6792, with respect to proposed rule 12d1-4 and proposed amendments to rule 12d1-2, Adam Glazer, Senior Counsel, or Penelope Saltzman, Acting Assistant Director, (202) 551-6792, Office of Regulatory Policy, Division of Investment Management, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-5041.

SUPPLEMENTARY INFORMATION:

The Commission is proposing for public comment new rules 6c-11 [17 CFR 270.6c-11] and 12d1-4 [17 CFR 270.12d1-4] and amendments to rule 12d1-2 [17 CFR 270.12d1-2] under the Investment Company Act of 1940 (“Investment Company Act” or “Act”), 1 and amendments to Form N-1A 2 under the Investment Company Act and the Securities Act of 1933 (the “Securities Act”). 3

1 15 U.S.C. 80a

TARY INFORMATION:

1 15 U.S.C. 80a. Unless otherwise noted, all references to rules under the Investment Company Act will be to Title 17, Part 270 of the Code of Federal Regulations [17 CFR 270], and all references to statutory sections are to the Investment Company Act.

2 17 CFR 239.15A, 17 CFR 274.11A.

3 15 U.S.C. 77a.

Table of Contents

I. Introduction II. Operation of Exchange-Traded Funds III. Exemptions Permitting Funds to Form and Operate as ETFs A. Scope of Proposed Rule 6c-11 1. Index-Based ETFs 2. Actively Managed ETFs 3. Organization as an Open-End Investment Company B. Conditions 1. Transparency of Index and Portfolio Holdings 2. Listing on a National Securities Exchange and Dissemination of Intraday Value 3. Marketing 4. Conflicts of Interest 5. Affiliated Index Providers C. Exemptive Relief 1. Issuance of “Redeemable Securities” 2. Trading of ETF Shares at Negotiated Prices 3. In-Kind Transactions Between ETFs and Certain Affiliates 4. Additional Time for Delivering Redemption Proceeds D. Disclosure Amendments 1. Delivery of Prospectuses to Investors 2. Amendments to Form N-1A E. Amendment of Previously Issued Exemptive Orders IV. Exemption for Investment Companies Investing in ETFs A. Background B. Proposed Rule 12d1-4 Conditions 1. Control 2. Redemptions 3. Complex Structures 4. Layering of Fees C. Scope of Proposed Rule 12d1-4 1. Acquiring Funds and ETFs Eligible for Relief 2. Investments in Affiliated ETFs Outside the Fund Complex 3. Use of Affiliated Broker To Effect Sales V. Exemption for Affiliated Fund of Funds Investments A. Affiliated Fund of Funds Investments in ETFs B

ackground B. Proposed Rule 12d1-4 Conditions 1. Control 2. Redemptions 3. Complex Structures 4. Layering of Fees C. Scope of Proposed Rule 12d1-4 1. Acquiring Funds and ETFs Eligible for Relief 2. Investments in Affiliated ETFs Outside the Fund Complex 3. Use of Affiliated Broker To Effect Sales V. Exemption for Affiliated Fund of Funds Investments A. Affiliated Fund of Funds Investments in ETFs B. Affiliated Fund of Funds Investments in Other Assets VI. Request for Comment VII. Paperwork Reduction Act VIII. Cost-Benefit Analysis IX. Consideration of Promotion of Efficiency, Competition and Capital Formation X. Initial Regulatory Flexibility Analysis XI. Statutory Authority Text of Proposed Rules and Form Amendments

I. Introduction

Exchange-traded funds are an increasingly popular investment vehicle. 4 Last year, the number of ETFs 5 Although aggregate ETF assets are less than seven percent of assets held by traditional mutual funds ( i.e. , open-end investment companies), 6 they are growing more rapidly. 7

4 When we refer to an ETF in this release, we refer to an ETF that meets the definition of “investment company” and is registered under the Investment Company Act generally because it issues securities and is primarily engaged or proposes to primarily engage in the business of investing in securities. Some other types of exchange-traded funds, which we will not discuss in this release, invest primarily in commodities or commodity-based instruments, such as crude oil and precious metal (“commodity ETFs”). Commodity ETFs are typically organized as trusts, and issue shares that trade on a securities exchange like other ETFs, but they are not “investment companies” under the Investment Company Act

Some other types of exchange-traded funds, which we will not discuss in this release, invest primarily in commodities or commodity-based instruments, such as crude oil and precious metal (“commodity ETFs”). Commodity ETFs are typically organized as trusts, and issue shares that trade on a securities exchange like other ETFs, but they are not “investment companies” under the Investment Company Act. See section 3(a)(1) (defining the term “investment company” as a company that “(A) is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting, or trading in securities; (B) is engaged or proposes to engage in the business of issuing face-amount certificates of the installment type, or has been engaged in such business and has any such certificate outstanding; or (C) is engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities, and owns or proposes to acquire investment securities having a value exceeding 40 per centum of the value of such issuer's total assets

5 Investment Company Institute (“ICI”), Outline of Supplemental Tables for Exchange-Traded Fund Report ( http://members.ici.org/stats/etfdata.xls (“ICI ETF Statistics 2007”)), Exchange-Traded Fund Assets December 2007 , Jan. 30, 2008 (“ ICI ETF Assets 2007 ”). ICI statistics cited in this release may be found at: http://www.ici.org/stats/etf/index.html and exclude commodity ETFs. By comparison, 153 ETFs were introduced in 2006, 50 were introduced in 2005, and 32 ETFs were introduced in 2004. ICI, 2007 Investment Company Fact Book , May 2007.

6 In 2007, net new investment in ETFs was approximately $142 billion compared to $212 billion in traditional mutual funds, or 67 percent of net new investment in traditional mutual funds. ICI ETF Statistics 2007, supra note 5; ICI, Trends in Mutual Fund Investing December 2007 , Jan. 30, 2008 (“ ICI Trends December 2007 ”).

7 ICI ETF Assets 2007 , supra note 5

ent Company Fact Book , May 2007.

7 ICI ETF Assets 2007 , supra note 5. As of December 2007, assets held by traditional equity and bond mutual funds were $8.9 trillion. ICI Trends December 2007 , supra note 6. In 2007, ETF assets grew 42 percent (from $407.9 billion to $579.5 billion) while traditional equity and bond mutual fund assets grew 9.7 percent (from $8.06 trillion to $8.9 trillion). See ICI ETF Statistics 2007, supra note 5; ICI Trends December 2007 , supra note 6.

ETFs offer public investors an undivided interest in a pool of securities and other assets and thus are similar in many ways to traditional mutual funds, except that shares in an ETF can be bought and sold throughout the day like stocks on an exchange through a broker-dealer. 8 ETFs therefore possess characteristics of traditional mutual funds, which issue redeemable shares, and of closed-end investment companies, which generally issue shares that trade at negotiated market prices on a national securities exchange and are not redeemable. 9

shares, and of closed-end investment companies, which generally issue shares that trade at negotiated market prices on a national securities exchange and are not redeemable. 9

8 ETF shares represent an undivided interest in the portfolio of assets held by the fund. ETFs are registered with the Commission and are organized either as open-end investment companies or unit investment trusts (“UITs”). See section 5(a)(1) of the Investment Company Act (defining “open-end company” as a management company that is offering for sale or has outstanding any redeemable security of which it is the issuer); section 4(2) of the Act (defining “unit investment trust” as an investment company that (A) is organized under a trust indenture, contract of custodianship or agency, or similar instrument, (B) does not have a board of directors, and (C) issues only redeemable securities, each of which represents an undivided interest in a unit of specified securities, but does not include a voting trust). 15 U.S.C. 80a-5(a)(1).

9 ETFs today have certain characteristics that have made them attractive to investors. Many have lower expense ratios and certain tax efficiencies compared to traditional mutual funds, and they allow investors to buy and sell shares at intra-day market prices. Moreover, investors can sell ETF shares short, write options on them, and set market, limit, and stop-loss orders on them. The shares of many ETFs often trade on the secondary market at prices close to the net asset value (“NAV”) of the shares, rather than at discounts or premiums.

Since they were first developed in the early 1990s, ETFs have evolved. The first ETFs held a basket of securities that replicated the component securities of broad-based stock market indexes, such as the S&P 500. 10 Many of the newer ETFs are based on more specialized indexes, 11 including indexes that are designed specifically for a particular ETF, 12 bond indexes, 13 and international indexes. 14 Originally marketed as opportunities for investors to participate in tradable portfolio or basket products, ETFs are held today in increasing amounts by institutional investors (including mutual funds) and other investors as part of sophisticated trading and hedging strategies. 15 Shares of ETFs can be bought and held (sometimes as a core component of a portfolio), 16 or they can be traded frequently as part of an active trading strategy. 17

10 See, e.g. , SPDR Trust, Series 1, Investment Company Act Release Nos. 18959 (Sept. 17, 1992) [57 FR 43996 (Sept. 23, 1992)] (notice) and 19055 (Oct. 26, 1992) (order) (“SPDR Order”); Diamonds Trust, Investment Company Act Release Nos. 22927 (Dec. 5, 1997) [62 FR 65453 (Dec. 12, 1997)] (notice) and 22979 (Dec. 30, 1997) (order). The S&P 500 stands for the Standard & Poor's 500 Composite Stock Price Index.

11 ETF providers offer ETFs that track the performance of indexes related to particular industries or market sectors. In 2007, domestic sector/industry ETFs increased by 62% from 135 to 219. ICI ETF Assets 2007 , supra note 5.

12 Many of these indexes are essentially portfolios of assets that are compiled (and change) on the basis of criteria that the index provider has designed for the particular ETF. Some indexes, for example, are “fundamental” indexes or rules-based indexes, in which the securities are chosen on criteria such as dividends and core earnings. See, e.g. , PowerShares Exchange-Traded Fund Trust, Investment Company Act Release Nos. 25961 (Mar. 4, 2003) [68 FR 11598 (Mar. 11, 2003)] (notice) (“PowerShares 2003 Notice”) and 25985 (Mar

ex provider has designed for the particular ETF. Some indexes, for example, are “fundamental” indexes or rules-based indexes, in which the securities are chosen on criteria such as dividends and core earnings. See, e.g. , PowerShares Exchange-Traded Fund Trust, Investment Company Act Release Nos. 25961 (Mar. 4, 2003) [68 FR 11598 (Mar. 11, 2003)] (notice) (“PowerShares 2003 Notice”) and 25985 (Mar. 28, 2003) (order) (“PowerShares 2003 Order”) (PowerShares offers ETFs that mirror custom-built indexes based on “Intellidexes,” which were created by a quantitative unit of the American Stock Exchange). A few of the index providers that compile and revise the indexes are affiliated with the sponsor of the ETF. See, e.g. , WisdomTree Investments, Investment Company Act Release Nos. 27324 (May 18, 2006) [71 FR 29995 (May 24, 2006)] (notice) (“WisdomTree Notice”) and 27391 (June 12, 2006) (order) (“WisdomTree Order”) (WisdomTree's ETFs seek to track the price and yield performance of domestic and international equity securities indexes provided by an affiliate).

13 As of December 2007, 49 ETFs track bond indexes. ICI, Exchange-Traded Fund Assets December 2007 , Jan. 30, 2008. See, e.g. , Ameristock ETF Trust, Investment Company Act Release Nos. 27847 (May 30, 2007) [72 FR 31113 (June 5, 2007)] (notice) (“Ameristock Notice”) and 27874 (June 26, 2007) (order); Vanguard Bond Index Funds, Investment Company Act Release Nos. 27750 (Mar. 9, 2007) [72 FR 12227 (Mar. 15, 2007)] (notice) and 27773 (Apr. 2, 2007) (order); Barclays Global Fund Advisors, Investment Company Act Release Nos. 27608 (Dec. 21, 2006) [71 FR 78235 (Dec. 28, 2006)] (notice) (“Barclays High Yield Notice”) and 27661 (Jan. 17, 2007) (order).

14 The first international equity ETFs were introduced in 1996. As of December 2007, there were 159 ETFs that provide exposure to international equity markets. ICI, Exchange-Traded Fund Assets December 2007 , Jan. 30, 2008. International index-based ETFs increased by 87% from 85 in 2006 to 159 in 2007. Id

(Dec. 28, 2006)] (notice) (“Barclays High Yield Notice”) and 27661 (Jan. 17, 2007) (order).

15 David Hoffman, Funds' grip loosens as ETFs gain , InvestmentNews, Apr. 28, 2006 (reporting that in 2004, 44% of 821 advisory firms polled by Financial Research Corp. of Boston said they collectively allocated an average of 12% of total assets under management to ETFs as compared with 2003, in which only 34% used ETFs and collectively allocated an average of 8% of assets under management).

16 See, e.g. , iShares Trust, Investment Company Act Release No. 25969 (Mar. 21, 2003) [68 FR 15010 (Mar. 27, 2003)].

17 See Gary L. Gastineau, Exchange-Traded Funds Manual, 2 (2002) (“Gastineau”) (ascribing the popularity of ETFs among active traders to high trading volume, competitive market makers, and active arbitrage pricing.). Morgan Stanley, Exchange-Traded Funds Quarterly Report , Nov. 16, 2006, at 13 (“They can be used by market timers wishing to gain or reduce exposure to entire markets or sectors throughout the trading day.”).

Like money market funds first offered in the 1970s, ETFs represent a new type of registered investment company (“fund”). And like money market funds, they have required exemptions from certain provisions of the Act before they can commence operations. 18 Since 1992, the Commission has issued 61 orders to ETFs and their sponsors. 19

18 See rule 2a-7 under the Act, which codified the standards for granting the applications filed by money market funds for exemptions from the pricing and valuation provisions of the Act

nd like money market funds, they have required exemptions from certain provisions of the Act before they can commence operations. 18 Since 1992, the Commission has issued 61 orders to ETFs and their sponsors. 19

18 See rule 2a-7 under the Act, which codified the standards for granting the applications filed by money market funds for exemptions from the pricing and valuation provisions of the Act. For a discussion of the administrative history of rule 2a-7, see Valuation of Debt Instruments and Computation of Current Price per Share by Certain Open-End Investment Companies (Money Market Funds), Investment Company Act Release No. 12206 (Feb. 1, 1982) [47 FR 5428 (Feb. 5, 1982)].

19 Since 2000, the Commission has provided ETF sponsors relief for any ETFs created in the future in connection with their exemptive orders so that the sponsors can introduce new ETFs if the ETFs meet the terms and conditions contained in the exemptive orders. See, e.g. , Barclays Global Fund Advisors, Investment Company Act Release Nos. 24394 (Apr. 17, 2000) [65 FR 21219 (Apr. 20, 2000)] (notice) and 24451 (May 12, 2000) (order).

In this release, we propose a new rule that would codify the exemptive orders we have issued to ETFs. Proposed rule 6c-11 would allow new competitors ( i.e. , those sponsors who do not already have exemptive orders) to enter the market more easily. We also are proposing amendments to our registration form for open-end funds, Form N-1A, to provide more useful information to individual investors who purchase and sell ETF shares on national securities exchanges. Finally, we are proposing a new rule to allow funds to invest in ETFs to a greater extent than currently permitted under the Act and our rules.

II. Operation of Exchange-Traded Funds

All ETFs trading today operate in a similar way. 20 Unlike traditional mutual funds, ETFs do not sell or redeem their individual shares (“ETF shares”) at net asset value (“NAV”)

s on national securities exchanges. Finally, we are proposing a new rule to allow funds to invest in ETFs to a greater extent than currently permitted under the Act and our rules.

II. Operation of Exchange-Traded Funds

All ETFs trading today operate in a similar way. 20 Unlike traditional mutual funds, ETFs do not sell or redeem their individual shares (“ETF shares”) at net asset value (“NAV”). Instead, financial institutions purchase and redeem ETF shares directly from the ETF, but only in large blocks called “creation units.” 21 A financial institution that purchases a creation unit of ETF shares first deposits with the ETF a “purchase basket” of certain securities and other assets identified by the ETF that day, and then receives the creation unit in return for those assets. The basket generally reflects the contents of the ETF's portfolio and is equal in value to the aggregate NAV of the ETF shares in the creation unit. After purchasing a creation unit, the financial institution may hold the ETF shares, or sell some or all in secondary market transactions. 22

20 Until recently, all ETFs had an investment objective of seeking returns that are correlated to the returns of a securities index, and in this respect operated much like traditional index funds. Recently, we issued orders approving actively managed ETFs. See WisdomTree Trust, et al. , Investment Company Act Release Nos. 28147 (Feb. 6, 2008) [73 FR 7776 (Feb. 11, 2008)] (notice) (“WisdomTree Actively Managed ETF Notice”) and 28174 (Feb. 27, 2008) (order) (“WisdomTree Actively Managed ETF”); Barclays Global Fund Advisors, et al. , Investment Company Act Release Nos. 28146 (Feb. 6, 2008) [73 FR 7771 (Feb. 11, 2008)] (notice) and 28173 (Feb. 27, 2008) (order) (“Barclays Actively Managed ETF”); Bear Sterns Asset Management, Inc., et al. , Investment Company Act Release Nos. 28143 (Feb. 5, 2008) [73 FR 7768 (Feb. 11, 2008)] (notice) and 28172 (Feb. 27, 2008) (order) (“Bear Sterns Actively Managed ETF”); PowerShares Capital Management LLC, et al

y Act Release Nos. 28146 (Feb. 6, 2008) [73 FR 7771 (Feb. 11, 2008)] (notice) and 28173 (Feb. 27, 2008) (order) (“Barclays Actively Managed ETF”); Bear Sterns Asset Management, Inc., et al. , Investment Company Act Release Nos. 28143 (Feb. 5, 2008) [73 FR 7768 (Feb. 11, 2008)] (notice) and 28172 (Feb. 27, 2008) (order) (“Bear Sterns Actively Managed ETF”); PowerShares Capital Management LLC, et al. , Investment Company Act Release Nos. 28140 (Feb. 1, 2008) [73 FR 7328 (Feb. 7, 2008)] (notice) (“PowerShares Actively Managed ETF Notice”) and 28171 (Feb. 27, 2008) (order) (“PowerShares Actively Managed ETF” and collectively, “Actively Managed ETF Orders”).

21 As discussed further below, creation units typically consist of at least 25,000 ETF shares. See infra note 113.

22 We note that depending on the facts and circumstances, broker-dealers that purchase a creation unit and sell the shares may be deemed to be participants in a distribution, which could render them statutory underwriters and subject them to the prospectus delivery and liability provisions of the Securities Act. See 15 U.S.C. 77b(a)(11).

Like operating companies and closed-end funds, ETFs register offerings and sales of ETF shares under the Securities Act and list their shares for trading under the Securities Exchange Act of 1934 (“Exchange Act”). 23 As with any listed security, investors may trade ETF shares at market prices. ETF shares purchased in secondary market transactions are not redeemable from the ETF except in creation units.

23 15 U.S.C. 78a.

ion units.

23 15 U.S.C. 78a.

The redemption process is the reverse of the purchase process. The financial institution acquires (through purchases on national securities exchanges, principal transactions, or private transactions) the number of ETF shares that comprise a creation unit, and redeems the creation unit from the ETF in exchange for a “redemption basket” of securities and other assets. 24 An investor holding fewer ETF shares than the amount needed to constitute a creation unit (most retail investors) may dispose of those ETF shares by selling them on the secondary market. The investor receives market price for the ETF shares, which may be higher or lower than the NAV of the shares, and pays customary brokerage commissions on the sale.

24 ETFs sometimes provide cash-in-lieu payments on some (or all) purchases or redemptions. See infra notes 120-121 and accompanying text.

The ability of financial institutions to purchase and redeem creation units at each day's NAV creates arbitrage opportunities that may help keep the market price of ETF shares near the NAV per share of the ETF. For example, if ETF shares begin trading on national securities exchanges at a price below the fund's NAV per share, financial institutions can purchase ETF shares in secondary market transactions and, after accumulating enough shares to comprise a creation unit, redeem them from the ETF in exchange for the more valuable securities in the ETF's redemption basket. Those purchases create greater market demand for the ETF shares, and thus tend to drive up the market price of the shares to a level closer to NAV. 25 Conversely, if the market price for ETF shares exceeds the NAV per share of the ETF itself, a financial institution can deposit a basket of securities in exchange for the more valuable creation unit of ETF shares, and then sell the individual shares in the market to realize its profit

t demand for the ETF shares, and thus tend to drive up the market price of the shares to a level closer to NAV. 25 Conversely, if the market price for ETF shares exceeds the NAV per share of the ETF itself, a financial institution can deposit a basket of securities in exchange for the more valuable creation unit of ETF shares, and then sell the individual shares in the market to realize its profit. These sales would increase the supply of ETF shares in the secondary market, and thus tend to drive down the price of the ETF shares to a level closer to the NAV of the ETF share. 26

25 The purchase of the ETF shares on the secondary market combined with the sale of the redemption basket securities also may create upward pressure on the price of ETF shares and/or downward pressure on the price of redemption basket securities, driving the market price and ETF NAV closer together.

26 The institution's purchase of the purchase basket securities combined with the sale of ETF shares also may create downward pressure on the price of ETF shares and/or upward pressure on the price of purchase basket securities, driving the market price and the ETF's NAV closer together.

ETF sponsors and market participants report that the average deviation between the daily closing price and the daily NAV of ETFs that track domestic indexes is generally less than 2%. See , e.g. , Vanguard U.S. Stock ETFs, Prospectus 56-59 (Apr. 27, 2007). ETFs that track foreign indexes may have a more significant deviation. See , e.g. , iShares FTSE/Xinhua China 25 Index Fund, Prospectus 19 (Dec. 1, 2006).

). ETFs that track foreign indexes may have a more significant deviation. See , e.g. , iShares FTSE/Xinhua China 25 Index Fund, Prospectus 19 (Dec. 1, 2006).

Arbitrage activity in ETF shares is facilitated by the transparency of the ETF's portfolio. Each day, the ETF publishes the identities of the securities in the purchase and redemption baskets, which are representative of the ETF's portfolio. 27 Each exchange on which the ETF shares are listed typically discloses an approximation of the current value of the basket on a per share basis (“Intraday Value”) 28 at 15 second intervals throughout the day and, for index-based ETFs, disseminates the current value of the relevant index. 29 This transparency can contribute to the efficiency of the arbitrage mechanism because it helps arbitrageurs 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 ETF's portfolio.

27 With respect to index-based ETFs, portfolio transparency is enhanced by the transparency of the underlying index. Index providers publicly announce the components of their indexes. Because an index-based ETF seeks to track the performance of an index, often by replicating the component securities of the index, the transparency of the underlying index results in a high degree of transparency in the ETF's investment operations. Similarly, each of the actively managed ETFs operating under the recent exemptive orders approved by the Commission is required to make public each day the securities and other assets in its portfolio. See Actively Managed ETF Orders, supra note 20.

28 The Intraday Value also is referred to as the Intraday Indicative Value, Indicative Optimized Portfolio Value, Indicative Fund Value, Indicative Trust Value, or Indicative Partnership Value.

29 National securities exchanges are permitted to disseminate this information at 60 second intervals for ETFs that track non-U.S. indexes. See , e.g

lio. See Actively Managed ETF Orders, supra note 20.

28 The Intraday Value also is referred to as the Intraday Indicative Value, Indicative Optimized Portfolio Value, Indicative Fund Value, Indicative Trust Value, or Indicative Partnership Value.

29 National securities exchanges are permitted to disseminate this information at 60 second intervals for ETFs that track non-U.S. indexes. See , e.g. , Commentary .01(b)(2) to NYSE Acra Equities Rule 5.2(j)(3); Commentary 0.2(a)(C)(c) to American Stock Exchange Constitution and Rules & Arbitration Awards Rule 1000A.

Arbitrage activity in ETF shares also appears to be affected by the liquidity of the securities in an ETF's portfolio. Most ETFs represent in their applications for exemptive relief that they invest in highly liquid securities. 30

30 Index-based ETFs track indexes that have specified methodologies for selecting their component securities. The methodologies generally ensure that an index consists of securities that will be highly liquid. See , e.g. , Barclays High Yield Notice, supra note 13 (“The Underlying Index is a rules-based index designed to reflect the 50 most liquid U.S. dollar-denominated high-yield corporate bonds registered for sale in the U.S. or exempt from registration.”). Because index-based ETFs either replicate or sample the indexes, their portfolio securities also should possess these characteristics. The actively managed ETFs also appear to invest in highly liquid securities. See WisdomTree Actively Managed ETF, supra note 20 (investing in U.S. and foreign money market securities); Barclays Actively Managed ETF, supra note 20 (investing in foreign supra note 20 (investing primarily in investment-grade fixed income securities); PowerShares Actively Managed ETF, supra note 20 (investing in large cap companies or U.S. government and corporate debt securities).

III

ties. See WisdomTree Actively Managed ETF, supra note 20 (investing in U.S. and foreign money market securities); Barclays Actively Managed ETF, supra note 20 (investing in foreign supra note 20 (investing primarily in investment-grade fixed income securities); PowerShares Actively Managed ETF, supra note 20 (investing in large cap companies or U.S. government and corporate debt securities).

III. Exemptions Permitting Funds To Form and Operate as ETFs

Today we are proposing for public comment a new rule that would codify much of the relief and many of the conditions of orders that we have issued to index-based ETFs in the past, and more recently to certain actively managed ETFs. The proposed rule is designed to enable most ETFs to begin operations without the need to obtain individual exemptive relief from the Commission.

A. Scope of Proposed Rule 6c-11

1. Index-Based ETFs

Proposed rule 6c-11, like our orders, would provide exemptions for ETFs that have a stated investment objective of maintaining returns that correspond to the returns of a securities index whose provider discloses on its Internet Web site the identities and weightings 31 of the component securities and other assets of the index. 32 In this respect, the rule would codify our previous exemptive orders. Our experience is that the conditions included in the index-based ETF orders have effectively preserved the statutory purposes of the Act.

31 Proposed rule 6c-11(e)(9) defines “weighting of the component security” as “the percentage of the index's value represented, or accounted for, by such component security.”

as “the percentage of the index's value represented, or accounted for, by such component security.”

32 Proposed rule 6c-11(e)(4)(v)(B) (defining “exchange-traded fund”); see infra Section III.B.1 for a discussion of this index transparency requirement. Index-based ETFs obtain returns that correspond to those of an underlying index by replicating or sampling the component securities of the index. An ETF that uses a replicating strategy generally invests in the component securities of the underlying index in the same approximate proportions as in the underlying index. See , e.g. , First Trust Exchange-Traded Fund, Investment Company Act Release No. 27051 (Aug. 26, 2005) [70 FR 52450 (Sept. 2, 2005)] (“First Trust Notice”) at n.1. If, however, there are practical difficulties or substantial costs involved in holding every security in the underlying index, the ETF may use a representative sampling strategy pursuant to which it will invest in some but not all of the relevant component securities. An ETF that uses a sampling strategy includes in its portfolio securities that are designed, in the aggregate, to reflect the underlying index's capitalization, industry, and fundamental investment characteristics, and to perform like the index. The ETF implements the sampling strategy by acquiring a subset of the component securities of the underlying index, and possibly some securities that are not included in the corresponding index that are designed to help the ETF track the performance of the index. See , e.g., id.

The proposed rule would not limit the types of indexes that an ETF may track or the types of securities that comprise any index. Thus, the rule would not limit the exemption to ETFs investing in liquid securities or assets, although existing ETFs generally have represented to us that their portfolios are comprised of highly liquid securities, 33 and, as open-end funds, are required to comply with the liquidity guidelines applicable to all open-end funds

at an ETF may track or the types of securities that comprise any index. Thus, the rule would not limit the exemption to ETFs investing in liquid securities or assets, although existing ETFs generally have represented to us that their portfolios are comprised of highly liquid securities, 33 and, as open-end funds, are required to comply with the liquidity guidelines applicable to all open-end funds. 34

33 See supra note 30 and accompanying and following text. See also WisdomTree Notice, supra note 12 at n.8 and accompanying text.

34 Long-standing Commission guidelines have required open-end funds to hold no more than 15% of their net assets in illiquid securities and other illiquid assets. See Statement Regarding “Restricted Securities,” Investment Company Act Release No. 5847 (Oct. 21, 1969) [35 FR 19989 (Dec. 31, 1970)]; Revisions of Guidelines to Form N-1A, Investment Company Act Release No. 18612 (Mar. 12, 1992) [57 FR 9828 (Mar. 20, 1992)]. A fund's portfolio security is illiquid if it cannot be disposed of in the ordinary course of business within seven days at approximately the value ascribed to it by the ETF. See Acquisition and Valuation of Certain Portfolio Instruments by Registered Investment Companies, Investment Company Act Release No. 14983 (Mar. 12, 1986) [51 FR 9773 (Mar. 21, 1986)] (adopting amendments to rule 2a-7 under the Act); Resale of Restricted Securities; Changes to Method of Determining Holding Period of Restricted Securities under Rules 144 and 145, Investment Company Act Release No. 17452 (Apr. 23, 1990) [55 FR 17933 (Apr. 30, 1990)] (adopting Rule 144A under the Securities Act).

We request comment regarding the effect of portfolio liquidity on the potential for deviation between ETF share market price and NAV and the amount of any deviation

; Changes to Method of Determining Holding Period of Restricted Securities under Rules 144 and 145, Investment Company Act Release No. 17452 (Apr. 23, 1990) [55 FR 17933 (Apr. 30, 1990)] (adopting Rule 144A under the Securities Act).

We request comment regarding the effect of portfolio liquidity on the potential for deviation between ETF share market price and NAV and the amount of any deviation. In addition to the liquidity guidelines applicable to all open-end funds, should the Commission include additional liquidity requirements as a condition of the exemptions? If so, what additional requirements and why? Should the chance (or likelihood) that substantial discounts or premiums may occur if an ETF portfolio contains less liquid securities or assets be a regulatory concern for the Commission, or should it be treated as a material risk to be disclosed to prospective investors, permitting them to evaluate whether the risk makes the ETF an appropriate investment in light of the investor's investment objectives? 35 We note that currently there is substantially more market interest in ETFs that track broad-based indexes that are comprised of highly liquid securities than ETFs that track more specialized indexes. 36 How would liquidity or illiquidity of securities or other assets in an ETF's portfolio affect the ability of financial institutions to assemble securities for a purchase basket and thus the arbitrage mechanism and operation of the ETF? Would liquidity requirements preclude the development of specialty ETFs that serve narrow investment purposes but which may satisfy particular investment needs of certain investors?

35 The Commission is proposing an amendment to Form N-1A that would codify the condition in our orders that ETFs disclose the extent and frequency with which market prices have tracked their NAV. See infra notes 169-170 and accompanying text.

36 See ICI ETF Statistics 2007, supra note 5.

erve narrow investment purposes but which may satisfy particular investment needs of certain investors?

36 See ICI ETF Statistics 2007, supra note 5.

2. Actively Managed ETFs

We recently issued exemptive orders to several actively managed ETFs and their sponsors. 37 Like our orders, proposed rule 6c-11 would provide an exemption for an actively managed ETF that discloses on its Internet Web site each business day the identities and weightings of the component securities and other assets held by the ETF. 38 Unlike index-based ETFs, an actively managed ETF does not seek to track the return of a particular index. Instead, an actively managed ETF's investment adviser, like an adviser to any traditional actively managed mutual fund, generally selects securities consistent with the ETF's investment objectives and policies without regard to a corresponding index.

37 See Actively Managed ETF Orders, supra note 20.

38 Proposed rule 6c-11(e)(4)(v)(A); see infra Section III.B.1 for a discussion of this requirement.

In 2001, we sought comment on the concept of an actively managed ETF (“2001 Concept Release”). 39 We requested comment on a broad number of questions that we felt were important to consider before expanding the scope of the exemptive orders we had issued. We wanted to know how investors would use an actively managed ETF because it seemed that, unlike an investment in an index-based ETF, an investment in an actively managed ETF could not be used, for example, to implement a hedging strategy. We questioned whether an actively managed ETF would provide investors with the same or similar benefits as

39 See Actively Managed Exchange-Traded Funds, Investment Company Act Release No. 25258 (Nov. 8, 2001) [66 FR 57614 (Nov. 15, 2001)] (“2001 Concept Release”)

ment in an index-based ETF, an investment in an actively managed ETF could not be used, for example, to implement a hedging strategy. We questioned whether an actively managed ETF would provide investors with the same or similar benefits as

39 See Actively Managed Exchange-Traded Funds, Investment Company Act Release No. 25258 (Nov. 8, 2001) [66 FR 57614 (Nov. 15, 2001)] (“2001 Concept Release”).

Our 2001 Concept Release also asked more focused questions about the structural and operational differences between the two types of ETFs and how those differences might affect the market value of ETF shares. We inquired whether as a matter of public policy an ETF must be designed to enable efficient arbitrage and thereby minimize the probability that ETF shares would trade at a material premium or discount. 40 We asked, for example, whether actively managed ETFs must have the same degree of portfolio transparency as index-based ETFs, a factor that appeared to contribute significantly to arbitrage efficiency. 41 It was unclear to us at that time whether an adviser to actively managed ETFs would be willing to provide the same degree of transparency as an adviser to index-based ETFs because, for example, disclosure could allow market participants to access the fund's investment strategy. 42 We were concerned that reduced transparency could expose arbitrageurs to greater investment risk and result in a less efficient arbitrage mechanism, which in turn could lead to more significant premiums and discounts than experienced by index-based ETFs.

40 Id. at text following n.35.

41 See supra note 27 and accompanying text.

42 We also noted concerns that full disclosure could permit market participants to “front-run” portfolio trades. See infra text accompanying and preceding note 84

nd result in a less efficient arbitrage mechanism, which in turn could lead to more significant premiums and discounts than experienced by index-based ETFs.

40 Id. at text following n.35.

41 See supra note 27 and accompanying text.

42 We also noted concerns that full disclosure could permit market participants to “front-run” portfolio trades. See infra text accompanying and preceding note 84. In addition, because actively managed portfolios likely would change more frequently and in less foreseeable ways than a portfolio of index-based ETFs, we were unclear how or whether an actively managed ETF would communicate intra-day portfolio changes to investors. See generally, Russ Wermers, The Potential Effects of More Frequent Portfolio Disclosure on Mutual Fund Performance, Investment Company Institute Perspective, June 2001, Vol. 7, No. 3, at http://www.ici.org/perspective/per07-03.pdf. (examining the potential effects of more frequent portfolio disclosure on the performance of mutual funds and concluding that, with more frequent disclosure, shareholders would likely receive lower total returns on their investments due to, among other things, front-running and free-riding).

We received 20 comments from market participants, many of which supported the introduction of actively managed ETFs. 43 Many commenters stated that actively managed ETFs would have the potential to provide investors with uses and benefits similar to index-based ETFs. For example, commenters maintained that, like index-based ETFs, actively managed ETFs could potentially serve as short-term or long-term investment vehicles, allow investors to gain exposure to an asset category such as value, growth or income, and play a significant role in an investor's hedging strategies. 44 Commenters also asserted that actively managed ETFs have the potential for providing investors benefits similar to index-based ETFs, including low expense ratios and intra-day exchange trading

erve as short-term or long-term investment vehicles, allow investors to gain exposure to an asset category such as value, growth or income, and play a significant role in an investor's hedging strategies. 44 Commenters also asserted that actively managed ETFs have the potential for providing investors benefits similar to index-based ETFs, including low expense ratios and intra-day exchange trading. 45 Other commenters, however, questioned whether some of the investor benefits traditionally associated with index-based ETFs would be present with actively managed ETFs. 46

43 The comment letters to the 2001 Concept Release are available for public inspection and copying in the Commission's Public Reference Room, 100 F Street, NE., Washington, DC 20549 (File No. S7-20-01), and are available on the Commission's Internet Web site: ( http://www.sec.gov/rules/concept/s72001.shtml. )

44 See , e.g. , Comment Letter of the American Stock Exchange LLC, File No. S7-20-01 (Mar. 5, 2002) (“For example, an investor may find that a particular actively managed ETF more closely tracks his securities holdings, and therefore may be a more effective hedge.”); Comment Letter of State Street Bank and Trust Company, File No. S7-20-01 (Jan. 14, 2002). One commenter asserted, however, that actively managed ETFs would be of greater interest to retail investors; institutional investors would not use active fund products for hedging, cash equitization or other strategies. Comment Letter of Barclays Global Investors, File No. S7-20-01 (Jan. 11, 2002).

45 See , e.g. , Comment Letter of the American Stock Exchange LLC, File No. S7-20-01 (Mar. 5, 2002); Comment Letter of State Street Bank and Trust Company, File No. S7-20-01 (Jan. 14, 2002).

See , e.g. , Comment Letter of the American Stock Exchange LLC, File No. S7-20-01 (Mar. 5, 2002); Comment Letter of State Street Bank and Trust Company, File No. S7-20-01 (Jan. 14, 2002).

46 One commenter, for example, asserted that an actively managed ETF would likely not experience similar tax efficiency because that is predominantly a function of the low portfolio turnover of index-based ETFs. The commenter also noted that actively managed ETFs are unlikely to have the low expenses associated with index-based ETFs, which result primarily from lower advisory fees associated with the passive management of those funds. Comment Letter of the Vanguard Group, File No. S7-20-01 (Feb. 14, 2002).

Commenters agreed that actively managed ETFs should be designed, like index-based ETFs, with an arbitrage mechanism intended to minimize the potential deviation between market price and NAV of ETF shares. 47 Not all commenters agreed, however, on whether we should be concerned with the extent of premiums or discounts and, therefore, whether we should require full portfolio transparency. Some asserted that the amount of any discount or premium that might develop ought not to be a consideration for us in determining whether to grant exemptive relief. 48 One commenter argued that ETFs with share prices that significantly deviate from NAV would likely not attract the interest of investors and would ultimately fail if they did not provide information necessary for market participants to make knowledgeable investment decisions. 49 Other commenters asserted that it is important to require that ETFs provide all investors with the same information about portfolio holdings 50 and to require clear fund disclosures regarding the risks associated with the level of transparency provided. 51 These commenters stressed the need, however, for sufficient market information to 52 Others argued that portfolio transparency is essential to support effective arbitrage

hat it is important to require that ETFs provide all investors with the same information about portfolio holdings 50 and to require clear fund disclosures regarding the risks associated with the level of transparency provided. 51 These commenters stressed the need, however, for sufficient market information to 52 Others argued that portfolio transparency is essential to support effective arbitrage. 53 One commenter asserted that any lack of transparency would negatively impact an ETF's arbitrage mechanism and would likely result in ETF shares trading at secondary market prices that do not reflect the value of the ETF's underlying portfolio. 54 The commenter noted that to the extent an ETF operates with less than full transparency during periods of market volatility, this would likely result in some individual investors buying or selling ETF shares at secondary market prices moving in the opposite direction of the ETF's NAV. The commenter urged us to consider carefully the consequence of granting an exemption that might yield such a result. 55 The Investment Company Institute asserted that to the extent that all or part of an ETF's portfolio is not transparent, it could raise significant investor protection concerns including the potential for disparate treatment of investors and the potential for the ETF to trade at significant premiums and discounts. 56

47 See, e.g. , Comment Letter of the Vanguard Group, File No. S7-20-01 (Feb. 14, 2002); Comment Letter of Barclays Global Investors, File No. S7-20-01 (Jan. 11, 2002).

48 See, e.g. , Comment Letter of the American Bar Association, Committee on Federal Regulation of Securities, File No. S7-20-01 (Feb. 1, 2002) (“We believe that the Commission should not mandate the level of transparency in ETFs' portfolios, but rather should allow fully informed demand in the financial markets to determine the proper levels. Different segments of the market with different needs might demand investment vehicles with different variation

ation, Committee on Federal Regulation of Securities, File No. S7-20-01 (Feb. 1, 2002) (“We believe that the Commission should not mandate the level of transparency in ETFs' portfolios, but rather should allow fully informed demand in the financial markets to determine the proper levels. Different segments of the market with different needs might demand investment vehicles with different variation. To prevent market demand from determining the structure of investment vehicles would retard efficiency, competition, and capital formation.”); Comment Letter of State Street Bank and Trust Company, File No. S7-20-01 (Jan. 14, 2002) (“* * *[A] non-transparent actively managed ETF will be no worse off than closed-end funds trading today. In fact, the premium/discount of a non-transparent ETF should be narrower due to the ETF's open-ended qualities.”); Comment Letter of the Vanguard Group, File No. S7-20-01 (Feb. 14, 2002) (“While [spreads] may be higher for actively managed ETFs than for index ETFs, we do not believe that the discounts between market price and NAV will approach those seen in closed-end funds.”).

49 See Comment Letter of State Street Bank and Trust Company, File No. S7-20-01 (Jan. 14, 2002); see also Comment Letter of the American Bar Association, Committee on Federal Regulation of Securities, File No. S7-20-01 (Feb. 1, 2002) (“Ultimately it is in the interest of the sponsor and investment adviser to provide for effective arbitrage opportunities. It is unlikely that an actively managed ETF sponsor would be able to convince the critical market participants such as specialists, market makers, arbitragers and other Authorized Participants to support a product that contained illiquid securities to a degree that would affect the liquidity of the ETF, making it difficult to price, trade and hedge, ultimately leading to its failure in the marketplace.”).

50 See, e.g. , Comment Letter of the Vanguard Group, File No. S7-20-01 (Feb

ical market participants such as specialists, market makers, arbitragers and other Authorized Participants to support a product that contained illiquid securities to a degree that would affect the liquidity of the ETF, making it difficult to price, trade and hedge, ultimately leading to its failure in the marketplace.”).

50 See, e.g. , Comment Letter of the Vanguard Group, File No. S7-20-01 (Feb. 14, 2002) (“Sponsors of actively managed ETFs should not be permitted to provide more information about portfolio holdings to the exchange specialist and market makers than they provide to other investors. Vanguard believes, as a matter of fundamental fairness, that all investors in a fund must be treated equally. Providing information only to a favored few is inconsistent with the foundation of our capital markets—full and fair disclosure to all investors.”).

51 See, e.g. , Comment Letter of Morgan Stanley & Co., File No. S7-20-01 (May 3, 2002) (“Even if the Commission were to determine that new forms of ETFs do pose a significant risk of trading at a discount or premium to NAV, we do not believe that the Commission should delay approval of the product for this reason. Instead, we would urge the Commission to address any perceived investor risks by requiring additional risk disclosure.”); Comment Letter of the Vanguard Group, File No. S7-20-01 (Feb. 14, 2002) (“Investors in an actively managed ETF must receive adequate disclosure about the risks associated with the level of the ETF's transparency (and other risks unique to actively managed ETFs) * * * if the ETF has limited transparency, the fund's disclosure documents should discuss the possibility that the spreads between bid and asked prices and between the market price and NAV of the fund's exchange-traded shares may be higher than is typically the case of index ETFs.”).

52 See, e.g. , Comment Letter of the American Stock Exchange LLC, File No. S7-20-01 (Mar

o actively managed ETFs) * * * if the ETF has limited transparency, the fund's disclosure documents should discuss the possibility that the spreads between bid and asked prices and between the market price and NAV of the fund's exchange-traded shares may be higher than is typically the case of index ETFs.”).

52 See, e.g. , Comment Letter of the American Stock Exchange LLC, File No. S7-20-01 (Mar. 5, 2002) (asserting that non-transparent actively managed ETFs need not disclose the full contents of their portfolios “so long as there is sufficient market information available to value the portfolio or a creation unit (or if different, the Redemption Basket) on an intra-day basis so as to facilitate secondary market trading and hedging.”); Comment Letter of State Street Bank and Trust Co., File No. S7-20-01 (“While the importance of an effective arbitrage mechanism is clear, there are potential ways to achieve an effective arbitrage mechanism with less than full transparency, and, potentially, with no portfolio transparency. This may be accomplished with proper disclosure of an actively managed ETF's investment strategy and portfolio characteristics.”).

53 See, e.g. , Comment Letter of Barclays Global Investors, File No. S7-20-01 (Jan. 11, 2002) (“It is generally accepted that portfolio transparency is the key to effective arbitrage. Therefore, the most significant issue for the Commission * * * is whether [actively managed ETFs] would provide the necessary level and frequency of portfolio disclosure to support efficient arbitrage.”).

54 Id.

55 Id.

56 Comment Letter of the Investment Company Institute, File No. S7-20-01 (Jan. 14, 2002).

nt Letter of the Investment Company Institute, File No. S7-20-01 (Jan. 14, 2002).

Today we propose exemptions applicable to both index-based and actively managed ETFs that provide portfolio transparency to market participants. The comments we received, together with subsequent developments, address the principal concerns we raised in the 2001 Concept Release with respect to actively managed ETFs. We have received a number of applications from actively managed ETFs whose sponsors are interested in offering fully transparent, actively managed ETFs, and recently we have issued orders approving several of these ETFs. 57 As described in these applications, an actively managed ETF would operate in the same manner as an index-based ETF. 58 Each would be registered under the Act as an open-end fund and would redeem shares in creation units in exchange for basket assets. Each would be listed on a national securities exchange, and investors would trade the ETF shares throughout the day at market prices in the secondary market. 59 The national securities exchange typically would disseminate the Intraday Value of ETF shares at 15-second intervals throughout the trading day, 60 thereby providing institutional investors and other arbitrageurs the information necessary to engage in ETF share purchases and sales on the secondary market, and purchases and redemptions with the fund, which should help keep ETF share prices from trading at a significant discount or premium. 61 Finally, the actively managed ETFs represent that they would provide ETF investors with uses and benefits similar to index-based ETFs. 62

managed ETFs represent that they would provide ETF investors with uses and benefits similar to index-based ETFs. 62

We believe that permitting fully transparent, actively managed ETFs would provide additional investment choices for investors and that exemptions necessary to permit the operation of these ETFs would be in the public interest and consistent with the policies and purposes of the Act. By proposing this rule we are not, however, suggesting that we will not consider applications for exemptive orders for actively managed ETFs that do not satisfy the proposed rule's transparency requirements. Rather, we are at this time proposing to permit fully transparent, actively managed ETFs to be offered without first seeking individual exemptive orders from the Commission.

We request comment on allowing actively managed ETFs with fully transparent portfolios to rely on the exemptions provided by the proposed rule. We only recently approved orders to allow certain actively managed ETFs and have not had the opportunity to observe how they operate in the markets over a significant period of time. Should we wait until we have gained greater experience with the operation of actively managed ETFs before adopting a final rule applicable to them? Is there any concern that a fully transparent actively managed ETF would not facilitate an efficient arbitrage mechanism? Would actively managed ETFs provide investors with uses and benefits similar to or different than their index-based counterparts? Do these or any other concerns regarding the operation of a fully transparent actively managed ETF warrant limiting the rule to index-based ETFs and considering exemptions for actively managed ETFs on a case by case basis through the exemptive applications process? Should we consider exemptions for other types of actively managed ETFs? If so, how would the arbitrage mechanism work in these ETFs? What kinds of conditions should we consider in order to facilitate an arbitrage mechanism?

d ETF warrant limiting the rule to index-based ETFs and considering exemptions for actively managed ETFs on a case by case basis through the exemptive applications process? Should we consider exemptions for other types of actively managed ETFs? If so, how would the arbitrage mechanism work in these ETFs? What kinds of conditions should we consider in order to facilitate an arbitrage mechanism?

3. Organization as an Open-End Investment Company

Our proposed rule would be available only to ETFs that are organized as open-end funds. 63 We have provided similar exemptions to unit investment trusts (“UITs”) in the past. 64 However, because we have not received an exemptive application for a new ETF to be organized as a UIT since 2002, there does not appear to be a need to include UIT relief in the proposed rule. 65 We understand that ETF sponsors prefer the open-end fund structure because it allows more investment flexibility. 66 In 67

57 See Actively Managed ETF Orders, supra note 20.

58 See id.

59 See infra notes 88-94 and accompanying text for a discussion of the proposed rule's condition that ETF shares be approved for listing and trading on a national securities exchange.

60 See infra notes 92-94 and accompanying text for a discussion of the proposed rule's condition that ETFs be listed on an exchange that disseminates the Intraday Value of ETF shares on a regular basis.

61 See supra notes 27-29 and accompanying and following text. See also Actively Managed ETF Orders supra note 20.

62 See, e.g. , In re PowerShares Capital Management LLC, et al. , Fifth Amendment, File No. 812-13386, filed Jan. 7, 2008 (“PowerShares Actively Managed ETF Application”), at 12-13 (available for public inspection and copying in the Commission's Public Reference Room, 100 F Street, NE., Washington, DC 20549).

63 Proposed rule 6c-11(e)(4).

64 See, e.g. , SPDR Order, supra note 10. See supra note 8 for a definition of UITs

ares Capital Management LLC, et al. , Fifth Amendment, File No. 812-13386, filed Jan. 7, 2008 (“PowerShares Actively Managed ETF Application”), at 12-13 (available for public inspection and copying in the Commission's Public Reference Room, 100 F Street, NE., Washington, DC 20549).

63 Proposed rule 6c-11(e)(4).

64 See, e.g. , SPDR Order, supra note 10. See supra note 8 for a definition of UITs.

65 Although two exemptive applications for ETFs organized as UITs were filed in 2007, the applications were occasioned by the transfer of the sponsorship from Nasdaq Financial Products Services, Inc. to PowerShares Capital Management, LLC and did not result in new ETFs. See BLDRs Index Funds Trust, Investment Company Act Release No. 27745 (Feb. 28, 2007) [72 FR 9787 (Mar. 5, 2007)] (“BLDRs Notice”); Nasdaq-100 Trust, Series 1, Investment Company Act Release No. 27740 (Feb. 27, 2007) [72 FR 9594 (Mar. 2, 2007)].

66 A UIT portfolio is fixed, and substitution of securities may take place only under certain circumstances. As a result, an ETF organized as a UIT typically replicates the holdings of the index it tracks. By contrast, existing ETFs organized as open-end funds may employ investment advisers and use a “sampling” strategy to track the index. Using a sampling strategy, an investment adviser can construct a portfolio that is a subset of the component securities in the corresponding index, See, e.g. , First Trust Notice, supra note 32, at. n.1.

67 The number of ETFs organized as UITs is based on information in the Commission's database of Form N-SAR filings.

We request comment on whether we should include ETFs organized as UITs in the definition of ETF under the proposed rule. If so, should they be subject to the same conditions set forth in the proposed rule?

B. Conditions

ETF sponsors have sought exemptions from certain provisions of the Act and our rules so that they may register ETFs as open-end funds

ission's database of Form N-SAR filings.

B. Conditions

ETF sponsors have sought exemptions from certain provisions of the Act and our rules so that they may register ETFs as open-end funds. The principal distinguishing feature of open-end funds is that they offer for sale redeemable securities. 68 The Act defines “redeemable security” as any security that allows the holder to receive his or her proportionate share of the issuer's current net assets upon presentation to the issuer. 69

68 15 U.S.C. 80a-5(a)(1); see infra notes 109-121 and accompanying text.

69 15 U.S.C. 80a-2(a)(32).

Section 22(d) of the Act prohibits any dealer in redeemable securities from selling open-end fund shares at a price other than a current offering price described in the fund's prospectus. 70 Rule 22c-1 under the Act requires funds, their principal underwriters, and dealers to sell and redeem fund shares at a price based on the current NAV next computed after receipt of an order to buy or redeem. 71 Together, these provisions are designed to require that fund shareholders are treated equitably when buying and selling their fund shares. 72

70 15 U.S.C. 80a-22(d).

71 17 CFR 270.22c-1(a). The rule requires that funds calculate their NAV at least once daily Monday through Friday (with certain exceptions, including days on which no securities are tendered for redemption and the fund receives no orders to purchase or sell securities). See 17 CFR 270.22c-1(b)(1). Today, most funds calculate NAV as of the time the major U.S. stock exchanges close (typically at 4 p.m. Eastern Time). Thus, a fund's NAV generally reflects the closing prices of the securities it holds. Under rule 22c-1, an investor who submits an order before the 4:00 p.m

ies are tendered for redemption and the fund receives no orders to purchase or sell securities). See 17 CFR 270.22c-1(b)(1). Today, most funds calculate NAV as of the time the major U.S. stock exchanges close (typically at 4 p.m. Eastern Time). Thus, a fund's NAV generally reflects the closing prices of the securities it holds. Under rule 22c-1, an investor who submits an order before the 4:00 p.m. pricing time receives that day's price, and an investor who submits an order after the pricing time receives the next day's price.

72 See generally, H.R. Rep. No. 2639, 76th Cong., 3d Sess., 8 (1940). See also Investment Trusts and Investment Companies, Report of the Securities and Exchange Commission, H.R. Doc. No. 279, 76th Cong., 1st Sess., pt. 3, at 860-874 (1939).

ETFs seeking to register as open-end funds under the Act require exemptions from these provisions because certain investors may purchase and sell individual ETF shares on the secondary market at current market prices, i.e. , at prices other than those described in the ETF's prospectus or based on NAV. As discussed above, investors (typically financial institutions) can purchase and redeem shares from the ETF at NAV only in creation units. 73 Because these financial institutions can take advantage of disparities between the market price of ETF shares and NAV, they may be in a different position than investors who buy and sell individual ETF shares only on the secondary market. 74 The disparities in market price and NAV, however, provide those institutional investors with opportunities for arbitrage that would tend to drive the market price in the direction of the ETF's NAV to the benefit of retail investors. 75

73 See supra Section II for a discussion on the operation of ETFs.

74 See, e.g., Comment Letter of Barclays Global Investors, File No. S7-20-01 (Jan

market. 74 The disparities in market price and NAV, however, provide those institutional investors with opportunities for arbitrage that would tend to drive the market price in the direction of the ETF's NAV to the benefit of retail investors. 75

73 See supra Section II for a discussion on the operation of ETFs.

74 See, e.g., Comment Letter of Barclays Global Investors, File No. S7-20-01 (Jan. 11, 2002) (“[D]uring periods of market volatility * * * it is not unreasonable to assume that some retail investors would buy or sell ETF shares at secondary market prices moving in the opposite direction of a fund's NAV.”).

75 See supra notes 25-26 and accompanying text.

Today, we propose a rule with certain conditions that may permit the ETF structure to operate within the scope of the Act without sacrificing appropriate investor protection, and is designed to be consistent with the purposes fairly intended by the policy and provisions of the Act. 76 Our orders have provided exemptions from the definition of “redeemable security” and section 22(d) and rule 22c-1 for ETFs with an arbitrage mechanism that helps maintain the equilibrium between market price and NAV. Our proposed rule would codify these exemptions subject to three conditions that appear to have facilitated the arbitrage mechanism: Transparency of the ETF's portfolio, disclosure of the ETF's Intraday Value, and listing on a national securities exchange.

76 Section 6(c) of the Act permits the Commission, conditionally or unconditionally, to exempt by rule any person, security, or transaction (or classes of persons, securities, or transactions) from any provision of the Act “if and to the extent that such exemption is necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions” of the Act. 15 U.S.C. 80a-6(c).

ly or unconditionally, to exempt by rule any person, security, or transaction (or classes of persons, securities, or transactions) from any provision of the Act “if and to the extent that such exemption is necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions” of the Act. 15 U.S.C. 80a-6(c).

1. Transparency of Index and Portfolio Holdings

To take advantage of the proposed exemption, an ETF must either (i) disclose on its Internet Web site each business day the identities and weightings of the component securities and other assets held by the fund, or (ii) have a stated investment objective of obtaining returns that correspond to the returns of a securities index, whose provider discloses on its Internet Web site the identities and weightings of the component securities and other assets of the index. 77 The Web page of the ETF or the index provider, as the case may be, must be publicly accessible at no charge. 78 Thus, the proposed rule would allow for an actively managed ETF provided that the actively managed ETF discloses its portfolio assets each business day. 79

77 Proposed rule 6c-11(e)(4)(v).

78 Id.

79 See supra discussion at Section III.A.2. An index-based ETF that has the investment objective of obtaining returns that correspond to the returns of multiple securities indexes may rely on the proposed rule provided that it discloses its portfolio in the same manner as a fully transparent actively managed ETF.

same manner as a fully transparent actively managed ETF.

We seek comment on these transparency conditions. In particular, we request comment on the proposed provision requiring that an ETF that tracks an index and does not disclose its portfolio each business day must track an index whose provider discloses on an Internet Web site the component securities and other assets of the index it tracks. 80 Is it necessary for the rule to include this option instead of simply requiring daily portfolio disclosure by the ETF? What circumstances, if any, would prevent an index-based ETF from disclosing its portfolio holdings? 81 Would Internet Web site disclosure of portfolio holdings be sufficient? If not, what other means of disclosure should the ETF or the index provider use?

80 The proposed rule defines an “index provider” to mean the person that determines the securities and other assets that comprise a securities index. See proposed rule 6c-11(e)(7).

81 See supra note 27.

We also seek comment on whether we should require ETFs to disclose daily on their Internet Web sites liabilities (as well as portfolio holdings) to permit investors, particularly arbitrageurs, to evaluate the impact of leverage from borrowings on the fund's portfolio. 82

82 For example, if an ETF enters into a written call to hedge the fair value exposure of an equity security in its portfolio, it would sacrifice any unrealized gains caused by the price of the equity security increasing above the price at which the call may be exercised ( i.e. the strike price). Unless the

equity security increasing above the price at which the call may be exercised ( i.e. the strike price). Unless the

One of the issues we discussed in the 2001 Concept Release was that full portfolio transparency could give market participants an ability to access the fund's market strategies ( i.e., “free-riding”) and, in some cases, the ability to trade ahead of the ETF ( i.e., “front-running”). 83 Those commenters who addressed the issue generally agreed that intra-day or advance portfolio disclosure may be detrimental to an actively managed ETF because it could enable third parties to front-run the fund. 84 Therefore, the proposed rule does not require disclosure of intra-day changes in the portfolio of the ETF, because currently, intra-day changes do not affect the composition of the ETF's basket assets until the next trading day. 85 The proposed rule also does not require advance disclosure of portfolio trades. 86

83 Market participants could trade ahead of an ETF if it disclosed portfolio assets in advance of the trades, rather than after the assets were acquired.

84 See, e.g. , Comment Letter of the Vanguard Group, File No. S7-20-01 (Feb. 14, 2002); Comment Letter of the Investment Company Institute, File No. S7-20-01 (Jan. 14, 2002).

85 Applicants seeking exemptions for actively managed ETFs noted that under accounting procedures followed by the funds, portfolio trades made on the prior business day (“T”) would be booked and reflected in the fund's NAV on the current business day (“T+1”). See, e.g., WisdomTree Actively Managed ETF Notice, supra note 20, at n.5. As a result, these funds will not have to announce trades before they are made. In addition, the funds will be able to disclose at the beginning of each trading day the portfolio that will form the basis of the NAV calculation at the end of the day. Id.

86 See proposed rule 6c-11(e)(4)(v)(A)

e current business day (“T+1”). See, e.g., WisdomTree Actively Managed ETF Notice, supra note 20, at n.5. As a result, these funds will not have to announce trades before they are made. In addition, the funds will be able to disclose at the beginning of each trading day the portfolio that will form the basis of the NAV calculation at the end of the day. Id.

86 See proposed rule 6c-11(e)(4)(v)(A). Under the proposed rule, an ETF could disclose its portfolio at the end of the day on which relevant portfolio trades occurred ( i.e., after the portfolio assets are acquired) or the beginning of the following day, which would eliminate the potential for front-running.

We request comment on these aspects of the proposal. Should the rule require disclosure of portfolio changes more often than once a day? How would more frequent disclosure affect the arbitrage mechanism? Would more frequent disclosure increase the likelihood of free-riding or front-running? The rule does not limit ETFs to tracking specialized indexes that change their assets at or below a specified frequency. How might this affect the transparency of the portfolios of ETFs that would rely on index rather than portfolio disclosure? 87

87 See supra note 77 and accompanying text.

Should the proposed rule prohibit advance portfolio disclosure? Would advance portfolio disclosure increase the likelihood of free-riding or front-running? If so, should the risk that participants may engage in these activities be treated as a material risk to be disclosed to prospective investors permitting them to evaluate whether the risk makes the ETF an appropriate investment in light of the particular investor's investment objectives? How would advance disclosure affect the arbitrage mechanism? If the portfolio disclosed in advance differed from the actual portfolio acquired, would that affect the market's ability to price the ETF's shares?

to be disclosed to prospective investors permitting them to evaluate whether the risk makes the ETF an appropriate investment in light of the particular investor's investment objectives? How would advance disclosure affect the arbitrage mechanism? If the portfolio disclosed in advance differed from the actual portfolio acquired, would that affect the market's ability to price the ETF's shares?

2. Listing on a National Securities Exchange and Dissemination of Intraday Value

An ETF that relies on rule 6c-11 would need to satisfy two additional conditions set forth in the paragraph defining “exchange-traded fund.” 88 First, shares issued by the ETF would have to be approved for listing and trading on a national securities exchange. 89 We have premised our previous exemptive orders on the ETF listing its shares for trading on a national securities exchange. 90 Listing on an exchange would provide an organized and continuous trading market for the ETF shares at negotiated prices. Applicants for exemptive relief have noted that this intra-day trading, combined with the arbitrage mechanism inherent in the ETF structure, should prevent significant premiums and discounts between the market price of ETF shares and the Intraday Value. 91

88 Proposed rule 6c-11(e)(4) (defining “exchange-traded fund”).

89 Proposed rule 6c-11(e)(4)(iii).

90 See, e.g., HealthShares, Inc., Investment Company Act Release No. 27553 (Nov. 16, 2006) [71 FR 67404, 67408 (Nov. 21, 2006)] (“HealthShares Notice”).

91 See, e.g., Amended and Restated Application of Ziegler Exchange Traded Trust, File No. 812-13224, filed Dec. 19, 2006 (“Ziegler Application”), at 10; PowerShares Actively Managed ETF Notice, supra note 20.

Dec. 19, 2006 (“Ziegler Application”), at 10; PowerShares Actively Managed ETF Notice, supra note 20.

Second, an ETF could rely on the rule only if a national securities exchange disseminates the Intraday Value at regular intervals during the trading day. 92 Applications for exemptive relief have noted that exchanges typically disseminate the Intraday Value every 15 seconds during trading hours. 93 They have also asserted that this regular dissemination of the Intraday Value enables market makers to engage in the arbitrage activities that determine the market price for ETF shares. 94

92 Proposed rule 6c-11(e)(4)(i).

93 See, e.g., Van Eck, Van Eck Associates Corp., Investment Company Act Release No. 27283 (Apr. 7, 2006) [71 FR 19214 (Apr. 13, 2006)], at n.3; PowerShares Actively Managed ETF Notice, supra note 20, at n.2.

94 See, e.g., Ziegler Application, supra note 91, at 26-27.

We request comment on these two conditions. Should the rule require that ETF shares be listed on a national securities exchange? Should the rule make allowance for shares that are delisted for a short time, or for suspensions in listing? If an ETF's shares were not listed for trading on a national securities exchange (even on a temporary basis), would the ETF structure permit the arbitrage mechanism to function appropriately? Should the rule require an ETF to liquidate or take other steps in the event of delisting? Should the proposed rule condition relief on listing exchanges disseminating the Intraday Value? If not, are there other means for market makers to receive the Intraday Value? Are there alternatives to using the basket as the basis for the Intraday Value calculation? For example, should the rule require the entity calculating the Intraday Value to use the ETF's portfolio (as opposed to the basket)? Should the calculation method be prescribed?

The proposed rule does not require the dissemination of an ETF's Intraday Value at specific intervals because the rules of national securities exchanges, as approved by the Co

e basis for the Intraday Value calculation? For example, should the rule require the entity calculating the Intraday Value to use the ETF's portfolio (as opposed to the basket)? Should the calculation method be prescribed?

The proposed rule does not require the dissemination of an ETF's Intraday Value at specific intervals because the rules of national securities exchanges, as approved by the Commission, establish the frequency of disclosure. 95 Should the rule specify a minimal frequency? For example, should the rule prohibit an ETF from relying on the exemption if it is listed on an exchange that permits dissemination at intervals longer than the current 15 or 60-second intervals?

95 An ETF's Intraday Value is disseminated every 15 seconds (or 60 seconds in the case of ETFs that track foreign indexes). See supra note 29 and accompanying text.

3. Marketing

Our exemptive orders included a condition requiring each ETF to agree not to market or advertise the ETF as an open-end fund or mutual fund and to explain that ETF shares are not individually redeemable. 96 This condition was designed to help prevent retail investors from confusing ETFs with traditional mutual funds. Similarly, the proposed rule would require each ETF relying on the rule to identify itself in any sales literature as an ETF that does not sell or redeem individual shares, and explain that investors may purchase or sell individual ETF shares in secondary market transactions that do not involve 97 This condition, like the prior condition in our orders, is designed to help prevent retail investors from confusing ETFs with traditional mutual funds.

96 See, e.g. , WisdomTree Order, supra note 12.

al mutual funds.

96 See, e.g. , WisdomTree Order, supra note 12.

97 Proposed rule 6c-11(e)(4)(ii). The term sales literature is defined in the proposed rule to mean any advertisement, pamphlet, circular, form letter, or other sales material addressed to or intended for distribution to prospective investors other than a registration statement filed with the Commission under section 8 of the Act. Proposed rule 6c-11(e)(8). An ETF would have to make similar disclosures in its prospectus under the proposed amendments to Form N-1A. See proposed Item 6(h)(3) of Form N-1A, and infra text accompanying note 159.

We request comment on whether the proposed condition is likely to provide a benefit for investors with respect to ETF marketing and advertising materials. Are investors confused about the distinction between ETFs and traditional mutual funds? Should any confusion be addressed through rule requirements? Should the rule require ETFs to identify themselves as either index-based or actively managed ETFs?

4. Conflicts of Interest

Section 1(b)(2) of the Investment Company Act states that the public interest and the interest of investors are adversely affected when investment companies are organized, operated, managed, or their portfolio securities are selected, in the interest of directors, officers, investment advisers, or other affiliated persons, and underwriters, brokers, or dealers rather than in the interest of shareholders. 98 The operation of an ETF—specifically, the process in which a creation unit is purchased by delivering basket assets to the ETF, and redeemed in exchange for basket assets—may lend itself to certain conflicts for the ETF's investment adviser, which has discretion to specify the securities included in the baskets. For example, the adviser could direct creation unit purchasers to purchase securities from affiliates of the adviser for subsequent presentation to the ETF

unit is purchased by delivering basket assets to the ETF, and redeemed in exchange for basket assets—may lend itself to certain conflicts for the ETF's investment adviser, which has discretion to specify the securities included in the baskets. For example, the adviser could direct creation unit purchasers to purchase securities from affiliates of the adviser for subsequent presentation to the ETF. As we noted in the 2001 Concept Release, these conflicts would appear to be minimized in the case of an index-based ETF because the universe of securities that may be included in the ETF's portfolio generally is restricted by the composition of its corresponding index. 99 We also noted that the same would not appear to be the case for an actively managed ETF. Because the adviser to an actively managed ETF would have greater discretion to designate securities to be included in the basket assets, a greater potential for conflicts appears to exist.

98 15 U.S.C. 80a-1(b)(2).

99 See 2001 Concept Release, supra note 39, at Section IV.E.2.

Commenters generally stated that actively managed ETFs would not be faced with conflicts that are different from those that currently exist for actively managed mutual funds. 100 One commenter, however, recommended that the Commission impose any prohibitions or conditions under the Act that would apply to transactions directly effected by the adviser on any transactions effected at the adviser's discretion. 101 The commenter noted that, for example, an ETF that is prohibited from acquiring a security in certain underwritings (under section 10(f) of the Act) 102 should be prohibited from circumventing this prohibition by including the security in the ETF's basket assets. Similarly, an adviser could attempt to circumvent section 17(a) restrictions on principal transactions between a registered fund and its affiliates by designating a security for the basket assets that a creation unit purchaser would have to purchase from an affiliate of the adviser. 103

100 See, e.g

hibited from circumventing this prohibition by including the security in the ETF's basket assets. Similarly, an adviser could attempt to circumvent section 17(a) restrictions on principal transactions between a registered fund and its affiliates by designating a security for the basket assets that a creation unit purchaser would have to purchase from an affiliate of the adviser. 103

100 See, e.g. , Comment Letter of the American Stock Exchange LLC, File No. S7-20-01 (Mar. 5, 2002); Comment Letter of State Street Bank and Trust Company, File No. S7-20-01 (Jan. 14, 2002); Comment Letter of Nuveen Investments, File No. S7-20-01 (Jan. 14, 2002).

101 Comment Letter of the Investment Company Institute, File No. S7-20-01 (Jan. 14, 2002).

102 Section 10(f) of the Act prohibits a fund from purchasing any security during an underwriting or selling syndicate if a principal underwriter of the security is an officer, director, member of an advisory board, investment adviser, or employee of the fund or if any of these persons is an affiliate of the principal underwriter. 15 U.S.C. 80a-10(f). This section protects fund shareholders by preventing an affiliated underwriter from placing or “dumping” unmarketable securities in the fund.

103 Section 17(a) 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 the fund (or any company the fund controls). 15 U.S.C. 80a-17(a).

We have not included a condition in the proposed rule prohibiting an actively managed ETF's adviser, directly or indirectly, from causing a creation unit purchaser to acquire a security for the ETF through a transaction in which the ETF could not engage directly. An adviser to an actively managed ETF already is subject to section 48(a) of the Act, which prohibits a person from doing indirectly, through another person, what that person is prohibited by the Act from doing directly

ed ETF's adviser, directly or indirectly, from causing a creation unit purchaser to acquire a security for the ETF through a transaction in which the ETF could not engage directly. An adviser to an actively managed ETF already is subject to section 48(a) of the Act, which prohibits a person from doing indirectly, through another person, what that person is prohibited by the Act from doing directly. An adviser, therefore, would be prohibited from causing an institution that transacts directly with the ETF (or any investor on whose behalf the institution may transact with the ETF) to acquire any security for the ETF through a transaction in which the ETF could not engage directly. 104

104 See Lessler v. Little, 857 F.2d 866, 873-874 (1st Cir. 1988) (reversing dismissal of a claim that principals of a registered investment company and its adviser had violated sections 17(a)(2) and 48(a) of the Act by purchasing the fund's assets indirectly by arranging for sale of the fund to a third party in conjunction with an arrangement whereby the adviser obtained excessive interest in the transferred assets); SEC v. Commonwealth Chemical Securities, 410 F. Supp 1002, 1018 (S.D.N.Y. 1976) (finding violations of sections 17(a) and 48(a) of the Act by directors of a registered investment company who caused a third party to purchase shares in an offering underwritten by an affiliated broker-dealer and sold the shares to the registered investment company).

We request comment on whether it would be useful to include a condition in the proposed rule reminding ETFs relying on the rule of the prohibitions contained in section 48(a) of the Act. We also request comment on potential conflicts of interest for an ETF's investment adviser. Does an adviser to a fully transparent, actively managed ETF face different conflicts of interest from the conflicts of an adviser to a traditional mutual fund? If so, what are those conflicts and how could the rule address them?

ing on the rule of the prohibitions contained in section 48(a) of the Act. We also request comment on potential conflicts of interest for an ETF's investment adviser. Does an adviser to a fully transparent, actively managed ETF face different conflicts of interest from the conflicts of an adviser to a traditional mutual fund? If so, what are those conflicts and how could the rule address them?

5. Affiliated Index Providers

Federal securities laws and the rules of national securities exchanges require funds and their advisers to adopt measures reasonably designed to prevent misuse of non-public information. 105 Funds are likely to be in a position to well understand the potential circumstances and relationships that could give rise to the misuse of non-public information, and can develop appropriate measures to address them. We believe these requirements should be sufficient to protect against the abuses addressed by the terms in the exemptive applications 106

105 See rule 38a-1 (requiring funds to adopt policies and procedures reasonably designed to prevent violation of federal securities laws); rule 17j-1 (requiring funds to adopt a code of ethics containing provisions designed to prevent certain fund personnel (“access persons”) from misusing information regarding fund transactions); Section 204A of the Investment Advisers Act of 1940 (“Advisers Act”) (15 U.S.C. 80b-204A) (requiring an adviser to adopt policies and procedures that are reasonably designed, taking into account the nature of its business, to prevent the misuse of material, non-public information by the adviser or any associated person, in violation of the Advisers Act or the Exchange Act, or the rules or regulations thereunder); Section 15(f) of the Exchange Act (15 U.S.C

rs Act”) (15 U.S.C. 80b-204A) (requiring an adviser to adopt policies and procedures that are reasonably designed, taking into account the nature of its business, to prevent the misuse of material, non-public information by the adviser or any associated person, in violation of the Advisers Act or the Exchange Act, or the rules or regulations thereunder); Section 15(f) of the Exchange Act (15 U.S.C. 78o(f)) (requiring a registered broker or dealer to adopt policies and procedures reasonably designed, taking into account the nature of the broker's or dealer's business, to prevent the misuse of material, nonpublic information by the broker or dealer or any person associated with the broker or dealer, in violation of the Exchange Act or the rules or regulations thereunder).

See, e.g. Rule Commentary .02(b)(i) of American Stock Exchange Rule 1000A (requiring “firewalls” between an ETF and an affiliated index provider).

106 The terms are intended to address the potential conflicts of interest between the ETF adviser and its affiliated index provider, and include: (i) All of the rules that govern inclusion and weighting of securities in each index are made publicly available; (ii) the ability to change the rules for index compilation is limited and public notice is given before any changes are made; (iii) “firewalls” exist between (A) the staff responsible for the creation, development and modification of the index compilation rules and (B) the portfolio management staff; (iv) the calculation agent, who is responsible for all index maintenance, calculation, dissemination, and reconstitution activities, is not affiliated with the index provider, the ETF or any of their affiliates; and (v) the component securities of the index may not be changed more frequently than on a specified periodic basis. See HealthShares Notice, supra note 90; WisdomTree Notice, supra note 12.

We request comment on our proposal to eliminate these terms

ntenance, calculation, dissemination, and reconstitution activities, is not affiliated with the index provider, the ETF or any of their affiliates; and (v) the component securities of the index may not be changed more frequently than on a specified periodic basis. See HealthShares Notice, supra note 90; WisdomTree Notice, supra note 12.

We request comment on our proposal to eliminate these terms. Should the rule include any of the terms included in previous exemptive applications for affiliated index providers? If so, which terms and why?

C. Exemptive Relief

The unique structure of ETFs has required ETF sponsors to seek relief from certain provisions of the Act and our rules in order to form and operate. Proposed Rule 6c-11 would permit an ETF that meets the conditions of the rule to redeem shares in creation unit aggregations, to trade at current market prices, to engage in in-kind transactions with certain affiliates and, in certain circumstances, to pay the proceeds from the redemption of shares in more than seven days. The proposed exemptions would be subject to certain conditions that are designed to address the concerns underlying the statute and thereby satisfy the requirement that exemptions from statutory provisions are in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy of the Act. 107

107 See 15 U.S.C. 80a-6(c).

1. Issuance of “Redeemable Securities”

Our exemptive orders have provided ETFs with relief from sections 2(a)(32) and 5(a)(1) 108 of the Act so that they may register under the Act as open-end funds while issuing shares that are redeemable in creation units only. 109 In support of the relief, ETF sponsors have noted that because the market price of ETF shares is disciplined by arbitrage opportunities, investors in ETF shares generally should be able to sell the shares in secondary market transactions at approximately their NAV. 110

108 15 U.S.C

y may register under the Act as open-end funds while issuing shares that are redeemable in creation units only. 109 In support of the relief, ETF sponsors have noted that because the market price of ETF shares is disciplined by arbitrage opportunities, investors in ETF shares generally should be able to sell the shares in secondary market transactions at approximately their NAV. 110

108 15 U.S.C. 80a-2(a)(32) (defining “redeemable security” as any security the terms of which permit the holder upon presentation to receive the holder's proportionate share of the issuer's current net assets, or the cash equivalent); 15 U.S.C. 80a-5(a)(1).

109 These exemptions are granted under section 6(c) of the Act. See supra note 76.

110 See, e.g. , Ziegler Exchange Traded Trust, Investment Company Act Release No. 27610 (Dec. 22, 2006) [72 FR 163 (Jan. 3, 2007)] (“Ziegler Notice”); PowerShares Actively Managed ETF Notice, supra note 20, at text following n.5.

Proposed rule 6c-11 would deem an equity security issued by an ETF to be a “redeemable security” for purposes of section 2(a)(32) of the Act. 111 This provision would permit an ETF to register with the Commission as an open-end fund, which the Act defines as an investment company that issues redeemable securities, 112 even though ETF shares are issued and redeemed in creation unit aggregations. 113 This approach would provide ETFs with the same relief contained in our exemptive orders without exempting ETFs from other requirements imposed under the Act and our rules that apply to funds that issue redeemable securities. 114

111 Proposed rule 6c-11(a). Our orders provided an exemption from sections 2(a)(32) and 5(a)(1) to allow ETFs to redeem securities in creation unit aggregations rather than individually.

112 See 15 U.S.C. 80a-5(a)(1).

113 ETF creation units have ranged from 25,000 to 200,000 ETF shares. See, e.g

nts imposed under the Act and our rules that apply to funds that issue redeemable securities. 114

111 Proposed rule 6c-11(a). Our orders provided an exemption from sections 2(a)(32) and 5(a)(1) to allow ETFs to redeem securities in creation unit aggregations rather than individually.

112 See 15 U.S.C. 80a-5(a)(1).

113 ETF creation units have ranged from 25,000 to 200,000 ETF shares. See, e.g. , PowerShares Actively Managed ETF Notice, supra note 20 (creation units are blocks of 50,000 to 100,000 ETF shares); ProShares Trust, Investment Company Act Release No. 27323 (May 18, 2006) [71 FR 29991 (May 24, 2006)] (notice) (“ProShares Notice”) (creation units are blocks of 25,000 to 50,000 ETF shares); WisdomTree Notice, supra note 12 (creation units are blocks of 25,000 to 200,000 ETF shares).

114 See, e.g. , 15 U.S.C. 80a-22; 17 CFR 270.22c-1. In addition, the rules under the Exchange Act that apply to redeemable securities issued by a mutual fund would apply to ETFs. See, e.g. , 17 CFR 240.15c3-1.

We request comment on this aspect of the proposed rule. Are there differences in ETFs and other funds that would justify not applying any provision of the Act or our rules that applies to funds that issue redeemable securities?

As discussed above, ETFs today operate with an arbitrage mechanism designed to minimize the potential deviation between the market price and NAV of ETF shares. The proposed rule would require that an ETF establish creation unit sizes the number of shares of which are reasonably designed to facilitate arbitrage, which is described in the proposed definition of creation unit as the purchase (or redemption) of shares from the ETF with an offsetting sale (or purchase) of shares on a national securities exchange at as nearly the same time as practicable for the purpose of taking advantage of a difference in the Intraday Value and the current market price of the shares

sonably designed to facilitate arbitrage, which is described in the proposed definition of creation unit as the purchase (or redemption) of shares from the ETF with an offsetting sale (or purchase) of shares on a national securities exchange at as nearly the same time as practicable for the purpose of taking advantage of a difference in the Intraday Value and the current market price of the shares. 115 The proposed rule also would require an ETF to disclose in its prospectus and any sales literature the number of ETF shares for which it will issue or redeem a creation unit to alert investors that they cannot purchase or redeem individual ETF shares directly from or with the ETF. 116

115 Proposed rule 6c-11(e)(3). We note that the Board of Governors of the Federal Reserve defines “arbitrage” in a similar manner in section 220.6(b) of Regulation T (“Arbitrage. A creditor may effect and finance for any customer bona fide arbitrage transactions. For the purpose of this section, the term “bona fide arbitrage” means: (1) A purchase or sale of a security in one market together with an offsetting sale or purchase of the same security in a different market at as nearly the same time as practicable for the purpose of taking advantage of a difference in prices in the two markets; or (2) A purchase of a security which is, without restriction other than the payment of money, exchangeable or convertible within 90 calendar days of the purchase into a second security together with an offsetting sale of the second security at or about the same time, for the purpose of taking advantage of a concurrent disparity in the prices of the two securities.”). 12 CFR 220.6.

116 Proposed rule 6c-11(e)(4)(ii); Proposed Item 6(h)(3) to Form N-1A

ction other than the payment of money, exchangeable or convertible within 90 calendar days of the purchase into a second security together with an offsetting sale of the second security at or about the same time, for the purpose of taking advantage of a concurrent disparity in the prices of the two securities.”). 12 CFR 220.6.

116 Proposed rule 6c-11(e)(4)(ii); Proposed Item 6(h)(3) to Form N-1A.

The proposed condition regarding creation unit size is intended to require ETFs that rely on the proposed rule to choose creation unit sizes that promote an arbitrage mechanism and to preclude ETFs from setting very low or high thresholds, such as one ETF share per creation unit or one million ETF shares per creation unit. A low creation unit size could, as a practical matter, make the use of creation unit redemption irrelevant. The ETF would, in effect, be issuing and redeeming ETF shares like a traditional mutual fund, but the shares would trade on an exchange. Conversely, a high creation unit size could reduce the willingness or ability of institutional arbitrageurs to engage in creation unit purchases or redemptions. Impeding the ability of arbitrageurs to purchase and redeem ETF shares could disrupt the arbitrage pricing discipline, which could lead to more frequent occurrences of pricing premiums or discounts.

We request comment on the proposed requirement for creation unit size, which is included in the proposed rule's definition of “creation unit.” Does the requirement that an ETF establish creation unit sizes the number of which is reasonably designed to facilitate arbitrage provide the sponsor or adviser of the ETF with sufficient guidance in setting appropriate thresholds? Should we include other elements in our description of arbitrage, which is included in the definition of creation

The proposed rule does not include numerical thresholds for the number of ETF shares in each creation unit

it sizes the number of which is reasonably designed to facilitate arbitrage provide the sponsor or adviser of the ETF with sufficient guidance in setting appropriate thresholds? Should we include other elements in our description of arbitrage, which is included in the definition of creation

The proposed rule does not include numerical thresholds for the number of ETF shares in each creation unit. Should the proposed rule include minimum or maximum numerical thresholds? If so, what would be appropriate thresholds and why? For example, should the rule set a minimum of 100 ETF shares, and/or a maximum of 500,000 ETF shares, per creation unit? Are our concerns with respect to smaller-or larger-sized creation units addressed by requiring ETFs to establish creation unit sizes that facilitate arbitrage? If the rule does not include any thresholds, would any of the exemptions provided by the proposed rule be inappropriate for an ETF with smaller-or larger-sized creation units? If so, which exemptions?

ETF applicants represent that ETF share prices are disciplined by arbitrage opportunities created by the ability to purchase and redeem creation units at NAV on a daily basis. 117 Would this pricing mechanism function differently for smaller-or larger-sized creation units? Because ETFs charge transaction fees for direct purchases and redemptions from the fund, ETF applicants have asserted that the interests of long-term shareholders should not be diluted by frequent traders, if those transaction fees accurately reflect the costs to the fund. 118 Are smaller-sized creation units likely to cause the transaction fees charged by ETFs to be insufficient to protect the long-term shareholders in the event of more frequent purchases and redemptions? If so, should an ETF relying on the proposed exemption be required to take additional measures designed to protect long-term shareholder interests from being diluted by frequent traders? If so, what measures?

117 See, e.g

ion units likely to cause the transaction fees charged by ETFs to be insufficient to protect the long-term shareholders in the event of more frequent purchases and redemptions? If so, should an ETF relying on the proposed exemption be required to take additional measures designed to protect long-term shareholder interests from being diluted by frequent traders? If so, what measures?

117 See, e.g. , Zeigler Application, supra note 91, at 52-53; see also supra notes 25-26 and accompanying and preceding text.

118 See Zeigler Application, supra note 91, at 23; PowerShares Actively Managed ETF Application, supra note 62, at 17-18.

As discussed above, ETFs issue and redeem shares in creation unit aggregations in exchange for the deposit or delivery of a basket of securities and other assets. The proposed rule defines “basket assets” to mean the securities or other assets specified each business day in name and number by the ETF as the securities or assets in exchange for which it will issue, or in return for which it will redeem, ETF shares. 119 The rule does not require that the basket mirror the portfolio of the ETF because in some circumstances it may not be practicable, convenient or operationally possible for the ETF to operate on an in-kind basis. 120 The rule, like our orders, allows an ETF to require or permit a purchasing or redeeming shareholder to substitute cash for some or all of the securities in the basket assets. 121

119 Proposed rule 6c-11(e)(1). Under the proposed rule, the term “business day” with respect to an ETF would mean any day that the fund is open for business, including any day on which it is required to make payment under section 22(e) of the Act. Section 22(e) of the Act prohibits registered funds from suspending the right of redemption or postponing the date of payment upon redemption of any redeemable security for more than seven days except for certain periods specified in the provision. See 15 U.S.C. 80a-22(e). Proposed rule 6c-11(e)(2)

business, including any day on which it is required to make payment under section 22(e) of the Act. Section 22(e) of the Act prohibits registered funds from suspending the right of redemption or postponing the date of payment upon redemption of any redeemable security for more than seven days except for certain periods specified in the provision. See 15 U.S.C. 80a-22(e). Proposed rule 6c-11(e)(2).

120 The ETF and its adviser may decide to permit cash-only purchases of creation units to minimize transaction costs or enhance the ETF's operational efficiency. For example, on a day when a substantial rebalancing of an index-based ETF's portfolio is required, the adviser might prefer to receive cash rather than in-kind securities so that it has the liquid resources at hand to make the necessary purchases. If the ETF received in-kind securities on that day, it might have to sell some securities and acquire new ones to properly track its underlying index, incurring transaction costs that could have been avoided if the ETF had received cash instead. See, e.g. , Ziegler Application, supra note 91, at 21-22. For some ETFs that track country-specific equity securities indexes, it is operationally necessary to engage in cash-only transactions because of local law restrictions on transferability of securities. See iShares, Inc., Investment Company Act Release Nos. 25595 (May 29, 2002) [67 FR 38684 (June 5, 2002)] (notice) and 25623 (June 25, 2002) (order) (certain iShares ETFs that invest in certain foreign markets currently effect purchases and redemptions through cash transactions).

rtain foreign markets currently effect purchases and redemptions through cash transactions).

121 Proposed rule 6c-11(e)(1). Though the standard operations of most existing ETFs involve in-kind purchases and redemptions, the Commission has consistently permitted the substitution of cash for certain securities in the basket assets. See, e.g. , WisdomTree Notice, supra note 12 at text preceding n.9. In addition, the Commission has permitted ETFs that primarily hold financial instruments, cash and cash equivalents in their portfolios to operate on a cash-only basis because of the limited transferability of financial instruments. See, e.g. , ProShares Notice, supra note 113, at n.2 and accompanying text. See also SPDR Lehman Municipal Bond ETF, Prospectus 19-22 (Sept. 10, 2007) (ETF generally sells creation units for cash only and redeems creation units in-kind only).

We request comment on the proposed definition of basket assets. Are there any reasons why an ETF should not be permitted to substitute cash for some or all of the assets in the basket? Should the proposed rule include any conditions for when an ETF may require or permit cash substitutions? If so, what conditions should be included? Should the rule specify how the ETF would announce the composition of the basket? For example, should the rule mandate that the ETF post the information on its Internet Web site? Should the rule specify the frequency with which the ETF must announce the composition of the basket? If so, how often?

2. Trading of ETF Shares at Negotiated Prices

As noted above, section 22(d), among other things, prohibits a dealer from selling a redeemable security that is being offered currently to the public by or through an underwriter, except at a current public offering price described in the prospectus. 122 Rule 22c-1 generally requires that a dealer selling, redeeming, or repurchasing a redeemable security do so only at a price based on its NAV. 123 Because secondary market trading in ETF shares takes place at current market prices, and not at the current offering price described in the prospectus or based on NAV, ETFs have obtained exemptions from section 22(d) and rule 22c-1.

122 15 U.S.C. 80a-22(d).

123 17 CFR 270.22c-1.

The provisions of section 22(d), as well as rule 22c-1, are designed to prevent dilution caused by certain riskless trading schemes by principal underwriters and dealers, and to prevent unjust discrimination or preferential treatment among investors purchasing and redeeming fund shares. 124 The proposed rule would exempt a dealer in ETF shares from section 22(d) of the Act and rule 22c-1(a) with regard to purchases, sales and repurchases of ETF shares in secondary market transactions at current market prices. 125 As discussed above, we have provided exemptions from section 22(d) and rule 22c-1 in our orders because the arbitrage function appears to address the potential concerns regarding shareholder dilution and unjust discrimination that these provisions 126 In addition, secondary market trading should not cause dilution for ETF shareholders because those transactions do not directly involve ETF portfolio assets (the transactions are with other investors, not the ETF), and thus have no direct impact on the NAV of ETF shares held by other investors. Moreover, to the extent that different prices for ETF shares exist during a given trading day, or from day to day, these variations occur as a result of third-party market forces, such as supply and demand, and not as a result of discrimination or preferential treatment among purchasers

other investors, not the ETF), and thus have no direct impact on the NAV of ETF shares held by other investors. Moreover, to the extent that different prices for ETF shares exist during a given trading day, or from day to day, these variations occur as a result of third-party market forces, such as supply and demand, and not as a result of discrimination or preferential treatment among purchasers.

124 For a complete legislative history of section 22(d), see Exemption from Section 22(d) to Permit the Sale of Redeemable Securities at Prices that Reflect Different Sales Loads, Investment Company Act Release No. 13183 (Apr. 22, 1983) [44 FR 19887 (May 10, 1983)]. See also Adoption of Rule 22c-1 under the Investment Company Act of 1940 Prescribing the Time of Pricing Redeemable Securities for Distribution, Redemption, and Repurchase and Amendment of Rule 17a-3(a)(7) under the Securities Exchange Act of 1934 Requiring Dealers to Time Stamp Orders, Investment Company Act Release No. 5519 (Oct. 16, 1968) [33 FR 16331 (Nov. 7, 1968)].

125 Proposed rule 6c-11(b).

126 See supra notes 71-7573 and accompanying text.

We request comment on this proposed relief. Should the relief also apply to parties other than dealers in ETF shares? If so, which other parties require similar relief, and why? Do dealers (or others) need relief from other provisions to facilitate transactions in ETF shares on the secondary market?

3. In-Kind Transactions Between ETFs and Certain Affiliates

o dealers (or others) need relief from other provisions to facilitate transactions in ETF shares on the secondary market?

3. In-Kind Transactions Between ETFs and Certain Affiliates

Section 17(a) of the Act generally prohibits an affiliated person of a registered investment company, or an affiliated person of such person, from selling any security to or purchasing any security from the company. 127 Purchases and redemptions of ETF creation units are typically in-kind rather than cash transactions, 128 and section 17(a) prohibits these in-kind purchases and redemptions by persons who are affiliated with the ETF, including those affiliated because they own 5 percent or more, and in some cases more than 25 percent, of the ETF's outstanding securities (“first-tier affiliates”), and by persons who are affiliated with the first-tier affiliates or who own 5 percent or more, and in some cases more than 25 percent, of the outstanding securities of one or more funds advised by the ETF's investment adviser (“second-tier affiliates”). 129

127 15 U.S.C. 80a-17(a).

128 ETFs must comply with the federal securities laws in accepting and satisfying redemptions with basket assets, including the registration provisions of the Securities Act. See, e.g. , Ameristock Notice, supra note 13, at n.3.

129 An affiliated person of a fund includes, among others: (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; (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; and (iii) any person directly or indirectly controlling, controlled by, or under common control with such other person. 15 U.S.C. 80a-2(a)(3)(A), (B) and (C). A control relationship will be presumed where one person owns more than 25 percent of another person's outstanding voting securities. 15 U.S.C. 80a-2(a)(9)

are directly or indirectly owned, controlled, or held with power to vote by the fund; and (iii) any person directly or indirectly controlling, controlled by, or under common control with such other person. 15 U.S.C. 80a-2(a)(3)(A), (B) and (C). A control relationship will be presumed where one person owns more than 25 percent of another person's outstanding voting securities. 15 U.S.C. 80a-2(a)(9).

We have granted exemptions from sections 17(a)(1) and (a)(2) 130 of the Act to allow these first- and second-tier affiliates of the ETF to purchase and redeem creation units through in-kind transactions. 131 In seeking this relief, applicants have submitted that because the first- and second-tier affiliates are not treated differently from non-affiliates when engaging in purchases and redemptions of creation units, there is no opportunity for these affiliated persons to effect a transaction detrimental to the other ETF shareholders. The securities to be deposited for purchases of creation units and to be delivered for redemptions of creation units are announced at the beginning of each day. All purchases and redemptions of creation units are at an ETF's next-calculated NAV (pursuant to rule 22c-1), and the securities deposited or delivered upon redemption are valued in the same manner, using the same standards, as those securities are valued for purposes of calculating the ETF's NAV.

130 15 U.S.C. 80a-17(a)(1), 80a-17(a)(2).

131 See, e.g. , HealthShares Notice, supra note 90, at text following n.10.

The proposed rule would permit first- and second-tier affiliates of the ETF to purchase and redeem creation units through in-kind transactions. 132 The proposed exemption would not, however, apply to a specific category of redemptions that would be addressed in new rule 12d1-4, which we also are proposing today. Section 12(d)(1) of the Act imposes substantial limitations on the ability of investment companies to invest in other investment companies

r affiliates of the ETF to purchase and redeem creation units through in-kind transactions. 132 The proposed exemption would not, however, apply to a specific category of redemptions that would be addressed in new rule 12d1-4, which we also are proposing today. Section 12(d)(1) of the Act imposes substantial limitations on the ability of investment companies to invest in other investment companies. 133 As discussed in Section IV of this release, proposed rule 12d1-4 would permit investment companies to acquire shares of ETFs in excess of the limitations on those investments under section 12(d)(1) of the Act subject to certain conditions intended to address the concerns underlying those limitations. One of the proposed conditions would prohibit investment companies from redeeming certain ETF shares acquired in reliance on proposed rule 12d1-4. 134 In order to make proposed rule 6c-11 consistent with the conditions in proposed rule 12d1-4, we propose to exclude investment companies that acquire ETF shares in reliance on proposed rule 12d1-4 from relying on proposed rule 6c-11(d) to redeem those ETF shares in kind. 135

132 Proposed rule 6c-11(d).

133 See infra note 194 and accompanying text.

134 As discussed in Section IV.B.2, infra, this condition is designed to prevent a fund that relies on the proposed rule to acquire ETF shares in excess of the limits of section 12(d)(1)(A)(i) from unduly influencing the ETF by the threat of a large-scale redemption.

135 The proposed rule would not permit an investment company that has acquired ETF shares in excess of the limits in section 12(d)(1)(A)(i) of the Act in reliance on proposed rule 12d1-4(a) to rely on proposed rule 6c-11(d) with regard to the purchase of basket assets ( i.e. , the purchase of securities identified in the basket when redeeming ETF shares). Proposed rule 6c-11(d).

We request comment on this proposed exemption

ot permit an investment company that has acquired ETF shares in excess of the limits in section 12(d)(1)(A)(i) of the Act in reliance on proposed rule 12d1-4(a) to rely on proposed rule 6c-11(d) with regard to the purchase of basket assets ( i.e. , the purchase of securities identified in the basket when redeeming ETF shares). Proposed rule 6c-11(d).

We request comment on this proposed exemption. Does the proposed exemption raise any risks with regard to affiliated transactions with the ETF? If so, should the exemption include any conditions to minimize those risks? Should the relief extend to parties that are affiliated persons of an ETF for other reasons? For example, should a broker-dealer that is affiliated with the ETF's adviser be allowed to transact in-kind with the ETF?

4. Additional Time for Delivering Redemption Proceeds

Section 22(e) of the Act generally prohibits a registered open-end investment company from suspending the right of redemption, or postponing the date of satisfaction of redemption requests more than seven days after the tender of a security for redemption. 136 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 seven days. These ETFs have requested, and we have granted, relief from section 22(e) so that they may satisfy redemptions up to a specified maximum number of calendar days depending upon specific circumstances in the local markets, as disclosed in the ETF's prospectus or statement of additional information (“SAI”). Other than in the disclosed situations, these ETFs satisfy redemptions within seven days. 137

136 15 U.S.C. 80a-22(e).

F's prospectus or statement of additional information (“SAI”). Other than in the disclosed situations, these ETFs satisfy redemptions within seven days. 137

136 15 U.S.C. 80a-22(e).

137 In their applications, ETFs acknowledge that no relief obtained from the requirements of section 22(e) will affect any obligations that they may otherwise have under rule 15c6-1 under the Exchange Act. See, e.g. , In re Barclays Global Fund Advisors, Second Amended and Restated Application, File No. 812-11598, filed May 11, 2000 (“Barclays Foreign Application”), at 76 (available for public inspection and copying in the Commission's Public Reference Room, 100 F Street, NE., Washington, DC 20549). Rule 15c6-1 requires that most securities transactions be settled within three business days of the trade date. 17 CFR 240.15c6-1.

Section 22(e) of the Act is designed to prevent unreasonable delays in the satisfaction of redemptions, and ETF sponsors have asserted that the requested relief will not lead to the problems that section 22(e) was 138 They have represented that the ETF's SAI would disclose those local holidays (over the period of at least one year following the date of the SAI) that are expected to prevent the satisfaction of redemptions in seven days and the maximum number of days needed to satisfy redemption requests with respect to the foreign securities at issue. 139

138 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. 291-293 (statements of David Schenker).

139 See, e.g. , Barclays Foreign Application, supra note 137, at 76-84.

ements of David Schenker).

139 See, e.g. , Barclays Foreign Application, supra note 137, at 76-84.

The delay in satisfying redemption requests seems reasonable under the circumstances described by the ETF sponsors because it is for a limited period of time and disclosed to investors. The proposed rule, therefore, would codify the relief from section 22(e) of the Act previously provided to ETFs. If an ETF has a foreign security in its basket assets and a foreign holiday prevents timely delivery of the foreign security, the ETF would be exempt from the prohibition in section 22(e) against postponing the date of satisfaction upon redemption for more than seven days. To rely on this exemption, the ETF would be required to disclose in its SAI the foreign holidays it expects to prevent timely delivery of the foreign securities and the maximum number of days it anticipates it would need to deliver the foreign securities. Finally, the delivery would have to take place no more than 12 calendar days after the tender of ETF shares (in a creation unit). 140

140 Proposed rule 6c-11(c). Applicants requesting this exemptive relief generally have represented that they would be able to deliver redemption proceeds within 12 calendar days. See, e.g. , WisdomTree Notice, supra note 12. An ETF relying on this exemption would disclose the information in the SAI. See Item 18 of Form N-1A (requiring disclosures regarding purchase, redemption, and pricing of shares).

We request comment on this relief in the proposed exemption. Is the relief necessary? We specifically request comment from ETFs regarding the frequency with which they have relied on this exemption

tice, supra note 12. An ETF relying on this exemption would disclose the information in the SAI. See Item 18 of Form N-1A (requiring disclosures regarding purchase, redemption, and pricing of shares).

We request comment on this relief in the proposed exemption. Is the relief necessary? We specifically request comment from ETFs regarding the frequency with which they have relied on this exemption. Could an ETF pay cash (as part of the basket assets) in lieu of foreign securities in the case of delays in settlement? Should the relief be limited to ETFs that satisfy redemptions entirely through in-kind transactions? Is the number of days in the proposed rule sufficient or is it too long? Should the rule refer to the applicable local market's settlement cycle without specifying a number of days? Should the disclosure be included in the prospectus of the ETF instead of the SAI, which is only delivered upon request? Should the disclosure be included in any sales literature of the ETF?

The rule would provide relief if the ETF's basket assets include a foreign security. Should the rule also provide relief if an ETF has foreign securities included in its portfolio and, if so, why? Would actively managed ETFs present any issues with respect to this exemption that do not exist with respect to index-based ETFs? Could the investment adviser to an actively managed ETF manage the ETF so as to comply with section 22(e)?

The proposed rule defines “foreign security” to mean any security issued by a government or any political subdivision of a foreign country, a national of any foreign country, or a corporation or other organization incorporated or organized under the laws of any foreign country, and for which there is no established United States public trading market as that term is used in Item 201 of Regulation S-K under the Exchange Act

“foreign security” to mean any security issued by a government or any political subdivision of a foreign country, a national of any foreign country, or a corporation or other organization incorporated or organized under the laws of any foreign country, and for which there is no established United States public trading market as that term is used in Item 201 of Regulation S-K under the Exchange Act. Use of the phrase “established United States public trading market” is designed to limit this relief to ETFs that invest in securities that do not have an active trading market in the United States. The rule does not rely on registration status because an unregistered large foreign private issuer may have an active U.S. market for its securities, in which case the ETF should be able to meet redemption requests in a timely manner. 141

141 See Termination of a Foreign Private Issuer's Registration of a Class of Securities Under Section 12(g) and Duty To File Reports Under Section 13(a) or 15(d) of the Securities Exchange Act of 1934, Securities Exchange Act Release No. 55540 (Mar. 27, 2007) [72 FR 16934 (Apr. 5, 2007)] (adopting rule 12h-6 under the Exchange Act, which permits a foreign issuer to terminate its Exchange Act registration and reporting obligations regarding a class of equity securities if the average daily trading volume (“ADTV”) of the securities in the United States has been 5 percent or less of the ADTV of that class of securities in the issuer's principal trading market during a recent 12-month period, regardless of the size of its U.S. public float).

We request comment on the definition of “foreign security.” Should the definition provide any additional exceptions?

D. Disclosure Amendments

float).

We request comment on the definition of “foreign security.” Should the definition provide any additional exceptions?

D. Disclosure Amendments

Congress enacted the federal securities laws to promote fair and honest securities markets, and an important purpose of these laws is to promote full and fair disclosure of important information by issuers of securities to the investing public. The Securities Act and the Exchange Act, as implemented by Commission rules and regulations, provide for systems of mandatory disclosure of certain material information in securities offerings and in periodic reports. Accordingly, the Securities Act requires delivery of a prospectus meeting the requirements of section 10(a) to each investor in a registered offering. 142 The Securities Act also requires dealers in a security, for a specified period of time after the registration statement for the security becomes effective, to deliver a final prospectus to purchasers, including to most persons purchasing shares in secondary market transactions. 143 The Investment Company Act, however, requires dealers to continue prospectus delivery to investors in open-end funds, including ETFs, which continuously offer their securities to the public. 144

142 15 U.S.C. 77j(a). This is known as a “final prospectus.” In 2005, the Commission adopted rule 172 under the Securities Act which generally deems final prospectus delivery satisfied when the prospectus is filed with the Commission (“access equals delivery”). 17 CFR 230.172. The Commission, however, specifically excluded registered investment companies from rule 172. See Securities Offering Reform, Securities Act Release No. 8591 (July 19, 2005) [70 FR 44722 (Aug. 3, 2005)]. For a detailed discussion on the prospectus delivery requirements and related liabilities with respect to open-end investment companies, see Enhanced Disclosure and New Prospectus Delivery Option for Registered Open-End Management Investment Companies, Investment Company Act Release No. 28064 (Nov

rities Offering Reform, Securities Act Release No. 8591 (July 19, 2005) [70 FR 44722 (Aug. 3, 2005)]. For a detailed discussion on the prospectus delivery requirements and related liabilities with respect to open-end investment companies, see Enhanced Disclosure and New Prospectus Delivery Option for Registered Open-End Management Investment Companies, Investment Company Act Release No. 28064 (Nov. 21, 2007) [72 FR 67790 (Nov. 30, 2007)] (“Enhanced Disclosure Proposing Release”) at sections II.B.1 and II.B.4.

143 Under section 4(3) of the Securities Act, dealers must deliver a prospectus in connection with original sales by the dealer of securities obtained from or through an underwriter, and resales by the dealer occurring during the 40 days (90 days for first-time issuers) after the effective date of the registration statement (or, under certain circumstances, a different date). This aftermarket delivery obligation applies to all dealers, whether or not they participated in the offering itself. 15 U.S.C. 77d(3). See also rule 174 under the Securities Act, which provides an exception from the requirement in section 4(3) that a prospectus be delivered prior to the expiration of the applicable 40-day or 90-day period. 17 CFR 230.174.

144 Section 24(d) of the Act eliminates the dealer's exception with respect to securities issued by funds and UITs on the theory that, because those issuers continuously offer their securities to the public, all dealers should be compelled to use the statutory prospectus. See H.R. Rep. No. 1542, 83d Cong., 2d Sess. 29-30 (1954).

1. Delivery of Prospectuses to Investors

Our orders generally have exempted broker-dealers selling ETF shares from the obligation to deliver prospectuses in most secondary market transactions. 145 146 Proposed rule 6c-11 would not include a similar exemption, and thus broker-dealers would be required to deliver a prospectus meeting the requirements of section 10(a) of the Securities Act to investors purchasing ETF shares

s to Investors

145 Most of the orders have granted exemptions from section 24(d) of the Act, which makes inapplicable the dealer exception in section 4(3) of the Securities Act to transactions in redeemable securities issued by an open-end fund. 15 U.S.C. 80a-24(d); 15 U.S.C. 77(d)(3); see, e.g. , WisdomTree Notice, supra note 12, at n.14. ETFs that have this relief continue to be subject to prospectus delivery requirements in connection with sales of creation units and other non-secondary market transactions. Our most recent orders permitting certain actively managed ETFs do not, however, provide this exemption. See Actively Managed ETF Orders, supra note 20.

146 See, e.g. , Ziegler Notice, supra note 110. The product description provides a summary of the salient features of the ETF and its shares, including the investment objectives of the fund, the manner in which ETF shares trade on the secondary market, and the manner in which creation units are purchased and redeemed. National securities exchanges on which ETFs are listed have adopted rules requiring the delivery of product descriptions. See, e.g. , American Stock Exchange Rules 1000 and 1000A.

147 15 U.S.C. 77j(a). This prospectus delivery requirement would apply to all ETFs, including ETFs operating under current exemptive orders. Therefore, we propose to amend orders we issued to open-end ETFs to exclude the section 24(d) exemption we have issued to existing ETFs. See infra Section III.E for a discussion of this proposed amendment to existing orders

ck Exchange Rules 1000 and 1000A.

We understand that many, if not most, broker-dealers selling ETF shares in secondary market transactions do, in fact, transmit a prospectus to purchasers, and thus they have not relied on the exemptions we have provided in our orders. More important, we believe an exemption allowing dealers to deliver product descriptions would be unnecessary given our proposal regarding summary prospectus disclosure. As discussed below, 148 we recently proposed amendments to Form N-1A and to rule 498 under the Securities Act, 149 in order to enhance the disclosures that are provided to mutual fund investors (“Enhanced Disclosure Proposing Release”). 150 The proposed amendments, if adopted, would require key information to appear in plain English in a standardized order at the front of the mutual fund prospectus (“summary section”). 151 A person could satisfy its mutual fund prospectus delivery obligations under section 5(b)(2) of the Securities Act by sending or giving this key information directly to investors in the form of a summary prospectus and providing a prospectus that meets the requirements of section 10(a) of the Securities Act (“statutory prospectus”) on an Internet Web site. 152 If adopted, broker-dealers selling ETF shares could deliver a summary prospectus in secondary market transactions. We believe the summary prospectus would contain material information that may not be included in a product description, but, like the product description, would be in a form that would be easy to use and readily accessible.

148 See infra notes 176-185 and accompanying text.

149 17 CFR 230.498

broker-dealers selling ETF shares could deliver a summary prospectus in secondary market transactions. We believe the summary prospectus would contain material information that may not be included in a product description, but, like the product description, would be in a form that would be easy to use and readily accessible.

148 See infra notes 176-185 and accompanying text.

149 17 CFR 230.498.

150 See Enhanced Disclosure Proposing Release, supra note 142.

151 See id., at Section II.A.

152 15 U.S.C. 77j(a). The fund also would be required to provide additional information on its Web site. See Proposed rule 498(c).

We request comment on this approach. Are we correct in our understanding that many, if not most, broker-dealers deliver a prospectus instead of a product description in connection with sales of ETF shares in secondary market transactions? If so, why?

If we were to adopt rule 6c-11 before the amendments proposed in the Enhanced Disclosure Proposing Release, we would expect to permit delivery of a product description in lieu of a prospectus, pending final determination of that proposal by the Commission. We request comment on this approach. Should we permit all ETFs, including actively managed ETFs and index-based ETFs that rely on the rule instead of an exemptive order to deliver product descriptions? Should we prescribe 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

he 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

ion 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.

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

quire 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

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

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

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

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

ospectuses provided to investors purchasing creation units, such as in the form of a supplementary prospectus?

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

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

losure 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?

imit 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, § 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

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 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

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 reques

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