While most exchange traded funds are structured like mutual funds, ETFs are not mutual funds, and providers will have to make that distinction in facing compliance issues.
“The leading compliance challenge confronting exchange-traded fund (ETF) sponsors is the threat of complacency,” Rajib Chanda, partner at Ropes & Gray law firm, wrote for Ignites. “It would be easy to presume that ETFs face compliance concerns identical to those of typical mutual funds — or worse, to presume that fewer concerns exist because ETFs typically employ passive investment strategies. Both presumptions are dangerously misleading.”
Chanda offers some basic points to consider when up against compliance issues: How are a sponsor’s ETF product and mutual fund product different? Do the same personnel service both mutual funds and ETFs? Are “non-traditional” ETFs or other exchange traded products and notes offered?
If a providers seeks to apply existing mutual fund compliance policies to new ETFs, some conditions need to be met to receive SEC exemptive relief. For instance, under Section 12(d)(1) of the Investment Act of 1940, unaffiliated funds that invest in ETFs can not go beyond the “3/5/10” limits – a mutual fund can not own over 3% of outstanding securities of any one fund, cannot invest more than 5% of its assets in any single fund and cannot hold over 10% of its assets in investment companies.
Not surprisingly, providers cannot grant special treatment to authorized participants, who create and redeem shares of an ETF.