Exchange traded funds are registered with the Securities and Exchange Commission as Investment Company Act of 1940 funds, like traditional open-end mutual funds. However, ETFs are not mutual funds, and providers should understand the regulatory and compliance issues involved in registering and operation an ETF.
The timeline of SEC applications and filings is changing, so coordination of policies and procedures, listing applications and FINRA filings are critical to timely success. In an upcoming in-person conference, the ETF Bootcamp slated for September 29 and 30 in New York City, industry experts will discuss different ETF structures and provide a checklist of important board and employee considerations. They will walk through the best practices for internal controls, audit tax, board construction, and oversight pertaining to the establishment and maintenance of ETFs.
For instance, if a providers tries 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 so-called 3/5/10 limits whereby 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.
Compliance challenges arise when a sponsor tries to promote both ETF and traditional mutual fund simultaneously on equal footing. Specifically, ETFs cannot be marketed as “mutual funds.”
Additionally, with the proliferation of new ETF strategies and styles, sponsors can not adhere to the same cookie-cutter compliance schematic for all ETFs as the funds have moved beyond the passive indexing structure. For instance, active ETFs will follow a different set of rules.