[Federal Register Volume 83, Number 147 (Tuesday, July 31, 2018)]
[Proposed Rules]
[Pages 37332-37411]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-14370]



[[Page 37331]]

Vol. 83

Tuesday,

No. 147

July 31, 2018

Part IV





Securities and Exchange Commission





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17 CFR Parts 239, 270 and 274





Exchange-Traded Funds; Proposed Rule

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

[[Page 37332]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 239, 270, and 274

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


Exchange-Traded Funds

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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

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

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

Electronic Comments

    <bullet> Use the Commission's internet comment form (http://www.sec.gov/rules/proposed.shtml); or
    <bullet> Send an email to <a href="/cdn-cgi/l/email-protection#fe8c8b929bd39d9193939b908a8dbe8d9b9dd0999188"><span class="__cf_email__" data-cfemail="d9abacb5bcf4bab6b4b4bcb7adaa99aabcbaf7beb6af">[email protected]</span></a>. Please include 
File Number S7-15-18 on the subject line.

Paper Comments

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

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

FOR FURTHER INFORMATION CONTACT: Zeena Abdul-Rahman (Senior Counsel), 
Joel Cavanaugh (Senior Counsel), John Foley (Senior Counsel), Jacob D. 
Krawitz (Branch Chief), Melissa S. Gainor (Senior Special Counsel), and 
Brian McLaughlin Johnson (Assistant Director), Investment Company 
Regulation Office, at (202) 551-6792, Sumeera Younis (Branch Chief) and 
Christian Sandoe (Assistant Director), Disclosure Review and Accounting 
Office, at (202) 551-6921, Division of Investment Management, 
Securities and Exchange Commission, 100 F Street NE, Washington, DC 
20549.

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

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

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

I. Introduction

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

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

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

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

[[Page 37335]]

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

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

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

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

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

[[Page 37336]]

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

A. Scope of Proposed Rule 6c-11

    Proposed rule 6c-11 would define an ETF as a registered open-end 
management investment company that: (i) Issues (and redeems) creation 
units to (and from) authorized participants in exchange for a basket 
and a cash balancing amount (if any); and (ii) issues shares that are 
listed on a national securities exchange and traded at market-
determined prices.\33\
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    \33\ See proposed rule 6c-11(a) (defining ``exchange-traded 
fund''). Under the proposed rule, the term ``basket'' would be 
defined to mean the securities, assets, or other positions in 
exchange for which an ETF issues (or in return for which it redeems) 
creation units. The term ``exchange-traded fund'' thus would include 
ETFs that transact on an in-kind basis, on a cash basis, or both.
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1. Organization as Open-End Funds
    Proposed rule 6c-11 would be available only to ETFs that are 
organized as open-end funds. The vast majority of ETFs currently in 
operation are organized as open-end funds, although the earliest ETFs 
were organized as UITs (``UIT ETFs'').\34\ These early UIT ETFs 
represent a significant amount of assets within the ETF industry.\35\ 
For example, two of the largest ETFs by total net assets and estimated 
dollar trading volume (SPDR S&P 500 ETF Trust (SPY) and PowerShares QQQ 
Trust, Series 1 (QQQ)) are organized as UITs.
---------------------------------------------------------------------------

    \34\ See, e.g., SPDR Trust, Series 1, Investment Company Act 
Release Nos. 18959 (Sept. 17, 1992) [57 FR 43996 (Sept. 23, 1992)] 
(notice) and 19055 (Oct. 26, 1992) (order) and related application 
(``SPDR'').
    \35\ As of Dec. 31, 2017, for example, the eight existing UIT 
ETFs had total assets of approximately $379 billion, representing 
approximately 11.3% of total assets invested in ETFs (based on data 
obtained from MIDAS, Bloomberg, and Morningstar Direct).
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    A UIT is an investment company organized under a trust indenture or 
similar instrument that issues redeemable securities, each of which 
represents an undivided interest in a unit of specified securities.\36\ 
By statute, a UIT is unmanaged and its portfolio is fixed. Substitution 
of securities may take place only under certain pre-defined 
circumstances.\37\ A UIT does not have a board of directors, corporate 
officers, or an investment adviser to render advice during the life of 
the trust. By contrast, ETFs organized as open-end funds are managed by 
investment advisers and, in addition to replicating an index, can be 
actively managed or use a ``sampling'' strategy to track an index.\38\ 
Unlike an ETF structured as a UIT, an open-end fund ETF may participate 
in securities lending programs and has greater flexibility to reinvest 
dividends from portfolio securities.\39\ ETFs structured as open-end 
funds also may invest in derivatives, which typically require a degree 
of management that is not provided for in the UIT structure.\40\ As a 
result, we understand that most ETF sponsors now prefer the open-end 
fund structure over the UIT structure given the increased investment 
flexibility the open-end structure affords. Indeed, we have received 
very few exemptive applications for new UIT ETFs since 2002 and no new 
UIT ETFs have come to market in that time.\41\
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    \36\ See section 4(2) of the Act [15 U.S.C. 80a-4]. A UIT has a 
fixed life--a termination date for the trust is established when the 
trust is created.
    \37\ The exemptive relief granted to UIT ETFs does not provide 
relief from the portion of section 4(2) that requires that UIT 
securities represent an undivided interest in a unit of specified 
securities. Because a UIT must invest in ``specified securities,'' 
the investment strategies that a UIT ETF can pursue are limited. All 
UIT ETFs today seek to track the performance of an index by 
investing in the component securities of the index in the same 
approximate proportions as in the index (i.e., ``replicating'' the 
index). The trustee of an UIT ETF may make adjustments to the ETF's 
portfolio only to reflect changes in the composition of the 
underlying index. See Actively Managed Exchange-Traded Funds, 
Investment Company Act Release No. 25258 (Nov. 8. 2001) [66 FR 57614 
(Nov. 15, 2001)] (``2001 Concept Release''), at n.11.
    \38\ An ETF that uses a sampling strategy includes assets in its 
portfolio that are designed, in the aggregate, to reflect the 
underlying index's capitalization, industry, and fundamental 
investment characteristics, and to perform like the index. The ETF 
implements the strategy by acquiring a subset of the underlying 
index's component securities and may invest a portion of the ETF's 
portfolio in securities and other financial instruments (including 
derivatives) that are not included in the corresponding index if the 
adviser believes the investment will help the ETF track the 
underlying index. See 2008 ETF Proposing Release, supra footnote 3.
    \39\ UIT dividends are held in a non-interest bearing account 
and paid out quarterly. The inability to reinvest dividends can have 
a cash drag on the tracking performance of a UIT ETF. See A. Seddik 
Meziani, Exchange-Traded Funds: Investment Practices and Tactical 
Approaches (2016), at 22.
    \40\ See Use of Derivatives by Registered Investment Companies 
and Business Development Companies, Investment Company Act Release 
No. 31933 (Dec. 11, 2015) [80 FR 80883 (Dec. 28, 2015)] 
(``Derivatives Proposing Release''), at n.139.
    \41\ The Commission has received applications for ETFs 
structured as a UIT, but with features that are different from 
typical UIT-structured ETFs. See Application of Elkhorn Securities, 
LLC and Elkhorn Unit Trust (Mar. 6, 2017) (``Elkhorn Application''); 
Application of Precidian ADRs LLC (Aug. 1, 2014) (``Precidian ADR 
Application''). The Commission has not taken any action on the 
Elkhorn Application, and the Precidian ADR Application was withdrawn 
by the applicant. Two orders modifying relief for existing ETFs 
organized as UITs were issued in 2007. See NASDAQ-100 Trust, Series 
1, et al., Investment Company Act Release Nos. 27740 (Feb. 27, 2007) 
[72 FR 9594 (Mar. 2, 2007)] (notice) and 27753 (Mar. 20, 2007) 
(order) and related application; BLDRS Index Funds Trust, et al., 
Investment Company Act Release Nos. 27745 (Feb. 28, 2007) [72 FR 
9787 (Mar. 5, 2007)] (notice) and 27768 (Mar. 21, 2007) (order) and 
related application.
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    The rule we proposed in 2008 would not have included UIT ETFs 
within its scope.\42\ Comments on the 2008 ETF Proposing Release were 
mixed with regard to providing relief to UITs, with two commenters 
supporting the exclusion of UITs.\43\ On the other hand, two commenters 
argued that the Commission should expand the rule to include UITs, 
contending that sponsors in the future may choose the UIT structure for 
some reason unforeseen today.\44\ Some commenters also stated that 
existing UIT ETFs should be able to rely on the rule, which may provide 
broader relief than provided by their exemptive orders.\45\
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    \42\ See 2008 ETF Proposing Release, supra footnote 3, at text 
accompanying nn.63-67 (noting that the Commission had not received 
an exemptive application for a new ETF to be organized as a UIT 
since 2002 and, as a result, there did not appear to be a need to 
include UIT relief in the proposed rule).
    \43\ See Comment Letter of Xshares Advisors LLC (May 20, 2008) 
(``Xshares 2008 Comment Letter''); Comment Letter of the Investment 
Company Institute (May 19, 2008) (``ICI 2008 Comment Letter'').
    \44\ See Comment Letter of Katten Muchin Rosenman LLP (May 30, 
2008) (``Katten 2008 Comment Letter''); Comment Letter of the 
Federal Regulation of Securities Committee, Section of Business Law, 
American Bar Association (May 29, 2008) (``ABA 2008 Comment 
Letter'').
    \45\ See Comment Letter of State Street Global Advisors (May 19, 
2008) (``SSgA 2008 Comment Letter''); Comment Letter of NYSE Arca 
(May 29, 2008) (``NYSE Arca 2008 Comment Letter''); Katten 2008 
Comment Letter.
---------------------------------------------------------------------------

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

[[Page 37337]]

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

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

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

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

    To the extent that ETF sponsors develop unforeseen, novel UIT ETFs, 
we believe that the Commission should review such products as part of 
its exemptive process to determine whether the relief is necessary or 
appropriate in the public interest and consistent with the protection 
of investors. We therefore are not proposing to include ETFs structured 
as UITs within the scope of proposed rule 6c-11.\54\
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    \54\ While we do not propose to include ETFs organized as UITs 
within the scope of proposed rule 6c-11, we are proposing amendments 
to Form N-8B-2 to require them to provide certain additional 
disclosures regarding trading costs. See infra section II.I.
---------------------------------------------------------------------------

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

[[Page 37338]]

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

    <bullet> Are there any other exemptions we should consider for UIT 
ETFs?
    <bullet> If we were to include UIT ETFs in rule 6c-11, are there 
any specific disclosures that should be required, other than the ones 
proposed herein?
    <bullet> If we do not include UIT ETFs within the scope of the 
rule, should we nonetheless require them to comply with any of the 
rule's requirements for ETFs organized as open-end funds?
2. Index-Based ETFs and Actively Managed ETFs
    Proposed rule 6c-11 would provide exemptions for both index-based 
ETFs and actively managed ETFs, but would not by its terms establish 
different requirements based on whether an ETF's investment objective 
is to seek returns that correspond to the returns of an index. We 
believe that index-based and actively managed ETFs that comply with the 
proposed rule's conditions function similarly with respect to 
operational matters, despite different investment objectives or 
strategies, and do not present significantly different concerns under 
the provisions of the Act from which the proposed rule grants relief. 
For example, both index-based and actively managed ETFs register under 
the Act, issue and redeem shares in creation unit sizes in exchange for 
baskets of assets, list on national securities exchanges, and allow 
investors to trade ETF shares throughout the day at market-determined 
prices in the secondary market.
    The distinction between index-based ETFs and actively managed ETFs 
in our current exemptive orders is largely a product of ETFs' 
historical evolution. The Commission did not approve the first actively 
managed ETF until nearly 15 years after index-based ETFs were 
introduced.\58\ As discussed in a 2001 concept release on actively 
managed ETFs, the Commission was initially concerned that actively 
managed ETFs would not be able (or willing) to provide portfolio 
transparency, potentially hindering the arbitrage mechanism deemed 
critical to the operation of an ETF.\59\ Actively managed ETFs were 
novel at the time of the 2008 ETF Proposing Release, and the Commission 
solicited comment on whether a proposed ETF rule should specifically 
include actively managed ETFs.\60\ Six commenters supported this 
approach,\61\ while a few commenters questioned whether it was 
premature to allow actively managed ETFs to operate using the rule.\62\
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    \58\ See, e.g., WisdomTree Trust, et al., Investment Company Act 
Release Nos. 28147 (Feb. 6, 2008) [73 FR 7776 (Feb. 11, 2008)] 
(notice) and 28174 (Feb. 27, 2008) (order) and related application 
(``2008 WisdomTree Trust''); Barclays Global Fund Advisors, et al., 
Investment Company Act Release Nos. 28146 (Feb. 6, 2008) [73 FR 7771 
(Feb. 11, 2008)] (notice) and 28173 (Feb. 27, 2008) (order) and 
related application (``Barclays Global 2008''). Approximately 100 
exemptive orders have been issued since 2008 for actively managed, 
transparent ETFs.
    \59\ See 2001 Concept Release, supra footnote 37, at n.31 and 
accompanying and following text. Comment letters to the 2001 Concept 
Release are available at http://www.sec.gov/rules/concept/s72001.shtml.
    \60\ See 2008 ETF Proposing Release, supra footnote 3, at 
section III.A.2.
    \61\ See e.g., Comment Letter of the Vanguard Group, Inc. (June 
19, 2008) (``Vanguard 2008 Comment Letter''); Xshares 2008 Comment 
Letter; Comment Letter of Barclays Global Fund Advisors (May 16, 
2008) (``BGFA 2008 Comment Letter''); ICI 2008 Comment Letter; SSgA 
2008 Comment Letter; Comment Letter of Mutual Fund Directors Forum 
(May 21, 2008).
    \62\ See Comment Letter of Brown & Associates LLC (May 19, 
2008); Katten 2008 Comment Letter.
---------------------------------------------------------------------------

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

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

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

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

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

    \67\ For these purposes, an index-based ETF was defined as an 
ETF that has a stated investment objective of obtaining returns that 
correspond to the returns of a securities index (whose provider 
discloses on its internet website the identities and weightings of 
the component securities and other assets of that index). See 2008 
ETF Proposing Release, supra footnote 3. See also infra section 
II.C.4 (discussing proposed condition regarding portfolio 
transparency).
    \68\ See 2015 ETP Request for Comment, supra footnote 9.
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    We request comment on whether proposed rule 6c-11 should provide

[[Page 37339]]

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

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

    <bullet> Should the proposed rule include requirements relating to 
index-based ETFs with an affiliated index provider? If so, what 
requirements and why? For example, should ETFs with affiliated index 
providers be required to adopt additional policies and procedures 
designed to further limit information sharing between portfolio 
management staff and index management staff? How should we define 
``index provider'' for these purposes?
    <bullet> Are there operational differences between index-based and 
actively managed ETFs that should be addressed in the proposed rule?
3. Leveraged ETFs
    Although the proposed rule would not distinguish between actively 
managed ETFs and index-based ETFs in general, it would take a different 
approach with respect to leveraged ETFs, which are a type of index-
based ETF that presents unique considerations.\70\ ``Leveraged ETFs'' 
refers to ETFs that seek, directly or indirectly, to provide returns 
that exceed the performance of a market index by a specified multiple 
or to provide returns that have an inverse relationship to the 
performance of a market index, over a fixed period of time.\71\ A 
leveraged ETF seeks to amplify the returns of its underlying index or 
to profit from a decline in the value of its underlying index. It also 
typically seeks to deliver the targeted return over a short period of 
time, such as a day. This means that investors holding shares over 
periods longer than the targeted period may experience performance that 
is different, and at times substantially different, from the targeted 
returns. Leveraged ETFs seek to achieve their targeted returns by using 
financial derivatives. These funds are sometimes referred to as trading 
tools because they can be used by investors to hedge against or profit 
from short-term market movements without using margin.\72\
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    \70\ We use the term ``leveraged ETFs'' in this release to refer 
to ETFs that pursue leveraged strategies (i.e., those that seek to 
provide returns that exceed the performance of a market index by a 
specified multiple over a period of time) and inverse strategies 
(i.e., those that seek to provide returns that have an inverse 
relationship to, or provide returns that are an inverse multiple of, 
the performance of a market index over a fixed period of time). At 
the end of December 2017, 187 ETFs employed leveraged or inverse 
investment strategies. All of these ETFs are structured as open-end 
funds. In total, these ETFs had total net assets of $35.26 billion 
or approximately 1% of all ETF assets. See infra footnote 427 and 
following text.
    \71\ See proposed rule 6c-11(c)(4); see also Item C.3.c. of Form 
N-CEN (requiring funds to identify if they seek to achieve 
performance results that are a multiple of an index or other 
benchmark, the inverse of an index or other benchmark, or a multiple 
of the inverse of an index or other benchmark).
    \72\ See ETF Handbook, supra footnote 22, at 266.
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    The strategy that leveraged ETFs pursue requires them to rebalance 
their portfolios on a daily basis in order to maintain a constant 
leverage ratio. This daily reset, and the effects of compounding,\73\ 
can result in performance that differs significantly from some 
investors' expectations of how index investing generally works.\74\ 
This effect can be more pronounced in volatile markets.\75\ As a 
result, buy-and-hold investors in a leveraged ETF with an intermediate 
or long-term time horizon--who may not evaluate their portfolios 
frequently--may experience large and unexpected losses.\76\
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    \73\ For example, as a result of compounding, leveraged ETFs can 
outperform a simple multiple of its index's returns over several 
days of consistently positive returns, or underperform a simple 
multiple of its index's returns over several days of volatile 
returns.
    \74\ See Office of Investor Education and Advocacy, SEC, 
Leveraged and Inverse ETFs: Specialized Products with Extra Risks 
for Buy-and-Hold Investors Investor Alert and Bulletins (Aug. 1, 
2009), available at http://www.sec.gov/investor/pubs/leveragedetfs-alert.htm; FINRA, Non-Traditional ETFs: FINRA Reminds Firms of Sales 
Practice Obligations Relating to Leveraged and Inverse Exchange-
Traded Funds, Regulatory Notice 09-31 (June 2009), available at 
http://www.finra.org/sites/default/files/NoticeDocument/p118952.pdf 
(``FINRA Regulatory Notice 09-31'') (providing an example of a four-
month period where a specified index gained 2%, while an ETF seeking 
to deliver twice the daily return of that index fell 6%, and the 
related ETF seeking to deliver twice the inverse of the index's 
daily return fell 26%).
    \75\ See FINRA Regulatory Notice 09-31, supra footnote 74 
(``Using a two-day example, if the index goes from 100 to close at 
101 on the first day and back down to close at 100 on the next day, 
the two-day return of an inverse ETF will be different than if the 
index had moved up to close at 110 the first day but then back down 
to close at 100 on the next day. In the first case with low 
volatility, the inverse ETF loses 0.02 percent; but in the more 
volatile scenario the inverse ETF loses 1.82 percent. The effects of 
mathematical compounding can grow significantly over time, leading 
to scenarios such as those noted above.'').
    \76\ See id. (reminding member firms of their sales practice 
obligations relating to leveraged ETFs and noting that leveraged 
ETFs are typically not suitable for retail investors who plan to 
hold these products for more than one trading session). See also, 
e.g., SEC v. Hallas, No. 1:17-cv-2999 (S.D.N.Y. Sept. 27, 2017); 
FINRA News Release, FINRA Sanctions Oppenheimer & Co. $2.9 Million 
for Unsuitable Sales of Non-Traditional ETFs and Related Supervisory 
Failures (June 8, 2016), available at http://www.finra.org/newsroom/2016/finra-sanctions-oppenheimer-co-29-million-unsuitable-sales-non-traditional-etfs. The Commission also settled an enforcement action 
against an investment adviser under section 206(4) of the Investment 
Advisers Act of 1940 (the ``Advisers Act'') and rule 206(4)-7, 
finding the adviser violated these provisions by failing to 
adequately implement written compliance policies that were designed 
to ensure that recommendations of single inverse ETFs to non-
discretionary advisory clients were suitable for each individual 
client. See In Re Morgan Stanley Smith Barney, LLC, Investment 
Advisers Act Release No. 4649 (Feb. 14, 2017) (settled action), 
available at https://www.sec.gov/litigation/admin/2017/ia-4649.pdf.
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    Leveraged ETFs, and their use of derivatives, also may raise issues 
under section 18 that we are evaluating as part of our broader 
consideration of the use of derivatives by registered funds and 
business development companies.\77\ In

[[Page 37340]]

2015, for example, we proposed new 17 CFR 270.18f-4 (``rule 18f-4'' 
under the Act). Proposed rule 18f-4 was designed to address the 
investor protection purposes and concerns underlying section 18 of the 
Act and to provide an updated and more comprehensive approach to the 
regulation of funds' use of derivatives transactions.\78\
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    \77\ The staff has not supported new exemptive relief for 
leveraged ETFs since 2009. The orders issued to current leveraged 
ETF sponsors prior to the staff moratorium, as amended over time, 
relate to leveraged ETFs that seek investment results of up to 300% 
of the return (or inverse of the return) of the underlying index. 
Rydex ETF Trust, et al., Investment Company Act Release Nos. 27703 
(Feb. 20, 2007) [72 FR 8810 (Feb. 27, 2007)] (notice) and 27754 
(Mar. 20, 2007) (order) and related application; Rafferty Asset 
Management, LLC, et al., Investment Company Act Release Nos. 28379 
(Sept. 12, 2008) [73 FR 54179 (Sept. 18, 2008)] (notice) and 28434 
(Oct. 6, 2008) (order) and related application. See also ProShares 
Trust, et al., Investment Company Act Release Nos. 28696 (Apr. 14, 
2009) [74 FR 18265 Apr. 21, 2009)] (notice) and 28724 (May 12, 2009) 
(order) and related application (amending the applicant's prior 
order) (``ProShares''); Rafferty Asset Management, LLC, et al., 
Investment Company Act Release Nos. 28889 (Aug. 27, 2009) [74 FR 
45495 (Sept. 2, 2009)] (notice) and 28905 (Sept. 22, 2009) (order) 
and related application (amending the applicant's prior order) 
(``Rafferty'').
    \78\ See Derivatives Proposing Release, supra footnote 40. 
Section 18 of the Act limits a fund's ability to obtain leverage or 
issue senior securities. 15 U.S.C. 80a-18.
---------------------------------------------------------------------------

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

    \79\ See supra footnote 77. As discussed in more detail in 
section II.G below, we are not proposing here to rescind the 
existing leverage ETF orders. Existing leveraged ETF sponsors would 
continue to operate under their exemptive orders. Existing leveraged 
ETFs, however, would be subject to the proposed amendments to Form 
N-1A discussed below.
    \80\ Proposed rule 6c-11(c)(4).
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    The daily or other periodic reset, and more particularly the 
effects of compounding, are what distinguish a leveraged ETF strategy 
from other strategies pursued by ETFs. The proposed condition relating 
to leveraged ETFs thus includes a temporal element (i.e., ``over a 
fixed period of time'') in order to specifically capture ETFs that seek 
to deliver the leveraged or inverse return of a market index over a 
fixed period of time, daily or otherwise.\81\ In addition, the proposed 
rule's use of the term ``multiple'' includes leverage that is not 
evenly divisible by 100, such as a fund that seeks to provide a return 
equal to 150% of the performance of an index.\82\ Finally, we believe 
it is important to specify that an ETF may not indirectly seek to 
provide returns that exceed the performance of a market index by a 
specified multiple or to provide returns that have an inverse 
relationship to the performance of a market index over a fixed period 
of time in order to prevent a fund from circumventing this condition, 
such as by embedding inverse leverage in the underlying index.
---------------------------------------------------------------------------

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

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

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

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

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

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[[Page 37341]]

    <bullet> The Commission understands that leveraged ETFs typically 
provide enhanced disclosure of the risks of investing in the ETF.\85\ 
Do investors understand leveraged ETFs better today than they did when 
Commission staff and FINRA jointly issued an investor alert expressing 
the concern that individual investors may be confused about the 
performance objectives of leveraged ETFs? \86\ For example, are 
investors more likely to be aware that leveraged ETFs are typically 
designed to achieve their stated performance objectives on a periodic 
basis (e.g., daily)? Do investors understand that leveraged ETFs may 
not achieve those performance objectives over the long-term? \87\
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    \85\ This understanding is based on Commission staff review of 
registration statements filed with the Commission and ETF websites.
    \86\ See supra footnote 74.
    \87\ See e.g., Paolo Guasoni and Eberhard Mayerhofer, Leveraged 
Funds: Robust Replication and Performance Evaluation (2017) 
(``Leveraged and inverse exchange-traded funds seek daily returns 
equal to fixed multiples of indexes' returns. Trading costs implied 
by frequent adjustments of funds' portfolios create a tension 
between tracking error, reflecting short-term correlation with the 
index, and excess return, the long-term deviation from the leveraged 
index's performance.''); Lu Lei, Jun Wang, and Ge Zhang, Long-term 
performance of leveraged ETFs, 21 Financial Services Review 1 (2012) 
(``Overall our results caution against the use of leveraged ETFs as 
long-term investment substitutes for long or short positions of the 
benchmark indices.'').
---------------------------------------------------------------------------

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

B. Exemptive Relief Under Proposed Rule 6c-11

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

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

1. Treatment of ETF Shares as ``Redeemable Securities''
    Under proposed rule 6c-11, an ETF, as defined in the rule, would be 
considered to issue a ``redeemable security'' within the meaning of 
section 2(a)(32) of the Act.\90\ As discussed above, ETFs have features 
that distinguish them from both traditional open-end and closed-end 
funds. A defining feature of open-end funds is that they offer 
redeemable securities, which allow the holder to receive his or her 
proportionate share of the fund's NAV per share upon presentation of 
the security to the issuer. Although individual ETF shares cannot be 
redeemed, except in limited circumstances,\91\ they can be redeemed in 
creation unit aggregations.\92\ Therefore, we believe that ETF shares 
are most appropriately classified under the proposed rule as redeemable 
securities within the meaning of section 2(a)(32),\93\ and that ETFs 
should be regulated as open-end funds within the meaning of section 
5(a)(1) of the Act.\94\
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    \90\ Proposed rule 6c-11(b)(1).
    \91\ See infra section II.C.1 (discussing circumstances where 
ETF shares can be individually redeemed).
    \92\ See proposed rule 6c-11(a) (defining an exchange-traded 
fund, in part, as a registered open-end management company that 
issues and redeems its shares in creation units). The proposed rule 
would define ``creation unit'' to mean a specified number of ETF 
shares that the ETF will issue to (or redeem from) an authorized 
participant in exchange for the deposit (or delivery) of a basket 
and a cash balancing amount (if any). See proposed definition of 
``creation unit'' in rule 6c-11(a).
    \93\ If ETF shares were not classified as redeemable securities 
within the meaning of section 2(a)(32) of the Act, an ETF would be 
subject to the provisions of the Act applicable to closed-end funds. 
See 15 U.S.C. 80a-5(a)(2) (defining a ``closed-end company'' as any 
management company other than an open-end company).
    \94\ 15 U.S.C. 80a-5(a)(1) (defining ``open-end company''); 15 
U.S.C. 80a-2(a)(32) (defining ``redeemable security'').
---------------------------------------------------------------------------

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

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

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

[[Page 37342]]

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

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

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

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

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

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

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

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

2. Trading of ETF Shares at Market-Determined Prices
    Section 22(d) of the Act, among other things, prohibits investment 
companies, their principal underwriters, and dealers from selling a 
redeemable security to the public except at a current public offering 
price described in the prospectus.\109\ Rule 22c-1 generally requires 
that a dealer selling, redeeming, or repurchasing a redeemable security 
do so only at a price based on its NAV.\110\ Together, section 22(d) 
and rule 22c-1 are designed to: (i) Prevent dilution caused by certain 
riskless trading practices of principal underwriters and dealers; (ii) 
prevent unjust discrimination or preferential treatment among investors 
purchasing and redeeming fund shares; and (iii) preserve an orderly 
distribution of investment company shares.\111\ ETFs seeking to 
register under the Act obtain exemptions from these provisions because 
investors may purchase and sell individual ETF shares from and to 
dealers on the secondary market at market-determined prices (i.e., at 
prices other than those described in the prospectus or based on NAV). 
Consistent with our prior exemptive orders, proposed rule 6c-11 would 
provide exemptions from these provisions.\112\
---------------------------------------------------------------------------

    \109\ 15 U.S.C. 80a-22(d).
    \110\ See 17 CFR 270.22c-1.
    \111\ See generally Mutual Fund Distribution Fees; 
Confirmations, Investment Company Act Release No. 29367 (July 21, 
2010) [75 FR 47064 (Aug. 4, 2010)] (discussing legislative history 
of section 22(d)).
    \112\ See proposed rule 6c-11(b)(2). The reference in the 
proposed rule to ``repurchases . . . at market-determined prices'' 
refers to secondary market transactions with dealers. Thus, the rule 
would not allow an ETF to repurchase shares from an investor at 
market-determined prices.
---------------------------------------------------------------------------

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

[[Page 37343]]

arbitrage mechanism--and the conditions in this rule designed to 
promote a properly functioning arbitrage mechanism--have adequately 
addressed, over the significant operating history of ETFs, the 
potential concerns regarding shareholder dilution and unjust 
discrimination that these provisions were designed to address.
---------------------------------------------------------------------------

    \113\ See, e.g., Comment Letter of Barclays Global Investors on 
2001 Concept Release (Jan. 11, 2002) (``[D]uring periods of market 
volatility . . . it is not unreasonable to assume that some retail 
investors would buy or sell ETF shares at secondary market prices 
moving in the opposite direction of a fund's NAV.'').
---------------------------------------------------------------------------

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

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

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

    These numbers represent only broad averages with respect to end-of-
day differences, however, and intraday deviations between market price 
and NAV per share may be greater under certain circumstances. These 
figures also do not reflect intraday deviations between market prices 
and the contemporaneous value of the ETF's portfolio.\122\ However, one 
academic paper has shown that deviations between intraday market prices 
and estimated intraday values for domestic ETFs also were generally 
small.\123\
---------------------------------------------------------------------------

    \122\ Most funds calculate NAV per share once per day as of the 
time the major U.S. stock exchanges close. See supra footnote 26.
    \123\ Engle Article, supra footnote 95. For domestic ETFs, the 
study showed intraday average daily premium of 0.25 basis points 
with an average standard deviation of 11.8 basis points. For 
international ETFs, the respective figures were 23.7 basis points 
and an average standard deviation of 64.8 basis points. The intraday 
premium was measured every minute as the percentage difference 
between: (i) The average of the bid and the ask of the ETF shares; 
and (ii) the intraday indicative value (IIV) of the ETF's portfolio. 
See infra sections II.C.3 and II.C.6 for a discussion of the IIV and 
the potential problems associated with using the IIV as a tool to 
measure the current value of the ETF's portfolio on an ongoing 
basis.
---------------------------------------------------------------------------

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

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

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

[[Page 37344]]

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

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

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

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

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

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

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

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

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

[[Page 37345]]

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

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

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

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

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

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

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

    \143\ See id. To utilize custom baskets, proposed rule 6c-
11(c)(3) would require an ETF to adopt and implement written 
policies and procedures that: (i) Set forth detailed parameters for 
the construction and acceptance of custom baskets that are in the 
best interests of the ETF and its shareholders, including the 
process for any revisions to, or deviations from, those parameters; 
and (ii) specify the titles or roles of the employees of the ETF's 
investment adviser who are required to review each custom basket for 
compliance with those parameters.
    \144\ See, e.g., Comment Letter of Barclays Capital Inc. (May 8, 
2008); ICI 2008 Comment Letter; SSgA 2008 Comment Letter.
    \145\ See, e.g., ICI 2008 Comment Letter; BGFA 2008 Comment 
Letter.
    \146\ See, e.g., ICI 2008 Comment Letter; ABA 2008 Comment 
Letter.
    \147\ Item E.2.a. of Form N-CEN requires ETFs to provide certain 
identifying information regarding its authorized participants. See 
Investment Company Reporting Modernization Adopting Release, 
Investment Company Act Release No. 32314 (Oct. 13, 2016) [81 FR 
81870 (Nov. 18, 2016)] (``Reporting Modernization Adopting 
Release'') (``[C]ollecting information concerning these entities on 
an annual basis will allow [the Commission] to understand and better 
assess the size, capacity, and concentration of the authorized 
participant framework and also inform the public about certain 
characteristics of the ETF primary markets.'').
---------------------------------------------------------------------------

    While we acknowledge that an increase in entities eligible to 
transact with an ETF could facilitate the arbitrage mechanism and 
reduce concentration risk, we preliminarily do not believe that it is 
appropriate to expand the scope of affiliated persons covered by the 
exemption at the same time that we are permitting additional 
flexibility with respect to custom baskets. The proposed rule would 
allow an ETF to utilize custom baskets if certain conditions are met, 
increasing the possibility that affiliates and non-affiliates could be 
treated differently in connection with an ETF's receipt or delivery of 
baskets.\148\ We believe that the conditions related to the issuance or 
acceptance of custom baskets in proposed rule 6c-11 would provide 
appropriate protections against overreaching and similar abusive 
practices when an ETF exchanges a custom basket with an affiliate; 
however, limiting the types of affiliates that are permitted to rely on 
this exemption would serve as an additional protection against 
potential disparate treatment in connection with an ETF's receipt or 
delivery of baskets.
---------------------------------------------------------------------------

    \148\ See proposed rule 6c-11(c)(3).
---------------------------------------------------------------------------

    We request comment on this aspect of the proposed rule.
    <bullet> Without an exemption from section 17(a) of the Act, would 
ETFs or authorized participants bear any costs that they do not incur 
today?
    <bullet> As discussed above, the exemptive relief from section 
17(a) of the Act that we are proposing would apply only to

[[Page 37346]]

in-kind purchases and redemptions of creation units, and only to 
persons affiliated with the ETF (or affiliates of those persons) by 
reason of holding the power to vote 5% or more of the ETF's shares or 
holding the power to vote 5% or more of any investment company that is 
affiliated with the ETF. Should the relief extend to parties that are 
affiliated persons of an ETF for other reasons, or to non-creation unit 
transactions, such as portfolio transactions? For example, should a 
broker-dealer that is affiliated with the ETF's adviser be allowed to 
transact in kind with the ETF? If so, should the proposed rule include 
any additional conditions to minimize potential risks of overreaching 
for this type of affiliated person? How would expanding the scope of 
the exemption in this manner interact with the proposed conditions 
regarding basket flexibility?
4. Additional Time for Delivering Redemption Proceeds
    Section 22(e) of the Act generally prohibits a registered open-end 
management investment company from postponing the date of satisfaction 
of redemption requests for more than seven days after the tender of a 
security for redemption.\149\ This prohibition can cause operational 
difficulties for ETFs that hold foreign investments and exchange in-
kind baskets for creation units. For example, local market delivery 
cycles for transferring foreign investments to redeeming investors, 
together with local market holiday schedules, can sometimes require a 
delivery process in excess of seven days. These ETFs have previously 
requested, and we have granted, relief from section 22(e) so that they 
may satisfy redemptions up to a specified maximum number of days 
(depending upon 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.\150\
---------------------------------------------------------------------------

    \149\ 15 U.S.C. 80a-22(e).
    \150\ See, e.g., Parker Global Strategies, supra footnote 18.
---------------------------------------------------------------------------

    Section 22(e) was designed to prevent unreasonable delays in the 
actual payment of redemption proceeds.\151\ Proposed rule 6c-11 would 
provide an exemption from section 22(e) of the Act because we believe 
that the limited nature of the exemption addresses the concerns 
underlying this section of the Act. As proposed, rule 6c-11 would grant 
relief from section 22(e) to permit an ETF to delay satisfaction of a 
redemption request for more than seven days if a local market holiday, 
or series of consecutive holidays, the extended delivery cycles for 
transferring foreign investments to redeeming authorized participants, 
or the combination thereof prevents timely delivery of the foreign 
investment included in the ETF's basket.\152\ To rely on this 
exemption, an ETF would be required to deliver foreign investments as 
soon as practicable, but in no event later than 15 days after the 
tender to the ETF.\153\ This proposed exemption thus would permit a 
delay in the delivery of foreign investments only if the foreign 
investment is being transferred in kind as part of the basket.\154\
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    \151\ 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).
    \152\ Proposed rule 6c-11(b)(4). This relief from the 
requirements of section 22(e) would not affect any obligations 
arising under rule 15c6-1 under the Exchange Act, which requires 
that most securities transactions be settled within two business 
days of the trade date. 17 CFR 240.15c6-1.
    \153\ Proposed rule 6c-11(b)(4).
    \154\ While mutual funds also may invest in foreign investments 
that require a delivery process in excess of seven days, mutual 
funds typically deliver redemption proceeds in cash, rather than in 
kind. Mutual funds, ETFs that redeem in cash, and ETFs that 
substitute cash in lieu of a particular foreign investment in a 
basket do not require an exemption from section 22(e) of the Act.
---------------------------------------------------------------------------

    The exemption would permit a delay only to the extent that 
additional time for settlement is actually required, when a local 
market holiday, or series of consecutive holidays, or the extended 
delivery cycles for transferring foreign investments to redeeming 
authorized participants prevents timely delivery of the foreign 
investment included in the ETF's basket. To the extent that settlement 
times continue to shorten, the ``as soon as practicable'' language 
embedded in the exemption is designed to minimize any unnecessary 
settlement delays.\155\ If a foreign investment settles in less than 15 
days, the ETF would be required to deliver it pursuant to the standard 
settlement time of the local market where the investment trades.
---------------------------------------------------------------------------

    \155\ Austria, Belgium, Bulgaria, Croatia, Cyprus, the Czech 
Republic, Denmark, Estonia, Finland, France, Germany, Greece, 
Hungary, Iceland, Italy, Ireland, the Netherlands, Latvia, 
Lichtenstein, Lithuania, Luxembourg, Malta, Norway, Poland, 
Portugal, Romania, Slovakia, Slovenia, Spain (certain fixed-income 
trades only), Sweden, Switzerland, and the United Kingdom moved to a 
T+2 settlement cycle by the end of 2014, while Australia and New 
Zealand transitioned to a T+2 settlement cycle in 2016. See 
Amendments to Securities Transaction Settlement Cycle, Exchange Act 
Release No. 78962 (Sept. 28, 2016) [81 FR 69240 (Oct. 5, 2016)], at 
n.134. Like the United States, Mexico, Canada, Peru and Argentina 
moved to a T+2 settlement cycle in September 2017. See T+2 Adopting 
Release, supra footnote 99. See also Annie Massa, Your Trades Will 
Soon Spend Less Time Stuck in Market's Plumbing, Bloomberg Markets 
(Aug. 31, 2017), available at https://www.bloomberg.com/news/articles/2017-08-31/your-trades-will-soon-spend-less-time-stuck-in-market-s-plumbing. There are many securities that trade over the 
counter (OTC) in certain foreign markets with agreed-upon settlement 
timeframes between the parties that could extend beyond the 
settlement timeframes of central securities depositories.
---------------------------------------------------------------------------

    In addition, given the continued movement toward shorter settlement 
times in markets around the world, we believe that the relief from 
section 22(e) in the proposed rule does not need to be permanent. 
Accordingly, we propose to include a sunset provision in the proposed 
rule relating to the relief from section 22(e). Absent further action 
by the Commission, the exemption from section 22(e) for postponement of 
delivering redemption proceeds would expire ten years from the rule's 
effective date. We believe that technological innovation and changes in 
market infrastructures and operations will lead to further shortening 
of settlement cycles, although these developments may be gradual. 
Therefore, we believe it is appropriate for the relief from section 
22(e) to be limited in duration to ten years.\156\
---------------------------------------------------------------------------

    \156\ ETFs that invest in foreign investments from jurisdictions 
that continue to require more than seven days to deliver redemption 
proceeds would have the option of redeeming in cash rather than in-
kind once the exemptive relief sunsets. Such ETFs also could request 
targeted exemptive relief from section 22(e) from the Commission.
---------------------------------------------------------------------------

    In 2008, we proposed a similar exemption for postponement of 
delivering redemption proceeds. However, that exemption would have 
allowed up to 12 days to deliver redemption proceeds without an 
offsetting requirement to deliver as soon as practicable and without a 
sunset provision.\157\ Commenters on the 2008 proposal agreed that the 
specified delay in satisfying redemption requests seemed reasonable 
because it was for a limited period of time and disclosed to 
investors.\158\ However, one commenter suggested increasing the period 
of time for settlement beyond 12 days consistent with the terms of 
exemptive orders that had been issued to some ETFs.\159\ Since 2012, 
numerous applicants for exemptive relief have indicated that payment or 
satisfaction of redemption requests may take as long as 15 days after a 
redemption request is received, and we have issued orders permitting 
delayed delivery of settlement proceeds for up to 15 days.\160\ We 
believe an extended

[[Page 37347]]

settlement period in these circumstances of 15 days, with the 
requirement that delivery nevertheless be made as soon as practicable, 
is reasonable in light of the limited nature and duration of the 
exemption.
---------------------------------------------------------------------------

    \157\ See 2008 ETF Proposing Release, supra footnote 3.
    \158\ See, e.g., Katten 2008 Comment Letter; Xshares 2008 
Comment Letter.
    \159\ Katten 2008 Comment Letter (recommending up to 14 days).
    \160\ See, e.g., Legg Mason ETF Trust, Investment Company Act 
Release Nos. 30237 (Oct. 22, 2012) [77 FR 65425 (Oct. 26, 2012)] 
(notice) and 30265 (Nov. 16, 2012) (order) and related application 
(``Legg Mason'').
---------------------------------------------------------------------------

    The exemption we proposed in 2008 would have required an ETF to 
disclose in its registration statement the foreign holidays that it 
expects may prevent timely delivery of foreign securities, and the 
maximum number of days that it anticipates it will need to deliver the 
foreign securities.\161\ We are not proposing a similar requirement for 
several reasons. First, we do not believe this disclosure is relevant 
to investors who purchase ETF shares on the secondary market, because 
the settlement of these investors' ETF trades would be unaffected by 
the potential delay. Only authorized participants engaged in redemption 
transactions with the ETF (and market participants that use the 
authorized participants as their agents for transacting with the ETF) 
would be affected. We believe that information regarding these 
potential delays is typically covered in the agreement governing the 
relationship between the ETF and the authorized participant (an 
``authorized participant agreement'') and would likely be shared by the 
authorized participant with other market participants, as 
necessary.\162\ Therefore, authorized participants already have 
information regarding potential delays. Second, given that these delays 
are typically covered by the authorized participant agreement, we do 
not believe it is necessary to require ETFs to provide registration 
statement disclosures.
---------------------------------------------------------------------------

    \161\ See 2008 ETF Proposing Release, supra footnote 3.
    \162\ For example, an authorized participant acting as an agent 
typically would share this information with its customer if it is a 
necessary part of the creation or redemption process.
---------------------------------------------------------------------------

    The proposed rule would define ``foreign investment'' as any 
security, asset or other position of the ETF issued by a foreign issuer 
(as defined by rule 3b-4 under the Exchange Act) for which there is no 
established U.S. public trading market (as that term is used in 
Regulation S-K under the Securities Act).\163\ This definition differs 
from the one we proposed in 2008 in that it references rule 3b-4 rather 
than enumerating the types of foreign entities that are considered 
issuers of foreign investments.\164\ We believe this approach is 
appropriate because it creates consistency with a long-accepted 
definition under Exchange Act rules.\165\ The reference to whether the 
investment has an ``established U.S. public trading market'' is 
designed to make the relief unavailable to an ETF that could trade the 
investment in its basket on a U.S. market, thereby avoiding the 
settlement delay that is the basis for the relief.\166\ In addition, 
this definition is not limited to ``foreign securities,'' but also 
would include other investments that may not be considered securities. 
Although these other investments may not be securities, they may 
present the same challenges for timely settlement as foreign securities 
if they are transferred in kind. This approach is consistent with the 
terms of some recent exemptive orders that provide relief from section 
22(e) for the delivery of foreign investments that may not be 
securities.\167\
---------------------------------------------------------------------------

    \163\ See proposed rule 6c-11(a); see also rule 201(a) of 
Regulation S-K [17 CFR 229.201(a)] (describing how a registrant 
should identify its principal United States market or markets); rule 
3b-4 of the Exchange Act [17 CFR 240.3b-4].
    \164\ The 2008 proposal defined ``foreign security'' as any 
security issued by a government or political subdivision of a 
foreign country, or corporation or other organization incorporated 
or organized under the laws of any foreign country and for which 
there is no established U.S. public trading market. See 2008 ETF 
Proposing Release, supra footnote 3.
    \165\ Rule 3b-4 under the Exchange Act was adopted in 1967. See 
Adoption of Rules Relating to Foreign Securities, Exchange Act 
Release No. 8066 (Apr. 28, 1967) [32 FR 7848 (May 30, 1967)].
    \166\ 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. 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, Exchange Act Release No. 
55540 (Mar. 27, 2007) [72 FR 16934 (Apr. 5, 2007)].
    \167\ See, e.g., Redwood Investment Management, LLC, et al., 
Investment Company Act Release Nos. 33076A (Apr. 26, 2018) [83 FR 
19367 (May 2, 2018)] (notice) and 33100 (May 21, 2018) (order) and 
related application.
---------------------------------------------------------------------------

    We request comment on this aspect of the proposed rule.
    <bullet> Is this relief necessary, particularly given that many 
non-U.S. jurisdictions have shorter settlement periods today than when 
we began granting this relief to ETFs? We specifically request comment 
regarding how frequently ETFs rely on this exemption. Should we permit 
the delayed delivery of settlement proceeds for up to 15 days? Is this 
period too long or too short? Should the rule refer to the applicable 
local market's settlement cycle without specifying a number of days? 
Should we require that the ETF deliver foreign investments as soon as 
practicable, as proposed, in order to minimize unnecessary settlement 
delays?
    <bullet> Should we include a sunset provision for this relief as 
proposed? Is the duration of the proposed sunset provision appropriate? 
Should it be longer or shorter?
    <bullet> Is the proposed definition of ``foreign investment'' 
appropriate for identifying investments that may routinely settle more 
than seven days after a redemption request? For example, are there 
circumstances where a U.S. entity could be subject to delays due to 
local market restrictions? Should we utilize a definition found 
elsewhere in rules and regulations set forth under the Exchange Act, 
the Investment Company Act, or other securities laws (e.g., the 
definition of ``foreign security'' set forth in rule 15a-6 under the 
Exchange Act, or the definition of ``foreign assets'' set forth in rule 
17f-5 under the Investment Company Act)? Alternatively, should we 
utilize the definition of ``foreign security'' set forth in the 2008 
ETF Proposing Release, or utilize an entirely new definition? If 
recommending an alternate definition, please explain the specific types 
of investments that would be better captured or that would be excluded 
by that definition.
    <bullet> Should the rule also provide relief if an ETF has foreign 
investments in its portfolio (and not in a particular basket)? If so, 
why? Should the rule permit the delayed delivery of the entire basket 
(instead of the specific foreign investments in a basket) if the basket 
is composed substantially of foreign investments subject to potential 
delays in the delivery of settlement proceeds?
    <bullet> Are we correct that information regarding potential delays 
in the delivery of settlement proceeds for foreign investments 
typically is covered in the authorized participant agreement? If so, 
are we also correct that authorized participants acting as agents 
typically would share this information with their customers if it is a 
part of the redemption process?
    <bullet> Should the rule require disclosure in an ETF's Statement 
of Additional Information of the foreign holidays an ETF expects may 
prevent timely delivery of the foreign investments and the maximum 
number of days it anticipates it would need to deliver the foreign 
investments as required by current exemptive orders? For example, 
should we require ETFs relying on this exemption to include a more 
general statement in their prospectus or SAI that the ETF may take up 
to 15 days to deliver settlement proceeds for certain foreign 
investments affected by foreign holidays, rather than the more specific 
statement of each holiday an ETF expects may prevent timely delivery of 
the investments that is currently required? Should these disclosures be 
included in an ETF's sales literature or

[[Page 37348]]

on its website? Alternatively, should we require ETFs to provide a 
written notice of the foreign holidays an ETF expects may prevent 
timely delivery of the foreign investments to authorized participants 
as a condition to rule 6c-11? If so, how often should this information 
be updated?
    <bullet> Do secondary market investors or others use information 
regarding delays in the delivery of foreign investments?

C. Conditions for Reliance on Proposed Rule 6c-11

    Proposed rule 6c-11 would require ETFs to comply with certain 
conditions that would allow them to operate within the scope of the 
Act, and that are designed to protect investors and to be consistent 
with the purposes fairly intended by the policy and provisions of the 
Act. These conditions are generally consistent with the conditions we 
have imposed under our exemptive orders, which we believe have 
effectively accommodated the unique structural and operational features 
of ETFs while maintaining appropriate protections for ETF investors. 
The conditions also reflect certain changes to the conditions imposed 
under our exemptive orders that, based on 26 years of experience 
regulating ETFs, we believe will improve the overall regulatory 
framework for these products.
1. Issuance and Redemption of Shares
    Proposed rule 6c-11 would include several requirements in the 
paragraph defining ``exchange-traded fund,'' including a requirement 
that the ETF issue (and redeem) creation units to (and from) authorized 
participants in exchange for baskets and a cash balancing amount (if 
any).\168\ As such, the proposed rule would seek to preserve the 
existing structure, reflected in our ETF exemptive orders, whereby only 
an authorized participant of an ETF may purchase creation units from 
(or sell creation units to) the ETF. This requirement is designed to 
preserve an orderly creation unit issuance and redemption process 
between ETFs and authorized participants. An orderly creation unit 
issuance and redemption process is of central importance to the 
arbitrage mechanism, which forms the basis for several of the proposed 
rule's exemptive provisions.
---------------------------------------------------------------------------

    \168\ See proposed rule 6c-11(a). See also infra section II.C.5 
(discussing definitions of baskets and cash balancing amount).
---------------------------------------------------------------------------

    The proposed rule would define an authorized participant as a 
member or participant of a clearing agency registered with the 
Commission, which has a written agreement with the ETF or one of its 
service providers that allows the authorized participant to place 
orders for the purchase and redemption of creation units.\169\ This 
definition differs from the definition of ``authorized participant'' we 
recently adopted in connection with Form N-CEN, which, in relevant 
part, defines the term as a broker-dealer that is also a member of a 
clearing agency registered with the Commission or a DTC Participant and 
has a written agreement with the ETF or one of its service providers 
that allows the authorized participant to place orders to purchase and 
redeem creation units of the ETF.\170\ Our proposed definition also 
differs from the definition of authorized participant in our ETF 
exemptive orders and Form N-CEN, because it does not include a specific 
reference to an authorized participant's participation in DTC since DTC 
is itself a clearing agency.\171\ We believe the definition that we are 
proposing remains largely consistent with our existing exemptive 
relief, while eliminating unnecessary terms. As discussed further 
below, we are proposing a corresponding amendment to Form N-CEN.\172\
---------------------------------------------------------------------------

    \169\ Proposed rule 6c-11(a).
    \170\ See Instruction to Item E.2 of Form N-CEN. See also 
Reporting Modernization Adopting Release, supra footnote 147.
    \171\ See, e.g., Legg Mason, supra footnote 160. The 2008 
proposal would not have defined the term ``authorized participant'' 
because this term was not used in the definition of an ETF. See 2008 
ETF Proposing Release, supra footnote 3 (defining ETF to mean, in 
relevant part, a registered open-end management company that issues 
(or redeems) creation units in exchange for the deposit (or 
delivery) of basket assets).
    \172\ See infra section II.J.
---------------------------------------------------------------------------

    The proposed rule would define the term ``creation unit'' to mean a 
specified number of ETF shares that the ETF will issue to (or redeem 
from) an authorized participant in exchange for the deposit (or 
delivery) of a basket and a cash balancing amount (if any).\173\ In 
their exemptive applications, ETFs have stated that they would 
establish a specific creation unit size (i.e., a minimum number of 
shares).\174\ Creation unit aggregations may differ among ETFs based on 
an ETF's investment strategy, the type and availability of the assets 
in the basket, and the types of authorized participants (and other 
market participants) that are expected to engage in creation and 
redemption transactions with the ETF. For example, an ETF tracking a 
narrowly focused niche strategy may establish a smaller creation unit 
size than an ETF tracking a broad-based index, such as the S&P 500, in 
order to facilitate arbitrage. Accordingly, we do not believe it is 
necessary to mandate a particular maximum or minimum creation unit size 
for all types of ETFs. This approach is consistent with our 2008 
proposal, and commenters who addressed this aspect of the 2008 proposal 
generally supported it.\175\
---------------------------------------------------------------------------

    \173\ Proposed rule 6c-11(a).
    \174\ See, e.g., Legg Mason, supra footnote 160.
    \175\ See 2008 ETF Proposing Release, supra footnote 3; see 
also, e.g., Comment Letter of James J. Angel (May 16, 2008); Comment 
Letter of Chapman and Cutler LLP (May 19, 2008) (``Chapman 2008 
Comment Letter'').
---------------------------------------------------------------------------

    While we believe that creation unit sizes are an important 
component in effective arbitrage, we do not propose to expressly 
require, as we proposed in 2008, that an ETF establish creation unit 
sizes reasonably designed to facilitate arbitrage.\176\ Commenters on 
this aspect of the 2008 proposal generally believed that the proposed 
standard was too vague and that an ETF would not have an incentive to 
establish creation unit sizes that would be too large or too small to 
facilitate effective arbitrage.\177\ Some commenters also questioned 
the description of arbitrage embedded within the 2008 definition of 
creation unit on the basis that the definition did not capture all 
forms of arbitrage.\178\
---------------------------------------------------------------------------

    \176\ See 2008 ETF Proposing Release, supra footnote 3 
(describing arbitrage, for these purposes, 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 [market price] of the 
shares.'').
    \177\ See, e.g., Vanguard 2008 Comment Letter; BGFA 2008 Comment 
Letter. But see Xshares 2008 Comment Letter (``The proposal to 
`establish creation unit sizes the number of which is reasonably 
designed to facilitate arbitrage' seems to describe the process that 
we apply when determining the basket size and is appropriate, as is 
the definition of arbitrage.'').
    \178\ See ICI 2008 Comment Letter; Katten 2008 Comment Letter.
---------------------------------------------------------------------------

    As we noted in the 2008 proposal, a large creation unit size could 
reduce the willingness or ability of authorized participants (and other 
market participants) to engage in creation unit purchases or 
redemptions.\179\ Impeding the ability of authorized participants to 
purchase and redeem ETF shares could disrupt arbitrage pricing 
discipline, which could lead to more frequent occurrences of premiums 
or discounts to NAV per share of the ETF. Conversely, a small creation 
unit size could discourage market making and render creation units 
irrelevant because the ETF could issue and redeem ETF shares much like 
a mutual fund.\180\ We agree with the view that ETFs are not likely to 
have an incentive to set very large or very small creation unit sizes 
that could disrupt the arbitrage

[[Page 37349]]

mechanism and that an ETF would establish a size that is appropriate 
for market demand given its investment strategies and objectives. 
Moreover, we believe that the conditions in the proposed rule designed 
to promote effective arbitrage are better suited for that purpose than 
conditions related to creation unit size.
---------------------------------------------------------------------------

    \179\ See 2008 Proposing Release, supra footnote 3.
    \180\ See id.
---------------------------------------------------------------------------

    An ETF generally would issue and redeem shares only in creation 
unit size aggregations under the proposed rule. However, the proposed 
rule would permit an ETF to sell or redeem individual shares on the day 
of consummation of a reorganization, merger, conversion or 
liquidation.\181\ In a merger, for example, an acquired ETF typically 
transfers substantially all of its assets to a surviving ETF in 
exchange for interests in the surviving ETF. We understand that, under 
these limited circumstances, a surviving ETF may need to issue shares, 
not necessarily in creation unit aggregations, to shareholders of the 
acquired ETF without utilizing authorized participants. Similarly, an 
ETF may need to issue individual shares in connection with a 
reorganization, conversion, or liquidation. We also understand that the 
redemptions that take place in connection with these transactions are 
generally intended to facilitate the transactions themselves and 
compensate individual shareholders that may be exiting the reorganized, 
merged, converted or liquidated ETF--activities likely to involve small 
cash amounts and to be outside the scope of an authorized participant's 
expected role of transacting in creation units. We believe that 
permitting ETFs to conduct redemptions with investors other than 
authorized participants in these limited circumstances is operationally 
necessary to facilitate reorganizations, mergers, conversions or 
liquidations. Permitting ETFs to transact with other investors in these 
limited circumstances also is consistent with prior exemptive relief, 
which permits ETF shares to be individually redeemable in connection 
with the termination of an ETF.\182\
---------------------------------------------------------------------------

    \181\ See proposed rule 6c-11(c)(5).
    \182\ See, e.g., Application of FFCM, LLC, et al. (June 12, 
2017), at n.23 (``Therefore, in the event of a termination, the 
Board in its discretion could determine to permit the Shares to be 
individually redeemable. In such circumstances, the Fund might elect 
to pay cash redemptions to all shareholders, with an `in-kind' 
election for shareholders owning in excess of a certain stated 
minimum amount.'').
---------------------------------------------------------------------------

    An additional issue related to the issuance and redemption of ETF 
shares is the extent to which an ETF may directly or indirectly suspend 
these processes. An ETF that suspends the issuance or redemption of 
creation units indefinitely could cause a breakdown of the arbitrage 
mechanism, resulting in significant deviations between market price and 
NAV per share. Such deviations may be harmful to investors that 
purchase shares at market prices above NAV per share and/or sell shares 
at market prices below NAV per share. An ETF may suspend the redemption 
of creation units only in accordance with section 22(e) of the 
Act,\183\ and an ETF may charge transaction fees on creation unit 
redemptions only in accordance with 17 CFR 270.22c-2 (``rule 22c-
2'').\184\ In addition, we believe an ETF generally may suspend the 
issuance of creation units only for a limited time and only due to 
extraordinary circumstances, such as when the markets on which the 
ETF's portfolio holdings are traded are closed for a limited period of 
time.\185\ We also believe that an ETF could not set transaction fees 
so high as to effectively suspend the issuance of creation units.
---------------------------------------------------------------------------

    \183\ Section 22(e) of the Act permits open-end funds to suspend 
redemptions and postpone payment for redemptions already tendered 
for any period during which the New York Stock Exchange is closed 
(other than customary weekend and holiday closings) and in three 
additional situations if the Commission has made certain 
determinations. See LRM Adopting Release, supra footnote 101, at 
n.36.
    \184\ See supra footnote 24 and accompanying text. Rule 22c-2 
limits redemption fees to no more than 2% of the value of shares 
redeemed. See rule 22c-2(a)(1)(i). In other contexts, the Commission 
has limited redemption fees paid by redeeming shareholders, as well 
as swing pricing NAV adjustments, to no more than 2%. See Investment 
Company Swing Pricing, Investment Company Act Release No. 32316 
(Oct. 13, 2016) [81 FR 82084 (Nov. 18, 2016)] (describing liquidity 
fees under rule 2a-7 and the swing factor upper limit under rule 
22c-1).
    \185\ See Comment Letter of BlackRock on 2015 ETP Request for 
Comment (Aug. 11, 2015) (noting that suspensions of creations are 
rare, but an ETF could suspend creations when it is unable to 
increase its exposure to underlying assets, such as when a non-U.S. 
market suspends capital inflows).
---------------------------------------------------------------------------

    We request comment on this requirement.
    <bullet> Should we require, as proposed, that an ETF issue (and 
redeem) creation units to (and from) authorized participants in 
exchange for baskets and a cash balancing amount if any? Are there 
alternative formulations that we should consider? Does this provision 
facilitate the arbitrage mechanism?
    <bullet> Should we define ``authorized participant'' as proposed? 
Should other criteria apply? For example, should the definition require 
authorized participants to be registered broker-dealers?
    <bullet> Instead of amending the definition of ``authorized 
participant'' in Form N-CEN as proposed below in order to correspond 
with proposed rule 6c-11, should we use the existing Form N-CEN 
``authorized participant'' definition for rule 6c-11? Should we have 
the same definition of ``authorized participant'' for both rule 6c-11 
and Form N-CEN? Would different definitions cause confusion or 
operational difficulties?
    <bullet> Do commenters agree with our understanding that ETFs are 
not likely to have an incentive to set very large or very small 
creation unit sizes that could disrupt the arbitrage mechanism?
    <bullet> Should we establish requirements for creation unit sizes 
and/or dollar amounts? Alternatively, should we establish a standard 
for how ETFs must establish creation unit sizes? If so, what standard 
should be established? Do differently sized creation units present 
different operational challenges? If so, please explain these 
challenges, and provide data to support such a view.
    <bullet> Would institutional investors engage in more create/redeem 
transactions with an ETF, through an authorized participant, if the ETF 
established a smaller creation unit size? If so, what are the costs and 
benefits of this result? Would it impact the efficiency of the ETF's 
arbitrage mechanism? If so, how?
    <bullet> Should we permit an ETF to sell or redeem individual 
shares on the day of consummation of a reorganization, merger, 
conversion or liquidation as proposed? Should we define any or all of 
the terms ``reorganization,'' ``merger,'' ``conversion'' and 
``liquidation'' for purposes of this condition? If so, how should those 
terms be defined? For example, as an alternative, should we consider 
the definition for ``merger'' in 17 CFR 270.17a-8 (``rule 17a-8'' under 
the Act)? \186\ Are there other circumstances or transactions that 
should be included within this provision? For example, should we 
specify in this provision that shares may be issued other than in 
creation unit size aggregations as part of a dividend reinvestment 
program? Is any additional relief needed to conduct these transactions? 
Should the relief be limited to the day of consummation of the 
transaction, as proposed? Should the relief be limited in time at all? 
Should more time be provided? If so, how much time?
---------------------------------------------------------------------------

    \186\ See rule 17a-8(b)(1) (defining ``merger'' as the ``merger, 
consolidation, or purchase or sale of substantially all of the 
assets between a registered investment company (or a series thereof) 
and another company'').
---------------------------------------------------------------------------

    <bullet> Do commenters generally agree that an ETF may suspend 
creations only in limited circumstances? Do commenters generally agree 
that an ETF could not set transaction fees so high as to effectively 
suspend the issuance of

[[Page 37350]]

creation units? Is any additional guidance needed? Should we consider 
including provisions in rule 6c-11 that would permit ETFs to suspend 
creations or redemptions in particular circumstances?
2. Listing on a National Securities Exchange
    Proposed rule 6c-11 defines ``exchange-traded fund,'' in part, to 
mean a fund that issues shares that are listed on a national securities 
exchange and traded at market-determined prices.\187\ Exchange-listing 
is one of the fundamental characteristics that distinguishes an ETF 
from other types of open-end funds (and UITs) and is one reason that 
ETFs need certain exemptions from the Act and the rules thereunder. The 
Commission has premised all of its previous exemptive orders on an ETF 
listing its shares for trading on a national securities exchange.\188\ 
Listing on an exchange provides an organized and continuous trading 
market for the ETF shares at market-determined prices. Trading on an 
exchange also is important to a functioning arbitrage mechanism. We 
proposed a similar condition in 2008 that would have required ETF 
shares to be approved for listing and trading on a national securities 
exchange.\189\ Commenters on the 2008 proposal generally agreed that 
listing on an exchange would provide an organized and continuous 
trading market for the ETF shares.\190\
---------------------------------------------------------------------------

    \187\ Proposed rule 6c-11(a). For purposes of the rule, a 
``national securities exchange'' would be defined as an exchange 
that is registered with the Commission under section 6 of the 
Exchange Act.
    \188\ See, e.g., PowerShares Capital Management LLC, et al., 
Investment Company Act Release Nos. 28140 (Feb. 1, 2008) [73 FR 7328 
(Feb. 7, 2008)] (notice) and 28171 (Feb. 27, 2008) (order) and 
related application (``PowerShares'').
    \189\ See 2008 ETF Proposing Release, supra footnote 3.
    \190\ See, e.g., NYSE Arca 2008 Comment Letter; SSgA 2008 
Comment Letter.
---------------------------------------------------------------------------

    The proposed definition would require that the ETF's shares be 
traded at market-determined prices. Like other exchange-traded equity 
securities, however, we understand that there may be instances where 
ETF shares simply may not trade for a given period due to a lack of 
market interest.\191\ This proposed requirement is not designed to 
establish a minimum level of trading volume for ETFs necessary in order 
to rely on the rule, but rather to distinguish ETFs from other products 
that are listed on exchanges, but trade at NAV-based prices (i.e., 
exchange-traded managed funds).\192\
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    \191\ Based on staff analysis of data obtained from Bloomberg, 
approximately 5% of ETFs do not trade on the secondary market on a 
given trading day.
    \192\ Proposed rule 6c-11 would not apply to exchange-traded 
managed funds (ETMFs), which are not ETFs, but rather hybrids 
between mutual funds and ETFs. Unlike ETFs, secondary market 
transactions in ETMFs do not occur at a market-determined price. 
Rather, they occur at the next-determined NAV plus or minus a 
market-determined premium or discount that may vary during the 
trading day. See Eaton Vance Management, et al., Investment Company 
Act Release Nos. 31333 (Nov. 6, 2014) [79 FR 67471 (Nov. 13, 2014)] 
(notice) and 31362 (Dec. 2, 2014) (order) and related application.
---------------------------------------------------------------------------

    An ETF that is delisted from a national securities exchange would 
not meet the definition of ``exchange-traded fund,'' and would no 
longer be eligible to rely on the proposed rule. Such a fund thus would 
be required to meet individual redemption requests within seven days 
pursuant to section 22(e) of the Act or liquidate.\193\ We requested 
comment in the 2008 proposal on whether the rule should include an 
exception for ETF shares that are delisted for a short time or 
suspended from listing.\194\ Commenters generally did not support such 
an exception, asserting that it would be difficult for the Commission 
to identify all of the circumstances in which such an exception would 
be appropriate, and recommended that ETFs seek individual exemptive 
relief from the listing requirement under these circumstances.\195\ We 
are not aware of any ETF requesting an order that omits the requirement 
that its shares be listed on an exchange. Therefore, we do not propose 
to include an exemption for ETFs whose shares are suspended or 
delisted.
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    \193\ Indeed, an ETF that does not comply with the provisions of 
the rule would be required to comply with the Investment Company Act 
in all respects unless it was relying on other relief.
    \194\ See 2008 ETF Proposing Release, supra footnote 3, at text 
following n.94.
    \195\ BGFA 2008 Comment Letter; ICI 2008 Comment Letter.
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    We request comment on this requirement.
    <bullet> Should the rule make allowance for shares that are 
delisted for a short time, or for halts or suspensions in trading? If 
so, how would the arbitrage mechanism function in these circumstances?
3. Intraday Indicative Value
    Exchange listing standards include a requirement that an intraday 
estimate of an ETF's NAV per share (an ``intraday indicative value'' or 
``IIV'') be widely disseminated at least every 15 seconds during 
regular trading hours (60 seconds for international ETFs).\196\ Our 
orders also require the dissemination of the IIV, and ETFs have stated 
in their exemptive applications that an ETF's IIV is useful to 
investors because it allows them to determine (by comparing the IIV to 
the market value of the ETF's shares) whether and to what extent the 
ETF's shares are trading at a premium or discount.\197\ We are not 
proposing, however, to require the dissemination of an ETF's IIV as a 
condition of the proposed rule. We understand that market makers today 
typically calculate their own intraday value of an ETF's portfolio with 
proprietary algorithms that use an ETF's daily portfolio disclosure and 
available pricing information about the assets held in the ETF's 
portfolio.\198\ We further understand that they generally use the IIV, 
if at all, as a secondary or tertiary check on the value that their 
proprietary algorithms generate.\199\
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    \196\ See, e.g., NYSE Arca Equities Rule 5.2-E(j)(3), Commentary 
.01(c) (stating that the IIV may be based upon ``current information 
regarding the required deposit of securities and cash amount to 
permit creation of new shares of the series or upon the index 
value''); see also supra footnote 14 and accompanying text. The IIV 
is also sometimes referred to as the ``iNAV'' (indicative net asset 
value) or the ``PIV'' (portfolio indicative value).
    \197\ See, e.g., 2006 WisdomTree Investments, supra footnote 66.
    \198\ David J. Abner, The ETF Handbook: How to Value and Trade 
Exchange Traded Funds (2010), at 90 (``Since stock trading now takes 
place in microseconds, a lot can happen between two separate 15-
second quotes. Professional traders are not using the published IIVs 
as a basis for trading. Most, if not all, desks that are trading 
ETFs are calculating their own [NAV of the ETF] based on real time 
quotes . . . that they are generating within their own systems.'').
    \199\ See, e.g., Spruce ETF Trust, et al., Investment Company 
Act Release Nos. 31301 (Oct. 21, 2014) [79 FR 63964 (Oct. 27, 2014)] 
(notice) and 31337 (Nov. 14, 2017) (order permitting withdrawal of 
application) and related application (withdrawn).
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    We believe that the IIV is no longer used by market participants 
when conducting arbitrage trading. In today's fast-moving markets, 15 
seconds is likely too long for purposes of efficient market making and 
could result in poor execution.\200\ An ETF's current value changes 
every time the value of any underlying component of the ETF portfolio 
changes. Therefore, the IIV for a more frequently traded component 
security might not effectively take into account the full trading 
activity for that security, despite being available every 15 seconds. 
In particularly volatile

[[Page 37351]]

markets, the dissemination lag of the IIV may not reflect the actual 
value of the ETF.\201\
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    \200\ See, e.g., Gary Gastineau, How to Minimize Your Cost of 
Trading ETFs, ETF.com (June 22, 2009), available at http://www.etf.com/publications/journalofindexes/joi-articles/6042-how-to-minimize-your-cost-of-trading-etfs.html, at Figure 2 and related 
discussion. See also Comment Letter of ICI on NASDAQ proposed rule 
change relating to iNAV pegged orders for ETFs, File No. SR-NASDAQ-
2012-117 (Nov. 8, 2012), at 4 (``Professional equity traders operate 
at speeds calculated in fractions of a second. In such markets, 15 
seconds can be an eternity, and establishing an order price based on 
data that is nearly 15 seconds old could result in poor 
execution.'').
    \201\ See Understanding iNAV, ETF.com, available at http://www.etf.com/etf-education-center/21028-understanding-inav.html 
http://www.etf.com/etf-education-center/21028-understanding-inav.html?nopaging=1; Gary Gastineau, Exchange-Traded Funds Manual, 
2nd Ed. (2010), at 200-202.
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    The IIV also may not reflect the actual value of an ETF that holds 
securities that do not trade frequently. For example, the IIV can be 
stale or inaccurate for ETFs with foreign securities or less liquid 
debt instruments. For such ETFs, there may be a difference in value 
between the IIV, which is constructed using the last available market 
quotations or stale prices, and the ETF's NAV, which uses fair value 
when market quotations are not readily available.\202\ Moreover, 
because there currently are no uniform methodology requirements, the 
IIV can be calculated in different, and potentially inconsistent, ways.
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    \202\ Section 2(a)(41)(B) of the Act defines ``value'' as: ``(i) 
with respect to securities for which market quotations are readily 
available, the market value of such securities; and (ii) with 
respect to other securities and assets, fair value as determined in 
good faith by the board of directors.'' This definition also is used 
in rule 2a-4 under the Act as the required basis for computing a 
fund's current NAV per share. With daily portfolio disclosure, 
market participants can estimate fair value on their own for the 
holdings of current ETFs. 15 U.S.C. 80a-2(a)(41)(B).
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    Several commenters to the 2008 ETF Proposing Release, which would 
have included an IIV dissemination requirement, agreed that market 
professionals no longer rely on the exchange-published IIV.\203\ 
Commenters on the 2015 ETP Request for Comment also stated that the IIV 
is not always reliable, and in some cases is misleading, particularly 
when the underlying holdings are less liquid, or, in the case of 
certain international ETFs, not traded during the same hours as the ETF 
shares.\204\
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    \203\ See BGFA 2008 Comment Letter; Xshares 2008 Comment Letter.
    \204\ See Schwab ETP Comment Letter, supra footnote 115, at 7 
(``[A]s the ETF marketplace has expanded into such markets as fixed 
income, precious metals, and foreign securities the published data 
points can be potentially misleading when the reference asset the 
ETF is covering is not open for pricing or transactions . . . [t]he 
requirement for publication of the IIV every 15 seconds seems 
antiquated in the evolving electronic trading world in which we are 
currently immersed. Trading now occurs in micro and nano seconds and 
the lag between the published IIV value and real time quoting and 
trading has essentially made the calculation of limited worth even 
when the reference asset is open for pricing.''); Comment Letter of 
Eaton Vance Corp. to Request for Comment on Exchange-Traded Products 
(File No. S7-11-15) (Aug. 17, 2015) (stating that the IIV is 
``frequently highly misleading'' as an indicator of current fund 
value and investor trading costs); see also John Spence, ETFs 
Unfairly Blamed in Recent Market Drama, USA Today (June 27, 2013), 
available at https://www.usatoday.com/story/money/personalfinance/2013/06/27/etfs-criticism-investing/2464741/ (``[I]t's meaningless 
to compare the share price of any international equity ETF with a 
stale NAV based on stock prices that are several hours old.'').
---------------------------------------------------------------------------

    As discussed below, we are proposing that rule 6c-11 condition its 
relief on the daily disclosure of portfolio holdings. We believe that 
this disclosure would promote the availability of information to market 
participants to support their ability to calculate an estimated 
intraday value of the ETF's portfolio holdings using their own 
methodologies. Therefore, the proposed rule would not include a 
requirement for IIV dissemination.
    We request comment on this aspect of our proposal.
    <bullet> Should proposed rule 6c-11 condition relief on 
dissemination of the IIV? If so, who should be required to disseminate 
the IIV? The national securities exchange on which the ETF is listed? 
Other entities?
    <bullet> Are we correct in our understanding that market 
participants today typically calculate their own intraday values of an 
ETF portfolio by utilizing proprietary algorithms?
    <bullet> Do market participants use the published IIV for any 
purpose, whether or not related to its original purpose of facilitating 
arbitrage? For example, do some market participants use the IIV as a 
secondary or tertiary check on their internal calculations of an ETF's 
intraday value?
    <bullet> Do retail investors use or rely on the IIV, and if so, 
how? Do they use the IIV for international and fixed-income ETFs, and 
if so, how? Is there a risk that this information could be misleading 
in certain circumstances? Would omitting the IIV have a disparate 
impact on retail investors as opposed to more sophisticated market 
participants?
    <bullet> Do the published IIVs provide an accurate indication of 
the value of ETFs' underlying holdings? Does the answer vary depending 
on the type of the ETF's underlying holdings? If we were to include a 
requirement to disseminate the IIV, should and can changes be made to 
improve its accuracy? For example, should we require that the IIV be 
disseminated at more frequent intervals? If so, how frequently (e.g., 
every second, every five seconds)? Should we require that the IIV be 
disseminated for all ETFs or only specific types of ETFs?
    <bullet> If we were to include an IIV requirement, should we 
establish a uniform method for calculation of the IIV for all ETFs 
relying on the rule? If so, what should that method take into account? 
How should fair valued securities be treated? Alternatively, should we 
prescribe methodologies for ETFs based on the types of portfolio 
holdings?
    <bullet> If the IIV is no longer required pursuant to exemptive 
relief or regulation, would ETFs continue to publish this information? 
If so, should we require ETFs that voluntarily disseminate the IIV to 
follow certain prescribed methodologies? For example, should we require 
that these ETFs disseminate the IIV more frequently? If so, how 
frequently?
4. Portfolio Holdings
    As discussed above, since the first exemptive order for an ETF, the 
Commission has relied on the existence of an arbitrage mechanism to 
keep the market prices of ETF shares at or close to the NAV per share 
of the ETF.\205\ One mechanism that facilitates the arbitrage mechanism 
is daily portfolio transparency. Portfolio transparency provides 
authorized participants and other market participants with an important 
tool to facilitate valuing the ETF's portfolio on an intraday basis, 
which, in turn, would enable them to assess whether arbitrage 
opportunities exist. It also provides information necessary to hedge 
the ETF's portfolio. The ability to hedge is important because market 
makers generally trade to provide liquidity, balance supply and demand, 
and profit from arbitrage opportunities (without seeking to profit from 
taking a directional position in a security).\206\ Without the ability 
to hedge, market makers may widen spreads or be reluctant to make 
markets because doing so may require taking on greater market risk than 
the firm is willing to bear. For this reason, to facilitate the ability 
of market makers to make markets in ETF shares, our exemptive orders 
have historically required ETFs to provide a certain degree of daily 
transparency.\207\ Furthermore, Commission staff has observed that all 
ETFs that could rely on the proposed rule currently provide full 
transparency as a matter of industry market practice.
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    \205\ See supra section I.B.
    \206\ See Stanislav Dolgopolov, Regulating Merchants of 
Liquidity: Market Making From Crowded Floors to High Frequency 
Trading, 18 U. of Penn Journal of Business Law 3 (2016), at 652 
(``[T]he distinguishing feature of a market maker is being `pretty 
well always even.''').
    \207\ Exemptive orders for actively managed ETFs and recent 
orders for index-based ETFs with an affiliated index provider have 
required full portfolio transparency. Exemptive orders for index-
based ETFs with an unaffiliated index provider have required 
publication of the ETF's baskets.

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[[Page 37352]]

a. Transparency of Portfolio Holdings
    Proposed rule 6c-11 would require an ETF to disclose prominently on 
its website, which is publicly available and free of charge, the 
portfolio holdings that will form the basis for each calculation of NAV 
per share.\208\ The portfolio holdings disclosure must be made each 
business day before the opening of regular trading on the primary 
listing exchange of the ETF's shares and before the ETF starts 
accepting orders for the purchase or redemption of creation units.\209\ 
For portfolio transparency to facilitate effective arbitrage, 
authorized participants or other market participants buying or selling 
ETF shares, whether on the secondary market or in a primary 
transaction, should have access to portfolio composition information at 
the time of the transaction. The proposed rule's timing requirements, 
therefore, are designed to prevent an ETF from disclosing its portfolio 
holdings only after the beginning of trading or after the ETF has begun 
accepting orders for the next business day.
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    \208\ Proposed rule 6c-11(c)(1)(i)(A). See also proposed rule 
6c-11(a) (defining the term ``portfolio holdings'' to mean the 
securities, assets, or other positions held by the ETF). For 
purposes of this proposed requirement, as well as other requirements 
to disclose information on a publicly available website under 
proposed rule 6c-11, we believe that an ETF should not establish 
restrictive terms of use that would effectively make the disclosures 
unavailable to the public or otherwise difficult to locate. For 
example, the proposed required website disclosure should be easily 
accessible on the website, presented without encumbrance by user 
name, password, or other access constraints, and should not be 
subject to usage restrictions on access, retrieval, distribution or 
reuse. We also would encourage ETFs to consider whether there are 
technological means to make the disclosures more accessible. For 
example, today, ETFs could include the portfolio holdings 
information in a downloadable or machine-readable format, such as 
comma-delimited or similar format.
    \209\ For these purposes, ``business day'' is defined as any day 
the ETF is open for business, including any day when it satisfies 
redemption requests as required by section 22(e) of the Act. See 
proposed rule 6c-11(a).
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    In addition, the proposed rule would require the portfolio holdings 
that form the basis for the ETF's NAV calculation to be the ETF's 
portfolio holdings as of the close of business on the prior business 
day.\210\ Changes in an ETF's holdings of portfolio securities would 
therefore be reflected on a T+1 basis. This condition is consistent 
with current ETF practices and enables an ETF to disclose at the 
beginning of the business day the portfolio that will form the basis 
for the next NAV calculation, helping to facilitate the efficient 
functioning of the arbitrage process.\211\
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    \210\ See proposed rule 6c-11(c)(2). Pursuant to this condition, 
an ETF would not be permitted to reflect portfolio changes on a T+0 
basis, notwithstanding the ability to do so under rule 2a-4 under 
the Act.
    \211\ See, e.g., Morgan Stanley ETF Trust, et al., Investment 
Company Act Release Nos. 32484 (Feb. 21, 2017) [82 FR 11956 (Feb. 
27, 2017)] (notice) and 32539 (Mar. 21, 2017) (order) and related 
application (``Morgan Stanley'').
---------------------------------------------------------------------------

    We believe that portfolio transparency is an effective means to 
facilitate the arbitrage mechanism. As noted above in our discussion of 
the IIV, authorized participants and other market participants today 
calculate the value of an ETF's net assets with proprietary algorithms 
that use an ETF's daily portfolio disclosure and available pricing 
information about the assets held in the ETF's portfolio on an ongoing 
basis during the course of the trading day. This information allows 
market participants to identify instances where an arbitrage 
opportunity exists and to effectively hedge their positions.
    The 2008 proposal would have required actively managed ETFs to 
disclose the identities and weightings of the portfolio securities and 
other assets held by the ETF on the ETF's website each business day 
(i.e. full portfolio transparency). By contrast, index-based ETFs would 
have been required to have a stated investment objective of obtaining 
returns that correspond to the returns of a securities index, whose 
provider discloses on its website the identities and weightings of the 
component securities and other assets of the index (i.e. index 
transparency).\212\ Commenters on that proposal generally concurred 
with the importance of transparency to the arbitrage mechanism and 
supported including a transparency requirement in the proposed 
rule.\213\ Some commenters, however, asserted that index transparency 
may not be effective for ETFs whose portfolios sample an index or 
include holdings in proportions that are different from those in the 
index.\214\ These commenters urged the Commission to consider 
alternative approaches, including permitting index-based ETFs to 
disseminate the identities and weightings of the securities in the 
basket, if the basket is a representative sample of the portfolio.\215\
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    \212\ In the event the ETF tracks multiple indexes, the 2008 ETF 
Proposing Release would have permitted an ETF to provide full 
transparency like actively managed funds. See 2008 ETF Proposing 
Release, supra footnote 3.
    \213\ See, e.g., BGFA 2008 Comment Letter.
    \214\ See, e.g., ICI 2008 Comment Letter. See also Vanguard 2008 
Comment Letter (opposing index transparency (as well as daily 
portfolio holdings disclosure) for index-based ETFs, voicing 
concerns about front running in the context of index-based ETFs).
    \215\ Commenters asserted that compliance with the index 
transparency requirement we proposed in 2008 would be difficult for 
ETFs that have licensing rights to an index that may preclude them 
from publicly disclosing the components of the index. See, e.g., 
NYSE Arca 2008 Comment Letter; Comment Letter of Russell Investments 
(Aug. 27, 2008). Today, Commission staff, through conversations with 
ETF industry participants, understands the preference for this 
basket transparency approach to be significantly lessened.
---------------------------------------------------------------------------

    We are proposing to require full transparency for all ETFs under 
this rule rather than proposing alternative transparency requirements 
for index-based ETFs or actively managed ETFs.\216\ We generally agree 
with commenters on the 2008 proposal that portfolio transparency 
provides more detailed information than the index alone when an index-
based ETF utilizes sampling techniques or holds derivatives or other 
instruments and, as noted above, all ETFs that could rely on the 
proposed rule already provide full portfolio transparency as a matter 
of market practice. Full portfolio transparency also may be useful for 
investors when they are determining the efficacy of an index-based ETF 
tracking a particular index because performance of two ETFs tracking 
the same index can differ based on sampling practices.\217\ Similarly, 
where the primary information used to support the arbitrage mechanism 
is information about holdings, full portfolio transparency may be more 
helpful to market makers modelling ETFs that seek to track highly 
customized or bespoke indexes.
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    \216\ See supra section II.A.2.
    \217\ See, e.g., Ben Johnson, Assessing the Total Cost of ETF 
Ownership, Morningstar Advisor (Apr. 12, 2017), available at http://beta.morningstar.com/articles/802211/assessing-the-total-cost-of-etf-ownership.html.
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    We seek comment on the portfolio transparency condition of the 
proposed rule.
    <bullet> Should the rule include other transparency options? For 
example, should we have different transparency requirements for index-
based ETFs and actively managed ETFs, similar to those proposed in 
2008? Would disclosure of an index's constituents alone provide 
detailed enough information to allow market participants to effectively 
hedge the ETF's portfolio when an index-based ETF utilizes sampling 
techniques or holds derivatives or other instruments? Do index 
providers make information about index constituents easily accessible 
today? Are there other alternatives we should consider? For example, 
would disclosure of an ETF's basket provide a basis for effective 
hedging? In setting forth an option, please explain how your proposed 
level of transparency would allow effective arbitrage.

[[Page 37353]]

    <bullet> Are there any circumstances that would prevent an index-
based ETF from disclosing its portfolio holdings?
    <bullet> Are we correct that all ETFs that could rely on the 
proposed rule currently provide full transparency as a matter of market 
practice?
    <bullet> Would publicly available website disclosure of portfolio 
holdings be an effective way to convey this information? If not, what 
other means of disclosure should the rule require or permit? For 
example, should we allow ETFs to comply with the transparency condition 
by transmitting a portfolio composition file or ``PCF'' to a central 
clearing facility? Would this method provide information to enough 
market participants to facilitate the arbitrage mechanism? Would it 
give fair and equal access to all market participants? Should we 
require ETFs to provide daily portfolio holdings information to the 
Commission through other means, such as filing on EDGAR?
    <bullet> Should proposed rule 6c-11 define ``publicly available'' 
for purposes of the website disclosure requirements? If so, what 
definition should we use? For example, should the rule require that all 
information publicly posted on a website pursuant to rule 6c-11 be and 
remain freely and persistently available and easily accessible by the 
general public on the ETF's website and that the information must be 
presented in an easily accessible manner, without encumbrance, and must 
not be subject to any restrictions, including restrictions on access, 
retrieval, distribution and reuse?
    <bullet> Should we require ETFs to reflect changes in portfolio 
holdings no earlier than a T+1 basis as proposed? Is this condition 
necessary?
    <bullet> Should we define ``business day'' as proposed or are there 
alternative definitions we should consider? Do commenters believe that 
ETFs are likely to calculate NAV per share more than once each business 
day in the future? If so, would a ``business day'' standard cause 
compliance challenges with the portfolio holdings disclosure 
requirements?
    <bullet> Should the rule require that portfolio holdings disclosure 
be provided before the opening of regular trading on the primary 
listing exchange of the ETF's shares and before the ETF starts 
accepting orders for the purchase or redemption of creation units? 
Alternatively, should the rule exclude timing requirements? Are there 
operational issues that would make compliance with the timing 
requirements challenging or costly?
    <bullet> Should we consider exemptions for ETFs with non-
transparent or partially transparent portfolios as part of proposed 
rule 6c-11? Would a rule of general applicability be the appropriate 
means to provide an exemption for ETFs using a novel arbitrage 
mechanism?
b. Disclosure of Securities, Assets or Other Investment Positions
    The proposed rule would require ETFs to disclose on their websites 
all portfolio holdings that will form the basis for the ETF's next 
calculation of NAV per share. Under the proposed rule, the term 
``portfolio holdings'' is defined to mean an ETF's securities, assets, 
or other positions.\218\ As a result, an ETF would be required to 
disclose its cash holdings, as well as holdings that are not securities 
or assets, including short positions or written options.\219\ We 
believe that this approach would provide more consistent and 
comprehensive information regarding an ETF's portfolio holdings 
compared to other means of disclosure, allowing market participants to 
fairly and effectively value the entirety of the ETF's portfolio 
holdings. We believe this, in turn, would facilitate the arbitrage 
mechanism by allowing authorized participants and other market 
participants to more effectively hedge their exposure to a particular 
ETF.
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    \218\ See proposed rule 6c-11(a).
    \219\ Under the proposed rule, for example, an ETF would have to 
disclose that it entered into a written call option, under which it 
would sacrifice potential gains that would result from the price of 
the reference asset increasing above the price at which the call may 
be exercised (i.e., the strike price). Unless the ETF discloses the 
presence of these and similar liabilities, authorized participants 
and other investors may not be able to fully evaluate the 
portfolio's exposure.
---------------------------------------------------------------------------

    In order to standardize the manner in which portfolio holdings are 
presented on the ETF's website, the proposed rule would require that 
portfolio holdings information be presented and contain information 
regarding description, amount, value and/or unrealized gain/loss (as 
applicable) in the manner prescribed within 17 CFR 210.12-12, 210.12-
12A, 210.12-13, 210.12-13A, 210.12-13B, 210.12-13C, and 210.12-13D 
(``Article 12 of Regulation S-X''), which sets forth the form and 
content of fund financial statements.\220\ This framework should be 
efficient for such disclosure because ETFs already comply with it for 
financial reporting purposes and track the relevant information for 
daily NAV calculations. Based on a staff review of ETF websites, there 
is currently little consistency regarding how portfolio holdings 
information is presented, particularly with respect to derivatives. We 
believe that this inconsistency may lead to investor confusion.\221\
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    \220\ See 17 CFR 210.12-12, 210.12-12A, 210.12-13, 210.12-13A, 
210.12-13B, 210.12-13C, and 210.12-13D. For investments in 
securities, securities sold short, and other investments, this would 
include the name of issuer and title of issue (as prescribed within 
the S-X schedules including any related footnotes on the description 
columns), balance held at close of period, number of shares, 
principal amount of bonds, and value of each item at close of 
period. For derivatives, this would include the description (as 
prescribed within the S-X schedules including any related 
footnotes), number of contracts, value, expiration date (as 
applicable), unrealized appreciation/depreciation (as applicable), 
and amount and description of currency to be purchased and to be 
sold (as applicable).
    \221\ We recognize that the generic listing standards for 
actively managed ETFs also currently require website disclosure of 
the ticker, CUSIP, description of the holding, and percentage of net 
assets for each portfolio holding. See NYSE Arca Rule 8.600-E(c)(2); 
Nasdaq Rule 5735(c)(2); Cboe BZX Rule 14.11(i)(3)(B).
---------------------------------------------------------------------------

    The proposed rule would not require disclosure of intraday changes 
in the portfolio holdings of the ETF or advance disclosure of portfolio 
trades because changes in holdings would not affect the composition of 
the ETF's portfolio that serves as a basis for NAV calculation until 
the next business day.\222\ The selective disclosure of nonpublic 
information regarding intraday changes in portfolio holdings and 
advance disclosure of portfolio trades, however, could result in the 
front-running of an ETF's trades, causing the ETF to pay more to obtain 
a security. We have stated that registered investment companies' 
compliance policies and procedures required by 17 CFR 38a-1 (``rule 
38a-1'' under the Act) should address potential misuses of nonpublic 
information, including the disclosure to third parties of material 
information about a fund's portfolio, its trading strategies, or 
pending transactions, and the purchase or sale of fund shares by 
advisory personnel based on material, nonpublic information about the 
fund's portfolio.\223\ ETFs are also required to describe their 
policies and procedures on portfolio security disclosure in the 
Statement of Additional Information and post such policies and 
procedures

[[Page 37354]]

on their websites.\224\ As we noted in the release adopting these 
disclosures, a fund or investment adviser that discloses the fund's 
portfolio securities may only do so consistent with the antifraud 
provisions of the federal securities laws and the adviser's fiduciary 
duties.\225\ Moreover, divulging nonpublic portfolio holdings to 
selected third parties is permissible only when the fund has legitimate 
business purposes for doing so and the recipients are subject to a duty 
of confidentiality, including a duty not to trade on the nonpublic 
information.\226\
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    \222\ See supra footnote 208. None of our exemptive orders has 
required advance disclosure of intraday changes in the portfolio of 
the ETF or advance disclosure of portfolio trades. Instead, our 
orders have required ETFs to use the prior business day's portfolio 
holdings.
    \223\ Compliance Programs of Investment Companies and Investment 
Advisers, Investment Company Act Release No. 26299 (Dec. 17, 2003) 
[68 FR 74714 (Dec. 24, 2003)] (``Rule 38a-1 Adopting Release''). 
ETFs typically disclose (and would be required to disclose pursuant 
to proposed rule 6c-11) portfolio holdings information with greater 
frequency than other open-end funds, which are generally required to 
publicly disclose holdings on a quarterly basis.
    \224\ See Items 9(d) and 16(f) of Form N-1A; see also Disclosure 
Regarding Market Timing and Selective Disclosure of Portfolio 
Holdings, Investment Company Act Release No. 26418 (Apr. 20, 2004) 
[69 FR 22299 (Apr. 23, 2004)] (``Disclosure of Portfolio Holdings 
Release''), at section II.C.
    \225\ See Disclosure of Portfolio Holdings Release, supra 
footnote 224, at section II.C.
    \226\ Id.
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    We seek comment on this aspect of the proposed rule.
    <bullet> Should we require ETFs to present the description, amount, 
value and unrealized gain/loss in the manner prescribed within Article 
12 of Regulation S-X? Would such a presentation be more or less 
effective in disclosing portfolio holdings information than current 
website disclosure practices for ETFs? Do investors use current 
portfolio holding disclosures? Do current disclosure practices 
regarding portfolio holdings result in investor confusion? For example, 
do investors find the lack of consistency around the presentation of 
derivatives holdings confusing?
    <bullet> Should we consider excluding any of the requirements in 
Article 12 of Regulation S-X? For example, is information regarding 
unrealized gain and loss useful for all ETFs? Should we only require 
that disclosure for ETFs that transact with authorized participants on 
a cash basis? Will disclosure of non-securities investment positions 
and assets permit investors, particularly authorized participants and 
other market participants engaged in arbitrage activities, to assess 
the full scope of the ETF's portfolio holdings?
    <bullet> Is there any additional or alternative holdings 
information that we should require ETFs to disclose on their websites? 
For example, should we require daily disclosure regarding the ticker, 
CUSIP, or other identifier; sub-categories of holdings; and the 
percentage of net assets for each holding?
    <bullet> Should ETFs be required to disclose all liabilities as 
part of their portfolio holding disclosure? For example, would 
disclosure of bank borrowings allow authorized participants and other 
market participants to evaluate the impact of leverage from these types 
of borrowings on the ETF's portfolio? How would the arbitrage mechanism 
work without this disclosure?
    <bullet> Would the presentation requirements facilitate clear and 
uniform disclosure? Are there alternative presentation requirements we 
should consider? If so, what would those requirements be?
    <bullet> The proposed rule would not require disclosure of intraday 
changes in the portfolio holdings of the ETF or advance disclosure of 
portfolio trades because changes in holdings would not affect the 
composition of the ETF's portfolio that serves as a basis for NAV 
calculation until the next business day. Should we require ETFs to 
disclose intraday changes in the portfolio or require advance 
disclosure of portfolio trades? Would such disclosure requirements 
improve transparency in a meaningful way? Would such disclosure 
requirements be costly to implement? Would an ETF or its investors 
suffer any harm if such information were disclosed? If so, how?
    <bullet> Should we require ETFs to maintain portfolio holdings 
disclosure on their websites for periods longer than one day? If so, 
for how long (e.g., 30 days)?
    <bullet> ETFs trade in both portfolio assets (e.g., when 
rebalancing) and creation units (when transacting with authorized 
participants). Does this raise any execution issues for ETFs? For 
example, how do ETFs prevent certain counterparties from receiving 
preferential treatment? \227\ Are the policies and procedures noted 
above adequate to protect nonpublic information from misuse by 
authorized participants and other market participants that have access 
to ETF sensitive trade data? For example, how do ETFs ensure that 
authorized participants are not trading ahead of ETF rebalancing trades 
or other changes to its portfolio? Are there other requirements that we 
should adopt to protect ETFs and their investors? For example, should 
an ETF be required to maintain communications (including electronic 
communications) with its authorized participants?
---------------------------------------------------------------------------

    \227\ See, e.g., Interpretive Release Concerning the Scope of 
Section 28(e) of the Securities Exchange Act of 1934 and Related 
Matters, Exchange Act Release No. 34-23170 (Apr. 28, 1986), at 
section V (discussing obligation of money manager to obtain best 
execution of client transactions).
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    <bullet> ETFs currently are not subject to Regulation FD, which 
prohibits the selective disclosure of information by publicly traded 
companies and other issuers.\228\ Should we amend Regulation FD to 
apply to ETFs given that any information that is selectively disclosed 
may be immediately used to trade ETF shares (or the ETF's portfolio 
holdings) on the secondary market and given the proposed relief from 
section 17(a) for affiliated transactions? \229\
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    \228\ 17 CFR 243.
    \229\ Regulation FD does not apply to investment companies, 
other than closed-end funds. The releases proposing and adopting 
Regulation FD do not specifically discuss ETFs. See Selective 
Disclosure and Insider Trading, Investment Company Act Release No. 
24209 (Dec. 20, 1999) [64 FR 72590 (Dec. 28, 1999)] (proposing 
release), at paragraph preceding n.54 (``Investment companies that 
are continually offering their securities to the public already are 
required to update their prospectuses to disclose material changes 
subsequent to the effective date of the registration statement or 
any post-effective amendment, and are not permitted to sell, redeem, 
or repurchase their securities except at a price based on their 
securities' net asset value. While we believe that Regulation FD 
would offer little additional protection to investors in these types 
of investment companies and therefore they should be excluded from 
its coverage, these considerations do not apply in the case of 
closed-end investment companies.''). See also Selective Disclosure 
and Insider Trading, Investment Company Act Release No. 24599 (Aug. 
15, 2000) [65 FR 51716 (Aug. 24, 2000)] (adopting release).
---------------------------------------------------------------------------

5. Baskets
    Proposed rule 6c-11 would require each ETF relying on the rule to 
adopt and implement written policies and procedures governing the 
construction of baskets and the process that would be used for the 
acceptance of baskets.\230\ In addition, the proposed rule would 
provide an ETF with the flexibility to use ``custom baskets'' if the 
ETF has adopted written policies and procedures setting forth detailed 
parameters for the construction and acceptance of custom baskets that 
are in the best interests of the ETF and its shareholders. The proposed 
rule also would require an ETF to disclose prominently on its website, 
which is publicly available and free of charge, information regarding a 
published basket that will apply to orders for the purchase or 
redemption of creation units each business day.\231\ We believe that 
the conditions we are proposing related to baskets would provide ETFs 
with the ability to customize baskets in circumstances that would 
benefit the ETF and its investors, while at the same time putting in 
place protections against the potential for authorized participants to 
overreach by dictating the composition of baskets to the detriment of 
other ETF investors.\232\
---------------------------------------------------------------------------

    \230\ See proposed rule 6c-11(c)(3). The proposed rule would 
define ``basket'' to mean the securities, assets or other positions 
in exchange for which an ETF issues (or in return for which it 
redeems) creation units. See proposed rule 6c-11(a).
    \231\ See proposed rule 6c-11(c)(1)(i)(B).
    \232\ See, e.g., proposed rule 6c-11(c)(2).

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[[Page 37355]]

a. Basket Flexibility
    Where an ETF uses in-kind creations and redemptions, the 
composition of the basket is an important aspect of the efficient 
functioning of the arbitrage mechanism.\233\ Basket composition affects 
the costs of assembling and delivering the baskets that will be 
exchanged for creation units as well as the costs of liquidating basket 
securities when redeeming creation units. For example, the number of 
positions included in a basket, as well as the difficulty and cost of 
trading those positions, will affect the cost of basket transactions. A 
basket with hundreds of relatively small positions may prove less 
efficient than a basket with fewer positions.
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    \233\ See supra section I.B.
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    Basket composition also is important to ETF portfolio management. 
Each in-kind creation or redemption increases or decreases positions in 
the ETF's portfolio. Managing the composition of a basket allows the 
ETF to add certain instruments to its portfolio during the creation 
process (by including those securities in the basket that it will 
accept in exchange for a creation unit), or, conversely, to remove 
certain portfolio holdings during the redemption process (by including 
them in a redemption basket while not accepting them in the creation 
unit). This can be an efficient way for a portfolio manager to execute 
changes in the ETF's portfolio because the manager can make the changes 
without incurring the additional expenses of trades in the market. When 
an ETF does not have flexibility to manage basket composition, however, 
it may result in undesired changes to the portfolio, such as the loss 
of desirable bonds when paying redemptions in kind.
    The exemptive relief we have provided ETFs relating to baskets has 
evolved over time. Our earliest ETF orders for index-based ETFs 
organized as UITs provided that in-kind purchases of creation units 
were to be made using a basket of securities substantially similar to 
the composition and weighting of the ETF's underlying index.\234\ Given 
the unmanaged nature of the UIT structure, a UIT ETF's basket generally 
reflected a pro rata representation of the ETF's portfolio.\235\
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    \234\ See, e.g., SPDR, supra footnote 34.
    \235\ See supra section II.A.1. A UIT ETF could substitute cash 
for basket assets in certain limited circumstances. See, e.g., SPDR, 
supra footnote 34.
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    Early orders for ETFs organized as open-end funds included few 
explicit restrictions on baskets, and these orders did not expressly 
limit ETFs' baskets to a pro rata representation of the ETF's portfolio 
holdings.\236\ Since approximately 2006, however, as the ETF industry 
grew and the Commission gained more experience with ETFs, our exemptive 
orders have placed tighter restrictions on ETFs' composition of 
baskets.\237\ These orders expressly require that the ETF's basket 
generally correspond pro rata to its portfolio holdings, while 
identifying certain limited circumstances under which an ETF may use a 
non-pro rata basket.\238\ Our recent exemptive orders, for example, 
permit ETFs to use baskets that do not correspond pro rata to the ETF's 
portfolio holdings when it is impossible to break up bonds beyond 
certain minimum sizes needed for transfer and settlement or where 
rounding is necessary to eliminate fractional shares.\239\ The orders 
have allowed baskets to deviate from a pro rata representation where 
the basket includes positions that cannot be transferred in kind, such 
as ``to be announced'' transactions (``TBA transactions''), short 
positions, and derivatives.\240\ We have also permitted index-based 
ETFs to use non-pro rata baskets where the ETF has determined to use 
representative sampling of its portfolio to create its basket,\241\ and 
for temporary periods to replicate changes in the ETF's portfolio 
holdings as a result of the rebalancing of the ETF's securities market 
index.
---------------------------------------------------------------------------

    \236\ See WEBs Index Fund, Inc., et al., Investment Company Act 
Release Nos. 23860 (June 7, 1999) [64 FR 31658 (June 11, 1999)] 
(notice) and 23890 (July 6, 1999) (order) and related application.
    \237\ See, e.g., 2006 WisdomTree Investments, supra footnote 66; 
see also infra footnote 245 and accompanying paragraph.
    \238\ See 2006 WisdomTree Investments, supra footnote 66 (``[I]n 
limited circumstances and only when doing so would be in the best 
interest of a Fund as determined by the Advisor or Subadvisor, each 
Fund may designate Deposit Securities that may not be an exact pro 
rata reflection of such Fund's Portfolio Securities. For example, a 
Fund might designate a non-pro rata basket of Deposit Securities if 
one or more Portfolio Securities were not readily available, or in 
order to facilitate or reduce the costs associated with a 
rebalancing of a Fund's portfolio in response to changes in its 
Underlying Index.'').
    \239\ See, e.g., Nationwide Fund Advisors, et al., Investment 
Company Act Release Nos. 32727 (July 6, 2017) [82 FR 32214 (July 12, 
2017)] (notice) and 32771 (Aug. 1, 2017) (order) and related 
application.
    \240\ Id. In the TBA market, lenders enter into forward 
contracts to sell agency mortgage-backed securities and agree to 
deliver such securities on a settlement date in the future. The 
specific agency mortgage-backed securities that will be delivered in 
the future may not yet be created at the time the forward contract 
is entered into. The purchaser will contract to acquire a specified 
dollar amount of mortgage-backed securities, which may be satisfied 
when the seller delivers one or more mortgage-backed securities 
pools at settlement. See LRM Adopting Release, supra footnote 101, 
at n.381.
    \241\ See Morgan Stanley, supra footnote 211. In this context, 
representative sampling means that the ETF's baskets do not reflect 
a pro rata representation of the ETF's portfolio but contain assets 
from the ETF's portfolio that have been determined by the ETF to 
constitute a representative sample of the portfolio. See id. Our 
exemptive orders have expressly limited the circumstances under 
which the ETF may use representative sampling to select its basket 
assets: (i) The sample must be designed to generate performance that 
is highly correlated to the performance of the ETF's portfolio; (ii) 
the sample must consist entirely of instruments that are already 
included in the ETF's portfolio; and (iii) the sample must be the 
same for all authorized participants on a given business day. See 
id.
---------------------------------------------------------------------------

    Our recent exemptive orders also have permitted ETFs to 
specifically substitute cash for some or all of the securities in the 
ETF's basket in certain limited circumstances, including where the 
basket includes securities that are not eligible for trading due to 
local trading restrictions or are not available in sufficient quantity 
for purchases of creation units.\242\ In addition, while most existing 
ETFs typically engage in creation and redemption transactions on an in-
kind basis, we have permitted ETFs to use an all-cash basket.\243\ Due 
to the limited transferability of certain financial instruments, some 
ETFs operate on a cash-only basis under their exemptive orders.\244\
---------------------------------------------------------------------------

    \242\ See, e.g., J.P. Morgan Exchange-Traded Fund Trust, et al., 
Investment Company Act Release Nos. 30898 (Jan. 30, 2014) [79 FR 
6941 (Feb. 5, 2014)] (notice) and 30927 (Feb. 25, 2014) (order) and 
related application. These orders also generally require an ETF to 
use the same basket for both purchases and redemptions on a 
particular business day, subject to certain exceptions. See, e.g., 
id.
    \243\ See, e.g., 2006 WisdomTree Investments, supra footnote 66.
    \244\ See, e.g., ProShares Trust, et al., Investment Company Act 
Release Nos. 27975 (Sept. 21, 2007) [72 FR 55257 (Sept. 28, 2007)] 
(notice) and 28014 (Oct. 17, 2007) (order) and related application.
---------------------------------------------------------------------------

    The requirement that baskets correspond pro rata to the ETF's 
portfolio holdings, and the increasingly limited exceptions to the pro 
rata requirement, were designed to address the risk that an authorized 
participant could take advantage of its relationship with the ETF and 
pressure the ETF to construct a basket to be used only for that 
authorized participant and that favors the authorized participant to 
the detriment of the ETF's shareholders. For example, because ETFs rely 
on authorized participants to maintain the secondary market by 
promoting an effective arbitrage mechanism, an authorized participant 
holding less liquid or less desirable securities potentially could 
pressure an ETF into accepting those securities in its basket in 
exchange for liquid ETF shares (i.e., dumping). An authorized 
participant also could pressure the ETF into including in its basket 
certain desirable securities in exchange for ETF shares tendered for 
redemption (i.e., cherry-

[[Page 37356]]

picking). In either case, the ETF's other investors would be 
disadvantaged and would be left holding shares of an ETF with a less 
liquid or less desirable portfolio of securities. These abuses also 
could occur when a liquidity provider or other market participant 
engages in primary market transactions with the ETF by using an 
authorized participant as an agent.\245\
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    \245\ See supra footnote 22 and accompanying text.
---------------------------------------------------------------------------

    Based on our experience with ETFs, however, we recognize that there 
are many circumstances, in addition to the specific circumstances 
enumerated in our orders, where allowing baskets to differ from a pro 
rata representation or allowing the use of different baskets for 
different authorized participants could benefit the ETF and its 
shareholders. For instance, ETFs without basket flexibility typically 
are required to include a greater number of individual securities 
within their baskets when transacting in kind, making it more difficult 
and costly for authorized participants and other market participants to 
assemble or liquidate baskets.\246\ This could result in wider bid-ask 
spreads and potentially less efficient arbitrage. In such 
circumstances, these ETFs may be at a competitive disadvantage to ETFs 
with greater basket flexibility. As a result, these differing 
conditions and requirements for basket composition in our exemptive 
orders may have created a disadvantage for newer ETFs that are subject 
to our more recent, stringent restrictions on baskets.
---------------------------------------------------------------------------

    \246\ See Schwab ETP Comment Letter, supra footnote 115, at n.10 
(``[W]e looked at the daily National Securities Clearing Corporation 
Portfolio Composition Files for three Fixed-Income ETFs that each 
seek to track the Barclays U.S. Aggregate Bond Index. The first ETF 
is subject to the pro rata requirement and on the August 7, 2015 
trade date that ETF included 1,486 securities in its creation 
basket. The second and third ETFs are not subject to the pro rata 
requirement. In striking contrast, on the same trade date these two 
ETFs included only 64 and 56 securities in their creation baskets, 
respectively.'').
---------------------------------------------------------------------------

    Moreover, we believe that certain exceptions to a pro rata basket 
requirement may help ETFs operate more efficiently. For example, a lack 
of basket flexibility may cause some ETFs, particularly fixed-income 
ETFs, to satisfy redemption requests entirely in cash in order to avoid 
losing hard-to-find securities and to preserve the ETF's ability to 
achieve its investment objectives.\247\ ETFs that meet redemptions in 
cash may be required to maintain larger cash positions to meet 
redemption obligations, potentially resulting in cash drag on the ETF's 
performance. The use of cash baskets also may be less tax-efficient 
than using in-kind baskets to satisfy redemptions, and may result in 
additional transaction costs for the purchase and sale of portfolio 
holdings.\248\
---------------------------------------------------------------------------

    \247\ As discussed above, many ETFs, including fixed-income 
ETFs, are permitted under their exemptive orders to satisfy 
redemptions entirely in cash where the ETF holds thinly traded 
securities, among other circumstances. See, e.g., Pacific Investment 
Management Company LLC et al., Investment Company Act Release Nos. 
28723 (May 11, 2009) [74 FR 22772 (May 14, 2009)] (notice) and 28752 
(June 1, 2009) (order) and related application.
    \248\ In-kind redemptions allow ETFs to avoid taxable events 
that arise when selling securities for cash within the ETF.
---------------------------------------------------------------------------

    We believe it is appropriate, therefore, to provide additional 
basket flexibility, subject to conditions designed to address concerns 
regarding the potential risk of overreaching. Additional basket 
flexibility potentially could benefit ETF investors through more 
efficient arbitrage and narrower bid-ask spreads, among other 
benefits.\249\ Further, we believe that permitting the same level of 
basket flexibility for all ETFs relying on the rule would give a 
consistent structure to ETFs relying on the rule and would remove a 
barrier to entry for new ETFs.
---------------------------------------------------------------------------

    \249\ See infra footnote 438 and accompanying paragraph; see 
also infra footnote 444 and accompanying text.
---------------------------------------------------------------------------

    As proposed, rule 6c-11 would require all ETFs relying on the rule 
to adopt and implement written policies and procedures that govern the 
construction of baskets and the process that will be used for the 
acceptance of baskets.\250\ These policies and procedures would be 
required to cover the methodology that the ETF would use to construct 
baskets. For example, the policies and procedures should detail the 
circumstances when the basket may omit positions that are not 
operationally feasible to transfer in kind. The policies and procedures 
should detail when the ETF would use representative sampling of its 
portfolio to create its basket, and how the ETF would sample in those 
circumstances.\251\ The policies and procedures also should detail how 
the ETF would replicate changes in the ETF's portfolio holdings as a 
result of the rebalancing or reconstitution of the ETF's securities 
market index, if applicable.
---------------------------------------------------------------------------

    \250\ See proposed rule 6c-11(c)(3). We note that ETFs already 
may have policies and procedures governing the construction of 
baskets in order to comply with the representations and conditions 
of their exemptive orders. These policies and procedures, however, 
would not have been subject to the requirements we are proposing for 
custom basket policies and procedures, which we discuss below.
    \251\ See supra footnote 38 for a discussion of sampling.
---------------------------------------------------------------------------

    In addition to requiring that ETFs relying on the proposed rule 
adopt and implement policies and procedures regarding the composition 
of baskets, the proposed rule defines two particular types of baskets 
as ``custom baskets,'' which are subject to additional conditions 
designed to protect ETF investors. First, baskets that are composed of 
a non-representative selection of the ETF's portfolio holdings would be 
defined as custom baskets.\252\ A non-representative selection of the 
ETF's portfolio holdings would include, but not be limited to, baskets 
that do not reflect: (i) A pro rata representation of the ETF's 
portfolio holdings; \253\ (ii) a representative sampling of the ETF's 
portfolio holdings; or (iii) changes due to a rebalancing or 
reconstitution of the ETF's securities market index, if applicable.
---------------------------------------------------------------------------

    \252\ See proposed rule 6c-11(a) (defining ``custom baskets'' to 
include baskets that are composed of a non-representative selection 
of the ETF's portfolio holdings).
    \253\ A basket that is a pro rata representation of the ETF's 
portfolio holdings, except for minor deviations when it is not 
operationally feasible to include a particular instrument within the 
basket, generally would not be considered a ``custom basket.''
---------------------------------------------------------------------------

    Second, different baskets used in transactions on the same business 
day are defined as custom baskets under the proposed rule.\254\ For 
example, if an ETF exchanges a basket with an authorized participant 
that reflects a representative sampling of the ETF's portfolio holdings 
and a different basket with either the same or another authorized 
participant that represents a different representative sampling, both 
baskets would be custom baskets. Similarly, if an ETF substitutes cash 
in lieu of a portion of basket assets for a single authorized 
participant, that basket would be a custom basket.
---------------------------------------------------------------------------

    \254\ See proposed rule 6c-11(a) (defining ``custom baskets'' to 
include different baskets used in transactions on the same business 
day).
---------------------------------------------------------------------------

    We believe the use of custom baskets presents an increased risk 
that the ETF may be subject to improper pressure by an authorized 
participant to create specific baskets that favor that authorized 
participant. For example, using a custom basket could give authorized 
participants more opportunities for cherry-picking, dumping, or other 
abuses, including the potential for manipulative trading in the 
underlying portfolio securities. The proposed rule includes heightened 
process requirements for ETFs that use custom baskets as a means to 
protect against these risks. We believe that requiring an ETF that 
relies on the proposed rule to adopt basket policies and procedures 
that include specified

[[Page 37357]]

requirements is an appropriately tailored means to address concerns 
that authorized participants may overreach. Furthermore, we believe 
that the consistent implementation of custom basket policies and 
procedures would discipline the basket process and would act as a 
safeguard against potential cherry picking or dumping of unwanted 
securities by authorized participants.\255\
---------------------------------------------------------------------------

    \255\ In addition, in a highly competitive market, such as the 
market for ETFs, low performance or high tracking error would make 
ETFs undesirable for participants in both the primary and secondary 
markets. ETFs that do not guard closely against dumping and cherry-
picking could have diminished performance or higher tracking error 
over time, which would likely cause flows out of the fund.
---------------------------------------------------------------------------

    Under the proposed rule, an ETF using custom baskets must adopt 
policies and procedures that: (i) Set forth detailed parameters for the 
construction and acceptance of custom baskets that are in the best 
interests of the ETF and its shareholders, including the process for 
any revisions to, or deviation from, those parameters; and (ii) specify 
the titles or roles of the employees of the ETF's investment adviser 
who are required to review each custom basket for compliance with those 
parameters (``custom basket policies and procedures'').\256\ Effective 
custom basket policies and procedures should provide specific 
parameters regarding the methodology and process that the ETF would use 
to construct or accept each custom basket. An ETF's custom basket 
policies and procedures should describe the ETF's approach for testing 
compliance with the custom basket policies and procedures and assessing 
(including through back testing or other periodic reviews) whether the 
parameters continue to result in custom baskets that are in the best 
interests of the ETF and its shareholders. The custom basket policies 
and procedures should be consistently applied and must establish a 
process that the ETF will adhere to if it wishes to make any revisions 
to, or deviate from, the parameters. In addition, ETFs should consider 
adopting reasonable controls designed to prevent inappropriate 
differential treatment among authorized participants.
---------------------------------------------------------------------------

    \256\ Proposed rule 6c-11(c)(3)(i). We also are proposing to 
require ETFs to maintain records detailing the composition of each 
custom basket. See infra section II.D.
---------------------------------------------------------------------------

    As part of the custom basket policies and procedures, an ETF must 
specify the titles or roles of employees of the ETF's investment 
adviser who are required to review each custom basket for compliance 
with the parameters set forth in those policies and procedures. An ETF 
may want to consider whether employees outside of portfolio management 
should review the components of custom baskets before approving a 
creation or redemption. Finally, as discussed in more detail below in 
section II.D, the ETF would be required to create a record stating that 
each custom basket complies with the ETF's custom basket policies and 
procedures.\257\
---------------------------------------------------------------------------

    \257\ See proposed rule 6c-11(d)(2)(ii).
---------------------------------------------------------------------------

    We believe that the ETF's investment adviser is in the best 
position to design and administer the custom basket policies and 
procedures and to establish parameters that are in the best interests 
of the ETF and its shareholders.\258\ The ETF's adviser (and personnel) 
would be familiar with the ETF's portfolio holdings and would be able 
to assess whether the process and methodology used to construct or 
accept a custom basket would be in the best interests of the ETF and 
its shareholders and whether a particular custom basket complies with 
the parameters set forth in the custom basket policies and procedures. 
We believe that these requirements would allow an ETF to establish a 
tailored framework for the utilization of custom baskets, while also 
requiring the ETF to put into place safeguards against abusive 
practices related to basket composition. Custom basket policies and 
procedures designed and utilized in the best interests of an ETF and 
its shareholders may help the ETF manage its portfolio more 
efficiently, facilitate the arbitrage mechanism for the ETF, provide 
liquidity in markets for the ETF's shares and/or the ETF's underlying 
portfolio holdings, or provide other benefits to the ETF.
---------------------------------------------------------------------------

    \258\ An investment adviser has a fiduciary duty to act in the 
best interests of a fund it advises. See section 36(a) under the 
Act. See also, e.g., Rosenfeld v. Black, 445 F.2d 1337 (2d Cir. 
1971); Brown v. Bullock, 194 F. Supp. 207, 229, 234 (S.D.N.Y.), 
aff'd, 294 F.2d 415 (2d Cir. 1961); In re Provident Management 
Corp., Securities Act Release No. 5155 (Dec. 1, 1970), at text 
accompanying n.12; Rule 38a-1 Adopting Release, supra footnote 223, 
at n.68.
---------------------------------------------------------------------------

    In addition, ETFs currently are required by rule 38a-1 under the 
Act to adopt, implement and periodically review written policies and 
procedures reasonably designed to prevent violations of the federal 
securities laws.\259\ An ETF's compliance policies and procedures 
should be appropriately tailored to reflect its particular compliance 
risks. An ETF's basket policies and procedures (including its custom 
basket policies and procedures), therefore, should be covered by the 
ETF's compliance program and other requirements under rule 38a-1.\260\ 
For example, an ETF would be required to preserve the basket policies 
and procedures pursuant to the requirements of rule 38a-1(d)(1). We 
believe that the ETF's board of directors' oversight of the ETF's 
compliance policies and procedures, as well as their general oversight 
of the ETF, would provide an additional layer of protection for an 
ETF's use of custom baskets.
---------------------------------------------------------------------------

    \259\ See Rule 38a-1 Adopting Release, supra footnote 223.
    \260\ For example, rule 38a-1 requires a fund's chief compliance 
officer to provide a written report to the ETF's board of directors, 
no less frequently than annually, that addresses, among other 
things, the operation of the fund's compliance policies and 
procedures and any material changes made to those policies and 
procedures since the date of the last report and any material 
changes to the policies and procedures recommended as a result of 
the annual review of the policies and procedures. See rule 38a-
1(a)(4)(iii)(A).
---------------------------------------------------------------------------

    Our 2008 proposal did not expressly contemplate that an ETF would 
be permitted to substitute other securities in lieu of other basket 
assets.\261\ Instead, the proposal noted that in some circumstances it 
may not be practicable, convenient or operationally possible for the 
ETF to operate on an in-kind basis, and indicated that a fund could 
substitute cash for some or all of the securities in the basket.\262\ 
Commenters on this aspect of the 2008 proposal agreed with the 
definition of basket and did not recommend any modifications.\263\
---------------------------------------------------------------------------

    \261\ The 2008 proposal would have defined the term ``basket 
assets'' as the securities or other assets specified each business 
day in name and number by an ETF as the securities or assets in 
exchange for which it will issue or in return for which it will 
redeem ETF shares. See 2008 ETF Proposing Release, supra footnote 3.
    \262\ See id., at nn.120-121 (describing the circumstances in 
which an ETF may use cash in lieu of certain securities in the 
basket).
    \263\ See, e.g., ICI 2008 Comment Letter.
---------------------------------------------------------------------------

    Under proposed rule 6c-11, however, an ETF would be permitted to 
construct baskets using cash, securities, or other positions, provided 
that the ETF has satisfied the appropriate policies and procedures 
requirement (i.e., the standard requirement or the heightened 
requirement for custom baskets). As noted above, the use of in-kind 
baskets can result in several advantages to an ETF and its investors, 
including tax efficiencies and transaction cost savings. We believe 
that this approach would provide ETFs with flexibility to cover 
operational circumstances that make the inclusion of certain portfolio 
securities and other positions in a basket operationally difficult (or 
impossible), while also facilitating portfolio management changes in a 
cost- and tax-efficient manner. We believe that an ETF's policies and 
procedures should include details regarding the

[[Page 37358]]

circumstances in which cash, securities, or other positions would be 
substituted.
    We seek comment on this aspect of the proposed rule.
    <bullet> Is our proposed definition of ``baskets'' appropriate? 
Should the term exclude investments that are not securities or assets? 
Should the term exclude instruments that cannot be transferred in kind?
    <bullet> Is our proposed requirement that all ETFs adopt written 
policies and procedures governing basket construction appropriate? Are 
there alternatives we should consider? For example, should we require 
only ETFs that use custom baskets to adopt policies and procedures? Or, 
instead of requiring ETFs to adopt policies and procedures governing 
basket construction generally and custom basket policies and 
procedures, should we adopt a single requirement that all ETFs adopt 
policies and procedures governing the construction of baskets? If so, 
what parameters should be placed on those policies and procedures? What 
parameters, if any, should we place on board oversight of the policies 
and procedures governing the construction of baskets?
    <bullet> Instead of permitting basket flexibility as proposed, 
should we require baskets to reflect a pro rata representation of the 
ETF's portfolio holdings? Should we enumerate specific exemptions to 
the pro rata representation requirement? If so, what should those 
exemptions include? For example, should we include an exemption for an 
authorized participant prohibited from transacting in a certain basket 
security? Should we require baskets to be representative of the ETF's 
portfolio holdings according to some other criteria?
    <bullet> Should we allow ETFs to utilize baskets that deviate from 
a pro rata representation of the ETF's portfolio holdings, but require 
ETFs to utilize the same basket for all transactions on a particular 
business day? If so, why?
    <bullet> Do the proposed basket conditions appropriately address 
concerns of overreaching by authorized participants or other market 
participants, including those that are first- or second-tier affiliates 
identified in the rule? Should the proposed rule include any other 
conditions to minimize the potential risks of overreaching or other 
conflicts of interest by such affiliates? For example, should we limit 
the ability of an ETF to utilize a custom basket when an authorized 
participant or other market participant is an affiliate covered by the 
proposed exemption from section 17(a)?
    <bullet> Is our proposed definition of ``custom basket'' 
appropriate? Alternatively, should the term encompass any basket that 
deviates from a pro rata representation of the identities and 
quantities of the portfolio holdings held by the ETF? Should we provide 
additional guidance regarding instances where the basket is composed of 
a non-representative selection of the ETF's portfolio? Should we 
include examples in the definition of ``custom baskets''?
    <bullet> Are there any reasons to prohibit an ETF from using a 
custom basket? If so, what are they?
    <bullet> Should we provide additional guidance or include 
additional requirements in the rule regarding the elements of effective 
custom basket policies and procedures? For example, should custom 
basket policies and procedures set forth the minimum number of 
positions that would be included in a custom basket? Should the custom 
basket policies and procedures set forth parameters regarding the 
effect of the custom basket on the value of the ETF's portfolio 
holdings, its tracking error (if applicable), and the portfolio's 
risks? Should these policies and procedures set forth the circumstances 
under which the ETF would substitute cash in lieu of portfolio holdings 
after considering the effect cash would have on performance, trading 
costs, and if accepting cash would have tax consequences? Should they 
set forth the parameters in which the ETF will accept odd-lot 
securities in a custom basket? Are there any other considerations that 
should be included? Alternatively, should we eliminate any or all of 
the considerations discussed above?
    <bullet> Should we require an ETF to adopt policies and procedures 
that set forth detailed parameters for the construction or acceptance 
of custom baskets that are in the best interests of the ETF and its 
shareholders as proposed? Should we require the policies and procedures 
to include a process for any revisions to or deviation from the 
parameters as proposed? Are there other parameters we should consider? 
Should we require the custom basket policies and procedures to list the 
titles or roles of the employees who review each custom basket for 
compliance with the parameters as proposed? Should we provide guidance 
regarding how this review should be done in cases where the ETF is sub-
advised? Should we require that this review be done only by employees 
outside of portfolio management? If so, which employees and why?
    <bullet> As proposed, rule 6c-11 would require an ETF to create a 
record stating that each custom basket complies with the ETF's custom 
basket policies and procedures.\264\ Should we establish any other 
recordkeeping requirements relating to basket flexibility?
---------------------------------------------------------------------------

    \264\ See proposed rule 6c-11(d)(2)(ii).
---------------------------------------------------------------------------

    <bullet> Should the proposed rule require the ETF's investment 
adviser to review the basket policies and procedures (including the 
custom basket policies and procedures) on an annual basis or with such 
frequency as the ETF's adviser deems reasonable and appropriate? Should 
the proposed rule include board reporting requirements? For example, 
should the proposed rule require the adviser to deliver an annual 
report to the ETF's board regarding the implementation of the basket 
policies and procedures?
b. Posting of a Published Basket
    We also are proposing to require an ETF to post on its website 
information regarding a published basket at the beginning of each 
business day, as well as the estimated cash balancing amount if 
any.\265\ We believe this disclosure would contribute to the efficiency 
of the arbitrage mechanism by providing authorized participants and 
other market participants with timely information regarding the 
contents of a basket that the ETF will accept for creations and 
redemptions each business day. This, in turn, would allow market 
participants to value the contents of the basket on an intraday basis 
to determine whether arbitrage opportunities exist. This information 
also permits market makers to compare the ETF's portfolio holdings with 
the basket.
---------------------------------------------------------------------------

    \265\ See proposed rule 6c-11(c)(1)(i)(B) and (C). Under 
proposed rule 6c-11(a), the ``cash balancing amount'' would be 
defined as an amount of cash to account for any differences between 
the value of a basket and the NAV of a creation unit. Our ETF 
exemptive orders have recognized a cash balancing amount to 
reconcile any difference between the asset value of a creation unit 
and the value of the ETF's basket.
---------------------------------------------------------------------------

    In particular, we are proposing to require that an ETF publish on 
its website one basket that it would exchange for orders to purchase or 
redeem creation units to be priced based on the ETF's next calculation 
of NAV per share each business day.\266\ This ``published'' basket must 
be disclosed before the opening of trading of the ETF's shares and 
before the ETF begins accepting orders for the purchase or redemption 
of creation units to be priced based on the ETF's next calculation of 
NAV.\267\ This requirement is designed to mitigate possible 
inefficiencies in the arbitrage

[[Page 37359]]

mechanism that could result from delaying the publication of an ETF's 
basket.\268\
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    \266\ See proposed rule 6c-11(c)(1)(i)(B).
    \267\ See id.
    \268\ As proposed, an ETF relying on the rule also would be 
required to disclose its portfolio holdings that will form the basis 
of the next calculation of NAV per share in this manner. See 
proposed rule 6c-11(c)(1)(i)(A).
---------------------------------------------------------------------------

    Under this requirement, an ETF would publish a basket that it would 
accept if presented by any authorized participant in exchange for 
creation units (or present to an authorized participant redeeming 
creation units).\269\ Accordingly, an ETF that planned to use only 
custom baskets on a particular business day (e.g., a basket reflecting 
a non-representative selection of the ETF's portfolio holdings), would 
be required to post a custom basket as its ``published'' basket.
---------------------------------------------------------------------------

    \269\ Our proposal does not prevent an ETF from changing the 
assets in a published basket to respond to market conditions after 
the basket is published.
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    Because an ETF would be required to post only one published basket 
to comply with this condition, there may be occasions where an ETF 
would not post the contents of every custom basket. We considered 
proposing that ETFs be required to publish, after the close of trading 
on each business day, information regarding every basket used by the 
ETF to serve as an additional check against overreaching by authorized 
participants. However, we preliminarily believe that this requirement 
is an unnecessary additional burden, resulting in compliance and other 
operational costs for ETFs to review the information before it is 
posted. Instead, as discussed below in section II.D, we are proposing 
to require ETFs to maintain records detailing the composition of 
baskets, which would allow our staff to review an ETF's baskets as part 
of an examination.
    The 2008 proposed rule did not require ETFs to disclose their 
baskets. We did note in that proposal, however, that basket disclosure 
was a widely adopted industry practice and facilitated effective 
arbitrage activity.\270\ On this issue, commenters on the 2008 proposal 
stated that it was not necessary for the Commission to require ETFs to 
disclose their baskets because that information was available in the 
portfolio composition files provided each business day by ETFs to the 
National Securities Clearing Corporation (``NSCC'').\271\ While this 
still may be true, the composition of an ETF's basket for a given day 
may be important information to not only authorized participants and 
large institutional investors (who, as NSCC members, have access to the 
daily portfolio composition files), but to other market participants as 
well. For example, the information allows investors to compare the 
ETF's baskets for a given day with its portfolio holdings, assists 
market participants who are building their intraday hedge (we 
understand that some market participants primarily look to the baskets 
rather than the whole portfolio), and is important for purposes of 
estimating any cash balancing amounts as it allows market participants 
to compare the basket to the whole portfolio. We also believe that this 
proposed basket disclosure requirement is sufficiently narrow to not 
impose a significant burden on ETFs because it requires only one 
basket-related disclosure each trading day, at the beginning of the 
day.
---------------------------------------------------------------------------

    \270\ See 2008 ETF Proposing Release, supra footnote 3, at n.27 
and accompanying text. Many exemptive orders also require ETFs to 
make basket information available on a daily basis. See, e.g., Salt 
Financial, LLC, et al., Investment Company Act Release Nos. 32974 
(Jan. 23, 2018) [83 FR 4097 (Jan. 29, 2018)] (notice) and 33007 
(Feb. 21, 2018) (order) (``Salt Financial'').
    \271\ See, e.g., NYSE Arca 2008 Comment Letter.
---------------------------------------------------------------------------

    We request comment on this proposed requirement.\272\
---------------------------------------------------------------------------

    \272\ We request comment regarding additional proposed website 
disclosures at infra section II.C.6.
---------------------------------------------------------------------------

    <bullet> Are we correct that disclosure of an ETF's basket 
facilitates the arbitrage mechanism? Is an ETF's basket composition 
useful information to ETF investors in the secondary market?
    <bullet> Should we require the posting of a basket as proposed? 
Should we provide additional guidance regarding what types of basket 
would constitute a published basket?
    <bullet> Would the disclosure of one basket at the beginning of 
each business day provide enough information to all market participants 
about an ETF's basket composition, particularly for ETFs using custom 
baskets? Should we instead require ETFs to disclose each basket used on 
a given business day after the close of trading on the ETF's website? 
Would these approaches cause competitive concerns or cause significant 
operational challenges? What costs and benefits would be associated 
with a requirement to publish all baskets used each business day? Would 
such an approach allow better policing of potential overreaching by 
authorized participants?
    <bullet> If an ETF is no longer willing to accept the basket posted 
on its website on a particular business day because of market events, 
should the rule require the ETF to post a replacement basket on the 
website that the ETF would accept?
    <bullet> Our proposal is designed to strike a balance between 
process and oversight requirements (i.e., policies and procedures 
governing basket construction) and disclosure requirements. Do 
commenters agree with this approach? Would additional basket 
transparency lessen the need for policies and procedures relating to 
basket composition? Is there a more appropriate balance between the two 
types of requirements that we should consider?
    <bullet> Is our proposed definition of ``cash balancing amount'' 
appropriate?
    <bullet> Should we require the disclosure of baskets on an ETF's 
website as proposed? Alternatively, should we allow ETFs to comply with 
the basket transparency condition by sending the portfolio composition 
file to a central clearing facility in accordance with current 
practices? What would be the costs or operational burdens of each 
approach? Would the website disclosure of this information benefit any 
market participants (including retail investors) that may not have 
access to the portfolio composition file? If so, how would market 
participants use this information?
6. Website Disclosure
    There has been a significant increase in the use of the internet as 
a tool for disseminating information,\273\ and we believe that many 
investors obtain information regarding ETFs on the ETFs' websites. 
Proposed rule 6c-11 therefore would require ETFs to disclose certain 
information on their websites as a condition to the rule.\274\ As noted 
above, we believe that the arbitrage mechanism works more efficiently 
when certain data is publicly available to investors each trading day, 
and are therefore proposing ETF website disclosures in order to provide 
transparency of portfolio holdings and baskets.\275\ In addition, we 
are proposing several website disclosure requirements that are designed 
to provide investors with key metrics to evaluate their investment and 
trading decisions in a format that is easily accessible and frequently 
updated. Specifically, the proposed rule would require disclosure 
regarding: (i) The ETF's NAV per share, market price, and premium or 
discount, each as of the end of the prior business day; (ii) bid-ask 
spreads; and (iii) historical information regarding premiums and 
discounts.
---------------------------------------------------------------------------

    \273\ See, e.g., Reporting Modernization Adopting Release, supra 
footnote 147.
    \274\ Proposed rule 6c-11(c)(1).
    \275\ See supra sections II.C.4 and II.C.5.
---------------------------------------------------------------------------

    Some of these conditions are based on our exemptive relief, which 
has required ETFs to disclose on their

[[Page 37360]]

websites certain information regarding their investments and 
operations, including quantitative information regarding discounts or 
premiums at which the ETF's shares trade on the secondary market.\276\ 
Our orders have required ETFs to publicly disclose on their websites: 
(i) The prior business day's NAV per share; (ii) the market closing 
price or the midpoint of the bid-ask spread at the time of the 
calculation of NAV; and (iii) a calculation of the premium or discount 
of the market closing price or midpoint of the bid-ask spread against 
NAV per share.\277\ Similarly, Form N-1A currently provides an ETF with 
the option to omit certain historical information regarding premiums 
and discounts from its prospectus and annual report if the disclosure 
is provided on its website.\278\ Based on our experience overseeing 
ETFs, we are proposing additional website disclosure requirements that 
have not been part of our exemptive relief or Form N-1A requirements. 
We also are requesting comment regarding ways to better inform 
investors about intraday deviations between an ETF's market price and: 
(i) NAV per share; (ii) the contemporaneous value of its portfolio; or 
(iii) both. Each of the proposed website disclosures is discussed 
below.
---------------------------------------------------------------------------

    \276\ See, e.g., Barclays Global 2008, supra footnote 58.
    \277\ See supra footnote 134 and accompanying text.
    \278\ See infra section II.H.
---------------------------------------------------------------------------

a. Daily NAV, Market Price, and Premiums and Discounts
    Proposed rule 6c-11(c)(1)(ii) would require ETFs to post on their 
websites, on each business day, the ETF's current NAV per share, market 
price, and premium or discount, each as of the end of the prior 
business day. This disclosure provides investors with a ``snapshot'' 
view of the difference between an ETF's NAV per share and market price 
on a daily basis. It is designed to alert investors to the relationship 
between NAV per share 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 NAV of the ETF. It also is designed to allow investors to compare 
this information across ETFs. For example, an investor using this 
information likely would notice that ETFs tracking emerging markets 
tend to have greater premiums or discounts than ETFs tracking broad-
based domestic indexes. We believe that daily website disclosure of 
this information would promote transparency and help investors better 
understand the risk that an ETF's market price may be higher or lower 
than the ETF's NAV per share. We further believe that ETF investors use 
this information today, as ETFs currently provide this website 
disclosure pursuant to the terms of their exemptive orders.
    This proposed requirement is consistent with our exemptive orders 
and generally consistent with our 2008 proposal, except we have changed 
the definition of ``market price''.\279\ Proposed rule 6c-11 would 
define the term ``market price'' to mean: (i) The official closing 
price of an ETF share; or (ii) if it more accurately reflects the 
market value of an ETF share at the time as of which the ETF calculates 
current NAV per share, the price that is the midpoint of the national 
best bid and national best offer (``NBBO''), calculated as of the time 
NAV per share is calculated.\280\
---------------------------------------------------------------------------

    \279\ See 2008 ETF Proposing Release, supra footnote 3.
    \280\ See proposed rule 6c-11(a).
---------------------------------------------------------------------------

    The 2008 proposed rule would have defined ``market price'' only as 
the last price at which ETF shares trade on their principal U.S. 
trading market during a regular trading session. However, we believe 
that using the ``official closing price,'' as opposed to the ``closing 
market price,'' is a better measure of an ETF's market price, 
particularly in situations where the last trade of the day was not 
reflective of the actual market price (e.g., due to an erroneous 
order). Exchanges have detailed rules regarding the determination of 
the official closing price of a security.\281\ For example, if a 
listing exchange experiences a systems disruption and cannot conduct 
closing auctions, exchanges use their back-up procedures to determine 
the ``official closing price'' for the affected securities (such as 
relying on a backup exchange's closing auction). As a result, we 
preliminarily believe that using the ``official closing price'' 
provides a more precise measurement of an ETF's market price, including 
during disruptive market events.
---------------------------------------------------------------------------

    \281\ See, e.g. Self-Regulatory Organizations; New York Stock 
Exchange LLC; NYSE MKT LLC; Notice of Filings of Amendment No. 1, 
and Order Granting Accelerated Approval of Proposed Rule Changes, as 
Modified by Amendment No. 1, to Provide for How the Exchanges Would 
Determine an Official Closing Price if the Exchanges are Unable to 
Conduct a Closing Transaction, Exchange Act Release No. 78015 (June 
8, 2016) [81 FR 38747 (June 14, 2016)] (NYSE backup procedures).
---------------------------------------------------------------------------

    Commenters on the 2008 ETF Proposing Release who addressed this 
aspect of the proposal opposed the proposed definition of market price 
because of concerns that the last price at which an ETF trades could be 
stale at the time as of which NAV per share is calculated.\282\ These 
commenters suggested that ETFs instead be permitted to use the midpoint 
between the highest bid and the lowest offer at the time as of which 
the ETF's NAV is calculated.\283\ We generally agree and, as a result, 
we are proposing to permit ETFs to use a price that is the midpoint of 
the NBBO as of that time, if it is more accurate.\284\ Because security 
information processors calculate NBBO continuously during the trading 
day, NBBO has the benefit of being a verifiable third-party quote. We 
believe that this approach provides an appropriate degree of 
flexibility to an ETF when its last reported sales price may be stale, 
while at the same time providing a consistent and verifiable 
methodology for how ETFs determine market price.
---------------------------------------------------------------------------

    \282\ See, e.g., Chapman 2008 Comment Letter (noting that shares 
of some smaller ETFs may not trade often or at all on a particular 
day); ICI 2008 Comment Letter (noting that closing price may be less 
accurate because the last trade occurred at a much earlier time than 
the time as of which NAV is calculated).
    \283\ See, e.g., Chapman 2008 Comment Letter.
    \284\ See proposed rule 6c-11(a) (defining ``market price''); 
see also rule 600(b)(42) of Regulation NMS (defining NBBO). [17 CFR 
242.600]. The NBBO represents the highest bid and lowest offer for 
an ETF share consolidated across all exchanges.
---------------------------------------------------------------------------

    As discussed in more detail below, the proposed definition of 
market price also differs from the definition currently used in Form N-
1A.\285\ Form N-1A defines ``market price'' as the last reported sale 
price or, if it more accurately reflects the current market value of 
the ETF's shares, ``a price within the range of the highest bid and 
lowest offer.'' \286\ We believe specifying that an ETF must use the 
midpoint of the NBBO, rather than ``a price within the range of the 
highest bid and lowest offer'' still provides the ETF with flexibility 
in determining a market price for its shares that accurately reflects 
the shares' market value. At the same time, requiring ETFs to use the 
midpoint in these circumstances would mitigate the potential for gaming 
practices that could inaccurately minimize a deviation between market 
price and NAV per share when showing premiums and discounts.\287\ We 
are proposing to amend Form N-1A to remove the definition of market 
price in that form

[[Page 37361]]

as it would no longer be used in the same manner.\288\
---------------------------------------------------------------------------

    \285\ See infra section II.H.1.
    \286\ See General Instruction A to Form N-1A.
    \287\ An ETF would use the market price of an ETF share in 
calculating premiums and discounts. See proposed rule 6c-11(a) 
(defining ``premium or discount'' to mean the positive or negative 
difference between the market price of an ETF share and the ETF's 
current NAV per share, expressed as a percentage of the ETF's 
current NAV per share).
    \288\ See infra section II.H.1.
---------------------------------------------------------------------------

    We believe that the daily premium/discount disclosures (and 
calculation methodology) we are proposing would provide investors with 
useful information regarding ETFs that frequently trade at a premium or 
discount to NAV per share. For example, some ETFs have frequent 
deviations between closing market price and NAV per share. These ETFs 
typically hold non-U.S. securities and trade during hours when the 
markets for their non-U.S. holdings are closed, allowing the trading 
price of ETF shares to reflect expected changes in the next opening 
price of the non-U.S. holdings (i.e., to help ``discover'' the price of 
the holdings). ETFs also may have greater premiums and discounts to the 
extent that there are greater transaction costs associated with 
assembling baskets. In addition, an ETF with less liquid portfolio 
holdings also may show a deviation between closing market price and NAV 
per share,\289\ and an ETF with a less efficient arbitrage mechanism 
may frequently show this type of end of day deviation.\290\
---------------------------------------------------------------------------

    \289\ See LRM Adopting Release, supra footnote 101, at n.33 and 
accompanying text.
    \290\ See id at text following n.524 (``[S]hares of an ETF whose 
underlying securities are relatively less liquid may not be able to 
be counted on to provide liquidity to a fund investing in these 
shares during times of stress. In the case of a significant decline 
in market liquidity, if authorized participants were unwilling or 
unable to trade ETF shares in the primary market, and the majority 
of trading took place among investors in the secondary market, the 
ETF's shares could trade continuously at a premium or a discount to 
the value of the ETF's underlying portfolio securities.'').
---------------------------------------------------------------------------

    We understand, however, that proposed premium/discount disclosure 
would not provide investors with information regarding intraday 
deviations between market prices and the next-calculated NAV or the 
contemporaneous value of the ETF's underlying securities, even if the 
deviation is significant. Some commentators have stated that the lack 
of disclosure regarding intraday deviations could, in some 
circumstances, be misleading.\291\ For example, some ETFs had 
relatively large intraday deviations between market price and intraday 
indicative values on August 24, 2015 that were not reflected as a 
``premium'' or ``discount'' because market price and NAV per share were 
tightly correlated by the end of the day.\292\
---------------------------------------------------------------------------

    \291\ See, e.g., Henry T.C. Hu and John D. Morley, A Regulatory 
Framework for Exchange-Traded Funds, 91 S. Cal. Law Review 
(forthcoming 2018) (``Hu and Morley'') at 53 (``While simplicity and 
other reasons help explain the SEC's decision to look only at the 
close and not intra-day performance, the result was an emphatically 
reassuring picture being presented to investors. As a result, an 
investor may have a misleading sense as to the true risks and 
returns of the ETF.'').
    \292\ See supra footnote 128 and accompanying text.
---------------------------------------------------------------------------

    While we believe that additional information regarding intraday 
deviations could help ETF investors understand both the potential for 
intraday deviations and the circumstances under which deviations have 
occurred in the past, developing an accurate and cost-effective 
methodology to calculate intraday deviations for all types of ETFs is 
challenging. For example, there are many ways to calculate a market 
price metric, such as the average of execution prices on a business day 
or the midpoint of the NBBO measured at specific intervals during the 
course of the trading day. These measures, however, often do not 
provide a meaningful picture of intraday deviations because they can 
give outliers either outsized importance (in the case of averages), 
particularly for ETFs with low trading volume, or insufficient 
importance (in the case of medians). In addition, the systems necessary 
to calculate and track these measures can be complex and costly.
    Similarly, developing an accurate measure of the contemporaneous 
value of the ETF's portfolio is complex. As we noted in our discussion 
of the IIV,\293\ calculations of contemporaneous value can be stale or 
inaccurate for ETFs with foreign securities or less liquid debt 
instruments for which market quotations are not readily available. For 
such an ETF, a contemporaneous value calculated using last available 
market quotations or stale prices may show a premium/discount to any 
ETF share price that factors in fair valuations of the ETF's portfolio 
holdings. Moreover, without prescribed uniform methodology 
requirements, contemporaneous values can be calculated in different, 
and potentially inconsistent, ways and lead to non-comparable premium/
discount disclosure. We request comment below on potential alternative 
calculations and disclosure requirements that could inform investors 
about intraday deviations.\294\
---------------------------------------------------------------------------

    \293\ See supra section II.C.3.
    \294\ Many ETFs provide qualitative disclosures in their 
prospectuses regarding the potential for periods of market 
volatility that could lead to deviations from NAV per share. See, 
e.g., supra footnote 126.
---------------------------------------------------------------------------

b. Bid-Ask Spread Disclosure
    As discussed in more detail below, our proposed amendments to Form 
N-1A would include new requirements for an ETF to disclose information 
regarding bid-ask spreads on its website and in its prospectus.\295\ 
Specifically, an ETF would be required to disclose the median bid-ask 
spread for the ETF's most recent fiscal year. A bid-ask spread is the 
difference between the highest price a buyer is willing to pay to 
purchase shares of the ETF (bid) and the lowest price a seller is 
willing to accept for share of the ETF (ask).\296\ The proposed website 
disclosures are designed to inform investors that they may bear bid-ask 
spread costs when trading ETFs on the secondary market, which 
ultimately could impact the overall cost of the investment. We are 
concerned that investors may not be aware of the impact trading costs 
may have on their investments in ETFs,\297\ and therefore, propose to 
require ETFs to disclose median bid-ask spread information pursuant to 
a prescribed methodology that would be set forth in Form N-1A. We 
believe that this information would provide ETF investors with greater 
understanding of these costs and would allow investors to compare this 
information across ETFs. Spread costs for ETFs can vary significantly, 
and disclosure regarding these costs could aid comparisons of ETFs 
pursuing similar investment strategies. We believe this information 
also would allow investors to better understand the costs of investing 
in an ETF.\298\
---------------------------------------------------------------------------

    \295\ See proposed amendment to Item 3 of Form N-1A. See also 
infra section II.H.2. for a discussion of the bid-ask spread 
disclosure requirements. We are also proposing to require ETFs to 
provide an interactive calculator that would provide investors with 
the ability to customize the hypothetical bid-ask spread disclosures 
in Item 3 of Form N-1A to the investor's specific investing 
situation. See id.
    \296\ See proposed amendment to Item 3 of Form N-1A.
    \297\ See, e.g., Simon Constable, How to Measure ETF Spreads, 
The Wall Street Journal (Nov. 5, 2017), available at https://www.wsj.com/articles/how-to-measure-etf-spreads-1509937200.
    \298\ As discussed in more detail below, mutual fund investors 
typically do not incur bid-ask spread costs in connection with their 
investment in a mutual fund. See infra section II.H.2.
---------------------------------------------------------------------------

    We are proposing to require the disclosure of the bid-ask spread 
information on an ETF's website to provide trading information that can 
help investors make better informed investment decisions in a format 
that is easily accessible and relied upon by a growing segment of 
investors. Given the importance of this information to understanding 
the total expenses an investor may bear when investing in an ETF, we 
preliminarily believe that bid-ask spread information also should be 
included in an ETF's prospectus. Without this bid-ask spread 
information, we preliminarily believe

[[Page 37362]]

the fee and expense information provided in a prospectus may not always 
provide a complete picture of an investment's true costs and/or allow 
investors to easily compare prospectus disclosures across certain 
investment options.\299\
---------------------------------------------------------------------------

    \299\ Required prospectus disclosures for open-end funds 
currently include shareholder fees such as sales charges and 
redemption fees, as well as annual fund operating expenses. See Item 
3 of Form N-1A.
---------------------------------------------------------------------------

c. Historical Information Regarding Premiums and Discounts
    We also are proposing to require that ETFs disclose on their 
websites historical information about the extent and frequency of an 
ETF's premiums and discounts. In particular, proposed rule 6c-
11(c)(1)(iii) and (iv) would require an ETF to post on its website both 
a table and line graph showing the ETF's premiums and discounts for the 
most recently completed calendar year and the most recently completed 
calendar quarters of the current year. Alternatively, for new ETFs that 
do not yet have this information, the proposed rule would require the 
ETF to post this information for the life of the fund.
    Currently, an ETF is required to disclose historical premium/
discount information in its prospectus by providing tabular disclosure 
of the number of trading days during the most recently completed 
calendar year and quarters since that year ended on which the market 
price of the ETF shares was greater than the ETF's NAV per share and 
the number of days it was less than the ETF's NAV per share.\300\ An 
ETF currently may omit the disclosure of specific premium/discount 
information in its prospectus or annual report if the ETF provides the 
information on its website and discloses in the prospectus or annual 
report a website address where investors can locate the 
information.\301\ We believe that investors may find this tabular 
information helpful in understanding how often an ETF trades at a 
premium or discount and the size of such premiums and discounts and are 
proposing to require publication of a table on the ETF's website as 
part of proposed rule 6c-11.\302\
---------------------------------------------------------------------------

    \300\ Instruction 2 to Item 11(g)(2) of Form N-1A. ETFs are also 
required to include a table with premium/discount information in 
their annual reports for the five most-recently completed fiscal 
years. Item 27(b)(7)(iv) of Form N-1A.
    \301\ Item 11(g)(2) of Form N-1A; Item 27(b)(7)(iv) of Form N-
1A. Although the time period required in the disclosure is different 
in the prospectus and annual report, ETFs are permitted to omit both 
disclosures by providing on their websites only the premium/discount 
information required by Item 11(g)(2) (the most recently completed 
fiscal year and quarters since that year).
    \302\ See proposed rule 6c-11(c)(1)(iii).
---------------------------------------------------------------------------

    We additionally believe that graphic disclosure could assist some 
investors with understanding how the arbitrage mechanism performs for 
an ETF under various market conditions. Depending on a variety of 
factors, an ETF could have persistent premiums or discounts (or both) 
from the ETF's NAV. For example, certain classes of ETFs, such as those 
that invest in less liquid securities, like high-yield bonds, and 
securities that trade on international markets, have more persistent 
deviations in ETF share prices from the ETF's NAV.\303\ Additionally, 
for certain types of ETFs, the disclosure may inform investors about 
the pricing of the ETF's portfolio holdings. ETFs holding foreign 
securities that are traded on markets that are closed during U.S. 
trading hours, for example, may have persistent premiums or discounts 
resulting from this timing differential. In other cases, a persistent 
deviation between market price and NAV per share could demonstrate 
inefficiencies in an ETF's arbitrage mechanism.\304\
---------------------------------------------------------------------------

    \303\ See Hu and Morley, supra footnote 291, at 12 (noting that 
certain kinds of ETFs have much higher 95% confidence intervals of 
almost 600 basis points) (internal citations omitted).
    \304\ See, e.g., Crystal Kim, This Levered Gold Mining ETF Looks 
Super Scary, Barrons (Apr. 20, 2017), available at https://www.barrons.com/articles/this-levered-gold-mining-etf-looks-super-scary-1492700892 (linking an ETF trading at a significant premium to 
NAV to the ETF's suspension of creation units, and in turn, linking 
the suspension to the limited availability of certain investments 
the ETF needed to make in order to seek its investment objective).
---------------------------------------------------------------------------

    While past performance cannot predict how an ETF will trade in the 
future, we believe that it is important that investors, and 
particularly retail investors, understand that certain classes of ETFs 
could have a larger and more persistent deviation from NAV, which could 
result in a higher cost to investors and a potential drag on returns. 
In addition to alerting secondary market investors that an ETF's NAV 
per share and market price may differ, these disclosures would provide 
information regarding the frequency and extent of these deviations. 
These disclosures thus would help investors understand the value of 
their investment and could help shape whether they want to invest in a 
particular ETF.
    We believe that presenting the data as both a table and a line 
graph would provide investors with useful information in a variety of 
formats that are easy to view and understand, depending on the 
investor's preference. For example, investors may find the proposed 
tabular disclosure an easy to understand demonstration of how often the 
ETF traded at a premium or discount. However, the tabular disclosure 
does not allow investors to observe the degree of those deviations, 
particularly during periods of market stress. For example, two ETFs may 
have traded at a discount for the same number of days. One ETF's daily 
deviations could have been small with little effect on investors 
trading on those days, whereas the other ETF could have had significant 
discounts. These distinctions would not be apparent based on the 
required tabular disclosure, but would be observable with the graphic 
disclosure we are proposing. As a result, in order to assist investors 
with understanding an ETF's premiums and discounts, we are proposing 
both tabular and graphical representations of daily premium and 
discounts.\305\ In order to eliminate potentially duplicative 
disclosure requirements, we are proposing to eliminate historical 
premium/discount disclosure requirements in Item 11(g)(2) and Item 
27(b)(7)(iv) of Form N-1A.\306\
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    \305\ Under the proposal, the historical premium/discount 
information would be required for the most recently completed 
calendar year and the most recently completed calendar quarters of 
the current year. This period was chosen as it was consistent with 
existing requirements in Item 11(g)(2) of Form N-1A. We believe the 
time period would allow investors to readily observe the extent and 
frequency of deviations from NAV per share in a graphic format.
    \306\ See infra section II.H.4.
---------------------------------------------------------------------------

    Proposed rule 6c-11(c)(1)(v) also would require any ETF whose 
premium or discount was greater than 2% for more than seven consecutive 
trading days to post that information on its website, along with a 
discussion of the factors that are reasonably believed to have 
materially contributed to the premium or discount. We propose that ETFs 
posting this information be required to post it on their websites on 
the trading day immediately following the day on which the ETF's 
premium or discount triggered this provision (i.e., on the trading day 
immediately following the eighth consecutive trading day on which the 
ETF had a premium or discount greater than 2%) and maintain it on their 
websites for at least one year following the first day it was posted.
    We believe that this proposed disclosure of information about ETFs' 
premiums and discounts would promote transparency regarding the 
significance and/or persistency of deviations between market price and 
NAV per share, and thus may permit investors to make more informed

[[Page 37363]]

investment decisions. This information also may provide the market (and 
the Commission) with information regarding the efficiency of an ETF's 
arbitrage mechanism. As noted above, in the Commission's experience, 
the deviation between the market price of ETFs and NAV per share, 
averaged across broad categories of ETF investment strategies and over 
time periods of several months, has been relatively small.\307\ 
Therefore, we believe that limiting this disclosure to ETFs that have a 
premium or discount of greater than 2% for more than seven consecutive 
trading days would serve to highlight potentially unusual circumstances 
when an ETF has a persistent premium or discount.\308\
---------------------------------------------------------------------------

    \307\ See supra footnotes 119-120 and accompanying text.
    \308\ This belief is based on data obtained from Morningstar and 
Bloomberg.
---------------------------------------------------------------------------

    Given the proposed threshold, we do not believe that many ETFs 
would be required to disclose this information.\309\ However, there 
could be certain categories of ETFs that could be particularly 
affected. An ETF that invests in foreign securities, for example, may 
be more likely to experience a persistent deviation between market 
price and NAV per share given that many foreign markets are closed 
during the U.S. trading day. Such deviations may be pronounced if the 
market on which the ETF's underlying securities trade is closed.\310\
---------------------------------------------------------------------------

    \309\ See infra footnote 477 and accompanying text.
    \310\ See Tom Lyndon, China A-Shares ETFs Trading at Steep 
Discount to NAV, ETF Trends (Jul. 9, 2015), available at http://www.etftrends.com/2015/07/china-a-shares-etfs-trading-at-steep-discount-to-nav/ (reporting that U.S.-listed China A-shares ETFs 
were trading at a steep discount to the underlying market because of 
the fact that a significant number of companies stopped trading on 
China's mainland stock exchanges).
---------------------------------------------------------------------------

    The proposed rule would require the disclosure to include a 
discussion of the factors that are reasonably believed to have 
contributed to the premium or discount. We believe that this 
requirement would provide secondary market investors with useful 
context for the disclosed deviations. In addition, we believe that 
requiring ETFs to maintain it on their website for at least one year 
following the first day it was posted would identify those ETFs that 
historically have had such an instance of persistent deviation between 
market price and NAV per share.\311\
---------------------------------------------------------------------------

    \311\ We recognize that historical information relating to these 
deviations may not be predictive of future deviations, and request 
comment below regarding whether the rule should require ETFs to 
include a legend in proximity to the historical information warning 
of its limitations.
---------------------------------------------------------------------------

    We request comment on our proposed website disclosure requirements 
for ETFs.\312\
---------------------------------------------------------------------------

    \312\ For our specific requests for comment regarding an ETF's 
daily portfolio and basket website disclosure, see our discussions 
of those subjects, at supra sections II.C.4 and II.C.5, 
respectively.
---------------------------------------------------------------------------

    <bullet> Would the proposed website disclosures be useful in 
informing investors of certain ETF characteristics and risks? For 
example, would the disclosures alert investors to the relationship 
between NAV per share and the market price of the ETF's shares? Would 
they assist investors in understanding that they may sell or purchase 
ETF shares at prices that do not correspond to NAV per share of the ETF 
or that may reflect a premium or discount to NAV per share that is not 
in line with the typical premium or discount for the same ETF? Would 
they assist investors in assessing costs associated with premiums and 
discounts and/or bid-ask spreads? Would the proposed requirements 
promote the goals of enhancing transparency and encouraging market 
discipline on ETFs? Understanding that ETF investors would be required 
to access each ETF's website, would this information allow investors to 
compare data across ETFs? Should we require ETFs to present their 
disclosures in a structured format on their websites or in a filing 
with the Commission in order to facilitate comparisons among ETFs?
    <bullet> To what extent would the proposed website disclosure 
requirements increase ETFs' costs or result in operational challenges?
    <bullet> Should we require that information regarding NAV per 
share, market price, and premiums and discounts be posted on an ETF's 
website each business day as proposed? Should we specify the time by 
which such information must be posted? For example, should we require 
that an ETF post the information on its website before the opening of 
trading each business day?
    <bullet> Should we define ``market price'' as proposed? Does the 
proposed definition provide ETFs with too much discretion in 
determining market price? Should we define market price using only the 
``official closing price''? Is there an alternative price that we 
should require instead of ``official closing price'' that would more 
accurately reflect the ETF's share price at market close? Should we 
provide an alternative calculation of market price, by using the 
midpoint of the NBBO, as proposed? Is the midpoint of the NBBO an 
appropriate alternative? If not, what method is appropriate? Do ETFs 
and their service providers currently receive the NBBO for their 
securities? If not, what are the additional costs, if any, of receiving 
a NBBO quote? Should we require ETFs to disclose if, for example, they 
use the midpoint of the NBBO rather than the official closing price? 
Should we define an alternative closing price? For example, should we 
use a definition similar to the one used by NYSE ARCA? \313\ 
Alternatively, should we adopt the definition of ``market price'' 
currently used in Form N-1A, which may provide even more discretion by 
not referencing the midpoint? What definition of market price would 
provide the most accurate presentation of market value? Would there be 
investor confusion because of the proposed change?
---------------------------------------------------------------------------

    \313\ See NYSE Arca Rule 1.1(ll) (defining how official closing 
price is determined if the exchange does not conduct a closing 
auction or if a closing auction trade is less than a round lot); see 
also Securities Exchange Act Release No. 82907 (March 20, 2018) [83 
FR 12980 (March 26, 2018)] (order).
---------------------------------------------------------------------------

    <bullet> Does calculating premiums and discounts using market close 
information provide investors with information they would use?
    <bullet> Should we instead require a calculation and disclosure of 
an intra-day premium or discount as compared to the next-calculated 
NAV? How would investors use the disclosure of intraday deviations 
between market prices and the next-calculated NAV? Would such 
disclosure be costly and/or burdensome to produce? What calculation 
methodology should we require for this disclosure? For example, should 
we require ETFs to disclose information regarding the difference 
between: (i) The mean or median of execution prices on a business day; 
and (ii) the next-calculated NAV per share, in order to capture 
situations where deviations between market price and NAV per share 
significantly widened during the trading day, but were tightly 
correlated at the time as of which NAV is calculated? Alternatively, 
should we require ETFs to disclose information regarding the difference 
between: (i) The midpoint of the NBBO calculated every minute; and (ii) 
the next-calculated NAV? If so, should the midpoint of the NBBO be 
calculated more or less frequently? Are there other ways to calculate 
intraday market prices that would provide investors with meaningful 
information regarding intraday deviations between market price and NAV 
per share? If we require this type of disclosure, should it be in 
addition to, or an alternative of, current premium/discount 
disclosures? Alternatively, would 5th and/or 95th percentile data be 
useful in this context? How frequently should ETFs disclose

[[Page 37364]]

information regarding intraday deviations between market prices and the 
next-calculated NAV? How long should ETFs be required to maintain this 
information on their website?
    <bullet> Should we instead require calculation and disclosure of an 
intra-day premium or discount as compared to the contemporaneous value 
of the ETF's portfolio? How would investors use the disclosure of 
intraday deviations between market price and the contemporaneous value 
of the ETF's portfolio? Would such disclosure be costly and/or 
burdensome to produce? What calculation methodology should we require 
for this disclosure? For example, despite the limitations of the IIV in 
the context of arbitrage activity, could the IIV be useful for the 
measurement and long-term tracking of an ETF's intraday market prices? 
If so, should we prescribe a uniform methodology for the calculation of 
the IIV? Should we require ETFs to value their portfolio holdings more 
frequently for purposes of assessing any deviations between market 
prices and the ETF's portfolio holdings, such as hourly or three times 
a day? Are there other ways to value an ETF's portfolio on an intraday 
basis that we should consider? How frequently should ETFs disclose 
information regarding intraday deviations with the contemporaneous 
value of the ETF's portfolio? How long should ETFs be required to 
maintain this information on their website?
    <bullet> Alternatively, should we require ETFs to assess the 
efficiency of their arbitrage mechanism pursuant to internal 
methodologies and require ETFs to provide narrative disclosure 
regarding intraday deviations between market price and (i) NAV; (ii) 
the contemporaneous value of the ETF's portfolio; or (iii) both?
    <bullet> We are proposing to require ETFs to disclose the ETF's 
median bid-ask spread for the most recent fiscal year. How would 
investors use this information? Is the median bid-ask spread an 
appropriate metric? For example, the median bid-ask spread would not 
capture extreme events and stress periods. Should we require additional 
bid-ask spread metrics, such as average spread, high-end spread (e.g., 
95th percentile) or effective spread? \314\ If so, why is it preferable 
and how should it be calculated? Should we require ETFs to provide the 
median or mean spreads for the year?
---------------------------------------------------------------------------

    \314\ For the purposes of this comment request, we consider the 
effective spread the ``actual'' spread (i.e., the difference between 
bid and the ask). We consider the average spread to be the figure 
that takes the average bids and asks over a period of time and finds 
the difference between them. As noted in the comment request, we 
also are soliciting input on calculation methodology.
---------------------------------------------------------------------------

    <bullet> Should we require that the bid-ask spread information be 
included on both an ETF's website and in its prospectus? Would 
investors benefit from having this information in both places? Should 
we instead require it only on an ETF's website? Should the information 
be required to be updated more or less frequently than proposed? If so, 
how frequently? For example, should we require an ETF to disclose on 
its website a trailing average spread over the course of a year, 
updated daily? Are there particular categories of investors that may 
not use or have access to the internet? If so, are there alternative 
ways of communicating this information to them in a cost-effective 
manner?
    <bullet> Proposed rule 6c-11(c)(1)(iii) would require an ETF to 
post on its website a table showing the ETF's premiums and discounts 
for the most recently completed calendar year and the most recently 
completed calendar quarters of the current year. As we discussed above, 
this disclosure is a condition in many of our exemptive orders and 
required by Form N-1A. Do investors or their advisers use this 
information? Are there other forms of presenting this data that would 
be easier for investors to understand?
    <bullet> Proposed rule 6c-11(c)(1)(iv) would require an ETF to post 
on its website a line graph showing the ETF's premiums and discounts 
for the most recently completed calendar year and the most recently 
completed calendar quarters of the current year. How would investors 
and their advisers use a line graph? Are there other forms of 
presenting this data that would be easier for investors to understand?
    <bullet> Should ETFs be required to include intra-day premiums and 
discounts (calculated using one of the methodologies for which we 
request comment above) as part of the line graph? How would this 
disclosure be used by investors?
    <bullet> Should we require ETFs to provide both forms of disclosure 
(i.e., table and line graph)? Would investors use this information? 
Should we require more layered disclosure, such as an interactive tool 
where investors can enter different variables to better understand 
historical premiums and discounts?
    <bullet> Should the table and line graph cover the most recently 
completed calendar year and the most recently completed calendar 
quarters of the current year as proposed or are there other periods we 
should consider? Should the period be longer or shorter? Should we 
consider fiscal year periods instead of calendar year periods? If so, 
what period and why? How would this change impact the comparability of 
the information across ETFs? In order to give investors more 
information on market dislocations that particularly affect ETFs, 
should we also require tabular and graphic disclosure for major market 
events over past five or ten years?
    <bullet> Proposed rule 6c-11(c)(1)(v) would require any ETF whose 
premium or discount was greater than 2% for more than seven consecutive 
trading days to post that information on its website, along with a 
discussion of the factors that are reasonably believed to have 
materially contributed to the premium or discount threshold. Should we 
require this proposed disclosure? Is 2% an appropriate premium or 
discount? If not, should we consider a higher or lower threshold for 
this disclosure (e.g., 1% or 5%)? If so, why? Should we vary the 
premium or discount based on other factors, such as fund strategy, 
asset class, geographic region, or historic premium/discount for the 
class? Should we instead base the reporting threshold on a different 
statistic, such as standard deviation? Should it be based on the 
average absolute value of the premium or discount over a seven-day 
period? \315\
---------------------------------------------------------------------------

    \315\ See supra footnote 120 (describing calculation of absolute 
value).
---------------------------------------------------------------------------

    <bullet> Is the seven consecutive trading day requirement 
appropriate? Should we require a shorter or longer period of time? If 
so, what period and why? Is there a more appropriate balance between 
the magnitude (2%) and length (seven consecutive trading days) of an 
ETF's premium or discount than we have proposed (e.g., 10% for one day 
or 5% for two days)?
    <bullet> Should we permit ETFs to determine what percentage premium 
or discount threshold is appropriate and what time period to disclose, 
based on the ETF's particularized circumstances?
    <bullet> Should we require any additional measures to trigger the 
proposed rule 6c-11(c)(1)(v) disclosure requirement? Should we require 
a second measure of non-consecutive days in addition to the seven 
trading day requirement? For example, should we also require a 
disclosure of factors if the ETF's premium or discount was greater than 
2% for seven of the past 30 days?
    <bullet> We propose that ETFs posting this information be required 
to post it by the end of the trading day immediately following the day 
on which the requirement was triggered. Is this a reasonable period of 
time to post this information? Why or why not? We also propose that 
ETFs posting this

[[Page 37365]]

information be required to maintain it on their websites for at least 
one year following the first day it was posted. Should these time 
periods be shorter or longer?
    <bullet> As an alternative (or in addition) to requiring disclosure 
of this information on an ETF's website, should we require disclosure 
in an ETF's prospectus or shareholder reports? Or should we require 
that it be publicly filed on EDGAR in a different regulatory filing?
    <bullet> Would this disclosure requirement disproportionately 
affect particular types of ETFs? Would investors use this information 
in assessing ETFs, or could it lead to confusion?
    <bullet> Should we require a discussion of the factors that are 
reasonably believed to have materially contributed to the premium or 
discount? Would this requirement provide investors with useful context 
for deviations between market price and NAV per share or would ETFs 
rely on boilerplate disclosure?
    <bullet> Should we provide additional guidance or impose additional 
requirements for cases where a deviation persists for an extended 
period (i.e., much longer than seven days)?
    <bullet> In addition to the disclosures regarding instances where 
the premium or discount was greater than 2% for more than seven 
consecutive trading days, should we require that ETFs disclose other 
information relating to premiums and discounts? For example, should we 
require ETFs to disclose rolling average premium and discount for a 
prior period? If so, what period? Should we require ETFs to provide the 
greatest premium and/or discount for the previous month, quarter, or 
year? If so, what period would be most useful to investors and other 
market participants?
    <bullet> Should we require ETFs to disclose index tracking error, 
if applicable? If so, how should we define tracking error? For what 
period should we require tracking error? Where should such disclosure 
be made and how frequently?
    <bullet> Should we require ETFs to include a disclaimer indicating 
the potential limitations of historical disclosures on its website? If 
so, should the rule prescribe the legend that should be used and where 
the legend should be placed? Should we require a legend similar to the 
current performance-related disclosure legend in Form N-1A, which 
states that ``past performance . . . is not necessarily an indication 
of how the Fund will perform in the future''? \316\
---------------------------------------------------------------------------

    \316\ See Item 4(b)(2)(i) of Form N-1A.
---------------------------------------------------------------------------

    <bullet> We are proposing that ETFs provide certain disclosures on 
their websites on a daily basis. Should we require funds to provide 
these disclosures less frequently? Are there other places that funds 
should be required to report this information?
    <bullet> Should we require this information to be posted 
``prominently'' on the ETF's website? Should we provide any other 
instruction as to the presentation of this information, in order to 
highlight the information and/or lead investors efficiently to the 
information? For example, should we require that the information be 
posted on the main page of a particular ETF series? Should the 
information be accessible in no more than two clicks from the ETF 
complex's home page? Should we adopt presentation requirements that 
would aid in the comparability of this information for different ETFs? 
In particular, should we adopt presentation requirements for the 
premium/discount line graph?
    <bullet> In our discussion of the proposed amendments to Item 3 of 
Form N-1A, we are proposing an exception from the disclosure 
requirements of trading information and related costs for newly created 
ETFs with limited trading history. Should there be a similar exception 
for newly created ETFs from the website disclosure requirements of the 
ETF's NAV per share, market price, premium or discount, and bid-ask 
spreads as of the end of the prior business day? Should the exception 
apply to the requirement to disclose historical information regarding 
the ETF's premiums and discounts? Why or why not?
    <bullet> Should we require ETFs to post the proposed additional 
website disclosures in a structured format and/or to file them on EDGAR 
or make them available in another centralized repository?
7. Marketing
    Our exemptive orders and our 2008 proposal included a condition 
requiring each ETF to identify itself in any sales literature as an ETF 
that does not sell or redeem individual shares and to explain that 
investors may purchase or sell individual ETF shares through a broker 
via a national securities exchange.\317\ This condition was designed to 
help prevent investors, particularly retail investors, from confusing 
ETFs with mutual funds. Given that ETFs have been available for over 26 
years, and the market has developed a familiarity with the product, we 
no longer believe this condition is necessary. We believe that retail 
investors generally understand that, unlike mutual funds, individual 
ETF shares may be purchased and sold only on secondary markets. We 
further believe that the website and registration statement disclosures 
we are proposing provide retail investors more useful information 
regarding the exchange-traded nature and costs of ETFs.\318\ Therefore, 
we are not proposing to include such a marketing disclosure requirement 
in rule 6c-11.
---------------------------------------------------------------------------

    \317\ See 2008 ETF Proposing Release, supra footnote 3. 
Commenters who addressed this aspect of the 2008 proposal generally 
supported this condition. See ICI 2008 Comment Letter; Katten 2008 
Comment Letter; Xshares 2008 Comment Letter.
    \318\ The proposed website disclosure requirements are described 
in section II.C.6 and the proposed amendments to Form N-1A are 
described in section II.H.
---------------------------------------------------------------------------

    We request comment on this aspect of our proposal.
    <bullet> Are we correct that a condition requiring an ETF to 
identify itself in any sales literature as an ETF that does not sell or 
redeem individual shares and to explain that investors may purchase or 
sell individual ETF shares through a broker via secondary markets is no 
longer necessary? Do retail investors understand that individual ETF 
shares can be bought and sold only on secondary markets? If not, should 
proposed rule 6c-11 condition relief on the inclusion of statements in 
an ETF's sales literature regarding the purchase and sale of ETF shares 
on secondary markets? Alternatively, should we consider adding a 
disclosure requirement only to Form N-1A?
    <bullet> Should we consider other limitations regarding ETF sales 
literature?
    <bullet> If the rule includes such a condition, how should we 
define sales literature? Should we define sales literature as we 
proposed in 2008? \319\ Are there other definitions that we should 
consider, including by reference to the definition in 17 CFR 230.156 
(``rule 156'')? \320\
---------------------------------------------------------------------------

    \319\ The 2008 proposed rule, consistent with the use of the 
term in section 24(b) of the Act and the existing definition in rule 
34b-1 under the Act, would have defined the term ``sales 
literature'' as ``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.'' 
See 2008 ETF Proposing Release, supra footnote 3.
    \320\ Rule 156 under the Securities Act defines the term ``sales 
literature'' to include ``any communication (whether in writing, by 
radio, or by television) used by any person to offer to sell or 
induce the sale of securities of any investment company.'' It also 
states that communications between issuers, underwriters and dealers 
are included in the definition of sales literature if such 
communications, or the information contained therein, can be 
reasonably expected to be communicated to prospective investors in 
the offer or sale of securities or are designed to be employed in 
either written or oral form in the offer or sale of securities. See 
17 CFR 230.156(c).

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[[Page 37366]]

    <bullet> If the rule included a condition regarding sales 
literature, should it also include an exception to permit an ETF to 
disclose to investors that it will issue or redeem individual shares in 
order to consummate a reorganization, merger, conversion or 
liquidation?
    <bullet> To further prevent investors from confusing ETFs with 
mutual funds, should the rule require an ETF to include the identifier 
``ETF'' in its name?
    <bullet> To further prevent investors from confusing ETFs with 
mutual funds, should the rule require an ETF to explicitly disclose in 
its sales literature that shareholders may pay more than NAV when 
buying shares and may receive less than NAV when selling ETF shares?
    <bullet> Should the rule impose any additional conditions or 
require any additional disclosures to help investors distinguish ETFs 
from other ETPs, such as exchange-traded notes or commodity pools that 
are not subject to the Investment Company Act? Should the Commission 
consider proposing naming conventions based on these or other 
distinctions in a future rulemaking? Are naming conventions useful to 
investors? Should ETFs be required to use a different identifier (e.g., 
``IC'' for ETFs that are registered under the Investment Company Act) 
before or after ``ETF'' to distinguish them from other ETPs? Should all 
ETPs be required to have identifiers (e.g., ETF-N (for exchange-traded 
notes), ETF-IC (for ETFs that are not leveraged ETFs), ETF-C (for 
exchange-traded commodity pools), ETF-L (for leveraged ETFs))?
    <bullet> Alternatively, are there ways we could address investor 
confusion by restricting certain sales practices? For example, should 
we consider proposing restrictions in a future rulemaking on how 
intermediaries communicate with retail investors about ETPs unless they 
disclose certain information designed to clearly differentiate ETPs 
that are not registered under the Act from ETFs that are registered 
investment companies?

D. Recordkeeping

    For the reasons discussed above, authorized participants play a 
central role in the proper functioning of the ETF marketplace.\321\ One 
of the defining characteristics of authorized participants under the 
proposed rule is that they have a written agreement with an ETF or one 
of the ETF's service providers whereby the authorized participant is 
allowed to purchase or redeem creation units directly from the ETF 
(``authorized participant agreement'').\322\ Thus, these agreements are 
critical to understanding the relationship between the authorized 
participant and the ETF. While we believe that most ETFs are currently 
preserving copies of their written authorized participant agreements 
pursuant to our current recordkeeping rules, for avoidance of doubt, we 
are proposing to expressly require that ETFs relying on rule 6c-11 
preserve and maintain copies of all such agreements.\323\
---------------------------------------------------------------------------

    \321\ See supra section I.
    \322\ Proposed rule 6c-11(a) (defining ``authorized 
participant'').
    \323\ See proposed rule 6c-11(d)(1).
---------------------------------------------------------------------------

    This requirement is designed to provide our examination staff with 
a basis to determine whether the relationship between the ETF and the 
authorized participant is in compliance with the requirements of 
proposed rule 6c-11 and other provisions of the Act and rules 
thereunder, based on the specific terms of their written agreement, 
including, but not limited to, terms related to postponement of 
redemptions and transaction fees. We did not include a specific 
preservation requirement for authorized participant agreements in the 
2008 proposal.\324\ However, Commission staff's experience with the ETF 
industry since 2008, including our examination staff's experience, has 
reinforced our belief that authorized participant agreements must be 
preserved.
---------------------------------------------------------------------------

    \324\ See 2008 ETF Proposing Release, supra footnote 3. Our 
orders also do not include a specific preservation requirement. See, 
e.g., Salt Financial, supra footnote 270.
---------------------------------------------------------------------------

    We are also proposing to require ETFs to maintain information 
regarding the baskets exchanged with authorized participants. In 
particular, the proposed rule would require an ETF to maintain records 
setting forth the following information for each basket exchanged with 
an authorized participant: (i) The names and quantities of the 
positions composing the basket; (ii) identification of the basket as a 
``custom basket'' and a record stating that the custom basket complies 
with the ETF's custom basket policies and procedures (if applicable); 
(iii) cash balancing amounts (if any); and (iv) the identity of the 
authorized participant conducting the transaction.\325\ These records 
would provide our examination staff with a basis to understand how 
baskets are being used by ETFs, as well as to evaluate compliance with 
the rule and other provisions of the Act and rules thereunder. In 
particular, we believe these records would allow our examination staff 
to evaluate whether the use of custom baskets is appropriate.
---------------------------------------------------------------------------

    \325\ See proposed rule 6c-11(d)(2).
---------------------------------------------------------------------------

    ETFs would be required to maintain these records for at least five 
years, the first two years in an easily accessible place. The retention 
period is consistent with the period provided in rules 22e-4 and 38a-
1(d) under the Act. Funds currently have compliance program-related 
recordkeeping procedures in place that incorporates this type of 
retention period, and we preliminarily believe consistency with that 
period would minimize any compliance burden to funds.
    We request comment on these proposed recordkeeping requirements.
    <bullet> Are these requirements necessary in light of the benefits 
that would result from Commission examination? Are there other records 
that we should require ETFs to preserve or other feasible alternatives 
that would minimize recordkeeping burdens? What are the costs 
associated with maintaining the proposed recordkeeping requirements 
under the rule and what effects would the proposed recordkeeping 
requirements have on an ETF's compliance policies and procedures?
    <bullet> Do ETFs already preserve their agreements with authorized 
participants under our current recordkeeping requirements?
    <bullet> Should we require an ETF to maintain a record stating that 
the custom basket complies with the ETF's custom basket policies and 
procedures? Is there any additional information that we should require 
ETFs to maintain in connection with their baskets? Should we require 
ETFs to record information regarding any transaction fees assessed in 
connection with each basket? Are there alternatives to this proposed 
recordkeeping requirement that would enable the Commission to examine 
the composition of ETFs' baskets, while minimizing the recordkeeping 
burdens imposed on ETFs?
    <bullet> Are there other records we should consider requiring ETFs 
to maintain regarding transaction fees? \326\ Should we consider 
requiring ETFs to disclose information regarding transaction fees

[[Page 37367]]

in their registration statement or on Form N-CEN? For example, should 
ETFs be required to describe transaction fees and the amount of such 
fees that are charged in connection with effecting purchases and 
redemptions of creation units? Should there be disclosure about the 
aggregate dollar amount or percentage of transaction fees paid over 
particular periods? Should we require ETFs to disclose the dollar 
amount (or percentage) of transaction fees waived over a particular 
periods? If so, how should this information be presented? Should we 
require ETFs to include narrative disclosure regarding waivers, noting 
for example, that the waiver of transaction fees may result in 
additional costs borne by the ETF?
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    \326\ We understand transaction fees are imposed by ETFs to 
defray the transaction expenses associated with the creation or 
redemption, as applicable, and prevent possible dilution resulting 
from the purchase or redemption of creation units. For cash baskets, 
the ETF may assess transaction fees to offset certain operational, 
brokerage and spread costs relating to the ETF's purchasing or 
selling of securities. Transaction fees can impact secondary market 
investors in ETF shares because an authorized participant or other 
market maker can cause the spread to widen on ETF shares to recoup 
or offset some of the costs from paying the transaction fees.
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    <bullet> Should we require ETFs to maintain these records for five 
years, the first two years in an easily accessible place, as proposed? 
Should we use a different retention period, such as the six-year 
retention period under 17 CFR 270.31a-2 (rule 31a-2 under the Act)?
    <bullet> Would compliance with these proposed requirements have any 
effect on ETFs' internal compliance policies and procedures?
    <bullet> Should we instead, or additionally, require that ETFs file 
their authorized participant agreements as exhibits to their 
registration statements? Why or why not?
    <bullet> Are there any additional alternative recordkeeping 
requirements we should consider?

E. Share Class ETFs

    The proposed rule does not provide any relief from sections 
18(f)(1) or 18(i) of the Act or expand the scope of 17 CFR 270.18f-3 
(``rule 18f-3'' under the Act) (the multiple class rule).\327\ Sections 
18(f) and (i) of the Act were intended, in large part, to protect 
investors from certain abuses associated with complex investment 
company capital structures, including conflicts of interest among a 
fund's share classes.\328\ These provisions also were designed to 
address certain inequitable and discriminatory shareholder voting 
provisions that were associated with many investment company securities 
before the enactment of the Act.\329\
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    \327\ See 15 U.S.C. 80a-18(f)(1) and (i); 17 CFR 270.18f-3. 
Section 18(f)(1) of the Act generally prohibits a fund from issuing 
a class of ``senior security,'' which is defined in section 18(g) to 
include any stock of a class having priority over any other class as 
to distribution of assets or payment of dividends. See 15 U.S.C. 
80a-18(g). Section 18(i) of the Act provides that all shares of 
stock issued by a fund must have equal voting rights.
    \328\ See Exemption for Open-End Management Investment Companies 
Issuing Multiple Classes of Shares, Investment Company Act Release 
No.19955 (Dec. 15, 1993) [58 FR 68074 (Dec. 23, 1993)] (proposing 
release), at nn.20 and 21 and accompanying text.
    \329\ See id.
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    In 1995, the Commission adopted rule 18f-3 under the Act to create 
a limited exemption from sections 18(f)(1) and 18(i) for funds that 
issue multiple classes of shares with varying arrangements for the 
distribution of securities and provision of services to 
shareholders.\330\ That rule generally provides that, notwithstanding 
sections 18(f)(1) and 18(i) of the Act, a registered open-end 
management investment company or series or class thereof may issue more 
than one class of voting stock, provided that each class, among other 
requirements, has in all other respects the same rights and obligations 
as each other class.\331\
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    \330\ See Exemption for Open-End Management Investment Companies 
Issuing Multiple Classes of Shares, Investment Company Act Release 
No. 20915 (Feb. 23, 1995) [60 FR 11876 (Mar. 2, 1995)] (adopting 
release) (``Multiple Class Adopting Release''), at n.8 and 
accompanying text.
    \331\ See 17 CFR 270.18f-3(a)(4).
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    An ETF cannot rely on rule 18f-3 to operate as a share class within 
a fund because the rights and obligations of the ETF shareholders would 
differ from those of investors in the fund's mutual fund share classes. 
For example, ETF shares would be redeemable only in creation units, 
while the investors in the fund's mutual fund share classes would be 
individually redeemable. Similarly, ETF shares are tradeable on the 
secondary market, whereas mutual fund shares classes would not be 
traded.
    An ETF structured as a share class of a fund that issues multiple 
classes of shares representing interests in the same portfolio would 
not be permitted to rely on proposed rule 6c-11. We recognize that the 
Commission has granted ETFs exemptive relief from the aforementioned 
provisions of section 18 of the Act in the past, subject to various 
conditions.\332\ However, relief from section 18 raises policy 
considerations that are different from those we seek to address in this 
rule, which is intended to address broadly the common type of relief 
that most ETFs have sought.
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    \332\ See Vanguard Index Funds, et al., Investment Company Act 
Release Nos. 24680 (Oct. 6, 2000) [65 FR 61005 (Oct. 13, 2000)] 
(notice) and 24789 (Dec. 12, 2000) (order) and related application; 
Vanguard Index Funds, et al., Investment Company Act Release Nos. 
26282 (Dec. 2, 2003) [68 FR 68430 (Dec. 8, 2003)] (notice) and 26317 
(Dec. 29, 2003) (order) and related application; Vanguard 
International Equity Index Funds, et al., Investment Company Act 
Release Nos. 26246 (Nov. 3, 2003) [68 FR 63135 (Nov. 7, 2003)] 
(notice) and 26281 (Dec. 1, 2003) (order) and related application; 
Vanguard Bond Index Funds, et. al., Investment Company Act Release 
Nos. 27750 (Mar. 9, 2007) [72 FR 12227 (Mar. 15, 2007)] (notice) and 
27773 (Apr. 25, 2007) (order) and related application (collectively, 
the ``Vanguard orders'').
---------------------------------------------------------------------------

    For example, an ETF share class that transacts with authorized 
participants on an in-kind basis and a mutual fund share class that 
transacts with shareholders on a cash basis may give rise to differing 
costs to the portfolio. As a result, while certain of these costs may 
result from the features of one share class or another, all 
shareholders would generally bear these portfolio costs.\333\ At the 
same time, the share class structure also can provide benefits to each 
share class, including economies of scale. Given these additional 
policy considerations, we believe it is appropriate for ETFs to 
continue to request relief from sections 18(f)(1) and 18(i) of the Act 
through our exemptive application process, and for the Commission to 
continue to weigh these policy considerations in the context of the 
facts and circumstances of each particular applicant.
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    \333\ These costs can include brokerage and other costs 
associated with buying and selling portfolio securities in response 
to mutual fund share class cash inflows and outflows, cash drag 
associated with holding the cash necessary to satisfy mutual fund 
share class redemptions, and distributable capital gains associated 
with portfolio transactions.
---------------------------------------------------------------------------

    We request comment on this aspect of the proposal.
    <bullet> Should proposed rule 6c-11 include exemptions from 
sections 18(f)(1) or 18(i) of the Act, or should we expand the scope of 
rule 18f-3 under the Act? Why or why not?
    <bullet> If commenters believe that such exemptions should be 
included in the proposed rule, should the rule include conditions 
designed to take into account the potential costs and benefits of a 
fund with both mutual fund and ETF share classes? If so, what 
conditions? Are we correct in our preliminary belief that combining an 
ETF share class with traditional share classes of a mutual fund may, in 
certain circumstances, result in the costs and benefits described 
above?

F. Master-Feeder ETFs

    Many of our recent ETF orders contain relief allowing ETFs to 
operate as feeder funds in a master-feeder structure.\334\ In general, 
an ETF that operates as a feeder fund in a master-feeder structure 
functions like any other ETF. An authorized participant deposits a 
basket with the ETF and receives a

[[Page 37368]]

creation unit of ETF shares in return for those assets. Conversely, an 
authorized participant that redeems a creation unit of ETF shares 
receives a basket from the ETF. In a master-feeder arrangement, 
however, the feeder ETF then also enters into a corresponding 
transaction with its master fund. The ETF may use the basket assets it 
receives from an authorized participant to purchase additional shares 
of the master fund, or it may redeem shares of the master fund in order 
to obtain basket assets and satisfy a redemption request.
---------------------------------------------------------------------------

    \334\ See, e.g., T. Rowe Price Associates, Inc., et al., 
Investment Company Act Release Nos. 30299 (Dec. 7, 2012) [77 FR 
74237 (Dec. 13, 2012)] (notice) and 30336 (Jan. 2, 2013) (order) and 
related application; SSgA Funds Management, Inc., et al., Investment 
Company Act Release Nos. 29499 (Nov. 17, 2010) [75 FR 71753 (Nov. 
24, 2010)] (notice) and 29524 (Dec. 13, 2010) (order) and related 
application (``SSgA'').
---------------------------------------------------------------------------

    Because the feeder ETF may, in the course of these transactions, 
temporarily hold the basket assets, it would not be able to rely on 
section 12(d)(1)(E) of the Act, which requires that a feeder fund hold 
no investment securities other than securities of the master fund.\335\ 
To accommodate these unique operational characteristics of ETFs, our 
recent exemptive orders have allowed a feeder ETF to rely on section 
12(d)(1)(E) without complying with section 12(d)(1)(E)(ii) of the Act 
to the extent that the ETF temporarily holds investment securities 
other than the master fund's shares for use as basket assets. These 
orders also provided the feeder ETF and its master fund with relief 
from sections 17(a)(1) and 17(a)(2) of the Act, with regard to the 
deposit by the feeder ETF with the master fund and the receipt by the 
feeder ETF from the master fund of basket assets in connection with the 
issuance or redemption of creation units,\336\ and section 22(e) of the 
Act if the feeder ETF includes a foreign security in its basket assets 
and a foreign holiday (or a series of consecutive holidays) prevents 
timely delivery of the foreign security.\337\
---------------------------------------------------------------------------

    \335\ Section 12(d)(1) of the Act limits the ability of a fund 
to invest substantially in shares of another fund. See sections 
12(d)(1)(A)-(C) of the Act; see also infra footnote 344. Section 
12(d)(1)(E) of the Act allows an investment company to invest all of 
its assets in one other fund so that the acquiring fund is, in 
effect, a conduit through which investors may access the acquired 
fund. See section 12(d)(1)(E)(ii) of the Act.
    \336\ Relief from the affiliated transaction prohibitions in 
sections 17(a)(1) and 17(a)(2) of the Act is necessary because these 
sections would otherwise prohibit the feeder ETF and its master fund 
from selling to or buying from each other the basket assets in 
exchange for securities of the master fund. See 15 U.S.C. 80a-
17(a)(1)-(2).
    \337\ See 15 U.S.C. 80a-22(e) (generally requiring the 
satisfaction of redemptions within seven days). See also supra 
section III.B.4.
---------------------------------------------------------------------------

    The exemptive orders we have granted to master-feeder ETFs, 
however, do not include relief from section 18 under the Act inasmuch 
as investment by several feeder funds or by mutual fund and ETF feeder 
funds in the same class of securities issued by a master fund generally 
do not involve a senior security subject to section 18. We are 
concerned, as discussed above, that if an ETF feeder fund transacts 
with a master fund on an in-kind basis, but non-ETF feeder funds 
transact with the master fund on a cash basis, all feeder fund 
shareholders would bear costs associated with the cash 
transactions.\338\
---------------------------------------------------------------------------

    \338\ See supra footnote 333 and accompanying text.
---------------------------------------------------------------------------

    We understand that while many orders contain this relief, only one 
fund complex has established master-feeder arrangements involving ETF 
feeder funds, and each arrangement involves an ETF as the sole feeder 
fund.\339\ Given the lack of interest in this structure and our 
concerns noted above, we are proposing to rescind the master-feeder 
relief granted to ETFs that do not rely on the relief as of the date of 
this proposal (June 28, 2018).\340\ However, we also propose to 
grandfather existing master-feeder arrangements involving ETF feeder 
funds, but prevent the formation of new ones, by amending relevant 
exemptive orders.\341\ Because these existing master-feeder ETFs 
involve only one feeder fund for each master fund, we do not believe 
they would raise the policy concerns discussed above so long as they do 
not add feeders, and therefore do not believe it is necessary to 
require these structures to change their existing investment 
practices.\342\
---------------------------------------------------------------------------

    \339\ See, e.g., SSGA Active Trust Prospectus (Oct. 31, 2017), 
available at https://us.spdrs.com/public/SPDR_ACTIVE%20ETF%20TRUST_PROSPECTUS.pdf.
    \340\ See infra section II.G.
    \341\ Based on staff analysis, we preliminarily believe that the 
fund complex currently utilizing this relief operates nine master-
fund arrangements, each involving only one ETF as the sole feeder 
fund. See SSgA, supra footnote 334.
    \342\ Rescinding the relief for existing master-feeder ETFs 
would require them to change the manner in which they invest. For 
example, transactions between each of the affected master funds and 
its corresponding feeder fund could be transacted in cash, rather 
than in-kind, obviating any need for exemptive relief for the feeder 
fund to hold securities other than those issued by the master fund. 
Alternatively, the feeder funds could opt to pursue their investment 
objectives through direct investments in securities and/or other 
financial instruments, rather than through investments in master 
funds.
---------------------------------------------------------------------------

    We request comment on the lack of master-feeder relief in proposed 
rule 6c-11.
    <bullet> Are we correct that the market interest for ETFs using 
master-feeder structures, as discussed above, is limited?
    <bullet> Should the proposed rule include master-feeder relief for 
ETFs, as provided in certain of our exemptive orders and discussed 
above? Why or why not?
    <bullet> Should we amend the exemptive relief relied upon by 
existing master-feeder arrangements? Alternatively, should we also 
rescind the master-feeder relief relied upon by existing arrangements? 
If so, how would these ETFs be impacted if we also rescinded their 
relief?
    <bullet> If the proposed rule provided master-feeder relief for 
master-feeder structures that include ETF and mutual fund feeder funds, 
should the rule include conditions designed to take into account the 
potential costs and benefits of such structures? If so, what 
conditions? For example, should the proposed rule require a 
determination that the investment in a master fund is in the best 
interest of the ETF and its shareholders? If so, who should be required 
to make such a determination? How frequently should such a 
determination be made? Alternatively, should the proposed rule provide 
master-feeder relief for master-feeder structures but allow only ETF 
feeder funds? If so, what conditions should apply?

G. Effect of Proposed Rule 6c-11 on Prior Orders

    The Commission has authority under the Act to amend or rescind our 
orders when necessary or appropriate to the exercise of the powers 
conferred elsewhere in the Act. Pursuant to this authority, we are 
proposing to amend and rescind the exemptive relief we have issued to 
ETFs that would be permitted to rely on the proposed rule.\343\ Our 
proposed rescission of orders would specifically be limited to the 
portions of an ETF's exemptive order that grant relief related to the 
formation and operation of an ETF and, with the exception of certain 
master-feeder relief discussed above in section II.F, would not rescind 
the relief from section 12(d)(1) \344\ and sections 17(a)(1) and (a)(2) 
\345\ under the Act related to

[[Page 37369]]

fund of funds arrangements involving ETFs.\346\
---------------------------------------------------------------------------

    \343\ See section 38(a) of the Act, 15 U.S.C. 80a-37(a).
    \344\ Section 12(d)(1) generally limits the ability of 
registered investment companies (including ETFs) to acquire 
securities issued by other investment companies in excess of certain 
thresholds, and the ability of registered open-end investment 
companies (including ETFs) from knowingly selling securities to 
other investment companies in excess of certain thresholds. The 
conditions set forth in ETF exemptive applications for relief 
necessary to create a fund of funds structure is generally designed 
to prevent the abuses that led Congress to enact section 12(d)(1), 
including abuses associated with undue influence and control by 
acquiring fund shareholders, the payment of duplicative or excessive 
fees, and the creation of complex structures. See Salt Financial, 
supra footnote 270. We also note that certain standalone exemptive 
orders, unrelated to ETF operations, are often granted to applicants 
to permit investments in ETFs beyond the limits in section 12(d)(1) 
of the Act; we are not proposing to rescind such exemptive orders.
    \345\ See supra section II.B.3.
    \346\ ETF exemptive relief typically segregates exemptive relief 
from section 17(a) under the Act necessary to create a fund of funds 
structure from section 17(a) exemptive relief necessary for the 
operation of the ETFs. This segregation of ``Fund of Funds Relief'' 
and ``ETF Relief'' appears in numerous representations and 
enumerated conditions set forth in applications for exemptive 
relief. See, e.g., Salt Financial, supra footnote 270.
---------------------------------------------------------------------------

    The terms of the exemptive relief granted to ETFs have evolved over 
time and have resulted in an uneven playing field among ETF complexes, 
subjecting ETFs that pursue the same or similar investment strategies 
to different operational requirements. Moreover, many ETF complexes 
have multiple exemptive orders permitting them to operate ETFs. Some of 
those orders contain different conditions for relief and different 
representations by the applicants regarding how the ETFs formed 
pursuant to the order would operate. Many of those orders also provide 
relief for future ETFs created pursuant to the terms of a particular 
exemptive order.\347\ As a result, ETF complexes with multiple orders 
can effectively choose the exemptive relief that would be applicable to 
a new ETF by selecting what legal entity should form the new ETF 
series. Moreover, differences in the terms of our various orders have 
had varying impact on the structure and costs of an ETF. For example, 
shares of an ETF with a less flexible basket condition in its order 
could have wider spreads than a similarly situated ETF with more 
flexible basket compositions. However, investors may not be able to 
discern the difference between these two ETFs' orders. As we have 
stated elsewhere in this release, among our goals in proposing rule 6c-
11 is to create a consistent, transparent and efficient regulatory 
framework for many ETFs. We do not believe this goal would be furthered 
if ETFs that could rely on the rule continue to rely on those orders.
---------------------------------------------------------------------------

    \347\ See supra footnote 12.
---------------------------------------------------------------------------

    In addition, we began including a condition in our ETF exemptive 
orders in 2008 stating that the relief permitting the operation of ETFs 
would expire on the effective date of any Commission rule that provides 
relief permitting the operation of ETFs.\348\ The purpose of this 
automatic expiration condition was to better establish equal footing 
between ETFs that have received exemptive relief and ETFs that may rely 
solely on a Commission rule, and to reduce competitive advantages that 
could potentially arise out of the conditions for relief set forth in 
our earlier exemptive orders.\349\ Of the approximately 300 orders we 
have issued that provide ETF exemptive relief, approximately 200 
include this automatic expiration condition, and thus the ETF relief 
would terminate if and when proposed rule 6c-11 is adopted and goes 
into effect. To provide time for ETFs to transition to rule 6c-11, 
however, we propose to amend these existing orders to provide that the 
ETF relief contained in those orders will terminate one year following 
the effective date of any final rule. Absent this modification or our 
determining to delay the effectiveness of any final rule 6c-11, the ETF 
relief included in orders with the automatic expiration provision could 
expire before ETFs were able to make any adjustments necessary to rely 
on rule 6c-11.
---------------------------------------------------------------------------

    \348\ See e.g., PowerShares, supra footnote 188; Javelin 
Exchange-Traded Trust, Investment Company Act Release Nos. 28350 
(July 31, 2008) [73 FR 46066 Aug. 7, 2008)] (notice) and 28637 (Aug. 
26, 2008) (order) and related application. In some cases, the 
automatic expiration condition applies to the ETF-related relief 
only, and expressly does not apply to certain other exemptive relief 
requested, such as master-feeder and ``fund of funds'' relief under 
section 12 of the Act. See, e.g., Fidelity Merrimack Street Trust, 
et al., Investment Company Act Release Nos. 30464 (Apr. 16, 2013) 
[78 FR 23793 (Apr. 22, 2013)] (notice) and 30513 (May 10, 2013) 
(order) and related application (``The requested relief, other than 
the Fund of Funds Relief and the Section 17 relief related to a 
master-feeder structure, will expire on the effective date of any 
Commission rule under the Act that provides relief permitting the 
operation of actively managed exchange traded funds.'').
    \349\ See 2008 ETF Proposing Release, supra footnote 3.
---------------------------------------------------------------------------

    We believe that rescinding ETF exemptive relief in connection with 
the proposed rule (and amending those orders that require ETF exemptive 
relief to automatically expire in order to allow a transitional period 
to any final rule) would result in a more transparent framework for 
covered ETFs, as those ETFs would no longer be subject to differing and 
sometimes inconsistent provisions of their exemptive relief. The relief 
and related conditions proposed under rule 6c-11, moreover, are largely 
consistent with our recent orders, and in some cases, provide ETFs with 
additional flexibility. For example, proposed rule 6c-11 would provide 
many ETFs with additional basket flexibility beyond what is currently 
permitted by their exemptive orders.\350\ We preliminarily believe, 
therefore, that the operations of most existing ETFs would not be 
significantly negatively affected by the need to comply with the 
requirements of rule 6c-11 as opposed to their exemptive relief. 
However, in order to limit any hardship that revocation of existing 
exemptive relief would have on current ETFs with orders that do not 
automatically expire, we are proposing a one-year period after the 
effective date before we rescind that exemptive relief to give those 
ETFs time to bring their operations into conformity with the 
requirements of proposed rule 6c-11.
---------------------------------------------------------------------------

    \350\ See proposed rule 6c-11(c)(3); see also supra section 
II.C.5. We note that a subset of the ETFs operating under exemptive 
relief has basket flexibility that would not be broadened by the 
proposed rule. Under the proposed rule, however, such ETFs would be 
required to adopt and implement written policies and procedures 
related to the construction of baskets and the process for the 
acceptance of baskets by the ETF.
---------------------------------------------------------------------------

    We do not propose to rescind the exemptive relief of ETFs that 
would not be permitted to rely on the proposed rule. Specifically, we 
do not propose to rescind the exemptive relief for ETFs organized as 
UITs,\351\ ETFs that are organized as a share class of a fund,\352\ or 
leveraged ETFs.\353\ We believe it is appropriate for ETFs seeking to 
utilize these structures to continue to request relief from the 
Commission through our exemptive application process, and for the 
Commission to continue to make facts-and-circumstances-based 
determinations regarding whether such relief is appropriate for any 
particular applicant.
---------------------------------------------------------------------------

    \351\ See discussion of ETFs organized as UITs, supra section 
II.A.1.
    \352\ See Vanguard orders, supra footnote 332.
    \353\ See discussion of leveraged ETFs, supra section II.A.3.
---------------------------------------------------------------------------

    The Commission does not believe that it is necessary to give 
individual hearings to the holders of the prior exemptive relief or to 
any other person. Proposed rule 6c-11 would be prospective in effect 
and is intended to set forth for covered ETFs the Commission's 
exemptive standards for ETFs organized as open-end funds. Recipients of 
existing exemptive relief may make their views known in the context of 
the comment process that accompanies this rulemaking, and those views 
will be given due consideration. Finally, investment companies would be 
able to request Commission approval to operate as an ETF under 
conditions that differ from those in proposed rule 6c-11.
    We request comment on our proposal to revoke existing ETF and 
certain existing master-feeder exemptive relief.
    <bullet> Should we revoke some or all of the existing ETF exemptive 
relief? If not, why not? Would allowing existing exemptive relief to 
continue create an unequal playing field for ETF market participants? 
If not, why not?
    <bullet> As discussed above, we are proposing a one year period 
before rescinding existing ETF exemptive relief. Is the one year period 
appropriate for ETFs with existing ETF exemptive

[[Page 37370]]

relief to bring their funds into compliance with rule 6c-11? If not, 
how long should this period last? Why? We are proposing to implement 
this one year period, in part, by amending existing orders with an 
automatic expiration condition to provide that the ETF exemptive relief 
contained in these orders would terminate one year following the 
effective date of any final rule. Should we, instead, delay the 
effectiveness of rule 6c-11 for one year? Are there different 
approaches we should consider?
    <bullet> Should we consider rescinding the exemptive relief for 
ETFs organized as UITs or ETFs organized as a share class of a fund and 
instead allow such ETFs to be covered by rule 6c-11? If so, how would 
such ETFs comply with the requirements of the rule? For example, would 
they have to restructure or liquidate?
    <bullet> Should we, as proposed, rescind the exemptive relief that 
we have previously granted that allows ETFs to operate as feeder funds 
in a master-feeder structure if they do not rely on the relief as of 
the date of this proposal? Do funds plan to use this relief in the 
future? If so, what kind of ETF master-feeder structures do funds 
envision creating? For what purpose?
    <bullet> We understand that the existing structures are organized 
with an ETF as the sole feeder fund. Is this understanding correct? 
Should we amend the exemptive relief applicable to these funds as 
proposed?
    <bullet> Would our proposal to rescind certain of our previously 
issued ETF exemptive relief, and allow the ETF exemptive relief 
contained in the orders with automatic expiration provisions to expire 
one year following the effective date of rule 6c-11, eliminate any 
competitive advantages arising from the relief we have granted via 
exemptive order?
    <bullet> Would existing ETFs face significant challenges in 
complying with the conditions of rule 6c-11 rather than exemptive 
relief?
    <bullet> Should we consider other approaches? For example, should 
we consider rescinding only ETF exemptive relief previously granted to 
ETF complexes that have multiple exemptive orders permitting them to 
operate ETFs?
    <bullet> Should we consider not rescinding any of the approximately 
100 pre-2008 orders that do not include the automatic expiration 
provision? Should we consider amending the orders that contain the 
automatic expiration provision of the ETF exemptive relief to remove 
that provision? Under these approaches, in which certain ETF exemptive 
orders would be left in place, ETFs would continue operating under 
different sets of conditions. Would permitting ETFs to operate under 
different sets of conditions have an adverse effect on competition and 
capital formation?
    <bullet> Are there other approaches to the existing ETF exemptive 
relief that we should consider in view of proposed rule 6c-11?
    <bullet> Exemptive relief granted prior to 2009 generally includes 
relief from section 24(d) of the Act to exempt broker-dealers selling 
ETF shares from the obligation to deliver prospectuses in most 
secondary market transactions, and the rescission of the ETF exemptive 
relief from those orders would eliminate this relief. We understand, 
however, that broker-dealers have not relied upon this relief and, 
subsequent to the adoption of amendments to rule 498 under the 
Securities Act permitting the delivery of an ETF's summary prospectus, 
most market participants use the summary prospectus to satisfy 
prospectus delivery obligations.\354\ Are we correct in our 
understanding? Should we provide relief from section 24(d) for ETFs 
that have this relief in their exemptive orders if we were to rescind 
those orders? If so, why?
---------------------------------------------------------------------------

    \354\ See rule 498 under the Securities Act [17 CFR 230.498].
---------------------------------------------------------------------------

H. Amendments to Form N-1A

    As discussed above in section II.C.6, because of the exchange-
traded nature of ETFs, ETF investors may be subject to different costs 
than mutual fund investors. For example, while an ETF may, in some 
cases, have a lower expense ratio than a comparable mutual fund, an ETF 
investor will be subject to certain unique costs associated 
specifically with ETFs, such as the bid-ask spread and premiums and 
discounts from the ETF's NAV. As a result of these differences, ETF 
investors may not be fully aware of the full costs associated with 
their investment in an ETF.
    We therefore are proposing several amendments to Form N-1A, the 
registration form used by open-end funds to register under the Act and 
to offer their securities under the Securities Act. The proposed 
amendments are designed to provide investors who purchase ETF shares in 
secondary market transactions with additional information regarding 
ETFs, including information regarding costs associated with an 
investment in ETFs. The proposal also would eliminate certain 
disclosures that would be duplicative of the proposed amendments to 
Item 3 of Form N-1A regarding the exchange-traded nature of ETFs. 
Finally, we are requesting comment on whether we should create a new 
ETF-specific registration form.
1. Definitions
    We are proposing several amendments to Form N-1A to reflect the 
adoption of proposed rule 6c-11.\355\ First, we are proposing to amend 
the definition of ``Exchange-Traded Fund'' in Form N-1A to add a 
specific reference to proposed rule 6c-11.\356\ Currently, Form N-1A 
defines ``Exchange-Traded Fund'' to include a fund or class that has 
formed and operates in reliance on an exemptive rule adopted by the 
Commission.\357\ We believe that Form N-1A should make specific 
reference to proposed rule 6c-11, rather than a generic exemptive rule, 
and that this change would be consistent with Form N-1A's general 
approach of referring specifically to exemptive rules in other defined 
terms.
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    \355\ All of the definitions discussed in this section would 
appear in Proposed General Instruction A of Form N-1A.
    \356\ Specifically, the proposed definition of ``exchange-traded 
fund'' would be a fund or class, the shares of which are listed and 
traded on a national securities exchange, and that has formed and 
operates under an exemptive order granted by the Commission or in 
reliance on rule 6c-11 under the Act.
    \357\ General Instruction A to Form N-1A.
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    Second, we propose to remove the defined term ``Market Price'' from 
the Definitions section of Form N-1A in light of our other proposed 
changes to Form N-1A. Market Price, as presently defined in Form N-1A, 
is used in several items that we are proposing to eliminate from the 
Form.\358\ The remaining instances in which ``Market Price'' is used do 
not require the use of a defined term, as they contemplate a more 
general use of the term, such as the requirement in Item 11 of Form N-
1A that an ETF explain in its prospectus that the price of its shares 
is based on Market Price.\359\ Accordingly, given our proposed changes 
to Form N-1A, we do not believe it is necessary to include ``Market 
Price'' as a defined term, and propose to remove this definition from 
the Form.
---------------------------------------------------------------------------

    \358\ See, e.g., proposed changes to Item 3 of Form N-1A.
    \359\ Item 11(a)(1) of Form N-1A. Also, in addition to the 
defined term ``Market Price,'' Form N-1A currently uses the 
undefined term ``market price'' in several instances where a more 
general use of the term is appropriate. See, e.g., Instruction 3 to 
Item 11(g) of Form N-1A. Our proposed amendments to the Form also 
include the use of the undefined term ``market price.'' See, e.g., 
proposed changes to Item 3 of Form N-1A.
---------------------------------------------------------------------------

    We request comment on the proposal to amend the definition section 
of Form N-1A.
    <bullet> Should we, as proposed, revise the definition of the term 
``Exchange-Traded

[[Page 37371]]

Fund'' in Form N-1A to make specific reference to proposed rule 6c-11?
    <bullet> Should we, as proposed, remove the defined term ``Market 
Price'' from the Definitions section of the General Instruction to Form 
N-1A? Alternatively, should we replace the current definition with a 
reference to the defined term ``Market price,'' as defined in proposed 
rule 6c-11?
2. Item 3 of Form N-1A
    Item 3 of Form N-1A requires funds to include a table describing 
the fees and expenses investors may pay if they buy and hold shares of 
the fund. Item 3 does not currently distinguish between ETFs and mutual 
funds, and only requires disclosure of sales loads, exchange fees, 
maximum account fees and redemption fees that funds charge directly to 
shareholders.\360\ We therefore are proposing several amendments to 
this Item to clarify that there are certain fees that are not reflected 
in the fee table for both mutual funds and ETFs and to require new 
disclosure requirements that capture ETF-specific trading information 
and costs. Like all information disclosed in Items 2, 3, or 4 of Form 
N-1A, the information disclosed in amended Item 3 would have to be 
tagged and submitted in a structured data format.\361\
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    \360\ Item 3 of Form N-1A.
    \361\ See General Instruction C.3.g.(i) to Form N-1A.
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a. Changes That Affect Mutual Funds and ETFs
    First, we are proposing a narrative disclosure that would clarify 
that, in addition to the current disclosures relating to investors who 
buy or hold shares, the fees and expenses reflected in the Item 3 
expense table may be higher for investors if they sell shares of the 
fund.\362\ This amendment would be applicable to both mutual funds and 
ETFs given that an investor may incur expenses other than redemption 
fees when selling shares of either a mutual fund or ETF. For example, 
although less common than they were in the past, an investor may incur 
a back-end sales load when selling a mutual fund share. Likewise, an 
investor may bear costs associated with bid-ask spreads when selling 
ETF shares.
---------------------------------------------------------------------------

    \362\ Proposed amendments to Item 3 of Form N-1A. In order to 
eliminate duplicative disclosures, we are proposing to amend 
Instruction 1(e) of Item 3 to eliminate the requirement that ETFs 
modify the narrative explanation for the fee table to state that 
investors may pay brokerage commissions on their purchase and sale 
of ETF shares, which are not reflected in the example. We are also 
proposing to eliminate the instruction that funds may only exclude 
fees charged for the purchase and redemption of the Fund's creation 
units if the fund issues or redeems shares in creation units of net 
less than 25,000 shares. Thus, as proposed, an ETF may exclude from 
the fee table any fees charged for the purchase and redemption of 
the Fund's creation units regardless of the number of shares. See 
proposed Instruction 1(e)(ii) to Item 3; see also proposed 
Instruction 1(e)(ii) to Item 27(d)(1) (proposing the same 
modification for the expense example in an ETF's annual and semi-
annual reports); see also infra footnote 397 and accompanying and 
following text.
---------------------------------------------------------------------------

    We are also proposing to require a statement that investors may be 
subject to other fees not reflected in the table, such as brokerage 
commissions and fees to financial intermediaries.\363\ We believe this 
is appropriate disclosure for both ETFs and mutual funds because 
brokerage commissions and fees to financial intermediaries could be 
applicable to ETFs and mutual funds alike.
---------------------------------------------------------------------------

    \363\ Proposed amendments to Item 3 of Form N-1A.
---------------------------------------------------------------------------

b. Changes That Affect ETFs
    Because ETF shares are exchange-traded, secondary market investors 
in ETF shares are subject to trading costs, such as bid-ask spreads, 
that are not currently required to be disclosed under Item 3. Trading 
costs, like all costs and expenses, affect investors' returns on their 
investment.\364\ In addition, some investors use ETFs more heavily as 
trading vehicles compared to mutual funds, and the extent of the 
trading costs borne by an investor depends on how frequently the 
investor trades ETF shares. We believe that investors could overlook 
these costs and that additional disclosure would help them better 
understand the total costs of investing in an ETF. Disclosure would 
also facilitate comparisons between different investment options.\365\
---------------------------------------------------------------------------

    \364\ See SEC Office of Investor Education and Advocacy, 
Investor Bulletin: How Fees and Expenses Affect Your Investment 
Portfolio (Feb. 2014), available at https://www.sec.gov/investor/alerts/ib_fees_expenses.pdf, at 2 (``As with any fee, transaction 
fees will reduce the overall amount of your investment 
portfolio.''); see also Andrea Coombes, Calculating the Costs of an 
ETF, The Wall Street Journal (Oct. 23, 2012), available at https://www.wsj.com/articles/SB10000872396390444024204578044293008576204.
    \365\ Alex Bryan & Michael Rawson, The Cost of Owning ETFs and 
Index Mutual Funds, Morningstar Manager Research (Dec. 1, 2014), 
available at http://global.morningstar.com/us/documents/pr/Cost-Of-Owning-Index-ETF-MFS.pdf, at 15 (``While trading commissions are the 
most conspicuous component of trading costs, indirect trading costs, 
such as the bid-ask spread and market impact of trading can often be 
more important.'').
---------------------------------------------------------------------------

    As a result, we are proposing a new section in Item 3 that would 
require disclosure of certain ETF trading information and trading 
costs.\366\ This proposed section is formatted as a series of question 
and answers (``Q&As''). We believe this format would help facilitate an 
investor's understanding of certain terminology and cost calculations. 
The proposed Q&A disclosures would require information related to the 
trading of ETFs on the secondary market and the costs associated with 
such trading. The specific question and answer disclosures are shown in 
Figure 1 below.
---------------------------------------------------------------------------

    \366\ Proposed amendments to Item 3 of Form N-1A.

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[[Page 37372]]

[GRAPHIC] [TIFF OMITTED] TP31JY18.016

    Q&A 1. Currently, Item 6(c) of Form N-1A requires that ETFs 
disclose that: (i) Shares may only be purchased and sold on a national 
securities exchange through a broker-dealer; and (ii) the price of ETF 
shares is based on market

[[Page 37373]]

price, and since ETFs trade at market prices rather than at net asset 
value, shares may trade at a price greater than net asset value 
(premium) or less than net asset value (discount).\367\ We are 
proposing to move this description from Item 6 to Q&A 1 in Item 3. We 
believe that moving this information to Item 3 would consolidate 
relevant disclosures regarding ETF trading costs and provide the 
investor with helpful background information relating to ETF 
trading.\368\ We also propose to replace the reference to ``national 
securities exchange'' with a reference to ``secondary markets'' to 
reflect that ETFs can be bought and sold over the counter or on an 
alternative trading system in addition to their primary listing 
exchanges.
---------------------------------------------------------------------------

    \367\ Item 6(c) of Form N-1A.
    \368\ See proposed amendments to Item 3 of Form N-1A.
---------------------------------------------------------------------------

    Q&A 2. The second Q&A we are proposing identifies the specific 
costs associated with trading shares of an ETF, such as brokerage 
commissions, bid-ask spread costs, and potential costs attributable to 
premiums and discounts. This question clarifies that the costs being 
discussed in the questions that follow should be considered in addition 
to the costs previously discussed in the fee table.
    Q&A 3. Proposed Q&A 3 would include ETF-specific disclosures 
relating to the median bid-ask spread for the ETF's most recent fiscal 
year.\369\ Costs attributable to the bid-ask spread may increase or 
decrease when certain market conditions exist or certain factors are 
present. We believe that this disclosure would inform investors 
regarding the potential impact of spread costs, including for investors 
who frequently trade ETF shares. We also believe that disclosure 
regarding median bid-ask spreads would provide a helpful metric for ETF 
investors to determine an ETF's historic liquidity, since a narrower 
bid-ask spread typically signals higher liquidity and a wider bid-ask 
spread generally signals lower liquidity.\370\ Investors can use the 
bid-ask spread to assess the ETF's tradability in comparison to other 
similar ETFs.\371\
---------------------------------------------------------------------------

    \369\ As discussed above, given the importance of this 
information to understanding the total expenses an investor may bear 
when investing in an ETF, we propose that bid-ask spread information 
be included in both the ETF's prospectus and on the ETF's website. 
Proposed Instruction 5(a) to Item 3 of Form N-1A. See also infra 
section II.C.6.
    \370\ CFA Institute Research Foundation, Comprehensive Guide to 
Exchange-Traded Funds (ETFS) (2015), available at https://www.cfapubs.org/doi/pdf/10.2470/rf.v2015.n3.1, at 67-8 (``CFA 
Guide''). See also Allen B. Atkins & Edward A. Dyl, Transactions 
Costs and Holding Periods for Common Stocks, 52 Journal of Finance 
1, 309-325 (1997) (``Additional evidence of an association between 
transactions costs and trading volume can be found in the literature 
on bid-ask spreads.''). Literature also suggests that the bid-ask 
spread could be affected by increased transaction costs. See Gerald 
W. Buetow & Brian J. Henderson, Are Flows Costly to ETF Investors?, 
40 Journal of Portfolio Management 3, 101 (Spring 2014), available 
at http://www.bfjlaward.com/pdf/25949/100-112_Henderson_JPM_0417.pdf 
(noting that authorized participants are likely to pass transaction 
fees onto shareholders through the spread).
    \371\ See CFA Guide, supra footnote 370, at 69 (noting that 
``for some ETFs, even though the underlying securities are liquid, 
bid-ask spreads may be wide simply because the ETF trades so little 
that the chances of an [authorized participant] rolling up enough 
volume to use the creation/redemption process are low'').
---------------------------------------------------------------------------

    The proposed Q&A would describe the bid-ask spread as the 
difference between the highest price a buyer is willing to pay to 
purchase shares of the ETF (bid) and the lowest price a seller is 
willing to accept for share of the ETF (ask). We are proposing to 
require this description because some investors may not be familiar 
with the term ``bid-ask spread,'' making it difficult for them to 
meaningfully analyze the specific bid-ask spread number that we propose 
to include in this Q&A. The proposed Q&A also would explain that the 
bid-ask spread can change throughout the day due to the supply of or 
demand for ETF shares, the quantity of shares traded, and the time of 
day the trade is executed, among other factors.
    In addition, we are proposing that an ETF calculate and disclose 
its median bid-ask spread over the most recently completed fiscal 
year.\372\ We propose that the median bid-ask spread be calculated by 
using trading data from each trading day of the ETF's prior fiscal 
year.\373\ Each daily bid-ask spread would be calculated by taking the 
average of the intraday bid-ask spreads, which are measured by using 
the best bid and best ask, respectively, at ten-second intervals 
throughout the trading day. We understand that this is a widely 
accepted method for calculating the bid-ask spread and believe that 
using the best bid and ask would be administratively easier and less 
burdensome than other methods of calculating the bid and ask price, 
such as weighting or averaging bid and ask prices throughout the 
trading day. We propose that the bid-ask spread be calculated by taking 
the difference between the bid and the ask and dividing that difference 
by the midpoint between the bid and the ask. The median would be 
expressed as a percentage, rounded to the nearest hundredth percent.
---------------------------------------------------------------------------

    \372\ Proposed Instruction 5(a) to Item 3 of Form N-1A.
    \373\ Proposed Instruction 5(b) to Item 3 of Form N-1A.
---------------------------------------------------------------------------

    As proposed, an ETF would be required to use data from the full 
trading day without excluding certain time periods, because we believe 
the spread metric should represent the costs that an actual investor 
could face at any time during the day. We note, however, that costs 
related to the bid-ask spread can fluctuate throughout the day. For 
example, the bid-ask spread tends to be higher at the beginning of the 
trading day and towards the end of the trading day.\374\ At market 
open, wide spreads may persist until all underlying stocks open and 
start trading. At market close, market makers may be less willing to 
purchase ETF shares because they do not want to hold the ETF shares 
overnight.
---------------------------------------------------------------------------

    \374\ Ogden H. Hammond & Michael Lieder, J.P. Morgan Asset 
Management, Debunking myths about ETF liquidity (May 2015), 
available at https://am.jpmorgan.com/blob-gim/1383272223898/83456/1323416812894_Debunking-myths-about-ETF-liquidity.pdf, at 6 (noting 
that certain ETF liquidity patterns tend to repeat and are well 
known to veteran traders, such as limited trading of ETFs 
immediately prior to the close). See also Sunil Wahal, Entry, Exit, 
Market Makers, and the Bid-Ask Spread, 10 Rev. Financial Stud 871 
(1997), available at http://www.acsu.buffalo.edu/~keechung/MGF743/
Readings/H1.pdf (``Large-scale entry (exit) is associated with 
substantial declines (increases) in quoted end-of-day inside 
spreads, even after controlling for the effects of changes in volume 
and volatility. The spread changes are larger in magnitude for 
issues with few market makers; however, even for issues with a large 
number of market makers, substantial changes in quoted spreads take 
place.'').
---------------------------------------------------------------------------

    We propose to require ETFs to use one full fiscal year of data 
because we believe a full year would capture spreads during varying 
market events throughout the year. Although we considered requiring 
ETFs to use a full calendar year of data for this disclosure 
requirement in order to promote greater comparability among ETFs, we 
are concerned that using calendar year data would necessarily mean that 
information in certain ETF prospectuses would be over a full year 
old.\375\ We preliminarily believe that, to the extent there are any 
concerns that using fiscal year data instead of calendar year data may 
undermine comparability of the spreads of different ETFs when there are 
significant market events in a particular calendar year, such concerns 
are mitigated by the relatively low impact of a single market event to 
a full year's

[[Page 37374]]

median bid-ask spread. Using one full fiscal year of data also is 
consistent with all other requirements for Item 3 of Form N-1A.\376\
---------------------------------------------------------------------------

    \375\ For example, if the ETF's fiscal year end was August 31, 
the annual update would be required to be filed no later than 
December 29, which would include spread cost information from the 
prior calendar year for up to one year thereafter, meaning that the 
spread cost information could be almost two years old. By using 
fiscal year end data, the information would never be more than 16 
months old.
    \376\ See Item 3 of Form N-1A.
---------------------------------------------------------------------------

    Under our proposal, an ETF would be required to disclose median 
bid-ask spread instead of average bid-ask spread because we believe the 
median spread better represents the spread that the average investor 
would experience, whereas the average spread better represents the 
spread of an average ETF share in a given transaction. We believe 
sorting the spreads across the entire fiscal year to determine the 
median--rather than taking the median spread of each trading day 
throughout the fiscal year first, sorting each day's median, and taking 
the median spread across all trading days--provides a better 
representation of the true median across the entire fiscal year. 
Requiring disclosure of the median bid-ask spread also avoids the 
problem of an outlier skewing the bid-ask spread figure. For example, 
if the spread is .05 in nine instances but 1.00 in one instance, then 
the average spread will be 0.145 which we believe is a less accurate 
reflection of the bid-ask spread for that fund.
    Q&A 4 and 5. We also propose to require ETFs to include questions 
on how the bid-ask spread impacts the return on a hypothetical $10,000 
investment for both buy-and-hold and frequent traders.\377\ These 
examples are designed to allow secondary market investors to see the 
impact that bid-ask spreads can have on the investor's trading expenses 
and ultimately the return on investment. For example, a hypothetical 
example of spread costs can highlight that these costs can be a drag on 
returns for someone who trades frequently in certain types of ETFs. On 
a percentage basis, spread costs for a single trade can equal, if not 
exceed, the ETF's annual operating expenses in some cases. If an 
investor trades in and out of an ETF several times within a relatively 
short period of time, the costs attributable to the bid-ask spread can 
increase rapidly. Transparency into trading costs also may promote 
greater comparability among ETFs and other investment products, such as 
mutual funds. For example, two ETFs may have very similar expense 
ratios, but one ETF consistently has higher bid-ask spreads, which 
could make the cost of that ETF significantly higher than the one with 
a low bid-ask spread.
---------------------------------------------------------------------------

    \377\ The proposal uses $10,000 in order to maintain consistency 
with the cost example in Item 3 of Form N-1A.
---------------------------------------------------------------------------

    The proposed example in Q&A 4 would require disclosure of 
hypothetical trading costs attributable solely to the median bid-ask 
spread based on data from the ETF's prior fiscal year.\378\ 
Specifically, the spread costs example would demonstrate the 
hypothetical impact of the ETF's bid-ask spread for one $10,000 
``round-trip'' trade (i.e., one buy and sell transaction). The proposed 
example reflects costs that are in addition to the annual fund 
operating expenses, which are currently disclosed in Item 3 of N-
1A.\379\ Thus, to assist investors with comparing the costs of 
investing in various ETFs, we believe that it is appropriate to use the 
same hypothetical investment amount, $10,000, which is used for the 
current expense example in Item 3 of Form N-1A.
---------------------------------------------------------------------------

    \378\ Proposed Instruction 5(b) to Item 3 of Form N-1A.
    \379\ Item 3 of Form N-1A. Item 3 only requires 1- and 3-year 
expense examples for annual fund operating expenses for ``New 
Funds.''
---------------------------------------------------------------------------

    To illustrate that more frequent trading can significantly increase 
costs, the proposed example in Q&A 5 demonstrates the costs associated 
with 25 $10,000 round-trip trades (50 total trades). This figure 
represents approximately two round-trip trades each month. While the 
number of trades that an investor makes during the course of a year can 
vary depending on the type of investor and the type of investment 
strategy the ETF pursues, we believe that an example showing the spread 
costs of 50 total trades could provide useful information for those 
that trade frequently.\380\ As discussed in more detail below, our 
proposal also would allow investors to obtain more tailored information 
regarding their costs on the ETF's website.\381\
---------------------------------------------------------------------------

    \380\ We acknowledge the inherent difficulty of setting a number 
of trades that reflects an ``average investor.'' Based on staff 
experience, however, we preliminarily believe that 50 total trades, 
which represents approximately 2 round-trip transactions per month, 
is a reasonable figure to utilize for the purposes of demonstrating 
the costs of trading for a frequent trader in Q&A 5.
    \381\ See proposed Instruction 5(e) to Item 3 of Form N-1A.
---------------------------------------------------------------------------

    Pursuant to this requirement, an ETF would be required to disclose 
``mid-range spread costs'' and ``high-end spread costs.'' The mid-range 
spread costs would be calculated by using the median spread, divided by 
two, and then multiplying the resulting number by a $10,000 trade size 
and the number of transactions. The high-end spread costs would be 
calculated by using the same calculated spread data from the ETF's 
prior fiscal year, except instead of choosing the median spread, the 
disclosure would represent the 95th percentile spread, after sorting 
that year's data.\382\ We preliminarily believe that utilizing the 95th 
percentile spread (i.e., the spread representing the threshold for the 
highest 5% of spreads) is appropriate for the purposes of representing 
high-end spread costs.
---------------------------------------------------------------------------

    \382\ We are proposing to divide the bid-ask spread by two on 
the assumption that the value of an ETF share is the midpoint 
between the bid price and the ask price. Therefore, the ``cost'' 
attributable to the bid-ask spread of executing one trade would be, 
in the case of purchasing a share of an ETF, the difference between 
the ask price and the midpoint between the bid and the ask prices--
in other words, this difference would represent the cost above which 
the share was valued for this purpose and not the full ``round-
trip'' cost. Likewise, in the case of selling an ETF share, the 
``cost'' attributable to the bid-ask spread of executing one trade 
would be the difference between the bid and the midpoint between the 
bid and the ask prices. To calculate the cost of multiple trades, 
the single trade cost would be multiplied by the number of 
transactions.
---------------------------------------------------------------------------

    We considered whether to also include ``low-end spread costs'' but 
determined that the combination of presenting ``mid-range spread 
costs'' and ``high-end spread costs'' would provide the most meaningful 
disclosure to investors. Many ``low-end spread costs'' for ETFs with 
significant volume have a penny spread and would therefore not provide 
as useful of a comparison across funds. Furthermore, some ``mid-range 
spread costs'' and ``high-end spread costs'' could account for more 
than 50% of the cost of an initial investment in an ETF, whereas a 
``low-end spread cost'' might only account for a small fraction of an 
investor's overall costs. We request comment on this point below.
    An investor could use both the median bid-ask spread figure from 
proposed Q&A 4 and the costs information in Q&A 5 to better assess the 
overall cost impact of the bid-ask spread. Proposed Q&As 1-5 also would 
provide investors with a better understanding of the basic terminology 
needed to understand some frequently overlooked costs associated with 
investing in ETFs, and then provide the data needed to understand how 
those costs materialize for the particular fund and how those costs 
compare to other ETFs.
    Q&A 6. Cross-reference to ETF's website and Interactive Calculator 
Requirement. As discussed above, proposed rule 6c-11 would require 
daily website disclosure of several items, including the NAV per share, 
market price, and premium or discount. As the disclosures on an ETF's 
website would be updated daily, we believe a cross-reference in Form N-
1A to the website disclosures would enable investors to receive timely 
and granular information that could assist with making an investment 
decision.

[[Page 37375]]

Accordingly, we propose to require a statement in Q&A 6 that would 
refer investors to the ETF's website for more information.\383\ Item 
11(g) currently requires an ETF to provide a website address in its 
prospectus if the ETF omits the historical premium/discount information 
from the prospectus and includes this information on its website 
instead. As a result, many ETFs already include a website address in 
their prospectus.\384\
---------------------------------------------------------------------------

    \383\ Proposed amendments to Item 3 of Form N-1A would require 
an ETF to include the following statement in its prospectus: ``The 
ETF's website at [www.[Series-SpecificLandingPage.com]] includes 
recent information on the Fund's net asset value, market price, 
premiums and discounts, as well as an interactive calculator you can 
use to determine how the bid-ask spread would impact your specific 
investment.'' The Commission explained in a 2000 release that filers 
submitting HTML documents on EDGAR should take reasonable steps when 
they create the document in order to prevent URLs from being 
converted into hyperlinks. See Rulemaking for Edgar System, 
Securities Act Release No. 33-7855 (Apr. 24, 2000).
    \384\ As discussed above, we propose to replace the historical 
premium/discount information in Item 11(g) with line graph 
disclosure regarding premiums and discounts that would be required 
by proposed rule 6c-11(c)(1)(iv). See supra section II.C.6.
---------------------------------------------------------------------------

    In addition, proposed Instruction 5(e) to Item 3 would require an 
ETF to provide an interactive calculator in a clear and prominent 
format on the ETF's website. The purpose of the interactive calculator 
is to provide investors with the ability to customize the hypothetical 
calculations in Item 3 to their specific investing situation. For 
example an investor with an investment of $2,500 opposed to $10,000 or 
wishing to trade 10 times opposed to the 25 times presented in Item 3 
could use the calculator to find more tailored cost-related 
information. We are sensitive to the fact that creating a web-based 
interactive calculator is not without cost, especially for smaller fund 
complexes. We have tried to mitigate these costs by limiting the 
proposed investor-input to two data points: Investment amount and 
number of trades. We also tried to limit the complexity of the tool by 
proposing to require the interactive calculator to use the calculations 
detailed in Instructions 5(a)--(d) to Item 3 to provide the information 
required by Q&As 3-5, which relates to the bid-ask spread.
c. Exception for ETFs With Limited Trading History
    Trading information and related costs may not be useful to 
secondary market investors in an ETF that has only a limited amount of 
trading history since inception. Therefore, we are proposing that an 
ETF that had its initial listing on a national securities exchange 
after the beginning of its most recently completed fiscal year would 
not be required to include the ETF's median bid-ask spread or the 
spread cost example in its Item 3 disclosure, nor would the ETF be 
required to provide an interactive calculator on its website.\385\ We 
preliminarily believe this information is most useful when there is at 
least one full fiscal year of data underlying the metrics. Without a 
minimum amount of trading data to calculate this information, the 
resulting calculations could be skewed for any number of reasons. For 
example, it is possible that the time of year during which the ETF was 
trading or the fact that an ETF was relatively new to the market and 
had not had significant marketing to gain interest for shares of the 
ETF resulted in low trading volume and higher bid-ask spreads. We 
propose to require a newly launched ETF to provide a brief statement to 
the effect that the ETF does not have sufficient trading history to 
report trading information and related costs.\386\ The proposed 
amendment would prohibit a new ETF from disclosing data based on very 
short trading histories, which we preliminarily believe could be 
misleading. This approach would also be consistent with our treatment 
of other disclosure items such as portfolio turnover data and annual 
returns.\387\
---------------------------------------------------------------------------

    \385\ Proposed Instruction 5(a) to Item 3 of Form N-1A.
    \386\ Id.
    \387\ See Items 3 and 4 of Form N-1A.
---------------------------------------------------------------------------

    We seek comment on our proposed amendments to Item 3:
    <bullet> Should we require ETFs and mutual funds to include a 
statement that investors may be subject to other costs not reflected in 
the fee table, such as brokerage commissions and other fees to 
financial intermediaries? Would this disclosure be confusing to 
individual investors, particularly those investing in mutual funds?
    <bullet> In addition to the statement regarding brokerage 
commissions, should we require quantitative disclosure of the range of 
brokerage commissions for transactions? Should this disclosure be 
required of both mutual funds and ETFs? Where in the registration 
statement should such disclosure be included? Or, would disclosure of 
brokerage commissions raise challenges too great to require disclosure? 
For example, would variations in methods used to collect and set 
commissions make such disclosure too complex? How costly or difficult 
would it be to obtain information about brokerage commissions?
    <bullet> Should other costs be disclosed in Item 3? If so, which 
costs and why? How and where should those other costs be disclosed? 
Should Item 3 include market price range or NAV range? What other 
trading information, if any, should be included in Item 3 and why? For 
example, should we require ETFs to disclose information regarding the 
number of days the ETF's shares traded on a national securities 
exchange, the ETF's average daily volume, and/or the ETF's total number 
of shares outstanding? If so, how should we require these metrics to be 
calculated and disclosed?
    <bullet> Should we include the specific ETF disclosures in Item 3? 
Should we require that those disclosures be made in a Q&A format? Would 
investors understand and find the proposed Q&A format useful? Are there 
other formats we should consider? Should we permit ETFs to use any 
format that is designed to effectively convey the information to 
investors?
    <bullet> Should we replace the reference to ``national securities 
exchange'' with ``secondary markets'' in Q&A 1 as proposed?
    <bullet> Should we require ETFs to explain bid-ask spreads and the 
factors that could affect bid-ask spreads in Item 3? Are there other 
explanations (or means to calculate bid-ask spreads) that we should 
consider? Are there other factors that could impact bid-ask spreads 
that we should include in this explanation?
    <bullet> Should the median bid-ask spread information be included 
in the prospectus? Should this information be included in Item 3 or in 
a different section of the registration statement? If so, where? 
Alternatively, should we require disclosure of this information on an 
ETF's website?
    <bullet> To what extent is historical spread data predictive of 
future spread data? Should we require language indicating that 
historical spread data may not be predictive of future spread data?
    <bullet> Should the spread calculation exclude data from the 
beginning and end of the trading day? If so, what time periods should 
it exclude and why? For example, should we exclude the first and last 
15 minutes of each trading day?
    <bullet> Should the spread calculation be based on data from an 
ETF's fiscal-year end or calendar-year end and why? Would the use of 
fiscal-year make comparability among funds more difficult since funds 
have different fiscal-year ends? Should the spread calculation be based 
on data from more than one year? If so, how many years and why? Should 
the spread calculation be based on data that, in addition to the fiscal 
or calendar year, also includes

[[Page 37376]]

data from the most recently completed fiscal or calendar quarter, 
respectively? Should the calculation be done on a daily basis first and 
then again across the entire fiscal year?
    <bullet> Should the calculation for the bid-ask spread throughout 
the trading day be done more or less frequently than every ten seconds? 
If so, how frequently and why?
    <bullet> Should the bid and ask be calculated using a different 
method, such as weighting the prices throughout the book? If so, 
explain the method and why it should be used.
    <bullet> Should a metric other than median be used for the spread 
calculation? For example, should we use average spread or effective 
spread? \388\ If so, why is it preferable and how should it be 
calculated? Would the use of a different spread calculation provide 
more comprehensive information about extreme market events? For 
example, should we also require disclosure of additional percentiles 
towards the extreme of the distribution, such as the 95th percentile?
---------------------------------------------------------------------------

    \388\ See supra footnote 314.
---------------------------------------------------------------------------

    <bullet> Instead of using the bid-ask spread as an indicator of 
trading costs, is there another method that would better reflect an 
ETF's overall trading costs? If so, what is that metric, why is it 
better than disclosing the bid-ask spread, and how should it be 
calculated and disclosed?
    <bullet> How difficult or costly would it be for ETFs to obtain the 
data necessary to calculate median bid-ask spread as proposed? Are 
there any negative consequences of disclosing the bid-ask spread? If 
so, what are they?
    <bullet> When calculating the spread costs example, should the bid-
ask spread be divided by two for each transaction listed or should each 
transaction reflect the full round-trip spread cost?
    <bullet> Should we require disclosure of costs associated with 
``mid-range spread costs'' and ``high-end spread costs'', as proposed? 
Should we additionally include a requirement to disclose ``low-end 
spread costs''? Why or why not? Would the disclosure of this data 
result in retail investor confusion?
    <bullet> Is the $10,000 trade amount used in the spread costs 
example reasonable? Should we consider a lower trade amount? 
Alternatively, should the spread costs example show varying trade sizes 
calculated using varying book depths? If so, what trade sizes and why 
should they be used?
    <bullet> Should the spread example include a different number of 
transactions? If so, how many transactions should be used for each 
column and why? Should the number of transactions vary based on the 
type of investment strategy the ETF pursues? If so, how should we 
determine the number of transactions and corresponding ETF types?
    <bullet> Are there any negative consequences of disclosing the 
spread costs example? If so, what are they?
    <bullet> Should each ETF be required to disclose a website address 
in Item 3 as proposed? Should we permit an ETF to comply with this 
requirement by including a general web address to an investment company 
complex's website or should we require a series-specific landing page 
for the ETF? Would a cross-reference to the ETF's series-specific page 
be useful?
    <bullet> Should we require ETFs to disclose information regarding 
premiums and discounts in Item 3 of Form N-1A, either in addition to, 
or in lieu of, the disclosures proposed in rule 6c-11? If so, should 
the information be based on data over the entire fiscal year or 
calendar year? Do commenters believe that the reference to the ETF's 
website, where such information may be found, provides investors with 
useful information regarding these potential costs?
    <bullet> Would investors find the information in our proposed 
amendments to Item 3 helpful in comparing between different investment 
options?
    <bullet> Should we require funds, as proposed, to provide investors 
with an interactive calculator on their website? Would investors find 
an interactive calculator helpful to better understand the costs of 
investing in ETFs? Are there data points that we have not discussed 
that the interactive calculator should include? Should the interactive 
calculator be required for both mutual funds and ETFs? For example, 
should the interactive calculator be expanded to include fee table 
information for both ETFs and mutual funds? Are there any challenges to 
posting an interactive calculator that we are not considering? What 
costs would be associated with developing this type of calculator?
    <bullet> Should we require funds to provide an interactive 
calculator on their website for other costs, such as any costs 
attributable to premiums or discounts? If so, what would be the user 
inputs and outputs for the calculator? How would the calculator 
calculate such a cost?
    <bullet> Should there be an exception to the requirement to 
disclose trading information and related costs for newly launched ETFs 
as proposed? If not, why not? Should a newly launched ETF nevertheless 
be required to provide an interactive calculator on its website? Should 
the threshold for the exemption to include trading information and 
related costs disclosure instead be based on Form N-1A's definition of 
``New Fund'' \389\ or a different period of time? If so, why? Should 
there be an exception to disclosing trading information and related 
costs for any other reason (e.g., limited trading book depth, low 
volume, or trading only on a percentage of the days throughout the 
year)? If so, what should the threshold be and why?
---------------------------------------------------------------------------

    \389\ Instruction 6 to Item 3 of Form N-1A defines a ``New 
Fund'' as ``a Fund that does not include in Form N-1A financial 
statements reporting operating results or that includes financial 
statements for the Fund's initial fiscal year reporting operating 
results for a period of 6 months or less.'' The instruction permits 
New Funds to estimate ``Other Expenses'' and to complete only 1- and 
3-year portions of the expense example. Id.
---------------------------------------------------------------------------

    <bullet> In lieu of providing an exception from the requirement to 
disclose trading information and related costs for newly launched ETFs, 
should we instead adopt a requirement for ETFs to disclose this 
information once the ETF reaches or exceeds a specified threshold of 
trading volume for a specified period of time, regardless of how long 
it has been in operation? Put differently, should we base this 
exception on level of trading volume rather than the length of an ETF's 
operation? If so, what should such thresholds be? If not, why not?
3. Item 6 of Form N-1A
    Currently, Item 6(c)(i) of Form N-1A requires an ETF to: (i) 
Specify the number of shares it will issue or redeem in exchange for 
the deposit or delivery of baskets; (ii) explain that the individual 
shares of the ETF may only be purchased and sold on a national 
securities exchange through a broker or dealer; and (iii) disclose that 
the price of ETF shares is based on the market price and as a result, 
shares may trade at a price greater than NAV (premium) or less than NAV 
(discount).\390\ The number of shares the ETF issues or redeems in 
exchange for the deposit or delivery of baskets is largely duplicative 
of reports required in Form N-CEN.\391\ We therefore propose to remove 
this requirement from Item 6.\392\ The remainder of the information 
required by Item 6(c)(i) is proposed to be moved to the Item 3 
disclosure.\393\ In order to eliminate duplicative disclosure, we 
propose to remove these requirements

[[Page 37377]]

from Item 6.\394\ As noted above, moving this information to Item 3 
would consolidate relevant disclosures regarding the fees and trading 
costs that may be borne by an ETF investor in one place.
---------------------------------------------------------------------------

    \390\ Item 6(c)(i) of Form N-1A.
    \391\ See Item E.3.a of Form N-CEN; see also Reporting 
Modernization Adopting Release, supra footnote 147, at n.1100 and 
accompanying text (requiring ETFs ``to report the number of ETF 
shares required to form a creation unit as of the last business day 
of the reporting period.'').
    \392\ See proposed amendments to Item 6 of Form N-1A.
    \393\ See proposed amendments to Item 3 of Form N-1A.
    \394\ See proposed amendments to Item 6 of Form N-1A.
---------------------------------------------------------------------------

    Additionally, Item 6(c)(ii) currently requires ETFs issuing shares 
in creation units of less than 25,000 to disclose the information 
required by Items 6(a) and (b).\395\ Current Items 6(a) and (b) require 
funds to: (i) Disclose their minimum initial or subsequent investment 
requirements; (ii) disclose that the shares are redeemable; and (iii) 
describe the procedures for redeeming shares. We are proposing to 
eliminate these disclosures.\396\ When we adopted these requirements, 
we reasoned that individual investors may be more likely to indirectly 
transact in creation units through authorized participants if the 
creation unit size was less than 25,000 shares.\397\ Based on staff 
experience, we understand that retail investors do not engage in 
primary transactions through authorized participants. Furthermore, to 
the extent that authorized participants act as agents for market makers 
in primary transactions with the ETF, we believe that the flow of 
information on how to purchase and redeem shares is robust given the 
market maker's relationship with an authorized participant. Therefore, 
we do not believe that this disclosure would be beneficial.
---------------------------------------------------------------------------

    \395\ Item 6(c)(ii) of Form N-1A.
    \396\ See proposed amendments to Item 6 of Form N-1A.
    \397\ See Enhanced Disclosure and New Prospectus Delivery Option 
for Registered Open-End Management Investment Companies, Investment 
Company Act Release No. 28584 (Jan. 13, 2009) [74 FR 4546 (Jan. 26, 
2009)] (``Summary Prospectus Adopting Release''), at nn.170-72.
---------------------------------------------------------------------------

    We request comment on the proposed amendments to Item 6.
    <bullet> Should we remove the disclosure regarding creation unit 
sizes from Form N-1A, as proposed? Are we correct in our understanding 
that this disclosure is largely duplicative of disclosure required in 
Form N-CEN? Are we correct in our belief that investors do not find 
this information useful in the context of a prospectus? Instead of 
removing this disclosure from Form N-1A entirely, should we move it to 
the Statement of Additional Information? Do retail investors typically 
use the information on creation unit size and if so, for what purpose? 
Is our belief correct that this information is more useful for 
authorized participants and market makers and less useful to investors 
purchasing individual shares on an exchange?
    <bullet> Alternatively, should we require ETFs to disclose 
information regarding their creation unit sizes or transaction fees, or 
both, on their websites?
    <bullet> Should ETFs continue to disclose in Item 6 (or any other 
Item included within the summary prospectus disclosure) information 
currently required by Items 6(a) and (b)? If so, why? Should this 
disclosure be based on a numerical threshold, and if so, what would the 
appropriate threshold be and why?
    <bullet> Should we require ETFs to provide disclosure regarding 
transaction fees associated with the purchase and redemption of 
creation units? If so, where should such disclosure be provided?
    <bullet> Are we correct in our understanding that that the flow of 
information on how to purchase and redeem ETF shares is robust due to 
the relationship between market makers and authorized participants?
4. Item 11 of Form N-1A
    Item 11(g)(1) currently specifies that an ETF may omit information 
required by Items 11(a)(2), (b), and (c) if the ETF issues or redeems 
shares in creation units of not less than 25,000 shares each.\398\ 
Similar to the reasoning discussed above regarding amendments to Item 
6,\399\ we propose to amend Item 11(g)(1) to permit all ETFs, not just 
ones with creation unit sizes of not less than 25,000 shares, to omit 
the information required by Items 11(a)(2), (b), and (c).\400\
---------------------------------------------------------------------------

    \398\ Item 11(g)(1) of Form N-1A.
    \399\ See supra section I.H.3.
    \400\ Proposed Item 11(g)(1) of Form N-1A.
---------------------------------------------------------------------------

    Item 11(a)(2) requires a fund to disclose when calculations of NAV 
are made and that the price at which a purchase or redemption is 
effected is based on the next calculation of NAV after the order is 
placed.\401\ Item 11(b) and (c) require a fund to describe the 
procedures used for purchasing and redeeming the fund's shares.\402\ In 
our view, eliminating these disclosure requirements for all ETFs would 
not detract from an understanding of how authorized participants 
transact directly with the ETF in the primary market. As discussed 
above, the proposed rule would define an authorized participant as a 
member or participant of a clearing agency registered with the 
Commission, which has a contractual arrangement with the ETF or one of 
the ETF's service providers.\403\ Thus, we believe the parties who 
purchase or redeem shares from the ETF directly would either have the 
knowledge necessary to do so without additional procedural disclosure 
or the ability to request such information.
---------------------------------------------------------------------------

    \401\ Item 11(a)(2) of Form N-1A. Item 11(a)(1) already requires 
that ETFs include an explanation that the price of fund shares is 
based on market price. Item 11(a)(1) of Form N-1A.
    \402\ Item 11(b) and (c) of Form N-1A.
    \403\ See proposed rule 6c-11(a).
---------------------------------------------------------------------------

    Item 11(g)(2) currently includes a requirement for an ETF to 
provide a table showing the number of days the market price of the 
ETF's shares was greater than the ETF's NAV per share for certain time 
periods.\404\ As discussed above, we propose to require information 
about the premium and discount of the ETF's shares to their NAV per 
share to be included on the ETF's website. Thus, we are proposing to 
remove the information currently required by Item 11(g)(2), as more 
timely information would be available on the ETF's website. For the 
same reasons, we are also proposing to eliminate Item 27(b)(7)(iv) of 
Form N-1A, which requires ETFs to include a table with premium/discount 
information in their annual reports for the five most-recently 
completed fiscal years.\405\
---------------------------------------------------------------------------

    \404\ Item 11(g)(2) of Form N-1A. The item provides that an ETF 
may omit the table if it provides a website address that investors 
can use to obtain the premium/discount information required by the 
item.
    \405\ Although the time period required by this disclosure is 
different than the requirement in Item 11(g)(2), ETFs are permitted 
to omit both disclosures by providing on their websites only the 
premium/discount information required by Item 11(g)(2) (the most 
recently completed fiscal year and quarters since that year).
---------------------------------------------------------------------------

    We request comment on the proposal to remove the requirement to 
disclose information required by Items 11(a)(2), (b), and (c) as well 
as the proposal to remove the requirement to disclose the premium/
discount information in the prospectus and annual report.
    <bullet> Should we keep this disclosure in the prospectus? If we 
were to keep this disclosure requirement, should we require ETFs to 
disclose different information about the procedures to purchase and 
redeem shares directly with the ETF?
    <bullet> Do most ETFs provide the premium/discount information 
required by this information on their websites? If we were to keep the 
requirement to disclose the premium/discount information in the 
prospectus, should it mirror the information proposed to be required on 
the ETF's website?
5. Potential Alternatives to Current ETF Registration Forms
    As discussed above, open-end funds, including ETFs organized as 
open-end funds, are required to file Form N-1A to

[[Page 37378]]

register under the Act and to offer their securities under the 
Securities Act. UITs, including ETFs organized as UITs, initially 
register under the Investment Company Act on Form N-8B-2 and register 
their offerings of securities under the Securities Act on Form S-
6.\406\ However, ETFs, regardless of structure, operate differently 
than the other investment companies that register on Forms N-1A and N-
8B-2. For example, unlike traditional open-end funds and UITs, ETFs are 
exchange-traded and investors rely on the arbitrage mechanism to ensure 
that the ETF's shares trade at or close to its NAV.\407\ As a result of 
these differences, in addition to our proposed amendments to Form N-1A 
and Form N-8B-2, we are seeking comment on whether we should create a 
new registration form that is specifically designed for ETFs or 
consider other disclosure formats as part of a future rulemaking.
---------------------------------------------------------------------------

    \406\ See infra section II.0.
    \407\ See generally Hu and Morley, supra footnote 291 (proposing 
a new ETP disclosure regime that ``responds to the significance of 
the arbitrage mechanism, model-related complexities and evolving 
understandings and conditions'').
---------------------------------------------------------------------------

    <bullet> Should we create a new registration form for ETFs? What 
types of ETFs should be required to file reports on such a form? For 
example, should we limit the form to ETFs that would be subject to 
proposed rule 6c-11? Or should all ETFs, including UIT ETFs, file 
reports on such a form?
    <bullet> What type of ETF-specific information should such a form 
include? Should the form require more disclosure on the effectiveness 
of the arbitrage mechanism? \408\ Should the disclosures require 
qualitative disclosures that relate specifically to ETFs, including the 
performance of the ETF's arbitrage mechanism? Should this disclosure be 
required as part of an annual report? \409\ Should we require a 
discussion of the ETF's bid-ask spread or premiums and discounts 
throughout the year? Should the form include a discussion of ETF-
specific risk factors? If so, what risk factors should be included?
---------------------------------------------------------------------------

    \408\ See generally id.
    \409\ Id.; see also Item 27(b)(7) of Form N-1A.
---------------------------------------------------------------------------

    <bullet> Should we require ETFs to provide investors with a short 
summary document that provides key information about the ETF? What type 
of information should the document include? For example, should it 
include information related to the ETF's strategy, portfolio 
investments, costs, risks, or performance? Should we require it to be 
in a standardized format? \410\
---------------------------------------------------------------------------

    \410\ For example, in 2017, the Canadian Securities 
Administrators began requiring ETFs traded on Canadian exchanges to 
provide investors with a document, not to exceed four pages in 
length, called ``ETF Facts.'' The ETF Facts document is required to 
include certain information about the ETF, including, among other 
things, information related to the ETF's investments, risks, and 
performance, as well as background information about ETFs generally. 
See Canadian Securities Administrators, Mandating a Summary 
Disclosure Document for Exchange-Traded Mutual Funds and Its 
Delivery--CSA Notice of Amendments to National Instrument 41-101 
(Dec. 8, 2016), available at http://www.osc.gov.on.ca/documents/en/Securities-Category4/ni_20161208_41-101_traded-mutual-funds.pdf.
---------------------------------------------------------------------------

    <bullet> As an alternative to a new ETF form, or in addition to 
such a form, should we consider a summary prospectus targeted 
specifically at ETFs and their unique features?
    <bullet> Should we require ETFs to file periodic reports, such as 
on Form 8-K? Under what circumstances should we require periodic 
reports? For example, should we require ETFs to file periodic reports 
after a market event that adversely affects the arbitrage mechanism 
during the trading day?

I. Amendments to Form N-8B-2

    Form N-8B-2 is the registration form under the Investment Company 
Act for UITs which are currently issuing securities and is used for 
registration of ETFs organized as UITs.\411\ For the reasons discussed 
above in section II.A.1, we believe that UIT ETFs should be regulated 
pursuant to their exemptive orders, rather than a rule of general 
applicability and are not proposing to include them within the scope of 
proposed rule 6c-11. However, we believe that it is important for 
investors to receive consistent disclosures for ETF investments, 
regardless of the ETF's form of organization.\412\ We are therefore 
proposing to amend Form N-8B-2 \413\ to require UIT ETFs to provide 
disclosures that mirror certain of our proposed disclosure changes in 
Form N-1A.\414\ Below are the proposed Form N-8B-2 amendments and the 
corresponding sections in Form N-1A.
---------------------------------------------------------------------------

    \411\ While open-end funds register with the Commission with 
Form N-1A, UITs must register with two forms: Form S-6 which is used 
for registering the offering of the UITs' units under the Securities 
Act, and Form N-8B-2, which is used for registration under the 
Investment Company Act. Form S-6, which must be filed with the 
Commission every 16 months, provides certain content requirements, 
mainly by referencing to the disclosure requirements in Form N-8B-2.
    \412\ See 2008 ETF Proposing Release, supra footnote 3, at 
section III.D.1. for a general discussion of ETF prospectus delivery 
requirements. Since UITs issue securities, and not subject to any of 
the applicable exemptions, both sponsors and dealers are required to 
deliver a current prospectus to unit holders. See section 5(b) of 
the Securities Act (requiring prospectus delivery with the sale of 
securities, including units of UITs); see also section 24(d) of the 
Act (eliminating the ``dealer exception'' in section 4(3) of the 
Securities Act for transactions in redeemable securities by UITs); 
see also supra footnote 27.
    \413\ Because Form S-6 requires UIT prospectuses to include 
disclosure required by specified provisions of Form N-8B-2, the 
proposed disclosure amendments to Form N-8B-2 would also apply to 
prospectuses on Form S-6.
    \414\ See section II.H.
    \415\ The proposed definition of the term ``exchange-traded 
fund'' in Form N-1A covers ETFs organized as open-end funds and 
includes ETFs relying on either exemptive orders or rule 6c-11 to 
operate. Form N-8B-2, on the other hand, is for UITs, which would 
not be able to rely on rule 6c-11 to operate. Accordingly, the 
proposed definition of ``exchange-traded fund'' in Form N-8B-2 omits 
the reference to rule 6c-11.

------------------------------------------------------------------------
                                                          Corresponding
                                Proposed Form N-1A ETF     Form N-8B-2
       Disclosure topic               disclosure            proposed
                                                           disclosure
------------------------------------------------------------------------
Definitions for Exchange-       General Instructions    General
 Traded Fund.                    Part A.                 Instructions
                                                         Definitions.\41
                                                         5\
Information Concerning Fees     Item 3. Risk/Return     Item I.13(h).
 and Costs.                      Summary: Fee Table.
Information Concerning Fees     Item 3. Exchange-       Item I.13(i).
 and Costs.                      Traded Fund Trading
                                 Information and
                                 Related Costs.
------------------------------------------------------------------------

    UIT ETFs, like other ETFs, are exchange-traded. As a result, 
secondary market investors in UIT ETFs, like other ETFs, are subject to 
costs, such as: bid-ask spreads; brokerage commissions for buying and 
selling shares of a UIT ETF through a broker-dealer; and potential 
costs related to purchasing UIT ETF shares at a premium or discount to 
NAV per share. As with investors in ETFs organized as open-end funds, 
we believe that unit holders could overlook these costs for UIT ETFs. 
We believe that additional disclosure would help investors better 
understand the total costs of investing in a UIT ETF. Accordingly, we 
are proposing disclosure requirements in Form N-8B-

[[Page 37379]]

2 that mirror those of Item 3 of Form N-1A, thus requiring prospectuses 
on Form S-6 for UIT ETFs to disclose that an ETF investor may pay 
additional fees, such as brokerage commissions and other fees to 
financial intermediaries, and to provide certain ETF trading 
information and related costs.\416\
---------------------------------------------------------------------------

    \416\ See proposed Items 13(h) and (i) of Form N-8B-2. See also 
supra section II.H.2 describing the ETF trading information and 
related costs disclosure requirements.
---------------------------------------------------------------------------

    As discussed above, the proposed instructions to Item 3 would 
require median bid-ask spread to be disclosed on an ETF's website. UIT 
ETFs would be subject to this requirement as well. We note in this 
regard that UIT ETFs currently are not subject to website disclosure 
requirements regarding trading costs or other information. However, as 
a matter of practice, UIT ETFs generally disclose information regarding 
market price, NAV per share, premium and discounts, and spreads on 
their websites today.\417\
---------------------------------------------------------------------------

    \417\ UIT ETFs also would be required to provide certain ETF 
specific information in reports on Form N-CEN. See Part E of Form N-
CEN. Additionally, a UIT ETF would be required to provide certain 
information relating to the index that it tracks, including the 
return difference and whether the index is constructed by an 
affiliated person or is exclusive to the UIT. See Item E.4 of Form 
N-CEN.
---------------------------------------------------------------------------

    We request comment on the proposed amendments to Form N-8B-2.
    <bullet> Should we require ETFs organized as UITs to provide 
disclosures that are consistent with Form N-1A in the manner proposed?
    <bullet> Do the proposed amendments to Form N-8B-2 ensure 
consistency between ETFs organized as open-end funds and UIT ETFs? Why 
or why not?
    <bullet> Are there additional amendments to Form N-8B-2 the 
Commission should consider? Are there any amendments to Form S-6 that 
the Commission should consider? For example, should we consider 
requiring UIT ETFs to provide disclosure regarding market price, NAV 
per share, and premiums and discounts? Should we consider requiring UIT 
ETFs to provide graphic disclosure regarding the ETF's historical 
premiums and discounts? Should we permit UIT ETFs to omit such premium/
discount in their registration statement if they include those 
disclosures on the ETF's website?
    <bullet> Would the proposed trading cost requirements in Form N-8B-
2 Items I.13(h)-(i) result in UIT ETFs having to disclose information 
not currently disclosed on their websites? If so, what information 
would be disclosed that is not currently disclosed?

J. Amendments to Form N-CEN

    Form N-CEN is a structured form that requires registered funds to 
provide census-type information to the Commission on an annual 
basis.\418\ Item C.7. of Form N-CEN requires management companies to 
report whether they relied on certain rules under the Investment 
Company Act during the reporting period.\419\
---------------------------------------------------------------------------

    \418\ See Reporting Modernization Adopting Release, supra 
footnote 147.
    \419\ Item C.7. of Form N-CEN.
---------------------------------------------------------------------------

    We are proposing to add to Form N-CEN a requirement that ETFs 
report if they are relying on rule 6c-11.\420\ While Form N-CEN already 
requires funds to report if they are an ETF,\421\ we are proposing to 
collect specific information on which funds are relying on rule 6c-11 
in order to better monitor reliance on rule 6c-11 and to assist us with 
our accounting, auditing and oversight functions, including compliance 
with the Paperwork Reduction Act.
---------------------------------------------------------------------------

    \420\ Proposed Item C.7.k. of Form N-CEN.
    \421\ See Item C.3.a.i. of Form N-CEN.
---------------------------------------------------------------------------

    As discussed above in section II.C.1, we are also changing the 
definition of ``authorized participant'' in Form N-CEN to exclude the 
specific reference to an authorized participant's participation in DTC 
in order to obviate the need for future amendments if additional 
clearing agencies become registered with the Commission. Revised Form 
N-CEN would define the term as ``a member or participant of a clearing 
agency registered with the Commission, which has a written agreement 
with the Exchange-Traded Fund or Exchange-Traded Managed Fund or one of 
its service providers that allows the authorized participant to place 
orders for the purchase and redemption of creation units.'' \422\
---------------------------------------------------------------------------

    \422\ See proposed amendment to Instruction to Item E.2 of Form 
N-CEN.
---------------------------------------------------------------------------

    We request comment on our proposed amendments to Form N-CEN.
    <bullet> Should we require any additional information concerning 
proposed rule 6c-11? If so, what information and where? For example, 
should we require ETFs to provide information to the Commission on a 
monthly basis on Form N-PORT? If so, what information?
    <bullet> Should we amend the definition of ``authorized 
participant'' in Form N-CEN as proposed or should we retain its 
existing definition?

III. Economic Analysis

A. Introduction

    ETF sponsors seeking to operate an ETF currently need to obtain an 
order from the Commission that exempts them from certain provisions of 
the Act that otherwise would prohibit several features essential to the 
ETF structure. Obtaining such exemptive relief typically has resulted 
in expenses and delays in forming new ETFs. In addition, the conditions 
in the exemptive orders issued by the Commission have evolved over 
time. As a result, some ETF sponsors may have a competitive advantage 
over other sponsors because some existing exemptive orders allow the 
sponsors to launch new funds under the terms and conditions of those 
orders, and because the terms in some of the existing exemptive orders 
may be more flexible than others.
    Proposed rule 6c-11 would allow ETFs that satisfy certain 
conditions to operate without obtaining an exemptive order from the 
Commission. As discussed above, the Commission also proposes to rescind 
the exemptive relief we have issued to ETFs that could rely on the 
proposed rule. However, we anticipate that ETFs whose exemptive relief 
would be rescinded under the proposed rule generally would be able to 
rely on the proposed rule without substantially changing their current 
operations, as the conditions for relying on the proposed rule would be 
similar to those contained in existing exemptive relief, consistent 
with existing market practice, or generally more flexible than those 
contained within existing exemptive relief.\423\ ETFs that wish to 
operate in a manner not covered by the proposed exemptive rule could 
seek individual exemptive relief from the Commission.
---------------------------------------------------------------------------

    \423\ As discussed in more detail below, some conditions in the 
proposed rule and the scope of the relief provided are less flexible 
than those included in certain exemptive orders (e.g., the absence 
in the proposed rule of master-feeder relief) and others represent 
requirements that were not included in exemptive orders (e.g., 
basket policies and procedures and the recordkeeping requirements).
---------------------------------------------------------------------------

    We believe that proposed rule 6c-11 would establish a regulatory 
framework that: (1) Reduces the expense and delay currently associated 
with forming and operating certain ETFs unable to rely on existing 
orders; and (2) creates a level playing field for ETFs that could rely 
on the proposed rule. As such, the proposed rule would enable increased 
product competition among certain ETF providers, which could lead to 
lower fees for investors, encourage financial innovation, and increase 
investor choice in the ETF market.
    Furthermore, the amendments to Forms N-1A and N-8B-2 as well as the 
additional website disclosures required by the proposed rule are 
intended to improve the information about ETFs available to the market 
and to allow

[[Page 37380]]

investors to more readily obtain information about fund products, 
resulting in reduced investor search costs. To the extent that the 
proposed amendments would improve investors' ability to evaluate the 
performance and other characteristics of fund products, the proposed 
amendments might result in better informed investor decisions and more 
efficient allocation of investor capital among fund products, and might 
further promote competition among ETFs and between ETFs and mutual 
funds.
    The proposed rule and amendments to Forms N-1A and N-8B-2 also may 
impact non-ETF products and market participants. To the extent that the 
proposed rule would lead to lower investor search costs, lower fees, 
and increased product innovation and investor choice in the ETF market, 
investors may shift their investments towards ETFs and away from funds 
similar to ETFs, such as mutual funds. Such a shift in investor demand 
also may affect broker-dealers and investment advisers, whose customers 
and clients may show increased interest in and demand for ETFs. 
Moreover, because ETF shares are traded on the secondary market, the 
proposed rule also could affect exchanges, alternative trading systems, 
facilities for OTC trading, broker-dealers, and clearing agencies to 
the extent that the rule causes changes in the ETF trading activity 
they support.

B. Economic Baseline

1. ETF Industry Growth and Trends
    The ETF industry has experienced extensive growth since the first 
US ETF began trading in 1993.\424\ From 1993 to 2002, an average of 10 
new ETFs registered each year and ETF net assets increased by an 
average of $10.7 billion annually. Industry growth accelerated from 
2003 to 2006, when, on average, 62 new ETFs and $77 billion in net 
assets were added to the industry annually. Since 2007, the industry 
has seen an average of 141 new ETF entrants and an average growth of 
$272.8 billion annually. Since 2007, ETF net assets have grown at an 
average rate of 18.4% per year, which compares to 4.2% for closed-end 
funds and 9.7% for open-end funds over the same period.\425\
---------------------------------------------------------------------------

    \424\ For the purpose of this release, we focus exclusively on 
ETFs that trade on US exchanges.
    \425\ The number and net assets of ETFs are based on a staff 
analysis of Bloomberg data. Growth rates for open- and closed-end 
funds are based on a staff analysis of Morningstar data.
---------------------------------------------------------------------------

    At the end of December 2017, there were 1,900 registered ETFs that 
had a total of $3.4 trillion in net assets, spanning six broad 
investment style categories. ETFs are predominantly structured as open-
end funds; however, eight funds that together represented 10.9% of ETF 
total net assets ($372.8 billion) were structured as UITs, and 70 ETFs 
that together represented 25.1% of total net assets ($854.9 billion) 
were structured as a share class of an open-end fund. The chart 
illustrates growth in ETF net assets by investment strategy beginning 
in 2000 (left-hand side axis). It also tracks the percentage of net 
assets invested in actively managed ETFs (right-hand side axis).

[[Page 37381]]

[GRAPHIC] [TIFF OMITTED] TP31JY18.017

    Although indexing is still the most common ETF strategy, over time 
ETFs have evolved to offer, among other things, active management, 
leveraged and inverse investment strategies, and exposure to various 
types of foreign securities. At the end of December 2017, 187 ETFs, 
structured as open-end funds, employed leveraged or inverse investment 
strategies.\426\ In total, leveraged ETFs had total net assets of 
$35.26 billion or approximately 1% of all ETF net assets. None of the 
eight registered ETFs structured as UITs employed leveraged or inverse 
investment strategies. Of the remaining unleveraged ETFs, both index-
based and active, 1,705 funds had combined net assets of $3 trillion 
operated as open-end funds, while eight funds had $372.8 billion in net 
assets operated as UITs.\427\
---------------------------------------------------------------------------

    \426\ As of the end of December 2017, 1,635 ETFs were neither 
organized as a UIT, nor as a share class of an open-end fund, and do 
not pursue leveraged or inverse investment strategies. During 2017, 
the number of such funds grew by 124. (In the last five years, the 
increase in such funds ranged from 90 in 2013 to 181 in 2015.)
    \427\ Bloomberg defines actively managed or index-based managed 
funds according to disclosure in the fund prospectus.
---------------------------------------------------------------------------

    There were 206 actively managed ETFs with total net assets of $45.8 
billion. The remaining 1,694 funds with combined $3.36 trillion in net 
assets were index-based funds. Of these, 1,686 with total net assets of 
$2.987 trillion were structured as open-end funds and eight with total 
net assets of $372.8 billion were structured as UITs.
    The majority of ETFs, in total 1,456, held some foreign exposure in 
their portfolio according to Morningstar data. These ETFs had total net 
assets of $2.976 trillion. Of these funds, seven were structured as 
UITs and had $350.4 billion in net assets. The remaining 1,449 funds 
and $2.63 trillion in net assets were organized as open-end funds. On 
average, these ETFs reported foreign exposure of 37.75%. This number 
was 57.13% for ETFs structured as UITs and 37.66% for ETFs structured 
as open-end funds.\428\
---------------------------------------------------------------------------

    \428\ We estimate funds' foreign holdings on April 11, 2018 from 
Morningstar data. For each ETF, foreign holdings of equity and debt 
securities are combined to obtain the approximate percentage of 
assets invested in foreign securities. Morningstar provided foreign 
holding data for 1,724 ETFs. In this data, 268 funds, one of which 
is structured as a UIT, reported holding no foreign securities and 
176 funds from the original 1,900 are missing foreign holdings data.
---------------------------------------------------------------------------

2. Exemptive Order Process
    As discussed above, ETFs seeking to operate as investment companies 
historically have needed exemptive relief from the Commission. Since 
the first exemptive relief was granted in 1992, the Commission has 
issued approximately 300 exemptive orders to

[[Page 37382]]

ETFs. The average number of approved exemptive orders between 1992 and 
2006 was approximately 2.5 per year, which has increased to 
approximately 25 per year since 2007.
    Based on our review of exemptive orders that granted relief for 
unleveraged ETFs between January 2007 and mid-March 2018, the median 
processing time from the filing of an initial application to the 
issuance of an order was 221 days, although there was considerable 
variation.\429\ Depending on the complexity of a fund's application, 
some ETF sponsors received exemptive relief in a relatively short 
period of time (the 10th percentile of the processing time was 83 days) 
while others waited over one year for approval (the 90th percentile of 
the processing time was 686 days).
---------------------------------------------------------------------------

    \429\ The earliest order in our sample was approved on 1/17/2007 
and the latest order was approved on 4/10/2018.
---------------------------------------------------------------------------

    In addition to the processing time associated with applying for an 
exemptive order, Commission staff estimates that the direct cost of a 
typical fund's application for ETF relief (associated with, for 
example, legal fees) is approximately $100,000, which may vary 
considerably depending on the complexity of the prospective fund.
3. Market Participants
    As discussed above, several non-ETF market participants may be 
affected by the proposed rule, including fund sponsors, authorized 
participants, trading venues, and institutional and retail investors.
    Using data from Bloomberg, we find that there are 83 unique ETF 
sponsors with approximately 1,900 ETFs as of December 31, 2017. The 
median number of ETFs per sponsor is eight and the mean is 23, 
suggesting that a small number of sponsors have a large share of the 
ETF market (in terms of number of ETFs). Indeed, the top five sponsors 
operate a combined 898 ETFs, whereas the bottom half of sponsors 
operate only a combined 121 ETFs.
    An ETF (or one of its service providers) has contractual 
arrangements with a set of authorized participants, who can place 
orders for the purchase or redemption of creation units with the 
ETF.\430\ While we currently lack data on authorized participants, a 
2015 survey-based study of fifteen fund sponsors, which together offer 
two-thirds of all existing ETFs (covering 90% of all ETF assets), finds 
that the average ETF has 34 authorized participant agreements.\431\ The 
study further reports that creation and redemption transactions 
occurred only on between 10% to 20% of trading days and that only 10% 
of the daily activity in all ETF shares (by volume) are creations or 
redemptions.\432\
---------------------------------------------------------------------------

    \430\ Some market makers and other market participants engage in 
creation and redemptions indirectly through authorized participants. 
See supra section I.B. The Commission, however, lacks data on the 
number of such market participants.
    \431\ See Antoniewicz, supra footnote 30. While we currently 
lack data on authorized participants, we note that, starting July 
30, 2018, Form N-CEN Item E.2 will require a fund to provide certain 
information regarding its authorized participants, including the 
authorized participant's name, the SEC file number, CRD number, and 
other information. See Reporting Modernization Adopting Release, 
supra footnote 147. This Item, however, will not provide data about 
other market participants that may transact through authorized 
participants.
    \432\ NSCC is the sole provider of clearing services for ETF 
primary market transactions. Whether a creation or redemption order 
is eligible to be processed through NSCC depends on the eligibility 
for NSCC processing of the securities in the ETF's basket. See 
Antoniewicz, supra footnote 30.
---------------------------------------------------------------------------

    ETF shares are mainly traded on securities exchanges.\433\ Table 1 
lists the 10 exchanges with the largest average daily ETF trading 
volume, measured over the 30 business days ending on February 12, 2018. 
The data is from Bloomberg and shows that NYSE Arca handles the largest 
portion of ETF trades ($23.8 billion), followed by Nasdaq InterMarket 
($12.8 billion), and Cboe BZX Exchange ($11.0 billion).
---------------------------------------------------------------------------

    \433\ In the first quarter of 2018, 68% of ETF trading by dollar 
volume was executed on exchanges, 23% over the counter, and 10% 
using alternative trading systems (ATSs), based on Trade and Quote 
(TAQ) data provided by the New York Stock Exchange, Trade Reporting 
Facility (TRF) data provided by FINRA, and ATS information made 
publicly available on the FINRA website.

   Table 1--ETFs Listed on National Exchanges and Their Trading Volume
------------------------------------------------------------------------
                                                          Trading volume
                Exchange                  Number of ETFs     (billion)
------------------------------------------------------------------------
NYSE Arca...............................           1,899           $23.8
NASDAQ InterMarket......................           1,537            12.2
Cboe BZX Exchange, Inc..................           1,840            11.0
Cboe EDGX Exchange, Inc.................           1,864             7.4
Cboe BYX Exchange, Inc..................           1,816             4.5
NASDAQ Global Market....................             339             3.2
Nasdaq BX, Inc..........................           1,801             2.7
Chicago Stock Exchange, Inc.............             169             2.5
Cboe EDGA Exchange, Inc.................           1,781             2.4
NASDAQ OMX PSX..........................           1,343             2.2
------------------------------------------------------------------------
The table reports the number of ETFs traded at each exchange and the
  average daily ETF trading volume, measured over the 30 business days
  ending on February 12, 2018. Trading volume is calculated as trade
  price multiplied by the number of shares relating to each price by
  exchange. The figures reflect an analysis by the Commission staff
  using data obtained through a subscription to Bloomberg.

    Both institutional and retail investors participate in the ETF 
secondary market. Using combined data from WRDS SEC Analytics Suite, 
Morningstar, and the Center for Research in Security Prices (CRSP) from 
the first quarter of 2014 to the fourth quarter of 2016, we estimate 
that institutions own, on average, 43% of ETF shares, when calculating 
the average using equal weights for all ETFs, and 55%, when calculating 
the average using total net assets (``TNA'')-based weights. The 
difference between the equal-weighted and TNA-weighted average 
institutional ownership numbers--43% vs. 55%--suggests that 
institutional investors tend to hold larger shares of ETFs with larger 
TNA. The table also shows that the median ownership by institutional 
investors is 40%. Additionally, the table shows that there is 
considerable variation in institutional investor holdings, ranging from 
an average for the 5th percentile of 6% to an average for the 95th 
percentile of 90%.\434\ However, we observe that the average 
institutional holding did not change considerably over time during the 
sample period.
---------------------------------------------------------------------------

    \434\ The data we use is from Form 13F filings, which does not 
capture all institutional positions because Form 13F does not 
require reporting of short positions (which would lead to an 
overstatement of institutional ownership) and because not all 
institutional investors are required to file the form, for example 
because they exercise investment discretion in less than $100 
million in Section 13(f) securities (which would lead to an 
understatement of institutional ownership).

[[Page 37383]]



                                                        Table 2--Institutional Ownership of ETFs
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                 Equal-        TNA-
                           Quarter                              weighted     weighted     SD (%)     P5 (%)    P25 (%)    P50 (%)    P75 (%)    P95 (%)
                                                              average (%)  average (%)
--------------------------------------------------------------------------------------------------------------------------------------------------------
2014Q1......................................................           40           53         24          6         22         37         56         86
2014Q2......................................................           42           54         25          7         22         37         58         90
2014Q3......................................................           41           55         24          7         23         38         59         88
2014Q4......................................................           43           55         24          6         24         40         60         88
2015Q1......................................................           41           54         24          5         22         38         58         85
2015Q2......................................................           42           55         25          6         23         40         60         91
2015Q3......................................................           44           56         26          7         25         41         62         94
2015Q4......................................................           44           57         26          5         24         43         62         92
2016Q1......................................................           44           57         26          5         24         42         62         92
2016Q2......................................................           43           56         26          6         23         41         61         92
2016Q3......................................................           43           56         26          5         24         41         62         91
2016Q4......................................................           44           57         25          6         24         42         61         91
                                                             -------------------------------------------------------------------------------------------
Average.....................................................           43           55         25          6         23         40         60         90
--------------------------------------------------------------------------------------------------------------------------------------------------------
The table reports the quarterly institutional ownership ratio of ETFs, measured as the total number of shares owned by institutional investors divided
  by the total shares outstanding adjusted for share splits. SD refers to standard deviation. Columns P5 to P95 refer to the 5th to 95th percentiles.
  All descriptive stats are equal-weighted except TNA-Weighted Average. The figures reflect an analysis by the Commission staff using data from 2014Q1
  to 2016Q4 obtained through a subscription to WRDS SEC Analytics Suite and the Center for Research in Security Prices (CRSP).

    Further analysis shows that the ownership structure varies 
considerably by the type of ETF. Using Morningstar categories, for the 
fourth quarter of 2016, Table 3 below shows that ETFs' equal-weighted 
average institutional ownership ranges from 23% for alternative ETFs to 
56% for taxable bond ETFs. We also find that TNA-weighted average 
institutional ownership is higher than equal-weighted average 
institutional ownership for international equity, municipal bond, 
sector equity, taxable bond, and U.S. ETFs, suggesting that 
institutional investors tend to hold ETFs with larger TNA within these 
categories. The converse is true for allocation, alternative and 
commodity ETFs. The table also shows that there is large variation 
within categories.\435\
---------------------------------------------------------------------------

    \435\ Morningstar category is assigned based on the underlying 
securities in each portfolio. Per Morningstar, funds in allocation 
categories seek to provide both income and capital appreciation by 
investing in multiple asset classes, including stocks, bonds, and 
cash. Funds in alternative strategies employ investment approaches 
(similar to those used by hedge funds) designed to offer returns 
different than those of the long-only investments in the stock, 
bond, or commodity markets. International equity portfolios expand 
their focus to include stocks domiciled in diverse countries outside 
the United States though most invest primarily in developed markets. 
Municipal bond strategies are generally defined by state or national 
focus and duration exposure. A fund is considered state-specific if 
at least 70% of its assets are invested in municipal securities 
issued by the various government entities of a single state. Sector-
specific equity funds are usually equity funds, in that they 
maintain at least 85% exposure to equity. Fixed Income Taxable bond 
portfolios invest at least 80% of assets in securities that provide 
bond or cash exposure. U.S. equity portfolios are defined as 
maintaining at least 85% exposure to equity and investing at least 
70% of assets in U.S.-domiciled securities.

                                      Table 3--Institutional Ownership of ETFs by Morningstar Category for 2016: Q4
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                 Equal         TNA
                           Quarter                              weighted     weighted     SD (%)     P5 (%)    P25 (%)    P50 (%)    P75 (%)    P95 (%)
                                                              average (%)  average (%)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Allocation..................................................           43           38         26          8         23         36         58         95
Alternative.................................................           23           16         22          2          6         17         33         68
Commodities.................................................           41           38         20         10         29         39         59         71
International Equity........................................           48           63         23         12         31         46         64         91
Municipal Bond..............................................           48           55         16         15         39         50         59         74
Sector Equity...............................................           42           57         22         10         26         40         58         83
Taxable Bond................................................           56           63         21         20         41         57         72         91
U.S. Equity.................................................           45           60         23         11         29         43         59         93
--------------------------------------------------------------------------------------------------------------------------------------------------------
The table reports the institutional ownership ratio of ETFs, measured as the total number of shares owned by institutional investors divided by the
  total shares outstanding adjusted for share splits, by Morningstar Category. SD refers to standard deviation. Columns P5 to P95 refer to the 5th to
  95th percentiles. All descriptive stats are equal-weighted except TNA-Weighted Average. The figures reflect an analysis by the Commission staff using
  data for 2016Q4 obtained a through subscription to WRDS SEC Analytics Suite and the Center for Research in Security Prices (CRSP).

4. Secondary Market Trading, Arbitrage, and ETF Liquidity
    Unlike shares of open-end funds, ETF shares are traded in the 
secondary market at prices that may deviate from the ETF's NAV. As a 
result, ETF investors may trade shares at prices that do not 
necessarily reflect the intrinsic value of the underlying ETF 
assets.\436\ To reduce the frequency and size of ETF premiums and 
discounts, our exemptive orders have contained several conditions 
designed to facilitate an efficient arbitrage mechanism, help ensure 
the proper functioning of the ETF market, and ultimately protect 
investors.
---------------------------------------------------------------------------

    \436\ It is possible for both the ETF's NAV per share and its 
share price to deviate from the intrinsic value of the ETF's 
underlying portfolio. In addition, there may be cases in which the 
ETF's share price is closer to the intrinsic value of the ETF's 
portfolio than its NAV per share. See, e.g., Madhavan, Ananth, & 
Aleksander Sobczyk, Price Discovery and Liquidity of Exchange-Traded 
Funds, 14 Journal of Investment Management 2 (2016).
---------------------------------------------------------------------------

    One set of conditions has required that ETFs be listed on a 
national stock exchange and that exchanges publish the fund's IIV every 
15 seconds for domestic ETFs and every 60 seconds for international 
ETFs. Another condition, which was designed to support the effective 
functioning of the arbitrage mechanism, is portfolio transparency. All 
ETFs in operation today have a provision in their exemptive order that 
requires them to provide some degree of transparency regarding their 
portfolio

[[Page 37384]]

holdings. As discussed above, actively managed ETFs and some ETFs that 
track an index from an affiliated index provider have been required to 
disclose their holdings prior to the commencement of trading each 
business day (i.e., full portfolio transparency). Other index-based 
ETFs are permitted to disclose their portfolio holdings indirectly, by 
specifying which index they seek to track, as long as the index 
provider lists the constituent securities on its website (i.e., index 
transparency) or by disclosing the components of their baskets. Based 
on a staff review of 100 index-based ETFs, randomly selected from all 
index-based ETFs, and 50 actively-managed ETFs, randomly selected from 
all actively-managed ETFs, all 150 ETFs maintain a website and provide 
the ETF's complete daily portfolio holdings. Therefore, we believe that 
all index-based and actively-managed ETFs that could rely on the 
proposed rule now, including those that are not subject to a full 
transparency condition in their exemptive order, currently provide full 
portfolio transparency.\437\
---------------------------------------------------------------------------

    \437\ The samples were randomly drawn from all index-based ETFs 
and all actively managed ETFs currently trading according to 
Bloomberg. We recognize that the selection of ETFs examined by Staff 
overweights the sample of actively managed ETFs relative to the 
entire population of actively managed ETFs. Our sampling procedure 
was done to avoid small sample bias as equally proportioned sampling 
would call for a survey of approximately 2 actively managed funds.
---------------------------------------------------------------------------

    The degree to which ETFs have flexibility in choosing the 
composition of creation and redemption baskets plays an important role 
for the effective functioning of the arbitrage mechanism. A more 
flexible basket composition may, among other considerations discussed 
in more detail below, allow authorized participants to exchange baskets 
for ETF shares at a lower cost, thus increasing arbitrage activity and 
efficient functioning of markets.\438\ The extent to which our 
exemptive orders have allowed ETFs to use creation and redemption 
baskets that deviate from a pro rata representation of the ETF's 
portfolio holdings (i.e., basket flexibility) has evolved over time. 
ETFs that received their exemptive orders in the early period from 
1992-1995 were mostly structured as UITs and, as a result, the creation 
and redemption baskets were mostly a strict pro rata representation of 
the index, plus some cash balancing amount. From 1996 to 2006, 
exemptive orders for ETFs, which then were mostly structured as open-
end funds, did not expressly limit baskets to a pro rata representation 
of the ETF's portfolio holdings. From 2006 to 2010, the Commission 
limited basket flexibility in exemptive orders for ETFs organized as 
open-end funds by requiring baskets to generally represent a pro rata 
slice of the fund's portfolio holdings and including conditions 
limiting the circumstances under which substitutions would be 
permitted. Starting around 2011, the exemptive orders required baskets 
to be a strict pro rata slice of the portfolio holdings and, in 
addition, to be the same for all authorized participants, with minor 
exceptions.\439\
---------------------------------------------------------------------------

    \438\ A more flexible basket composition may create potential 
risks such as dumping and cherry-picking, as discussed in more 
detail below.
    \439\ Our exemptive orders have generally included future funds 
relief to allow sponsors to form and operate new ETFs without having 
to obtain additional exemptive orders. See supra footnote 5. As a 
result, the Commission does not have records that would allow us to 
determine the specific exemptive order under which any particular 
fund is operating. We thus do not quantify the number of funds 
operating under each of the different basket flexibility conditions 
included in our orders.
---------------------------------------------------------------------------

    For ETFs that hold foreign investments in their portfolio, the 
redemption process for these securities may take more than the seven 
days specified under section 22(e) of the Act. The Commission has 
granted exemptive relief to certain ETFs who hold foreign investments, 
in many instances up to 15 days, to satisfy redemption of a foreign 
investment.
    Many exemptive orders have required ETFs to disclose on their 
website, free of charge, the previous day's NAV and the price of the 
ETF shares, as well as the premium or discount associated with the 
ETF's share price at the market close.\440\ Based on a staff review of 
the websites of 150 randomly selected ETFs, all of which provided the 
previous day's NAV, price of the ETF shares (one active ETF provided a 
price based on the midpoint between the bid and ask prices while the 
remainder of the active and all index-based ETFs provided closing 
prices), as well as the premium or discount associated with the ETF 
share price at the market close, we believe that all ETFs that could 
rely on the proposed rule currently disclose this information on their 
website.\441\
---------------------------------------------------------------------------

    \440\ In addition, some funds disclose some historical 
information on premiums and discounts on their website pursuant to 
the flexibility provided on Form N-1A. See supra section II.C.6.c.
    \441\ See supra footnote 437.
---------------------------------------------------------------------------

    ETFs have also been required to have contractual agreements with 
authorized participants to purchase or redeem ETF shares in creation 
unit aggregations in exchange for a basket of securities and other 
assets. Having an accurate estimate of the current ETF share value and 
an opportunity to efficiently create or redeem ETF shares in creation 
unit sizes allows authorized participants to engage in arbitrage 
activity that brings the market price of ETF shares and the value of 
the ETF's portfolio closer together. As noted earlier, market 
participants can also engage in arbitrage activity in the secondary 
market by taking a long and short position on the ETF shares and the 
underlying basket assets. For example, if the ETF is trading at a 
premium relative to the NAV per share of the ETF's portfolio, a market 
participant can short the ETF and buy the underlying basket assets in 
proportion to the ETF shares. Alternatively, if the ETF is trading at a 
discount relative to NAV per share, a market participant may buy the 
ETF and short the underlying basket assets in proportion to the ETF 
shares. Then the market participant could realize a profit by closing 
the position when the gap between the ETF's share price and NAV per 
share gets closer to zero. This trading activity could help close the 
gap even further.
    However, authorized participants, other market participants, and 
arbitrageurs acting in secondary markets may incur costs and be exposed 
to risk when engaging in arbitrage. The costs include bid-ask spreads 
and transaction fees associated with the arbitrage trades. In addition, 
during the time it takes arbitrageurs to execute these trades, they are 
exposed to the risk that the prices of the basket assets and the ETF 
shares change. As a consequence, arbitrageurs may decide to wait for 
any mispricing between the market price of ETF shares and NAV per share 
to widen until the expected profit from arbitrage is large enough to 
compensate for any additional costs and risks associated with engaging 
in the transaction.
    Using data from Bloomberg, we find that ETFs, on average, trade at 
a price slightly higher than the NAV per share (i.e., at a premium), as 
shown in Table 4 below. The equal-weighted and TNA-weighted average 
premium/discount over the last 15 years for all ETFs in the dataset 
are, respectively, 0.074% and 0.065%, and the median is 0.024%, 
indicating that the prices of ETF shares are, on average, higher than 
the NAV per share. One study finds similar results and concludes that, 
on average, ETF market prices tend to reflect NAV per share closely. 
However, consistent with the study, we find that ETF premiums/discounts 
vary significantly.\442\ For example, we find

[[Page 37385]]

that the average premiums/discounts ranges from 0.03% in 2003 to 0.14% 
in 2009, and the average standard deviation of premiums/discounts 
ranges from 0.16% in 2017 to 0.60% in 2008. Moreover, not all ETF 
shares trade at a premium. For example, the table shows, in a given 
year, at least 25% of ETF shares trade at a discount, at an average 
discount of -0.044% between all years (see the column P25).
---------------------------------------------------------------------------

    \442\ Commenters to our 2015 ETP Request for Comment, supra 
footnote 9, report qualitatively similar results. See, e.g., Comment 
Letter of Eaton Vance Corp. to Request for Comment on Exchange-
Traded Products (File No. S7-11-15) (Aug. 17, 2015).

                    Table 4--Time-Series Averages of Cross-Sectional Descriptive Statistics of Premium/Discount (%) Using Daily Data
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                 Equal         TNA
                            Year                                weighted     weighted       SD         P5        P25        P50        P75        P95
                                                                average      average
--------------------------------------------------------------------------------------------------------------------------------------------------------
2003........................................................        0.134        0.030      0.235     -0.215     -0.061      0.015      0.091      0.343
2004........................................................        0.095        0.039      0.262     -0.259     -0.060      0.023      0.095      0.549
2005........................................................        0.058        0.078      0.276     -0.221     -0.038      0.036      0.111      0.617
2006........................................................        0.074        0.082      0.338     -0.344     -0.042      0.029      0.141      0.671
2007........................................................        0.140        0.079      0.386     -0.389     -0.060      0.034      0.198      0.639
2008........................................................        0.087        0.100      0.603     -0.785     -0.142      0.055      0.343      1.054
2009........................................................        0.126        0.143      0.537     -0.557     -0.079      0.020      0.342      1.027
2010........................................................        0.072        0.066      0.353     -0.436     -0.046      0.022      0.164      0.635
2011........................................................        0.035        0.068      0.412     -0.550     -0.040      0.021      0.170      0.766
2012........................................................        0.058        0.072      0.286     -0.309     -0.019      0.022      0.141      0.582
2013........................................................        0.060        0.035      0.278     -0.352     -0.025      0.017      0.091      0.432
2014........................................................        0.046        0.038      0.216     -0.245     -0.013      0.016      0.082      0.351
2015........................................................        0.036        0.042      0.235      -0.25     -0.015      0.015      0.079      0.401
2016........................................................        0.026        0.044      0.228     -0.222     -0.015      0.013      0.091      0.389
2017........................................................        0.069        0.058      0.159     -0.085     -0.008      0.015      0.094      0.332
                                                             -------------------------------------------------------------------------------------------
Average.....................................................        0.074        0.065      0.320     -0.348     -0.044      0.024      0.149      0.586
--------------------------------------------------------------------------------------------------------------------------------------------------------
The table reports time-series averages of cross-sectional descriptive statistics of premiums/discounts (%). The TNA-Weighted Average is weighted based
  on an ETF's previous month's total net assets. SD refers to standard deviation. Columns P5 to P95 refer to the 5th to 95th percentiles. Fund premiums
  or discounts are from daily Bloomberg data covering 1,838 funds for a total of 2,732,620 daily observations. Per Bloomberg, premium/discount (%) is
  the difference between the fund's closing price on the day of the most recent Net Asset Value (NAV) and the NAV of the fund on that day. The data
  covers the period from 01/03/2003 to 08/31/2017.

    Premiums and discounts to NAV per share also vary considerably by 
the type of assets that make up the ETF.\443\ We use Morningstar 
investment categories to divide ETFs into groups of similar assets and, 
in Table 5, report the time-series averages of cross-sectional 
descriptive statistics for premiums/discounts in the different 
Morningstar Investment Categories. We find that the TNA-weighted 
average premium/discount ranges from as low as 0.003% for alternative 
to 0.197% for taxable bond ETFs. The results are qualitatively similar 
for equal-weighted average premium/discounts.
---------------------------------------------------------------------------

    \443\ See Engle Article, supra footnote 95.

           Table 5--Time-Series Averages of Cross-Sectional Descriptive Statistics of Premium/Discount (%) by Morningstar Investment Category
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                 Equal         TNA
                          Category                              weighted     weighted       SD         P5        P25        P50        P75        P95
                                                                average      average
--------------------------------------------------------------------------------------------------------------------------------------------------------
Allocation..................................................        0.072        0.083      0.233     -0.119     -0.039      0.047      0.237      0.295
Alternative.................................................        0.007        0.003      0.345     -0.404     -0.126     -0.004      0.116      0.468
Commodities.................................................        0.211        0.112      0.481     -0.545      0.011      0.084      0.158      1.007
International Equity........................................        0.185        0.193      0.440     -0.482     -0.068      0.204      0.458      0.833
Municipal Bond..............................................        0.086        0.076      0.314     -0.358     -0.090      0.061      0.273      0.532
Sector Equity...............................................        0.031        0.013      0.189     -0.243     -0.074      0.005      0.085      0.304
Taxable Bond................................................        0.207        0.197      0.206     -0.068      0.088      0.188      0.273      0.539
U.S. Equity.................................................       -0.001        0.005      0.079     -0.104     -0.036      0.008      0.048      0.113
--------------------------------------------------------------------------------------------------------------------------------------------------------
The table reports time-series averages of cross-sectional descriptive statistics of premiums/discounts (%). The funds are first divided into groups
  based on Morningstar categories. The TNA-Weighted Average is weighted based on an ETF's previous month's total net assets. SD refers to standard
  deviation. Columns P5 to P95 refer to the 5th to 95th percentiles. Fund premiums or discounts are from daily Bloomberg data covering 1,838 funds for a
  total of 2,732,620 daily observations. Per Bloomberg, premium/discount (%) is the difference between the fund's closing price on the day of the most
  recent Net Asset Value (NAV) and the NAV of the fund on that day. The data covers the period from 01/03/2003 to 08/31/2017.

    When the ETF arbitrage mechanism functions effectively, ETFs also 
should trade at smaller bid-ask spreads.\444\ As shown in Table 6, the 
TNA-weighted average bid-ask spread, as a percentage of the mid-price, 
has declined from 0.062% in 2012 to 0.030% in 2017.\445\ The table 
shows a qualitatively similar decreasing pattern when using equal-
weighted average bid-ask spreads. The percentiles of the bid-ask 
spreads also follow a decreasing trend. For example, we observe that 
the median bid-ask spread drops from 0.024% in 2012 to 0.016% in 2017 
(see column P50). The table also shows that the bid-ask spread varies 
considerably. For example, the average standard deviation of the bid-
ask spread (0.081%) is almost twice as large as its average (0.043%).
---------------------------------------------------------------------------

    \444\ See, e.g., CFA Guide, supra footnote 370.
    \445\ This analysis starts in 2012 because the available data 
begins in that year.

[[Page 37386]]



                         Table 6--Time-Series Averages of Cross-Sectional Descriptive Statistics of Relative Bid-Ask Spread (%)
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                 Equal         TNA
                            Year                                weighted     weighted       SD         P5        P25        P50        P75        P95
                                                                average      average
--------------------------------------------------------------------------------------------------------------------------------------------------------
2012........................................................        0.370        0.062      0.125      0.007      0.016      0.024      0.049      0.275
2013........................................................        0.330        0.053      0.106      0.006      0.014      0.022      0.048      0.212
2014........................................................        0.273        0.038      0.061      0.005      0.012      0.020      0.045      0.114
2015........................................................        0.324        0.039      0.067      0.005      0.012      0.019      0.045      0.122
2016........................................................        0.372        0.037      0.066      0.005      0.011      0.019      0.038      0.111
2017........................................................        0.349        0.030      0.063      0.004      0.009      0.016      0.030      0.086
                                                             -------------------------------------------------------------------------------------------
Average.....................................................        0.336        0.043      0.081      0.005      0.012      0.020      0.043      0.153
--------------------------------------------------------------------------------------------------------------------------------------------------------
This table reports time-series averages of cross-sectional descriptive statistic of relative bid-ask spreads (%). The TNA-Weighted Average is weighted
  based on an ETF's previous month's total net assets. SD refers to standard deviation. Columns P5 to P95 refer to the 5th to 95th percentiles. Bid-ask
  spreads are from daily Bloomberg data covering 1,838 funds for a total of 1,843,729 daily bid-ask spreads. Per Bloomberg, the bid-ask spread (%) is
  the average of all bid/ask spreads taken as a percentage of the mid-price. The data covers the period from 01/03/2003 to 08/31/2017.

    Table 7 reports bid-ask spreads for ETF shares by Morningstar 
category. US Equity ETFs have the smallest average bid-ask spread of 
0.027%, whereas allocation ETFs--funds that seek to provide both income 
and capital appreciation by investing in multiple asset classes, 
including stocks, bonds, and cash strategy--have the largest average 
bid-ask spread of 0.223%.

            Table 7--Time-Series Averages of Cross-Sectional Descriptive Statistics of Relative Bid-Ask Spread (%) by Morningstar Investment
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                 Equal         TNA
                          Category                              weighted     weighted       SD         P5        P25        P50        P75        P95
                                                                average      average
--------------------------------------------------------------------------------------------------------------------------------------------------------
Allocation..................................................        0.590        0.223      0.307      0.073      0.084      0.147      0.227      0.642
Alternative.................................................        0.391        0.094      0.162      0.017       0.03      0.047      0.089      0.315
Commodities.................................................        0.353        0.041      0.060      0.009      0.009      0.009      0.061      0.118
 International Equity.......................................        0.450        0.072      0.110      0.017      0.024      0.030      0.086      0.212
Municipal Bond..............................................        0.281        0.100      0.111      0.038      0.045      0.064      0.107      0.306
Sector Equity...............................................        0.285        0.061      0.092      0.015      0.018      0.036      0.062      0.198
Taxable Bond................................................        0.306        0.043      0.080      0.011      0.014      0.016      0.041      0.159
U.S. Equity.................................................        0.207        0.027      0.041      0.006      0.012      0.014      0.029      0.081
--------------------------------------------------------------------------------------------------------------------------------------------------------
This table reports time-series averages of cross-sectional descriptive statistic of relative bid-ask spreads (%). The funds are first divided into
  groups based on Morningstar categories. The mean is weighted based on an ETF's previous month TNA and the data covers the period from 01/03/2012 to 08/
  31/2017. SD, Min and Max refer to standard deviation, minimum and maximum. Columns P5 to P95 refer to the 5th to 95th percentiles. Bid-ask spreads are
  from daily Bloomberg data covering 1,838 funds for a total of 1,843,729 daily bid-ask spreads. Per Bloomberg, the bid-ask spread (%) is the average of
  all bid/ask spreads taken as a percentage of the mid-price.

    The summary statistics presented thus far in this section suggest 
that the arbitrage mechanism generally functions effectively during 
normal market conditions. However, as described above in section III.B, 
the Commission has observed periods of market stress during which the 
arbitrage mechanism has functioned less effectively and during which 
there were significant deviations for some ETFs between market price 
and NAV per share and when bid-ask spreads widened considerably. We 
note, however, that these conditions only persisted for very short 
periods of time for the periods of market stress we have observed, 
suggesting that the arbitrage mechanism recovered quickly.\446\
---------------------------------------------------------------------------

    \446\ See, e.g. Madhavan Article, supra footnote 130.
---------------------------------------------------------------------------

C. Benefits and Costs of Proposed Rule 6c-11 and Amendments to Forms N-
1A and N-8B-2

    The Commission is sensitive to the economic effects that could 
result from proposed rule 6c-11 and amendments to Forms N-1A and N-8B-
2, including benefits and costs. However, as discussed in further 
detail below, the Commission is unable to quantify many of the economic 
effects, either because they are inherently difficult to quantify or 
because we lack the information necessary to provide a reasonable 
estimate.
1. Proposed Rule 6c-11
    Proposed rule 6c-11 would allow new ETFs to operate in reliance on 
a rule rather than individual exemptive orders if they meet the 
requirements and conditions of the rule. In addition, we propose to 
rescind all existing ETF exemptive orders, with the exception of: (i) 
The section 12(d)(1) relief included in those orders; \447\ and (ii) 
orders relating to ETFs structured as UITs, leveraged ETFs, and those 
that are organized as a share class of a mutual fund.\448\ This section 
first evaluates the general considerations associated with the proposed 
rulemaking and then discusses the effects of the specific requirements 
and conditions of the proposed rule.
---------------------------------------------------------------------------

    \447\ The proposal would however rescind relief that has been 
provided to allow master-feeder arrangements for those ETFs that do 
not currently rely on the relief. In addition, we propose to 
grandfather existing master-feeder arrangements involving ETF feeder 
funds, but prevent the formation of new ones, by amending relevant 
exemptive orders.
    \448\ ETFs relying on exemptive orders that we propose to 
rescind could no longer rely on their orders to launch additional 
ETFs.
---------------------------------------------------------------------------

a. General Considerations
    Proposed rule 6c-11 would grant exemptive relief from the 
provisions of the Act that would otherwise prohibit several features 
essential to the ETF structure. This section evaluates the overall 
effect of reducing the expense and delay of operating certain new ETFs 
by granting this exemptive relief as part of a rule rather than through 
the individual exemptive order process.
    As the requirements and conditions of the proposed rule are either 
similar to those contained in existing exemptive orders, consistent 
with market practice, or generally provide more flexibility, we 
anticipate that the proposed rule and the related rescission of ETF 
exemptive

[[Page 37387]]

relief would not require any existing ETFs whose exemptive relief would 
be rescinded to significantly change the way they operate. Conversely, 
some funds whose exemptive orders contain conditions that are more 
restrictive than those contained in the proposed rule may decide to 
change the way they operate in order to make use of such increased 
flexibility.
    Relative to the baseline, proposed rule 6c-11 would eliminate the 
costs associated with applying to the Commission for an exemptive order 
to form and operate as an ETF for funds relying on the rule. 
Specifically, the process of forming new ETFs in reliance on the 
proposed rule would be quicker, more predictable, less complex, and 
therefore less costly than obtaining an exemptive order as new ETFs are 
currently required to do. ETFs that could not rely on the rule, which 
includes those structured as UITs, leveraged ETFs, and those that are 
organized as a share class of a mutual fund, would continue to be 
required to apply for an exemptive order to form and operate.\449\
---------------------------------------------------------------------------

    \449\ As discussed below, some ETFs would incur additional costs 
as a result of the rule's requirement to adopt and implement written 
policies and procedures that govern the construction of basket 
assets and the process that will be used for the acceptance of 
basket assets, the rule's additional website disclosure 
requirements, and the proposed amendments to Forms N-1A and N-8B-2. 
The operation of such ETFs may therefore become more costly, on 
balance, to the extent that these costs are not offset by the 
benefits from the other parts of the proposed rule, such as the 
increased basket flexibility and, for new funds, the reduced costs 
of forming the fund.
---------------------------------------------------------------------------

    As described above in section IV.B.2, we estimate that the cost for 
a typical ETF of filing for exemptive relief is $100,000. In addition, 
based on our review of exemptive orders that granted relief for 
unleveraged ETFs between January 2007 and mid-March 2018, the median 
processing time from the filing of an initial application to the 
issuance of an order was 221 days, although there was considerable 
variation. Thus, any new ETF planning to operate within the parameters 
set forth by the proposed rule would save this expected cost and avoid 
this delay. In addition, such ETFs would avoid the uncertainty about 
the length of the delay associated with the exemptive order process, 
allowing sponsors to better control the timetable for launching a new 
ETF product in a way that maximizes benefits to its business. 
Conversely, funds that are not able to comply with the conditions of 
the rule would continue to need to apply for an exemptive order. 
Assuming that the number of new ETFs seeking to form and operate under 
the proposed rule that would otherwise have needed to apply for 
exemptive relief is equal to the average number of ETFs that have 
applied for exemptive relief since 2007, these cost and time savings 
would accrue to approximately 25 ETFs per year.\450\ Using this 
assumption, the annual costs savings to this group of ETF sponsors 
would equal $2.5 million.\451\ We are unable to quantify the benefit a 
new ETF would derive from avoiding the delay and the uncertainty about 
the length of the delay associated with the exemptive order process as 
the cost of a delayed registration for a new ETF is inherently 
difficult to measure.
---------------------------------------------------------------------------

    \450\ Compared to the baseline, these cost and time savings 
would only accrue to such new ETFs whose sponsors have not received 
exemptive relief that would allow such ETFs to operate.
    \451\ This estimate is based on the following calculation: 25 x 
$100,000 = $2,500,000.
---------------------------------------------------------------------------

    By eliminating the need for ETFs that can rely on the proposed rule 
to seek an exemptive order from the Commission, the proposed rule would 
also eliminate certain indirect costs associated with the exemptive 
application process. Specifically, ETFs that apply for an order forgo 
potential market opportunities until they receive the order, while 
others forgo the market opportunity entirely rather than seek an 
exemptive order because they have concluded that the cost of seeking an 
exemptive order would exceed the anticipated benefit of the market 
opportunity.
    In addition, we believe that the proposed rule would make it easier 
for some fund complexes to ensure that each ETF in the complex is in 
compliance with regulations. Specifically, we anticipate that it would 
be easier, and thus less costly, for ETF complexes that today operate 
funds under multiple exemptive orders to ensure compliance with a 
single set of requirements and conditions contained in the proposed 
rule rather than with multiple exemptive orders to the extent that the 
orders vary in the requirements and conditions they contain.
    We acknowledge that fund complexes may initially incur costs 
associated with assessing the requirements of the proposed rule. 
However, we believe that these costs would be relatively small.\452\ In 
addition, we anticipate that it would be easier for third-party 
providers, such as lawyers and compliance consultants, to offer 
services that help ETFs ensure compliance with the proposed rules, 
which will have broad applicability, than is currently the case with 
ETFs relying on exemptive orders with varying conditions. As a result, 
third party service providers may be able to reduce the price of their 
services, compared to the baseline, for ETFs that could rely on the 
proposed rule, which may partially or fully offset the initial costs of 
studying the requirements of the proposed rulemaking that ETFs may 
incur.
---------------------------------------------------------------------------

    \452\ We estimate that assessing the requirements of the 
proposed rule would require 5 hours of a compliance manager ($298 
per hour) and 5 hours of a compliance attorney ($352 per hour), 
resulting in a cost of $6,500 (10 x $298 + 10 x $352) per fund. The 
total cost for all 1,635 ETFs that could rely on the proposed rule 
would thus be $10,627,500 (1,635 x $6,500). The Commission's 
estimates of the relevant wage rates are based on salary information 
for the securities industry compiled by the Securities Industry and 
Financial Markets Association's Office Salaries in the Securities 
Industry 2013. The estimated wage figures are modified by Commission 
staff to account for an 1,800-hour work-year and multiplied by 2.93 
to account for bonuses, firm size, employee benefits, overhead, and 
adjusted to account for the effects of inflation. See Securities 
Industry and Financial Markets Association, Report on Management & 
Professional Earnings in the Securities Industry 2013 (``SIFMA 
Report'').
---------------------------------------------------------------------------

    We expect that the proposed rule also would benefit ETF investors 
to the extent it would remove a possible disincentive for ETF sponsors 
to form and operate new ETFs that provide investors with additional 
investment choices for which these sponsors currently do not have 
relief. As noted above, the direct and indirect costs of the exemptive 
application process may discourage potential sponsors, particularly 
sponsors interested in offering smaller, more narrowly focused ETFs 
that may serve the particular investment needs of certain investors. By 
eliminating the need for individual exemptive relief we anticipate that 
the proposed rule would accelerate the rate at which the ETF industry 
would otherwise grow. In those circumstances, the proposed rule would 
provide ETF investors with greater investment choices.
    As we discuss below in section IV.D, we believe that the proposed 
rule could increase competition in the ETF market as a whole, which 
could also lead to lower fees. Any effect of increased competition on 
fees would likely be larger for segments of the ETF market that 
currently may be less competitive (e.g., active ETFs) and smaller for 
segments of the market that currently may be more competitive (e.g., 
index-based ETFs tracking major stock indices).
    Additionally, some types of funds could experience reductions in 
trading costs associated with bid-ask spreads or premiums and discounts 
to NAV per share. Specifically, as discussed below in section IV.C.1.c, 
the proposed rule's increased basket flexibility could reduce

[[Page 37388]]

the cost of arbitrage for authorized participants of fixed-income, 
international and actively managed ETFs more than for authorized 
participants and other market participants of other types of ETFs. This 
could potentially lead to a reduction in costs for investors associated 
with bid-ask spreads and premiums and discounts to NAV per share for 
fixed-income and international ETFs that could be significantly smaller 
or immaterial for other types of ETFs.
    As discussed above, by eliminating the need for individual 
exemptive relief, we anticipate that the proposed rule would, over 
time, lead to an increase in ETFs that can meet the requirements and 
conditions of the rule and thus reinforce the current growth trend in 
the ETF industry. In addition, the proposed rule would increase demand 
for such ETFs, to the extent that such ETFs lower their fees to 
investors and investors are sensitive to fees.\453\ To the extent that 
some ETFs would experience larger reductions in trading costs (e.g., 
fixed-income, international, and active) or larger increases in 
competition (e.g., actively managed), demand for these types of ETFs 
would likely increase more than for other types of ETFs. The increased 
demand would likely be due in part to investors substituting away from 
comparable types of funds, such as mutual funds, and possibly due to 
investors increasing the rate at which they save.\454\ Consequently, 
the proposed rule could increase total assets of ETFs and could 
decrease total assets of other funds, such as mutual funds. The size of 
these effects would depend on the degree to which ETFs would lower 
their fees or experience reduced trading costs, as well as on the 
sensitivity of investor demand for ETFs and other funds to changes in 
ETF fees and trading costs. We are unable to quantify these effects on 
investor demand for various types of funds, in part, because we cannot 
estimate the extent to which funds would lower their fees or experience 
reduced trading costs and how lower fees and trading costs could change 
investor demand.
---------------------------------------------------------------------------

    \453\ There is research to support that fund investors are 
sensitive to fees. For instance, one paper (Erik R. Sirri & Peter 
Tufano, Costly Search and Mutual Fund Flows, 53 The Journal of 
Finance 5 (1998)) finds that ``lower-fee funds and funds that reduce 
their fees grow faster''. However, we acknowledge that there are 
studies that suggest that investors' sensitivity to fees may be 
limited. For instance, one experimental study (James J. Choi, David 
Laibson, & Brigitte C. Madrian, Why does the law of one price fail? 
An experiment on index mutual funds, 23 The Review of Financial 
Studies 4 (2010)) finds that investors may not always pick the 
lowest-fee fund when presented with a menu of otherwise identical 
funds to choose from. In addition, other studies (e.g., Michael J. 
Cooper, Michael Halling, & Wenhao Yang, The Mutual Fund Fee Puzzle, 
Working Paper (2016)) find evidence of significant fee dispersion 
among mutual funds, even after controlling for other observable 
differences between funds. While these studies investigate the 
sensitivity of investors to fees of mutual funds rather than ETFs, 
we believe that these results are likely hold for ETFs as well. We 
are not aware of any studies that specifically study the sensitivity 
of ETF investors to fees.
    \454\ Investments in ETFs are one of many ways for investors to 
save. If investors choose to increase their investment in ETFs, 
there can be two sources for this additional investment: (1) An 
increase in overall savings and (2) a decrease in savings allocated 
to other investments, such as mutual funds. These two sources are 
not mutually exclusive, so that an increase in ETF investments can 
be accompanied by both an increase in overall savings and a decrease 
in savings invested elsewhere, for example in mutual funds.
---------------------------------------------------------------------------

    Since ETFs are traded in the secondary market, an increase in total 
assets of ETFs would likely coincide with larger trade volumes for the 
exchanges where ETFs are traded, as well as the clearing agencies and 
broker-dealers involved in these trades. To the extent that these 
market participants are compensated by volume, the proposed rule would 
thus benefit them by leading to an increase in revenues.
    In addition, we expect the proposed rule to remove applications for 
more standard forms of exemptive relief from consideration, leaving for 
staff review only applications for more complex or novel exemptive 
relief that falls outside the parameters of the proposed rule. To the 
extent that this speeds up the processing time for these remaining 
applications, the proposal may reduce the indirect costs of forming and 
operating for funds that seek to operate outside its parameters.
b. Conditions for Reliance on Proposed Rule
    Proposed rule 6c-11 contains several conditions that are designed 
to facilitate an effective arbitrage mechanism, reduce costs, and 
inform and protect investors. Beyond the general impact of reducing the 
expense and delay of new ETFs discussed above, much of the codification 
of conditions in proposed rule 6c-11 does not offer any additional 
benefits or costs when measured against the baseline, as they are 
generally codifications of the current regulatory practice. However, 
some conditions are departures from current exemptive orders or current 
market practice and we discuss the effects of these departures in more 
detail below.
i. Conditions We Believe May Facilitate an Effective Arbitrage 
Mechanism
    Arbitrage is the practice of buying and selling equivalent or 
similar assets (or portfolios of assets) in different markets to take 
advantage of a price difference.\455\ As a consequence, arbitrageurs 
generate price pressure that works to equalize the prices of these 
assets across different markets. Arbitrage is thus important for 
investors as it helps ensure that asset prices reflect market 
fundamentals (i.e., are efficient) irrespective of the market in which 
they are traded.
---------------------------------------------------------------------------

    \455\ See, e.g., Jonathan B. Berk & Peter DeMarzo, Corporate 
Finance, 3rd Ed (2013).
---------------------------------------------------------------------------

    The ETF structure makes use of such an arbitrage mechanism with the 
goal of establishing a close link between the price of an ETF's shares 
and the NAV per share of the ETF portfolio. Specifically, as discussed 
above, the combination of the creation and redemption process with the 
secondary market trading in ETF shares provides arbitrage opportunities 
that, if effective, help keep the market price of ETF shares at or 
close to the NAV per share of the ETF and also help reduce bid-ask 
spreads of ETF shares. Smaller deviations of ETF prices from the NAV 
per share of the ETF benefit investors as they allow investors to 
transact in ETF shares at prices closer to the value of the ETF's 
underlying portfolio of securities. Similarly, small bid-ask spreads 
for ETF shares benefit investors as they reduce the cost to trading ETF 
shares.\456\
---------------------------------------------------------------------------

    \456\ For a detailed discussion of the ETF arbitrage mechanism, 
see, e.g., CFA Guide, supra footnote 370.
---------------------------------------------------------------------------

    There are several factors that are important for arbitrageurs to 
determine the existence of arbitrage opportunities and execute an 
arbitrage strategy effectively. First, when the assets involved in the 
arbitrage are similar but not the same, as is the case for ETFs, 
arbitrage will be more effective the more closely the prices of the two 
assets track each other and the more transparency arbitrageurs have 
into any factors that may cause price differences between the two 
assets. In addition, arbitrage requires that arbitrageurs have the 
ability to enter into the trades necessary to execute the arbitrage 
strategy, and arbitrage is more effective the smaller and more 
predictable the associated trading costs are. The proposed rule 
contains several provisions (many codifying current exemptive orders) 
that take these considerations into account and are designed to promote 
the effective functioning of the arbitrage mechanism for ETFs.
    First, the proposed rule would require ETFs relying on the rule to 
adopt and implement written policies and procedures that govern the 
construction of basket assets and the process that will be used for the 
acceptance of basket assets, including policies and

[[Page 37389]]

procedures specific to the creation of custom baskets.
    As discussed in section II.C.5.a, the proposed additional policies 
and procedures requirements for custom baskets are designed to reduce 
the potential for cherry-picking, dumping, and other potential abuses 
by authorized participants. We acknowledge that this principles-based 
approach may not be effective at preventing all such abuses by 
authorized participants. However, as proposed, ETFs would be required 
to maintain records related to the custom baskets used, which would 
allow the Commission to examine for potential abuses.
    As outlined above, current exemptive orders contain varying 
provisions for basket flexibility. However, based on a staff review of 
existing orders, we believe that the existing ETFs that would operate 
under the proposed rule and have their exemptive orders rescinded would 
not be required to change how they construct their baskets, because the 
proposed rule would give ETFs the ability to implement policies and 
procedures for basket flexibility, subject to certain enumerated 
requirements for the custom basket policies and procedures. In 
addition, we expect that some existing ETFs that would operate under 
the proposed rule would be able to implement policies and procedures 
with respect to basket flexibility that would give them more 
flexibility than what is allowed by their existing exemptive orders.
    We believe that fixed-income, international, and actively managed 
ETFs would particularly benefit from the increased basket flexibility 
the rule would afford compared to existing exemptive orders. 
Specifically, the increased basket flexibility should allow fixed-
income ETFs to avoid losing hard-to-find bonds when meeting redemptions 
or to use sampling techniques to construct baskets that are composed of 
fewer individual bonds and thus reduce trading costs for authorized 
participants. Similarly, international ETFs would be able to tailor 
their creation and redemption baskets to accommodate difficulties in 
transacting in certain international securities. In addition, actively 
managed ETFs would, in certain instances, be able to use the increased 
basket flexibility to acquire or dispose of securities by adjusting the 
composition of the creation or redemption basket rather than by 
directly purchasing or selling the securities. In these instances, 
actively managed funds would be able to reduce certain transaction 
costs, such as those associated with bid-ask spreads.
    For these reasons we believe the proposed rule would benefit ETFs 
that make use of the increased basket flexibility the rule affords as 
well as their investors to the extent that ETFs are able to implement 
procedures that facilitate the arbitrage mechanism or reduce costs for 
the ETFs. Due to a lack of data, however, we are unable to quantify the 
number of ETFs that would choose to implement policies and procedures 
to increase basket flexibility, and thus the potential benefits arising 
to ETFs and their investors.
    To the extent that existing ETFs do not already have policies and 
procedures governing basket assets in place, ETFs would incur a cost 
associated with developing and implementing such policies and 
procedures.\457\ However, such costs may be partially or totally offset 
by the basket flexibility discussed above. As discussed in section 
IV.B, we estimate that an average ETF would incur an initial cost of 
$10,268 \458\ associated with setting up the process for documenting 
the construction and acceptance of baskets and with documenting and 
adopting the custom basket policies and procedures. In addition, we 
estimate that an average ETF would incur an ongoing cost of $3,985 
\459\ each year to review and update its custom basket policies and 
procedures as well as its process for documenting the construction and 
acceptance of baskets. We thus estimate that the total industry cost 
associated with the policies and procedures requirement in the proposed 
rule for ETFs that could rely on the rule in the first year would equal 
$23,303,655.\460\
---------------------------------------------------------------------------

    \457\ While exemptive orders do not require ETFs to have 
policies and procedures for basket assets in place, we believe that 
some ETFs may currently have methodologies or compliance policies 
for basket assets in place.
    \458\ See infra footnote 553.
    \459\ See infra footnote 554.
    \460\ This estimate is based on the following calculation: 
($10,268 + $3,985) x 1,635 ETFs = $23,303,655. This estimate may be 
an over-estimate in that it assumes that all ETFs, regardless of 
their actual use of custom baskets, would implement policies and 
procedures for custom basket assets.
---------------------------------------------------------------------------

    Second, the proposed rule would require an ETF to disclose 
prominently on its website the portfolio holdings that will form the 
basis for the next calculation of NAV per share. We believe that this 
requirement supports the effective functioning of the arbitrage 
mechanism as it allows authorized participants to identify arbitrage 
opportunities and chose an appropriate hedging strategy.
    As discussed above in section III.B.4, the requirements for 
portfolio transparency in existing exemptive orders have varied.\461\ 
As also discussed in section III.B.4, based on a staff review of ETFs' 
websites, we understand that all ETFs that could rely on the proposed 
rule currently provide daily full portfolio transparency, including all 
actively managed ETFs, and thus already bear ongoing costs associated 
with maintaining such disclosures.\462\ However, we believe that the 
ETFs that could rely on the proposed rule would incur a one-time cost 
associated with reviewing whether their current portfolio disclosure is 
compliant with the requirements of proposed rule 6c-11 and, if 
necessary, make changes to the information that is presented on their 
website.\463\ We estimate this one-time cost to be $1,939.50 for the 
average ETF, resulting in an aggregate one-time cost of $3,171,082.50 
for all ETFs that could rely on the proposed rule.\464\
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    \461\ Actively managed ETFs and some ETFs that track an index 
from an affiliated index provider have been required to disclose 
their holdings prior to the commencement of trading each business 
day (i.e., full portfolio transparency). Other index-based ETFs are 
permitted to disclose their portfolio holdings indirectly, by 
specifying which index they seek to track, as long as the index 
provider lists the constituent securities on its website (i.e., 
index transparency) or by disclosing the components of their 
baskets. Some index-based ETFs have been required to provide full 
portfolio transparency. See discussion of portfolio transparency, 
supra section II.C.4.a; see also supra footnote 207 and accompanying 
text.
    \462\ From a staff review of ETF websites, the sampled index and 
actively-managed ETFs already provide daily portfolio holdings. 
Extrapolating the sampled results to the entire universe of ETFs, 
ETFs in general should bear no additional costs above the baseline 
to collect and maintain on their websites these holdings. If some 
ETFs that were not sampled, however, do not currently maintain on 
their websites their daily portfolio holdings, Commission staff 
estimates that an ETF each year would spend approximately 5 hours of 
professional time to update the relevant web page daily with this 
information at a cost of $1,405.50. See supra note 537. We 
preliminarily believe that the number of ETFs that would have to 
bear these additional costs would be small due to our experience 
with the sampled ETFs.
    \463\ The proposed rule would require that portfolio holdings 
information be presented and contain information regarding 
description, amount, value and/or unrealized gain/loss (if 
applicable) in the manner prescribed within Article 12 of Regulation 
S-X.
    \464\ This estimate is based on the following calculations: 3 
hours (for website development) x $296.50 per hour (blended rate for 
a senior systems analyst ($274) and senior programmer ($319) + 2 
hours (for review of current portfolio disclosures) x $325 (blended 
rate for a compliance manager ($298) and a compliance attorney 
($352)) + $400 for external website development = $1,939.50. The 
industry cost is 1,635 x $1,939.50 = $3,171,082.50.
---------------------------------------------------------------------------

    Finally, the proposed rule also would require additional disclosure 
by the ETF of the median daily bid-ask spread over the most recent 
fiscal year on its website. We believe that this

[[Page 37390]]

requirement would further inform investors about the expected cost of 
trading an ETF and facilitate comparison of transaction costs across 
ETFs. As such, the disclosure of median bid-ask spreads could reduce 
investors' uncertainty about the trading environment and facilitate the 
selection of ETF investments that fit individual investors' needs. 
Currently, disclosure of median bid-ask spreads by ETFs are not 
required by exemptive orders, although some funds may voluntarily 
provide this information on their websites. For those funds that do not 
already disclose this information, they would have to implement 
processes and systems to compute the median bid-ask spreads and would 
have to accommodate a new data point on their web page to report this 
information. We preliminarily do not believe the incremental cost of 
such disclosure will be substantial. The estimated costs for computing 
and establishing processes and systems to update the median bid-ask 
spread are $296.50 per fund, while aggregate costs for computing and 
updating the web pages of ETFs to include the median bid-ask spread 
would be $484,777.50.\465\ We preliminarily believe that funds will 
incorporate the processes of updating the median bid-ask spread with 
other daily processes associated with updating the web page, such as 
reporting the daily portfolio holdings, and therefore, there will be no 
additional daily costs associated with updating the median bid-ask 
spread on the webpage. We also believe that funds currently maintain a 
record of historical prices as a matter of current business practices 
which could be used to satisfy the requirement at a nominal cost, as 
discussed above. If a fund does not maintain a record of historical 
prices, it may incur a one-time estimated cost of $296.50 to satisfy 
the requirement, or an upper bound of $484,777.50 in aggregate, 
assuming that no ETFs currently maintain historical price records.\466\
---------------------------------------------------------------------------

    \465\ Commission staff estimate a one-time cost of computing and 
implementing processes and systems for daily updating of the median 
bid-ask spread of one burden hour at a per hour cost of $296.50 
(blended rate for a senior systems analyst ($274) and senior 
programmer ($319)). The one-time cost of updating the web page to 
include the median bid-ask spread would be incorporated as part of 
the web page development discussed in section IV.B.1 (see also infra 
footnote 535). As median bid-ask spreads are not currently required 
to be reported or computed by ETFs, we estimate that the aggregate 
costs would be $296.50 x 1,635 ETFs = $484,777.50.
    \466\ Commission staff estimate a one-time cost of computing and 
implementing processes and systems for daily updating of historical 
prices of one burden hour at a per hour cost of $296.50 (blended 
rate for a senior systems analyst ($274) and senior programmer 
($319)). Although we preliminarily estimate that funds already 
maintain a record of historical prices, an upper bound on aggregate 
costs would be estimated at $296.50 x 1,635 ETFs = $484,777.50.
---------------------------------------------------------------------------

ii. Omission of Conditions We Believe May Save Costs for Funds
    First, the proposed rule would not contain a requirement that an 
ETF's IIV be disseminated at least every 15 seconds during regular 
trading hours (60 seconds for international ETFs), as is currently 
required under all exemptive orders. We believe that many sophisticated 
institutional market participants do not rely on the IIV to value an 
ETF's assets, as discussed above in section II.C.3.
    In some cases, the IIV may not reflect the actual value of an ETF's 
assets (e.g., for funds that invest in foreign securities whose markets 
are closed during the ETF's trading day or funds whose assets trade 
infrequently, as is the case for certain bond funds). In those cases, 
we believe that both institutional and retail market participants would 
benefit from the omission of the IIV as a requirement of the proposed 
rule by avoiding the possibility that investors base their investment 
decisions on this potentially misleading information. However, the IIV 
may, for certain funds, provide a reasonably accurate estimate of the 
value of an ETF's assets, including for those funds whose underlying 
assets are very frequently traded during the ETF's trading day. Less 
sophisticated institutional investors as well as retail investors 
relying on the IIV for those ETFs may thus find the IIV useful and 
could see their ability to evaluate ETFs reduced without this 
metric.\467\
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    \467\ While the IIV may be very accurate for ETFs whose 
underlying assets trade frequently (and thus are liquid as well), 
such ETFs also tend to have small premiums/discounts to NAV per 
share, reducing the incremental usefulness of the IIV for investors 
in these ETFs compared to observing only the ETF's share price.
---------------------------------------------------------------------------

    Exchange listing standards currently require the IIV to be 
disseminated. As long as exchange listing standards continue to include 
this requirement, the proposed rule's omission of such a requirement 
would not represent a change from the baseline and would not result in 
any costs or benefits to market participants. Nonetheless, if the 
listing standards change, ETFs would not be subject to the cost of 
dissemination of IIV information under the proposed rule.
    Second, under the terms of the exemptive orders, ETFs are required 
to disclose in their registration statement that redemptions may be 
postponed for foreign holidays. The proposed amendments to Forms N-1A 
and N-8B-2 do not contain such a requirement and would thus eliminate 
the cost of preparing and updating this disclosure for existing ETFs. 
As discussed above in section III.B.4, we believe that such a 
requirement is not necessary, since this information is already covered 
by the agreement between the ETF and the authorized participant.\468\ 
As discussed in section III.C.1, we further believe that such a 
disclosure would not be relevant for retail investors, who purchase ETF 
shares on the secondary market.
---------------------------------------------------------------------------

    \468\ As discussed above, we believe that authorized 
participants would share this information with other market 
participants as necessary, for example when a market participant 
uses an authorized participant as agent for transacting with an ETF 
and this information is a necessary part of the creation or 
redemption process.
---------------------------------------------------------------------------

    Third, the proposed rule would not require an ETF 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 through a broker via a national securities 
exchange. Although this condition has been included in our exemptive 
orders, we no longer believe that it is necessary given that markets 
have become familiar with ETFs in the multiple decades they have been 
available. The omission of such a requirement could lead to cost 
savings for existing and future ETFs associated with preparing and 
reviewing this disclosure for sales literature.\469\
---------------------------------------------------------------------------

    \469\ We estimate that the omission of this requirement would 
save 0.25 hours of a compliance attorney ($352 per hour), resulting 
in a cost savings of $88 (0.25 x $352) per fund each year. The total 
cost savings for all 1,635 ETFs that could rely on the proposed rule 
would thus be $143,880 (1,635 x $88).
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iii. Website Disclosure Provisions
    Proposed rule 6c-11 would require an ETF to disclose certain 
information prominently on its website, which is publicly accessible 
and free of charge.\470\ The goal of these disclosure requirements is 
to provide investors with key metrics to evaluate their trading and 
investment decisions in a location that is easily accessible and 
frequently updated.\471\ Based on a staff

[[Page 37391]]

review of ETFs' websites, we believe that all ETFs that could rely on 
the proposed rule currently have a website.\472\ As a consequence, 
existing ETFs would generally not incur any additional cost associated 
with the creation and technical maintenance of a website.
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    \470\ See supra footnote 208.
    \471\ According to the most recent U.S. census data, 
approximately 77.2% of U.S. households had some form of internet 
access in their home in 2015 and 86.8% have a computer (e.g., 
desktop, laptop, tablet or smartphone). See Camille Ryan & Jamie M. 
Lewis, Computer and internet Usage in the United States: 2015, ACS-
37 (Sept. 2017), available at https://www.census.gov/content/dam/Census/library/publications/2017/acs/acs-37.pdf; see also Sarah 
Holden, Daniel Schrass & Michael Bogdan, Ownership of Mutual Funds, 
Shareholder Sentiment, and Use of the internet, 2017 (Oct. 2017), 
available at https://www.ici.org/pdf/per23-07.pdf (``[i]n mid-2017, 
95 percent of households owning mutual funds had internet access, up 
from about two-thirds in 2000'' and ``86 percent of mutual fund-
owning households with a household head aged 65 or older had 
internet access in mid-2017''); Andrew Perrin & Maeve Duggan, 
Americans' Internet Access: 2000-2015, Pew Research Center (June 
2015), available at http://assets.pewresearch.org/wp-content/uploads/sites/14/2015/06/2015-06-26_internet-usage-across-demographics-discover_FINAL.pdf (finding in 2015, 84% of all U.S. 
adults use the internet). Retail investors that do not have internet 
access in their homes may have access outside their homes, such as 
at public libraries.
    \472\ See supra footnote 437.
---------------------------------------------------------------------------

    As discussed above, a requirement for daily website disclosures of 
NAV, closing price, and premiums and discounts--each as of the end of 
the prior business day has been included in substantially all exemptive 
relief orders starting from 2008. As discussed in section III.B.4, 
based on a staff review of ETFs' websites, we believe that all ETFs 
that could rely on the proposed rule currently provide daily website 
disclosures of NAV, closing price, and premiums or discounts.\473\ As a 
consequence, existing ETFs would generally not incur any additional 
cost associated with these website disclosure requirements.
---------------------------------------------------------------------------

    \473\ See supra footnote 437.
---------------------------------------------------------------------------

    Our exemptive orders have not included requirements for line graph 
and tabular historical information regarding premiums and discounts. 
However, Form N-1A contains tabular website disclosures relating 
historical premium/discount in Items 11(g)(2) and 27(b)(7)(iv), which 
we are proposing to eliminate.\474\ Nonetheless, we anticipate that all 
existing ETFs that fall within the scope of the proposed rule would 
incur some additional costs associated with these disclosures. We 
believe that substantially all ETFs already have the required data 
available to them as part of their regular operations (as it is 
required by Form N-1A and also allows ETFs to monitor the trading 
behavior of their shares), as well as have systems (such as computer 
equipment, an internet connection, and a website) in place that can be 
used for processing this data and uploading it to their websites. 
However, these ETFs would still incur the costs associated with 
establishing and following (potentially automated) processes for 
processing and uploading this data to their websites. We estimate that 
an average ETF would incur a one-time cost of $1,939.5 \475\ for 
implementing this website disclosure and an ongoing cost of $473.25 
\476\ per year for updating the relevant web page with this 
information. We thus estimate the total industry cost, in the first 
year, to ETFs that could rely on the proposed rule for providing this 
website disclosure, of $3,944,846.35.
---------------------------------------------------------------------------

    \474\ See infra section II.H.4.
    \475\ This estimate is based on the following calculations: 3 
hours (for website development) x $296.50 per hour (blended rate for 
a senior systems analyst ($274) and senior programmer ($319)) + (2 
hours (for review of website disclosures) x $325 (blended rate for a 
compliance manager ($298) and a compliance attorney ($352)) + $400 
for an external website developer to develop the web page = 
$1,939.50.
    \476\ This estimate is based on the following calculations: 0.5 
hours (for website updates) x $296.50 per hour (blended rate for a 
senior systems analyst ($274) and senior programmer ($319)) + (1 
hour (for review of website disclosures) x $325 (blended rate for a 
compliance manager ($298) and a compliance attorney ($352) = 
$473.25.
---------------------------------------------------------------------------

    Our exemptive orders have not included a requirement for ETFs to 
provide disclosure of the factors that materially contributed to a 
premium or discount, if known, if an ETF's premium or discount is 
greater than 2% for more than seven consecutive trading days. As a 
result, under the proposed rule those ETFs that experience such a 
premium or discount would incur additional costs associated with 
determining what factors contributed to the premiums or discounts and 
drafting and uploading a discussion to their website. Based on a staff 
analysis of historical data on ETF premiums and discounts from 2008 to 
2017 using Bloomberg data, we believe that this disclosure requirement 
would be triggered for, on average, 4.7% of those ETFs that could rely 
on the proposed rule per year.\477\ We estimate that a fund required to 
make such a disclosure in a given year would incur an average cost of 
$1,438.50, yielding a total annual industry cost of $110,541.53.\478\
---------------------------------------------------------------------------

    \477\ This estimate represents the average of the percentage of 
ETFs for which the reporting requirement was triggered at least once 
in a given year, for those ETFs that could rely on the proposed 
rule. During the sample period from 2008 to 2017, the percentage of 
ETFs for which the reporting requirement was triggered at least once 
varied from 1.5% in 2010 to 10% in 2008.
    \478\ We believe that such disclosure would require 4 internal 
hours (2.5 hours for the compliance attorney to determine if this 
requirement has been triggered and produce a draft of the required 
disclosures + 1.5 hours for the webmaster to include the information 
on the website), at a time cost of (2.5 hours x $352 compliance 
attorney hourly rate) + (1.5 hours x $239 webmaster hourly rate) in 
addition to $200 for external website development = $1,738.50. The 
annual cost of this requirement for those ETFs that could rely on 
the proposed rule is calculated as 4.7% x 1,635 ETFs x $1,738.50 = 
$110,541.53.
---------------------------------------------------------------------------

    The proposed rule would also require an ETF to post on its website 
one ``published'' basket at the beginning of each business day. While 
we believe that authorized participants already have access to this 
information in the daily portfolio composition file provided to NSCC, 
many market participants, such as smaller institutional investors and 
retail investors, are not NSCC members and do not currently have access 
to this information.
    Our exemptive orders have not included requirements for daily 
website disclosures of ETF baskets. As a result, we anticipate that all 
existing ETFs that rely on the proposed rule would incur additional 
costs associated with this disclosure.\479\ Since specifying basket 
assets is part of the regular operation of an ETF, we believe that all 
ETFs already have the required data available to them. In addition, we 
believe that most ETFs already have systems (such as computer 
equipment, an internet connection, and a website) in place that can be 
used for processing this data and uploading it to their websites. 
However, these ETFs would still incur the costs associated with 
establishing and following (potentially automated) processes for 
processing and uploading this data to their websites. We estimate that 
an average ETF would incur a one-time cost of $2,909.25 \480\ for 
implementing this website disclosure and an ongoing cost of $784 \481\ 
per year for updating the relevant web page daily with this 
information. We thus estimate the total industry cost, in the first 
year, to ETFs that could rely on the proposed rule for providing this 
website disclosure, of 6,038,463.75.\482\
---------------------------------------------------------------------------

    \479\ As proposed, the rule would require that basket 
information be presented and contain information regarding 
description, amount, value and/or unrealized gain/loss (if 
applicable) in the manner prescribed within Article 12 of Regulation 
S-X.
    \480\ This estimate is based on the following calculations: 4.5 
hours (for website development) x $296.50 per hour (blended rate for 
a senior systems analyst ($274) and senior programmer ($319)) + (3 
hours (for review of website disclosures) x $325 (blended rate for a 
compliance manager ($298) and a compliance attorney ($352)) + $600 
for an external website developer to develop the web page = 
$2,909.25.
    \481\ This estimate is based on the following calculations: 1 
hour (for website updates) x $296.50 per hour (blended rate for a 
senior systems analyst ($274) and senior programmer ($319)) + (1.5 
hours (for review of website disclosures) x $325 (blended rate for a 
compliance manager ($298) and a compliance attorney ($352) = $784.
    \482\ This estimate is based on the following calculation: 1,635 
ETFs x ($2,909.25 + $784) = $6,038,463.75.
---------------------------------------------------------------------------

    As discussed in section IV.A above, the proposed disclosures on 
ETFs' websites, which are publicly available and free of charge, would 
enable investors to more readily obtain certain key metrics for 
individual ETFs,

[[Page 37392]]

potentially resulting in better informed investment decisions.\483\ The 
proposed conditions standardize certain content requirements to 
facilitate investor analysis of information while allowing ETFs to 
select a format for posting information that the individual ETF finds 
most efficient and appropriate for their website. Because the 
information in the proposed disclosures would be made available on 
individual websites, in the format chosen by the ETF, we acknowledge 
that an investor's ability to efficiently extract information from 
website disclosures for purposes of aggregation, comparison, and 
analysis across multiple funds and time periods may be limited. 
Investors seeking to compare multiple ETFs would have to visit the 
website of every ETF, navigate to the relevant section of the website, 
and extract the information provided in the format chosen by the fund. 
Depending on the manner in which a typical fund investor would use the 
website disclosures, these considerations may decrease the information 
benefits of the proposed disclosures. However, we recognize that 
investors may rely on third-party providers that aggregate such 
information for all ETFs into a structured format that investors can 
more easily access and process for the purpose of statistical and 
comparative analyses. While investors may incur costs of obtaining 
information from third-party service providers, it would likely be 
lower than the cost they would incur than if they performed the 
collection themselves, and the cost of such services may otherwise be 
reduced as a result of competition among service providers. Overall, we 
believe that requiring ETFs to provide this information on their 
websites would ultimately provide an efficient means for facilitating 
investor access to information.
---------------------------------------------------------------------------

    \483\ See supra footnote 208.
---------------------------------------------------------------------------

c. Recordkeeping
    The proposed rule would require that ETFs preserve and maintain 
copies of all written authorized participant agreements for at least 
five years, the first two years in an easily accessible place. This 
requirement would provide Commission examination staff with a basis to 
evaluate whether the authorized participant agreement is in compliance 
with the rule and other provisions of the Investment Company Act and 
the rules thereunder, and would also promote internal supervision and 
compliance.\484\ As the agreement forms the contractual foundation on 
which authorized participants engage in arbitrage activity, compliance 
of the agreement with the proposed rule is important for the arbitrage 
mechanism to function properly.
---------------------------------------------------------------------------

    \484\ ETFs already will be required to provide some information 
about authorized participants on Form N-CEN, including the name of 
each authorized participant, additional identifying information, and 
the dollar values of the fund shares the authorized participant 
purchased and redeemed during the reporting period. However, this 
information alone would not be sufficient for Commission staff to 
evaluate whether a fund's authorized participant agreements are in 
compliance with the proposed rule.
---------------------------------------------------------------------------

    We are also proposing to require ETFs to maintain information 
regarding the baskets exchanged with authorized participants on each 
business day the ETF exchanged creation units, including a record 
stating that the custom basket complies with the ETF's custom basket 
policies and procedures. As discussed above, we believe that these 
records would help our examination staff understand how baskets are 
being used by ETFs, evaluate compliance with the rule and other 
provisions of the Act and rules thereunder, and examine for potential 
overreach by ETFs in connection with the use of custom baskets or 
transactions with affiliates.
    Existing exemptive orders have not required ETFs to preserve and 
maintain copies of authorized participant agreements or information 
about basket composition. However, we believe that most ETFs already 
preserve and maintain copies of authorized participant agreements as 
well as data on baskets used as a matter of established business 
practice. Existing ETFs that do not already preserve and maintain 
copies of these documents and data, as well as all new ETFs that would 
operate under the proposed rule, would incur maintenance and storage 
costs associated with these requirements. As discussed in section IV.B, 
we estimate that an average ETF that does not currently comply with 
these recordkeeping requirements would incur an annual cost of $380 per 
year \485\ to maintain these records.\486\ Assuming that 20% of ETFs 
would incur this cost, the total industry cost for ETFs that could rely 
on the proposed rule would be $124,260 per year.\487\ In addition, the 
existing orders have not required that ETFs prepare and maintain a 
record stating that custom baskets comply with the custom basket 
policies and procedures. We anticipate that all ETFs that could operate 
under the proposed rule will incur additional recordkeeping costs 
associated with the requirement that custom baskets comply with custom 
basket policies and procedures. Assuming that 25% of the total annual 
recordkeeping costs can be attributed to the new requirement for custom 
baskets, we estimate a total cost per ETF of $95 per year for the 
requisite five-year period and an annual industry cost of $155,325 for 
ETFs that could rely on the rule.\488\
---------------------------------------------------------------------------

    \485\ See infra footnote 544.
    \486\ An average ETF would have to maintain and store 34 
authorized participant agreements. See supra footnote 431 and 
accompanying text.
    \487\ This estimate is based on the following calculation: 1,635 
ETFs x $380 x 20% = $124,260.
    \488\ This estimate is based on a total record keeping cost of 
$380 per ETF over five years, see infra note 544, 25% x $380 = $95, 
$95 x 1,635 ETFs = $155,325.
---------------------------------------------------------------------------

d. Master-Feeder Relief
    The proposed rule would rescind the master-feeder relief granted to 
ETFs that do not rely on the relief as of the date of this proposal. We 
are proposing to rescind such relief because there generally is a lack 
of interest in ETF master-feeder arrangements, and certain master-
feeder arrangements raise policy concerns discussed above. While there 
are currently many exemptive orders that contain the master-feeder 
relief, it is our understanding that only one fund complex currently 
relies on this relief to structure several master-feeder arrangements 
with one master and one feeder fund each.\489\ As discussed above, we 
would also propose to grandfather existing master-feeder arrangements 
involving ETF feeder funds, but prevent the formation of new ones, by 
amending relevant exemptive orders.\490\ As a result, we do not expect 
that the rescission of the existing master-feeder relief would impose 
costs on ETFs that currently rely on the relief to structure master-
feeder arrangements.

[[Page 37393]]

At the same time, the rescission of the relief may benefit investors in 
prospective feeder ETFs to the extent that it protects them from any 
concerns associated with feeder ETFs discussed above.\491\
---------------------------------------------------------------------------

    \489\ See supra footnote 341.
    \490\ As discussed above, without this relief, the affected 
funds could continue operating by effecting creation and redemption 
transactions between authorized participants and the feeder fund (as 
well as the transactions between the master and feeder fund) in cash 
rather than in kind. As cash creations and redemptions can be less 
efficient than in-kind transactions for certain ETFs, this could 
impose a cost on the ETFs that are part of the fund family. Cash 
redemptions and creations could also affect the current 
relationships that funds have with authorized participants if the 
authorized participants would be unwilling to perform the arbitrage 
function when receiving cash instead of baskets of securities, which 
could have unintended spillover effects on the secondary market 
trading of these funds' shares. Alternatively, these feeder funds 
may opt to pursue their investment objectives through direct 
investments in securities and/or other financial instruments, rather 
than through investments in master funds. Such a restructuring of 
the funds involved would also lead to costs (primarily associated 
with legal and accounting work) on the ETFs that are part of the 
fund family. As a result, if this change would require portfolio 
transactions to occur at the fund, there could be additional costs 
such as lower overall total returns to the fund or that investors 
may find the fund to be a less attractive investment.
    \491\ See supra section II.F.
---------------------------------------------------------------------------

2. Disclosure (Amendments to Forms N-1A and N-8B-2)
    The amendments to Form N-1A and N-8B-2 are designed to provide 
authorized participants and investors with tailored information 
regarding the costs associated with investing in ETFs. As discussed in 
section IV.A above, we expect that the new disclosures would benefit 
investors by helping them better understand and compare specific funds, 
potentially resulting in more informed investment decisions, more 
efficient allocation of investor capital, and greater competition for 
investor capital among funds.
    As discussed above, we propose to add a set of Q&As related to fees 
and trading information and costs that we anticipate would help 
investors better understand costs specific to ETFs, such as bid-ask 
spreads, brokerage commissions, and purchasing or selling ETF shares at 
a premium or discount to NAV. The answers to the Q&As would include 
information about trading costs specific to an ETF, such as the median 
bid-ask spread over the previous year.
    In addition, the proposed amendments to Forms N-1A and N-8B-2 would 
require an ETF to provide information on the ETF's median bid-ask 
spread as well as an interactive calculator on the ETF's website that 
can be used to determine how the bid-ask spread would impact the costs 
associated with frequent trading of ETF shares. As discussed above, the 
purpose of the interactive calculator is to provide investors with the 
ability to customize the hypothetical calculations in Item 3 of Form N-
1A to their specific investing situation by choosing either the number 
or size of the hypothetical round-trip trades, or both.
    While we believe that substantially all ETFs already have the 
required data for these new disclosures on Forms N-1A and N-8B-2 and 
for the interactive calculator as part of their regular operations, 
these funds would still incur costs for processing the data, entering 
them into the form, and programming the interactive calculator.\492\ We 
estimate that each ETF would incur a one-time cost of $6,710 \493\ and 
an ongoing cost of $3,355 \494\ per year.\495\ We thus estimate that 
the total industry cost for ETFs in the first year would equal 
$19,123,500.\496\
---------------------------------------------------------------------------

    \492\ As discussed in more detail below in section V.D, the 
ongoing costs of complying with the proposed amendments to Form N-
8B-2 for all UIT ETFs as well as the one-time initial costs for 
existing UIT ETFs would accrue to Form S-6.
    \493\ We estimate that each ETF would incur a one-time burden of 
an additional 20 hours, at a time cost of an additional $6,710 (10 
hours x $335.50 (blended rate for a compliance attorney ($352) and a 
senior programmer ($319)) = $6,710) to draft and finalize the 
required disclosure, amend its registration statement, implement the 
interactive calculator, and update its website.
    \494\ We estimate that each ETF would incur an ongoing burden of 
an additional 10 hours, at a time cost of an additional $3,355 (10 
hours x $335.50 (blended rate for a compliance attorney ($352) and a 
senior programmer ($319)) = $3,355) each year to review and update 
the proposed disclosures.
    \495\ Like all information disclosed in Items 2, 3, or 4 of Form 
N-1A, the information disclosed in amended Item 3 would have to be 
tagged and submitted in a structured data format. See supra footnote 
361. We note that we are adopting amendments to require the use of 
Inline XBRL format in a companion release, which would apply to the 
information disclosed in amended Item 3 according to the compliance 
dates of those amendments. See Inline XBRL Filing of Tagged Data, 
Investment Company Act Release No. 33139 (June 28, 2018). Given that 
filers already have systems in place to submit the existing 
information in Item 3 in a structured format and that filers will 
already be required to update those systems to comply with the 
Inline XBRL requirement, we believe that there would not be any 
significant additional costs associated with the information in 
amended Item 3 being filed in a structured format.
    \496\ This estimate is based on the following calculation: 1,900 
ETFs x ($6,710 + $3,355) = $19,123,500.
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D. Effects on Efficiency, Competition, and Capital Formation

    This section evaluates the impact of proposed rule 6c-11 and the 
amendments to Forms N-1A and N-8B-2 on efficiency, competition, and 
capital formation. However, as discussed in further detail below, the 
Commission is unable to quantify many of the effects on efficiency, 
competition and capital formation either because they are inherently 
difficult to quantify or because it lacks the information necessary to 
provide a reasonable estimate.
1. Efficiency
    The proposed rule would likely increase total assets of ETFs, as a 
result of reducing the expense and delay of forming and operating new 
ETFs organized as open-end funds, reducing the cost for certain ETFs to 
monitor their own compliance with regulations, and as well increased 
competition among ETFs as discussed below. At the same time, the 
proposed rule could lead to a decrease in total assets of other fund 
types that investors may regard as substitutes, such as certain mutual 
funds.\497\ As a result, ETF ownership (as a percentage of market 
capitalization) for some securities, such as stocks and bonds, would 
likely increase, and ownership by other funds, such as mutual funds, 
would likely decrease. The academic literature that we discuss in this 
section suggest that such a shift in ownership could affect the price 
efficiency (the extent to which an asset price reflects all public 
information at any point in time) and liquidity of these portfolio 
securities.\498\
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    \497\ The proposed disclosure requirements would also serve to 
increase investors' awareness of the trading costs that they can 
incur when trading ETFs, which can be substantial in some cases. As 
a result, investors who may previously not have been fully aware of 
these costs may shift their demand away from ETFs and towards other 
types of funds, such as mutual funds. We believe, however, that the 
rulemaking as a whole is likely to increase demand for ETFs rather 
than decrease it.
    \498\ In documenting the impact of ETF arbitrage on price 
efficiency and liquidity, the academic literature does not generally 
distinguish ETFs that could rely on the rule from those that could 
not. However, these studies investigate a broad range of ETFs with 
varying degrees of relief including basket flexibility. Therefore, 
we believe that the subsample of ETFs that could rely on the rule 
(those organized as open-end funds that are not leveraged) is 
representative of those used in the academic literature. As a 
result, we believe that inferences from the academic research 
generally apply to ETFs that can rely on the rule.
---------------------------------------------------------------------------

    The literature suggests that a shift in stock ownership towards 
ETFs may improve some dimensions of price efficiency while impeding 
price efficiency along other dimensions. Specifically, the results in 
one paper suggest that stock prices incorporate systematic information 
more quickly when they are held in ETF portfolios.\499\ The evidence in 
this paper thus indicates that ETF activity increases stock market 
efficiency with regard to systematic information, i.e., information 
relating to market-wide risks. On the other hand, some studies find 
that an increase in ETF ownership may introduce non-fundamental 
volatility into stock prices, i.e., cause temporary deviations of stock 
prices from their fundamental values. For example, one paper finds that 
ownership by US equity index ETFs is associated with higher volatility 
among component stocks and argues that the increased volatility is non-
fundamental.\500\ Another paper finds that higher authorized 
participant arbitrage activity in US equity ETFs is

[[Page 37394]]

associated with a higher correlation of returns among stocks in the 
ETF's portfolio.\501\ The authors find evidence that changes in the 
prices of these stocks tend to partially revert over the next trading 
day and argue that the increased co-movement in returns is thus a sign 
of excessive price movement due to non-fundamental shocks that ETF 
trading helps propagate.
---------------------------------------------------------------------------

    \499\ Lawrence Glosten, Suresh Nallareddy & Yuan Zou, ETF 
Trading and Informational Efficiency of Underlying Securities, 
Columbia Business School Research Paper No. 16-71 (2016).
    \500\ See Itzhak Ben-David, Francesco Franzoni & Rabih Moussawi, 
Do ETFs Increase Volatility?, Swiss Finance Institute Research Paper 
No. 11-66 (2017). This paper also finds that mutual fund ownership 
is associated with higher volatility in the underlying indexes. 
Thus, to the extent that part of the increase in ETF assets would be 
accompanied by a decrease in mutual fund assets, the net effect on 
price efficiency would be unclear.
    \501\ Zhi Da & Sophie Shive, Exchange Traded Funds and Asset 
Return Correlations, Working Paper, Notre Dame University (2016).
---------------------------------------------------------------------------

    The proposed rule could decrease the liquidity of stocks held by 
ETFs, as one study finds that higher ownership of a stock by US equity 
ETFs is associated with lower liquidity as measured by market 
impact.\502\ Conversely, the academic literature offers mixed evidence 
regarding the impact of ETFs on bond liquidity. While one paper finds 
that increased ETF ownership is associated with lower bond liquidity 
for investment grade bonds,\503\ another study finds that bonds 
included in ETFs experience improvements in their liquidity.\504\
---------------------------------------------------------------------------

    \502\ See Sophia JW. Hamm, The effect of ETFs on stock 
liquidity, Working Paper, Ohio State University (2014). However, the 
study also finds the same relationship for ownership by index mutual 
funds. Thus, to the extent that part of the increase in ETF assets 
would be accompanied by a decrease in mutual fund assets, the net 
effect on price efficiency would be unclear.
    \503\ Caitlin Dillon Dannhauser, The Impact of Innovation: 
Evidence from Corporate Bond ETFs, Journal of Financial Economics, 
forthcoming (2016) (``Dannhauser Article'').
    \504\ Jayoung Nam, Market Accessibility, Corporate Bond ETFs, 
and Liquidity, Working Paper, Indiana University Bloomington (2017).
---------------------------------------------------------------------------

    A shift in stock ownership towards ETFs could also have an effect 
on the co-movement of liquidity for stocks held by ETFs. Specifically, 
one paper observes that the liquidity of a stock with high ETF 
ownership co-moves with the liquidity of other stocks that also have 
high ETF ownership.\505\ The authors argue that this co-movement in 
liquidity represents a risk to investors, as it exposes them to the 
possibility that many assets in their portfolio will be illiquid at the 
same time.
---------------------------------------------------------------------------

    \505\ Vikas Agarwal, Paul Hanouna, et al., Do ETFs Increase the 
Commonality in Liquidity of Underlying Stocks, Working Paper, 
Villanova University (2017).
---------------------------------------------------------------------------

    Since we do not know the degree to which the proposed rule would 
increase ETF ownership of stocks and bonds, we are unable to quantify 
the proposed rule's effects on price efficiency and liquidity.
    As a result of the proposed rule's allowance of increased basket 
flexibility, some ETFs that did not already have this flexibility in 
their baskets may choose to increase the weight of more liquid 
securities and decrease the weight of less liquid securities in their 
baskets compared to their portfolios.\506\ During normal market 
conditions, this may lead those ETFs' shares to trade at smaller bid-
ask spreads, thus benefiting investors. We note, however, that such a 
reduction in bid-ask spreads by over-weighting more liquid securities 
may not work during stressed market conditions, if a large proportion 
of such an ETF's portfolio securities become less liquid.\507\ As a 
result, the gap between bid-ask spreads of some ETFs' shares during 
normal and stressed market periods may grow as a result of the proposed 
rulemaking, which some investors may not anticipate and fail to fully 
take into account when making their investment decisions.\508\
---------------------------------------------------------------------------

    \506\ This would be the case for those ETFs that hold less 
liquid securities in their portfolios.
    \507\ Under rule 22e-4 under the Act, an ETF is required to 
consider: (i) The relationship between portfolio liquidity and the 
way in which, and the prices and spreads at which, ETF shares trade, 
including, the efficiency of the arbitrage mechanism and the level 
of active participation by market participants (including authorized 
participants); and (ii) the effect of the composition of baskets on 
the overall liquidity of the ETF's portfolio as part of its 
assessment, management and review of liquidity risk. See LRM 
Adopting Release, supra footnote 101.
    \508\ Conversely, some ETFs may choose to decrease, rather than 
increase, the weight of more liquid securities and increase the 
weight of less liquid securities in their basket compared to their 
portfolio in order to reduce transaction costs borne by an ETF's 
existing/remaining shareholders when the ETF must buy and sell 
portfolio holdings. This would lead to a reduction in transaction 
costs for existing/remaining shareholders and to an increase in 
transactions costs for authorized participants and, ultimately, 
investors buying and selling ETF shares. Thus, we believe that most 
funds would choose to limit such behavior as they would likely find 
it to be in their best interest to balance costs imposed on 
remaining and existing/remaining shareholders.
---------------------------------------------------------------------------

    Finally, the proposed amendments to Forms N-1A and N-8B-2 as well 
as the additional website disclosures required by proposed rule 6c-11 
would allow investors and other market participants to better 
understand and compare ETFs using more relevant and standardized 
disclosure. For example, as discussed above, the proposed amendments to 
Item 3 of Form N-1A would add a requirement for ETFs to disclose their 
median bid-ask spread and include a statement that ETF investors may be 
subject to other expenses that are specific to ETF trading, including 
brokerage commissions and potential costs related to purchasing ETF 
shares at a premium or discount to NAV per share.\509\ These costs are 
not currently required to be disclosed by Item 3. Since these costs are 
incurred by ETF investors and not mutual fund investors, we believe 
that adding this disclosure would help investors and other market 
participants better assess and compare fees and expenses between 
certain funds and fund types, such as ETFs and mutual funds. Thus, the 
proposed rule could help investors make more informed investment 
decisions that are more suited for their investment objectives. The 
degree to which investors would benefit from the ability to make more 
informed investment decisions is inherently difficult to quantify, so 
we are unable to estimate the size of this benefit.
---------------------------------------------------------------------------

    \509\ James J. Angel, Todd J. Broms, & Gary L. Gastineau, ETF 
Transaction Costs Are Often Higher Than Investors Realize, 42 The 
Journal of Portfolio Management 3, 65-75 (2016) find that the cost 
of trading ETF shares depends both on bid-ask spreads as well as 
premiums and discounts to NAV per share.
---------------------------------------------------------------------------

2. Competition
    The proposed rule would likely increase competition among ETFs that 
could rely on the proposed rule. The first channel through which the 
proposed rule would likely foster competition is by reducing the costs 
for ETF sponsors to form new ETFs that comply with the conditions set 
by the proposed rule. This cost reduction would lower the barriers to 
entering the ETF market, which would likely lead to increased 
competition among ETFs that could rely on the proposed rule.
    In addition, new ETFs that enter the market in reliance on the 
proposed rule as well as those existing ETFs that would have their 
exemptive relief rescinded and replaced by the proposed rule, would no 
longer be subject to requirements that vary between exemptive orders. 
Instead, these ETFs would operate under uniform requirements, which 
would help promote competition among ETFs that could rely on the 
proposed rule.
    An increase in competition among ETFs that could rely on the 
proposed rule would likely also lead to an increase in competition 
between those ETFs and ETFs that could not rely on the proposed rule as 
well as other types of funds and products that investors may perceive 
to be substitutes for ETFs, such as certain mutual funds.\510\
---------------------------------------------------------------------------

    \510\ The types of funds and products that investors may 
consider substitutes for ETFs would depend on an individual 
investor's preferences and investment objectives. Other types of 
products that some investors may consider to be substitutes for ETFs 
include closed-end funds and other exchange-traded products, such as 
exchange-traded notes and commodity pools.
---------------------------------------------------------------------------

    Furthermore, as discussed above, the proposed website disclosures 
and amendments to Forms N-1A and N-8B-2 would allow investors to 
compare ETFs and other open-end investment companies, which could 
further foster

[[Page 37395]]

competition among open-end investment companies as well as between 
open-end investment companies and other types of funds that investors 
may perceive to be substitutes for open-end investment companies, such 
as closed-end funds and certain exchange-traded products.
    Increased competition would likely lead to lower fees for 
investors, encourage financial innovation, and increase consumer choice 
in the markets for ETFs, open-end investment companies, and other types 
of funds that investors may perceive to be substitutes.\511\ Due to the 
limited availability of data, however, we are unable to quantify these 
effects.
---------------------------------------------------------------------------

    \511\ As discussed above, the proposed rule would likely lead to 
increased competition both among ETFs that could rely on the 
proposed rule as well as between ETFs that could rely on the rule 
and those that could not. While we believe that increased 
competition generally is conducive to innovation, any increased 
competition in the ETF market resulting from the proposed rule would 
be more likely to involve novel ETFs that would continue to need to 
obtain exemptive relief from the Commission.
---------------------------------------------------------------------------

    To the extent the proposed rule would increase the number and total 
assets of ETFs, more authorized participants or other market 
participants may enter the market. This could lead to increased 
competition among authorized participants or other market participants 
and result in authorized participants or other market participants 
exploiting arbitrage opportunities sooner (i.e., when premiums/
discounts to NAV per share are smaller). As a result, bid-ask spreads 
may tighten and premiums/discounts to NAV per share for ETF shares may 
decrease. As authorized participants and some of the other market 
participants that engage in ETF arbitrage are large broker-dealers, 
however, we would expect new entries of authorized participants or 
other arbitrageurs as a result of the rule to be limited and any 
effects on bid-ask spreads and premiums/discounts to NAV per share to 
be small.
3. Capital Formation
    The proposed rule may lead to increased capital formation. 
Specifically, an increase in the demand for ETFs, to the extent that it 
would increase demand for intermediated assets as a whole, would likely 
spill over into primary markets for equity and debt securities. As a 
consequence, companies may be able to issue new debt and equity at 
higher prices in light of the increased demand for these assets in 
secondary markets created by ETFs. As a consequence, the cost of 
capital for firms could fall, facilitating capital formation.
    The conclusion that an increase in the demand for ETFs may lower 
the firm's cost of capital is further supported by a paper \512\ that 
finds that bonds with a higher share of ETF ownership have lower 
expected returns.\513\ Due to the limited availability of data, 
however, we are unable to quantify these effects of the proposed rule 
on capital formation.
---------------------------------------------------------------------------

    \512\ Dannhauser Article, supra footnote 503.
    \513\ We acknowledge that there is research (see Yakov Amihud & 
Haim Mendelson, Asset Pricing and the Bid-Ask Spread, 17 Journal of 
Financial Economics 2, 223-249 (1986)) that provides evidence that 
expected returns of an asset are positively associated with its 
liquidity. As discussed above, the academic literature suggests that 
stocks with a higher share of ETF ownership have lower liquidity 
(whereas the evidence on the effect of underlying bonds is mixed). 
Thus, there may be an offsetting effect that could weaken the 
potential benefits of the rule for capital formation through new 
equity issuances by firms.
---------------------------------------------------------------------------

E. Reasonable Alternatives

1. Treatment of Existing Exemptive Relief
    As discussed above, we propose to rescind the exemptive relief we 
have issued to ETFs that would be permitted to rely on the proposed 
rule. As an alternative, we considered allowing ETFs with existing 
exemptive relief in orders that do not contain a self-termination 
clause to continue operating under their relief rather than requiring 
them to operate in reliance on the rule.
    The Commission believes that allowing ETFs to continue operating 
under their existing relief would create differences in the conditions 
under which funds operate. Specifically, some ETFs that determine they 
do not need the additional flexibility (e.g., basket flexibility) the 
proposed rule would provide compared to their existing exemptive relief 
could choose to continue operating under their existing relief rather 
than in reliance on the rule. This could allow these ETFs to circumvent 
the other requirements that are part of the rule (e.g., daily website 
disclosure of the basket assets). This self-selection would create a 
disparity in the conditions under which ETFs are allowed to operate.
    Measured against the baseline, the alternative would thus have 
smaller benefits arising from improved disclosure, including that the 
alternative would not level the playing field among ETFs with regard to 
these conditions and thus not be as effective at promoting product 
competition as the proposed rule. In addition, it would be more 
difficult for the Commission to evaluate compliance with regulations 
under the alternative compared to the proposed rule, as some of the 
ETFs whose exemptive relief we propose to rescind could choose to 
continue to operate under their exemptive relief. The Commission also 
believes that the costs to funds associated with rescinding the 
existing exemptive relief would be minimal, as we anticipate that 
substantially all funds whose relief would be rescinded would be able 
to continue operating with only minor adjustments, other than being 
required to comply with the additional website disclosures and to 
develop basket asset policies and procedures.\514\
---------------------------------------------------------------------------

    \514\ Some ETFs may change the way they operate voluntarily by 
taking advantage of the increased basket flexibility of the proposed 
rule.
---------------------------------------------------------------------------

2. ETFs Organized as UITs
    Proposed rule 6c-11 would be available only to ETFs that are 
organized as open-end funds.\515\ As an alternative, we considered 
including ETFs organized as UITs in the scope of the proposed rule. 
However, as discussed above in section III.A.1, we believe that the 
terms and conditions of the existing exemptive orders for UITs are 
appropriately tailored to address the unique features of the UIT 
structure.
---------------------------------------------------------------------------

    \515\ As discussed in above in section IV.B.1, while the vast 
majority of ETFs currently in operation are organized as open-end 
funds, some early ETFs, which currently have a significant amount of 
assets, are organized as UITs. Examples include SPDR S&P 500 ETF 
Trust (SPY) and PowerShares QQQ Trust, Series 1 (QQQ).
---------------------------------------------------------------------------

    In addition, as also discussed above, ETFs have greater investment 
flexibility under the open-end fund structure than the UIT structure, 
which leads us to believe that most new ETFs entering into the market 
would prefer to operate under the open-end fund structure rather than 
the UIT structure. No new UIT ETFs have come to market in recent years, 
and we do not think that there would be significant economic benefits 
to including UITs in the scope of the proposed rule, and thus we 
propose to exclude ETFs organized as UITs from the proposed rule.\516\
---------------------------------------------------------------------------

    \516\ We note that fund sponsors that plan to launch a new ETF 
organized as a UIT would continue to be able to rely on the 
exemptive order process.
---------------------------------------------------------------------------

3. Basket Flexibility
    Proposed rule 6c-11would require ETFs relying on the rule to adopt 
and implement written policies and procedures that govern the 
construction of basket assets and the process that will be used for the 
acceptance of basket assets. As an alternative, we considered requiring 
that an ETF's basket generally correspond pro rata to its portfolio 
holdings, while identifying certain limited circumstances under which 
an ETF may use a non-pro rata basket, as

[[Page 37396]]

we have done in our exemptive orders since approximately 2006.\517\
---------------------------------------------------------------------------

    \517\ ETFs whose orders we are proposing to rescind and that are 
operating under exemptive orders issued before approximately 2006, 
which included few explicit restrictions, would have reduced basket 
flexibility under the alternative compared to the baseline.
---------------------------------------------------------------------------

    The requirement included in these orders was designed to address 
the risk that an authorized participant or other market participant 
could take advantage of its relationship with the ETF (i.e., engage in 
cherry picking or dumping). However, as discussed above, we believe 
that the proposed rule's additional policies and procedures 
requirements for custom baskets would provide a principles-based 
approach that is designed to limit potential abuses so that they would 
be unlikely to cause significant harm to investors. In addition, as 
also discussed above in section III.C.1.b, we believe that the 
increased basket flexibility under the proposed rule would benefit the 
effective functioning of the arbitrage mechanism, particularly 
benefiting fixed-income, international, and actively managed ETFs.\518\
---------------------------------------------------------------------------

    \518\ Section III.D discusses the possibility that some ETFs may 
use the increased basket flexibility of the proposed rule to over- 
or under-weight securities in their baskets compared to their 
portfolios based on the liquidity of these securities. Such a 
practice would not be possible under the alternative that would 
require an ETF's basket to generally correspond pro rata to its 
portfolio holdings.
---------------------------------------------------------------------------

4. Website Disclosure of Every Basket Used by an ETF
    Proposed rule 6c-11 would require ETFs to post, on the ETF's 
website at the beginning of each business day, a published basket 
applicable to orders for the purchase or redemption of creation units 
to be priced based on the ETF's next calculation of NAV. Because an ETF 
would be required to post only one published basket to comply with this 
condition, it would not be required to post the contents of its other 
custom baskets in many instances. As an alternative, we considered 
proposing that ETFs be required to publish information regarding every 
basket used by the ETF after the close of trading on each business day.
    The additional disclosure under this alternative could reveal 
whether an authorized participant has pressured an ETF into accepting 
illiquid securities in exchange for liquid ETF shares (i.e., dumping) 
or into giving an authorized participant desirable securities in 
exchange for ETF shares tendered for redemption (i.e., cherry-picking) 
by comparing an ETF's portfolio assets and published basket to the 
baskets used by various authorized participants throughout the day.
    However, the proposed rule contains additional conditions for 
basket policies and procedures, which seek to prevent overreaching. 
Moreover, the proposed rule would require an ETF to maintain records 
regarding the baskets used, which would allow Commission staff to 
examine an ETF's use of basket flexibility. Consequently, we believe 
that the risk for these abusive practices under the proposed rule would 
be low while, at the same time, the rule would avoid additional 
operational and compliance costs for ETFs to post and review the 
information, under the alternative.\519\
---------------------------------------------------------------------------

    \519\ We estimate that, under the alternative, an average ETF 
would incur a one-time cost of $3,879 (6 hours (for website 
development) x $296.50 per hour (blended rate for a senior systems 
analyst ($274) and senior programmer ($319)) + (4 hours (for review 
of website disclosures) x $325 (blended rate for a compliance 
manager ($298) and a compliance attorney ($352)) + $800 for an 
external website developer to develop the web page = $3,879) for 
implementing this website disclosure and an ongoing cost of 
$1,596.50 (1 hour (for website updates) x $296.50 per hour (blended 
rate for a senior systems analyst ($274) and senior programmer 
($319)) + (4 hours (for review of website disclosures) x $325 
(blended rate for a compliance manager ($298) and a compliance 
attorney ($352)) = $1,596.50) per year for updating the relevant web 
page daily with this information.
---------------------------------------------------------------------------

5. The Use of a Structured Format for Additional Website Disclosures 
and the Filing of Additional Website Disclosures in a Structured Format 
on EDGAR
    As discussed in section II.C.6 above, we are proposing to require 
ETFs to post on their websites certain disclosures to enable investors 
to more readily obtain certain key metrics for individual ETFs. The 
proposed rule would allow ETFs to select a format for posting 
information that the individual ETF finds most efficient and 
appropriate for the content management system of their website.
    As an alternative, we could require ETFs to post the disclosures in 
a structured format on their websites. Structured disclosures are made 
machine-readable by having reported disclosure items labeled (tagged) 
using a markup language that can be processed by software for 
analysis.\520\ Compared with each ETF selecting its own layout and 
format for the website disclosures, the resulting standardization under 
this alternative would allow for extraction, aggregation, comparison, 
and large-scale analysis of reported information through significantly 
more automated means than is possible with unstructured formats such as 
HTML. This alternative would facilitate the extraction and analysis 
through automated means of an individual fund's disclosures over time--
which would offer the greatest benefit for higher-frequency ETF 
disclosures--and potentially the comparison of disclosures across a 
small number of ETFs. However, requiring a structured disclosure format 
would not lower the collection burden incurred by the requirement to 
separately visit each website to obtain each ETFs disclosure.
---------------------------------------------------------------------------

    \520\ Structured information can be stored, shared and presented 
in different systems or platforms. Standardized markup languages, 
such as XML or XBRL, use sets of data element tags for each required 
reporting element, referred to as taxonomies.
---------------------------------------------------------------------------

    The structured data requirement could impose an incremental cost on 
ETFs of tagging the information in a structured format, particularly to 
the extent that ETFs don't otherwise structure this data for their own 
purposes. Although, if the XML format is used for the additional 
disclosure, the incremental cost of tagging information in a structured 
format would likely be small.\521\
---------------------------------------------------------------------------

    \521\ For example, based on staff experience with XML filings, 
the costs of tagging the information in XML are expected to be 
minimal given the technology that will be used to structure the 
data. XML is a widely used data format, and based on the 
Commission's understanding of current practices, most reporting 
persons and third party service providers have production systems 
already in place to report schedules of investments and other 
information. Therefore, we believe systems should be able to 
accommodate XML data without significant costs, and large-scale 
changes will likely not be necessary to output structured data 
files.
---------------------------------------------------------------------------

    As another alternative, we could require ETFs to make the 
additional website disclosures available in a centralized repository in 
a structured format, such as by filing them on EDGAR. Making the 
information available in a structured format on EDGAR would likely 
improve its accessibility and the ability of investors, the Commission, 
and other data users to efficiently extract information for purposes of 
aggregation, comparison and analysis of information across multiple 
funds and time periods.\522\ As stated above, if the XML format is used 
for the additional disclosure, the incremental cost of tagging the 
information in a structured format would likely be small. However, 
funds would still incur a cost of filing the disclosures on EDGAR, 
which might be higher than the cost of posting the disclosures on 
individual ETF websites.
---------------------------------------------------------------------------

    \522\ The Commission has implemented requirements for the 
structuring of certain information disclosed by funds. See, e.g., 
Release No. 33-10231 (Oct. 13, 2016) [81 FR 81870]; Release No. IC-
29132 (Feb. 23, 2010) [75 FR 10059]; Release No. 33-9006 (Feb. 11, 
2009) [74 FR 7747].
---------------------------------------------------------------------------

6. Treatment of Leveraged ETFs
    As discussed in section II.A.3. above, leveraged ETFs would not be 
able to

[[Page 37397]]

rely on proposed rule 6c-11. As an alternative, we considered 
permitting leveraged ETFs to rely on the proposed rule, while 
maintaining the status quo of existing exemptive orders with respect to 
the amount of leveraged market exposure that leveraged ETFs may obtain 
(i.e., 300% of the return or inverse return).\523\ This alternative 
would thus prohibit a leveraged ETF from seeking a performance result, 
directly or indirectly, that exceeds three times the performance, or 
inverse performance, of the specified market index or benchmark. This 
alternative could benefit competition among leveraged ETFs as compared 
to the baseline, as fund sponsors that currently do not have an 
exemptive order permitting them to operate this type of ETF could enter 
the market. As a result, fees for leveraged ETFs would likely decrease 
and their assets could increase. However, as discussed in detail in 
section II.A.3., in light of our ongoing consideration, including the 
potential staff recommendation of a re-proposal on funds' use of 
derivatives, we do not believe it is appropriate to permit sponsors to 
form and operate leveraged ETFs in reliance on our proposed rule.
---------------------------------------------------------------------------

    \523\ See supra footnote 77.
---------------------------------------------------------------------------

F. Request for Comments

    The Commission requests comment on all aspects of this initial 
economic analysis, including whether the analysis has: (1) Identified 
all benefits and costs, including all effects on efficiency, 
competition, and capital formation; (2) given due consideration to each 
benefit and cost, including each effect on efficiency, competition, and 
capital formation; and (3) identified and considered reasonable 
alternatives to the proposed new rule and disclosure amendments. We 
request and encourage any interested person to submit comments 
regarding the proposed rule, our analysis of the potential effects of 
the proposed rule and proposed amendments, and other matters that may 
have an effect on the proposed rule. We request that commenters 
identify sources of data and information as well as provide data and 
information to assist us in analyzing the economic consequences of the 
proposed rule and proposed amendments. We also are interested in 
comments on the qualitative benefits and costs we have identified and 
any benefits and costs we may have overlooked. In addition to our 
general request for comment on the economic analysis associated with 
the proposed rule and proposed amendments, we request specific comment 
on certain aspects of the proposal:
    <bullet> Would the proposed rule require any existing ETFs whose 
exemptive orders would be rescinded to materially change the way they 
operate? If so, what types of funds would have to materially change the 
way they operate and it what ways? Would these funds require any 
additional exemptive relief to continue operating?
    <bullet> Would the elimination of the direct costs of obtaining 
exemptive relief result in additional benefits to ETFs or their 
investors? Are there other costs of the proposed rule that would offset 
any cost savings resulting from not having to file an exemptive 
application?
    <bullet> Would the proposed rule result in greater product 
innovation in the ETF market? Would the proposed rule result in 
increased investment options?
    <bullet> Are we correct to assume that substantially all ETFs that 
are currently not required to make daily website disclosures of NAV, 
closing price, and premiums and discounts would have the data required 
to make these disclosures available to them as part of their regular 
operations as well as systems (such as computer equipment, an internet 
connection, and a website) in place that can be used for processing 
this data and uploading it to their websites? If not, what data or 
systems would currently be unavailable, which ETFs would it be 
unavailable for, and what would the cost of acquiring the unavailable 
data or systems be?
    <bullet> Do ETFs already have policies and procedures in place 
governing the composition of baskets? How long would it take and how 
much would it cost to implement such policies and procedures for funds 
that do not already have them in place, particularly the custom basket 
policies and procedures?
    <bullet> Are we correct to assume that substantially all ETFs would 
already have the required data available for daily website disclosures 
of bid-ask spreads and historical information regarding premiums and 
discounts as well as systems (such as computer equipment, an internet 
connection, and a website) in place that can be used for processing 
this data and uploading it to their websites? If not, what data or 
systems would currently be unavailable, which funds would it be 
unavailable for, and what would the cost of acquiring the unavailable 
data or systems be?
    <bullet> Are we correct to assume that substantially all funds 
would already have the required data to complete the new disclosures 
required by the proposed amendments to Forms N-1A and N-8B-2 available 
to them as part of their regular operations? If not, what data would 
currently be unavailable, which funds would it be unavailable for, and 
what would the cost of acquiring the unavailable data be?
    <bullet> Is our estimate correct that the cost to a typical fund 
for applying for an ETF exemptive order is approximately $100,000? If 
not, what would be a more accurate estimate?
    <bullet> How many ETFs (representing how much in assets) currently 
are required to disclose on their website, free of charge, the previous 
day's NAV and the price of the ETF shares, as well as the premium or 
discount associated with the closing price and information pertaining 
to the composition and proportion of underlying holdings? How many ETFs 
(representing how much in assets) are not required to provide this 
disclosure but nevertheless voluntarily provide it?
    <bullet> Do commenters agree that requiring ETFs to make the 
additional website disclosures available in a structured format, which 
is an alternative we considered, would be associated with only a small 
cost of tagging this information?
    <bullet> Would the proposed rule lead to more competition and lower 
fees in the leveraged ETF market if leveraged ETFs were allowed to rely 
on the rule?

IV. Paperwork Reduction Act

A. Introduction

    Proposed rule 6c-11 would result in new ``collection of 
information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995 (``PRA'').\524\ In addition, the proposed 
amendments to Form N-1A, Form N-8B-2, and Form N-CEN would impact the 
collection of information burden under those forms and Form S-6.\525\ 
Proposed rule 6c-11 also would impact the current collection of 
information burden of rule 0-2 under the Act.\526\
---------------------------------------------------------------------------

    \524\ 44 U.S.C. 3501-3520.
    \525\ 17 CFR 274.11A; 17 CFR 274.12; 17 CFR part 101; 17 CFR 
239.16.
    \526\ 17 CFR 270.0-2.
---------------------------------------------------------------------------

    The titles for the existing collection of information are: ``Form 
N-1A under the Securities Act of 1933 and under the Investment Company 
Act of 1940, Registration Statement for Open-End Management Companies'' 
(OMB No. 3235-0307); ``Form N-8B-2 under the Investment Company Act of 
1940, Registration Statement of Unit Investment Trusts Which are 
Currently Issuing Securities'' (OMB No. 3235-0186); ``Form S-6 [17 CFR 
239.19], for registration under the Securities Act of 1933 of Unit 
Investment Trusts registered on Form N-8B-2'' (OMB Control No. 3235-
0184); ``Form N-

[[Page 37398]]

CEN'' (OMB Control No. 3235-0730); and ``Rule 0-2 under the Investment 
Company Act of 1940, General Requirements of Papers and Applications'' 
(OMB Control No. 3235-0636). The title for the new collection of 
information would be: ``Rule 6c-11 under the Investment Company Act of 
1940, `Exchange-traded funds.' '' The Commission is submitting these 
collections of information to the Office of Management and Budget 
(``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 
1320.11. An agency may not conduct or sponsor, and a person is not 
required to respond to, a collection of information unless it displays 
a currently valid control number.
    We published notice soliciting comments on the collection of 
information requirements in the 2008 ETF Proposing Release and 
submitted the proposed collections of information to OMB for review and 
approval in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11.\527\ 
We received no comments on the collection of information requirements.
---------------------------------------------------------------------------

    \527\ See 2008 ETF Proposing Release, supra footnote 3.
---------------------------------------------------------------------------

    We discuss below the collection of information burdens associated 
with proposed rule 6c-11 and its impact on rule 0-2 as well as proposed 
amendments to Forms N-1A, N-8B-2, S-6 and N-CEN.

B. Proposed Rule 6c-11

    Proposed rule 6c-11 would permit ETFs that satisfy certain 
conditions to operate without first obtaining an exemptive order from 
the Commission. The rule is designed to create a consistent, 
transparent, and efficient regulatory framework for such ETFs and 
facilitate greater competition and innovation among ETFs. The proposal 
attempts to eliminate historical distinctions and conditions that we no 
longer believe are necessary and thus appropriately level the playing 
field for such ETFs that pursue the same or similar investment 
strategies.
    Proposed rule 6c-11 would require an ETF to disclose certain 
information on its website, to maintain certain records, and to adopt 
and implement written policies and procedures governing their 
constructions of baskets, as well as written policies and procedures 
that set forth detailed parameters for the construction and acceptance 
of custom baskets that are in the best interests of the ETF and its 
shareholders. These requirements are collections of information under 
the PRA.
    The respondents to proposed rule 6c-11 would be ETFs registered as 
open-end management investment companies other than ETFs within 
multiple-class funds or leveraged ETFs.\528\ This collection would not 
be mandatory, but would be necessary for those ETFs seeking to operate 
without individual exemptive orders. We estimate that 1,635 ETFs would 
likely rely on rule 6c-11.\529\ Information provided to the Commission 
in connection with staff examinations or investigations would be kept 
confidential subject to the provisions of applicable law.
---------------------------------------------------------------------------

    \528\ See proposed rule 6c-11(a) (defining ``exchange-traded 
fund'').
    \529\ See supra footnote 425 and accompanying text. This is 
estimate does not include UIT ETFs, share class ETFs, or leveraged 
ETFs.
---------------------------------------------------------------------------

1. Website Disclosures
    Under the proposal, ETFs would be required to post on their 
websites: (i) The ETF's NAV per share, market price, and premium or 
discount; and (ii) historical information regarding premiums and 
discounts. In addition, proposed rule 6c-11 would require an ETF to 
disclose on its website, each business day, the portfolio holdings that 
will form the basis for each calculation of NAV per share,\530\ and 
information regarding a published basket that will apply to orders for 
the purchase or redemption of creation units each business day.\531\ As 
proposed, the rule would require that portfolio holdings and basket 
information be presented and contain information regarding description, 
amount, value and/or unrealized gain/loss (if applicable) in the manner 
prescribed within Article 12 of Regulation S-X.\532\ Additionally, the 
proposed rule would require an ETF to disclose on its website a tabular 
chart and line graph showing the ETF's premiums and discounts for the 
most recently completed calendar year and the most recently completed 
calendar quarters of the current year. For new ETFs that do not yet 
have this information, the proposed rule would require the ETF to post 
this information for the life of the fund. As discussed above, we 
believe the disclosures provide useful information to investors who 
purchase and sell ETF shares on national securities exchanges.
---------------------------------------------------------------------------

    \530\ See proposed rule 6c-11(c)(1)(i)(A).
    \531\ See proposed rule 6c-11(c)(1)(i)(B).
    \532\ See supra footnote 220.
---------------------------------------------------------------------------

    Proposed rule 6c-11(c)(1)(v) also would require any ETF whose 
premium or discount was greater than 2% for more than seven consecutive 
trading days to post that information on its website, along with a 
discussion of the factors that are reasonably believed to have 
materially contributed to the premium or discount.\533\ Given the 
proposed threshold, we do not believe that many ETFs would be required 
to disclose this information on a routine basis. For purposes of this 
PRA, we assume that all ETFs will be required to make this disclosure 
only once in their lifetime. Therefore, we believe that this 
requirement will impose only initial costs and that there will be no 
ongoing costs associated with it.\534\
---------------------------------------------------------------------------

    \533\ This information would be posted on the trading day 
immediately following the eighth consecutive trading day on which 
the ETF had a premium or discount greater than 2% and be maintained 
on the ETF's website for at least one year following the first day 
it was posted. See supra at text following footnote 306.
    \534\ For purposes of this analysis, we estimate that 1,635 ETFs 
would be required to make this disclosure at least once in their 
lifetime.
---------------------------------------------------------------------------

    For purposes of the PRA analysis, we estimate that an ETF would 
incur a one-time average burden of 25 hours associated with updating 
the relevant website disclosures, at a time cost of $7,697.50.\535\ The 
staff estimates the initial external cost would be $2,000 for an 
external website developer to develop the web page.\536\ Amortized over 
a 3-year period, the hour burden per ETF would be approximately 8.3 
hours, at a time cost of $2,565.8, and an external cost of 
approximately $666.65. Additionally, Commission staff estimates that an 
ETF each year would spend approximately 5 hours of professional time to 
update the relevant web page daily with this information, at a time 
cost of $1,405.50.\537\ Commission staff does not believe there will be 
any ongoing external costs related to the website disclosure 
requirements. Accordingly, we estimate that the total burden for 
drafting, reviewing and uploading the website disclosures would be 
21,745.50 hours,\538\ at a time

[[Page 37399]]

cost of approximately $6,493,075.50,\539\ and an external cost of 
$1,089,972.75.\540\
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    \535\ This estimate is based on the following calculations: (15 
hours (for website development) x $296.50 per hour (blended rate for 
a senior systems analyst ($274) and senior programmer ($319)) + (10 
hours (for review of website disclosures) x $325 (blended rate for a 
compliance manager ($298) and a compliance attorney ($352)) = 
$7,697.50).
    \536\ Based on staff experience, the staff estimates that each 
ETF initially would spend an additional $2,000 on external website 
developers.
    \537\ This estimate is based on the following calculations: (2 
hours (for website updates) x $296.50 per hour (blended rate for a 
senior systems analyst ($274) and senior programmer ($319)) + (2.5 
hours (for review of website disclosures) x $325 (blended rate for a 
compliance manager ($298) and a compliance attorney ($352)) = 
$1,405.50. See SIFMA Report, supra footnote 452.
    \538\ This estimate is based on the following calculation: 13.3 
hours x 1,635 ETFs = 21,745.50 hours.
    \539\ This estimate is based on the following calculation: 
$3,971.3 x 1,635 ETFs = $6,493,075.50.
    \540\ This estimate is based on the following calculation: 
$666.65 x 1,635 ETFs = $1,089,972.75.
---------------------------------------------------------------------------

2. Recordkeeping
    The proposed rule requires that ETFs to preserve and maintain 
copies of all written authorized participant agreements.\541\ 
Additionally, we are proposing to require ETFs to maintain records 
setting forth the following information for each basket exchanged with 
an authorized participant: (i) The names and quantities of the 
positions composing the basket; (ii) identification of the basket as a 
``custom basket'' and a record stating that the custom basket complies 
with the ETF's custom basket policies and procedures (if applicable); 
(iii) cash balancing amounts (if any); and (iv) the identity of the 
authorized participant conducting the transaction.\542\
---------------------------------------------------------------------------

    \541\ See proposed rule 6c-11(d).
    \542\ See supra footnote 325 and accompanying text.
---------------------------------------------------------------------------

    ETFs would have to maintain these records for at least five years, 
the first two years in an easily accessible place.\543\ We estimate 
that the burden would be 5 hours per ETF to retain these records, with 
2.5 hours spent by a general clerk and 2.5 hours spent by a senior 
computer operator. We estimate a time cost per ETF of $380.\544\ We 
estimate the total recordkeeping burden related to rule 6c-11 would be 
8,175 hours, at an aggregate cost of $621,300.\545\
---------------------------------------------------------------------------

    \543\ Id.
    \544\ This estimate is based on the following calculations: 2.5 
hours x $60 (hourly rate for a general clerk) = $150; 2.5 hours x 
$92 (hour rate for a senior computer operator) = $230. $150 + $230 = 
$380.
    \545\ We estimate that 1,635 ETFs would be required to maintain 
these records.
---------------------------------------------------------------------------

3. Policies and Procedures
    As proposed, rule 6c-11 would require ETFs relying on the proposed 
rule to adopt and implement written policies and procedures that govern 
the construction of baskets and the process that will be used for the 
acceptance of basket assets.\546\ Additionally, to use custom baskets, 
an ETF would be required to adopt and implement written policies and 
procedures setting forth detailed parameters for the construction and 
acceptance of custom baskets that are in the best interests of the ETF 
and its shareholders.\547\ These policies and procedures also may 
include a periodic review requirement in order to ensure that the ETF's 
custom basket procedures are being consistently followed.\548\ Finally, 
as discussed above, such an ETF would be required to maintain records 
detailing the composition of each custom basket.
---------------------------------------------------------------------------

    \546\ See proposed rule 6c-11(c)(3).
    \547\ See proposed rule 6c-11(c)(3)(i).
    \548\ See supra text accompanying footnote 256.
---------------------------------------------------------------------------

    For purposes of this PRA analysis, we estimate that an ETF would 
incur a one-time average burden of 6 hours associated with setting up 
the process for documenting the construction and acceptance of 
baskets.\549\ Accordingly, we estimate that a total initial burden 
associated with setting up the process for documenting the construction 
and acceptance of baskets would be 9,810 hours,\550\ at a time cost of 
$4,094,325.\551\ An ETF utilizing custom baskets would also incur a 
one-time average burden of 20 hours associated with documenting and 
adopting the custom basket policies and procedures. Amortized over a 3-
year period, this would be an annual burden per ETF of about 2 hours 
for documenting the construction and acceptance of baskets and an 
annual burden per ETF of about 6.7 hours for the custom basket policies 
and procedures. Accordingly, we estimate that a total burden for 
initial documentation and review of both the process for documenting 
the construction and acceptance of baskets as well as an ETF's custom 
basket policies and procedures would be 42,510 hours,\552\ at a time 
cost of $16,788,180.\553\ Amortizing these costs over three years, the 
annual burden of complying with these requirements would be 14,170 
hours, at a time cost of $5,596,060. We also estimate that there would 
be no external cost for an ETF associated with these requirements.
---------------------------------------------------------------------------

    \549\ We estimate that all ETFs relying on the rule will use 
custom baskets to some extent. Moreover, we estimate that the cost 
associated with this requirement is small because the records 
detailing the composition of each custom basket are readily 
available.
    \550\ This estimate is based on the following calculations: 6 
hours x 1,635 ETFs = 9,810 hours.
    \551\ This estimate is based on the following calculations: 3 
hours x 317 (hourly rate for a senior manager) = $951; 2 hours x 511 
(hourly rate for chief compliance officer) = $1,022; 1 hour x $352 
(hourly rate for compliance attorney) = $352; $951 + $1,022 + $352 = 
$2,325; $2,325 x 1,635 ETFs = $3,801,375.
    \552\ This estimate is based on the following calculation: (6 
hours + 20 hours) x 1,635 ETFs = 42,510 hours.
    \553\ These estimates are based on the following calculations: 
12 hours x $317 (hourly rate for a senior portfolio manager) = 
$3,804; 12 hours x $480 (blended hourly rate for assistant general 
counsel ($449) and chief compliance officer ($511) = $5,760; 2 hours 
(for a fund attorney's time to prepare and review materials) x $352 
(hourly rate for a compliance attorney) = $704. $3,804 + $5,760 + 
$704 = $10,268; $10,268 x 1,635 ETFs = $16,788,180. See SIFMA 
Report, supra footnote 452.
---------------------------------------------------------------------------

    We estimate that each ETF would incur an ongoing burden of an 
additional 10 hours, at a time cost of an additional $3,985 \554\ each 
year to review and update its custom basket policies and procedures as 
well as its process for documenting the construction and acceptance of 
baskets. In aggregate, we estimate that the total ongoing costs 
associated with these requirements are 16,350 hours, at a time cost of 
$6,515,475.\555\ We do not estimate that there will be any ongoing 
external costs associated with these requirements. Therefore, we 
estimate that the total initial and ongoing costs associated with 
complying with the policies and procedures requirements of proposed 
rule 6c-11 would be 30,520 \556\ hours at a time cost of 
$12,111,535.\557\
---------------------------------------------------------------------------

    \554\ These estimates are based on the following calculations: 5 
hours x $317 (hourly rate for a senior portfolio manager) = $1,585; 
5 hours x $480 (blended hourly rate for assistant general counsel 
($449) and chief compliance officer ($511) = $2,400. $1,585 + $2,400 
= $3,985.
    \555\ This estimate is based on the following calculation: 
$3,985 x 1,635 ETFs = $6,515,475.
    \556\ This estimate is based on the following calculation: 
14,170 hours + 16,350 hours = 30,520 hours.
    \557\ This estimate is based on the following calculation: 
$5,596,060 + $6,515,475 = $12,111,535.
---------------------------------------------------------------------------

4. Estimated Total Burden
    We estimate that the total hour burdens and time costs associated 
with proposed rule 6c-11, including the burden associated with: (i) 
Website disclosure; (ii) recordkeeping; and (iii) developing policies 
and procedures, would result in an average aggregate annual burden of 
60,440.5 hours \558\ and an average aggregate time cost of 
$19,225,910.50.\559\ We also estimate that there are $1,089,972.75 
external costs associated with this collection of information. \560\ 
Therefore, to comply with rule 6c-11 each ETF would incur an annual 
burden of approximately 36.97 \561\ hours, at an average time cost of 
approximately $11,758.97 \562\, and an external cost of $666.65.\563\
---------------------------------------------------------------------------

    \558\ This estimate is based on the following calculation: 
21,745.5 hours + 8,175 hours + 30,520 hours = 60,440.5 hours.
    \559\ This estimate is based on the following calculation: 
$6,493,075.50 + $621,300 + $12,111,535 = $19,225,910.50.
    \560\ See supra footnote 540 and accompanying text.
    \561\ This estimate is based on the following calculation: 
60,440.5 hours / 1,635 ETFs = 36.97 hours.
    \562\ This estimate is based on the following calculation: 
$19,225,910.50 / 1,635 ETFs = $11,758.97.
    \563\ This estimate is based on the following calculation: 
$1,089,972.75 / 1,635 ETFs = $666.65.

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

[[Page 37400]]

C. Rule 0-2

    Section 6(c) of the Act provides the Commission with authority to 
conditionally or unconditionally exempt 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. Rule 0-2 under the 
Act, entitled ``General Requirements of Papers and Applications,'' 
prescribes general instructions for filing an application seeking 
exemptive relief with the Commission.\564\ We currently estimate for 
rule 0-2 a total hour burden of 5,340 hours at an annual time cost of 
$2,029,200.60 and the total annual external cost burden is 
$14,090,000.\565\
---------------------------------------------------------------------------

    \564\ See Supporting Statement of Rule 0-2 under the Investment 
Company Act of 1940, General Requirements of Paper Applications 
(Nov. 23, 2016), available at https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201602-3235-008 (summarizing how applications are 
filed with the Commission in accordance with the requirements of 
rule 0-2).
    \565\ This estimate is based on the last time the rule's 
information collection was submitted for PRA renewal in 2016.
---------------------------------------------------------------------------

    As discussed above, proposed rule 6c-11 would permit ETFs that 
satisfy the conditions of the rule to operate without the need to 
obtain an exemptive order from the Commission under the Act. Therefore, 
proposed rule 6c-11 would alleviate some of the burdens associated with 
rule 0-2 because it would reduce the number of entities that require 
exemptive relief in order to operate.\566\ Based on staff experience, 
we estimate that approximately one-third of the annual burdens 
associated with rule 0-2 are attributable to ETF applications. 
Therefore, we estimate that proposed rule 6c-11 would result in a 
decrease of the annual burden of rule 0-2 to approximately 3,738 \567\ 
hours at an annual time cost of $1,420,440.42 \568\ and an annual 
external cost of $9,863,000.\569\
---------------------------------------------------------------------------

    \566\ As discussed above, we expect to continue to receive 
applications for complex or novel ETF exemptive relief that are 
beyond the scope of the proposed rule. See supra at text following 
footnote 454.
    \567\ This estimate is based on the following calculation: 5,340 
hours-(5,340 hours x 0.3) = 3,738 hours.
    \568\ This estimate is based on the following calculation: 
$2,029,200.60-($2,029,200.60 x 0.3) = $1,420,440.42.
    \569\ This estimate is based on the following calculation: 
$14,090,000-($14,090,000 x 0.3) = $9,863,000.
---------------------------------------------------------------------------

D. Form N-1A

    Form N-1A is the registration form used by open-end management 
investment companies. The respondents to the proposed amendments to 
Form N-1A are open-end management investment companies registered or 
registering with the Commission. Compliance with the proposed 
disclosure requirements of Form N-1A is mandatory for open-end funds 
(to the extent applicable) including all ETFs organized as open-end 
funds. Responses to the disclosure requirements are not confidential. 
We currently estimate for Form N-1A a total burden hour of 1,579,974 
burden hours, with an estimated internal cost of $129,338,408, and 
external cost of $124,820,197.\570\
---------------------------------------------------------------------------

    \570\ This estimate is based on the last time the form's 
information collection was submitted for PRA renewal in 2017.
---------------------------------------------------------------------------

    We are proposing amendments to Form N-1A designed to provide 
investors who purchase ETF shares in secondary market transactions with 
tailored information regarding ETFs, including information regarding 
costs associated with an investment in ETFs.\571\ Specifically, the 
proposed amendments to Form N-1A would require new disclosures 
regarding fees and expenses, such as brokerage commission and financial 
intermediary fees, and certain trading costs.\572\ In addition, we are 
proposing to include instructions in Form N-1A requiring an ETF to 
provide bid-ask spread information on the ETF's website and an 
interactive calculator, in a clear and prominent format on the ETF's 
website, to allow investors to customize certain hypothetical 
calculations to their specific investing situation.\573\
---------------------------------------------------------------------------

    \571\ See proposed Instruction 5(e) to Item 3 of Form N-1A.
    \572\ See proposed amendments to Item 3 of Form N-1A.
    \573\ Proposed Instruction 5(e) to Item 3 of Form N-1A.
---------------------------------------------------------------------------

    We also are proposing amendments to Form N-1A designed to eliminate 
certain disclosures for ETFs that are duplicative of the new 
disclosures we are proposing, discussed above, or are no longer 
necessary.\574\ These proposed amendments include eliminating certain 
disclosures in Item 6(c) of Form N-1A relating to creation units, 
secondary market transactions, premiums and discounts, as well as 
certain disclosures required of ETFs issuing creation units of less 
than 25,000 shares. Additionally, we are proposing to eliminate 
historical premium/discount disclosure requirements in Item 11(g)(2) 
and Item 27(b)(7)(iv) of Form N-1A.
---------------------------------------------------------------------------

    \574\ See supra footnotes 390-397 and accompanying text.
---------------------------------------------------------------------------

    Form N-1A generally imposes two types of reporting burdens on 
investment companies: (i) The burden of preparing and filing the 
initial registration statement; and (ii) the burden of preparing and 
filing post-effective amendments to a previously effective registration 
statement (including post-effective amendments filed pursuant to 17 CFR 
230.485(a) or (b) (rule 485(a) or 485(b) under the Securities Act), as 
applicable). We estimate that each ETF would incur a one-time burden of 
an additional 10 hours, at a time cost of an additional $3,355,\575\ to 
draft and finalize the required disclosure and amend its registration 
statement. We further estimate that an ETF would incur a one-time 
average burden of 10 hours associated with implementing the bid-ask 
spread disclosures and interactive calculator on its website, at a time 
cost of $3,355,\576\ as required by proposed Instruction 5(e) to Item 
3. In the aggregate, we estimate that ETFs would incur a one-time 
burden of an additional 20 hours, at a time cost of an additional 
$6,710 to comply with the proposed Form N-1A disclosure requirements 
for ETFs. Amortizing the one-time burden over a three-year period 
results in an average annual burden of an additional 6.67 hours at a 
time cost of an additional $2,236.67.
---------------------------------------------------------------------------

    \575\ This estimate is based on the following calculation: 10 
hours x $335.50 (blended rate for a compliance attorney ($352) and a 
senior programmer ($319)) = $3,355.
    \576\ Id.
---------------------------------------------------------------------------

    We estimate that each ETF would incur an ongoing burden of an 
additional 5 hours, at a time cost of an additional $1,677.50 \577\ 
each year to review and update the proposed disclosures.\578\ We also 
estimate that each ETF would incur an ongoing burden of an additional 5 
hours, at a time cost of an additional $1,677.50,\579\ relating to the 
bid-ask spread disclosures and to maintain the interactive calculator 
on its website. In aggregate, we estimate that each ETF would incur an 
annual ongoing burden of an additional 10 hours, at a time cost of an 
additional $3,355, to comply with the proposed Form N-1A disclosure 
requirements. We do not estimate any change to the external costs 
associated with the proposed amendment for Form N-1A.
---------------------------------------------------------------------------

    \577\ This estimate is based on the following calculation: 5 
hours x $335.50 (blended rate for a compliance attorney ($352) and a 
senior programmer ($319)) = $1,677.50.
    \578\ The estimated burden associated with the amendments to 
Form N-1A accounts for the proposal to remove the information 
currently required by Item 11(g)(2) and Item 27(b)(7)(iv) of Form N-
1A.
    \579\ Id.
---------------------------------------------------------------------------

    In total, we estimate that ETFs, other than UIT ETFs, would incur 
an average

[[Page 37401]]

annual increased burden of approximately 31,596.4 hours,\580\ at a time 
cost of approximately $10,579,307.2,\581\ to comply with the proposed 
Form N-1A disclosure requirements. We do not estimate any change to the 
external costs associated with the proposed amendment for Form N-1A.
---------------------------------------------------------------------------

    \580\ This estimate is based on the following calculation: (6.7 
hours + 10 hours) x 1,892 ETFs = 31,596.4 hours.
    \581\ This estimate is based on the following calculation: 
($2,236.67 + $3,355) x 1,892 ETFs= $10,579,307.20.
---------------------------------------------------------------------------

E. Disclosure Amendments to Forms N-8B-2 and S-6

    Form N-8B-2 is used by UITs to initially register under the 
Investment Company Act pursuant to section 8 thereof.\582\ UITs are 
required to file Form S-6 in order to register offerings of securities 
with the Commission under the Securities Act.\583\ As a result, UITs 
file Form N-8B-2 only once when the UIT is initially created and then 
use Form S-6 to file all post-effective amendments to their 
registration statements in order to update their prospectuses.\584\ We 
currently estimate for Form S-6 a total burden of 106,620 hours, with 
an internal cost burden of approximately $34,000,000, and an external 
cost burden estimate of $67,359,556.\585\ Additionally, we currently 
estimate for Form N-8B-2 a total burden of 10 hours, with an internal 
cost burden of approximately $3,360, and an external burden estimate of 
$10,000.\586\
---------------------------------------------------------------------------

    \582\ See Form N-8B-2 [17 CFR 274.12].
    \583\ See Form S-6 [17 CFR 239.16]. Form S-6 is used for 
registration under the Securities Act of securities of any UIT 
registered under the Act on Form N-8B-2.
    \584\ Form S-6 incorporates by reference the disclosure 
requirements of Form N-8B-2 and allows UITs to meet the filing and 
disclosure requirements of the Securities Act.
    \585\ This estimate is based on the last time the form's 
information collection was submitted for PRA renewal in 2014.
    \586\ This estimate is based on the last time the form's 
information collection was submitted for PRA renewal in 2018.
---------------------------------------------------------------------------

    In order to assist investors with better understanding the total 
costs of investing in a UIT ETF, we are proposing disclosure 
requirements in Form N-8B-2 that mirror those disclosures proposed for 
Form N-1A.\587\ All UIT ETFs would be subject to these disclosure 
requirements. For existing UIT ETFs, the one-time and ongoing costs of 
complying with the amendments to Form N-8B-2 would accrue on Form S-
6.\588\
---------------------------------------------------------------------------

    \587\ See proposed Items 13(h) and (i) of Form N-8B-2. See also 
supra section II.H.5.
    \588\ See supra footnote 583.
---------------------------------------------------------------------------

    For purposes of the PRA analysis, we estimate that each UIT ETF 
would incur a one-time burden of an additional 20 hours, at a time cost 
of an additional $6,710 \589\ to draft and finalize the required 
disclosure and amend its Form S-6. For each newly created UIT ETF, 
these same costs would be incurred on Form N-8B-2.\590\ Therefore, in 
the aggregate, we estimate that existing UIT ETFs would incur a one-
time burden of an additional 160 hours,\591\ at a time cost of an 
additional $53,680,\592\ to comply with the proposed Form N-8B-2 
disclosure requirements on Form S-6. Additionally, in the aggregate, we 
estimate that newly created UIT ETFs would incur a one-time burden of 
an additional 20 hours, at a time cost of an additional $6,710, to 
comply with the proposed amendments and complete Form N-8B-2. 
Amortizing the one-time burden for both existing and newly created UIT 
ETFs over a three-year period results in an average annual burden of an 
additional 6.67 hours, at a time cost of an additional $2,236.67.
---------------------------------------------------------------------------

    \589\ This estimate is based on the following calculation: 20 
hours x $335.50 (blended rate for a compliance attorney ($352) and a 
senior programmer ($319)) = $6,710.
    \590\ Although we noted above that no new UIT ETFs have come to 
market since 2002, for purposes of calculating the time and cost 
burdens associated with completing Form N-8B-2, we estimate that 1 
UIT ETF will be created annually. See supra footnote 41 and 
accompanying text.
    \591\ This estimate is based on the following calculation: 20 
hours x 8 UIT ETFs= 160 hours.
    \592\ This estimate is based on the following calculation: 
$6,710 x 8 UIT ETFs = $53,680.
---------------------------------------------------------------------------

    We estimate that each UIT ETF would incur an ongoing burden of an 
additional 10 hours, at a time cost of an additional $3,355, each year 
to review and update the proposed disclosures on Form S-6. In 
aggregate, we estimate that UIT ETFs would incur an annual burden of an 
additional 80 hours,\593\ at a time cost of an additional $26,840,\594\ 
to comply with the proposed Form N-8B-2 disclosure requirements on Form 
S-6.
---------------------------------------------------------------------------

    \593\ This estimate is based on the following calculation: 10 
hours x 8 UIT ETFs = 80 hours.
    \594\ This estimate is based on the following calculation: 
$3,355 x 8 UIT ETFs = $26,840.
---------------------------------------------------------------------------

    Additionally, we estimate that newly created UIT ETFs would also 
incur an average annual increased burden of approximately 10 hours, at 
a time cost of an additional $3,355, to complete Form N-8B-2. We do not 
estimate any change to the external costs, on either Form N-8B-2 or 
Form S-6, associated with the proposed amendments to Form N-8B-2.

F. Form N-CEN

    As discussed above, Form N-CEN is a structured form that requires 
registered funds to provide census-type information to the Commission 
on an annual basis.\595\ The Commission is proposing amendments to Form 
N-CEN to require ETFs to report if they are relying on rule 6c-11.\596\
---------------------------------------------------------------------------

    \595\ See Reporting Modernization Adopting Release, supra 
footnote 147. The compliance date for Form N-CEN is June 1, 2018.
    \596\ See proposed Item C.7.k. of Form N-CEN.
---------------------------------------------------------------------------

    In the Reporting Modernization Adopting Release, we estimated that 
the Commission would receive an average of 3,113 reports on Form N-
CEN.\597\ We estimated that the average annual hour burden per response 
for Form N-CEN for the first year to be 32.37 hours and 12.37 hours in 
subsequent years.\598\ Amortizing the burden over three years, we 
estimated that the average annual hour burden per fund per year to be 
19.04 hours and the total aggregate annual hour burden to be 59,272 
hours.\599\ Finally, we estimated that all applicable funds will incur, 
in the aggregate, external annual costs of $2,088,176 to prepare and 
file reports on Form N-CEN.\600\
---------------------------------------------------------------------------

    \597\ See Reporting Modernization Adopting Release, supra 
footnote 147, at text accompanying n.1524.
    \598\ See id., at text accompanying nn.1531-1532.
    \599\ See id., at text accompanying nn.1533-1534.
    \600\ See Reporting Modernization Adopting Release, supra 
footnote 147, at text accompanying n.1538.
---------------------------------------------------------------------------

    Based on Commission staff experience, we believe that our proposal 
to require ETFs to report if they are relying on rule 6c-11 would 
increase the estimated burden hours associated with Form N-CEN by 
approximately 0.1 hours, both initially and on an ongoing basis.\601\ 
Therefore, in the aggregate, we estimate that ETFs will incur an annual 
burden of an additional 163.5 hours to comply with the proposed 
amendments to Form N-CEN.\602\ We estimate that there are no additional 
external costs associated with this collection of information.
---------------------------------------------------------------------------

    \601\ This estimate stems from the Commission staff's 
understanding of the time it takes to complete initially complete 
and review items on Form N-CEN.
    \602\ This estimate is based on the following calculation: 0.1 
hours x 1,635 ETFs = 163.5 hours.
---------------------------------------------------------------------------

G. Request for Comments

    We request comment on whether these estimates are reasonable. 
Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments 
in order to: (i) Evaluate whether the proposed collections of 
information are necessary for the proper performance of the functions 
of the Commission, including whether the information will have 
practical utility; (ii) evaluate the accuracy of the Commission's 
estimate of the burden of the proposed

[[Page 37402]]

collections of information; (iii) determine whether there are ways to 
enhance the quality, utility, and clarity of the information to be 
collected; and (iv) determine whether there are ways to minimize the 
burden of the collections of information on those who are to respond, 
including through the use of automated collection techniques or other 
forms of information technology.
    Persons wishing to submit comments on the collection of information 
requirements of the proposed rules and amendments should direct them to 
the OMB, Attention Desk Officer for the Securities and Exchange 
Commission, Office of Information and Regulatory Affairs, Washington, 
DC 20503, and should send a copy to, Brent J. Fields, Secretary, 
Securities and Exchange Commission, 100 F Street NE, Washington, DC 
20549-1090, with reference to File No. S7-15-18. OMB is required to 
make a decision concerning the collections of information between 30 
and 60 days after publication of this release; therefore a comment to 
OMB is best assured of having its full effect if OMB receives it within 
30 days after publication of this release. Requests for materials 
submitted to OMB by the Commission with regard to these collections of 
information should be in writing, refer to File No. S7-15-18, and be 
submitted to the Securities and Exchange Commission, Office of FOIA 
Services, 100 F Street NE, Washington, DC 20549-2736.

V. Initial Regulatory Flexibility Analysis

    The Commission has prepared the following Initial Regulatory 
Flexibility Analysis (``IRFA'') in accordance with section 3 of the 
Regulatory Flexibility Act \603\ regarding our proposed new rule 6c-11 
and proposed amendments to Form N-1A, Form N-8b-2, and Form N-CEN.
---------------------------------------------------------------------------

    \603\ See 5 U.S.C. 603(a).
---------------------------------------------------------------------------

A. Reasons for and Objectives of the Proposed Actions

    As described more fully above, proposed rule 6c-11 would allow ETFs 
that meet the conditions of the rule to form and operate without the 
expense and delay of obtaining an exemptive order from the Commission. 
The Commission's objective is to create a consistent, transparent and 
efficient regulatory framework for ETFs and to facilitate greater 
competition and innovation among ETFs. The Commission also believes the 
proposed disclosure amendments would provide useful information to 
investors who purchase and sell ETF shares in secondary markets. 
Finally, the goal of the proposed amendments to Form N-CEN is for the 
Commission to be able to better monitor reliance on rule 6c-11 and to 
assist the Commission with its accounting, auditing and oversight 
functions.

B. Legal Basis

    The Commission is proposing new rule 6c-11 pursuant to the 
authority set forth in sections 6(c), 22(c), and 38(a) of the 
Investment Company Act [15 U.S.C. 80a-6(c), 22(c), and 80a-37(a)]. The 
Commission is proposing amendments to registration Form N-1A under the 
authority set forth in sections 6, 7(a), 10 and 19(a) of the Securities 
Act of 1933 [15 U.S.C. 77f, 77g(a), 77j, 77s(a)], and sections 8(b), 
24(a), and 30 of the Investment Company Act [15 U.S.C. 80a-8(b), 80a-
24(a), and 80a-29]. The Commission is proposing amendments to 
registration Form N-8b-2 under the authority set forth in section 8(b) 
and 38(a) of the Investment Company Act [15 U.S.C. 80a-8(b) and 80a-
37(a)]. The Commission is proposing amendments to Form N-CEN under the 
authority set forth sections 8(b), 30(a), and 38(a) of the Investment 
Company Act [15 U.S.C. 80a-8(b), 80a-29(a), and 80a-37(a)].

C. Small Entities Subject to the Rule

    An investment company is a small entity if, together with other 
investment companies in the same group of related investment companies, 
it has net assets of $50 million or less as of the end of its most 
recent fiscal year.\604\ Commission staff estimates that, as of 
December 2017, there are approximately 8 open-end ETFs that may be 
considered small entities.\605\ Commission staff estimates there are no 
UIT ETFs that would be considered small entities subject to the 
proposed disclosures for Form N-8B-2.\606\
---------------------------------------------------------------------------

    \604\ 17 CFR 270.0-10(a).
    \605\ This estimate is derived from an analysis of data reported 
on Form N-1A with the Commission for the period ending December, 
2017.
    \606\ This estimate is derived from an analysis of data reported 
on Forms S-6 and N-8B-2 with the Commission for the period ending 
December 2017.
---------------------------------------------------------------------------

D. Projected Reporting, Recordkeeping, and Other Compliance 
Requirements

    The proposed amendments would amend current reporting requirements 
for ETFs considered small entities.
1. Rule 6c-11
    Proposed rule 6c-11 would require an ETF to disclose on its 
website: (i) Portfolio holding information and information regarding a 
published basket on each business day; (ii) the ETF's current NAV per 
share, market price, and premium or discount, each as of the end of the 
prior business day; (iii) if an ETF's premium or discount is greater 
than 2% for more than seven consecutive trading days, a discussion of 
the factors that are reasonably believed to have materially contributed 
to the premium or discount; and (iv) a table and line graph showing the 
ETF's premiums and discounts.\607\ We also are proposing to require 
that ETFs preserve and maintain copies of all written authorized 
participant agreements, as well as records setting forth the following 
information for each basket exchanged with an authorized participant: 
(i) The names and quantities of the positions composing the basket; 
(ii) identification of the basket as a ``custom basket'' and a record 
stating that the custom basket complies with the ETF's policies and 
procedures (if applicable); (iii) cash balancing amounts (if any); and 
(iv) the identity of the authorized participant conducting the 
transaction.\608\ Proposed rule 6c-11 would also require ETFs relying 
on the proposed rule to adopt and implement written policies and 
procedures that govern the construction of baskets and the process that 
will be used for the acceptance of basket assets.\609\ ETFs using 
custom baskets under the proposed rule must adopt custom basket 
policies and procedures that include certain enumerated 
requirements.\610\
---------------------------------------------------------------------------

    \607\ See proposed rule 6c-11(c)(1)(iii) and (iv).
    \608\ See supra section II.C.5.a.
    \609\ Proposed rule 6c-11(c)(3).
    \610\ Proposed rule 6c-11(c)(3).
---------------------------------------------------------------------------

    We estimate that approximately 8 ETFs are small entities that would 
comply with proposed rule 6c-11, and we do not believe that their costs 
would differ from other ETFs. As discussed above, we estimate that an 
ETF would incur an annual burden of approximately 36.97 hours, at an 
average time cost of approximately $11,758.97, and an external cost of 
$666.65.\611\
---------------------------------------------------------------------------

    \611\ See supra footnote 561 and accompanying text.
---------------------------------------------------------------------------

2. Disclosure and Reporting Requirements
    We are proposing amendments to Form N-1A and Form N-8B-2 designed 
to provide investors who purchase ETF shares in secondary market 
transactions with tailored information regarding ETFs, including 
information regarding costs associated with an investment in ETFs. 
Specifically, proposed amendments to Form N-1A would require new 
disclosure regarding fees and expenses, such a brokerage

[[Page 37403]]

commission and financial intermediary fees, and additional information 
on certain trading costs.\612\ In addition, we are proposing to include 
instructions in Form N-1A requiring an ETF to provide bid-ask spread 
information on the ETF's website and an interactive calculator, in a 
clear and prominent format on the ETF's website, to allow investors to 
customize certain hypothetical calculations to their specific investing 
situation.\613\ Proposed amendments to Form N-8B-2 mirror proposed 
disclosures for Form N-1A. We are also proposing amendments to Form N-
CEN that would require ETFs to report on Form N-CEN if they are relying 
on rule 6c-11. The proposed Form N-CEN amendments are designed to 
assist us with monitoring reliance on rule 6c-11 as well with our 
accounting, auditing and oversight functions, including compliance with 
the PRA.
---------------------------------------------------------------------------

    \612\ See supra footnote 572 and accompanying text.
    \613\ Proposed Instruction 5(e) to Item 3 of Form N-1A.
---------------------------------------------------------------------------

    All ETFs would be subject to the proposed disclosure and reporting 
requirements, including ETFs that are small entities. We estimate that 
8 ETFs are small entities that would be required to comply with the 
proposed disclosure and reporting requirements.\614\
---------------------------------------------------------------------------

    \614\ See supra footnote 605.
---------------------------------------------------------------------------

    As discussed above, we estimate that each ETF, including ETFs that 
are small entities, would incur a one-time burden of an additional 10 
hours, at a time cost of an additional $3,355 to draft and finalize the 
required disclosure and amend its registration statement.\615\ We 
further estimate that ETFs, including ETFs that are small entities, 
would incur a one-time average burden of 10 hours associated with 
implementing the interactive calculator on its website, at a time cost 
of $3,355, as required by proposed Instruction 5(e) to Item 3. In the 
aggregate, we estimate that ETFs, including ETFs that are small 
entities, would incur a one-time burden of an additional 20 hours, at a 
time cost of an additional $6,710, to comply with the proposed Form N-
1A disclosure requirements for ETFs.\616\
---------------------------------------------------------------------------

    \615\ See supra footnote 576 and accompanying text.
    \616\ See supra footnote 576 and accompanying text.
---------------------------------------------------------------------------

    We also estimate that each ETF, including ETFs that are small 
entities, would incur an ongoing burden of an additional 5 hours, at a 
time cost of an additional $1,677.50, each year to review and update 
the proposed disclosures. We further estimate that each ETF, including 
ETFs that are small entities, would incur an ongoing burden of an 
additional 5 hours, at a time cost of an additional $1,677.50, to 
maintain the interactive calculator on its website. In aggregate, we 
estimate that each ETF, including ETFs that are small entities, would 
incur an annual ongoing burden of an additional 10 hours, at a time 
cost of an additional $3,355, to comply with the proposed Form N-1A 
disclosure requirements. We do not estimate any change to the external 
costs associated with the proposed amendments to Form N-1A.\617\
---------------------------------------------------------------------------

    \617\ Id.
---------------------------------------------------------------------------

    As discussed above, because the amendments made to Form N-8B-2 
mirror those made on Form N-1A, we believe that UIT ETFs, including UIT 
ETFs that are small entities, would incur the same costs as all ETFs 
associated with updating their registration statements. However, none 
of the UIT ETFs are small entities.

E. Duplicative, Overlapping or Conflicting Federal Rules

    Commission staff has not identified any federal rules that 
duplicate, overlap, or conflict with the proposed regulations.

F. Significant Alternatives

    The RFA directs the Commission to consider significant alternatives 
that would accomplish our stated objectives, while minimizing any 
significant economic impact on small entities. We considered the 
following alternatives for small entities in relation to the proposed 
regulations:
    <bullet> Exempting ETFs that are small entities from the proposed 
disclosure, reporting or recordkeeping requirements, to account for 
resources available to small entities;
    <bullet> establishing different disclosure, reporting or 
recordkeeping requirements or different frequency of these 
requirements, to account for resources available to small entities;
    <bullet> clarifying, consolidating, or simplifying the compliance 
requirements under the amendments for small entities; and
    <bullet> using performance rather than design standards.
    We do not believe that exempting any subset of ETFs, including 
small entities, from proposed rule 6c-11 or proposed form amendments 
would permit us to achieve our stated objectives. Nor do we believe 
establishing different disclosure, reporting or recordkeeping 
requirements or different frequency of these requirements for small 
entities would permit us to achieve our stated objectives. Similarly, 
we do not believe that we can establish simplified or consolidated 
compliance requirements for small entities under the proposed rule 
without compromising our objectives. As discussed above, the conditions 
necessary to rely on proposed rule 6c-11 and the reporting, 
recordkeeping and disclosure requirements are designed to provide 
investor protection benefits, including, among other things, tailored 
information regarding ETFs, including information regarding costs 
associated with an investment in ETFs. These benefits should apply to 
investors in smaller funds as well as investors in larger funds. 
Similarly, we do not believe it would be in the interest of investors 
to exempt small ETFs from the proposed disclosure and reporting 
requirements or to exempt small ETFs from the proposed recordkeeping 
requirements. We believe that all ETF investors, including investors in 
small ETFs, would benefit from disclosure and reporting requirements 
that permit them to make investment choices that better match their 
risk tolerances. We further note that the current disclosure 
requirements for reports on Form N-1A and Form N-8B-2 do not 
distinguish between small entities and other funds.\618\
---------------------------------------------------------------------------

    \618\ See Reporting Modernization Adopting Release, supra 
footnote 147, at section V.E (noting that small entities currently 
follow the same requirements that large entities do when filing 
reports on Form N-SAR, Form N-CSR, and Form N-Q, and stating that 
the Commission believes that establishing different reporting 
requirements or frequency for small entities (including with respect 
to proposed Form N-PORT and proposed Form N-CEN) would not be 
consistent with the Commission's goal of industry oversight and 
investor protection).
---------------------------------------------------------------------------

    Finally, we believe that proposed rule 6c-11 and related disclosure 
and reporting requirements appropriately use a combination of 
performance and design standards. Proposed rule 6c-11 provides ETFs 
that satisfy the requirements of the rule with exemptions from certain 
provisions of the Act necessary for ETFs to operate. Because the 
provisions of the Act from which ETFs would be exempt provide important 
investor and market protections, the conditions of the proposed rule 
must be specifically designed to ensure that these investor and market 
protections are maintained. However, where we believe that flexibility 
is beneficial, we proposed performance-based standards that provide a 
regulatory framework, rather than prescriptive requirements, to give 
funds the opportunity to adopt policies and procedures tailored to 
their specific

[[Page 37404]]

needs without raising investor or market protection concerns.\619\
---------------------------------------------------------------------------

    \619\ See e.g., supra section II.C.5 (noting that proposed rule 
6c-11 would provide an ETF with the flexibility to use ``custom 
baskets'' if the ETF has adopted written policies and procedures 
that set forth detailed parameters for the construction and 
acceptance of custom baskets that are in the best interests of the 
ETF and its shareholders).
---------------------------------------------------------------------------

G. General Request for Comment

    The Commission requests comment regarding this analysis. We request 
comments on the number of small entities that would be subject to the 
proposed ETF regulations and whether the proposed ETF regulations would 
have any effects that have not been discussed. We request that 
commenters describe the nature of any effects on small entities subject 
to the proposed ETF regulations and provide empirical data to support 
the nature and extent of such effects. We also request comment on the 
estimated compliance burdens of the proposed ETF regulations and how 
they would affect small entities.

VI. Consideration of Impact on the Economy

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996, or ``SBREFA,'' \620\ the Commission must advise OMB 
whether a proposed regulation constitutes a ``major'' rule. Under 
SBREFA, a rule is considered ``major'' where, if adopted, it results in 
or is likely to result in:
---------------------------------------------------------------------------

    \620\ Public Law 104-121, Title II, 110 Stat. 857 (1996) 
(codified in various sections of 5 U.S.C., 15 U.S.C. and as a note 
to 5 U.S.C. 601).
---------------------------------------------------------------------------

    <bullet> An annual effect on the economy of $100 million or more;
    <bullet> A major increase in costs or prices for consumers or 
individual industries; or
    <bullet> Significant adverse effects on competition, investment or 
innovation.
    We request comment on whether our proposal would be a ``major 
rule'' for purposes of SBREFA. We solicit comment and empirical data 
on:
    <bullet> The potential effect on the U.S. economy on an annual 
basis;
    <bullet> Any potential increase in costs or prices for consumers or 
individual industries; and
    <bullet> Any potential effect on competition, investment, or 
innovation.

Commenters are requested to provide empirical data and other factual 
support for their views to the extent possible.

VII. Statutory Authority

    The Commission is proposing new rule 6c-11 pursuant to the 
authority set forth in sections 6(c), 22(c), and 38(a) of the 
Investment Company Act [15 U.S.C. 80a-6(c), 80a-22(c), and 80a-37(a)]. 
The Commission is proposing amendments to registration Form N-1A under 
the authority set forth in sections 6, 7(a), 10 and 19(a) of the 
Securities Act of 1933 [15 U.S.C. 77f, 77g(a), 77j, 77s(a)], and 
sections 8(b), 24(a), and 30 of the Investment Company Act [15 U.S.C. 
80a-8(b), 80a-24(a), and 80a-29]. The Commission is proposing 
amendments to registration Form N-8B-2 under the authority set forth in 
section 8(b) and 38(a) of the Investment Company Act [15 U.S.C. 80a-
8(b) and 80a-37(a)]. The Commission is proposing amendments to Form N-
CEN under the authority set forth in sections 8(b), 30(a), and 38(a) of 
the Investment Company Act [15 U.S.C. 80a-8(b), 80a-29(a), and 80a-
37(a)].

List of Subjects

17 CFR Part 239

    Reporting and recordkeeping requirements, Securities.

17 CFR Parts 270 and 274

    Investment companies, Reporting and recordkeeping requirements, 
Securities.

Text of Proposed Rules and Form Amendments

    For reasons set out in the preamble, title 17, chapter II of the 
Code of Federal Regulations is proposed to be amended as follows:

PART 239--FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933

0
1. The authority citation for part 239 continues to read, in part, as 
follows:

    Authority: 15 U.S.C. 77c, 77f, 77g, 77h, 77j, 77s, 77z-2, 77z-3, 
77sss, 78c, 78l, 78m, 78n, 78o(d), 78o-7 note, 78u-5, 78w(a), 78ll, 
78mm, 80a-2(a), 80a-3, 80a-8, 80a-9, 80a-10, 80a-13, 80a-24, 80a-26, 
80a-29, 80a-30, and 80a-37; and sec. 107 Pub. L. 112-106, 126 Stat. 
312, unless otherwise noted.
* * * * *

PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940

0
2. The authority citation for part 270 continues to read, in part, and 
is amended by adding a sectional authority for Sec.  270.6c-11 to read 
as follows:

    Authority: 15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, 80a-39, 
and Pub. L. 111-203, sec. 939A, 124 Stat. 1376 (2010), unless 
otherwise noted.
* * * * *
    Section 270.6c-11 is also issued under 15 U.S.C. 80a-6(c) and 
80a-37(a).
* * * * *
0
3. Section 270.6c-11 is added to read as follows:


Sec.  270.6c-11   Exchange-traded funds.

    (a) Definitions. For purposes of this section:
    Authorized participant means a member or participant of a clearing 
agency registered with the Commission, which has a written agreement 
with the exchange-traded fund or one of its service providers that 
allows the authorized participant to place orders for the purchase and 
redemption of creation units.
    Basket means the securities, assets or other positions in exchange 
for which an exchange-traded fund issues (or in return for which it 
redeems) creation units.
    Business day means any day the exchange-traded fund is open for 
business, including any day when it satisfies redemption requests as 
required by section 22(e) of the Act (15 U.S.C. 80a-22(e)).
    Cash balancing amount means an amount of cash to account for any 
difference between the value of the basket and the net asset value of a 
creation unit.
    Creation unit means a specified number of exchange-traded fund 
shares that the exchange-traded fund will issue to (or redeem from) an 
authorized participant in exchange for the deposit (or delivery) of a 
basket and a cash balancing amount if any.
    Custom basket means:
    (i) Baskets that are composed of a non-representative selection of 
the exchange-traded fund's portfolio holdings; or
    (ii) Different baskets used in transactions on the same business 
day.
    Exchange-traded fund means a registered open-end management 
company:
    (i) That issues (and redeems) creation units to (and from) 
authorized participants in exchange for a basket and a cash balancing 
amount if any; and
    (ii) Whose shares are listed on a national securities exchange and 
traded at market-determined prices.
    Exchange-traded fund share means a share of stock issued by an 
exchange-traded fund.
    Foreign investment means any security, asset or other position of 
the ETF issued by a foreign issuer as that term is defined in Sec.  
240.3b-4 of this title, and for which there is no established United 
States public trading market, as that term is used in 17 CFR 227.201 
(Item 201 of Regulation S-K under the Securities Act of 1933).
    Market price means:
    (i) The official closing price of an exchange-traded fund share; or
    (ii) If it more accurately reflects the market value of an 
exchange-traded

[[Page 37405]]

fund share at the time as of which the exchange-traded fund calculates 
current net asset value per share, the price that is the midpoint 
between the national best bid and national best offer as of that time.
    National securities exchange means an exchange that is registered 
with the Commission under section 6 of the Securities Exchange Act of 
1934 (15 U.S.C. 78f).
    Portfolio holdings means the securities, assets or other positions 
held by the exchange-traded fund.
    Premium or discount means the positive or negative difference 
between the market price of an exchange-traded fund share at the time 
as of which the current net asset value is calculated and the exchange-
traded fund's current net asset value per share, expressed as a 
percentage of the exchange-traded fund share's current net asset value 
per share.
    (b) Application of the Act to Exchange-Traded Funds. If the 
conditions of paragraph (c) of this section are satisfied:
    (1) Redeemable security. An exchange-traded fund share is 
considered a ``redeemable security'' within the meaning of section 
2(a)(32) of the Act (15 U.S.C. 80a-2(a)(32)).
    (2) Pricing. A dealer in exchange-traded fund shares is exempt from 
section 22(d) of the Act (15 U.S.C. 80a-22(d)) and Sec.  270.22c-1(a) 
with regard to purchases, sales and repurchases of exchange-traded fund 
shares at market-determined prices.
    (3) Affiliated transactions. (i) A person who is an affiliated 
person of an exchange-traded fund (or who is an affiliated person of 
such a person) solely by reason of the circumstances described in 
paragraphs (b)(3)(i)(A) and (B) of this section is exempt from sections 
17(a)(1) and 17(a)(2) of the Act (15 U.S.C. 80a-17(a)(1) and (a)(2)) 
with regard to the deposit and receipt of baskets:
    (A) Holding with the power to vote 5% or more of the exchange-
traded fund's shares; or
    (B) Holding with the power to vote 5% or more of any investment 
company that is an affiliated person of the exchange-traded fund.
    (4) Postponement of redemptions. If an exchange-traded fund 
includes a foreign investment in its basket, and if a local market 
holiday, or series of consecutive holidays, or the extended delivery 
cycles for transferring foreign investments to redeeming authorized 
participants prevents timely delivery of the foreign investment in 
response to a redemption request, the exchange-traded fund is exempt, 
with respect to the delivery of the foreign investment, from the 
prohibition in section 22(e) of the Act (15 U.S.C. 80a-22(e)) against 
postponing the date of satisfaction upon redemption for more than seven 
days after the tender of a redeemable security if the exchange-traded 
fund delivers the foreign investment as soon as practicable, but in no 
event later than 15 days after the tender of the exchange-traded fund 
shares. The exemption provided in paragraph (b)(4) of this section will 
expire and no longer be effective on [date ten years from effective 
date of rule].
    (c) Conditions. (1) Each business day, an exchange-traded fund must 
disclose prominently on its website, which is publicly available and 
free of charge:
    (i) Before the opening of regular trading on the primary listing 
exchange of the exchange-traded fund shares and before the exchange-
traded fund starts accepting orders for the purchase or redemption of 
creation units:
    (A) The portfolio holdings that will form the basis of the next 
calculation of current net asset value per share;
    (B) A basket applicable to orders for the purchase or redemption of 
creation units to be priced based on the next calculation of current 
net asset value; and
    (C) The estimated cash balancing amount, if any;
    (ii) The exchange-traded fund's current net asset value per share, 
market price, and premium or discount, each as of the prior business 
day;
    (iii) A table showing the number of days the exchange-traded fund's 
shares traded at a premium or discount during the most recently 
completed calendar year and the most recently completed calendar 
quarters since that year (or the life of the exchange-traded fund, if 
shorter);
    (iv) A line graph showing exchange-traded fund share premiums or 
discounts for the most recently completed calendar year and the most 
recently completed calendar quarters since that year (or the life of 
the exchange-traded fund, if shorter); and
    (v) If the exchange-traded fund's premium or discount is greater 
than 2% for more than seven consecutive trading days, a discussion of 
the factors that are reasonably believed to have materially contributed 
to the premium or discount, which must be maintained on the website for 
at least one year thereafter; and
    (vi) The exchange-traded fund must present the description, amount, 
value and unrealized gain/loss in the manner prescribed within 17 CFR 
210.12-12, 210.12-12A, 210.12-13, 210.12-13A, 210.12-13B, 210.12-13C, 
and 210.12-13D (Article 12 of Regulation S-X) for each portfolio 
holding or basket asset required to be disclosed pursuant to paragraphs 
(c)(1)(i) of this section.
    (2) An exchange-traded fund must reflect changes in the exchange-
traded fund's portfolio holdings in the first calculation of net asset 
value per share on the first business day following the trade date.
    (3) An exchange-traded fund must adopt and implement written 
policies and procedures that govern the construction of baskets and the 
process that will be used for the acceptance of baskets; provided, 
however, if the exchange-traded fund utilizes a custom basket:
    (i) These written policies and procedures also must:
    (A) Set forth detailed parameters for the construction and 
acceptance of custom baskets that are in the best interests of the 
exchange-traded fund and its shareholders, including the process for 
any revisions to, or deviations from, those parameters; and
    (B) Specify the titles or roles of the employees of the exchange-
traded fund's investment adviser who are required to review each custom 
basket for compliance with those parameters.
    (4) The exchange-traded fund may not seek, directly or indirectly, 
to provide returns that exceed the performance of a market index by a 
specified multiple, or to provide returns that have an inverse 
relationship to the performance of a market index, over a fixed period 
of time.
    (5) Notwithstanding the definition of exchange-traded fund in 
paragraph (a) of this section, an exchange-traded fund is not 
prohibited from selling (or redeeming) individual shares on the day of 
consummation of a reorganization, merger, conversion or liquidation.
    (d) Recordkeeping. The exchange-traded fund must maintain and 
preserve for a period of not less than five years, the first two years 
in an easily accessible place:
    (1) All written agreements (or copies thereof) between an 
authorized participant and the exchange-traded fund or one of its 
service providers that allows the authorized participant to place 
orders for the purchase or redemption of creation units;
    (2) For each basket exchanged with an authorized participant, 
records setting forth:
    (i) The names and quantities of the positions composing the basket 
exchanged for creation units;
    (ii) If applicable, identification of the basket as a custom basket 
and a record stating that the custom basket complies with policies and 
procedures that the

[[Page 37406]]

exchange-traded fund adopted pursuant to paragraph (c)(3)(i) of this 
section;
    (iii) Cash balancing amount, if any; and
    (iv) Identity of authorized participant transacting with the 
exchange-traded fund.

PART 274--FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY ACT OF 1940

0
4. The general authority citation for part 274 continues to read, in 
part, as follows:

    Authority:  15 U.S.C. 77f, 77g, 77h, 77j, 77s, 78c(b), 78l, 78m, 
78n, 78o(d), 80a-8, 80a-24, 80a-26, 80a-29, and Pub. L. 111-203, 
sec. 939A, 124 Stat. 1376 (2010), unless otherwise noted.
* * * * *
0
5. Form N-1A (referenced in Sec. Sec.  239.15A and 274.11A) is amended 
as follows:
0
a. In General Instruction A revise the definition of ``Exchange-Traded 
Fund.''
0
b. In General Instruction A, remove the definition of ``Market Price.''
    The additions and revisions read as follows:
    Note: The text of Form N-1A does not, and this amendment will not, 
appear in the Code of Federal Regulations.
Form N-1A
* * * * *
GENERAL INSTRUCTIONS
* * * * *
A. Definitions
* * * * *
    ``Exchange-Traded Fund'' means a Fund or Class, the shares of which 
are listed and traded on a national securities exchange, and that has 
formed and operates under an exemptive order granted by the Commission 
or in reliance on rule 6c-11 [17 CFR 270.6c-11] under the Investment 
Company Act.
* * * * *
0
6. Amend Item 3 of Form N-1A to read as follows:
BILLING CODE 8011-01-P

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BILLING CODE 8011-01-C
* * * * *
0
7. Amend Instruction 1 of Item 3 of Form N-1A as follows:
* * * * *
Instructions
    1. General
    (a) Round all dollar figures to the nearest dollar and all 
percentages to the nearest hundredth of 1%.
    (b) Include the narrative explanations in the order indicated. A 
Fund may modify the narrative explanations if the explanation contains 
comparable information to that shown. The narrative explanation 
regarding sales charge discounts is only required by a Fund that offers 
such discounts and should specify the minimum level of investment 
required to qualify for a discount as disclosed in the table required 
by Item 12(a)(1).
    (c) Include the caption ``Maximum Account Fees'' only if the Fund 
charges these fees. A Fund may omit other captions if the Fund does not 
charge the fees or expenses covered by the captions.
    (d)
    (i) If the Fund is a Feeder Fund, reflect the aggregate expenses of 
the Feeder Fund and the Master Fund in a single fee table using the 
captions provided. In a footnote to the fee table, state that the table 
and Example reflect the expenses of both the Feeder and Master Funds.
    (ii) If the prospectus offers more than one Class of a Multiple 
Class Fund or more than one Feeder Fund that invests in the same Master 
Fund, provide a separate response for each Class or Feeder Fund.

[[Page 37410]]

    (e) If the Fund is an Exchange-Traded Fund, exclude any fees 
charged for the purchase and redemption of the Fund's creation units.
* * * * *
0
8. Amend Instruction 5 of Item 3 of Form N-1A to read as follows:
* * * * *
    5. Exchange-Traded Fund Trading Information and Related Costs.
    (a) Include the median bid-ask spread for the Fund's most recent 
fiscal year only if the Fund is an Exchange-Traded Fund. However, do 
not include the median bid-ask spread for any Exchange-Traded Fund that 
had its initial listing on a national securities exchange after the 
beginning of the most recently completed fiscal year. For an Exchange-
Traded Fund that had an initial listing after the beginning of the most 
recently completed fiscal year, explain that the Exchange-Traded Fund 
did not have a sufficient trading history to report trading information 
and related costs. Information should be based on the most recently 
completed fiscal year end. The Fund also must provide information on 
the Fund's website, which is publicly accessible, free of charge, that 
investors can use to obtain the bid/ask spread information required in 
this Item.
    (b) Bid-Ask Spread (Median). Calculate the median bid-ask spread by 
dividing the difference between the ask and the bid by the midpoint of 
the ask and the bid for each ten-second interval throughout each 
trading day of the Exchange-Traded Fund's most recent fiscal year. Once 
the bid-ask spread for each ten-second interval throughout the fiscal 
year is determined, sort the spreads from lowest to highest. If there 
is an odd number of spread intervals, then the median is the middle 
number. If there is an even number of spread intervals, then the median 
is the average between the two middle numbers. Express the spread as a 
percentage, rounded to the nearest hundredth percent.
    (c) Determine the mid-range spread cost for each number of 
transactions in the table according to the following formula:

(S<INF>Mid</INF>/2) * $10,000 * T

Where:

S<INF>Mid</INF> = Median spread as calculated in Instruction 5(b) 
during most recently completed calendar year, expressed as a 
percentage;
T = Number of Transactions (1 and 25).

    (d) Determine the high-end spread cost for each number of 
transactions in the table according to the following formula:

(S<INF>High</INF>/2) * $10,000 * T

Where:

S<INF>High</INF> = High-end spread is calculated by dividing the 
difference between the ask and the bid by the midpoint of the ask 
and the bid for each ten-second interval throughout each trading day 
of the Exchange-Traded Fund's most recently completed fiscal year. 
Once the bid-ask spread for each ten-second interval throughout the 
fiscal year is determined, sort the spreads from lowest to highest. 
The high end spread is the number closest to the 95th percentile, 
expressed as a percentage. If two numbers are equally close to the 
95th percentile, use the average of the two numbers;
T = Number of Transactions (1 and 25).

    (e) Provide an interactive calculator in a clear and prominent 
format on the Fund website which uses the calculations in Instructions 
5(a)-(d) to Item 3 to provide the information required by Q&As 3, 4 and 
5.
* * * * *
0
9. Amend Item 6 of Form N-1A as follows:
* * * * *
Item 6. Purchase and Sale of Fund Shares
    (a) Purchase of Fund Shares. Disclose the Fund's minimum initial or 
subsequent investment requirements.
    (b) Sale of Fund Shares. Also disclose that the Fund's shares are 
redeemable and briefly identify the procedures for redeeming shares 
(e.g., on any business day by written request, telephone, or wire 
transfer).
    (c) Exchange-Traded Funds. If the Fund is an Exchange-Traded Fund, 
the Fund may omit the information required by this Item.
* * * * *
0
10. Amend Items 11(a)(1) and 11(g) of Form N-1A as follows:
* * * * *
Item 11. Shareholder Information
    (a) Pricing of Fund Shares. Describe the procedures for pricing the 
Fund's shares, including:
    (1) An explanation that the price of Fund shares is based on the 
Fund's net asset value and the method used to value Fund shares (market 
price, fair value, or amortized cost); except that if the Fund is an 
Exchange-Traded Fund, an explanation that the price of Fund shares is 
based on a market price.
* * * * *
    (g) Exchange-Traded Funds. If the Fund is an Exchange-Traded Fund, 
the Fund may omit from the prospectus the information required by Items 
11(a)(2), (b), and (c).
* * * * *
0
11. Remove Item 27(b)(7)(iv) of Form N-1A and instructions thereto.
0
12. Amend Instruction 1(e)(ii) of Item 27(d)(1) of Form N-1A as 
follows:
* * * * *
Instructions
* * * * *
    1. General.
* * * * *
    (e) If the fund is an Exchange-Traded Fund:
* * * * *
    (ii) Exclude any fees charged for the purchase and redemption of 
the Fund's creation units.
* * * * *
0
13. Amend Form N-8B-2 (referenced in Sec. Sec.  239.16 and 274.12) as 
follows:
    The additions and revisions read as follows:
    Note: The text of Form N-8B-2 does not, and this amendment will 
not, appear in the Code of Federal Regulations.
Form N-8B-2
* * * * *
GENERAL INSTRUCTIONS FOR FORM N-8B-2
* * * * *

Definitions

* * * * *
    Exchange-Traded Fund (ETF): The term ``Exchange-Traded Fund'' or 
``ETF'' means a trust, the shares of which are listed and traded on a 
national securities exchange, and that has formed and operates under an 
exemptive order granted by the Commission.
* * * * *

Information Concerning Loads, Fees, Charges, and Expenses

    13.
* * * * *
    (h) If the trust is an Exchange-Traded Fund, furnish an explanation 
indicating that an ETF investor may pay additional fees not described 
by any other item in this form, such as brokerage commissions and other 
fees to financial intermediaries.
    (i) If the trust is an Exchange-Traded Fund, furnish the 
disclosures and information set forth in Item 3 of Form N-1A 
[referenced in 17 CFR 274.11A], in the section of that Item titled 
``Exchange-Traded Fund Trading Information and Related Costs.'' Provide 
information specific to the trust as necessary, utilizing the ETF-
specific methodology set forth in the Instructions to Form N-1A Item 3.
* * * * *
0
14. Amend Items C.7. and E.2. Form N-CEN (referenced in Sec.  274.101):

[[Page 37411]]

    The additions read as follows:
    Note: The text of Form N-CEN does not, and this amendment will not, 
appear in the Code of Federal Regulations.
FORM N-CEN
ANNUAL REPORT FOR REGISTERED INVESTMENT COMPANIES
* * * * *
Part C. Additional Questions for Management Investment Companies
* * * * *
Item C.7.
* * * * *
    k. Rule 6(c)-11 (17 CFR 270.6c-11): ___
* * * * *
Part E. Additional Questions for Exchange-Traded Funds and Exchange-
Traded Managed Funds
* * * * *
Item E.2.
* * * * *
    Instruction. The term ``authorized participant'' means a member or 
participant of a clearing agency registered with the Commission, which 
has a written agreement with the Exchange-Traded Fund or Exchange-
Traded Managed Fund or one of its service providers that allows the 
authorized participant to place orders for the purchase and redemption 
of creation units.
* * * * *

    By the Commission.

    Dated: June 28, 2018.
Brent J. Fields,
Secretary.
[FR Doc. 2018-14370 Filed 7-30-18; 8:45 am]
 BILLING CODE 8011-01-P


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