SEC headquarters in Washington. (Photo: National Law Journal)SEC headquarters in Washington. (Photo: National Law Journal) SEC headquarters in Washington. (Photo: National Law Journal)

While delivering an exchange-traded fund rule is a “high priority” for the Securities and Exchange Commission’s Division of Investment Management and is overdue, said Dalia Blass, IM’s director, perhaps it’s also time for ETF index providers to register as investment advisors.

During her March 19 remarks at the Investment Company Institute’s mutual funds and investment management conference in San Antonio, Blass noted that, as it stands now, the ETF industry is a more than $3.5 trillion market operating under more than 300 individually issued exemptive orders.

“It is not ideal for such an important segment of the asset management market to operate under so many individual exemptive orders,” Blass said.

While exemptive orders “are great for flexibility, they have drawbacks, too,” Blass continued. For instance, “there is the obvious expense to new entrants of obtaining orders. There are also less obvious costs. These include differences in the playing field as well as uncertainty that results from lengthy orders and variable wording.”

With all of this in mind, she said, “delivering a recommendation to the Commission for a rule is a high priority for the Division, and our ETF team is hard at work.”

ETF nomenclature will be a focus, too, Blass said, in that the term “ETF” has been “stretched,” so that “investors have had to work harder and harder to identify important differences in risk.”

In the early days, the term “ETF” meant something “fairly specific,” Blass said. “Today, however, the term is used to describe investment companies with a wide range of strategies as well as a number of products that are not investment companies or even funds.”

Said Blass: “Are the differences in risks, investment strategies and investor protections among ETFs, commodity pools and exchange-traded notes (ETNs) clear when the term ‘ETF’ is often used for all three? Do people assume, when they see ‘ETF,’ that they are looking at a 1940 Act fund? Should we be considering different approaches to ETP nomenclature? I would welcome thoughts from investors, funds and advisors on whether addressing ETP nomenclature would be helpful to investors and the markets.”

In her remarks at the ICI event, Blass also questioned whether ETF index providers should continue to claim a “blanket exemption” from investment advisor registration.

“As market practices around indexes change, however, should we revisit the status of certain index providers as investment advisors?” Blass asked rhetorically.

Noting the exemption for publishers of broad-based indexes to register as advisors, Blass questioned whether providers of more narrow indexes should register as investment advisors especially where such providers create indexes for a single fund or take significant input from the fund sponsor.

Blass cautioned “against assuming that the status of a provider can be determined based simply on its characterization as an index provider” and encouraged fund sponsors and index providers to “refresh your analysis if you are looking at a bespoke or narrowly focused index.”

Blass also advised funds to consider disclosure implications of narrow indexes.

In light of Blass’ remarks, Cipperman Compliance Services said that index providers should expect “some hard questions from fund counsel and independent directors’ counsel as the lines blur between index creation and investment recommendations.”

— Check out BlackRock Launches New Brand of Sector ETFs on ThinkAdvisor.