In a long, open meeting with a sprawling agenda on Thursday, the Securities and Exchange Commission approved a proposal that would allow many ETFs to come to market without first obtaining exemptive relief from the Investment Company Act of 1940.
The commission also approved a proposal that would allow it to limit whistleblower awards, and it adopted amendments to current rules concerning liquidity risk disclosure by open-end mutual funds, reporting requirements of smaller public companies and the use of a certain format, known as Inline XBRL, in corporate and fund filings.
The ETF proposal, approved unanimously, updates rules that are 26 years old and have resulted in over 300 exemptive orders, creating “an eclectic regulatory quilt” with “personalized exemptions,” said Commsision Kara Stein.
Durng that time, the ETF market has grown to more than 1,900 funds with $3.4 trillion in assets held by one of every three investors, according to SEC Chairman Jay Clayton.
Under the proposal, which will be out for public comment for 60 days, the majority of ETFs would not have to obtain exemptive relief to come to market but would be required to provide daily portfolio holdings on their websites as well historical information regarding premiums and discounts of their market price to their net asset value and bid-ask spread information.
In addition, the ETFs would be allowed to use a “custom basket” of holdings they choose when creating or redeeming shares rather than a “pro-rata representation” of the portfolio, if they adopt policies and procedures detailing the parameters they use for custom baskets to show they are in the best interest of the ETF and its shareholders.
The policies and procedures would to be designed to prevent authorized participants that are central to the trading of ETFs from dumping or cherry-picking assets they deliver to ETF issuers.
Stein explained that the difference between pro-rata and custom baskets is like the difference between a slice of cake that has all the ingredients of the larger cake (pro-rata) and a slice that has only some ingredients (custom) but tastes similar.
Leveraged and inverse ETFs and ETFs structured as unit investment trusts would not be able to come to market using the proposed streamlined rule. ETFs now operating under exemptive relief would have to comply with the new proposed rule, which if adopted, would standardize the approval process for most ETFs.
In another key vote on Thursday, the SEC amended liquidity-related disclosure requirements for open-end mutual funds and ETFs.
Funds will be required to disclose the operation and effectiveness of their liquidity risk management programs in annual or semiannual reports to shareholders instead of quarterly, and they will have to include cash and cash equivalents on Form N-Port, which lists portfolio holdings.
The amended requirements replace a previous pending rule that would have required funds to publicly report on a quarterly basis — on Form N-Port — the aggregate risk profiles of their holdings, whether highly liquid, moderately liquid, less liquid and illiquid investments.
Funds will still have to disclose this bucketing data to the SEC but not until later this year. The SEC in March extended the deadline by six months.
The amended liquidity disclosure requirement was approved by a vote of 3-2, with the two Democratic members of the commission, Stein and Robert Jackson Jr., voting against. Stein said she couldn’t support “to eliminate requirements for funds to provide investors basic liquidity information about the funds in which they invest.”
Clayton said the requirement would provide information about the past when “liquidity in the future is what matters to most investors.”
In another vote today, the SEC approved proposed amendments to its whistleblower program that will allow the commission to adjust rewards of less than $2 million upward, up to $2 million. In addition, the amendment would allow the commission to reduce awards of at least $100 million to a minimum $30 million.
Since the rule was enacted nearly seven years ago, the SEC has paid out over $266 million in 50 awards to 55 whistleblowers. Three awards accounted for 40% of the total payout. Whistleblowers provided information that led to enforcement actions involving over $1.4 billion in financial remedies, about half from disgorgement of ill-gotten gains and interest.
Stein and Jackson also voted against the whistleblower amendment, both noting that the change could reduce the incentive for whistleblowers to come forward. Clayton said he wants to hear from people about whether reducing an award to above $30 million would have that effect. A 60-day comment period on the proposal will commence after publication in the Federal Register.
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