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SEC Says Access Persons Should Report Trades in ETF Shares

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  • Baker, John
    The staff of the Securities and Exchange Commission, in response to a request for a no-action letter, has announced that access persons of registered
    Message 1 of 1 , Dec 2, 2005
      The staff of the Securities and Exchange Commission, in response to a request for a no-action letter, has announced that access persons of registered investment advisers must report their holdings of, and trades in, shares of exchange-traded funds that are organized as unit investment trusts. National Compliance Services, SEC No-Action Letter (Nov. 30, 2005). While most ETFs are organized as open-end investment companies and, as the staff acknowledged, are therefore excluded from the definition of Reportable Securities under Rule 204A-1 under the Investment Advisers Act of 1940, some of the largest ETFs - SPDRs, MidCap SPDRs, Nasdaq-100 Shares, and DIAMONDS - are organized as UITs, making their shares subject to the reporting requirement.

      The SEC staff also recommended that investment advisers consider treating open-end ETF shares as Reportable Securities and that persons subject to the similar reporting requirements of Rule 17j-1 under the Investment Company Act of 1940 consider treating open-end ETF shares as "covered securities" when complying with the requirements of that rule. The staff recommendation, if followed, will require investment companies and investment advisers to revise their codes of ethics to require access persons to report ETF holdings and trades.

      I represent National Compliance Services, which requested the
      no-action letter, and I won't pretend to be neutral. I can't imagine a plausible circumstance where there would be an opportunity for front-running or other conflicts of interest involving any of these four ETFs. The staff clearly took this no-action position not because they were concerned about trades in UIT ETFs (which are covered by the rules), but because they were concerned about trades in open-end ETFs (which are not). Admittedly, some open-end ETFs are much more thinly traded than, say, SPDRs or Nasdaq-100 Shares. The staff's letter notes that "investment advisers may wish to consider treating open-end ETF shares as Reportable Securities due to other provisions of the Advisers Act and its rules (e.g., Section 203(e)(6) of the Advisers Act, which provides that procedures reasonably designed to detect and prevent violations of the federal securities laws can serve as a defense against a charge that an investment adviser has failed to reasonably supervise its advisory personnel who have, for instance, violated the anti-fraud provisions of the Advisers Act)." That's a pretty strong hint.

      The no-action letter should be available shortly at


      In the meantime, I've temporarily posted the no-action request and
      response in their alphabetical place under N on the FundLaw website
      (free registration with Yahoo Groups required) at


      The National Compliance Services press release announcing the
      no-action letter is reproduced below.

      National Compliance Services, Inc.
      355 N.E. 5th Avenue, Suite 4
      Delray Beach, Florida 33483

      Securities and Exchange Commission Recommends That Codes of Ethics Cover Exchange-Traded Fund Shares

      December 1, 2005

      Delray Beach, Fla. - The Securities and Exchange Commission has recommended that investment advisers' and investment companies' codes of ethics should require their access persons to report trades in shares of exchange-traded funds, or ETFs. The SEC guidance was contained in a Nov. 30 no-action letter provided to National Compliance Services, Inc., a provider of registration and compliance services to investment advisers and broker-dealers.

      ETFs are investment companies that track investment indexes and whose shares trade on a stock exchange or Nasdaq at a price
      approximating their net asset value. ETFs have become increasingly
      significant in the marketplace, with combined assets of $263.84 billion in October. Net ETF issuances in October were $11.00 billion, almost $3 billion greater than the $8.13 billion of net issuances for all mutual funds (other than money market funds), according to Investment Company Institute figures.

      The SEC's rules require federally registered investment advisers and investment companies to have codes of ethics covering their personnel with access to trading information, and the codes of ethics must require the access persons to report their securities trades, with certain exceptions for trades in securities with little opportunity for improper trading. The rules by their terms exempt reports of trades in ETF shares, except for trades in ETFs legally organized as unit investment trusts, or UITs. These include some of the largest ETFs, including DIAMONDS (AMEX: DIA), Nasdaq-100 Shares (NASDAQ: QQQQ), and SPDRs (AMEX: SPY).

      National Compliance Services sought SEC guidance that these ETF shares, too, could be omitted from access persons' trade reports. The SEC responded that purchases and sales of these shares in the market present the opportunity for conflicts of interest that the rules are intended to reveal, and therefore should be subject to monitoring under codes of ethics. The SEC also said that ETFs not organized as UITs present the same opportunity for conflicts of interest. It recommended that investment advisers and investment companies consider requiring their access persons to report their trades in all ETF shares, even for ETFs that are not organized as UITs.

      "It wasn't the result that we were looking for," said Rita Dew, President of National Compliance Services. "But it does give clear guidance on an important issue for our clients. The SEC was probably more concerned about some of the smaller ETFs organized as open-end funds, as opposed to transparent and liquid securities like SPDRs." She said that National Compliance Services would work with its clients to revise their codes of ethics to comply with the SEC guidance. The SEC no-action letter is available by contacting Les Abromovitz at Les@....

      National Compliance Services is a leader in the compliance and
      regulatory services industry. It provides a wide range of products and services to more than 6,000 clients, both domestically and


      Contact Persons:

      Rita G. Dew, President
      (561) 330-7645 X206

      John M. Baker <JMB@...>
      Stradley Ronon Stevens & Young, LLP http://www.stradley.com
      1220 19th Street NW, Suite 600
      Washington DC 20036
      202.822.0140 fax
      FundLaw Listowner http://groups.yahoo.com/group/fundlaw
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