SEC No-Action Letter: Directors, Officers and Principal Stockholders

The SEC Division of Corporation Finance provided no-action relief regarding a broker-dealer’s pecuniary interest, as defined in Exchange Act Rule 16a-1(a)(2), in any “Insider Security” in certain transactions in the component securities of an certain exchange-traded funds (“ETF”).  The relief would not be available to ETFs that are actively managed, ETFs with component securities that are issued by foreign private issuers or ETFs holding debt instruments.  As to those ETFs within the scope of the rule, the relief permits broker-dealers to engage in a variety of transactions with respect to buying and selling shares as part of an ETF without concern that the purchases and sales will be “matched” against each other for purposes of Section 16, or that the broker-dealer will be subject to, among other requirements, the obligation of giving up any profit on the matched transactions. 

The Division is of the view that a broker-dealer acting as an authorized participant (“AP”) would not have a pecuniary interest in an Insider Security in the following circumstances, albeit subject to a number of conditions:

  • The security was obtained by the broker-dealer to create a Deposit Basket to be delivered to an ETF Agent in exchange for ETF shares in connection with an ETF Cash Transaction or ETF Loan Transaction;
  • The security was transferred in a Deposit basket by the broker-dealer to an ETF Agent in exchange for ETF shares when creating an ETF in connection with an ETF Cash Transaction or ETF Loan Transaction;
  • The security was received in a Deposit Basket by the broker-dealer from an ETF Agent when redeeming an ETF in connection with an ETF Cash Transaction or ETF Loan Transaction;
  • The security was transferred by the broker-dealer to its clients or others in a disposition of the component securities received from an ETF Agent after redeeming the ETF;
  • The security was purchased or sold in order to hedge against exposure to intraday trading prices of component securities in the period between the customer order of an ETF share and the end of the day of the order when ETF shares are created or redeemed; and
  • The security was, in connection with an ETF Loan Transaction, purchased or sold in order to hedge against market risk in relation to ETF Rebalancing.

As noted above, the relief is subject to a number of limitations on the relevant circumstances and conditions, including (i) that the relevant Insider Securities have not been previously in the broker-dealer’s inventory and (ii) that neither the broker-dealer nor any of its affiliates are involved in managing the index underlying the relevant ETF.

  Lofchie Comment:  Firms relying on the relief should be quite careful as to the various limitations.  For example, as drafted, the letter would not apply to transactions in the securities of an ETF if even one security were that of a foreign private issuer, which seems an odd limitation to me.

View letter in full here (links externally to SEC website).

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