- Regulatory framework. Most ETFs are registered as investment firms with the Securities and Exchange Commission (SEC) under the Investment Company Act of 1940, and the public shares they issue are registered under the Securities Act of 1933. Although their publicly-offered shares are registered under the Securities Act, several ETFs that invest in commodities, currencies, or commodity- or currency-based securities are not registered investment companies.
- Style of management Many ETFs, like index mutual funds, are meant to replicate a specific market index passively. By investing in all or a representative sample of the stocks included in the index, these ETFs try to attain the same return as the index they track. Actively managed ETFs have been a popular option for investors in recent years. Rather than monitoring an index, the portfolio manager of an actively managed ETF buys and sells equities in accordance with an investing plan.
- The goal of the investment. The investment objectives of each ETF, as well as the management style of each ETF, differ. The goal of passively managed exchange-traded funds (ETFs) is to match the performance of the index they monitor. Actively managed ETF advisers, on the other hand, make their own investment decisions in order to attain a certain investment goal. Some passively managed ETFs aim to achieve a return that is a multiple (inverse) of the return of a specific stock index. Leveraged or inverse ETFs are what they’re called. The investment objective of an ETF is indicated in the prospectus.
- Indices are being tracked. ETFs follow a wide range of indices. Some indices, such as total stock or bond market indexes, are very wide market indices. Other ETFs follow smaller indices, such as those made up of medium and small businesses, corporate bonds only, or overseas corporations exclusively. Some ETFs track extremely narrowand, in some cases, brand-newindices that aren’t entirely transparent or about which little is known.
Is an exchange-traded fund (ETF) a regulated investment company?
To be classified as a regulated investment firm, a corporation must meet certain criteria.
- Exist as a corporation or other entity that would normally be subject to corporate taxes.
- Register with the Securities and Exchange Commission as an investment business (SEC).
- Elect to be treated as a RIC under the Investment Company Act of 1940 if its income source and asset diversification meet certain criteria.
In addition, capital gains, interest, or dividends produced on investments must account for at least 90% of a RIC’s income. An RIC must also distribute a minimum of 90% of its net investment income to its shareholders in the form of interest, dividends, or capital gains. If the RIC does not disperse this portion of its earnings, the IRS may levy an excise tax.
Finally, at least 50% of a business’s total assets must be in the form of cash, cash equivalents, or securities to qualify as a regulated investment company. Unless the investments are government securities or the securities of other RICs, no more than 25% of the company’s total assets may be invested in securities of a single issuer.
Who is required to register under the 1940 Investment Company Act?
Investment businesses must register with the Assets and Exchange Commission (SEC) before they can sell their securities on the open market, according to the Investment Company Act of 1940. The Act also outlines the measures that must be followed by an investment business throughout the registration process.
Companies apply for various classes based on the sort of product or range of products they want to manage and issue to the investing public. Mutual funds/open-end management investment companies, unit investment trusts (UITs), and closed-end funds/closed-end management investment companies are the three forms of investment firms in the United States (as defined by federal securities regulations). Investment companies must meet certain requirements based on their classification and product offerings.
Who oversees ETFs?
ETFs are regulated by the Securities and Exchange Commission (SEC) under the Investment Company Act of 1940, and are subject to the same regulatory standards as mutual funds and unit investment trusts (UITs). 2 Like publicly traded stocks, most investors purchase and sell ETF shares through broker-dealers at market-determined rates.
Is an ETF a form of communal investment?
ETFs are Collective Investment Schemes that are categorized as conventional securities. ETFs do not require daily margin calculations or mark-to-market because they are not derivatives, and they can be traded using existing systems without the requirement for additional risk assessment tools.
Is the Investment Company Act applicable to REITs?
REITs rely on the Investment Company Act’s Section 3(c)(5)(C) to qualify for regulatory exemption as “investment firms.” Because the operations of most, if not all, mortgage REITs are incompatible with the Investment Company Act’s standards, exemption from the Act is deemed important for REITs.
Are REITs considered investment firms?
Many REITs (equity and mortgage) are registered with the Securities and Exchange Commission (SEC) and traded on a stock exchange. These are known as publicly traded real estate investment trusts (REITs). There are also REITs that are registered with the Securities and Exchange Commission but are not publicly traded.
Under the Investment Company Act of 1940, what is an investment company?
The Investment Company Act’s section 3(a)(1) defines a “investment company” for the purposes of federal securities laws. An investment company is defined as an issuer that is or sets itself up as being involved primarily, or plans to be engaged principally, in the business of investing, reinvesting, or trading in “securities,” according to Section 3(a)(1)(A) of the Investment Company Act. See the Investment Company Act’s Section 2(a)(36) for further information. An investment company is defined as an issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities, and owns or proposes to acquire “investment securities” with a value exceeding 40% of its total assets (exclusive of government securities and cash items) on an unconsolidated basis, according to Section 3(a)(1)(C) of the Investment Company Act. The Investment Company Act, Section 3(a)(2).
Management companies, unit investment trusts, and face-amount certificate companies are the three types of investment firms. See the Investment Company Act, Section 4 for further information.
(a) Management firms are typically organized as corporations or trusts. The management of a management company is overseen by the board of directors (or trustees). The Investment Company Act, Section 2(a)(12), explains this. For a fee, the investment adviser of a management company (which is normally a separate corporation registered with the Commission) manages the firm’s portfolio securities. See the Investment Company Act’s Section 2(a)(20).
Open-end and closed-end management firms are the two types of management companies. See the Investment Company Act, Section 5(a). Based on the makeup of their assets, management businesses are further classed as “diversified” or “non-diversified” funds. See the Investment Company Act, Section 5(b).
- Open-ended businesses ( “Management investment companies that offer or have outstanding redeemable securities of which they are the issuers are referred to as “mutual funds.” The Investment Company Act, Section 5(a)(1). The phrase “The Investment Company Act’s Section 2(a)(32) defines “redeemable security.” Mutual funds are investment vehicles that hold a portfolio of securities that are typically managed by an investment manager. Mutual funds often sell an unlimited number of shares to the general public on a regular basis.
Closed-end firms (sometimes known as “closed-end funds”) are investment companies that do not issue redeemable securities and hold a portfolio of assets managed by an investment adviser. They normally sell a set number of non-redeemable securities to the general public. See the Investment Company Act’s Sections 5(a)(2) and 23. Closed-end fund shares are frequently traded on stock exchanges in the secondary market.
- Interval funds are a type of closed-end fund that differs from typical closed-end funds in that the securities held by the interval fund are subject to periodic buyback offers at net asset value. Interval funds may also differ from standard closed-end funds in that they offer their shares at net asset value on a continual basis. (See the Investment Company Act’s Rule 23c-3.)
- Business development companies (“BDCs”) are a type of closed-end fund that invests in small and emerging enterprises as well as financially distressed corporations. See the Investment Company Act’s Section 2(a)(46). BDCs provide extensive management support to their portfolio firms. See the Investment Company Act’s Section 2(a)(48). Under the Investment Company Act, BDCs have more latitude than conventional investment companies when it comes to working with portfolio companies, issuing securities, and compensating its managers. The Investment Company Act, Sections 54 through 65. Furthermore, under the Investment Company Act, BDCs are not obliged to register as investment companies. The Securities Exchange Act of 1934, however, requires them to register their securities. For more information on the regulatory system that applies to BDCs, see Adoption of Permanent Notification Forms for Business Development Companies; Statement of Staff Position, SEC Release No. IC-12274 (Mar. 5, 1982) and Interim Notification Forms for Business Development Companies, SEC Release No. IC-11703 (Mar. 26, 1981).
Unit investment trusts (UITs) are a type of unit investment trust that invests in a “Investment businesses that do not have a board of directors, corporate officers, or an investment manager are known as “unit investment trusts.” They usually invest in a small number of securities in a very stable portfolio. UITs often sell a set number of redeemable securities (or units) to the general public “(“units”) After the first public offering, UIT sponsors may retain a secondary market for trading UIT units. Sections 4(2) and 26 of the Investment Company Act are relevant.
(c) Face-amount certificate companies are investment firms that are engaged in or plan to participate in the business of issuing installment-type face-amount certificates, or that have previously done so and have any outstanding certificates. See the Investment Company Act’s Sections 3(a)(1)(B) and 4(1). The phrase “The Investment Company Act’s Section 2(a)(15) defines “face-amount certificate.” Today, there are just a few companies that issue face-amount certificates.
An exchange-traded fund (ETF) is a relatively new type of investment firm “ETF”): an investment company that is either an open-end fund or a unit investment trust (UIT) as defined by the Investment Company Act. For more information on ETFs, see SEC Concept Release: Actively Managed Exchange-Traded Funds, SEC Release No. IC-25258 (Nov. 8, 2001).
Which of the following organizations is not considered an investment firm under the Investment Company Act?
An investment advisor, as defined by the Financial Advisors Act of 1940, is a person who is compensated for providing investment advice. Any bank or bank holding company, as well as anyone whose advice or services are only related to US government securities, are excluded from this term.
The Investment Company Act of 1940 defines which of the following as an investment company?
Face amount certificate companies, unit investment trusts, and management companies are the three forms of investment firms defined by the Investment Company Act of 1940.
Are ETFs considered taxable securities?
Investment advisers and broker-dealers can use National Compliance Services, Inc.’s registration and compliance services. The question of whether a share of an exchange-traded fund (“ETF”) structured as a unit investment trust (“UIT”) is a “reportable security” within the meaning of Rule 204A-1(e) has arisen in advising our clients on compliance with Rule 204A-1 under the Investment Advisers Act of 1940 (the “Advisers Act”) (10). We respectfully request the staff’s assurance that, unless the ETF is a “reportable fund” within the meaning of Rule 204A-1(e), it will not recommend enforcement action to the Commission against our clients who are registered investment advisers if they do not treat ETF shares as reportable securities (9).
An ETF is a registered investment company organized as an open-end management investment company, a unit investment trust, or a similar entity that holds securities constituting or otherwise based on or representing an investment in an index. Its shares or other securities are principally traded on a national securities exchange or through the facilities of a national securities association and reported as a national market security.
1ETFs only sell and redeem their shares in huge blocks known as creation units at net asset value.
Individual ETF shares, on the other hand, can be bought and sold at market prices by investors throughout the trading day.
Because of the arbitrage opportunities inherent in the ETF structure, ETF shares have rarely traded at a large premium or discount to net asset value in the secondary market.
12
In January 2005, the combined assets of the country’s ETFs were $222.89 billion.
3
The bulk of exchange-traded funds (ETFs) are structured as open-end management investment companies (OMICs).
Some of the larger ETFs, on the other hand, are structured as UITs.
DIAMONDS Trust, Series 1, had net trust assets of $8.19 billion on October 31, 2004;4 MidCap SPDR Trust, Series 1, had net trust assets of $6.54 billion on September 30, 2004;5 Nasdaq-100 Trust, Series 1, had net trust assets of $20.38 billion on September 30, 2004;6 and SPDR Trust, Series 1, had net trust assets of $45.72 billion on September 30, 2004.
7
According to Rule 204A-1, every registered investment advisor must establish, maintain, and enforce a written code of ethics that requires access individuals to file reports of their holdings of, and transactions in, reportable securities, among other things.
Rule 204A-1(e)(10) defines a “reportable security” as a security as defined in Section 202(a)(18) of the Advisers Act, with certain stated exceptions, such as shares issued by open-end registered investment organizations that are not reportable funds (i.e., registered investment companies with which the registered investment adviser has certain relationships).
8
Except for the tiny number of investment advisers for whom the ETF is a reportable fund, the majority of ETFs are open-end registered investment companies, and their shares are not reportable securities under Rule 204A-1.
ETFs constituted as UITs, on the other hand, do not qualify for any of the exceptions in Rule 204A-1(e)(10), and their shares are thus reportable securities in the strictest sense of the term.
9
The exceptions to the “reportable security” definition are designed to exclude stocks that appear to present minimal chance for the type of unlawful trading that the access person reports are designed to detect, according to the Commission’s Adopting Release.
10
We believe that ETFs, which are among the most transparent and liquid instruments available, are especially unlikely to provide possibilities for illegal trading.
Furthermore, there appears to be little need to distinguish between ETFs organized as unit investment trusts (UITs) and ETFs organized as open-end investment companies (OEICs).
Because of their generally larger size, better liquidity, and high level of transparency and liquidity of their underlying holdings, ETFs constituted as UITs are even less likely than other ETFs to present chances for inappropriate trading.
We believe that financial advisers regard ETF shares as a single type of security and that an arbitrary requirement to discriminate between ETFs organized as open-end investment companies and ETFs organized as unit investment trusts will confuse them.
It’s worth noting that the way ETFs are treated under Rule 204A-1 has generated some consternation in the industry.
This firm’s members have attended three conferences in the last few months where the topic has been discussed.
As a result, a no-action response would provide important guidance to the sector.