Regulation of ETFs

ETFs are regulated by the Securities and Exchange Commission. The SEC’s Division of Investment Management regulates the investment companies that issue ETFs and the SEC’s Division of Trading and Markets regulates the trading-related aspect of ETFs. Both divisions require ETFs to comply with certain rules.

Division of Investment Management

The Division of Investment Management regulates all investment companies, including mutual fund companies, closed-end funds, and federally registered investment advisors. With the adoption of rule 6c-11 the “ETF Rule” ETF sponsors are no longer required file for exemptive relief. However, the rule does not rescind the exemptive orders of UIT ETFs, leveraged/inverse ETFs, share class ETFs, or non-transparent ETFs. Additionally, the regulatory distinction between index-based and actively managed ETFs was eliminated to provide a more consistent and transparent regulatory framework. The SEC approved the first index-based ETF in 1993 but did not approve the first actively managed ETF until 2008.

As is the case with mutual funds, each ETF is required to file a prospectus. All investors who purchase shares receive a prospectus. Some ETFs may furnish investors with a summary prospectus, as long as the full prospectus is available on the issuer’s website and can be printed upon request and without charge.

Division of Trading and Markets

The SEC Division of Trading and Markets regulates all the major US stock exchanges. Its purview includes listing rules for all securities, including ETFs. With the implementation of rule 6c-11, the majority of ETFs (index-based and actively managed) are now able to comply with the generic listing standards.

Important listing requirements include:

  • The ETF must meet the requirements of Rule 6c-11 on the initial and continued listing basis.
  • Having at least 50 beneficial shareholders of the ETF following the initial 12-month period after commencement of trading on the exchange for 30 or more consecutive trading days
  • The ETF must meet the Exchange’s minimum requirement for the number of ETF shares required to be outstanding at the time trading commences. (Exchanges generally consider at least one creation unit outstanding at the time of listing to be sufficient for the purposes of complying with this requirement.)
  • Certain firewalls must be implemented to prevent prohibited insider trading (actively managed and index-based ETFs have slightly different firewall policies).

If an ETF meets these requirements, it does not have to comply with the more onerous listing requirements. ETFs must have been in compliance with the new rule by December 22, 2020 to meet compliance guidelines.

ETFs that do not meet the new 6c-11 listing requirements must receive specific permission from the SEC before listing on a stock exchange. Typically, the ETF sponsor will collaborate with the exchange on the specific rules regarding the fund, and the exchange files a 19b-4 filing with the SEC Division of Trading and Markets to amend the exchange rules.

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Article copyright 2012 by David J. Abner. Reprinted and adapted from The ETF Handbook: How to Value and Trade Exchange Traded Funds with permission from John Wiley & Sons, Inc. The statements and opinions expressed in this article are those of the author. Fidelity Investments® cannot guarantee the accuracy or completeness of any statements or data. This reprint and the materials delivered with it should not be construed as an offer to sell or a solicitation of an offer to buy shares of any funds mentioned in this reprint.

Exchange-traded products (ETPs) are subject to market volatility and the risks of their underlying securities, which may include the risks associated with investing in smaller companies, foreign securities, commodities, and fixed income investments. Foreign securities are subject to interest rate, currency exchange rate, economic, and political risks, all of which are magnified in emerging markets. ETPs that target a small universe of securities, such as a specific region or market sector, are generally subject to greater market volatility, as well as to the specific risks associated with that sector, region, or other focus. ETPs that use derivatives, leverage, or complex investment strategies are subject to additional risks. The return of an index ETP is usually different from that of the index it tracks because of fees, expenses, and tracking error. An ETP may trade at a premium or discount to its net asset value (NAV) (or indicative value in the case of exchange-traded notes). The degree of liquidity can vary significantly from one ETP to another and losses may be magnified if no liquid market exists for the ETP's shares when attempting to sell them. Each ETP has a unique risk profile, detailed in its prospectus, offering circular, or similar material, which should be considered carefully when making investment decisions.