Key Legal and Compliance Issues of an ETF

If you are looking to launch an Exchange-traded fund (ETF), you need to understand the legal and compliance issues that come with this type of investment vehicle. This article will walk you through the U.S. Securities and Exchange Commission’s (SEC’s) Rule 6c-11 and common marketing concerns to keep in mind.

ETF Rule 6c-11

SEC Rule 6c-11 (the Rule) imposed specific requirements and disclosure amendments for most ETFs. The intent of the Rule is to foster greater competition and innovation by lowering barriers to entry. Specifically, the Rule allows ETF sponsors to operate within the scope of the Investment Company Act of 1940 and launch funds without the burden of obtaining an exemptive order from the SEC. ETFs that are subject to the Rule include active and passive strategies that qualify as open-end funds and provide daily transparency within the portfolio.

Conversely, ETFs that are structured as unit investment trusts (UITs) use leverage or inverse techniques, or are considered non-transparent are not subject to the Rule, and therefore, must continue to abide by the SEC’s exemptive relief requirements.

Certain conditions imposed by the Rule include the following:

• Transparency - ETFs are required to provide daily portfolio transparency on their websites.
• Website disclosure - ETFs must disclose certain information on their websites to inform investors about the costs of investing in ETFs and the efficiency of an ETF’s arbitrage process.
• Custom basket policies and procedures - ETFs are permitted to use baskets that do not reflect a pro-rata representation of the fund’s portfolio or that differ from the initial basket used in transactions on the same business day, provided the ETF adopts written policies and procedures that speak to this topic.
• Recordkeeping - ETFs must comply with certain recordkeeping and filing requirements. For example, Form N-1A was amended to provide more useful, ETF-specific information to investors who purchase ETF shares on an exchange.

ETF Marketing Material and Marketing Activities

Let’s start with some website requirements that are unique to ETFs. For example, the website must show:

• Each portfolio holding, unless the fund qualifies as a semi-transparent ETF
• The ETF’s net asset value (NAV), market price, and the premium or discount from the prior day
• The ETF’s median bid/ask spread during the past 30 days, and
• A table and line graph at quarter-end listing each day that the ETF’s shares traded at a premium or discount during the previous calendar year

Other marketing material items to keep in mind include:

• If a passively managed ETF shows it’s tracking of the underlying index, the ETF may be able to also show the pre-inception index performance. The caveat is that data can only be used with institutional marketing material that complies with the Financial Industry Regulatory Authority’s (FINRA’s) interpretive guidance.
• When presenting ETF performance, the NAV and market price must be defined in the material.
• Many ETF clients are active users of social media such as X (Twitter), YouTube, and LinkedIn. The use of social media presents unique issues and will trigger additional oversight and potential regulatory scrutiny. Therefore, your firm should scrutinize the type of social media you seek to employ and understand how these fit within SEC and FINRA rules.
• Interactive tools are becoming more common within ETF websites. Accordingly, dynamic websites with interactive technology must be functional, accurate, and follow regulatory guidance. Many tools contain performance information and other data that trigger specific disclosures that need to be prominently displayed within the marketing message.
• Funds that use leverage or derivative strategies also trigger additional risk disclosures, which can be found in the prospectus. These risks need to be prominently displayed, which may mean including them within the main text of the material versus the disclosure passage.
• Lastly, ETF managers need to ensure that their marketing materials comply with SEC Rule 6c11 or the fund’s exemptive order.

Most ETF fund sponsors use wholesalers to market their funds by hiring a third-party marketing firm or engaging sales staff who are employees of the sponsor. Because these wholesalers are required to be licensed with a FINRA member broker-dealer, they are subject to FINRA rules and regulations as well as the broker-dealer’s oversight and supervisory procedures. For example, wholesaler registered representatives must:

• At a minimum hold SIE, Series 7, and 63 licenses.
• Be knowledgeable of the ETFs they represent (e.g., regulatory structure, management style, investment objectives, indices tracked (if applicable), unique risks and expenses, and tax treatment).
• Ensure their communications to financial intermediaries are fair, balanced, and not misleading, and participate in mandatory training, education, and compliance meetings.

Ready to launch an ETF?

If you too are looking to launch an ETF, then download our guide below. We will walk you through everything you need to know to get started, including the differences between ETFs and other product offerings, startup costs, necessary service providers, and how to gain assets via distribution.

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How we help

If you are ready to launch an ETF, then contact us today to get started.

Year-over-year, the most well-known global wealth and asset managers continue to choose ACA Foreside to help expand and support their product line up of ETFs. In 2023, our specialists partnered with more than half of the ETF launches in the U.S., and we support 1,000+ ETFs distributed across 275 managers. 

We work with asset management firms throughout the world to facilitate compliance and product distribution through legal underwriting, registered rep licensing and chaperoning, and DTCC/NSCC fund sponsorship. We have experience working with all types of pooled investment vehicles, such as traditional mutual funds, ETFs, alternative products, closed-end interval funds, and private placements.

Once launched, we can further support you with our broad range of advisory, managed services, and regulatory technology solutions, to help you grow and protect your business, while also addressing your compliance, ESG, investment performance, and cybersecurity challenges.