Securities Regulation Daily SEC proposes ETF framework and tweaks liquidity risk disclosure; proposes changes to whistleblower program
Thursday, June 28, 2018

SEC proposes ETF framework and tweaks liquidity risk disclosure; proposes changes to whistleblower program

By Amy Leisinger, J.D.

The SEC has unanimously approved a proposal that would permit certain exchange-traded funds to operate without first obtaining fund-specific exemptive orders from the Commission and, by a split vote, adopted changes to fund disclosures concerning liquidity risk management. By a 3-2 vote, the Commission also proposed to amend the rules governing its whistleblower program to provide additional considerations for award amounts, develop a uniform definition of "whistleblower," and increase efficiency in the claim review process (Exchange-Traded FundsRelease No. 33-10515Investment Company Liquidity DisclosureRelease No. IC-33142, June 28, 2018).

ETF approval process. In its proposal to modernize the regulatory framework for ETFs, the SEC adopted a new rule and form amendments to establish a framework for certain ETFs to operate without applying for individual exemptive orders. Since 1992, the Commission has issued more than 300 exemptive orders allowing ETFs to operate under the Investment Company Act, and the proposal is designed to incorporate standards and conditions set forth in many of those orders and foster consistency in regulation while protecting ETF investors.

Proposed Rule 6c-11 would be available to ETFs organized as open-end funds; an ETF structured as a unit investment trust or a share class of a multi-class fund, or acting as a leveraged or inverse ETF, would be unable to rely on the rule. The rule would provide certain exemptions from the Investment Company Act but would require an ETF to provide daily portfolio information on its website. An ETF also would have to disclose other information on its website, including historical premium and discount and bid-ask spread information, as well as information regarding a published basket at the start of each business day. An ETF relying on the rule would be permitted to use baskets not reflecting a pro-rata representation of its portfolio or differing custom baskets if it adopts written policies and procedures setting forth guidelines for the development and acceptance of the baskets that are in the best interests of the ETF and its shareholders.

In addition to setting forth certain recordkeeping requirements, the proposal recommends rescinding previously granted exemptive relief for ETFs that able to rely on the rule and proposes amendments to Forms N-1A and N-8B-2 to facilitate ETF registration.

Comments are due within 60 days of publication of the proposing release in the Federal Register.

Liquidity risk management disclosures. The SEC also adopted amendments to change liquidity disclosure requirements for certain funds. Under the amendments, funds would discuss the operation and effectiveness of their liquidity risk management programs in shareholder reports, replacing the pending requirement that funds publicly disclose a quantitative snapshot of aggregate portfolio liquidity classification data on monthly Form N-PORT.

In addition, the Commission amended Form N-PORT to require that funds disclose their holdings of cash and cash equivalents not reported elsewhere and to provide funds with the flexibility to classify their portfolio holdings into multiple categories when split reporting will fairly or more accurately reflect investment liquidity or reduce costs.

In support of the changes, Chairman Clayton urged funds to develop disclosure practices with a focus on informing investors of their respective approaches to liquidity management, and Commissioner Michael Piwowar suggested that the SEC should have gone further in revising Rule 22e-4’s "onerous requirements" and "one-size-fits-all methodology" for liquidity classification.

The amendments will become effective 60 days after publication in the Federal Register.

Whistleblower program. The SEC also proposed amendments to the rules governing its whistleblower program to provide additional tools to assist the Commission in making award determinations, increase efficiencies in the claim review process, and clarify the parameters for employment retaliation protection.

To ensure that whistleblowers are appropriately rewarded for their efforts, the SEC proposes to allow awards based on deferred and non-prosecution agreements with law enforcement or a settlement agreement entered into by the agency outside of a judicial or administrative proceeding. With regard to small awards, the proposal would allow the Commission to upwardly adjust an award percentage if it finds that an increase would more effectively reward the whistleblower and sufficiently incentivize future whistleblowers. In the context of particularly large awards, the Commission could adjust the award percentage to yield a payout that does not exceed an amount that is reasonably necessary to reward the whistleblower, but not below $30 million. The proposal also would eliminate the potential for double recovery that could occur if a whistleblower provides information to, and obtains recoveries from, different whistleblower programs.

The Commission also proposed amendments to address the Supreme Court’s decision in Digital Realty Trust, Inc. v. Somers, which invalidated the Commission’s rule interpreting Section 21F’s anti-retaliation protections to apply in cases involving internal reports. Rule 21F-2 would be amended to establish a uniform definition of "whistleblower" that would apply to all aspects of Exchange Act Section 21F and to require an individual to report information to the Commission "in writing." In addition, the SEC’s whistleblower rules would be amended to, among other things: (1) provide that individuals may be barred from the program when found to have submitted false information or repeatedly made frivolous award claims; (2) allow for the use a summary disposition procedure for claims likely to result in a denial of an award; (3) provide the Commission with additional flexibility in connection with whistleblower form submissions; and (4) clarify the specific materials on which the Commission may rely in making determinations.

In connection with the proposal, the SEC is publishing proposed interpretive guidance to help clarify the meaning of the term "independent analysis" used in award applications.

"The proposed rules are intended to help strengthen the whistleblower program by bolstering the Commission’s ability to more appropriately and expeditiously reward those who provide critical information that leads to successful enforcement actions," said SEC Chairman Jay Clayton.

The proposal seeks comment on a broad range of topics relating to the whistleblower program; comments are due within 60 days following publication in the Federal Register.

The releases are No. 33-10515 and No. IC-33142.

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