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Donohue Says Staff is Working to Speed Up ETF Application Process

The efficient processing of exchange-traded fund applications is a top priority, according to Andrew Donohue, the director of the SEC's Division of Investment Management. In remarks at a recent indexing summit, Donohue acknowledged that many people believe the review process is much too slow and may impede the introduction of new ETFs into the market. Based on press reports and the number of recently filed ETF registration statements, Donohue said it appears likely that the number of ETFs will continue to increase significantly.

The process for reviewing ETF exemptive applications can be complex and multi-faceted, according to Donohue, depending on their structure. Investment advisers submit applications for certain exemptions from the Investment Company Act to permit the operations of their ETFs. The application process can involve several rounds of comments and responses, Donohue explained. If the ETF proposal is novel, the staff presents the issue to the Commission for the authorization of any action.

Donohue said the staff has been issuing ETF orders at a record pace in recent months, but has also received a record number of proposals. The staff is trying to think creatively about how to improve the review process, he said, including the prioritization of routine index applications. The Division is also considering an approach that would lessen the emphasis on the securities indices underlying ETFs now that it has gained a fair amount of administrative experience.

The staff is considering whether to expand the future relief contained in ETF orders to permit sponsors to introduce similar ETFs without going through the exemptive process a second time. Donohue said the most significant initiative may be the development of an ETF rule that would permit new ETFs to come to the market without first obtaining an exemptive order. The rule must be tailored to the types of ETFs with which the staff has substantial experience, he explained, such as routine index-based ETFs.

Donohue also addressed the issue of actively-managed ETFs, none of which have been approved or launched. The SEC issued a concept release on actively-managed ETFs five years ago to learn more about the issues surrounding these products, such as transparency. Portfolio managers have advised that too much transparency can affect performance since it may telegraph the manager's moves to the marketplace. The staff likely will have to assess the extent to which transparency is critical to the ETF structure, according to Donohue, and make recommendations to the Commission on how the issue should be addressed.

Donohue added that since estimates have placed individual investments in the secondary market for ETFs as high as 70%, the staff must bear in mind the changing nature of the investor base and ways that new ETFs may differ from the standard structure. Innovations in ETF structure, including actively managed ETFs, must be carefully considered with a view to the potential implications for investors and the marketplace, he said.

Priorities for the Division

In a speech before IA Week's recent compliance conference in New York, Donohue reviewed the priorities of his Division, one of the most significant of which is the investment adviser/broker dealer study. Since his September 25 remarks, the SEC has announced the award of a contract to RAND Corporation to conduct the research and analysis of the regulatory systems that apply to broker-dealers and investment advisers. The information provided by the study should assist the SEC in making informed evaluations about the regulatory schemes and their impact on firms and investors, according to Donohue.

A second major initiative is the modernization of the investment adviser books and records rule. Donohue noted that the rule was adopted in the early 1960s and has not kept up with changes in the industry. Donohue said he envisions a comprehensive review of the books and records requirements, taking into account the technologies that are available today to help firms maintain and produce records in a cost-effective manner.

Donohue said the staff is also working on a reproposal of amendments to ADV Part 2. The SEC deferred the adoption of Part 2 in 2000, he noted. Since so much time has elapsed, Donohue believes the staff should obtain a fresh set of comments on the form and content of Part 2.

Fund boards and the SEC commissioners have asked for additional guidance on soft dollars, portfolio trading practices and best execution, Donohue reported. The staff would like to provide guidance that will promote a meaningful dialogue between fund boards and management about soft dollar practices and the adviser's philosophy on brokerage and trade allocation.

The final initiative relates to hedge funds. SEC Chairman Christopher Cox has announced plans for a new anti-fraud rule under the Investment Advisers Act that would "look through" a hedge fund to its investors in order to reverse an unintended result of the Goldstein decision, which overturned the SEC's hedge fund adviser registration rule. Donohue said the staff is analyzing the drafting of a rule that is based on the SEC's authority under section 206(4).