Exchange-Traded Fund Fails to Clear SEC Staff Comment Process Prior to Launch

Who may be interested: Exchange-Traded Funds, Registered Funds and their Investment Advisers

Quick Take: The Staff of the Securities and Exchange Commission (SEC) Division of Investment Management publicly issued a comment letter to a new exchange-traded fund (ETF) that commenced trading without resolving significant Staff issues with the ETF’s disclosures.

A new ETF recently launched without addressing outstanding Staff comments. On the same day of the launch, the Staff publicly issued a comment letter to the ETF describing the Staff’s significant outstanding issues. The ETF was a novel fund that offered exposure to, among other assets, privately issued debt (private credit) that a private credit originator stood ready and willing to repurchase from the ETF to provide a measure of liquidity to the private credit held by the ETF.

The ETF is the first to feature more than 15% of its assets in ostensibly illiquid private credit securities. Rule 22e-4 limits ETFs and other open-end registered funds from investing more than 15% of their net assets in illiquid investments. The liquidity facility with the private credit originator allows the ETF to exceed this cap.

In its initial letter, the Staff objected to the extensive redactions of material terms of the liquidity facility agreement with the private credit originator that the ETF filed as an exhibit to its publicly available registration statement. The Staff stated its belief that the liquidity facility with the private credit originator alone was not sufficient to determine the liquidity of private credits held by the ETF. The Staff expressed concerns with how the ETF was to daily value its private credit holdings. The Staff was also concerned with the use of the private credit originator’s name in the ETF’s name where the originator was not under contract to provide investments to the ETF, will not be the sole buyer of the ETF’s credit instruments and does not function as a sponsor, distributor, promotor or adviser to the ETF. Finally, the Staff admonished the ETF’s counsel for failing to respond to Staff comments by filing responses on the SEC’s public EDGAR filing system and for making inappropriate claims of confidential treatment over comment responses.

The next day, the Staff sought in a subsequent letter further information about how liquidity risk management would occur with the private credits held by the ETF. Additionally, the Staff requested additional information regarding the methodology for the valuation of the ETF. Counsel to the Fund responded to the Staff letters, indicating that the Fund would make all of the changes to its disclosures that were recommended by the Staff. Such changes included removing the redactions from the liquid facility, uploading all comment responses to EDGAR, revising the ETF’s name, and affirming the ETF’s liquidity risk management and valuation methodologies.

The first Staff comment letter can be found here, and the second Staff comment letter can be found here.

The ETF’s comment response letter can be found here.