BlackRock Settles Charges of Operating ETF Without Required SEC Exemptive Relief
On April 25, 2017, the Securities and Exchange Commission (SEC) announced the settlement of administrative proceedings against BlackRock Fund Advisors (BlackRock) for causing iShares MSCI Russia Capped ETF (the Russia ETF), an exchange-traded fund (ETF) it advised, to operate in violation of Sections 22(d) and (e) of the 1940 Act and Rule 22c-1 thereunder.
Section 22(d) of the 1940 Act, among other things, prohibits a dealer from selling a redeemable security that is being offered currently to the public by or through an underwriter, except at a current public offering price described in the prospectus. Rule 22c-1 generally requires that a dealer selling, redeeming, or repurchasing a redeemable security only do so at a price based on the security’s net asset value (NAV). As the SEC’s order explains, because secondary market trading in shares of ETFs takes place at current market prices, and not at the current offering price described in the prospectus or based on the security’s NAV, ETFs have obtained exemptions from Section 22(d) of the 1940 Act and Rule 22c-1 in order to operate lawfully. Section 22(e) of the 1940 Act also prohibits a registered open-end fund from suspending the right of redemption, or postponing the date of payment or satisfaction upon redemption for more than seven days after the tender of such security for redemption. As also explained in the SEC’s order, ETFs that invest in foreign securities and effect redemptions in kind are sometimes unable to meet this requirement because the ETFs track foreign indexes with local market delivery cycles that require a delivery process in excess of seven days. Thus, ETFs and their sponsors also seek exemptive relief from Section 22(e) in order to operate without violating the 1940 Act.
The SEC order states that BlackRock believed that the Russia ETF, the sole series of iShares MSCI Russia Capped ETF, Inc. (the iShares Russia Registrant), was already covered by previously issued exemptive relief which had been granted to iShares Inc. and iShares Trust. Each of iShares Inc. and iShares Trust, the order explains, is an open-end management investment company consisting of numerous ETFs, each of which is organized as a series of iShares Inc. or iShares Trust, respectively. The order notes that in January 2007, the SEC granted exemptive relief to iShares Inc. and iShares Trust allowing them “to offer additional series, based on securities indices (the ‘Future Funds’), without the need for additional exemptive relief from the Commission” (the iShares Future Fund Relief). The SEC order states that because the iShares Future Fund Relief only covered iShares Inc. and iShares Trust and their series, the separately organized iShares Russia Registrant and its series, the Russia ETF, were not covered by the iShares Future Fund Relief. Consequently, the SEC alleged that from December 2010, when the Russia ETF began selling its shares, until January 2015, when the Russia ETF was merged into a newly created series of iShares Inc., and in the absence of exemptive relief, BlackRock (1) caused shares of the Russia ETF to be purchased and sold at prices other than the NAV in the secondary market; (2) caused shares of the Russia ETF to be sold in the secondary market at negotiated prices, rather than a current public offering price described in the prospectus; and (3) caused the Russia ETF to violate Section 22(e) of the 1940 Act when it postponed the date of payment or satisfaction for more than seven days after its shares were tendered for redemption.
Pursuant to the terms of the order, BlackRock agreed to pay a civil money penalty of $1.5 million and agreed to cease and desist from any violations (and future violations) of the laws violated by the foregoing conduct.
The SEC order is available here.