SEC Ready to Let Fund Shops Explore Their Dual Share-Class Natures

The SEC had some classy news to share yesterday.

At long last, the agency is (almost certainly) approving dual share classes, which would give asset managers the ability to add ETF share classes of existing mutual funds and vice versa. Companies began seeking exemptions from the Securities and Exchange Commission two years ago, soon after Vanguard’s exclusive patent on dual share classes expired. Unless a hearing is requested, the first exemption from Dimensional Fund Advisors will be approved. The firm’s application, and amendments to it, have served as a template for others, as the SEC worked with the firm to incorporate changes based on its own feedback and input from other industry players.

“We are thrilled that meaningful progress has been made, and we think it’s the watershed moment,” said Aisha Hunt, partner at law firm Kelly Hunt, who has worked with the company second in line, F/m Investments. “Within 15 days, hopefully there is a clear path the SEC will approve to permit dual share classes. This has been a long time in the making.”

Share and Share Alike

The approval allows asset managers to add share classes to funds rather than having to prepare, launch and manage separate versions of products in the two different wrappers, which is something that some of the larger fund companies already do. It could be a major opportunity for active mutual fund managers that don’t have full complements of ETFs, given that sales trends have strongly favored index funds and ETFs. Mutual funds will benefit from the tax capabilities of ETFs, and ETFs can benefit from the cash flow and distribution of mutual funds.

But it will take most fund companies some time before they are ready to launch. Dimensional has been preparing and “intend[s] to launch as soon as we are operationally ready,” co-CEO Gerard O’Reilly said in an announcement. “We know many investors are eager for the ability to exchange mutual fund shares for ETF shares without incurring transaction costs or taxes. However, investors’ custodial platforms will need to facilitate these transactions, and readiness will likely vary across platforms.”

 There were several significant steps that took place this year as the SEC moved ahead with the approval process:

• Firms made changes to their applications over the summer to address the responsibilities that fund boards have in deciding whether adding a mutual fund or ETF share class is appropriate, and what disclosures should be made to help investors understand the differences.
• Most of the amendments to the most recently revised applications address differences in dividend schedules between the two wrappers, Hunt noted.

Government Shutdown, Maybe? There are roughly 80 different applicants for dual share classes waiting on what happens next. It’s no small detail that the federal government may shut down starting next week, unless Congress reaches a funding deal. “It will be helpful to get more definitive guidance about how the regulatory procedure and timeline would play out if there is a government shutdown, or even a prolonged government shutdown,” Hunt said.