The latest tax-management fad is getting a reality check.

ETF investors have increasingly taken advantage of Section 351 of the US tax code over the past several years, allowing them to move appreciated assets into a new vehicle without immediately paying capital gains taxes (provided the new fund meets certain requirements).

Now, the Treasury may finally be taking aim at certain so-called “351 conversions” that it says don’t jibe with tax law. The department on Monday limited one such transaction involving an ETF and flagged several others. The move signaled the government’s willingness to crack down on some of the funds that fall into this category.

“Investors purportedly avoid recognition of the built-in gains in their securities while effectively exchanging those securities for an indirect interest in an ETF with a materially different portfolio,” the Treasury’s statement reads. “In these transactions, [Sections] 351, 721 and 852(b)(6) are being applied … to achieve a result that these provisions were not intended to produce.”

Laying Down the Law

The Treasury had previously signaled its disapproval of 351 conversions — officials called them “too good to be true” at a recent industry event — but until now, no regulatory actions had been taken. Funds that use the strategy now number over 120, with more than half of those launching in the past year alone. Guidance on the subject was much-needed, said Shang Chou, co-founder of the multi-family office Dishmi Capital. “This is a positive thing. There are now clear[er] guidelines on where investors should be standing,” he said. “Going in there with a plan to skirt out on the capital gains tax to get diversification with this pre-planned idea to dispose of those assets — that’s going to be a no-go going forward.” That said, the department’s language seems to leave a window for what Chou called “well-behaved 351s” — that is, funds that make use of assets already aligned with the ETF’s core strategy.

The trend is real: The MIG Core ETF, for example, took assets from the Hot Pocket empire earlier this year and put them into the ETF structure. “I would contrast that with ETF firms looking to launch S&P 500-tracking ETFs and willing to take in diversified baskets,” Chou said.

Not Over Yet: The underlying principle behind the Internal Revenue Service’s actions is economic substance over tax gains, Chou said. “You shouldn’t be contorting your balance sheet in weird ways just to avoid or defer taxes. That makes no sense,” he added.

The government will also seek public comment on the transactions it targeted, as well as asking about others that it said should be regulated similarly, with the comment period closing at the end of October.

It’s closing time for Crypto Mom’s SEC.

Friday marks the last day of Hester Peirce’s tenure at the agency, according to her recent resignation letter to President Trump. The commissioner will be returning to academia as an associate professor at the Regent University School of Law, the school announced in May.

Peirce, who took office in 2018, was a fierce advocate for the crypto industry. She urged the Securities and Exchange Commission to provide clear regulatory roadmaps for digital assets instead of regulating through enforcement, and she publicly criticized her own agency’s early rejections of spot bitcoin ETFs. But now, she’s making her exit when crypto-related lawmaking is at an inflection point: The CLARITY Act, which would have provided a regulatory framework for digital assets, failed to win enough Senate votes to advance this month. The SEC has made it clear it will offer guidance where it can without Congress’ buy-in, most recently via a five-year exemption that allows trading venues to offer tokenized stocks.

“With Commissioner Peirce’s departure, the SEC has lost a trailblazer who was not afraid to advance boundary-pushing policy ideas,” said Arun Sundararajan, a professor at New York University’s Stern School of Business. “Her influence will remain with the regulatory direction she helped advance, away from enforcement and regulatory ambiguity and towards clear, technology-neutral rules.”

Crypto’s Regulatory Future

Peirce helped usher in a new era for Wall Street’s watchdog. “Now that the SEC has gotten to a place of embracing new financial technology, it seems a good time for her to move on,” said Steven McClurg, founder and CEO of crypto-focused asset manager Canary Capital.

Will her departure change the landscape for crypto investment products?

• Nate Geraci, president of NovaDius Wealth Management, said he doesn’t believe it’ll have a meaningful impact on the future of crypto ETFs, given the SEC’s much more crypto-friendly posture today.
• But while SEC Chair Paul Atkins and Commissioner Mark Uyeda share her market-driven approach, an immediate challenge to new regulation will be whether they can reach unanimity, Sundararajan said. “A two-commissioner agency leaves no margin of error for reaching quorum.”
• The agency may also shift its focus away from crypto and toward addressing the sudden increases in systemic risk from generative and agentic artificial intelligence, Sundararajan said.

A Final Word: There’s plenty Peirce would have liked to do at the SEC, including finalizing transfer agent rules, work related to investment advisor and investment company custody, and starting a compliance officer advisory committee, she recently told The Block. But now that that’s in other commissioners’ hands, her advice for them is fairly simple. “Keep seeking public input,” she said. “We need to be working with a whole range of people on the outside, not just people who are in the crypto industry, but people who are critical of the crypto industry as well.”

The biggest ETF issuer has something to share.

BlackRock is coming to the table with its first exchange-traded fund share classes. The company, which filed with the Securities and Exchange Commission for them this week, is giving the dual-share-class treatment to actively managed strategies representing $55 billion. The five mutual funds don’t already have iShares counterparts.

“iShares is pretty heavily dominated by passive, index-based strategies,” said Dan Sotiroff, associate director of manager research at Morningstar. “Mutual funds aren’t selling right now. ETFs are where the money is going.”

Easy Wins

Three of the funds getting an ETF share class are muni bond funds, which makes sense, as those are less likely to be used heavily within 401(k)s and be complicated by the dual-share-class treatment, Sotiroff noted. BlackRock’s initial set of products includes its High Yield Portfolio, Strategic Municipal Opportunities Fund, California Municipal Opportunities Fund, New York Municipal Opportunities Fund and Equity Dividend Fund. Current investors in those mutual funds will not have to move their assets, per a company announcement. “The proposed share classes would give investors greater choice in how they access the same established portfolios, combining the flexibility and potential tax and cost efficiencies of an ETF with BlackRock’s investment expertise and long-term track records,” Elise Terry, head of Americas iShares at BlackRock, said in the firm’s announcement.

The company is one of relatively few that have moved forward with dual share classes, even as 80-plus have received exemptions from the SEC to do so. The slow rollout industrywide is due in part to the operational complexities of offering both vehicles. Some longtime asset managers in the mutual fund space have only recently started offering ETFs, as facilitating the creation and redemption process is a new development for them. It has been more common for firms to add corresponding ETFs for mutual funds or to convert strategies, as Northern Trust is planning to do with six mutual funds representing about $33 billion.

Some of those that have either launched or have filed for dual share classes:

• Dimensional Fund Advisors, which has launched and merged ETFs as a share class.
• F/m Investments, which brought the first mutual fund share class to an ETF, and is being acquired by T. Rowe Price.
• Fidelity, which added its first ETF share classes of several funds in June.

Open the Floodgates … Ever So Slightly: It’s likely that more asset managers will add dual share classes as the structure becomes more common and operation becomes second nature. “It’s not a tidal wave,” Sotiroff said. Dual share classes, like fund conversions, are “both tricky to do. You don’t just flip a switch.”