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News November 1, 2004 Issue

Count ETFs As Investment Companies

For purposes of investment restrictions and applicable ICA Section 12(d)(1) limits, donít forget to count exchange-traded funds (ETFs) as investment companies.

"The average portfolio manager may not recognize an ETF, thatís traded on Amex," as an investment company, said OCIE associate director Gene Gohlke at last weekís NSCP conference. Thinking "itís just another security," the portfolio manager "may go ahead and invest significantly in ETFs and blow right past his or her fundís investment restrictions." Gohlke added that if the value of the ETF shares goes down and the fund has a loss, "the board of the fund will come knocking on the adviserís door to make the fund whole."

A CCO that has some indication that the firm is thinking about permitting portfolio managers to invest in ETFs should "try to get out ahead of the game" and address the issue, he said. Similarly, if a CCO has cause to believe that portfolio managers are investing in ETFs on their own (perhaps the CCO sees ETFs showing up in a report of the fundís holdings), "a light ought to go off," said Gohlke.