Nontransparent ETFs would be detrimental to ETF investors. Nontransparent ETFs fly in the face of the primary tenets of what constitutes an ETF. Nontransparent ETFs are not in the public interest.

Earlier this week, the SEC struck down a request that would have allowed ETFs to keep their holdings hidden. Many news sources are spinning this as a setback for the ETF industry, but in reality, it is a victory for ETF investors.

The ETF industry has flourished, and much of its success is the result of what ETFs have come to stand for in the eyes of the investing public. ETFs are popular because they fully disclose their holdings (transparent) and have a share creation and redemption mechanism that helps force trading prices to closely track the fund’s net asset value (“NAV”). These are the core features that define ETFs and differentiate them from other investment vehicles.

Before an ETF can be launched, it needs to get exemptive relief from the SEC. In its ruling, the SEC said it, “believes that Applicants’ proposed ETFs do not meet the standard for exemptive relief under section 6c of the Investment Advisers Act of 1940”. According to that section, exemption is allowed only if it “is necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions” of the Investment Advisors Act.

The SEC elaborated by stating the proposed nontransparent structure “presents a significant risk that the market price of ETF shares may materially deviate from the NAV per share of the ETF, particularly in times of market stress when the need for verifiable pricing information becomes more acute.”

In my opinion, the SEC has been lax recently by allowing ETFs and ETNs without a functioning creation/redemption mechanism to continue trading without a ticker symbol change or other investor warning. Additionally, the mutual fund industry has built a 70+ year history on being pass-through vehicles with regard to taxes, yet tax-paying C-corporations are now allowed to call themselves ETFs and mutual funds.

In short, the SEC has not been regulating the ETF industry in a manner that protects investors. However, this recent ruling is a concrete step in the right direction. The SEC has rightfully determined that nontransparent ETFs are not in the public interest.

I’m not against products that trade on a stock exchange and have secret portfolios. However, I am against calling such a product an ETF. Doing so would be a disservice to investors and the $1.8 trillion currently invested in transparent ETFs.

Disclosure covering writer, editor, and publisher: No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.