A statutory principal underwriter, often referred to as the distributor, is perhaps one of the most underrated roles and is often overlooked in the ETF formation process. While it may become the last piece of the puzzle trusts put in place, it should be determined around the same time as the ETF鈥檚 custodian and transfer agent, along with the listing exchange for trading.
If a firm has its own registered broker-dealer (鈥淏D鈥�), that doesn鈥檛 necessarily mean it can be the statutory principal underwriter and distributor for ETFs. There are a whole host of reasons that we will highlight at a high level in consideration of requisite rules, regulations and guidance issued by the Depository Trust and Clearing Corporation (鈥淒TCC鈥�), National Securities Clearing Corporation (鈥淣SCC鈥�), U.S. Securities and Exchange Commission (鈥淪EC鈥�) and the Financial Industry Regulatory Authority, Inc. (鈥淔INRA鈥�).
The distributor is registered with the SEC as a broker-dealer under the Securities Exchange Act of 1934, as amended (鈥�1934 Act鈥�) and is a member of FINRA. To facilitate purchase and redemption orders for creation units issued by ETFs, the distributor is a member of the Depository Trust Company (鈥淒TC鈥�) and NSCC. Such membership maintenance and the initial membership process can be cumbersome and costly. Accordingly, this may be a significant factor in a firm鈥檚 determination as to whether to self-distribute ETFs (i.e., through an affiliated or proprietary BD) or utilize a third-party distributor (such as SS&C ALPS) with an established infrastructure to distribute, as well as facilitate orders, for ETFs. SS&C ALPS also has an extensive and longstanding repository of Authorized Participant (鈥淎P鈥�) agreements with AP firms that serve as lead market makers, market makers and institutional order managers which, coupled with firmly founded AP relationships, streamline the process for efficient legal contract negotiation and operational set-ups for ETF order management.
As mentioned, the distributor serves as the principal underwriter of ETFs for the creation and redemption of creation units issued by ETFs and negotiates and enters into AP agreements with AP firms, whereby the trust is a third-party beneficiary, for the ETFs to be distributed. The distributor manages the end-to-end order flow in the primary market, by reviewing and approving all creation and redemption orders, either on the SS&C ALPS proprietary order entry platform or such other platform supported by the ETF鈥檚 designated transfer agent/custodian. This is a critical component of the issuance process because the secondary or retail market for ETFs must be preceded by primary market activity (i.e., APs and market makers creating creation units for availability on the ETF鈥檚 selected listing exchange).
In addition, all ETF advertising, marketing and sales materials that will be utilized to market and sell the ETF must be reviewed and approved through our proprietary portal by one or more of the distributor鈥檚 FINRA-licensed principals; specifically, one that has a FINRA Series 24 or Series 26. Such materials include, but are not limited to, website pages, fact sheets and even social media posts. The distributor will also file any such materials according to the requirements set forth by FINRA.
Key factors you may want to consider when selecting a third-party distributor:
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