ETF or Mutual Fund Becomes Majority Owner

When it comes to ETFs, Mutual Funds or an investor with deep pockets, the problem with funds of all types in general is clear.

Once a fund buys 20% of all voting shares of a corporation, it must contact a lawyer to make sure that the fund is not breaking any Canadian securities laws.  Therefore, an ETF that tracks an index can easily overflow and takeover a company just by having too much investors money in the ETF.

The number of shares in an ETF can grow and shrink to accommodate the ETF’s demand, but the number of shares in a company cannot grow and shrink without affecting the price of the stock.  Therefore, it does not take much for an ETF to drive up the prices of all the underlying securities and own over 20% of the shares of a corporation.  After all, if money keeps pouring into an ETF, the underlying securities get bought up and less securities are available to be bought on the open market if the ETF investors are buy and hold investors.  This in turn will increase the ETF’s stake in the underlying securities.

Therefore, to avoid the ire of the various securities regulators, an ETF must either be closed to new investors or buy securities outside of the index the ETF is tracking.

Some analysts say that ETFs will blow up.  I wonder if this is what they are talking about.

I am curious on why a provider cannot just create a second or third ETF called ETF2 and ETF3 to prevent an ETF from breaking the securities regulations.  After all, an ETF’s price is the value of the underlying securities.  Furthermore, the price of ETF1, ETF2, and ETF3 can be the same since they are all tracking the same index.  They can merge or separate to not break the securities regulations.

The securities regulations must prohibit this since it could be a possible takeover loophole.

TMX’s copy of the IIROC insider trader takeover rules

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