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In September 2019, the SEC promulgated Rule 6c-11 to standardize the operation of all exchange-traded funds. Importantly, this rule provided all ETFs with the ability to issue “custom baskets,” which are baskets of stocks that are not composed of a pro rata representation of a fund’s holdings. Such baskets are important because they give ETFs additional flexibility to lower their tax liability by using custom baskets to remove stocks that would incur the highest capital gains from their portfolios. This Note analyzes how expanded custom basket access impacts ETFs use of a certain type of tax-evading trade known as a “heartbeat” trade. It finds that there has been a substantial increase in such trades since the Rule went into effect and that the increase was much larger among funds who were only able to use custom baskets after Rule 6c-11.
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