In 1977, Manfred Mann’s Earth Band rocketed to the top of the Billboard charts faster than a little deuce coupe with a hit many of you know well, “Blinded by the Light”. Maybe the best cover song ever. The original, written and performed by Bruce Springsteen, debuted in 1973 with little fanfare. Why was Manfred Mann’s version so much better? It really comes down to the composition, not just the words. In just about every compositional way, Manfred Mann got it right. Springsteen’s version was a little too loose and really, just about the words.
That may be a useful way to think about the future of Section 351 SMA-to-ETF conversions.
Recent Treasury and IRS guidance appears to be drawing a distinction between asset managers that neatly follow the words of Section 351 but deliberately ignore nuances and purposefully miss the compositional intent. The rules outlined last week are new, the boundaries are still developing, and there is plenty we do not yet know. But a few themes seem to be emerging.
Start With the Investment Story
Perhaps the best place to begin is not with Section 351 at all.
Why should the SMA become an ETF?
There are plenty of legitimate reasons: greater operating efficiency, scalability, potentially lower client costs, broader distribution, better tax management, greater transparency or more consistent implementation of a strategy.
Section 351 can provide an attractive tax outcome, but the emerging regulatory message seems to suggest that tax deferral should be the supporting act rather than the headliner.
Keep Playing the Same Song
The cleanest fact pattern may be one where the ETF is genuinely a continuation of the SMA strategy.
Same portfolio manager. Same investment philosophy. Same security-selection process. Same risk framework. Similar client outcome.
The wrapper changes, but the investment strategy largely does not.
The greater the continuity between what existed before the conversion and what exists afterward, the easier it may be to argue that investors changed investment vehicles rather than exchanged one portfolio for an economically different one.
Contribute Securities You Actually Want
One particularly interesting part of Notice 2026-62 is what Treasury did not address: newly formed ETFs receiving securities that fit the ETF’s investment thesis and are expected to remain in the portfolio unless circumstances change.
That seems important.
A practical question for managers might therefore be:
If the ETF had cash instead of these securities, would we want to buy them today?
If the answer is yes, that would appear to be a much more comfortable fact pattern.
If the answer is, “Not really, but we can contribute them and get rid of them later,” the transaction may start to look very different.
Be Careful With the Opening Set
Revenue Ruling 2026-20 focused on a transaction where securities went into an ETF and then quickly moved back out through redemption activity, leaving behind a materially different portfolio.
That suggests managers may want to be cautious about launching an ETF with a prearranged plan to immediately reposition the portfolio.
Large, planned sales, predetermined redemptions, and coordinated authorized participant (AP) activity or rapid turnover immediately after the conversion could make an otherwise legitimate conversion look more like a portfolio exchange.
That does not mean an active manager suddenly has to stop managing the portfolio. Markets change. Investment views change. Securities get bought and sold.
The question may increasingly be why those trades occurred.
Write Down the Story
Because intent matters, contemporaneous documentation could become more important.
That might include investment committee materials, board materials, launch rationale, explanations for why contributed securities fit the strategy and expectations for portfolio management after conversion.
Documentation will not magically determine the tax result. But it can help establish that investment considerations—not a prearranged tax strategy—were driving the decision.
Don’t Obsess Over a Magic Holding Period
One thing Treasury has not provided is a bright-line rule for how long contributed securities must remain in the ETF.
There is no obvious 30-day, 60-day or 90-day safe harbor.
That may mean managers are better served focusing on the investment rationale behind post-launch trading rather than trying to manage to an arbitrary calendar.
The Simplest Test
For now, one question may capture much of the emerging framework:
If Section 351 offered no tax benefit, would we still want to launch this ETF with these securities and manage substantially the same strategy afterward?
If the answer is yes, the structure may look more like a genuine evolution from an SMA to an ETF.
If the answer is no—and the real attraction is turning an appreciated portfolio into a substantially different portfolio without paying current tax—the music may have changed enough that regulators hear a different song altogether.
That feels like the direction of travel. Not a prohibition on SMA-to-ETF conversions, but a greater emphasis on making sure the ETF is the next version of the strategy—not simply a tax-efficient remix of the portfolio.
Cheers to Manfred Mann and being, “Revved up like a deuce. . .” … not whatever other lyric we were all singing 50 years ago.
Important Disclosures & Definitions
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