On May 25, 2022, the U.S. Securities and Exchange Commission (SEC) announced a proposal to amend rule 35-d1, known as The Names Rule. If approved, the new proposal will impact the scope of funds required to monitor for the 80% investment policy requirement.
The Names Rule was adopted under the Investment Company Act of 1940 in 2001 to change how registered funds presented themselves to investors. The goal was to eliminate materially deceptive and misleading fund names to create a more transparent market for investors. The Names Rule requires funds to invest a minimum of 80% of their assets in investments in line with their name. 35-d1 currently applies to all registered investment companies with fund names that suggest a focus on the type of investment, industry, geographic makeup, or tax-exempt status [1]. For example, if a fund were named “IMP Technology Fund,” 35-d1 would require 80% of the fund’s assets to be invested in companies representing the technology industry.
SEC Chair Gary Gensler stated, “As the fund industry has developed, gaps in the current Names Rule may undermine investor protection. In particular, some funds have claimed that the rule does not apply to them — even though their name suggests that investments are selected based on specific criteria or characteristics” [2]. For example, the increased use of ESG terminology in fund names has led to interpretation issues and investor skepticism when relying solely on the name.
The SEC has thus proposed ten amendments to rule 35-d1. If approved, funds will be given a 1-year transition period to comply with the requirements. Listed below are three significant amendments included in the proposal:
In addition to the current scope (investment type, industry, geographic makeup, and tax-exempt status), the amendment would require any fund name with terms that suggest a focus on investments that have, or issuers that have, particular characteristics to follow the 80% investment policy requirement. If approved, funds with names indicating a specific investment strategy (“growth”) or one or more Environmental, Social, or Governance (ESG) characteristics (“sustainable”) must now comply with the 80% requirement [3].
The definition of ESG funds would become significantly more precise. “Integration funds,” which use multiple factors (including ESG) in investment decisions, could no longer be marketed as ESG vehicles. Integration funds would be prohibited from using ESG terminology in their names if it is not a central role in the fund strategy. Any integration fund to do so would be labeled as materially deceptive and misleading.
Unlike the current “under normal circumstances” requirement, funds would now be limited as to when and how long they could deviate below 80%. For example, trading into a shortfall would become harder to justify and may have as little as 30 days to return to compliant levels.
The comment period for the proposal will remain open until August 16, 2022. If you want to learn more about how to prepare for The Names Rule Amendment Proposal, check back next week for IMP's Guide: Preparing for the 10 Proposed Names Rule Updates (Part 2/2).
[1] Securities and Exchange Commission. “Investment
Company Names.” U.S. Securities and Exchange Commission, May 25 2022, https://www.sec.gov/rules/proposed/2022/33-11067.pdf.
[2] Gensler, Gary. “Statement on Proposed Updates to Names Rule.” U.S Securities and Exchange Commission, May 25 2022, https://www.sec.gov/news/statement/gensler-statement-proposed-updates-names-rule-052522.
[3] Securities and Exchange Commission. “SEC Proposes Rule Changes to Prevent Misleading or Deceptive Fund Names.” U.S. Securities and Exchange Commission, May 25 2022, https://www.sec.gov/news/press-release/2022-91.