SEC Expands Its Rule on Fund Names

“The only thing that this rule achieves is to insert the SEC deeper into funds’ investment decision-making processes,” Pan said. “Portfolio managers won’t be able to make routine investments without the SEC second-guessing whether it fits neatly with the subjective terms that make up their fund’s name. This will hurt American retail investors.”

Added Pan: “The current SEC has decided once again that it knows better than investors, that investors need changes to fund names they simply haven’t asked for, and that the higher costs, which will be ultimately borne by investors, are merely inconvenient details.”

As Gensler explained, under the current Names Rule, “if a registered investment company’s name suggests it has a focus in particular investment types, industries, or geographies, or that it has tax-exempt status, the fund must adopt a policy to invest at least 80% of the value of its assets consistent with its name.”

Changes under the new rule include:

• Applying the rule’s 80% investment policy requirement to any fund name with terms suggesting that the fund focuses on investments that have, or investments whose issuers have, particular characteristics. The primary types of names that the amended rule is anticipated to cover include fund names with terms such as “growth” or “value” or certain terms that reference a thematic investment focus, including terms indicating that the fund’s investment decisions incorporate one or more environmental, social or governance factors.
• Broadening the scope of applicability of the Names Rule, including its 80% requirement. The updated rule will apply not only to funds whose names suggest a focus in particular investments, industries or geographies, but also to funds whose names suggest a focus in investments with particular characteristics.
• Requiring funds that drift from the 80% requirement to come back into compliance in a timely manner — in most cases, within 90 days.
• Requiring a fund to disclose how it defines the terms in its name and selects investments in line with its name.
• Requiring a fund to indicate on periodic reports which holdings count toward the 80% requirement.
• Addressing how funds account for any use of derivatives. Funds will be required to use the notional amount of derivatives, rather than the market value, for determining compliance with the 80% requirement.

SEC Commissioner Mark Uyeda, a Republican, dissented.

Uyeda stated that with the expansion of the fund names rule “to approximately 82% of funds — an estimate likely on the conservative side — funds likely will face significant initial and ongoing costs complying with the amendments, including those relating to prospectus disclosure, notifying shareholders, and complying with new Form N-PORT and recordkeeping requirements.”

Specifically, Uyeda said that under the amended Form N-PORT requirements, funds must report:

• Whether each investment in the fund’s portfolio is in the fund’s 80% basket;
• The value of the fund’s 80% basket, as a percentage of fund assets; and
• The definitions of the terms used in its name — a new requirement that was not proposed for public comment.

Stephen Hall, legal director for Better Markets, a group that supports increased market regulation, said in another statement that the SEC’s names rule “will help prevent funds from misleading investors with baseless if not false claims about ESG, climate, and sustainability,” calling the changes a “long overdue modernization” of the Names Rule as investors seek to invest in mutual funds and ETFs that focus on ESG and sustainability.

Better Markets, Hall said, applauds the SEC for adopting “a strong final rule. It will benefit all investors, while also resisting the often baseless arguments by the funds that seek to greenwash their investment products by including terms such as ‘ESG’ and ‘Sustainable’ in their names to attract investors, without changing the investment policy of the fund.”