SEC Proposes Significant Amendments To The Fund Names Rule – Commodities/Derivatives/Stock Exchanges
On May 25, 2022, the U.S. Securities and Exchange Commission
(SEC) proposed significant amendments seeking to enhance Rule 35d-1
under the Investment Company Act of 1940 (the 1940 Act), the
“Names Rule” governing registered fund names. A summary
of various components of the sweeping proposals follows.
Expansion of Fund Names Requiring 80% Investment Policy
The proposed amendments would expand the types of names that are
subject to the Names Rule’s requirements for adopting an 80%
investment policy to also include names suggesting a focus in
investments or issuers that have particular characteristics, in
addition to fund names currently subject to an 80% investment
policy. Thus, registered funds whose names suggest a focus in a
particular type of investment characteristic or style (e.g.,
“global,” “income,” “intermediate
(term),” “growth,” “value”) or that
reflect use of environmental, social and governance (ESG) factors
(e.g., “ESG,” “social,” “green,”
“sustainable”) would be required to adopt a policy to
invest at least 80% of the value of their assets in those
investments. Currently, these names are not specifically covered by
the Names Rule, and 80% investment policies may not be
required.
The SEC clarified in the proposing release that names that
reference characteristics of the fund’s portfolio as a whole or
that reference elements of an investment thesis without specificity
as to particular characteristics of the portfolio components (such
as “balanced” and “long/short”) would continue
to not be subject to an 80% investment policy.
The proposing release further clarified that, where a fund’s
name suggests an investment focus with multiple elements, the 80%
investment policy must address all elements in the name, whether by
noting that each security in the 80% basket must represent all the
elements noted in the name or by noting that the basket will be
invested as a mix of investments that contain one or more of the
named elements. A fund would be permitted to take a reasonableness
approach in specifying how the fund’s investments will
incorporate each element of a multielement name.
The proposed amendments would also add a provision that a
fund’s name may still be considered materially deceptive or
misleading under the 1940 Act notwithstanding the adoption of a
compliant 80% investment policy. Included as examples of
circumstances where a fund’s name may be materially deceptive
or misleading notwithstanding an 80% investment policy are
scenarios where a fund makes substantial investments in assets that
are antithetical to the fund’s investment focus or a fund
invests in a manner where the source of a substantial portion of
the fund’s risk/return profile is different than what would
reasonably be expected based on the fund name.
Temporary Departures From 80% Investment Policy
The proposed amendments further provide guidelines for when a
fund is permitted to temporarily depart from the 80% investment
policy. Under the proposed amended rule, temporary departures would
be permitted only (i) as a result of market fluctuations or other
circumstances where the temporary departure is not caused by the
fund’s purchase or sale of a security or the fund’s
entering into or exiting an investment, (ii) to address unusually
large cash inflows or redemptions, (iii) to take a position in cash
and cash equivalents or government securities to avoid a loss in
response to adverse market, economic, political or other
conditions, (iv) to reposition or liquidate a fund’s assets in
connection with a reorganization or following provision of notice
of a change in the 80% investment policy to shareholders, or (v)
when constructing the portfolio upon a fund’s launch. The
proposing release indicates that in the event of a fund launch, the
temporary departure may not exceed 180 consecutive days, and in the
event of an 80% investment policy change, such departure may not
exceed 60 consecutive days. For all other scenarios, the temporary
departure may not last for more than 30 consecutive days (and in
each case may not last longer than reasonably practicable). This
proposed change would replace the “under normal
circumstances” standard currently existing in the Names
Rule.
Use of Derivatives in Assessing Names Rule Compliance
The proposed amendments seek to address both the valuation of
derivatives instruments for purposes of determining compliance with
an 80% investment policy and the derivatives that a fund may
include in its 80% basket. In calculating assets for purposes of
Names Rule compliance, a fund would be required to value each
derivatives instrument using its notional amount (with certain
adjustments) and reduce the value of its assets by excluding cash
and cash equivalents up to the notional amounts of the derivatives
instruments. The proposed amendments further specify that, in
addition to any derivatives investment that a fund includes in its
80% basket, because such instrument provides investment exposure to
the investments suggested by the fund’s name, the fund may also
include in its 80% basket an instrument that provides investment
exposure to one or more of the market risk factors associated with
the investments suggested by the fund’s name.
Unlisted Closed-End Funds and BDCs
The proposed amendments would require that a fund’s 80%
investment policy always be a fundamental investment policy if the
fund is a registered closed-end investment company or BDC that does
not have shares that are listed on a national securities exchange.
As a result, such funds would not be permitted to change their 80%
investment policy without shareholder approval and would no longer
have the ability to change their 80% investment policy through the
use of a 60-day advance notice to shareholders.
Materially Deceptive and Misleading Use of ESG Terminology
The proposed amendments further address what the SEC refers to
as ESG “integration funds.” The proposed amendments would
define the names of integration funds as materially misleading if
the name includes terms suggesting that the fund’s investment
decisions incorporate one or more ESG factors but such factors are
generally no more significant than other factors in the investment
selection process, such that the ESG factors may not be
determinative in deciding to include or exclude any particular
investment in the portfolio. This definition would extend to any
funds using names including ESG-related terms, such as
“sustainable.”
Modernization of Notice
The proposed amendments would require notices to describe both a
change in the fund’s 80% investment policy and any changes to
fund names that accompany investment policy changes. The proposed
amendments would allow such notices to be delivered electronically
and would require such notices to be separate from any other
document published by the fund.
Changes to Form N-PORT
The proposing release also indicates an amendment to Form N-PORT
to include a new reporting item regarding a fund’s 80%
investment policy, which would require such funds to report the
value of the fund’s 80% basket as a percentage of the value of
the fund’s assets and, if applicable, the number of days that
the value of the fund’s 80% basket fell below 80% of the
fund’s assets during the reporting period. A further reporting
item is proposed to be added to Form N-PORT; that item would
require each portfolio investment to be designated as included or
excluded from the fund’s 80% basket.
* * *
The SEC has indicated that, if the proposed amendments are
adopted, they may be accompanied by withdrawal of certain no-action
letters and staff statements regarding compliance with the Names
Rule. It has indicated that any adoption of the proposed amendments
would be accompanied by a one-year transition period to provide
funds time to come into compliance with the proposed
amendments.
Comments on the proposal are due within 60 days of the
publication of the proposed amendments in the Federal
Register.
For the full SEC release regarding the proposed amendments, see
here.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
