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Investment Company Names rule (2023)

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TheInvestment Company Names rule was issued by theSecurities and Exchange Commission (SEC) effective December 11, 2023. It added terms includingenvironmental, social, and corporate governance (ESG) to the list subject to the 80% rule, which refers to the requirement that security funds with terminology in their names that imply certain specifications invest at least 80% of their assets accordingly.[1]

HIGHLIGHTS
  • Name: Investment Company Names
  • Code of Federal Regulations: 17 CFR Parts 230, 232, 239, 270 and 274
  • Agency: Securities and Exchange Commission
  • Action:Final rule

    • Timeline

    The following timeline details key rulemaking activity:

    Background

    Environmental, social, and corporate governance
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    •What is ESG?
    •    Enacted ESG legislation
    •Arguments for and against ESG
    •Opposition to ESG
    •Federal ESG rules
    •ESG legislation tracker
    •Economy and Society: Ballotpedia's weekly ESG newsletter
    See also:Environmental, social, and corporate governance (ESG)

    The SEC prohibits materially deceptive or misleading words in security fund names. The SEC adopted rule 35d-1 –also known as the names rule– in 2001 pursuant to its rulemaking authority under the Investment Company Act of 1940. This rule requires a fund with terms in its name suggesting a specific type of investment, a particular industry, or a geographic focus to allocate at least 80% of the value of its assets to match that focus.[1]

    The Investment Company Names rule amends rule 35d-1 to incorporate a broader scope of terms.[1]

    Summary of the rule

    The following is a summary of the rule from the rule's entry in theFederal Register:[1]

    “The Securities and Exchange Commission (“Commission”) is amending the rule under the Investment Company Act of 1940 (“Investment Company Act” or “Act”) that addresses certain broad categories of investment company names that are likely to mislead investors about an investment company's investments and risks. The amendments to this rule are designed to increase investor protection by improving, and broadening the scope of, the requirement for certain funds to adopt a policy to invest at least 80 percent of the value of their assets in accordance with the investment focus that the fund's name suggests, updating the rule's notice requirements, and establishing recordkeeping requirements.[4]”

    Summary of provisions

    The Investment Company Names rule included provisions expanding the list of terms that would subject a fund to the 80% investment policy rule if included in a security fund's name. The expanded scope of terms includes growth, value, andenvironmental, social, and corporate governance (ESG). The following is a summary of this and other provisions from the final rule's entry in theFederal Register:[1]

    “We are adopting amendments to the names rule, as well as related disclosure and reporting requirements, in consideration of the issues discussed above.
    • Expansion of Scope. We are adopting, substantially as proposed, amendments to the names rule that expand the rule's 80% investment policy requirement beyond its current scope, to apply to any fund name with terms suggesting that the fund focuses in investments that have, or investments whose issuers have, particular characteristics. This coverage will include, for example, fund names with terms such as “growth” or “value,” or terms indicating that the fund's investment decisions incorporate one or more ESG factors. These names will be added to the names that are currently within the scope of the 80% investment policy requirement—that is, generally, fund names that suggest a focus in a particular type of investment, or investments in a particular industry or geographic focus, and fund names suggesting that a fund's distributions are tax-exempt.
    • Temporary Departures from the 80% Investment Requirement. In a change from the proposal, under which funds would have been permitted to depart from the fund's 80% investment policy only under certain specified circumstances, the final amendments retain the names rule's current requirements for a fund to invest in accordance with its 80% investment policy “under normal circumstances” (the “80% investment requirement”), and for the 80% investment requirement to apply at the time a fund invests its assets. Also, in a change from the proposal, the final amendments add a new provision that requires a fund to review its portfolio assets' inclusion in its “80% basket” at least quarterly. Like the proposal, the final amendments include specific time frames—generally 90 days, as opposed to 30 days as proposed—for getting back into compliance if a fund departs from the 80% requirement as a result of drift or in other-than-normal circumstances.
    • Derivatives. Consistent with the proposal, the final amendments generally require funds to use a derivatives instrument's notional amount to determine the fund's compliance with its 80% investment policy, with certain adjustments. In a change from the proposal, the final amendments include a limited modification to this approach that would exclude certain currency hedges from the names rule compliance calculation. As proposed, we are also amending the names rule to address the derivatives instruments that a fund may include in its 80% basket.
    • Unlisted Registered Closed-End Funds and BDCs. Consistent with the proposal, the final amendments generally prohibit an unlisted registered closed-end fund or BDC that is required to adopt an 80% investment policy from changing that policy without a shareholder vote. In a modification from the proposal, the final amendments permit these funds to change their 80% investment policies without such a vote if: (1) the fund conducts a tender or repurchase offer with at least 60 days' prior notice of the policy change, (2) that offer is not oversubscribed, and (3) the fund purchases shares at their net asset value.[49]
    • Enhanced Prospectus Disclosure. Substantially as proposed, we are adopting amendments to funds' prospectus disclosure requirements that will require a fund to define the terms used in its name, including the criteria the fund uses to select the investments that the term describes.
    • Plain English Requirements for Terms Used in Fund Names. The final amendments to the names rule, as proposed, effectively require that any terms used in the fund's name that suggest either an investment focus, or that the fund's distributions are tax-exempt, must be consistent with those terms' plain English meaning or established industry use.
    • Form N-PORT Reporting Requirements. Consistent with the proposal, we are adopting amendments to Form N-PORT for funds to report the value of the fund's 80% basket, and whether an investment is included in the fund's 80% basket. In a change from the proposal, the final amendments also include a new reporting item to include the definition(s) of terms used in the fund's name. Funds will have to report this information for the third month of every quarter, instead of for each month as proposed.
    • Recordkeeping. Consistent with the proposal (but with conforming changes to address the final rules' approach to temporary departures from the 80% investment requirement), the final rules include recordkeeping provisions related to a fund's compliance with the rule's requirements. The final rules do not, however, include the proposed requirement for funds that do not adopt an 80% investment policy to maintain a record of their analysis that such a policy is not required.[4]
    		”

    Text of the rule

    The full text of the rule is available below:[1]

    Responses

    The following sections provide a selection of responses to the final rule issued by the DOL:

    Support for the rule

    SEC Chair Gary Gensler (D) stated that the new rule adjusted for gaps that had emerged since the original names rule was created in the SEC's press release about the Investment Company Names rule:[2]

    “As the fund industry has developed over the last two decades, gaps in the current Names Rule may undermine investor protection. Today’s final rules will help ensure that a fund’s portfolio aligns with a fund’s name. Such truth in advertising promotes fund integrity on behalf of fund investors.[4]”

    Opposition to the rule

    SEC Commissioner Hester M. Peirce (R) commented that the rule was redundant and unnecessary:[5]

    “We can bring, and already have brought, greenwashing cases using existing rules, so why is additional rulemaking necessary? Should our focus instead be on identifying where there may be gaps in Commission rules and tailor[ing] any new rulemaking accordingly, rather than producing a new rule that is arguably redundant?[4]”


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