What's In an (Investment Company) Name?

Posted by Lori Ehleben on Jun 30, 2022 12:15:00 PM

The Securities and Exchange Commission has long enforced consistency between the name and strategy of a regulated investment company.

The original “Names Rule,” Rule 35d-1 of the Investment Company Act of 1940, was issued in 2001 and was intended to help ensure a fund’s name does not misrepresent the fund’s investments and risks to investors. It generally requires that if a fund’s name suggests a focus in a particular investment type, industry or geographic region, the fund must adopt a policy to invest at least 80% of its assets accordingly. Similarly, if the fund’s name suggests that its distributions are tax-exempt, for example, the investment policy must adhere to this claim.

Since the implementation of the 2001 rule, there have been vast changes to fund types and investment strategies, and gaps have been noted between the requirements of the original rule and current market trends. Advisors managing funds with names suggesting a particular investment focus, such as in ESG or similar terminology, cybersecurity, blockchain, or even funds that mirror the performance of a particular index, may have believed that their funds were outside the scope of the original rule. Untitled design (25)

A rule revision proposed in May 2022 clarifies and modernizes the scope of the original rule and now requires more funds to adopt a policy to invest at least 80% of their assets in accordance with the investment strategy the fund name suggests. The revised rule also requires the implementation of additional recordkeeping and disclosure requirements.

In addition, the proposed rule amendments include other directives to enhance investor protections, including:

In addition, the proposed rule amendments include other directives to enhance investor protections, including:

  • A requirement to address the circumstances under which a fund may depart from its 80% investment policy and parameters for getting back into compliance
  • A requirement to use derivatives’ notional amounts rather than market value for compliance with the 80% investment policy
  • A requirement for unlisted closed-end funds and business development companies to make the 80% investment policy a fundamental policy, that thereby could not be changed without a shareholder vote
  • A requirement for a fund to define the terms used in its name
  • A requirement to avoid using misleading ESG terminology when the ESG factors are not significant
  • Modernization of the notice requirement for a change in the 80% investment policy to allow electronic delivery
  • A new reporting item on fund name compliance in Form N-Port filings
  • A recordkeeping requirement for a fund to maintain records that would support compliance with the 80% investment policy

The SEC is currently accepting comments through July 2022 on the proposed amendments.

Bottom Line:

During our audits of regulated investment companies, BBD has come across various SEC comment letters that address aligning fund names with fund investment strategies and are not too surprised that the SEC is concentrating on updating the “Names Rule” to better include current investment focuses and strategies.

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