What’s in a name? SEC Proposes Amendment to Investment Company Names Rule | Kilpatrick Townsend & Stockton LLP

On May 25, 2022, the Securities and Exchange Commission (“SEC“) announced the proposed amendments (“Proposal“) to Rule 35d-1 under the Investment Company Act of 1940 (“Name rule”), aimed at modernizing the Names Rule for Today’s Markets and preventing misleading or deceptive names of registered investment companies and business development companies (collectively, “Funds“).[1]

Originally adopted by the SEC in 2001, the Names Rule establishes requirements designed to ensure that a fund’s name does not misrepresent the fund’s investments and risks.[2] The name rule, in its current form, prohibits a registered investment company from including as part of its name any title or word that the SEC considers to be materially deceptive or misleading.[3] In addition, the Names Rule currently requires a fund whose name implies a focus on a particular type of investment, industry or geographic region to adopt policies to invest at least 80% of the value of its assets in those investments, industries or regions.[4] However, the SEC believes that the Names Rule should be updated to address certain problems with the interpretation of the current rule and to modernize the Names Rule to today’s markets.[5]

Some of the key elements of the proposal are described below:

Expanding the scope

The proposal, if adopted, would expand the name rule to apply to any fund name containing a term that suggests the fund focuses on investments or issuers that have specific characteristics. Specifically, and marking a change from the current name rule, the proposal would extend the 80% investment policy requirement to fund names that include terms such as “growth”, “value”, “international”, “income” and “global” – any of which would normally be interpreted as outside the scope of this naming rule.[6]

ESG Fund Names

The proposal also addresses the use of ESG and ESG-related fund names, in particular including fund names containing terms indicating that a fund’s investment decisions include one or more ESG factors (e.g. “socially responsible investing” , “sustainable”, “green”, “ethical”, “impact”, etc.) as being within the scope of the 80% investment policy requirement.[7] The proposal further provides that fund names that indicate that the fund’s investment philosophy includes multiple factors must adopt a policy that addresses everyone element in the name of the fund. For example, a fund with “ESG” in its name will need to adopt an 80% investment policy that addresses the E (environmental), S (social) and G (governance) elements of its name.[8] The proposal also states that the use of ESG or an ESG-related name would be considered materially deceptive and misleading for funds where ESG considerations do not play a central role in the fund’s strategy, but are simply considered alongside other factors that do not are ESG.[9]

Temporary deviations from the fund’s 80% investment policy

The Names Rule currently requires funds to adhere to an 80% investment policy “under normal circumstances”, which allows flexibility to deviate from the policy under certain market conditions or other circumstances. [10] However, the proposal would limit temporary deviations from the Fund’s 80% investment policy to four specified circumstances: (1) as a result of market fluctuations or other circumstances where the temporary deviation is not caused by the Fund’s purchase or sale of a security or entry or exit; from an investment of the Fund; (2) to deal with unusually large cash flows or unusually large redemptions; (3) take a position in cash and cash equivalents or government securities to avoid loss in response to adverse market, economic, political or other conditions; or (4) to reposition or liquidate assets of a Fund in connection with a reorganization, start-up of the Fund or when notice of a change in the 80% investment policy of the Fund is provided to the shareholders of the Fund at least 60 days before the change. [11] In any of these circumstances, a fund that deviates from its 80% investment policy will be required to return to compliance with its policy as soon as reasonably practicable, but no later than 30 consecutive days after the deviation from its policy (unless in the case of reorganization or fund launch).[12]

Derivation considerations when evaluating naming convention compliance

The proposal would clarify the treatment of derivatives under the names rule. Under the proposal, for purposes of complying with the name rule (and applying the 80% test), a fund must value each derivative instrument using its notional value rather than its market value.[13] In addition, the fund would reduce the value of its assets by excluding cash and cash equivalents to the notional values ​​of the derivative instrument(s).[14]

Under the current name rule, a fund may include derivative instruments in the fund’s 80% basket if the instrument has economic characteristics similar to the securities included in the 80% basket.[15] Pursuant to the Proposal, however, the fund may include in its basket of 80% both: (i) derivative instruments that provide investment exposure to the investments offered on behalf of the fund; and (ii) derivative instruments that provide exposure to one or more of the market risk factors associated with the investments offered on behalf of the Fund.[16]

Unlisted closed-end funds and BDCs

The proposal requires an 80% investment policy to be the primary policy for unlisted closed-end funds and business development companies (“BDCs”) whose shares are not listed on a national securities exchange.[17] As a result, an unlisted closed-end fund or BDC cannot change its 80% investment policy without shareholder approval.[18]

Enhanced Prospectus Disclosure

The proposal will require changes to the fund registration forms (i.eForm N-1A, Form N-2, Form N-8B-2 and Form S-6), which would require the Fund to include disclosures in its prospectus that define the “terms” used in its name, including the specific criteria the Fund uses , to select the investments that the “term” describes.[19] For purposes of the offering, “terms” will mean any word or phrase used in the fund’s name related to the fund’s investment focus or strategies.[20] Likewise, the proposal would require any “terms” used in a fund’s name that imply either an investment focus or that such fund is a tax-exempt fund to be consistent with the plain English meaning of the “term” or established industry usage .[21]

If adopted as proposed, a one-year transition period would run from the date of publication of all final amendments to the Names Rule in the Federal Register, allowing funds time to comply with any new requirements.

[2] look 47 CFR § 270.35d-1 (2001).

[4] Proposition 8. The 80% investment policy is not a safe harbor for materially deceptive or misleading names and “a name that would lead a reasonable investor to conclude that the fund is investing in a manner that is inconsistent with the fund’s actual or intended investments or risks these investments would be fraudulent or misleading even if the fund were consistent with its 80 [percent] investment policy.” ID. on the 11th.

[5] look Proposal at 6, 13.

[6] look Motion at 23-24.

[7] look Proposal at 14, 18.

[11] Motion at 33–34.

[12] The proposal provides exceptions to this 30-day compliance window in the case of fund launches (180 consecutive days), reorganizations (no time frame specified) or when the 60-day notice is provided to shareholders. look Proposal of 34.