Key updates from the SEC’s expansion of the Fund Names Rule

The SEC has strengthened the Names Rule, requiring funds to align with an 80% investment policy to combat greenwashing.
The expanded scope includes thematic focuses and ESG factors.
Find out more on how to navigate the recent updates and how they may affect your business.


The United States Securities and Exchange Commission (SEC) has recently strengthened the
Investment Company Act’s “Names Rule”, aiming to address concerns about misleading fund names and enhance transparency for investors. The amendments, implemented on 20 September 2023, are designed to ensure that investment funds accurately represent their strategies through their names. Specifically targeting issues related to greenwashing, the SEC’s final regulation is intended to combat deceptive practices in fund naming. This article explores the key aspects of the expanded rule, including expanded investment policies, increased transparency, and penalties for non-compliance, highlighting a broader industry move towards sustainability and how Position Green can help you navigate these changes.

 

Overview of the updates to the Fund Names Rule

The SEC has broadened the scope of the Names Rule, mandating that a fund must embrace an 80% investment policy if its name implies a focus in investments that have, or whose issuers have, particular characteristics. The SEC’s motivation behind the amendments is to align a fund’s investment portfolio more closely with its advertised focus, emphasizing transparency and consistency. Terminology that may be especially powerful in fund names to attract investors is particularly targeted with these amendments. The updates represent a significant modernization of the Names Rule, addressing developments in the fund industry over the past two decades and furthering the SEC’s goals of investor protection.

 

Reasoning behind the amendments

The SEC’s recent amendments to the Fund Names Rule signify a response to critical gaps that could undermine investor protection. The primary motivation behind the update is the prevalence of greenwashing, where funds falsely claim to have a sustainability or ESG focus without aligning their investments accordingly. The amendments aim to enhance transparency, prevent misleading fund names, and ensure that a fund’s portfolio genuinely reflects its stated ESG and sustainability strategies. By expanding the rule’s scope and disclosure requirements, the SEC intends to combat deceptive practices in the financial market. This regulatory shift is not only a response to the increasing number of investment funds but also aligns with the growing global emphasis on responsible investing and the need to address misleading advertising related to ESG issues such as greenwashing.

 

Who does it apply to and when will they be expected to comply?

This expanded rule is expected to cover 76% of funds, up from the previous 60%. The enhanced rule applies to both existing funds and those established after the amendments come into effect. Existing funds are obligated to undergo reviews and align their portfolios to ensure that their names accurately reflect their commitment to responsible investing. The amendments to the Names Rule became effective on 11 December 2023 with compliance deadlines for the amended fund names rule contingent on the size of the funds.

Compliance deadlines:

  • Funds with net assets >$1 billion: 24 Months
  • Funds with net assets <$1 billion: 30 Months
  • New funds: 180 days

 

Key updates:

1. Expansion of the 80 percent investment policy requirement

The rule previously targeted registered investment companies with names indicating a specific type of investment focus. The rule now extends its reach to encompass funds with names implying a focus on specific characteristics like “growth”, “value” or “artificial intelligence” and additionally, to thematic investment focuses incorporating environmental, social, or governance (ESG) factors. This expansion means that funds with names suggesting particular investments, industries, or geographies and those indicating characteristics or thematic focuses will have to comply with the 80% investment policy. This policy requires funds to invest at least 80% of their respective assets in alignment with how they are advertised and named.

2. Quarterly portfolio reviews

To enhance the integrity of fund portfolios, the amendments introduce a crucial element: a mandatory review of portfolio assets under the 80% investment policy at least quarterly. This periodic assessment ensures ongoing compliance with the rule, allowing funds to promptly address any deviations from the specified requirements. The amendments also reinforce regulatory oversight by introducing additional reporting and record keeping requirements for funds, promoting transparency and accountability within the fund industry.

3. Compliance within 90 days

Under the SEC’s final rule, funds found to be misaligned with the 80% investment policy have a grace period of 90 days to rectify the deviation. This adjustment, a modification from the original proposal issued in May 2022, reflects considerations raised by fund managers who expressed concerns about a 30-day compliance timeframe. The extended 90-day period allows for temporary departures from 80% investment policy requirement and offers funds a more measured approach to realign their portfolios and meet the specified requirements, mitigating potential market disruptions, provided the fund comes into compliance within 90 days.

4. Plain-English and industry standard terminology and definition use

The amendments to the fund names rule bring changes to terminology and definitions. The updated rule grants investment companies flexibility in defining terms used in their fund names and criteria for investment selection. However, there is an emphasis on ensuring that these terms align with plain-English meanings or established industry use, particularly in the context of any ESG terms.

5. Notional amount derivatives

The amended Names Rule stipulates that, in calculating compliance with the 80% investment policy, a fund must value each derivative instrument in its portfolio using its notional amount, rather than the market value of the derivative. Specific rules apply to certain derivatives and more information can be found in the final rule.

 

Penalties for non-compliance

Violations are identified through the quarterly portfolio reviews and failure to meet the 80% investment threshold within the specified timeframe can lead to penalties. This underscores the significance of adhering to the fund names rule and genuine advertisement of sustainability and ESG-focused funds. The SEC’s recent $19 million penalty against DWS Investment Management Americas illustrates the regulatory commitment to ensuring accuracy in ESG investment processes.

 

How can Position Green help?

At Position Green, we help you make sense of the evolving ESG regulatory landscape. Our sustainability management software and built-in finance expertise supports general partners during the entire investment cycle – from screening new investment opportunities and conducting ESG due diligence for potential investments to monitoring their portfolio while invested.

Talk to one of our experts to find out how you can unlock equity value with ESG.

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