Proposed Rule2022-11742
Investment Company Names
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
June 17, 2022
Issuing agencies
Securities and Exchange Commission
Abstract
The Securities and Exchange Commission (the "Commission") is proposing to amend the rule under the Investment Company Act of 1940 (the "Investment Company Act" or the "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 proposed amendments to this rule are designed to increase investor protection by improving and clarifying the requirement for certain funds to adopt a policy to invest at least 80% 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. The Commission also is proposing enhanced prospectus disclosure requirements for terminology used in fund names, and additional requirements for funds to report information on Form N-PORT regarding compliance with the proposed names-related regulatory requirements.
Full Text
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[Federal Register Volume 87, Number 117 (Friday, June 17, 2022)]
[Proposed Rules]
[Pages 36594-36651]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2022-11742]
[[Page 36593]]
Vol. 87
Friday,
No. 117
June 17, 2022
Part II
Securities and Exchange Commission
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17 CFR Parts 230, 232, 239, et al.
Investment Company Names; Proposed Rule
Federal Register / Vol. 87, No. 117 / Friday, June 17, 2022 /
Proposed Rules
[[Page 36594]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 230, 232, 239, 270 and 274
[Release No. 33-11067; 34-94981; IC-34593; File No. S7-16-22]
RIN 3235-AM72
Investment Company Names
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Securities and Exchange Commission (the ``Commission'') is
proposing to amend the rule under the Investment Company Act of 1940
(the ``Investment Company Act'' or the ``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
proposed amendments to this rule are designed to increase investor
protection by improving and clarifying the requirement for certain
funds to adopt a policy to invest at least 80% 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. The Commission also is proposing enhanced prospectus
disclosure requirements for terminology used in fund names, and
additional requirements for funds to report information on Form N-PORT
regarding compliance with the proposed names-related regulatory
requirements.
DATES: Comments should be received on or before August 16, 2022.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
<bullet> Use the Commission's internet comment form (<a href="https://www.sec.gov/rules/submitcomments.htm">https://www.sec.gov/rules/submitcomments.htm</a>); or
<bullet> Send an email to <a href="/cdn-cgi/l/email-protection#6614130a034b05090b0b030812152615030548010910"><span class="__cf_email__" data-cfemail="394b4c555c145a5654545c574d4a794a5c5a175e564f">[email protected]</span></a>. Please include
File Number S7-16-22 on the subject line;
Paper Comments
<bullet> Send paper comments to Vanessa A. Countryman, Secretary,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549-1090.
All submissions should refer to File Number S7-16-22. This file number
should be included on the subject line if email is used. To help the
Commission process and review your comments more efficiently, please
use only one method. The Commission will post all comments on the
Commission's website (<a href="http://www.sec.gov/rules/proposed.shtml">http://www.sec.gov/rules/proposed.shtml</a>).
Comments are also available for website viewing and printing in the
Commission's Public Reference Room, 100 F Street NE, Washington, DC
20549, on official business days between the hours of 10 a.m. and 3
p.m. Operating conditions may limit access to the Commission's public
reference room. All comments received will be posted without change.
Persons submitting comments are cautioned that we do not redact or edit
personal identifying information from comment submissions. You should
submit only information that you wish to make available publicly.
Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any such materials
will be made available on the Commission's website. To ensure direct
electronic receipt of such notifications, sign up through the ``Stay
Connected'' option at <a href="http://www.sec.gov">www.sec.gov</a> to receive notifications by email.
FOR FURTHER INFORMATION CONTACT: Pamela Ellis, Mykaila DeLesDernier,
Bradley Gude, Senior Counsels; Amanda Hollander Wagner, Branch Chief;
or Brian McLaughlin Johnson, Assistant Director, at (202) 551-6792,
Investment Company Regulation Office, Division of Investment
Management, Securities and Exchange Commission, 100 F Street NE,
Washington, DC 20549-8549.
SUPPLEMENTARY INFORMATION: The Commission is proposing for public
comment: amendments to 17 CFR 270.35d-1 (``rule 35d-1'') under the
Investment Company Act; amendments to Form N-1A [referenced in 17 CFR
239.15A and 17 CFR 274.11A], Form N-2 [referenced in 17 CFR 239.13 and
17 CFR 274.11a-1], Form N-8B-2 [referenced in 17 CFR 274.12], and Form
S-6 [referenced in 17 CFR 239.16] under the Investment Company Act and
the Securities Act of 1933 (``Securities Act'') [15 U.S.C. 77a et
seq.]; amendments to Form N-PORT [referenced in 17 CFR 274.150] under
the Investment Company Act; amendments to 17 CFR 232.11 (``rule 11 of
Regulation S-T'') and 17 CFR 232.405 (``rule 405 of Regulation S-T'')
under the Securities Exchange Act of 1934 (``Exchange Act'') [15 U.S.C.
78a et seq.]; amendments to 17 CFR 230.485 (``rule 485'') under the
Securities Act; and amendments to 17 CFR 230.497 (``rule 497'') under
the Securities Act.
Table of Contents
I. Introduction and Background
A. Overview of Section 35(d) of the Act and the Names Rule
B. Challenges Regarding Application of the Names Rule and Need
for Modernization
C. Overview of Rule Proposal
II. Discussion
A. 80% Investment Policy Requirement
1. Names Suggesting an Investment Focus
2. Temporary Departures From the 80% Investment Requirement
3. Considerations Regarding Derivatives in Assessing Names Rule
Compliance
4. Unlisted Closed-End Funds and BDCs
5. Effect of Compliance With an 80% Investment Policy
B. Prospectus Disclosure Defining Terms Used in Fund Name
C. Plain English/Established Industry Use Requirement
D. Materially Deceptive and Misleading Use of ESG Terminology in
Certain Fund Names
E. Modernizing the Rule's Notice Requirement
F. N-PORT Reports
1. Investment Company Act Names Rule Investment Policy
2. Investments To Be Included in a Fund's 80% Basket
G. Recordkeeping
1. Funds Required To Adopt an 80% Investment Policy
2. Funds That Do Not Adopt an 80% Investment Policy
H. Unit Investment Trusts
I. Transition Period and Compliance Date
III. Economic Analysis
A. Introduction
B. Broad Economic Considerations
C. Economic Baseline
1. Fund Industry Overview
D. Benefits, Costs, and Effects on Efficiency, Competition and
Capital Formation
1. Benefits
2. Costs
E. Reasonable Alternatives Considered
1. Returns-Based Requirement
2. Permit the Use of Derivatives' Notional Values for Purposes
of Names Rule Compliance
3. Modify Requirements for Tagging Prospectus Disclosure
4. Board Approval or Notification of Temporary Departures
5. Require a Higher Percentage of Assets Invested in Accordance
With the Investment Focus
6. Unlisted Closed-End Funds and BDCs
F. General Request for Comment
IV. Paperwork Reduction Act Analysis
A. Introduction
B. Rule 35d-1
C. Prospectus Disclosure
1. Form N-1A
2. Form N-2
3. Form N-8B-2
4. Form S-6
D. N-PORT Reporting Requirements
E. Investment Company Interactive Data
F. Request for Comments
V. Initial Regulatory Flexibility Analysis
A. Reasons for and Objectives of the Proposed Actions
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B. Legal Basis
C. Small Entities Subject to Proposed Rule Amendments
D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
1. 80% Investment Policy Requirements--Proposed Scope Expansion
and Other Proposed Amendments
2. Effect of Compliance With an 80% Investment Policy
3. Recordkeeping Requirements
4. Disclosure and Reporting Requirements
5. Materially Deceptive and Misleading Use of ESG Terminology in
Certain Fund Names
6. Exceptions for Certain UITs
E. Duplicative, Overlapping, or Conflicting Federal Rules
F. Significant Alternatives
G. Request for Comment
VI. Consideration of Impact on the Economy
VII. Statutory Authority
I. Introduction and Background
The name of a registered investment company or business development
company (``BDC'') is a means of communicating information about the
fund to investors and is also an important marketing tool for the
fund.\1\ While the Commission has often cautioned against investors
relying on a fund's name as the sole source of information about the
fund's investments and risks, it has also recognized that the name of a
fund may communicate a great deal to an investor.\2\ A fund's name is
often the first piece of fund information investors see and, while
investors should go beyond the name itself and look closely at a fund's
underlying disclosures, a fund's name can have a significant impact on
their investment decisions. These considerations provided the policy
basis underlying the Commission's adoption of rule 35d-1 under the Act,
the ``names rule,'' in 2001.\3\
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\1\ This release refers to registered investment companies and
BDCs collectively as ``funds.''
\2\ See Investment Company Names, Investment Company Act Release
No. 24828 (Jan. 17, 2001) [66 FR 8509 (Feb. 1, 2001)] (``Names Rule
Adopting Release''); see also Request for Comments on Fund Names,
Investment Company Act Release No. 33809 (Mar. 2, 2020) [85 FR 13221
(Mar. 6, 2020)] (``2020 Request for Comment''), at n.11 and
accompanying text. The comment letters on the 2020 Request for
Comment (File No. S7-04-20) are available at <a href="https://www.sec.gov/comments/s7-04-20/s70420.htm">https://www.sec.gov/comments/s7-04-20/s70420.htm</a>. All references to comment letters in
this release are available in this comment file.
\3\ Names Rule Adopting Release, supra footnote 2.
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Congress provided the Commission with rulemaking authority to
address materially deceptive or misleading fund names, recognizing the
concern that investors may rely inordinately on a fund's name to
determine its investments and risks.\4\ The names rule, in turn, helps
ensure that a fund's name does not misrepresent the fund's investments
and risks. Consequently, the rule helps to ensure that investors'
assets in funds are invested in accordance with their reasonable
expectations based on the fund's name.\5\ The role of this rule remains
important and distinct from other disclosure requirements, in that fund
names are subject to the unique practical constraint of being concise
by necessity, but still convey significant information to an investor.
However, as the fund industry has developed, and practices regarding
names rule compliance have continued to evolve over the past two
decades, we believe that improvements to the names rule are appropriate
for the rule to continue to meet this purpose.\6\ For example,
interpretive issues as to when a fund is subject to the names rule have
raised questions about the rule's application with respect to
particular fund names that could mislead investors about the fund's
investment focus, such as when a fund's name suggests investment in
companies that meet certain environmental, social, or governance
(``ESG'') criteria. Competitive market pressures create incentives for
asset managers to include terminology in their funds' names designed to
attract investor assets. We believe it is critical that fund names that
suggest certain information about a fund's investments and attendant
risks do so accurately. Under certain circumstances, the current
structure of the rule also may permit funds to depart from the
investment focus suggested by their name over time, which can deprive
investors of the protections of the rule.
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\4\ See id. at n.3 and accompanying text (``In amending section
35(d), Congress reaffirmed its concern that investors may focus on
an investment company's name to determine the company's investments
and risks, and recognized that investor protection would be improved
by giving the Commission rulemaking authority to address potentially
misleading investment company names.'').
\5\ See id. at text preceding n.48; see also, e.g., Comment
Letter of the CFA Institute (May 5, 2020) (``CFA Institute Comment
Letter''); Comment Letter of Chris Barnard (Mar. 9, 2020) (``Barnard
Comment Letter''); Comment Letter of the University of Miami School
of Law Investor Rights Clinic (Apr. 27, 2020) (``IRC Comment
Letter''). But see ICI Comment Letter I (emphasizing that the
Commission noted when it adopted the names rule that investors
should not rely on a fund's name as the sole source of information
about that fund).
\6\ See Comment Letter of Allianz Global Investors U.S. Holdings
LLC (May 27, 2020) (``AllianzGI Comment Letter''); see also Comment
Letter of the Consumer Federation of America (May 12, 2020) (``CFA
Comment Letter'') (arguing that funds ``clearly understand both how
important fund names can be in communicating and advertising to
investors and that fund names can influence investor decisions,''
and, as a result, funds ``are very careful to choose names that are
appealing to investors'').
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The rule also is not currently well-suited to address ways in which
the fund industry has evolved since its adoption, both in terms of
funds' increasing use of derivatives to further their investment
strategies and investors' increasing election for the electronic
delivery of fund documents, such as prospectuses and shareholder
reports. We are proposing to amend the names rule to address these and
other concerns.
A. Overview of Section 35(d) of the Act and the Names Rule
Section 35(d) of the Act prohibits a registered investment company
from adopting as part of its name or title any word or words that the
Commission finds are materially deceptive or misleading.\7\ This
section of the Act further authorizes the Commission to define such
names or titles as are materially deceptive or misleading. Congress
adopted this provision due to concerns that investors may focus on an
investment company's name to determine the company's investment
objectives and level of risk, and recognized that investor protection
would be improved by giving the Commission rulemaking authority to
address potentially misleading fund names.\8\
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\7\ 15 U.S.C. 80a-34(d). BDCs, which are not registered
investment companies, are subject to the requirements of section
35(d) pursuant to section 59 of the Act [15 U.S.C. 80a-58].
\8\ See S. Rep. No. 293, 104th Cong., 2d Sess. 8-9 (1996).
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The names rule generally requires that if a fund's name suggests a
focus in a particular type of investment (e.g., ABC Stock Fund, the XYZ
Bond Fund, or the QRS U.S. Government Fund), or in investments in a
particular industry (e.g., the ABC Utilities Fund or the XYZ Health
Care Fund), or geographic focus (e.g., the ABC Japan Fund or XYZ Latin
America Fund), the fund must adopt a policy to invest at least 80% of
the value of its assets in the type of investment, or in investments in
the industry, country, or geographic region, suggested by its name.\9\
The names rule imposes a similar 80% investment policy requirement for
funds that have names suggesting that a fund's distributions are exempt
from federal income tax or from both federal and state income tax
(``tax-exempt funds'').\10\ Under the rule, a
[[Page 36596]]
fund may generally elect to make its 80% investment policy a
fundamental policy (i.e., a policy that may not be changed without
shareholder approval) or instead provide shareholders notice at least
60 days prior to any change in the 80% investment policy.\11\ However,
an 80% investment policy relating to a tax-exempt fund name must be a
fundamental policy. Further, unit investment trusts (``UITs'') that
have made their initial deposit prior to July 31, 2002 are not required
to comply with the rule's requirements to adopt an 80% investment
policy.\12\
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\9\ ``Assets'' is currently defined in the names rule as net
assets, plus the amount of any borrowings for investment purposes;
see also section 2(a)(41) of the Act [15 U.S.C 80a-2(a)(41)]
(defining ``value'').
\10\ Such a fund must adopt a fundamental policy: (1) to invest
at least 80% of the value of its assets in investments whose income
is exempt from federal income tax or from both federal and state
income tax, or (2) to invest its assets so that at least 80% of the
income that it distributes will be exempt from federal income tax or
from both federal and state income tax.
\11\ Under the Act, a fund may not depart from a fundamental
policy unless it has been authorized by the vote of a majority of
its outstanding shareholders. 15 U.S.C. 80a-13(a)(3). In this
release, we refer to a policy that a fund must currently adopt under
the names rule as an ``80% investment policy'' and the fund's
investments invested in accordance with this policy, the fund's
``80% basket.'' We are proposing a parallel definition of ``80%
basket'' in the proposed amendments to the names rule, and when
referring to the proposed rule, references to a fund's ``80%
basket'' refer to the proposed definition of this term. See proposed
rule 35d-1(g)(1).
\12\ July 31, 2002 was the compliance date of the rule. See
Names Rule Adopting Release, supra footnote 2. Based upon a review
of Morningstar data as of October 2021, 222 currently-active UIT
series were formed before this date.
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Under the rule, a fund is required to invest in accordance with its
80% investment policy ``under normal circumstances.'' In addition, the
rule provides that a fund must apply its 80% investment policy at the
time the fund invests its assets. If, subsequent to an investment, the
fund's assets are no longer invested in accordance with the policy, the
fund's future investments must be made in a manner that will bring it
into compliance.
The rule also includes certain requirements for the notices that
funds must send prior to a change in an 80% investment policy that is
not a fundamental policy. These notices are required to be provided in
plain English in a separate written document. A fund must also include
a prominent statement reading ``Important Notice Regarding Change in
Investment Policy,'' or a similar clear and understandable statement,
in bold-face type.
In adopting the names rule, the Commission made clear that it is
not intended to be a safe harbor for materially deceptive or misleading
names.\13\ The prohibitions of section 35(d) and, indeed, the anti-
fraud provisions of the federal securities laws regarding disclosures
to investors, continue to apply to funds notwithstanding their
compliance with the names rule.\14\ A name that would lead a reasonable
investor to conclude that the fund invests in a manner that is
inconsistent with the fund's actual or intended investments or the
risks of those investments would be deceptive or misleading even if the
fund is in compliance with its 80% investment policy.\15\ In addition,
a fund must adopt and implement written compliance policies and
procedures reasonably designed to prevent violations of the federal
securities laws generally, which would include section 35(d) and the
names rule.\16\ Fund compliance officers are required to include a
discussion of any material compliance matter involving the names rule
in their required annual reports to the board addressing the operation
of funds' compliance policies and procedures.\17\
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\13\ See Names Rule Adopting Release, supra footnote 2, at n.16
and accompanying text.
\14\ See, e.g., 15 U.S.C. 77q(a) and 17 CFR 240.10b-5(b)
(prohibiting making untrue statements of material fact or making
material omissions to obtain money or property in the offer or sale
of securities or in connection with the purchase or sale of a
security); 17 CFR 230.156 (prohibiting sales literature that is
materially misleading in connection with the offer or sale of
securities issued by an investment company); and 17 CFR 275.206(4)-8
(prohibiting investment advisers to pooled investment vehicles from
making untrue statements of material fact or making material
omissions to an investor or prospective investor in the pooled
investment vehicle); see also In re Ambassador Capital Management,
LLC, and Derek H. Oglesby, Initial Decision Rel. No. 672 (Sep. 19,
2014) (made final in Investment Company Act Release No. 31371 (Dec.
11, 2014)) (determining an adviser caused violations by a fund of
sections 34(b) and 35(d) of the Act by causing violations of 17 CFR
270.2a-7 while still holding the fund out as a money market fund);
Names Rule Adopting Release, supra footnote 2, at n.44 and
accompanying text.
\15\ Names Rule Adopting Release, supra footnote 2, at nn.16 and
44 and accompanying text; see also In the Matter of the Private
Investment Fund for Governmental Personnel, Inc., Investment Company
Act Release No. 2474 (Jan. 18, 1957) (``[The Commission] must take
into account the effect which the name may have not only on the
sophisticated and informed investor, but also on the unwary and the
ignorant. . . . Actual deception of investors need not be shown; it
is sufficient that the name of the company or its securities be
found to have a tendency or capacity to deceive or mislead. Nor is
it necessary that we sample public opinion to determine what the
name in question may mean to investors. . .'').
\16\ See 17 CFR 270.38a-1 (``rule 38a-1'').
\17\ See rule 38a-1(a)(4)(iii).
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B. Challenges Regarding Application of the Names Rule and Need for
Modernization
The names rule has not been amended following its adoption in 2001,
and since that time, the staff, members of the fund industry, and
investor advocacy groups have identified a number of challenges
regarding the application of the names rule that could have investor
protection implications. The Commission published a Request for Comment
on Fund Names in March 2020, which sought public comment on the
framework for addressing funds' names, particularly in light of market
and other developments since the rule's adoption.\18\
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\18\ 2020 Request for Comment, supra footnote 2.
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Commenters generally agreed that a fund's name is an important
piece of information that investors use to select a fund, and that
asset managers give considerable thought to the fund names that they
choose in light of their goals in communicating to investors.\19\ They
also agreed that the names rule provides important investor protections
and stated that it has been largely effective in regulating misleading
and deceptive fund names, but some commenters suggested further
improvements.\20\ Some provided context as to just how much the
investment management industry has changed in the twenty years since
the names rule was adopted and suggested updates may be appropriate.
For example, commenters stated that registered investment companies
manage considerably more assets than they did in 2001 ($22.8 trillion
total net assets as of March 2020 compared to $7.2 trillion in 2001)
and that the variety of fund types and fund strategies has increased
since 2001, with exchange-traded funds (``ETFs'') and funds of funds
having grown since then and funds such as emerging market,
international, and alternative strategy funds having attracted
substantial amounts of investment.\21\ The Commission staff have also
observed an increase in filings by funds with investment focuses in ESG
or ``thematic'' areas such as cybersecurity, blockchain, and artificial
intelligence.
[[Page 36597]]
Further, as highlighted in the 2020 Request for Comment, since the
Commission adopted the names rule there has been significant growth in
``passive management'' funds that seek to replicate the return on a
particular index.\22\
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\19\ See, e.g., Comment Letter of Aaron Cantrell, Head of
Economic Research, Record Currency Management and Isabel Estevez,
Ph.D. Candidate, University of Cambridge (May 5, 2020) (``Cantrell
and Estevez Comment Letter''); CFA Comment Letter; ICI Comment
Letter I; AllianzGI Comment Letter.
\20\ See, e.g., Comment Letter of Invesco Ltd. (May 5, 2020)
(``Invesco Comment Letter''); Comment Letter of the Public Investors
Advocate Bar Association (Apr. 15, 2020) (``PIABA Comment Letter'');
CFA Institute Comment Letter.
\21\ See ICI Comment Letter I; see also SIFMA AMG Comment Letter
(stating that there have been significant evolution and innovation
in the asset management industry since 2001); Comment Letter of T.
Rowe Price (May 21, 2020) (``T. Rowe Price Comment Letter'')
(stating that since the adoption of the names rule, funds have
``expanded their strategies, increased the use of derivatives and
new types of financial instruments, and expanded the diversity of
products available to investors''); and Comment Letter of State
Street Global Advisors (May 5, 2020) (``SSGA Comment Letter'')
(``[t]he investment management industry has changed considerably
since the Names Rule was adopted in 2001'').
\22\ 2020 Request for Comment, supra footnote 2, at n.22; see
also Investment Company Institute, 2021 Fact Book: A Review of
Trends and Activities in the Investment Company Industry, at 48-49,
available at <a href="https://www.ici.org/system/files/2021-05/2021_factbook.pdf">https://www.ici.org/system/files/2021-05/2021_factbook.pdf</a> (``2021 ICI Fact Book'') (stating that at the end
of 2020, index mutual funds and index ETFs together had $9.9
trillion in total net assets and accounted for 40% of assets in
long-term funds, as compared to 19% at the end of 2010).
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The current scope of the rule has created interpretive issues. The
Commission has previously taken the position that fund names that
incorporate terms such as ``growth'' and ``value'' connote an
investment objective, strategy, or policy (i.e., ``investment
strategies'') and are therefore not within the scope of the 80%
investment policy requirement.\23\ This has resulted in some fund names
being excluded from this requirement because the name contains a term
suggesting an investment strategy, even if the name also suggests an
investment focus to investors. Certain funds with names that may raise
the same types of concerns as those that the rule's current scope
directly addresses may therefore not have adopted an 80% investment
policy.
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\23\ Names Rule Adopting Release, supra footnote 2, at n.43 and
accompanying text. (``In addition, the rule does not apply to fund
names that incorporate terms such as ``growth'' and ``value'' that
connote types of investment strategies as opposed to types of
investments.'')
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The potential investor protection issues that these interpretive
scoping considerations raise are particularly evident in the treatment
of funds with names that suggest an investment focus in companies that
meet certain ESG standards. Investors may reasonably expect funds with
these names to invest in companies with policies, practices, or
characteristics that are consistent with these standards, particularly
when the fund's name contains the term ``ESG'' or similar terminology
(such as ``sustainable,'' ``green,'' or ``socially responsible'').\24\
As discussed in more detail below, this type of terminology may be
particularly powerful in fund names, as funds can attract significant
interest and stand out to investors by using these terms in their
names.\25\ The proposed amendments to the names rule would address fund
names with ESG and similar terminology by providing that funds whose
names include these terms are subject to the rule's 80% investment
policy requirement, and by defining certain uses of ESG terminology in
fund names as materially deceptive and misleading. This would help to
prevent potential ``greenwashing'' in fund names by requiring a fund's
investment activity to support the investment focus its name
communicates so that investors will not be deceived or misled by the
fund's name. Interpretive positions taken by funds that these kinds of
names are not subject to the rule have resulted in investors in these
funds not receiving these protections.
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\24\ See Enhanced Disclosures by Certain Investment Advisers and
Investment Companies about Environmental, Social, and Governance
Investment Practices, Investment Company Act Release No. 34594 (May
25, 2022) (``ESG Proposing Release''), published elsewhere in this
issue of the Federal Register.
\25\ See infra footnote 124 and accompanying text.
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The 2020 Request for Comment also asked questions exploring whether
the names rule is as effective as it could be at addressing changes to
funds' portfolios over time, for example by asking whether compliance
with the rule's 80% investment policy requirements should continue to
be determined as of the time of investment, as opposed to a fund
maintaining the required level of investment at all times. A fund in
some circumstances can drift away over time from the type of investment
focus that the fund's name suggests.\26\ The current names rule may not
be as effective as it could be at addressing changes in funds over
time, both due to possible ``drift'' and the current rule's allowing a
fund to comply with its 80% investment policy only under ``normal
circumstances.''
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\26\ This drift, however, currently may be limited in that any
future investment must be made in a manner that will bring the fund
into compliance with the 80% investment requirement. See rule 35d-
1(b).
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The 2020 Request for Comment also raised the issue that, in the
years following the names rule's adoption in 2001, funds have
increasingly used derivatives and other financial instruments to
execute their strategies.\27\ The Commission has interpreted the names
rule to permit funds to include synthetic instruments, such as
derivatives, in the fund's 80% basket if the instrument has economic
characteristics similar to the securities included in the 80%
basket.\28\ However, the Commission has not specifically addressed how
to include a derivatives instrument in that calculation. This, in turn,
may have implications for whether a fund's name accurately reflects the
economic reality of the fund's sources of returns and risk.
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\27\ See 2020 Request for Comment, supra footnote 2, at 7-8; see
also, e.g., Use of Derivatives by Registered Investment Companies
and Business Development Companies; Required Due Diligence by
Broker-Dealers and Registered Investment Advisers Regarding Retail
Customers' Transactions in Certain Leveraged/Inverse Investment
Vehicles, Investment Company Act Release No. 33704 (Nov. 25, 2019)
[85 FR 446 (Jan. 24, 2020)] and Use of Derivatives by Registered
Investment Companies and Business Development Companies, Investment
Company Act Release No. 34084 (Nov. 2, 2020) [85 FR 83162 (Dec. 21,
2020)] (``Derivatives Rule Adopting Release'').
\28\ Names Rule Adopting Release, supra footnote 2, at section
II.A.1.
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Lastly, the rule's requirements for delivering notices of changes
to a fund's investment policy are worded in a way that could suggest
that funds must deliver these notices in paper. For example, the rule
includes requirements on the envelope in which the notice is delivered.
A number of commenters raised this issue given many investors have
elected to receive fund materials electronically, stating that the rule
should provide funds with more flexibility on delivery method.\29\ We
believe that we could provide greater specificity about the application
of the notice requirement to investors who have elected electronic
delivery.\30\
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\29\ See, e.g., Fidelity Comment Letter; Invesco Comment Letter;
ICI Comment Letter I.
\30\ See infra footnote 136.
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C. Overview of Rule Proposal
After consideration of these issues, we are proposing amendments to
the names rule to modernize and enhance the investor protections that
it currently provides.
<bullet> Expansion of Scope. We are proposing to 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 would include, for example, fund names with terms
indicating that the fund's investment decisions incorporate one or more
ESG factors.
<bullet> Changes Over Time and Temporary Departures from a Fund's
80% Investment Policy. To address concerns as to whether the rule
effectively addresses changes to fund names and portfolios over time
and about when a fund must be in compliance with its 80% investment
policy, we are proposing amendments to the current requirement that a
fund's policy apply at the time of investment, and ``under normal
circumstances.'' Instead, the proposed amendments specify the
particular circumstances under which a fund may depart from its 80%
investment policy, including specific time frames for getting back into
compliance.
[[Page 36598]]
<bullet> Derivatives. To address the rule's application to
derivatives investments, we are proposing to amend it to require funds
to use a derivatives instrument's notional amount, rather than its
market value, for the purpose of determining the fund's compliance with
its 80% investment policy. Also, we are proposing to amend the names
rule to address the derivatives instruments that a fund may include in
its 80% basket.
<bullet> Unlisted Closed-End Funds and BDCs. We are proposing to
require that a registered closed-end fund or BDC, whose shares are not
listed on a national securities exchange and that is required to adopt
an 80% investment policy, must make its 80% investment policy a
fundamental policy in all cases. As a result, these funds would not be
permitted to change their 80% investment policies without a shareholder
vote. This proposed amendment is meant to address investor protection
concerns regarding funds that can change their 80% investment policies
without shareholders having the ability to vote on the change or
readily exit the fund.
<bullet> Enhanced Prospectus Disclosure. We also are proposing
amendments to funds' prospectus disclosure requirements that would
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.
<bullet> Plain English Requirements for Terms Used in Fund Names.
We are proposing effectively to require that any terms used in the
fund's name that suggest either an investment focus, or that the fund
is a tax-exempt fund, must be consistent with those terms' plain
English meaning or established industry use.
<bullet> Materially Deceptive and Misleading Use of ESG
Terminology. The use of ESG or similar terminology in a fund's name
would deceive and mislead investors where the identified ESG factors do
not play a central role in the fund's strategy. Accordingly, we would
define the names of ``integration funds'' as materially deceptive or
misleading if the name indicates that the fund's investment decisions
incorporate one or more ESG factors. For purposes of this release, an
integration fund is a fund that considers one or more ESG factors
alongside other, non-ESG factors in its investment decisions, but such
ESG factors are generally no more significant than other factors in the
investment selection process, such that ESG factors may not be
determinative in deciding to include or exclude any particular
investment in the portfolio.
<bullet> Modernization of Notice Requirement. We are further
proposing to update the names rule's notice requirement to expressly
address funds that use electronic delivery methods to provide
information to their shareholders. The proposed amendments also would
require notices to describe not only a change in the fund's 80%
investment policy, but also a change to the fund's name that
accompanies the investment policy change.
<bullet> Form N-PORT Reporting Requirements. We are proposing
amendments to Form N-PORT to require greater transparency on how fund
investment selection methods match the investment focus that the fund's
name suggests. These proposed amendments would include a new reporting
item regarding a fund's names rule compliance. They also would include
a new reporting item requiring a fund subject to the 80% investment
policy requirement to indicate, with respect to each portfolio
investment, whether the investment is included in the fund's 80%
basket.
<bullet> Recordkeeping. The proposed amendments would require funds
that must adopt an 80% investment policy to adhere to recordkeeping
requirements that are designed to provide the Commission and staff, as
well as the fund's compliance personnel, the ability to evaluate the
fund's compliance with the rule's requirements.
Funds that do not adopt an 80% investment policy would be required
to maintain a written record of their analysis that such a policy is
not required under the names rule.
II. Discussion
A. 80% Investment Policy Requirement
1. Names Suggesting an Investment Focus
We are proposing to broaden the scope of the names rule's current
80% investment policy requirement also to apply to fund names that
include terms suggesting that the fund focuses in investments that
have, or whose issuers have, particular characteristics.\31\ The
proposed amendments provide as examples fund names with terms such as
``growth'' or ``value,'' or terms indicating that the fund's investment
decisions incorporate one or more ESG factors.\32\ This would be in
addition to fund names that currently require an 80% investment policy,
which are funds whose names suggest a focus in a particular type of
investments or industry, or in particular countries or geographic
regions, or those that suggest certain tax treatment.
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\31\ We are also proposing to add BDCs to the definition of
``fund'' in the rule. See proposed rule 35d-1(g)(5) (defining
``fund'').
\32\ Proposed rule 35d-1(a)(2). The term ``ESG'' encompasses
terms such as ``socially responsible investing,'' ``sustainable,''
``green,'' ``ethical,'' ``impact,'' or ``good governance'' to the
extent they describe environmental, social, and/or governance
factors that may be considered when making an investment decision.
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This scope expansion is designed to help ensure that fund names
that communicate to investors that the fund focuses its investments in
a particular way are addressed by the rule. The names rule is designed
to ensure that a fund's investment activity supports the investment
focus its name communicates and, thus, the investor expectations the
name creates.\33\ The proposed scope expansion recognizes that even
where a fund's name could be construed as referring to an investment
strategy, it nevertheless can also connote an investment focus, and we
believe this connotation is likely to be materially deceptive and
misleading unless supported by an 80% investment policy.\34\ That is, a
fund name might connote a particular investment focus and result in
reasonable investor expectations regardless of whether the fund's name
describes a strategy as opposed to a type of investment.\35\ Further,
as we note below, academic research indicates that a significant number
of funds follow an investment strategy that does not align with the
investment strategy identified in the fund's name and, thus, we believe
that the proposed scope expansion would
[[Page 36599]]
better define and help prevent materially deceptive and misleading fund
names in light of the investor protection concerns that this practice
raises.\36\
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\33\ As used in this release, consistent with proposed rule 35d-
1(a)(2), ``investment focus'' means a focus in a particular type of
investment or investments, a particular industry or group of
industries, particular countries or geographic regions, or
investments that have, or whose issuers have, particular
characteristics. As discussed in more detail below, under the
proposed amendments, where a fund's name suggests an investment
focus that has multiple elements, the fund's 80% investment policy
must address each element.
\34\ See supra paragraph accompanying footnote 23.
\35\ Distinguishing whether a term connotes a ``strategy''
versus a ``type of investment'' can be a subjective determination,
prone to second guessing, and the categories of ``strategy'' versus
``type of investments'' are not mutually exclusive. Interpretive
questions caused by these issues draw Commission resources to
address. For example, the Division of Investment Management's
Disclosure Review and Accounting Office staff spends a significant
amount of time and attention on names rule compliance issues. We
also believe that the proposal would address concerns raised by
commenters regarding inconsistent treatment across funds in
interpreting ``strategy'' by expanding the rule's coverage,
rendering moot the need to determine whether a fund name describes a
type of investment versus an investment strategy. See, e.g., SIFMA
AMG Comment Letter; T. Rowe Price Comment Letter.
\36\ See infra footnote 165 and accompanying text.
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Investors' expectations as to the composition of a fund's portfolio
can result even when investment-focus-suggesting terms used in a fund's
name may have more than one reasonable definition. For example, terms
like ``green'' or ``sustainable'' may be more subjective than a term
like ``large cap equity'' and thus not always viewed as referring to a
``type'' of investment. But these terms still communicate to investors
that the fund will concentrate in investments that the fund considers
``green'' or ``sustainable.'' Current fund practices are mixed on how
funds understand the scope of the names rule, in that some funds
consider certain terminology in their names to require an 80%
investment policy under the rule, while others do not.\37\
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\37\ See ICI Comment Letter I.
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Some commenters responding to the 2020 Request for Comment
supported an approach similar to our proposal.\38\ Some of these
commenters asserted that many investors often rely on fund names,
rather than disclosures such as those concerning the fund's objective,
strategies, and risks, when making an investment decision and that fund
managers purposefully adopt names designed to draw interest in their
fund.\39\ Some also stated that funds with certain names not currently
required to adopt an 80% investment policy can often connote an
investment focus to investors and, therefore, can have the effect of
misleading or deceiving investors.\40\ Commenters similarly said the
inclusion of ``buzzwords'' in funds' names can ``give the illusion of
safety or preservation of capital as objectives.'' \41\ One commenter
also stated that investors do not make a distinction between
``strategies'' and ``types of investments'' when making an investment
decision and, instead, will assume that the fund will invest in the
ways suggested by the name.\42\
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\38\ See, e.g., Crowley Comment Letter; Silver Comment Letter;
CFA Comment Letter.
\39\ See IRC Comment Letter; Silver Comment Letter; CFA Comment
Letter.
\40\ See PIABA Comment Letter (``PIABA contends that the Names
Rule should apply to the investment strategy of a fund, particularly
where the investment strategy entails a high degree of risk. The
terms ``growth'' and ``value'' should not [be] used to mislead
investors as to aggressive, high risk funds.''); CFA Comment Letter;
see also CFA Institute Comment Letter (stating that the rule is
limited in its effectiveness but that it should not be expanded to
cover strategies).
\41\ See Silver Comment Letter; see also PIABA Comment Letter
(discussing funds--registered funds as well as hedge funds--that
have been marketed using language such as ``high-grade'' although
the funds employ risky (including leveraged) investment strategies);
CFA Comment Letter.
\42\ See CFA Institute Comment Letter.
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Other commenters objected to any expansion of the rule to require
an 80% investment policy for fund names that suggest an investment
strategy.\43\ These commenters' concerns generally centered around
perceived complexity and subjectivity in determining what assets are
appropriate for the 80% basket. Specifically, these commenters argued
that investment strategies are too subjective to be quantifiably
measured in an asset-based test like the 80% investment policy
requirement and that there can often be many investment methods to
achieve the same strategy.\44\ A number of commenters raised these
points specifically in discussing an approach that would require funds
with ESG terminology in their names to adopt an 80% investment
policy.\45\ Some commenters also stated that application of the 80%
investment policy requirement to a strategy could lead to
standardization in funds' investment portfolios that is not market-
driven and limit fund flexibility to change strategies in response to
market changes or events.\46\ For these reasons, a number of commenters
suggested that fund disclosure would be a more appropriate tool for
investors to educate themselves about the strategy better, rather than
requiring funds whose names describe a strategy to adopt an 80%
investment policy.\47\
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\43\ See, e.g., SIFMA AMG Comment Letter; Comment Letter of
Capital Research and Management Company (May 5, 2020) (``Capital
Group Comment Letter''); ICI Comment Letter I. But see, e.g., CFA
Comment Letter; Practus Comment Letter; PIABA Comment Letter; MSCI
Comment Letter (arguing that names suggesting strategies should be
subject to the 80% investment policy requirement).
\44\ See, e.g., Nia Impact Capital Comment Letter (stating that
the terms ``sustainable'' and ``ESG'' are ``still quite subjective
in nature''); SIFMA AMG Comment Letter; T. Rowe Price Comment
Letter; see also CFA Comment Letter (arguing that while the rule
should apply to strategies, a different approach than an 80%
investment policy should be taken).
\45\ See, e.g., Cantrell & Estevez Comment Letter; Credit Suisse
Comment Letter; Invesco Comment Letter. Some commenters also
recommended avoiding prescriptive definitions of terms like ``ESG''
and sustainable.'' See, e.g., BlackRock Comment Letter; Cantrell &
Estevez Comment Letter; Ceres Comment Letter. But see, e.g.,
Beirbaum Comment Letter; Global Affairs Associates Comment Letter;
Janain Comment Letter (each maintaining that funds that include ESG
terms or similar terminology in their names should be subject to the
requirement to adopt an 80% investment policy).
\46\ See Capital Group Comment Letter; ICI Comment Letter I;
Invesco Comment Letter; SIFMA AMG Comment Letter.
\47\ See SIFMA AMG Comment Letter; Capital Group Comment Letter;
T. Rowe Price Comment Letter.
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As discussed above, we believe that fund names included in the
proposed expanded scope--such as names with terms like ``growth,''
``value,'' or ``sustainable'' where a fund may not have adopted an 80%
investment policy under the current rule--communicate to investors that
the fund will concentrate in investments that the fund believes have
those particular characteristics. The proposed amendment also would
apply to other fund names that historically may have not required an
80% investment policy (depending on the context), such as names that
include terms like ``global,'' ``international,'' ``income,'' or
``intermediate term (or similar) bond.'' \48\
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\48\ See Names Rule Adopting Release, supra footnote 2, at n.42
and Division of Investment Management, Frequently Asked Questions
about Rule 35d-1(Investment Company Names) (available at <a href="https://www.sec.gov/divisions/investment/guidance/rule35d-1faq.htm">https://www.sec.gov/divisions/investment/guidance/rule35d-1faq.htm</a>) at
Questions 8, 9, and 11. These FAQs represent the views of the staff
of the Division of Investment Management. They are not a rule,
regulation, or statement of the Commission. The Commission has
neither approved nor disapproved the FAQs' content. The FAQs, like
all staff statements, have no legal force or effect: they do not
alter or amend applicable law, and they create no new or additional
obligations for any person.
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Conversely, there would continue to be fund names that would not
require the fund to adopt an 80% investment policy because the names
would not connote an investment focus under the proposal. For example,
these would include names that reference characteristics of a fund's
portfolio as a whole, or that reference elements of an investment
thesis without specificity as to the particular characteristics of the
component portfolio investments. We do not believe that such names
suggest that the fund focuses its investments in any of the ways
covered under the proposed expanded scope, though such names would
continue to be subject to section 35(d)'s prohibition on materially
misleading or deceptive names, and funds with these names would
continue to be subject to the anti-fraud provisions of the federal
securities laws regarding disclosures to investors. These names would
include, for instance, names that suggest characteristics of the fund's
overall portfolio, such as a name indicating the fund seeks to achieve
a certain portfolio ``duration'' or that the fund is ``balanced.'' \49\
They also include
[[Page 36600]]
names that reference a particular investment technique, such as ``long/
short.'' We also believe that names that suggest a possible result to
be achieved, such as ``real return,'' or a name that references a
retirement target date, similarly do not suggest a focus in a
particular type of investment or investments that have particular
characteristics. In these cases the name indicates the fund's
objectives but without specifying the fund's investments or intended
investments. Regardless of whether a fund is required to adopt an 80%
investment policy under the rule, a fund must, consistent with rule
38a-1, adopt and implement written policies and procedures reasonably
designed to prevent violations of the federal securities laws, which
include section 35(d) and the names rule.\50\
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\49\ To the extent that a term used in a fund name could
reasonably be understood to describe the characteristics of the
portfolio as well as, or alternatively, the characteristics of the
component portfolio investments--for example, the term ``global''--
we believe such a name would suggest an investment focus under the
proposed amendments. Nevertheless, as discussed in more detail
below, a ``global'' fund could use any reasonable definition of
``global'' as we are not proposing to mandate any particular test
for what this term means.
\50\ See supra footnote 16 and accompanying text.
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Where a fund's name suggests an investment focus that has multiple
elements, the fund's 80% investment policy must address all of the
elements in the name. Take, for example, the fund name ``ABC Wind and
Solar Power Fund.'' The fund's investment policy could provide that
each security included in the 80% basket must be in both the wind and
solar industries, or instead that 80% of the value of the fund's assets
will be invested in a mix of investments, with some solar investments,
some wind investments, and some investments in both industries.
Similarly, the ``XYZ Preferred Securities and Income Fund'' could adopt
a policy to invest at least 80% of the value of its assets in preferred
securities and securities that meet the fund's standards for being
income-producing. A fund's 80% investment policy must address each
element in the fund name that suggests an investment focus, but permits
the fund to take a reasonable approach in specifying how the fund's
investments will incorporate each such element in the name. For
example, the ``XYZ Environmental, Social, and Governance Fund'' must
adopt an 80% investment policy to address all three of those elements,
and we recognize that there are multiple reasonable ways the policy
could address these elements. Any fund that has a name that suggests an
investment focus would be required to adopt an 80% investment policy
even if the fund's name also contains a term that does not suggest an
investment focus. For example, the ``XYZ Technology and Real Return
Fund'' would be required to adopt an 80% investment policy to invest
80% of the value of its assets in the technology sector despite the
phrase ``real return'' also appearing in the name.
In some cases, what would be appropriate to include in the fund's
80% basket would be context-specific. For example, we understand that
funds currently do not include the value of short positions, including
short-exposure derivatives, related to the investment focus suggested
by a fund's name in their 80% baskets, absent some terminology in the
fund's name such as ``inverse,'' ``hedged,'' or ``long/short'' that
suggests to investors that short activity is or may be part of the
fund's investment approach (e.g., the ``XYZ Long/Short Equity
Fund'').\51\ We request comment below on funds' current practices
regarding including or excluding short positions in their 80% baskets
and whether any changes in this area would be appropriate.
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\51\ This hypothetical fund would be subject to the 80%
investment requirement because of the inclusion of the term
``equity,'' which suggests a type of investment, and not because of
the term ``long/short,'' which does not suggest an investment focus.
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Consistent with the current names rule, funds would be able to
define terms used in their names in a reasonable way, but, in a change
from the current rule, would be subject to the proposed requirement
that any terms used in the fund's name that suggest an investment focus
must be consistent with those terms' plain English meaning or
established industry use.\52\ What constitutes ``reasonable'' in this
context could vary depending on the fund name, but requires a
meaningful nexus between the given investment and the focus suggested
by the name. For instance, when the investment focus relates to an
industry, there are different approaches a fund could take to determine
if a given security is tied to the economic fortunes and risks
associated with the named industry. For example, we believe it would be
reasonable for a fund to define securities in a given industry as
securities issued by companies that derive more than 50% of their
revenue or income from, or own significant assets in, the industry. In
such cases, there may be instances where the percentage could be
smaller, such as where a large company is a dominant firm in a given
industry (e.g., the firm is an acknowledged leader in the industry). A
fund's compliance policies and procedures could address its processes
to allocate portfolio companies in its 80% basket, for example, by
reference to a specific test based on the source of the companies'
revenue.
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\52\ Cf. Names Rule Adopting Release, supra footnote 2, at n.43
(``As a general matter, an investment company may use any reasonable
definition of the terms used in its name and should define the terms
used in its name in discussing its investment objectives and
strategies in the prospectus.'').
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We understand that some funds also use text analytics to assign
issuers to industries based on the frequency of particular terms in an
issuer's disclosures. For example, if an issuer's public disclosure
documents repeatedly use a term like ``blockchain,'' some funds would
assign the issuer to the blockchain or fintech industry without further
analysis. Although text analysis may be a helpful component of a fund's
analysis, we do not believe it is reasonable to conclude that an issuer
is in a given industry solely because the issuer's disclosure documents
frequently include words associated with the industry.
Further, we believe it would generally be reasonable for a fund of
funds or other acquiring fund to include the entire value of its
investment in an appropriate acquired fund when calculating compliance
with the 80% investment requirement without looking through to the
acquired fund's underlying investments. For example, a fund of funds
with the name ``XYZ Industrials Fund'' with an 80% investment policy to
invest in the industrials sector could count the entire value of its
investments in the ``ABC Automotive Fund'' when calculating compliance
with the 80% investment requirement, provided that the ABC Automotive
Fund has an 80% investment policy to invest in its subsection of the
industrials sector.
We request comment on the proposed requirement for funds with names
that suggest an investment focus to adopt and implement an 80%
investment policy.
1. Should we expand the requirement for certain funds to adopt an
80% investment policy, as proposed, to cover names that include terms
suggesting an investment focus in investments or issuers that have
particular characteristics? Is it clear what types of names would
subject a fund to the expanded scope of this requirement under the
proposed rule? Should we only require certain fund names that suggest
an investment focus, such as those that ``reasonably suggest'' an
investment focus, to adopt an 80% investment policy? Would the proposed
amendments address all types of names that connote an investment focus
to investors, or otherwise create investor expectations regarding the
composition of the fund's portfolio? Conversely, are there certain
names that would be
[[Page 36601]]
included under the expanded scope for which investors would not have
these types of expectations?
2. Is it appropriate to retain, as proposed, the requirement for
fund names that suggest a focus in a particular type of investment or
investments, investments in a particular industry or group of
industries, or particular countries or geographic regions to adopt an
80% investment policy? Should we eliminate or add to these types of
names in the rule text, given the proposed expanded scope of the
requirement (i.e., including within the scope names that include terms
suggesting a focus in investments or issuers that have particular
characteristics)?
3. Should we, as proposed, adopt a scoping requirement that does
not distinguish between types of investments and investment strategies?
Do investors make a distinction between investment strategies and types
of investments when assessing fund names in making an investment
decision?
4. Should the names rule's 80% investment policy requirement apply,
as proposed, to fund names with terms such as ``ESG'' and
``sustainable'' that reflect certain qualitative characteristics of an
investment? Why or why not? Are investors relying on these terms as
indications of the kinds of companies in which the fund invests or does
not invest? Would this be the case even to the extent that funds with
ESG and similar terminology in their names may use disparate means to
select their portfolio investments? Should there be any additional
requirements for funds that use ESG or similar terminology in their
names?
5. As an alternative to basing the calculation of the 80% basket on
the fund's assets, should we instead use a different method of
calculation? As discussed in more detail below, we considered, as a
reasonable alternative to the proposal, whether to require funds'
historical returns to exhibit minimum exposures to certain risk factors
in lieu of the percentage of assets test. Should we instead adopt this
sort of method of calculation that assesses the returns that a fund's
investments contribute to the fund's overall performance, or that
requires a fund with a name suggesting a particular investment focus to
exhibit minimum exposures to certain risk factors that correlate with
the investment focus its name suggests?
6. Will funds be able to reasonably determine what investments
qualify for their 80% baskets under the proposed rule? What steps and
tools will funds use to make these determinations? If not, what steps
should we take to clarify this, particularly given the proposed
expanded scope of the 80% investment policy requirement? Is it likely
that funds with similar names will come to different reasonable
determinations as to what investments qualify for inclusion in their
80% baskets? If so, will investors be confused by these names?
7. Should funds with names with multiple elements be required to
address all of those elements? Should this be required at all times or,
if not, what limits, if any, should there be regarding fund names with
multiple elements in light of the prohibition against materially
deceptive or misleading names under the Act? Should a fund whose name
includes multiple elements be required to invest some specific minimum
percentage (e.g., 5%, 10%, 25%) in each element?
8. Is there any particular topic or issue that funds encounter in
complying with the 80% investment policy currently, or that they would
encounter in complying with the proposed amendments to the 80%
investment policy requirement, that should be addressed by Commission
guidance? For example, would funds benefit from guidance about what
procedures might be reasonable for a fund whose name indicates a focus
in a particular industry to select its 80% basket investments?
9. As discussed above, we understand that, absent a term in a
fund's name such as ``inverse,'' funds do not currently include short
positions in the fund's 80% basket. Should the Commission address by
guidance or a provision in the names rule the inclusion of short
positions in a fund's 80% basket related to the fund's investment
focus, and if so, what practices with respect to the inclusion or
exclusion of short positions would be appropriate in light of section
35(d) and the policy goals of the names rule's 80% investment policy
requirement? For example, assume a fund with ``equity'' in its name and
nothing in the name suggesting that the fund also engages in short
sales, such as the phrase ``long/short.'' If the fund had $100 and
invested it all in equity securities, then were to sell short equity
securities with a value of $50, how should that short sale affect the
fund's compliance with its 80% investment policy? Should the short sale
reduce the value of the equity investments included in the 80% basket,
and are there specific circumstances where a short sale should not
reduce the value of the fund's 80% basket securities? How should we
address short sales where the returns of the assets sold short are
correlated with returns of securities (or the asset class) in the
fund's 80% basket, but the assets sold short are not identical to any
of the securities in the 80% basket (or are not in the same asset class
as the securities in the 80% basket)? If the short sale should reduce
the value of the equity investment in the 80% basket in the example
above, what reduction would be appropriate--e.g., should the reduction
be $50, the value of the equity securities sold short? \53\
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\53\ See infra section II.A.3 (addressing the valuation of
derivatives instruments for the purpose of determining a fund's
compliance with its 80% investment policy).
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10. Should we provide a specific provision in the rule requiring
funds with ESG (or similar terminology) in their names only to
attribute a particular type of investment towards their 80% basket, or
guidance that addresses this? Why or why not? Are there other types of
guidance regarding ESG investing and the names rule that we should
provide?
11. Should we adopt any specific requirements with regards to the
portion of the fund's assets not included in the 80% basket? For fund
names that suggest an investment focus that has multiple elements,
should we adopt any specific requirements, such as a specific minimum
percentage (e.g., 20%, 25%, etc.) of assets invested, with regards to
how each element must be accounted for in the fund's 80% investment
policy?
12. Are there any other particular types of fund names we have not
specifically addressed above, for which we should require a specific
treatment under the names rule as we propose to amend it? Should those
particular names be subject to the requirement to adopt an 80%
investment policy or not?
13. Should we codify any of the guidance provided above? For
example, should we add an exception to the rule that permits funds of
funds, and other acquiring funds, to include the entire value of their
investment in an appropriate acquired fund in calculating their 80%
basket without looking through to the acquired fund's underlying
investments?
14. With respect to certain name terms that could connote both an
investment focus and the characteristics of the fund's overall
portfolio (e.g., ``global''), should we, as proposed, require funds
with names including these terms to adopt an 80% investment policy? If
not, how should we differentiate when these terms are being used to
suggest an investment focus and when they are not?
15. Consistent with the current names rule, the proposed amendments
would
[[Page 36602]]
generally apply to money market funds. 17 CFR 270.2a-7 (``rule 2a-7'')
also requires funds that use the term ``money market'' in their names
to comply with the requirements of that rule. Are the requirements of
rule 2a-7 sufficient to prevent materially misleading or deceptive
money market funds names, or should we continue to apply the names rule
to those funds?
2. Temporary Departures From the 80% Investment Requirement
The proposed amendments would permit a fund to depart temporarily
from the requirement to invest at least 80% of the value of its assets
in accordance with the investment focus or tax treatment its name
suggests (``80% investment requirement'') only under certain specified
circumstances.\54\ These temporary departures would be permitted only:
(1) 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; (2) to
address unusually large cash inflows or unusually large redemptions;
(3) 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; or (4) to reposition or liquidate a
fund's assets in connection with a reorganization, to launch the fund,
or when notice of a change in the fund's 80% investment policy has been
provided to fund shareholders at least 60 days before the change
pursuant to the rule.\55\ Under each of these circumstances except fund
launches (where accompanying temporary departures could not exceed a
period of 180 consecutive days), reorganizations (for which the
proposed rule does not specify a required time frame for accompanying
temporary departures), or where the 60-day notice has been provided to
shareholders, a fund would have to bring its investments back into
compliance with the 80% investment requirement within 30 consecutive
days.\56\ In all cases, a fund would have to come back into compliance
as soon as reasonably practicable.\57\
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\54\ The proposed temporary departure provision would be
applicable not only to funds whose names suggest a particular
investment focus, but also to tax-exempt funds that are required to
invest their assets in accordance with the provisions of proposed
rule 35d-1(a)(3)(i).
\55\ ``Reorganization'' is defined in section 2(a)(33) of the
Act and includes actions such as voluntary liquidations.
\56\ Proposed rule 35d-1(b)(1) and (g)(7) (defining ``launch''
as a period, not to exceed 180 consecutive days, starting from the
date the fund commences operations).
\57\ ``As soon as reasonably practicable'' would not strictly
mean ``as soon as possible'' in all cases and is intended to allow
for consideration by the adviser of how to return to compliance in a
manner that best serves the interest of the fund and its
shareholders (but in no case longer than the proposed 30-day limit
where applicable). For example, a fund need not return to compliance
within 2 days, even if doing so is technically possible, if such an
approach would harm the fund or its shareholders by, for instance,
causing the fund to purchase illiquid assets at a premium.
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In contrast, the names rule currently provides that a fund's 80%
investment policy applies ``under normal circumstances,'' leaving it to
funds to determine what constitutes something other than a normal
circumstance. This aspect of the current rule was designed to provide
funds flexibility to manage their portfolios while requiring that they
normally invest 80% of their assets consistent with their 80%
investment policy.\58\ In addition, under the current rule, compliance
with the 80% investment requirement is determined at the time a fund
invests its assets. This provision was designed to avoid requiring a
fund to rebalance its investments if the fund's portfolio were no
longer invested in accordance with the fund's 80% investment policy as
a result of, for example, market movements or an influx of cash from
new investors.\59\ The rule currently requires that if, subsequent to
an investment, the 80% investment requirements of the rule are no
longer met, the fund's future investments must be made in a manner that
will bring the fund into compliance with those requirements.
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\58\ See Names Rule Adopting Release, supra footnote 2, at
nn.37-40 and accompanying text.
\59\ See Investment Company Names, Investment Company Act
Release No. 22530 (Feb. 27, 1997) [62 FR 10955 (Mar. 10, 1997)] at
n.28 and accompanying text.
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The new approach we are proposing is designed to permit appropriate
flexibility to depart temporarily from the 80% investment requirement
in particular, time-limited circumstances when doing so would be
beneficial to the fund and its shareholders, while providing additional
parameters designed to prevent a fund from investing inconsistently
with its 80% investment policy for an extended period of time. The new
approach continues to address, for instance, certain circumstances in a
fund's life cycle in which it might not be invested fully in its 80%
basket, as well as circumstances in which external events could cause
the portfolio to ``drift'' in a way that causes the fund to depart
temporarily from the 80% investment requirement. For example, a new
fund may need a reasonable amount of time after commencing operations
to comply with the 80% investment requirement, or a fund with ``small
cap'' in its name may see certain of its investments grow such that
they are no longer ``small cap'' and need to re-invest in relative
short order.\60\ An investor choosing to invest in a fund with a name
conveying a particular investment focus may expect that the fund will
not stray from this investment focus for a protracted period of time in
these and similar examples. While the current rule includes a
requirement that a fund must make future investments in a manner to
bring the fund into compliance with the 80% investment requirement,
this provision does not address situations where the fund is not
investing its assets in a given period of time.
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\60\ See also Names Rule Adopting Release, supra footnote 2, at
n.39 and accompanying text.
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Moreover, the parameters we are including in the proposal reflect
our belief that investors' expectations for funds' investment focuses
may not depend on whether market events negatively affect the
investment in the fund's portfolio. For example, investors increasingly
seek out funds that are structured as passive investment vehicles, such
as index-based mutual funds and ETFs, in order to obtain specific types
of investment exposure for their portfolios.\61\ These investors are
specifically seeking a return tied to the investment focus suggested in
the fund's name.\62\ These investors may expect the fund to invest in a
manner that is consistent with its stated investment focus with the
understanding that investors may rebalance their own portfolios if
desired rather than expecting the fund to do so. As another example,
consistency in investment companies' investments with their names and
investors' reasonable expectations may be particularly important to
retirement plan and other investors who place great emphasis on
allocating their investment company holdings in well-defined types of
investments, such as stocks, bonds, and
[[Page 36603]]
money market instruments.\63\ As a result, consistency with the
investment focus suggested by the fund's name would seem to be a
primary concern for these investors.
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\61\ Based on data obtained from Morningstar Direct, in 2001
there were approximately 432 mutual fund and ETF index funds. As of
the end of 2019, there were approximately 2,311 index funds. 2020
Request for Comment, supra footnote 2, at n.22. At the end of 2020,
index mutual funds and index ETFs together had $9.9 trillion in
total net assets and accounted for 40% of assets in long-term funds,
as compared to 19% at the end of 2010. See 2021 ICI Fact Book.
\62\ See CFA Comment Letter (stating that when funds deviate
from their 80% investment policy for extended periods of time, this
can affect asset allocation programs some investors use to determine
which funds to buy or sell by changing the nature of the
investment).
\63\ See id.; see also Names Rule Adopting Release, supra
footnote 2, at n.8 and accompanying text.
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To address these concerns, the proposed rule amendments specify
that a fund departing from the 80% investment requirement must bring
its investments back into compliance as soon as reasonably practicable,
and that the maximum amount of time for the departure would be 30
consecutive days, other than in the case of a fund launch (which would
be limited to 180 consecutive days starting from the day the fund
commences operations) or a reorganization (for which the proposed rule
does not specify a required time frame for accompanying temporary
departures). We are proposing this ``as soon as reasonably
practicable'' standard because we anticipate that most temporary
departures would last substantially less than 30 days, though this
could depend on the specific facts and circumstances. We recognize that
some investors may prefer for a fund to be permitted to depart from its
investment focus for longer than 30 days to avoid any losses that the
fund may incur to come back into compliance within that time period. We
believe, however, that, at some point, departures may begin to change
the nature of the fund fundamentally, which would undermine investor
expectations created by the fund's name.\64\ The proposed time limits
are designed to prevent such a fundamental change.
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\64\ See Janain Comment Letter (recommending limiting the amount
of time funds can engage in temporary defensive positions as they
believe that some funds have taken liberties and that ``[a]t some
point, temporary becomes normal''); see also CFA Comment Letter
(highlighting concerns about ``drift''); Crowley Comment Letter
(expressing concerns about extended departures from the 80%
investment requirement).
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A shorter required time period to come back into compliance, for
example seven days, would ensure a fund rapidly rebalances its
portfolio, but could result in forced sales at depressed prices or in a
tax-disadvantaged manner, to the detriment of investors.\65\ As another
example, purchasing less liquid securities in a compressed timeframe in
order to comply with the fund's 80% investment policy could drive up
the price for those securities, also potentially adversely affecting
investors. While there is still the possibility that these adverse
effects could occur with the proposed, longer periods, we believe that
it is a lessened concern in those time frames given the increased
flexibility that a longer period of time would provide to rebalance the
portfolio and for any market-wide issue to resolve.
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\65\ Some commenters highlighted these sorts of challenges while
expressing concerns regarding changing the rule to include a
maintenance test for the 80% investment requirement. See, e.g.,
BlackRock Comment Letter; Capital Group Comment Letter; ICI Comment
Letter I.
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We are proposing to give fund launches a longer period, 180
consecutive days, in recognition of the likelihood that it can take
longer for funds to find investments during their start-up,
particularly for funds that invest in securities whose supply is
limited.\66\ We acknowledge that establishing a set time frame to
return to the 80% investment requirement may result in operational
changes for some funds, in order to assess the new time limits on
temporary departures relative to the current rule's requirement to
assess compliance with the 80% investment requirement at the time of
investment. However, we anticipate many funds, particularly open-end
funds, already assess their names rule compliance daily or intra-daily
(for example, those that trade portfolio assets daily). Therefore we
anticipate that for many funds, the proposed new approach, which would
require compliance with the 80% investment requirement except under the
rule's specified limited circumstances, would not result in significant
operational changes although we acknowledge that may not be the case
for all funds.
---------------------------------------------------------------------------
\66\ See also Names Rule Adopting Release, supra footnote 2, at
n.39 and accompanying text.
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While we continue to believe that there are circumstances where a
fund's temporary departure from the 80% investment requirement would be
appropriate, we believe that specifying these circumstances in the
rule, as opposed to a more principles-based approach, would help ensure
that these departures are temporary in nature and limited in scope.\67\
Thus, in place of the rule's current standard that a fund's 80%
investment policy applies ``under normal circumstances,'' we are
proposing four specific exceptions that address circumstances where
such departures would be limited in time, have investor protection
benefits, and/or involve circumstances where an investor is unlikely to
be materially misled or deceived.
---------------------------------------------------------------------------
\67\ See, e.g., SIFMA AMG Comment Letter; BlackRock Comment
Letter; T. Rowe Price Comment Letter.
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First, the proposed rule would permit temporary departures that
occur 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. This
recognizes that a fund may not be in compliance with the 80% investment
requirement for a short period of time while the fund addresses such an
event. For example, the investments in a fund's 80% basket may decline
in value such that they fall below 80% of the fund's assets. Further,
the underlying index of an index fund could rebalance, which may cause
the fund to have less than 80% of its assets invested in the
reconstituted index until the fund has the opportunity to realign its
investments.
The proposed rule also would permit funds experiencing unusually
large cash inflows or outflows in response to redemption requests to
depart temporarily from the 80% investment requirement. This would
provide a fund the opportunity to depart temporarily from the fund's
80% investment requirement in order to invest the incoming cash, or
sell investments to meet the outflow, in an orderly way. Similarly, the
proposed rule would permit temporary departures for funds to take
temporary defensive positions in cash, cash equivalents, or government
securities to react to adverse conditions.\68\ These generally reflect
prior Commission statements regarding some circumstances in which
departures from the 80% investment requirement would be appropriate
under the current rule.\69\
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\68\ See, e.g., Registration Form Used by Open-End Management
Investment Companies, Investment Company Act Release No. 23064 (Mar.
13, 1998) [63 FR 13916 (Mar. 23, 1998)]. The proposed provision
permitting temporary departures to avoid losses in response to
adverse market, economic, political, or other conditions in the
names rule reflects the formulation of temporary defensive positions
from Form N-1A. See Form N-1A, Instruction 6 to Item 9(b)(1). As a
result, funds should understand this provision as consistent with
this disclosure requirement and any related disclosure the fund
provides. Further, we believe that context dictates that ``other
conditions'' is not all-encompassing, but rather would be other
conditions similar to an adverse market, economic, or political
condition.
\69\ See Names Rule Adopting Release, supra footnote 2, at
section II.A.4 (describing ways in which funds might use the ``under
normal circumstances'' standard to engage in temporary departures).
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We are also proposing to permit funds temporarily to invest less
than 80% of their assets in the 80% basket to reposition or liquidate
assets in connection with a reorganization or to launch the fund. For
fund launches, the temporary period would not be permitted to exceed
180 consecutive days starting from the day the fund commences
operations. Both reorganizations and launches may result in a fund
holding assets in a way that is inconsistent with its 80% investment
[[Page 36604]]
policy in order to complete the action. For example, at start-up it may
take time for a new fund to find and purchase available investments
consistent with the fund's investment focus and hold cash in the
interim. In the case of a merger, a target fund may need to rebalance
its portfolio to more closely mirror the investments held by the
acquiring fund.
Unlike the other circumstances in which the proposed rule
amendments would permit temporary departures, the proposed rule
amendments would not limit the time of departures associated with fund
reorganizations or where the fund has provided notice it intends to
change its 80% investment policy, and additionally the time for
departures associated with fund launches could last for 180 consecutive
days from the date the fund commences operations. Planned
reorganizations may take longer to complete than 30 days or even 180
days. Moreover, the planned action will be disclosed and the
reorganization is likely to be a permanent change to the nature of the
investor's investment.\70\ Similarly, a change to a fund's 80%
investment policy is a permanent change to the fund's investments,
about which funds notify investors pursuant to the provisions of the
rule. Thus, we do not believe that changes in the fund's investment
portfolio to support the upcoming reorganization would generally be
inconsistent with investors' reasonable expectations. As a result, we
do not believe that an express time limit is necessary for departures
from the 80% investment requirement made in connection with these
actions. Such departures, like all of the proposed departures, would
still be required to be resolved as soon as reasonably practicable.
---------------------------------------------------------------------------
\70\ For example, when the board of an open-end fund determines
to approve a reorganization, the fund would supplement its
prospectus.
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In the case of the launch of a new fund, it may be better for
investors if the fund takes additional time to invest in a manner
consistent with the fund's 80% investment policy in order to avoid the
potential for adverse impacts on the price of a targeted investment, to
scale up an investment, or to find a better investment that corresponds
to the investment focus relative to what is currently available.
Nonetheless, we believe that, consistent with current guidance, such a
period should not exceed 180 consecutive days.\71\ The proposed
amendments therefore would not permit any fund to exceed 180
consecutive days to invest its assets consistent with the 80%
investment requirements when launching a fund.\72\ Further, in effect,
the proposed amendments would generally require open-end funds to be
fully invested within a much shorter time than 180 days, consistent
with the proposed requirement to do so ``as soon as reasonably
practicable.'' These funds should be able to fully invest in their
investment focus relatively quickly because they invest in relatively
liquid assets and because they receive cash from share purchases on an
ongoing basis. Accordingly, if a new open-end fund were to acquire
assets at the time of launch that largely mirrored the assets in
another pre-existing fund in the fund family, but with a different name
that reflects a different set of investment parameters that would be
applied to that portfolio in the future, the manager should generally
adjust the new fund's portfolio to the new parameters in a much shorter
time than 180 days in accordance with an 80% investment policy based on
the investment focus the fund's name suggests.
---------------------------------------------------------------------------
\71\ See Names Rule Adopting Release, supra footnote 2, at n.39
and accompanying text.
\72\ Cf. id. at n.40 (stating that, in very limited
circumstances, it may be appropriate for a closed-end fund that
invests in securities whose supply is limited to take longer than
six months to invest offering proceeds).
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We request comment on the proposed treatment of temporary
departures from the 80% investment requirement.
16. To what extent do funds currently ``drift'' away from the
investment focus suggested by their name? If they do, to what extent is
this attributable to the provisions of the current names rule, such as
the time of investment test? In general, how effective is this
provision, and the ``under normal circumstances'' provision, at
addressing materially deceptive or misleading names over time?
17. Should we limit the exceptions for market fluctuations,
unusually large cash flows, and temporary defensive positions to 30
days as proposed or some other amount of time? Does the proposed 30-day
limit raise any interpretive questions or potential compliance concerns
the Commission should address in the rule text or as guidance? Are we
correct in our belief that it will be unusual for funds to need to
engage in these activities past that period? At what point can it be
reasonably said that the nature of the fund has changed in these
circumstances?
18. Should funds be limited, as proposed, to taking positions in
cash and cash equivalents or government securities outside of their 80%
investment policies in the case of a temporary defensive position? Are
there other investments that funds use to protect the fund in the case
of adverse market, economic, political, or other conditions? For
example, should the rule allow funds to invest in securities that are
similar to these investments? What kinds of investments do funds hold
currently when taking defensive positions?
19. Is the requirement to bring a fund back into compliance with
the 80% investment requirement as soon as reasonably practicable
appropriate? Is it sufficient to protect against concerns about
portfolio drift?
20. Is ``as soon as reasonably practicable'' readily understood?
Would funds benefit from additional guidance on what would (or would
not) satisfy this standard? How long would it typically take for a fund
to come back into compliance with its 80% investment policy where a
fund asset has increased or decreased in value?
21. Under the proposed amendments, the 30-day period runs from the
time the fund invests less than 80% of the value of its assets in
accordance with its 80% investment policy. Should the rule instead
specify that it run from the beginning of one of the precipitating sets
of circumstances that the rule describes?
22. Under what circumstances do funds currently depart from the 80%
investment requirement? Are there any circumstances not covered by the
proposed rule amendments that an investor would expect? For example,
should we also exempt departures relating to a name or investment
policy change? If so, how long do these actions typically take? Should
we limit such departures to 30 days? To what extent do these actions
typically fall within the definition of ``reorganization'' under the
Act, for example, by resulting in the sale of 75% or more in value of
the assets of a fund?
23. Instead of specifying the circumstances in which a fund may
depart from the 80% investment requirement, should we retain the
current provision that an 80% investment policy applies under normal
circumstances but specify that, in any event, departures may not
persist for more than 30 days? Would investor expectations be met under
these circumstances?
24. Instead of limiting temporary departures (except in the context
of fund reorganizations or launches) to 30 days, should the rule
instead provide that, if a temporary departure persists past 30 days,
the fund's board must approve, or be informed in writing about, the
temporary departure? If we
[[Page 36605]]
were to require board approval, should we require that a majority of
the independent directors also approve of the departure? Should the
approval or written report be required to be given by, or provided to,
the board immediately, or no later than its next regularly scheduled
board meeting? To the extent that the rule were to include board
reporting, should we also require the report to include a
recommendation from the fund's adviser about whether to rebalance the
fund's holdings over a longer period of time, or to initiate a name
change? Should we include a recordkeeping requirement for the report?
Should we also require reporting to the Commission on a non-public
basis regarding a departure that lasts longer than 30 days, the reasons
for the departure, and the adviser's plan to resolve the departure,
with a follow-up report to the Commission once the departure has been
resolved? Should we require a fund to notify the board about temporary
departures even if they do not persist beyond 30 days? For example,
while funds would be required to include a discussion of material
compliance matters involving the names rule in their annual reports
required under rule 38a-1, should we further require that these
reports, or board reports in connection with regularly scheduled board
meetings, identify the number of and reason for temporary departures
during the period covered by the report? \73\
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\73\ See supra footnote 17.
---------------------------------------------------------------------------
25. Does the proposed 30-day limitation create any compliance
issues with other provisions of the federal securities laws? For
example, how would a fund address a situation where, in order to meet
the 30-day limit, it had to invest more than 15% of its net assets in
illiquid investments, contrary to 17 CFR 270.22e-4 (``rule 22e-4,'' or
the ``liquidity rule'')? Should we permit temporary departures to
exceed the 30- or 180-day limits where meeting the 80% investment
requirement would conflict with the requirements of the liquidity rule,
and if so, how should we address any attendant investor protection
concerns? Are there any circumstances when the investments suggested by
a fund's name become illiquid for more than 30 days?
26. Should we provide a specific time limit on temporary departures
relating to fund reorganizations? If so, how long should it be?
27. Similarly, should we provide a specific time limit on the
temporary departure where the fund has provided notice to shareholders
under the rule? If so, should it be 60 days consistent with the rule's
notice requirements or some other time? Should we extend a similar
provision to funds with redeemable securities that have suspended
redemptions under section 22(e) of the Act, or under analogous
circumstances, such as market closures, for funds that do not issue
redeemable securities?
28. Is 180 consecutive days the appropriate time to permit
temporary departures relating to fund launches? If not, what would be a
more appropriate time? Should we generally provide different time
frames depending on the type of fund? For example, should we require a
shorter period than 180 days for launches of open-end funds, which
typically invest in relatively liquid assets and which receive cash
from share purchases on an ongoing basis, to avoid harm to early
investors in those funds? Is the proposed definition of ``launch''
appropriate, or would a different definition (e.g., the date that a
fund's registration statement becomes effective) be more appropriate?
29. To what extent do portfolio managers keep funds close to the
80% investment requirement currently, or do they typically retain some
buffer above that amount?
30. How often do different types of funds currently assess
compliance with an 80% investment policy? Are we correct in our
assessment that many funds already review their names rule compliance
daily or on an intraday basis? How does this compliance assessment take
into account whether characteristics of an investment may have changed
(e.g., changes in market capitalization of equity holdings, or changes
with respect to whether a particular holding continues to be an
investment in a particular industry)? To the extent that certain funds
generally assess compliance at least daily, does the proposed
alternative approach to the current time of investment test increase
investor protection, both for these funds specifically and across the
fund industry?
31. Should we make any changes to the proposed temporary departure
provisions to more specifically address tax-exempt funds? For example,
should the provisions' 30-day limit specifically address tax-exempt
funds that adopt a policy to invest their assets so that at least 80%
of the income they distribute is tax-exempt, given that income
distributions can be less frequent than monthly? How often do such
funds engage in temporary departures under the current rule?
3. Considerations Regarding Derivatives in Assessing Names Rule
Compliance
We are proposing to address both the valuation of derivatives
instruments for purposes of determining compliance with its 80%
investment policy, as well the derivatives that a fund may include in
its 80% basket. Specifically, the proposed amendments would require
that, in calculating its assets for purposes of names rule compliance,
a fund must value each derivatives instrument using its notional
amount, with certain adjustments discussed below, and reduce the value
of its assets by excluding cash and cash equivalents up to the notional
amounts of the derivatives instrument(s).\74\ The proposed amendments
also would specify that, in addition to any derivatives instrument that
a fund includes in its 80% basket because the derivatives instrument
provides investment exposure to the investments suggested by the fund's
name, the fund may include in its 80% basket a derivatives instrument
that provides investment exposure to one or more of the market risk
factors associated with the investments suggested by the fund's
name.\75\ Accordingly, when a fund determines its compliance with its
80% investment policy, all derivatives instruments would be included in
the denominator in the calculation, as well as any derivatives in the
fund's 80% basket, i.e., the numerator in the calculation. We designed
these proposed amendments to reflect the investment exposure
derivatives investments create better and to increase comparability, as
some funds currently value derivatives instruments using their notional
amounts for purposes of determining their compliance with the 80% test
while other funds use market values.\76\ The amendments are designed
both to allow funds to use names that may more effectively communicate
their investments and risks to investors and reduce the risk that a
fund may use derivatives to invest in a manner inconsistent with the
investment focus suggested by the fund's name.
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\74\ See proposed rule 35d-1(g)(2).
\75\ See proposed rule 35d-1(b)(2).
\76\ See, e.g., Capital Markets Comment Letter (stating that
``[i]n practice, however, funds have been inconsistent in how
derivative investments apply towards the 80% investment requirement:
while some funds assert that a derivative's notional value is more
appropriate than its market value for purposes of complying with the
80% investment policy, many funds employ a derivative's market value
for the asset-based test'').
---------------------------------------------------------------------------
Funds currently are permitted to include synthetic instruments,
such as derivatives instruments, in the fund's 80% basket if the
synthetic instrument
[[Page 36606]]
has economic characteristics similar to the securities included in the
80% basket.\77\ A fund, therefore, currently could include derivatives
with these characteristics along with cash market investments in
assessing whether 80% of the value of its assets is invested in
accordance with the investment focus that the fund's name suggests. A
derivatives instrument's ``value,'' as defined in the Act, however, may
bear no relation to the investment exposure created by the derivatives
instrument.\78\ For example, a total return swap on a market index
generally will have a zero market value at inception, and will change
in market value based on any appreciation or depreciation in the index,
not on the fund's investment exposure. A fund entering into a swap or
other derivative referencing a market index with a notional amount of
$1 million would achieve the same economic exposure as investing $1
million in the underlying securities directly, but the swap's market
value therefore generally would be far smaller than $1 million and
would not reflect the swap's investment exposure.
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\77\ Names Rule Adopting Release, supra footnote 2, at 8511,
n.13 (stating that the rule's reference to ``investments,'' rather
than ``securities'' as proposed, would permit a fund in appropriate
circumstances to include a synthetic instrument in the 80% basket if
it has economic characteristics similar to the securities included
in that basket).
\78\ 15 U.S.C 2(a)(41)(B) (defining ``value,'' in part, as the
market value of securities for which market quotations are readily
available and, for all other investments, as fair value as
determined in good faith by the board of directors).
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Further, using a derivatives instrument's market value for purposes
of assessing names rule compliance could prevent a fund from using a
name that effectively communicates its investments. Take, for example,
a fund with the term ``emerging market debt'' in its name. While the
fund could directly own emerging market debt securities, this could be
inefficient due to transaction and custody costs, foreign regulatory
requirements, and reduced liquidity. It may be most efficient for the
fund to enter into a total return swap that provides economic exposure
to the emerging market debt securities. However, the swap's market
value may be a small percentage of the fund's net assets such that the
fund's emerging market debt investments would not be sufficient to
comply with the fund's 80% investment policy.
Moreover, using derivatives instruments' market values for purposes
of assessing names rule compliance could result in a fund being in
compliance with the fund's 80% investment policy despite the fund
having significant exposure to investments that are not suggested by
the fund's name. For example, a fund with emerging market debt in its
name could invest 80% of its assets in emerging market debt, but also
could use derivatives to obtain substantial investment exposure to U.S.
equities. The fund might satisfy its 80% investment policy using the
derivatives' market values for this purpose because the market value of
a fund's derivatives investment can be small and unrelated to its
investment exposure, as discussed above. But this fund's name could be
deceptive and misleading if the performance of U.S. equities and not
emerging market debt were the primary driver of the fund's risk and
returns.
Use of Derivatives' Notional Amounts
The names rule is designed to ensure that a fund's investment
activity supports the investment focus its name communicates, and for
funds that use derivatives instruments, the investment exposure of
those derivatives instruments is generally better reflected by a
derivatives instrument's notional amount than by its market value. For
most types of derivatives instruments, the notional amount generally
serves as a measure of a fund's investment exposure to the underlying
reference asset or metric. A total return swap, for example, can
provide a return that is the economic equivalent of a direct investment
in the derivative's reference asset. Accordingly, we are proposing that
for purposes of determining a fund's compliance with its 80% investment
policy, the fund must value a derivatives instrument using its notional
amount with certain adjustments.\79\
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\79\ A fund's use of notional amounts when determining the value
of the fund's assets in the 80% basket would not affect the fund's
valuation practices under rule 2a-5 under the Act [17 CFR 270.2a-5].
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In calculating notional amounts for these purposes, a fund would be
required to convert interest rate derivatives to their 10-year bond
equivalents and to delta adjust the notional amounts of options
contracts. The proposed requirement to convert interest rate
derivatives to 10-year bond equivalents is designed to result in
adjusted notional amounts that better represent a fund's exposure to
interest rate changes.\80\ We believe that, absent this adjustment,
short-term interest rate derivatives can produce large unadjusted
notional amounts that may not correspond to large exposures to interest
rate changes.\81\ Further, the proposed requirement to delta adjust
options is designed to provide for a more tailored notional amount that
better reflects the exposure that an option creates to the underlying
reference asset.\82\ We believe that requiring these tailoring
adjustments is appropriate for purposes of the names rule in order for
a fund's 80% investment policy to best reflect the fund's investment
exposure, which in turn would help ensure that the investment focus a
fund's name communicates is not materially deceptive or misleading.
Requiring these adjustments would prevent a fund, for example, from
including a deep out-of-the money option in its 80% basket to comply
with its 80% investment policy. In that case, the option's unadjusted
notional amount would not represent the exposure that the option
creates to the underlying reference asset at that time.
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\80\ See Derivatives Rule Adopting Release, supra footnote 27,
at section II.E.1.
\81\ Id.
\82\ Id.
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Scope of the Proposed Approach
Our proposed approach would apply to all of a fund's derivatives
instruments. That is, when assessing compliance with a fund's 80%
investment policy, the fund would be required to value all of its
derivatives positions using notional amounts. The proposed approach
would apply to both the numerator and the denominator in the
calculation that the fund would use to determine compliance with its
80% investment policy.\83\
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\83\ Our proposed approach to value derivatives instruments
using their notional amounts does not distinguish between
derivatives instruments that are assets versus derivatives that are
liabilities of the fund. For example, assume a fund enters into a
total return swap based on an index with a notional amount of $100
million, and that index declines a very small amount. The total
return swap would be a liability of the fund until the fund
extinguishes that liability through the payment of variation margin.
The notional amount of the swap would still reflect the magnitude of
the fund's investment exposure notwithstanding the fund's then-
current loss on the investment. For this reason, the proposal would
require funds, in measuring their assets for purposes of names rule
compliance, to include the notional amount of any derivatives
instrument, regardless of whether it is an asset or liability of the
fund.
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Deduction From Assets of Cash and Cash Equivalents Up to Notional
Amounts
Funds that use derivatives instruments to gain exposure to the
markets in which they invest may maintain portions of their assets in
cash and cash equivalents. For purposes of determining such a fund's
compliance with its 80% investment policy, our proposed approach would
require the deduction of cash and cash equivalents from assets (i.e.,
the denominator in the
[[Page 36607]]
80% calculation) up to the notional amounts of the fund's derivatives
instruments.\84\ This aspect of the proposed approach is designed to
remove from the calculation cash and cash equivalents, which do not
themselves provide market exposure, where they effectively function as
low-risk collateral for the derivatives instruments whose notional
amounts already are included in the denominator and thus including this
collateral would effectively ``double-count'' the fund's exposure.\85\
That is, where a fund holds derivatives and cash and cash equivalents,
the fund is obtaining its investment exposure through the derivatives,
not the cash and cash equivalents, and including both the derivatives
measured at their notional amounts and the value of the cash and cash
equivalents would overstate the scale of the fund's market exposure
obtained through the derivatives instruments. If a fund held
derivatives and cash market securities, like investments in equity
securities or bonds, both the notional amounts of the derivatives and
the value of the securities would be required to be included because
the fund would be obtaining market exposure through both kinds of
investments.
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\84\ See proposed rule 35d-1(g)(2).
\85\ Cf. Invesco Comment Letter (recommending that a fund
electing to include derivatives in its 80% investment policy be
required to deduct the value of cash and cash equivalents when
determining the denominator for its 80% test).
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Using an example, assume an equity fund enters into an equity swap
with a notional amount of $80 and holds $80 in U.S. Treasury bills and
$20 in other securities.\86\ Assume the swap has a market value of $0.
If the equity fund were to include the notional amount of the swap in
numerator and in the denominator when determining the fund's compliance
with its 80% investment policy without excluding the U.S. Treasury
bills, the fund would not be in compliance with the 80% investment
requirement ($80 swap notional amount/$180 = 44%). This would be the
case even though, economically, the fund is achieving an investment
exposure akin to investing $80 in equity securities directly (i.e., the
swap could be viewed as a synthetic position in equity securities). If
the equity fund were to deduct the $80 in U.S. Treasury bills from the
denominator when determining the fund's compliance with its 80%
investment policy, the fund would satisfy that requirement ($80 swap
notional amount/$100 = 80%). By way of contrast, however, assume that
the fund invests the $80 in corporate debt instead. Now, the fund would
fail the 80% investment requirement: $80 swap notional amount/$180,
composed of $80 swap notional + $80 corporate debt + $20 other
investments = 44%. The equity fund would not predominately have the
equity exposure that its name would suggest.
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\86\ See, e.g., Derivatives Rule Adopting Release, supra
footnote 27, at text accompanying n.749 (stating that ``[t]he
Commission has also stated that items commonly considered to be cash
equivalents include Treasury bills, agency securities, bank
deposits, commercial paper, and shares of money market funds'').
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Derivatives Instruments Included in the 80% Basket
We recognize that, in addition to using derivatives as direct
substitutes for cash market investments, some funds use derivatives
instruments to hedge exposures or to obtain exposure to market risk
factors associated with the fund's investments (for example, interest
rate risk, credit spread risk, and foreign currency risk). Those
instruments may have very high notional amounts. For example, a foreign
equity or bond fund may hold substantial currency forwards or swaps to
hedge foreign currency risk. If the rule did not allow funds to treat
the notional amounts of those derivatives instruments as investments
that reflect the fund's investment focus, the notional amounts of those
derivatives instruments could cause a fund to fall out of compliance
with its 80% investment policy. For example, if ABC Foreign Equity Fund
invested $100 in foreign equity securities, $100 in currency forwards,
and held no other assets, the fund would not satisfy its 80% investment
policy if the currency forwards were not included in the fund's 80%
basket ($100 in foreign equity securities/$100 in foreign equity
securities + $100 currency forwards = 50%).
Thus, in addition to any derivatives instrument that the fund
includes in its 80% basket because it provides investment exposure to
the investments suggested by the fund's name, our proposed approach
would permit a fund to include in its 80% basket a derivatives
instrument that provides investment exposure to one or more of the
market risk factors associated with the investments suggested by the
fund's name. As a result, the derivatives instruments included in a
fund's 80% basket would either be functioning as a substitute for
direct investments in the securities suggested by the fund's name or
used to facilitate the fund's investment in those securities by
increasing or decreasing the fund's exposure to risk factors associated
with those securities. We believe that our proposed approach would help
ensure that the fund's use of derivatives would not be inconsistent
with investors' reasonable expectations of the fund's investment
activity.
As illustrated in the example above regarding ABC Foreign Equity
Fund, a foreign equity fund may hedge currency risks by entering in
currency forwards with high notional amounts. If these notional amounts
were not included in the fund's 80% basket, the fund might not be able
to comply with its 80% investment policy even though the currency
forwards relate to the foreign equity securities suggested by the
fund's name. Accordingly, we believe it would be reasonable for a fund
to include a derivatives instrument in its 80% basket where the
derivatives instrument provides investment exposure to one or more of
the market risk factors associated with the investments suggested by
the fund's name. As another example, the XYZ Corporate Bond Fund, whose
portfolio includes corporate bonds as well as interest rate swaps to
manage the portfolio's overall duration, could include the interest
rate derivatives in its 80% basket.
Comments Received
Several commenters responding to the 2020 Request for Comment
addressed the valuation of derivatives in measuring a fund's compliance
with its 80% investment policy. Many commenters urged the Commission to
permit funds to use notional amounts to value derivatives instruments
because a derivatives instrument's market value may bear little
relation to the fund's investment exposure to the kinds of investments
suggested by the fund's name.\87\ Further, one commenter suggested
amendments to the names rule that generally would require a fund that
includes derivatives in its 80% basket to use the notional value of
derivatives instruments, adjusted as this proposal reflects, when
measuring its compliance with its 80% investment policy.\88\ We agree
with commenters
[[Page 36608]]
that notional amounts better reflect the fund's investment exposure.
For the reasons discussed above, our proposed approach would require a
fund to use the notional amounts of its derivatives instruments when
measuring the fund's compliance with its 80% investment policy.
---------------------------------------------------------------------------
\87\ See, e.g., BlackRock Comment Letter; Capital Group Comment
Letter; ICI Comment Letter I; T. Rowe Price Comment Letter.
\88\ See Invesco Comment Letter (suggesting that a fund should
generally value a derivatives instrument included in its 80% basket
using the derivatives instrument's notional value, ``gross up'' the
denominator in the 80% test to include these derivatives' notional
amounts, and suggesting adjustments for interest rate derivatives
and involving the ``delta adjustments'' of the notional value of
options positions; also suggesting that the fund deduct the value of
cash and cash equivalents when determining the denominator for its
compliance with the 80% investment policy requirement); see also
BlackRock Comment Letter (requesting clarification that the market
value of cash and cash equivalents should be deemed an eligible
asset that is included in a fund's 80% basket and considered part of
the derivatives exposure in determining compliance with a fund's 80%
investment policy).
---------------------------------------------------------------------------
In contrast, other commenters suggested that a fund's derivatives
investments generally should be valued at market value for these
purposes.\89\ Some commenters stated that this approach better
indicates price sensitivity, the risks to a fund's portfolio, and
comparability across funds.\90\ A derivative's market value reflects
profits and losses that the fund has incurred on any given date, and we
agree that the concerns that commenters discuss are important for funds
to consider as part of their valuation and risk management processes.
However, we believe these topics are less relevant to the names rule's
policy goal of ensuring that a fund's investments, and the sources of
the fund's returns, are in line with the investment focus that the
fund's name reflects. This is because, as discussed above, a fund's
gains and losses on a derivatives investment do not reflect the
investment exposure the derivatives create. We also believe that
transparency regarding a fund's compliance with its 80% investment
policy and the investments a fund includes in its 80% basket are
important. Our proposal would provide transparency, which in turn would
permit additional comparability, in the proposed Form N-PORT reporting
requirements that would require funds to identify each investment that
is included their 80% baskets.\91\ Current Form N-PORT reporting
requirements would continue to provide transparency regarding the
market value of each of these investments.
---------------------------------------------------------------------------
\89\ See, e.g., Council of Institutional Investors Comment
Letter; Nuckolls Comment Letter.
\90\ Id.
\91\ See infra section II.F; see also proposed Item C.2.e of
Form N-PORT.
---------------------------------------------------------------------------
Another commenter addressed the use of derivatives instruments more
generally. This commenter suggested that the Commission ``limit'' an
approach that would permit funds to use notional values for purposes of
names rule compliance, stating that derivatives instruments have risks
that differentiate them from cash market holdings.\92\ That commenter
also stated that it would be misleading or deceptive for a fund to gain
significant exposure through a derivative to a particular asset class
but use a name that reflects exposure to a different asset class.\93\
Alternatively, a commenter suggested that a fund's name should reflect
the use of derivatives when a fund uses derivatives frequently or when
the fund uses derivatives for frequent, non-tactical uses and creates
exposures equal to or greater than one-third of the total exposures for
all investment vehicles in the fund's portfolio.\94\
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\92\ Consumer Federation of America Comment Letter.
\93\ Id.
\94\ CFA Institute Comment Letter.
---------------------------------------------------------------------------
We agree that funds' use of derivatives presents unique risks.
After the compliance date of rule 18f-4 (17 CFR 270.18f-4), funds that
enter into derivatives under that rule will be required to satisfy that
rule's conditions.\95\ We do not believe that a fund's name generally
would provide such specific information about fund risks--such as
differences in risks between derivatives and cash-market investments--
which instead must be disclosed in a fund's prospectus. Particularly
where a fund name refers to asset classes like ``equity'' or
``credit,'' investors might not form specific expectations about how
the fund would obtain that investment exposure--in contrast to fund
names that refer to categories of instruments like ``stock'' that may
result in these types of investor expectations.
---------------------------------------------------------------------------
\95\ See Derivatives Rule Adopting Release, supra footnote 27.
---------------------------------------------------------------------------
However, we do agree that it could be misleading or deceptive for a
fund to gain significant exposure through a derivatives instrument to a
particular asset class but use a name that reflects exposure to a
different asset class. Our proposed approach is designed to address
this concern, in requiring a fund to value all of its derivatives
instruments using their notional amounts for purposes of determining
names rule compliance as this would better reflect the investment
exposure of all of the fund's derivatives investments.
We request comment on our proposed approach with regard to the
valuation of derivatives instruments when assessing the fund's
compliance with its 80% investment policy, as well as the derivatives
that a fund may include in its 80% basket:
32. Is it appropriate to require a fund to use a derivatives
instrument's notional amount, with certain adjustments, and to reduce
the value of its assets for this purpose by excluding any cash and cash
equivalents up to the notional amount of the derivatives instrument, as
proposed? Are there circumstances in which the use of market values
would be more appropriate, and if so, what are these circumstances?
Should we restrict the use of notional amounts in cases where investors
place importance on the fund holding the underlying assets, as opposed
to cases where investors place importance on the exposures that the
fund's investments create? How would we identify those cases? For
example, should we limit the extent to which an ESG-focused fund, or
some subset of ESG-focused funds, may use derivatives' notional
amounts? Alternatively, rather than focusing on the fund's financial
exposure, should we, for example, focus on measures of risk? If so,
which risk measures would be most effective for this purpose and why?
33. Is it appropriate to require a fund to convert the notional
amounts of interest rate derivatives into 10-year bond equivalents and
to delta adjust the notional amounts of options contracts for purposes
of determining compliance with the 80% investment policy, as proposed?
Are there compliance or other challenges associated with the proposed
approach for interest rate derivatives and options contracts? Are there
additional adjustments that should be made for purposes of assessing a
fund's compliance with its 80% investment policy? Should we permit
these adjustments rather than require them? Is it sufficiently clear
that funds would eliminate from the calculation closed-out derivatives
positions, that is, derivatives that were closed out with the same
counterparty and result in no credit or market exposure to the fund, or
should the rule address these positions? What positions do funds treat
as closed-out currently when determining compliance with the names
rule?
34. For purposes of determining a fund's compliance with its 80%
investment policy, we are proposing that the fund reduce the value of
its assets by excluding any cash and cash equivalents up to the
notional amount of the derivatives instruments. Is this reduction
appropriate? Does this exclusion of cash and cash equivalents up to the
notional amount of the derivatives instruments reduce the value of the
fund's assets by too much or too little? Are there other low-risk
collateral investments that may be used for cash management, such as
short-term bonds, that also should be excluded for this purpose? Should
only assets that may be used as collateral for
[[Page 36609]]
derivatives instruments be excluded for this purpose? If so, how should
we determine if those assets may be used as collateral for derivatives
instruments? Alternatively, rather than excluding cash and cash
equivalents from the value of assets, should we permit a fund to
include in its 80% basket cash and cash equivalents used as collateral
for derivatives instruments that provide synthetic exposure to the type
of investment(s) in which the fund's name suggests a focus?
35. As proposed, the derivatives valuation approach would apply not
only to non-tax-exempt funds that are required to adopt an 80%
investment policy, but also to funds that have adopted a policy to
invest at least 80% of the value of their assets in investments the
income from which is exempt, as applicable, from federal income tax or
from both federal or state income tax. We are not aware of
circumstances in which the returns of a derivatives instrument
referencing a tax-free security are themselves tax-free. Are there such
circumstances? If not, should we specifically exclude tax-exempt funds
from the requirement to use derivative instruments' notional amounts
for purposes of determining their assets under the names rule?
36. Should we permit, rather than require as proposed, a fund to
use notional amounts of derivatives instruments for purposes of
determining the fund's compliance with its 80% investment policy? If
so, are there any limits that the rule should include--or guidance the
Commission should provide--on funds' ability to use notional amounts
for these purposes, or to switch between notional and market values?
For example, should a fund that chooses to use notional amounts to
value derivatives instruments for purposes of determining names rule
compliance, but then later chooses to use their market value for these
purposes, be required to provide prior notice to investors, for
example, 60 days before the change were effected? Would investors find
such information helpful? Should the fund's board be informed of, or
approve, such a change?
37. Would permitting the use of notional amounts, rather than
requiring this approach, as proposed, result in a fund valuing similar
derivatives instruments differently for purposes of complying with the
fund's 80% investment policy? Should a fund be permitted to value
similar derivatives instruments differently for purposes of complying
with the fund's 80% investment policy as long as the fund discloses
that difference in its prospectus? Would an investor find that
disclosure helpful?
38. Are there operational or interpretive challenges associated
with the proposed approach to addressing derivatives instruments in the
names rule, and if so, what are these and how should the Commission's
rules and/or guidance address those challenges?
39. If a fund were to use derivatives instruments to obtain
exposure to short positions in one or more reference assets, the
proposed amendments would require a fund to use these derivatives
instruments' notional amounts for purposes of determining compliance
with its 80% investment policy. These investments therefore would be
valued at their notional amounts in the denominator in all cases, and
at their notional amounts in the numerator where the fund includes
investments that provide short exposure in the numerator. Is this
treatment appropriate, or would the use of market values for short
positions in the context of assessing names rule compliance be more
appropriate? If funds currently subject to the 80% investment policy
requirement include short positions in their 80% baskets, how are these
positions valued for these purposes (e.g., using the value of the short
position, the value of the asset sold short, or if the fund obtains
short exposure using derivatives, the derivatives' notional amounts)?
Should the names rule address the valuation of physical short sales,
and if so, how should these be valued for purposes of assessing names
rule compliance? Should we provide in the rule that, for purpose of the
names rule, a short sale's value is the value of the security or other
asset sold short? Would that provide reasonably comparable treatment
for physical short sales and derivatives that provide short investment
exposure? Should the rule prohibit a fund from including derivatives
instruments in its 80% basket when those instruments provide inverse
exposure to the investments suggested by the fund's name?
40. In addition to any derivatives instrument that the fund
includes in its 80% basket because it provides investment exposure to
the investments suggested by the fund's name, we are proposing to
permit a fund to include in its 80% basket derivatives instruments that
provide investment exposure to one or more of the market risk factors
associated with the investments suggested by the fund's name. What
types of funds, and derivatives use, would be implicated by our
proposed approach? Would this proposed approach raise investor
protection issues? Alternatively, should we require, rather than
permit, a fund to include in its 80% basket derivatives instruments
that provide investment exposure to one or more of the market risk
factors associated with those investments? Are there circumstances in
which exposure to associated risk factors provided by the derivatives
instruments may be contrary to, or otherwise different from, the
investments suggested by the fund's name and should not be permitted?
41. Are there limits to the derivatives instruments that a fund
should be permitted to include in its 80% basket because they provide
investment exposure to one or more of the market risk factors
associated with the investments suggested by a fund's name? For
example, should the rule permit a fund only to include derivatives
instruments in its 80% basket when they hedge currency or interest rate
risks associated with one or more specific investments that the fund
holds in its 80% basket?
42. A fund's name generally does not provide investors with
specific information about fund risks, such as differences in risks
between derivatives and cash-market investments--which instead must be
disclosed in a fund's prospectus. However, where a fund's name refers
to certain asset classes, for example ``stocks'' and ``bonds,'' do
investors form specific expectations about how the fund would obtain
that investment exposure? In those cases, should we prohibit a fund
from including derivatives in its 80% basket on the basis that
investors expect the fund to invest directly in those kinds of
securities in the cash markets? Alternatively, should we require a fund
that includes derivatives instruments in the fund's 80% basket to
include ``derivatives'' (or similar terminology) in its name? Are there
other cases where we should require a fund that includes derivatives
instruments in the fund's 80% basket to include this type of
terminology in its name?
43. In addition to derivatives, are there other asset types or
instruments that would benefit from more clarification about how they
should be valued for purposes of determining compliance with the fund's
80% investment policy?
4. Unlisted Closed-End Funds and BDCs
We are proposing to require that a fund's 80% investment policy
must 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 (together,
[[Page 36610]]
``unlisted closed-end funds and BDCs'').\96\ A ``fundamental investment
policy'' under the proposed rule amendments would be a policy adopted
under section 8(b)(3) of the Act or, if the fund is a BDC, a policy
that is changeable only if authorized by the vote of a majority of the
outstanding voting securities of the fund.\97\ As a result, unlisted
closed-end funds and BDCs would not be permitted to change their 80%
investment policies without shareholder approval.
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\96\ See proposed rule 35d-1(a)(2)(ii).
\97\ Proposed rule 35d-1(g)(6). Section 8(b)(3) of the Act
requires a registered investment company to recite all of its
policies that it deems matters of fundamental policy in its
registration statement. For a registered investment company, section
13(a)(1) of the Act requires a vote of a majority of its outstanding
voting securities for changes to policies adopted under section
8(b)(3). The proposed amendments would only permit BDCs to change
such policies if authorized by the vote of a majority of the
outstanding voting securities of the BDC.
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Under the current rule, unless a fund's name suggests that it is a
tax-exempt fund, an unlisted closed-end fund's or BDC's 80% investment
policy must either be a fundamental policy or subject to a requirement
in the rule to provide shareholders 60-days' advance notice of any
change in the policy. The Commission permitted funds to provide
shareholders advance notice, in lieu of adopting a fundamental policy,
because the advance notice would provide shareholders sufficient time
to decide whether to redeem their shares in the event that the
investment company decides to pursue a strategy involving a different
investment focus.\98\ Unlisted closed-end funds and BDCs, however, do
not issue redeemable shares or list their shares on a national
securities exchange. A shareholder in an unlisted closed-end fund or
BDC generally will have no ready recourse, such as the ability to
redeem or quickly sell their shares, if the fund were to change its
investment policy and the investment focus that the fund's name
indicates.\99\ We therefore do not believe that advance notice is
effective in the case of unlisted closed-end funds and BDCs because
their shareholders generally cannot use the time provided by the notice
to exit their investments if they do not wish to remain invested after
the change in the fund's investment policy. For example, absent this
proposed change, these funds could launch with one name and
corresponding 80% investment policy but then change that policy with
little to no recourse for their shareholders. The proposal would
address this by ensuring that investors in unlisted closed-end funds
and BDCs would be able to vote on a change in investment policy in
light of their limited options to exit their investments if the change
were made.
---------------------------------------------------------------------------
\98\ Names Rule Adopting Release, supra footnote 2, at n.19 and
accompanying text.
\99\ While unlisted closed-end funds and BDCs often offer a
periodic issuer repurchase tender offer, these can be discretionary
on behalf of the issuer or adviser, only offered at specific
intervals (e.g., quarterly), and limited to a certain percentage or
amount to repurchase, such as participation in the issuer's dividend
re-investment program. See, e.g., FS Energy and Power Fund, SEC
Staff No-Action Letter (Jan. 10, 2012), available at <a href="https://www.sec.gov/divisions/marketreg/mr-noaction/2012/fsenergy-011012.pdf">https://www.sec.gov/divisions/marketreg/mr-noaction/2012/fsenergy-011012.pdf</a>
(discussing one such BDC's repurchase program). These share
repurchases can take an extended period of time, and shareholders
may be unable to fully divest their shares.
---------------------------------------------------------------------------
We request comment on the proposed requirement for unlisted closed-
end funds and BDCs that any 80% investment policy they adopt in
compliance with the names rule must be a fundamental investment policy.
44. Should we expand this requirement to any other type of fund?
For example, secondary-market liquidity for some listed closed-end
funds and BDCs may not be sufficient for shareholders to exit their
investments within the 60-day notice period without needing to sell at
a price that represents a significant discount from net asset value
either because of the introduction of significant new sell-side
interest or because of an existing discount in the market. Should we
require that any 80% investment policy that these funds adopt also be a
fundamental investment policy?
45. Are there any unlisted closed-end funds or BDCs for which our
proposed approach may be less necessary to address investor protection
considerations? For example, are there any unlisted closed-end funds or
BDCs that offer shareholders liquidity through discretionary repurchase
programs sufficient to allow shareholders to tender all of their shares
within the 60-day notice period?
46. As an alternative to this requirement, should we require longer
advance notice than 60 days for these funds? If so, what length of time
would be necessary for shareholders to exit their investments? Further,
should we not require fundamental policies of unlisted interval funds
that provide advance notice and make a discretionary repurchase offer
under 17 CFR 270.23c-3(c) for their outstanding shares? Would the
current regulatory limits on interval funds' repurchases affect the
investor protection considerations of this alternative approach?
47. Should potential barriers to exit be the primary consideration
underlying whether we require funds' names rule investment policies to
be fundamental investment policies? For example, should we only require
unlisted closed-end funds or BDCs to adopt their names rule investment
policies as fundamental investment policies, and remove the current
requirement for tax-exempt funds' names rule investment policies to be
fundamental investment policies?
48. Should we require any other protections for investors in
unlisted closed-end funds and BDCs? For example, should we mandate that
these funds must make an issuer tender offer or a repurchase offer when
they change an 80% investment policy and are not already required to
redeem their shares? Should we offer this as an alternative in the
names rule to the proposed fundamental policy requirement? If so, how
much should we require these funds to offer to repurchase, for example,
100% or some other percentage?
5. Effect of Compliance With an 80% Investment Policy
We are proposing a new provision in the names rule providing that a
fund's name may be materially deceptive or misleading under section
35(d) even if the fund adopts an 80% investment policy and otherwise
complies with the rule's requirement to adopt and implement the
policy.\100\ The Commission has previously stated that the names rule's
80% investment policy requirement is not intended to create a safe
harbor for fund names, and we are proposing to codify this view to make
clear that a fund name may be materially deceptive or misleading even
where the fund complies with its 80% investment policy.\101\
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\100\ Proposed rule 35d-1(c).
\101\ Names Rule Adopting Release, supra footnote 2 (``We note,
however, that the 80% investment requirement is not intended to
create a safe harbor for investment company names. A name may be
materially deceptive and misleading even if the investment company
meets the 80% requirement.'').
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The rule requires, and proposed rule amendments would continue to
require, a fund to invest at least 80% of its assets consistent with
its name, but do not prescribe how the fund invests the remaining 20%.
A fund's name could be materially deceptive or misleading for purposes
of section 35(d) if, for example, a fund complies with its 80%
investment policy but makes a substantial investment that is
antithetical to the fund's investment focus (e.g., a ``fossil fuel-
free'' fund making a substantial investment in an issuer with fossil
fuel reserves). Similarly, a fund's name could be materially deceptive
or misleading for purposes of section 35(d) if the fund invests in a
way such that the source of
[[Page 36611]]
a substantial portion of the fund's risk or returns is different from
that which an investor reasonably would expect based on the fund's
name, regardless of the fund's compliance with the requirements of the
names rule (e.g., a short-term bond fund using the 20% basket to invest
in highly volatile equity securities that introduce significant
volatility into a fund that investors would expect to have lower levels
of volatility associated with short-term bonds). In discussing fund
names that may be materially deceptive and misleading notwithstanding
the fund's compliance with its 80% investment policy, the Commission
previously stated that index funds generally would be expected to
invest more than 80% of the value of their assets in investments
connoted by the applicable index.\102\ As noted in the 2020 Request for
Comment, a fund may be invested 80% or more in an index included in the
fund's name, but that underlying index may have components that are
contradictory to the index's name. In such circumstances, even though
the fund meets the names rule requirements by its investments in the
index, the name could still be materially misleading or deceptive.\103\
As a final example, a fund that is perpetually out of compliance with
the 80% investment requirement on account of temporary departures may
have a name that is materially deceptive or misleading under section
35(d) even if each temporary departure is permissible under the rule.
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\102\ See Names Rule Adopting Release, supra footnote 2, at
section II.A.1 (also stating that a UIT with a name indicating that
its distributions are tax-exempt may have a misleading name even if
it invests 80% of its assets in tax-exempt investments).
\103\ See also, e.g., IRC Comment Letter; Silent Majority
Comment Letter; PIABA Comment Letter (recommending treating names of
indexes used in fund names the same as fund names themselves). But
see BlackRock Comment Letter; Invesco Comment Letter; SIFMA AMG
Comment Letter (recommending the Commission clarify that index funds
can meet their 80% investment policies if they invest 80% of the
value of their assets in the constituents of the underlying index).
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We request comment on the proposed provision stating that technical
compliance with an 80% investment policy does not cure a fund name that
is otherwise materially deceptive or misleading.
49. Should we codify in the rule, as proposed, the position that
the names rule's 80% investment policy requirement is not intended to
create a safe harbor for fund names? Is the proposed provision clear?
50. Under what circumstances would a fund's name be misleading or
deceptive under section 35(d) even where the fund complies with its 80%
investment policy? Should we identify any of these circumstances in the
rule? For example, when a fund uses terminology such as ``XYX-free'' in
its name, or any similar terminology suggesting exclusionary screens in
its investment selection process, would the fund's name be materially
deceptive or misleading if the fund's portfolio were to include
investments, in any amount, that contradict this terminology? As
another example, should the rule define a fund's name as materially
deceptive or misleading if the name includes the term ``XYX Index,''
where the fund's 80% basket investments include components of the XYZ
Index, but those component securities themselves are not closely tied
to the type of investments suggested by the ``XYZ'' term in the fund's
name? Conversely, should the rule specify that a fund's 80% investment
policy meets the requirements of the rule if the fund invests 80% or
more of the value of its assets in the components of the underlying
index, regardless of whether that index has components that are not
closely tied to the type of investments suggested by the ``XYZ'' term
in the fund's name?
51. Should the rule require certain funds, such as index funds, to
invest a greater percentage of their assets in the investments
suggested by the fund's name (e.g., 95%)? As another example, should
ESG-focused funds be subject to a greater percentage (e.g., 95%) than
the proposed 80%? Why or why not?
B. Prospectus Disclosure Defining Terms Used in Fund Name
We are proposing amendments to funds' registration forms--
specifically, Form N-1A, Form N-2, Form N-8B-2, and Form S-6--that
would require each fund that is required to adopt and implement an 80%
investment policy to include disclosure in its prospectus that defines
the terms used in its name, including the specific criteria the fund
uses to select the investments that the term describes, if any.\104\ We
are also proposing a requirement that funds must tag new information
that would be included using a structured data language (specifically
Inline eXtensible Business Reporting Language or ``Inline XBRL'').\105\
For purposes of the proposed disclosure requirements, ``terms'' would
mean any word or phrase used in a fund's name, other than any trade
name of the fund or its adviser, related to the fund's investment focus
or strategies. However, words like ``fund'' or ``portfolio'' in a
fund's name do not describe an investment focus or strategy and would
not need to be defined. The proposed amendments are designed to help
investors better understand how the fund's investment strategies
correspond with the investment focus that the fund's name suggests, as
well as to provide additional information about how the fund's
management seeks to achieve the fund's objective.
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\104\ See proposed instruction to Item 4(a)(1) of Form N-1A;
proposed instruction to Item 8(2) of Form N-2; and proposed
instruction to Item 11 of Form N-8B-2.
\105\ See General Instruction C.3.(g) of Form N-1A; General
Instruction I of Form N-2; proposed General Instruction 2.(l) of
Form N-8B-2; and proposed General Instruction 5 of Form S-6; see
also infra footnote 114.
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Neither the names rule nor funds' registration forms currently
incorporate a general requirement for a fund that is subject to the
names rule to include disclosure in its prospectus defining the terms
used in the fund's name. However, the names rule does currently include
this requirement for funds with names suggesting investment in
particular countries or geographic regions.\106\ These funds must
disclose in their prospectuses the specific criteria used by the fund
to select these investments.
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\106\ See rule 35d-1(a)(3)(ii).
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Similarly, in adopting the names rule, the Commission stated that a
fund that is subject to the rule's 80% investment policy requirement
should disclose this policy as one of its principal investment
strategies in its prospectus.\107\ Further, the Commission also stated
that, generally, a fund may use any reasonable definition of the terms
used in its name and should define the terms used in its name in
discussing its investment objectives and strategies in the
prospectus.\108\ Therefore, although there is not currently a general
requirement for funds to define the terms used in their names, we
understand that it is currently common practice for funds to include
prospectus disclosure that describes their 80% investment policies and
that defines any terms that their names include. The amendments we are
proposing would codify certain best practices of some funds that
currently provide disclosure defining terms used in a fund's name.\109\
[[Page 36612]]
The proposed disclosure requirement would not, however, otherwise alter
or address disclosure that funds currently provide, for example in
response to prospectus disclosure requirements regarding the fund's
investment policies.
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\107\ See Names Rule Adopting Release, supra footnote 2, at
n.15.
\108\ See id. at n.43; see also section 8(b) of the Act
(requiring a registered investment company's registration statement
to contain certain information, including a recital of its
investment policies).
\109\ Codifying these practices might especially be helpful for
a fund that relies on rule 498 under the Securities Act of 1933 to
send a summary prospectus, since such a fund would include only
content that the form requirements specifically require or permit to
be included in the summary prospectus. The proposal would amend Item
4 of Form N-1A, which is one of the items that is required to be
included in a summary prospectus that an open-end fund uses. See
rule 498(b)(2) under the Securities Act of 1933 [17 CFR
230.498(b)(2)]; see also Enhanced Disclosure and New Prospectus
Delivery Option for Registered Open-End Management Investment
Companies, Investment Company Act Release No. 28584 (Jan. 13, 2009)
[74 FR 4546 (Jan. 26, 2009)] (permitting the use of a summary
prospectus by registered open-end management investment companies).
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Understanding how terms used in a fund's name are understood by the
fund's investment manager is key information that an investor needs to
make an investment decision, as this will help the investor understand
whether the investment focus the name suggests is consistent with the
investor's investment goals and risk tolerance. There are many types of
fund names for which understanding additional detail about how these
terms are defined would provide greater clarity to an investor about
the investment focus that the name suggests. We are therefore proposing
to replace the specific disclosure requirement for fund names focusing
on particular countries or geographic regions with the general
requirement to define terms used in the fund's name whenever the fund's
name suggests an investment focus requiring an 80% investment policy.
Funds have flexibility to use reasonable definitions of the terms
that their names use. A fund's use of reasonable definitions of the
terms used in the fund's name may not, however, under the proposed rule
otherwise change the meaning of these terms to be inconsistent with
their plain English meaning or established industry use.\110\ As
discussed above, definitions should have a meaningful nexus between the
term used in the fund's name and the fund's investment focus.\111\
However, there could be multiple reasonable definitions of the same
term that multiple funds use in their names, so understanding
additional detail about these definitions would help investors better
distinguish among funds.\112\ For example, multiple funds may include
the term ``large-cap'' in their name to indicate that they invest in
``large-capitalization'' stock. There could be multiple reasonable
definitions of the term ``large cap,'' however, because these funds may
have different ways of analyzing pertinent references (including, for
example, common indices, classifications used by rating organizations,
and definitions used in financial publications).
---------------------------------------------------------------------------
\110\ See proposed rule 35d-1(a)(2)(iii) and 35d-1(a)(3)(ii);
see also infra section II.C (discussion of the proposed requirement
that terms used in a fund's name be consistent with those terms'
plain English meaning or established industry use).
\111\ See supra discussion accompanying footnote 52. Commission
staff could request information from the fund regarding the fund's
basis for determining that the fund name is sufficiently consistent
with the definitions provided, just as staff currently may request
information from a fund to support its disclosure reflecting the
fund's compliance with various provisions of the Act and rules
thereunder.
\112\ See supra section II.A.1 discussing how a fund may make
determinations for what investments are appropriate for the 80%
basket.
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We are proposing to require that all funds that would be subject to
the proposed new prospectus disclosure requirements would have to tag
the information we are proposing to require funds disclose on their
registration forms in a structured, machine-readable data
language.\113\ The proposed requirements would include block text
tagging of narrative information about a fund's 80% investment policy
and the terms used in its name, including the specific criteria the
fund uses to select the investments that the term describes, if any.
Specifically, we are proposing to require funds to tag the disclosures
in Inline XBRL in accordance with Rule 405 of Regulation S-T (17 CFR
232.405) and the EDGAR Filer Manual.\114\
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\113\ Many funds are already required to tag certain
registration statement disclosure items using Inline XBRL. See infra
footnote 115. However, UITs that register on Form N-8B-2 and file
post-effective amendments on Form S-6 are not currently subject to
any tagging requirements. The costs of these requirements for funds
that are currently subject to tagging requirements and those that
newly would be required to tag certain disclosure items are
discussed in the Economic Analysis and the Paperwork Reduction Act
Analysis sections below. See infra discussion in sections III.D.2
and IV.E.
\114\ This proposed tagging requirement would be implemented by
including cross-references to rule 405 of Regulation S-T in each
applicable fund registration form (and, as applicable, updating
references to those fund registration forms in rule 11 and rule 405
in those fund registration forms that currently require certain
information to be tagged in Inline XBRL--that is, Form N-1A and Form
N-2), by revising rule 405(b) of Regulation S-T to include the
proposed names rule disclosures, and by proposing conforming
amendments to rule 485 and rule 497 under the Securities Act.
Pursuant to rule 301 of Regulation S-T, the EDGAR Filer Manual is
incorporated by reference into the Commission's rules. In
conjunction with the EDGAR Filer Manual, Regulation S-T governs the
electronic submission of documents filed with the Commission. Rule
405 of Regulation S-T specifically governs the scope and manner of
disclosure tagging requirements for operating companies and
investment companies, including the requirement in rule 405(a)(3) to
use Inline XBRL as the specific structured data language to use for
tagging the disclosures.
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Many funds are already required to tag certain registration
statement disclosure items using Inline XBRL.\115\ Requiring Inline
XBRL tagging of names rule disclosure for all funds that would be
subject to this disclosure requirement would benefit investors, other
market participants, and the Commission by making the disclosures more
readily available and easily accessible for aggregation, comparison,
filtering, and other analysis, as compared to requiring a non-machine-
readable data language such as ASCII or HTML. This would enable
automated extraction and analysis of granular data about how funds are
defining the terms used in their names, allowing investors and other
market participants to more efficiently perform large-scale analysis
and comparison across funds and time periods. An Inline XBRL
requirement would facilitate other analytical benefits, such as more
easily extracting and searching disclosures about funds' names and
their 80% investment policies (rather than having to manually run
searches for these disclosures through entire documents), and
automatically comparing these disclosures against prior periods. We
believe requiring structured data for the new names-related disclosure
for all funds that would be subject to these disclosure requirements
would make this disclosure more readily available, accessible, and
comparable for investors, other market participants, and the
Commission.
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\115\ The Commission has adopted rules requiring funds
registering on Forms N-1A and N-2 to submit certain information
using Inline XBRL format. See, e.g., Interactive Data to Improve
Financial Reporting, Release No. 33-9002 (Jan. 30, 2009) [74 FR 6776
(Feb. 10, 2009)] as corrected by Release No. 33-9002A (Apr. 1, 2009)
[74 FR 15666 (Apr. 7, 2009)] (requiring, among other things, open-
end funds to provide risk/return summary information from their
prospectuses in XBRL format); Inline XBRL Filing of Tagged Data,
Release No. 33-10514 (June 28, 2018) [83 FR 40846 (Aug. 16, 2018)];
Securities Offering Reform for Closed-End Investment Companies,
Release No. 33-10771 (Apr. 8, 2020) [85 FR 33290 (Jun. 1, 2020)];
Filing Fee Disclosure and Payment Methods Modernization, Release No.
33-10997 (Oct. 13, 2021) [86 FR 70166 (Dec. 9, 2021)].
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We request comment on the proposed amendments to prospectus
disclosure requirements regarding funds' definition of the terms used
in their names.
52. Are the proposed new instructions in the applicable fund
registration forms requiring funds to define the terms used in their
names appropriate and clear? Would the proposed amendments help meet
the needs of investors to better understand how the fund's investment
strategies correspond with the investment focus that the fund's name
suggests as well as provide additional information about how the fund's
[[Page 36613]]
management seeks to achieve the fund's objective?
53. Should the proposed prospectus disclosure requirements be
applicable, as proposed, to registrants on Form N-1A, Form N-2, Form N-
8B-2, and Form S-6? If some types of funds should be exempt, have
different disclosure requirements, or not be subject to the proposed
structured data requirement, which and why?
54. Would it be helpful and appropriate to revise the proposed
instruction to expressly provide that a fund must use a reasonable
definition of the terms used in its name?
55. Is the definition of ``terms'' in the proposed instructions
sufficiently clear? Should these proposed instructions use another word
instead of ``terms'' or define the word ``terms'' differently? If so,
what should this alternate definition be and how should we define it?
56. Should we require all funds that would be subject to the
proposed new prospectus disclosure requirements to tag the newly-
required information in Inline XBRL, as proposed? Why or why not?
57. Should we require funds to use a different structured data
language to tag the proposed disclosure on fund names? Why or why not?
If so, what structured data language should we require?
C. Plain English/Established Industry Use Requirement
For funds that are required to adopt an 80% investment policy, we
are proposing to require that any terms used in the fund's name that
suggest either an investment focus, or that such fund is a tax-exempt
fund, must be consistent with those terms' plain English meaning or
established industry use.\116\ This requirement is designed to provide
investors with a better understanding of the fund and its investment
objectives by effectively requiring a fund's name to be consistent with
a reasonable investor's likely understanding of the investment focus or
tax status that the fund's name suggests.
---------------------------------------------------------------------------
\116\ See proposed rule 35d-1(a)(2)(iii) and 35d-1(a)(3)(ii).
---------------------------------------------------------------------------
The proposed plain English or established industry use requirement
would address concerns that a fund sponsor may subvert an investor's
reasonable expectations of a fund's investment focus by using
terminology in the fund's name in a manner that is inconsistent with
the plain English or established industry use. The proposed amendments
similarly reflect our belief that a name's meaning should not be
permitted to be materially altered by fund disclosure. For example a
fund that calls itself a ``solar energy fund'' would not be able to use
disclosure to qualify the name in the prospectus by stating that the
fund's 80% basket includes investments in the securities of any type of
alternative energy company. While we understand that certain terms may
be defined in multiple reasonable ways, we believe that defining a
given term in a fund's name in a way that is inconsistent with those
terms' plain English meaning or established industry use is misleading
for investors. The proposed amendments would define these names as
materially deceptive or misleading even if the fund's prospectus
disclosure defines a given term in the name to match the fund's
investments.
We received comments on the 2020 Request for Comment that
identified this issue and stated that funds should not be able to use
disclosure to ``cure'' misleading names.\117\ Under the proposed
amendments, disclosure would not be permitted to ``fix'' or ``remedy''
a misleading name that uses terms in a way that is inconsistent with
their plain English meaning or established industry use, and therefore
contrary to reasonable expectations. This is consistent with section
35(d), which addresses fund names specifically and without regard to
other disclosure. It also is consistent with the Commission's belief
that a fund's name may communicate a great deal to an investor, even
though investors should not rely on the name as the sole source of
information about the fund's investments and risks.
---------------------------------------------------------------------------
\117\ See, e.g., Consumer Federation Comment Letter; Duffy
Comment Letter; McPhee, Jason K. Comment Letter.
---------------------------------------------------------------------------
We seek comment on the proposed plain English and established
industry use requirement:
58. Should the names rule include the proposed requirement that
terms used in a fund's name must be consistent with the terms' plain
English meaning or established industry use?
59. Is the proposed requirement clear? Is Commission guidance
needed to clarify the requirement? If so, what guidance would be
helpful? Are there standards that should be considered with respect to
what is plain English and/or established industry use?
60. Are there any terms that could be consistent with established
industry use that would not be consistent with those terms' plain
English meaning or the understanding of a reasonable investor? If so,
what terms, and how should we address these?
61. Would current funds be required to change their names or
disclosure if the plain English/established industry use requirement is
adopted as proposed?
62. Would the proposed plain English requirement encourage funds to
select names (or cause them to have to change their names to new names)
that could be less informative to investors? For example, would the
proposed requirement result in overly-broad or neutral names that may
be less helpful to investors?
D. Materially Deceptive and Misleading Use of ESG Terminology in
Certain Fund Names
As approaches to ESG investing vary, and investment products that
incorporate one or more ESG factors vary in the extent to which ESG
factors are considered versus other factors, the use of ESG or similar
terminology in fund names would deceive and mislead investors where the
identified ESG factors do not play a central role in the fund's
strategy. Accordingly, our proposed amendments would address what we
refer to in this release as ``integration funds,'' and would define the
names of ``integration funds'' as materially deceptive and misleading
if the name includes terms suggesting that the fund's investment
decisions incorporate one or more ESG factors.
As used in this release, integration funds are funds that consider
one or more ESG factors alongside other, non-ESG factors in the fund's
investment decisions but those ESG factors are generally no more
significant than other factors in the investment selection process,
such that ESG factors may not be determinative in deciding to include
or exclude any particular investment in the portfolio.\118\ Such funds
may select investments because those investments met other criteria
applied by the fund's adviser (e.g., investments selected on the basis
of macroeconomic trends or company-specific factors like a price-to-
earnings ratio). The proposed approach to integration funds targets
misleading
[[Page 36614]]
fund names; and relatedly it is designed to promote ``truth in
advertising'' in fund names by making clear that we believe it would be
misleading for a fund for which ESG factors are generally no more
significant than other factors in the investment selection process to
include ESG terminology in its name, as this has the potential to
overstate the importance of the ESG factors in the fund's selection of
its portfolio investments.
---------------------------------------------------------------------------
\118\ See proposed rule 35d-1(d); see also ESG Proposing
Release, supra footnote 24; ``Funds' Use of ESG Integration and
Sustainable Investing Strategies: An Introduction,'' Investment
Company Institute (July 2020) at 4 (discussing integration
strategies as funds that ``integrate ESG factors into their
traditional investment process as a way to seek financial returns'')
available at <a href="https://www.ici.org/system/files/attachments/20_ppr_esg_integration.pdf">https://www.ici.org/system/files/attachments/20_ppr_esg_integration.pdf</a>; Morningstar Comment Letter (stating that
Morningstar draws a distinction between ``sustainable investment''
and ``ESG Consideration'' funds where ESG Consideration funds are
``otherwise conventional, actively managed funds that have added
environmental, social, and governance criteria to their prospectuses
but do not make the claim that they invest only in full-fledged
sustainable investments (meaning they do not meet the criteria for
any of the [sustainable investment categories of focus, impact, and
sustainable sector])'').
---------------------------------------------------------------------------
Many commenters responding to our 2020 Request for Comment
discussed the role of the names rule in addressing concerns about funds
whose names include ESG terms or similar terminology.\119\ A number of
commenters noted the growth of funds with ESG terminology in their
names and expressed concerns about ``greenwashing.'' \120\ Some
commenters, in particular, urged that a fund should not be permitted to
use ``ESG'' or ``sustainable'' in its name if ESG inputs are merely one
factor among many driving an investment decision, as this could mislead
investors.\121\
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\119\ Over 35 comment letters addressed these issues, including:
BlackRock Comment Letter; Consumer Federation of America Comment
Letter; Comment Letter of Federated Hermes (May 6, 2020)
(``Federated Hermes I Comment Letter''); Morningstar Comment Letter;
Principles for Responsible Investing Comment Letter; SIFMA AMG
Comment Letter.
\120\ See, e.g., Capital Group Comment Letter (noting that the
2020 Request for Comment includes an estimate that, as of December
31, 2019, nearly 300 funds included the terms ``ESG,'' ``clean,''
``environmental,'' ``impact,'' ``responsible,'' ``social'' or
``sustainable'' in their names); Morningstar Comment Letter
(discussing the growth of ESG); Practus Comment Letter (noting that
``some observers predict that the style could command half of all
assets under management in 2025'' and expressing concerns about
``greenwashing''); Principles for Responsible Investment Comment
Letter; SIFMA AMG Comment Letter; Sustainable Research and Analysis
Comment Letter (discussing the growth of ESG).
\121\ See Abdullah Comment Letter.
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We agree. Where a fund considers one or more ESG factors alongside
other, non-ESG factors in its investment decisions but ESG factors are
generally no more significant than other factors in the investment
selection process, such that those ESG factors may not be determinative
in deciding to include or exclude any particular investment in the
portfolio, including ESG terminology in the fund's name would mislead
investors by suggesting that the ESG factors play a more prominent
role.\122\ For example, consider a fund with ``sustainable'' in its
name that selects investments based on the adviser's holistic analysis
of a company, including conventional financial metrics as well as the
extent to which the company has good labor and environmental practices.
No one factor, including sustainability considerations, is more
significant than other factors in the investment selection process. As
a result, the fund may invest in companies that do not meet the
adviser's own criteria for labor or environmental practices, if the
adviser determines to make the investment on the basis of other, non-
sustainability considerations. The fund's name would be materially
deceptive and misleading because the use of the term ``sustainable'' in
its name connotes an emphasis on ``sustainability'' considerations that
is not consistent with the fund's investment strategy.
---------------------------------------------------------------------------
\122\ See, e.g., Consumer Federation of America Comment Letter
(quoting George Serafeim, a Harvard Business School professor, who
has stated that there are ``now stronger incentives for asset
managers to greenwash,'' and that ``there is a false sense of
security or satisfaction if an investor buys an ESG product that
might not be what the investor thinks it is'').
---------------------------------------------------------------------------
While the 80% investment policy requirement is an effective way of
generally addressing the consistency of a fund's investment portfolio
with the investment focus its name suggests, adopting an 80% investment
policy would not address the specific concern that the use of ESG terms
in an integration fund's name overstates the emphasis of ESG
considerations in selecting that fund's portfolio investments. Adopting
an 80% investment policy where the 80% investment basket investments
were selected considering ESG factors as one factor among many would
not address the overemphasis concern. In the ``sustainable'' fund
example above, if the fund's investments may be selected without regard
to their satisfaction of the adviser's sustainability criteria--and may
score poorly on such criteria because they are only one factor--this
would be misleading under section 35(d) regardless of whether the
investments were consistent with any 80% investment policy under the
rule. Because funds' names necessitate brevity, the inclusion of ESG
terminology in their names would be materially deceptive and misleading
unless a fund prioritizes those ESG considerations that their names
suggest, as contrasted to funds that analyze ESG factors only as part
of a broader investment selection process.\123\ While we understand
that many integration fund managers thoughtfully consider ESG factors
as one of multiple components of their investment processes, we believe
it would be materially deceptive or misleading for the names of those
funds to indicate to investors that consideration of ESG factors is a
central part of their investment processes, particularly in light of
information suggesting that the use of ESG terminology in fund names is
effective in attracting inflows.\124\
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\123\ See, e.g., Practus Comment Letter; Principles for
Responsible Investment Comment Letter.
\124\ See, e.g., Letter from Morningstar to Chair Gary Gensler
(Jun. 9, 2021) attaching ``Sustainable Funds U.S. Landscape Report--
More funds, more flows, and impressive returns in 2020,''
Morningstar Manager Research (Feb. 10, 2021) available at <a href="https://www.sec.gov/comments/climate-disclosure/cll12-8899329-241650.pdf">https://www.sec.gov/comments/climate-disclosure/cll12-8899329-241650.pdf</a>;
see also ``ESG in 2021 So Far: An Update,'' M. Gerber, G. Norman,
and S. Toms, Harvard Law School Forum on Corporate Governance (Sept.
18, 2021) available at <a href="http://corpgov.law.harvard.edu/2021/09/18/esg-in-2021-so-far-an-update/">http://corpgov.law.harvard.edu/2021/09/18/esg-in-2021-so-far-an-update/</a>; ``ESG assets may hit $53 trillion by
2025, a third of global AUM,'' Bloomberg Intelligence (Feb. 23,
2021) available at <a href="https://www.bloomberg.com/professional/blog/esg-assets-may-hit-53-trillion-by-2025-a-third-of-global-aum/">https://www.bloomberg.com/professional/blog/esg-assets-may-hit-53-trillion-by-2025-a-third-of-global-aum/</a>.
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We request comment on our proposed amendments to address
integration funds with ESG terminology in their names:
63. Should we, as proposed, define a fund name as materially
deceptive and misleading when the fund is an integration fund that uses
ESG terms in its name? Are there circumstances in which an integration
fund's use of an ESG term in its name would not be materially deceptive
and misleading?
64. Should a fund be able to use an ESG term in its name as long as
the fund also identifies itself in its name as an integration fund
(e.g., ``XYZ ESG Integration Fund''), and the fund meets the definition
of ``integration fund'' that this release describes? \125\ Is the term
``integration'' sufficiently understood by investors such that its
inclusion in a fund name would not make the name materially deceptive
and misleading? Are there other, similar terms or phrasing that
generally would be better understood than the term ``integration?''
Could there be a benefit to permitting a fund to use ``ESG
integration'' or similar terms in its name? Would an integration fund
that uses these terms in its name be able to satisfy the 80% investment
policy requirement, and would adopting an 80% investment policy address
the consistency of an integration fund's investment portfolio with the
investment focus its name suggests? If not, is there a way to adapt the
80% investment policy requirement for integration funds to address the
investor protection concerns about the potential overstatement of the
consideration of ESG factors that our proposed approach addresses?
Alternatively, should an integration fund be exempt from the 80%
investment policy requirement?
[[Page 36615]]
Would such an exemption raise investor protection issues?
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\125\ See supra footnote 118 and accompanying text.
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65. Should we further limit the extent to which funds may use
specific ESG-related terms in their names, for example permitting the
use of certain terms only if a fund has a certain investment focus? For
example, notwithstanding the principle that a fund may use any
reasonable definition of the terms used in its name, should we require
that a fund with the terms ``zero'' carbon in its name to have an
investment policy that requires investments in companies with no or low
carbon emissions, or should we permit the fund's investment policy to
include investments in companies that are transitioning away from
certain practices while they are still involved in that activity? If
so, what terms should we mandate for what types of investment focus?
E. Modernizing the Rule's Notice Requirement
The proposed amendments to the names rule, like the current rule,
would require that unless the 80% investment policy is a fundamental
policy of the fund, notice must be provided to fund shareholders of any
change in the fund's 80% investment policy.\126\ The proposed
amendments would incorporate some modifications to the current notice
requirement that are designed to better address the needs of
shareholders who have elected electronic delivery and to incorporate
additional specificity about the content and delivery of the notice.
The Commission has historically acted to modernize the manner in which
information is disclosed to the public and provided to investors in
order to keep up with changes in the industry and technology. As an
additional modification, the proposed amendments would require notices
to describe not only a change in the fund's 80% investment policy, but
also a change to the fund's name that accompanies the investment policy
change.
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\126\ Proposed rule 35d-1(e).
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As discussed above, the names rule currently requires funds that
are subject to the 80% investment policy requirement, other than tax-
exempt funds, either to adopt and implement a fundamental investment
policy, or to adopt an 80% investment policy that is not a fundamental
policy if they also provide shareholders notice of a change to the
policy at least 60 days before the change occurs.\127\ The notice
alternative requires that the notice be separate from other fund-
related communications and identified as involving a change in the
fund's investment policy. These requirements are designed to focus
investors' attention on the upcoming change so that they can determine
whether to redeem or otherwise exit their investments before the change
occurs. A number of commenters who addressed the notice alternative in
response to the 2020 Request for Comment suggested allowing funds to
post notification of a change to the policy on their websites.\128\
Delivery of the notices directly to shareholders, rather than
permitting funds to post these notices to a website or a similar
alternative in which shareholders do not directly receive notices,
increases the likelihood that investors would see and read it, and this
goal is particularly important given the strong link between a fund's
name and a shareholder's expectations about the fund's investment
focus, its portfolio holdings, and its risks and returns.
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\127\ The staff has observed that most funds choose the 60-day
notice requirement alternative as opposed to adopting an 80%
investment policy that is a fundamental policy. See 2020 Request for
Comment, supra footnote 2 at n.8.
\128\ See e.g., Fidelity Comment Letter; Comment Letter of T.
Rowe Price (May 21, 2020).
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We are proposing to retain the notice alternative to provide
eligible funds flexibility to respond efficiently to market events or
new regulatory requirements, and we believe that this flexibility is
appropriate where there are not significant barriers for shareholders
to exit the fund if they decide to do so upon receiving the required
notice.\129\ For example, if the Commission were to adopt final rule
amendments defining the names of certain ESG integration funds as
materially deceptive and misleading as discussed above, the proposed
notice alternative would allow affected funds to respond to the
requirement--by changing their name or investment policy--after sending
appropriate notice to shareholders. Most commenters who addressed this
aspect of the current rule in response to the 2020 Request for Comment
generally supported the fact that the names rule includes a notice
alternative, but many commenters requested modernization of the notice
requirement, given advancements in technology and changes in
shareholder preferences since the names rule was adopted.\130\ In light
of these comments and our experience administering the current rule, we
are proposing amendments to the current notice requirement to provide
greater clarity and facilitate compliance.
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\129\ See Names Rule Adopting Release, supra footnote 2 at
II.A.(1); see also supra section II.A.4 (discussing shareholders of
unlisted closed-end funds and BDCs having higher barriers to exit
these types of funds).
\130\ See e.g., Invesco Comment Letter; Fidelity Comment Letter.
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Like the current rule, the proposed amendments would require that
the notice be provided at least 60 days prior to the change the notice
describes. We believe that 60 days is sufficient time for shareholders
to decide whether to redeem their shares. The proposed amendments, like
the current rule, also would require the notice to be provided in plain
English and separately from any other documents.\131\ While the
proposed requirement that the notice be provided ``separately from any
other document'' is worded differently than in the current rule, it is
functionally the same as the current rule's requirement.\132\ This
proposed rewording is designed to provide clarity regarding what it
means for the notice to be provided separately from any other documents
(i.e., the notice cannot be built into the fund's prospectus or into
other required shareholder communications). Further, the proposed
amendments would specifically state that if the notice is delivered in
paper form, it may be provided in the same envelope as other written
documents. This proposed amendment is designed to clarify the current
rule's provisions that address when and how the notice can be provided
with other written documents, but not to alter these current provisions
substantively. We understand that staff have often received questions
about the meaning of the current requirement to provide the notice ``in
a separate written document.'' We believe the clarification would help
facilitate compliance with the notice requirement.
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\131\ Proposed rule 35d-1(e)(1).
\132\ See rule 35d-1(c)(1) (``the notice will be provided in
plain English in a separate written document'').
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Similar in part to the current notice requirement, the proposed
amendments would require that the notice contain the following
prominent statement or similar clear and understandable statement, in
bold-face type: ``Important Notice Regarding Change in Investment
Policy [and Name].'' \133\ The prominent statement would alert
shareholders that the notice contains information about the change in
the fund's investment policy. In a change from the current requirement,
however, the required prominent statement would have to reference the
fact of the name change, as applicable.\134\ This requirement is
[[Page 36616]]
designed to put investors on alert that, going forward, the fund that
is described in various regulatory materials and other fund and
intermediary communications is the same fund in which they are
currently invested.
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\133\ Proposed rule 35d-1(e)(2).
\134\ The current prominent statement requirement does not
include a reference to the fund's name. See rule 35d-1(c)(2). We are
proposing a conforming change to the reference to the notice
requirement in paragraph (a)(2)(ii) of the names rule, which as
proposed would require notice of ``any change in the policy
described in paragraph (a)(2)(i) of this section, and any change in
the fund's name that accompanies the change'' (emphasis added).
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The proposed amendments incorporate changes to provide specificity
with respect to notices that may be delivered electronically. Under the
current notice requirement, the mandated statement is required to
appear on the envelope in which the notice is delivered, or if the
notice is delivered separately from other communications to investors,
the statement must appear either on the notice or on the envelope.\135\
The Commission's current guidance regarding electronic delivery does
not prohibit names rule notices from being delivered
electronically.\136\ Some commenters who addressed this aspect of the
current rule in response to the 2020 Request for Comment questioned the
relevance of the requirement that the notice appear on the envelope in
light of funds' increasing use of electronic delivery methods for
regulatory materials.\137\ Under the proposed amendments, for any
notice that is provided in paper form, the required statement also
would appear on the envelope in which the notice is delivered.\138\
This proposed expansion of the current requirement (which only requires
the statement to appear on the envelope when the envelope includes
other materials) is designed to help draw shareholders' attention to an
important document that provides them information about the change in
the fund's investment policy. This could help shareholders decide
whether to redeem their shares or remain invested in the fund.
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\135\ Rule 35d-1(c)(3).
\136\ See Use of Electronic Media for Delivery Purposes,
Investment Company Act Release No. 21399 (Oct. 6, 1995) [60 FR 53458
(Oct. 13, 1995)] (providing Commission views on the use of
electronic media to deliver information to investors, with a focus
on electronic delivery of prospectuses, annual reports, and proxy
solicitation materials); Use of Electronic Media, Investment Company
Act Release No. 24426 (Apr. 28, 2000) [65 FR 25843 (May 4, 2000)]
(providing updated interpretive guidance on the use of electronic
media to deliver documents on matters such as telephonic and global
consent, issuer liability for website content, and legal principles
that should be considered in conducting online offerings). Although
paper is the default format for delivery of prospectuses and certain
other required disclosures such as the proposed notice, the
Commission has provided guidance noting that electronic delivery may
be used to satisfy prospectus and certain other required disclosure
delivery requirements if: (1) the investor has notice of the
availability of the information; (2) the use of the medium is not so
burdensome that intended recipients cannot effectively access the
information being provided; and (3) the issuer has evidence of
delivery.
\137\ See e.g., ICI Comment Letter; T. Rowe Price Comment
Letter.
\138\ Proposed rule 35d-1(e)(2)(i).
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If the notice is provided electronically, the proposed amendments
would require the statement to appear on the subject line of the email
communication that includes the notice.\139\ This new requirement is
designed to highlight the purpose of the electronic notice to
shareholders, in the same way that the current requirement for a
statement to appear on the delivery envelope highlights the purpose of
the included paper notice. This proposed amendment is designed to
clarify the application of the rule's requirements to electronic
notices, which in turn will help ensure that investors who have opted
into electronic delivery will receive the notices the names rule
requires in the format that they prefer.
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\139\ Proposed rule 35d-1(e)(2)(ii). The proposed amendments
specifying that the statement must appear on the subject line of the
email notice also would permit ``an equivalent indication of the
subject of the communication in other forms of electronic media.''
This is designed to help the proposed requirement remain evergreen
in the face of evolving technology and methods of communication.
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Finally, the proposed amendments would require additional
specificity with respect to the content that the notices include. The
proposed amendments would require that the notice describe, as
applicable, the fund's 80% investment policy, the nature of the change
to the 80% investment policy, the fund's old and new names, and the
effective date of any investment policy and/or name changes.\140\ These
proposed requirements are designed to codify certain best practices of
some funds, help facilitate funds' compliance with the notice
requirement, and increase consistency in the content that notices
include in order to provide the information that fund shareholders need
to decide whether to stay invested in a fund whose investment policy is
changing.
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\140\ Proposed rule 35d-1(e)(3).
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We request comment on the proposed amendments to the names rule's
notice requirement, including the following items:
66. Are the proposed amendments to the current notice requirement
appropriate? Is it appropriate to require notices to describe not only
a change in the fund's 80% investment policy, but also a change to the
fund's name that accompanies the investment policy change?
67. The proposed amendments, consistent with the current rule,
would require that the notice be provided at least 60 days prior to the
change the notice describes. Does 60 days remain a sufficient time
period for shareholders who purchased shares in a fund to decide to
redeem their shares? Should the rule allow for shorter or a longer
period?
68. Should we continue to require that the notice be provided
separately from other documents? Are there instances in which
shareholders would benefit from the notice being built into any other
shareholder communications? For example, would there be a shareholder
benefit--or conversely a detriment to shareholder understanding--if the
notice were built into the fund's prospectus?
69. Should we continue to require the notice to include a prominent
statement regarding the purpose of the notice? Should we allow funds
some flexibility to determine a similar alternate statement that would
inform shareholders of a change to a fund's 80% investment policy (and
related change to the fund's name), as proposed? Should there be
additional content in the notice regarding instances when a fund
substantially changes it strategy without a shareholder vote? Should
the notice include any factors that the board considered, such as
whether the change is likely to be consistent with reasonable investor
expectations, whether it would result in cost savings that would
benefit existing shareholders, whether it would have tax implications
to the fund and shareholders, and/or whether the fund's shares are
freely redeemable or have limitations attached to redemptions? Would an
explanation of material factors that the board considered in approving
the 80% policy be useful to shareholders? What information would be
helpful to investors to consider whether to hold or sell their shares
in a fund when a fund substantially changes its investment strategy?
70. Should we require this prominent statement also to appear on
the envelope in which the notice is delivered? The proposed rule would
expand the current requirement for the statement to appear on the
envelope, which applies only where the notice is delivered in the same
envelope as other communications to investors. Is this proposed
expansion appropriate? Why or why not?
71. For funds that deliver the notice electronically, the proposed
rule would include a new requirement that the
[[Page 36617]]
statement appear in the email subject line. Is this new requirement
appropriate? The proposed rule would permit funds that deliver the
notice electronically to include an equivalent indication of the
subject of the communication in other forms of electronic media. Would
this flexibility help the proposed requirement to remain evergreen in
the face of evolving technology and methods of communication? Why or
why not? Are there any further requirements that would be appropriate
to facilitate the accessibility of electronic notices, such as stating
that the required statement in the subject line must appear in all
capital letters, or a required font size for electronic notices?
72. The proposed rule would allow investors who have opted into
electronic delivery to receive the notices electronically. Should we
also allow funds to satisfy this requirement by making the notices
accessible on a website? What potential benefits for shareholders could
this website-based approach to notices entail? Conversely, would
shareholders not receive adequate notice of investment policy changes
if the Commission were to adopt such a website-based approach?
73. Are the proposed requirements for additional specificity, with
respect to the content that the notices include, appropriate? Would
prescribing the minimum disclosure required in the notice help funds
understand how to comply with the notice alternative? Should we require
funds to include in the notice definitions of the terms used in the new
name? Would prescribing the minimum disclosure required in the notice
help investors receive the information that they need to make an
informed decision about whether to remain invested in a fund whose
investment policy is changing? Should we prescribe any additional or
different content in the notices? If so, what content?
F. N-PORT Reports
1. Investment Company Act Names Rule Investment Policy
We are proposing to amend Form N-PORT to include a new reporting
item for registered investment companies, other than money market
funds, regarding the 80% investment policy that a fund would adopt in
compliance with the names rule.\141\ Such registered investment
companies, other than m
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