Rule2023-20793
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
October 11, 2023
Effective
December 11, 2023
Issuing agencies
Securities and Exchange Commission
Abstract
The Securities and Exchange Commission ("Commission") is amending the rule under the Investment Company Act of 1940 ("Investment Company Act" or "Act") that addresses certain broad categories of investment company names that are likely to mislead investors about an investment company's investments and risks. The amendments to this rule are designed to increase investor protection by improving, and broadening the scope of, the requirement for certain funds to adopt a policy to invest at least 80 percent of the value of their assets in accordance with the investment focus that the fund's name suggests, updating the rule's notice requirements, and establishing recordkeeping requirements. The Commission is also adopting 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 names-related regulatory requirements.
Full Text
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<title>Federal Register, Volume 88 Issue 195 (Wednesday, October 11, 2023)</title>
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[Federal Register Volume 88, Number 195 (Wednesday, October 11, 2023)]
[Rules and Regulations]
[Pages 70436-70513]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2023-20793]
[[Page 70435]]
Vol. 88
Wednesday,
No. 195
October 11, 2023
Part II
Securities and Exchange Commission
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17 CFR Parts 230, 232, 239, Et al.
Investment Company Names; Final Rule
Federal Register / Vol. 88, No. 195 / Wednesday, October 11, 2023 /
Rules and Regulations
[[Page 70436]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 230, 232, 239, 270 and 274
[Release No. 33-11238; 34-98438; IC-35000; File No. S7-16-22]
RIN 3235-AM72
Investment Company Names
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'') is
amending the rule under the Investment Company Act of 1940
(``Investment Company Act'' or ``Act'') that addresses certain broad
categories of investment company names that are likely to mislead
investors about an investment company's investments and risks. The
amendments to this rule are designed to increase investor protection by
improving, and broadening the scope of, the requirement for certain
funds to adopt a policy to invest at least 80 percent of the value of
their assets in accordance with the investment focus that the fund's
name suggests, updating the rule's notice requirements, and
establishing recordkeeping requirements. The Commission is also
adopting 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 names-related
regulatory requirements.
DATES: This rule is effective December 11, 2023.
FOR FURTHER INFORMATION CONTACT: Blair Burnett, Mykaila DeLesDernier,
Pamela Ellis, Senior Counsels; Bradley Gude, Branch Chief; Amanda
Hollander Wagner, Senior Special Counsel, 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 adopting 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 239.14 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. Regulatory Context
B. Developments and Analysis Informing Final Rule Amendments
C. Overview of the Final Rules
1. Final Rules' Principal Elements
2. Other Aspects of the 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 Registered 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. Modernizing the Rule's Notice Requirement
E. Form N-PORT Reporting
1. Investments To Be Included in a Fund's 80% Basket
2. Investment Company Act Names Rule Investment Policy
F. Recordkeeping
G. Unit Investment Trusts
H. Compliance Dates
III. Other Matters
IV. Economic Analysis
A. Introduction
B. Broad Economic Considerations
C. Economic Baseline
1. Fund Industry Overview
2. Market Practice
3. Current Regulatory Framework
D. Benefits, Costs, and Effects on Efficiency, Competition and
Capital Formation
1. Benefits
2. Costs
3. Effects on Efficiency, Competition and Capital Formation
E. Reasonable Alternatives Considered
1. Disclosure-Based Framework
2. Alternatives to 90-Day Temporary Departure Limit
3. Permit But Not Require the Use of Derivatives' Notional
Values for Purposes of Names Rule Compliance
4. Exclude Unit Investment Trusts From Requirements for Tagging
Prospectus Disclosure
V. 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. Form N-PORT Reporting Requirements
E. Investment Company Interactive Data
VI. Final Regulatory Flexibility Analysis
A. Need for and Objectives of the Rule and Form Amendments
B. Significant Issues Raised by Public Comments
C. Small Entities Subject to Rule Amendments
D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
1. 80% Investment Policy Requirements--Scope Expansion and Other
Amendments
2. Effect of Compliance With an 80% Investment Policy
3. Recordkeeping Requirements
4. Disclosure and Reporting Requirements
5. Treatment of UITs
E. Agency Action To Minimize Effect on Small Entities
Statutory Authority
I. Introduction and Background
The Commission is adopting rule and form amendments that are
designed to modernize and enhance the protections that rule 35d-1 under
the Investment Company Act, the ``names rule,'' provides. This rule
addresses the names of registered investment companies and business
development companies (``BDCs'') that the Commission defines as
materially misleading or deceptive.\1\ The amendments the Commission is
adopting update the rule and other names-related regulatory
requirements to improve the protections that the rule provides, and to
address changes in the fund industry in the approximately 20 years
since the rule was adopted.
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\1\ This release refers to registered investment companies and
BDCs collectively as ``funds.''
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In May 2022, the Commission proposed rule and form amendments that
would update the regulatory requirements associated with funds'
names.\2\ The proposed amendments included an expansion of the names
rule's scope, improvements to the requirements for funds' investment
policies adopted under the names rule (including, among other things,
specific requirements addressing temporary departures from these
policies' requirements), updated notice requirements, and new
recordkeeping requirements. The proposed amendments also effectively
would
[[Page 70437]]
have required that terms in a fund's name be consistent with those
terms' plain English meaning or established industry use, and addressed
materially deceptive and misleading use of environmental, social, or
governance (``ESG'') terminology in fund names. Finally, the 2022
Proposal included amendments that would require a fund to define the
terms used in its name in its prospectus, and amendments to Form N-PORT
to add several new names-rule-related reporting items.
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\2\ See Investment Company Names, Investment Company Act Release
No. 34593 (May 25, 2022) [87 FR 36594 (June 17, 2022)] (``Proposing
Release'' or the ``2022 Proposal''). The Commission voted to issue
the Proposing Release on May 25, 2022. The release was posted on the
Commission website that day, and comment letters were received
beginning the following day. The comment period closed on August 16,
2022. We have considered all comments received since May 25, 2022.
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The Commission received comment letters on the 2022 Proposal from a
variety of commenters, including funds, law firms, investor advocacy
groups, environmental advocacy groups, professional and trade
associations, public policy research institutes, academics, and
interested individuals.\3\ Many commenters expressed support for the
names rule generally, and the overall goals of improving and clarifying
the regulatory framework related to fund names, with some commenters
recognizing that the names rule has not been revisited since its
implementation in 2001.\4\ Comments on specific aspects of the proposed
amendments, however, were mixed. While some commenters generally
supported the proposed scope expansion, as well as the amendments
addressing the operation of investment policies adopted under the names
rule, many others expressed concerns with these aspects of the proposal
or suggested certain modifications.\5\ Comments on the proposed
prospectus disclosure requirements were generally supportive, but
comments on the proposed new Form N-PORT reporting items were mixed,
with some largely objecting to these requirements or suggesting
modifications and others arguing that the proposed new reporting items
would help promote transparency and accountability.\6\
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\3\ The comment letters on the Proposing Release are available
at <a href="https://www.sec.gov/comments/s7-16-22/s71622.htm">https://www.sec.gov/comments/s7-16-22/s71622.htm</a>.
\4\ See, e.g., Comment Letter of Better Markets (Aug. 16, 2022)
(``Better Markets Comment Letter''); Comment Letter of the Consumer
Federation of America (Aug. 16, 2022) (``Consumer Federation of
America Comment Letter'') (each expressing support for the
Commission's efforts to modernize the names rule, stating,
respectively, that the rule has not been revisited since 2001, and
it is ``well past time'' for the Commission to revisit and update
the names rule); see also Comment Letter of the CFA Institute (Aug.
22, 2022) (``CFA Institute Comment Letter''); Comment Letter of the
Teachers Insurance and Annuity Association of American and Nuveen,
LLC (Aug. 16, 2022) (``TIAA-Nuveen Comment Letter'').
\5\ See infra discussion at sections II.A.1-II.A.4.
\6\ See infra discussion at sections II.B and II.E.
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After considering the comments on the 2022 Proposal and as
discussed in more detail below, we are adopting amendments to the names
rule, with some modifications based on the comments we received.
A. Regulatory Context
Congress provided the Commission with rulemaking authority to
address materially deceptive or misleading fund names, recognizing the
concern that investors may focus on a fund's name to determine its
investments and risks.\7\ The names rule, in turn, responds to this
concern by helping to ensure that investors' assets in funds are
invested in accordance with investors' reasonable expectations based on
the fund's name.
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\7\ 15 U.S.C. 80a-34(d); Public Law 104-290, 208, 110 Stat.
3416, 3432 (1996).; see also S. Rep. No. 293, 104th Cong., 2d Sess.
8-9 (1996).
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The role of the names rule remains important and distinct from
other disclosure requirements. A fund's name is not meant to supplant
other required fund disclosure, and a name cannot communicate
everything about a fund's investments, risks, and other features. The
Commission has historically stated that investors should not rely on an
investment company's name as the sole source of information about a
company's investments and risks.\8\ We continue to encourage investors
to look beyond a fund's name to other information, such as disclosure
included in a fund's registration statement, to obtain a complete
understanding of a fund's investment objective, policies, strategies,
and risks, as several commenters suggested.\9\ A fund's name, however,
is unique in several respects. It is typically the first piece of
information that investors receive about a fund.\10\ Fund names offer
important signaling for investors in assessing their investment
options.\11\ Relatedly, incentives exist for asset managers to include
terminology in fund names that is designed to attract investor
assets.\12\
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\8\ See Investment Company Names, Investment Company Act Release
No. 24828 (Jan. 17, 2001) [66 FR 8509 (Feb. 1, 2001)] (``2001 Names
Rule Adopting Release'') at nn.4-5 and accompanying text.
\9\ See, e.g., Comment Letter of Massachusetts Financial
Services Company (Aug. 16, 2022) (``MFS Comment Letter''); Comment
Letter of Capital Research and Management Company (Aug. 16, 2022)
(``Capital Group Comment Letter''); Comment Letter of the Cato
Institute (Aug. 12, 2022) (``Cato Institute Comment Letter'').
\10\ See Comment Letter of the North American Securities
Administrators Association, Inc. (Aug. 16, 2022) (``NASAA Comment
Letter''); see also Comment Letter of the Public Investors Advocate
Bar Association (Aug. 15, 2022) (``PIABA Comment Letter'') (stating
that retail investors frequently base their purchase of funds solely
upon the name of the fund and ``do little to investigate'' the
portfolio holdings or the specific strategy of a fund beyond relying
on the fund's name).
\11\ See Comment Letter of U.S. SIF: The Forum for Sustainable
and Responsible Investment (Aug. 16, 2022) (``U.S. SIF Comment
Letter'').
\12\ See Proposing Release, supra footnote 2, at n.6; see also,
e.g., Comment Letter of the Center for American Progress (Aug. 16,
2022) (``Center for American Progress Comment Letter'') (stating
that the current investing environment creates strong incentives for
investment companies to name funds in ways that will attract
investors). But see Comment Letter of Benjamin Zycher, Senior
Fellow, American Enterprise Institute (Nov. 1, 2022) (``Zycher
Comment Letter'') (arguing that ``the implicit argument that firms
or funds have incentives to mislead or to adopt deceptive names is
not correct'' because funds' reputations for honesty are in funds'
long-term interests).
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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.\13\ This
section of the Act further authorizes the Commission to define such
names or titles as are materially deceptive or misleading. The
Commission adopted the names rule in 2001 in exercise of this
authority.\14\
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\13\ 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].
\14\ See 2001 Names Rule Adopting Release, supra footnote 8.
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The current names rule generally requires that if a fund's name
suggests a focus in a particular type of investment, or in investments
in a particular industry or geographic focus, 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.\15\ Under the current rule, a fund
generally may 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.\16\ An 80% investment
policy relating to a tax-
[[Page 70438]]
exempt fund, however, must be a fundamental policy.
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\15\ The rule imposes a similar 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'').
\16\ Under the Act, a fund may not deviate 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 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 adopting a parallel definition of ``80% basket'' in the final
amendments to the names rule, and when referring to the final
amendments, references to a fund's ``80% basket'' refer to this
definition. See final rule 35d-1(g) (defining ``eighty percent (80%)
basket''); see also proposed rule 35d-1(g)(1) (defining ``80%
basket,'' but otherwise identical to definition in final rule).
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Currently, a fund is required to invest in accordance with its 80%
investment policy ``under normal circumstances,'' and a fund must apply
its 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 current 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.
In adopting the names rule, the Commission made clear that it is
not a safe harbor for materially deceptive or misleading names.\17\ The
prohibitions of section 35(d) and 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.\18\ 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--both
currently, and following the Commission's adoption of amendments to the
names rule--would include section 35(d) and the names rule.\19\
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\17\ See 2001 Names Rule Adopting Release, supra footnote 8, at
paragraph accompanying n.16; see also Proposing Release, supra
footnote 2, at nn.13-15 and accompanying text.
\18\ See Proposing Release, supra footnote 2, at n.14 and
accompanying text.
\19\ See id. at nn.16-17 and accompanying text (also addressing
the requirement for fund compliance officers to discuss any material
compliance matter involving the names rule in annual reports to the
board on the operation of funds' compliance policies and
procedures).
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B. Developments and Analysis Informing Final Rule Amendments
The names rule has not been amended since its adoption in 2001. In
past years, the Commission and staff have received input about the
operation of the names rule, as well as areas for potential
improvement, through a variety of venues. The Commission published a
Request for Comment on Fund Names in March 2020.\20\ The 2020 Request
for Comment sought public comment on the framework for addressing
funds' names, particularly in light of market and other developments
since the rule's adoption. The Commission received broad comments in
response to the 2020 Request for Comment and, as described above, in
response to the 2022 Proposal. In addition, staff in the Commission's
Division of Investment Management, particularly the Division's
Disclosure Review and Accounting Office, receive input from funds on
names rule compliance issues regularly, for example during the course
of staff's review of fund registration statements.
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\20\ See 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''); see also Proposing Release, supra
footnote 2, at section I.B (describing the input commenters provided
in response to the 2020 Request for Comment).
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Commenters generally recognized that investors view a fund's name
as an important piece of information that communicates the fund's
objectives.\21\ Several commenters expressed that asset managers have
an incentive to create fund names that are designed to attract
investors.\22\ Many commenters, including funds and others, expressed
their general agreement that the names rule provides important investor
protections and that the rule has been largely effective in addressing
misleading and deceptive fund names.\23\ Commenters expressed support
for a requirement, such as the rule's 80% investment policy provision,
that requires a fund's underlying investments to correspond with the
focus its name suggests in light of reasonable investor
expectations.\24\ One, for example, with respect to funds' use of ESG
related terminology in their names, stated that a naming requirement
where ``the underlying strategy and data must significantly support the
name'' is a ``basic consumer protection.'' \25\
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\21\ See, e.g., Comment Letter of the Asset Management Group of
the Securities Industry and Financial Markets Association (Aug. 16,
2022) (``SIFMA AMG Comment Letter''); NASAA Comment Letter; Consumer
Federation of America Comment Letter; Comment Letter of Wellington
Management Company (Aug. 16, 2022) (``Wellington Comment Letter'');
Comment Letter of Adriana Z. Robertson and Jill E. Fisch (Apr. 20,
2023) (``Robertson-Fisch Comment Letter''); see also PIABA Comment
Letter (asserting fund names are particularly important for 401(k)
plan investments, which employers make available from a pre-
determined list of options and comprise the entirety of retirement
savings for many Americans).
\22\ See, e.g., Consumer Federation of America Comment Letter;
Center for American Progress Comment Letter; CFA Institute Comment
Letter.
\23\ See Proposing Release, supra footnote 2, at n.20 and
accompanying text; see also, e.g., Comment Letter of Invesco Ltd.
(Aug. 16, 2022) (``Invesco Comment Letter'') (``Since its adoption
in 2001, the Names Rule has provided an effective regulatory
framework for ensuring that fund names are not materially deceptive
or misleading and has served to help investors understand what they
can expect when they invest in a fund.''); Comment Letter of the
Investment Company Institute (Aug. 16, 2022) (``ICI Comment Letter
I'') The Investment Company Institute also submitted a separate
comment letter dated December 6, 2022 (``ICI Comment Letter II''), a
comment letter dated May 22, 2023 (``ICI Comment Letter III''), and
a comment letter dated July 31, 2023 (``ICI Comment Letter IV'').
Unless otherwise indicated, these letters are referred to
collectively as if they were a single letter (``ICI Comment
Letter'').
\24\ See, e.g., Comment Letter of T. Rowe Price (Aug. 16, 2022)
(``T. Rowe Comment Letter'') (discussing effectiveness of current
80% investment policy requirement in aligning fund names with
investor expectations); CFA Institute Comment Letter (stating that
the terms used in fund names should reflect the fund's ``investment
objective, strategies, and types of securities held'' and that the
current names rule ``provide[s] a level of assurance to
investors'').
\25\ See Comment Letter of Amalgamated Financial Corp. (Aug. 16,
2022) (``Amalgamated Comment Letter'').
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Some commenters expressed that certain changes to the names rule
would be beneficial to ensure that the rule continues to serve its
investor protection purposes. Some of these commenters expressed the
view that the current scope of the rule does not cover all instances in
which fund names create the reasonable expectation that a fund will
invest in a certain way.\26\ Some also expressed concern that the
current rule's ``under normal circumstances'' standard increases the
risk that a fund's investments will not be consistent with its name
over an extended period and that investors will be misled.\27\
Commenters also suggested other, more technical updates to the names
rule, such as addressing how funds that use derivatives calculate
compliance with their 80% investment policies, and updating the rule's
notice provision to reflect technological changes over the past two
decades.\28\
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\26\ See, e.g., Consumer Federation of America Comment Letter
(stating that ``significant gaps and loopholes'' exist in the
current rule); Center for American Progress Comment Letter; see also
infra section IV.D (estimating that approximately 62% of funds have
names that implicate the current 80% investment policy requirement).
\27\ See, e.g., NASAA Comment Letter; Comment Letter of the
Environmental Defense Fund (Aug. 16, 2022) (``Environmental Defense
Fund Comment Letter'').
\28\ See Proposing Release, supra footnote 2, at section I.B;
see also, e.g., ICI Comment Letter; Comment Letter of J.P. Morgan
Asset Management (Aug. 16, 2022) (``J.P. Morgan Asset Management
Comment Letter'').
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In considering updates to the names rule, both the Commission and
commenters have taken into account developments in the fund industry
since the rule was originally adopted. Registered investment companies
manage considerably more assets today than they did in 2001 (with this
amount nearly quadrupling), and the number of registered investment
companies has also increased--by close to 20%--in the two decades
following the names rule's adoption.\29\ Similarly, over this time
[[Page 70439]]
period, it has become more likely that retail investors access the
markets through registered investment companies than through direct
ownership of stocks and bonds.\30\ Although the increase in the number
of registered investment companies is modest compared to the increase
in registered investment companies' assets under management, the number
of funds tells only part of the story about the breadth of fund
investment options currently available. The range of fund investment
strategies has become notably more diverse over the past two
decades.\31\
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\29\ See Investment Company Institute, 2022 Fact Book (2022)
(``2022 ICI Fact Book''), available at <a href="https://www.icifactbook.org/pdf/2022_factbook.pdf">https://www.icifactbook.org/pdf/2022_factbook.pdf</a>. In 2001, there were 8,860 registered open-end
and closed-end management investment companies, representing
approximately $7.15 trillion in assets under management. In 2021,
there were 10,450 registered open-end and closed-end management
investment companies, representing approximately $28.2 trillion in
assets under management. See also Fund Industry Overview at infra
section IV.C.1 (discussing fund industry statistics as of Dec.
2022).
\30\ See Federal Reserve Bulletin, Changes in U.S. Family
Finances from 2016 to 2019: Evidence from the Survey of Consumer
Finances (Sept. 2020), available at <a href="https://www.federalreserve.gov/publications/files/scf20.pdf">https://www.federalreserve.gov/publications/files/scf20.pdf</a>; Federal Reserve Bulletin, Recent
Changes in U.S. Family Finances: Evidence from the 1998 and 2001
Survey of Consumer Finances, available at <a href="https://www.federalreserve.gov/econres/files/2001_bull0103.pdf">https://www.federalreserve.gov/econres/files/2001_bull0103.pdf</a>. The
percentage of U.S. families holding stocks and bonds directly
decreased from 24.9% in 1992 to 16.3% in 2019. The percentage of
U.S. families holding pooled investment funds and retirement
accounts (including individual retirement accounts, Keogh accounts,
and certain employer-sponsored accounts such as 401(k) and 403(b)
accounts) increased from 33.3% in 1992 to 59.5% in 2019. Mutual
funds made up a significant portion of defined contribution plan
assets (58%) and IRA assets (45%) at year-end 2021. In addition, the
share of defined contribution plan assets held in mutual funds has
grown over the past two decades, from 44% at year-end 2001 to 58% at
year-end 2021. See 2022 ICI Fact Book.
\31\ See Proposing Release, supra footnote 2, at nn.21-22 at
accompanying text.
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For example, the number of equity mutual funds and exchange-traded
funds (``ETFs'') that are sector funds (e.g., consumer, financial,
utilities) increased by nearly 70% from 2001 to 2021.\32\ Mutual fund
and ETF assets in ``thematic'' strategies have surged over the past
three years, with data from Morningstar Direct identifying a record 589
thematic mutual funds and ETFs debuting globally in 2021.\33\ As of
December 2022, Morningstar data categorized 334 domestic funds
(including mutual funds, ETFs, and registered closed-end funds) as
thematic funds, comprising 4 ``broad themes'' (broad thematic, physical
world, social, and technology), 27 ``themes'' (e.g., artificial
intelligence and big data, food, space, and wellness), and 150
``subthemes'' (e.g., health innovation, next gen auto, millennials and
``Generation Z,'' cannabis, robotics, and travel/tourism).\34\ While
fund managers and others understand certain of these thematic names to
be included in the current scope of the names rule, there can be
questions about whether certain thematic terms suggest a focus in a
particular type of investment, or in investments in a particular
industry or group of industries. As fund managers have incentives to
include ``buzzwords'' in their names to attract assets, and the current
market for funds includes a substantially broader variety of names
suggesting a particular focus than two decades ago, a rule providing
specific requirements to address deceptive and misleading fund names
for any fund name that suggests a particular investment focus is even
more relevant now than it was when it was adopted.\35\
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\32\ See 2022 ICI Fact Book, supra footnote 29. In 2001, there
were 452 sector equity mutual funds and ETFs; in 2021, there were
757.
\33\ See Sonya Swink, Thematic Assets Have Surged--And Are Here
to Stay, Ignites (Dec. 22, 2022), available at <a href="https://www.ignites.com/c/3870954/500734/thematic_assets_have_surged_here_stay?referrer_module=issueHeadline&module_order=1">https://www.ignites.com/c/3870954/500734/thematic_assets_have_surged_here_stay?referrer_module=issueHeadline&module_order=1</a>. These strategies are dominated by technology-related
themes, such as internet, blockchain, cloud computing, and
cybersecurity (based on staff analysis of data obtained from
Morningstar Direct as of Dec. 15, 2022).
\34\ Id.
\35\ See supra footnote 12; see also NASAA Comment Letter
(discussing the application of the names rule to names suggesting a
focus on ``trendy `thematic areas,' . . . including cybersecurity,
blockchain/digital assets, and artificial intelligence'').
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Funds that consider ESG factors in their investment strategies
comprise a thematic area that entails unique considerations, and that
involves the use of terminology that may be especially powerful in fund
names to attract investors. The use of ESG or similar terminology (such
as ``sustainable,'' ``green,'' or ``socially responsible'') in fund
names may present particular investor protection concerns for several
reasons. Investor interest in--and funds that offer--ESG strategies
have rapidly increased in recent years.\36\ Asset managers have created
and marketed funds that consider ESG factors in their selection
process, and these funds can attract significant interest and stand out
to investors by using ESG and related terms in their names. Approaches
to ESG investing vary, however, and funds that consider ESG factors
have strategies that vary in the extent to which ESG factors are
considered versus other factors. The breadth of ESG-related terms, as
well as evolving investor expectations around terms like
``sustainable'' or ``socially responsible,'' compound the possibility
of investor confusion and potential ``greenwashing'' in fund names.\37\
---------------------------------------------------------------------------
\36\ See Proposing Release, supra footnote 2, at n.120 and
accompanying text. See also, e.g., Letter from Morningstar to Chair
Gary Gensler (June 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>; 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>; Amalgamated
Comment Letter, NASAA Comment Letter, U.S. SIF Comment Letter, CFA
Institute Comment Letter (all discussing investor interest in funds
with ESG strategies and names).
\37\ ``Greenwashing'' involves the risk that funds marketing ESG
strategies may exaggerate their ESG practices or the extent to which
their investment products take into account ESG factors. See, e.g.,
Comment Letter of Public Citizen (Aug. 15, 2022) (``Public Citizen
Comment Letter'') (discussing evolving investor expectations around
ESG terms). But see Robertson-Fisch Comment Letter (``interrogating
the concept of greenwashing'' and comparing the portfolios of funds
with ESG terminology in their names to the portfolios of ``sister
funds''--``the non-ESG fund in the same fund family most comparable
to the ESG fund''--with the authors concluding that little evidence
of greenwashing exists).
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In consideration of the broad public input the Commission has
received on fund names, our analysis of this input, the Commission and
staff's experience with the names rule over the past two decades,
developments in the fund industry, and the growth of the fund industry
and families' investments in funds during this time period, we are
adopting amendments to the names rule (and related disclosure and
reporting requirements) to modernize the rule and to enhance the
investor protections it currently provides. First, it is in investors'
interests to align the rule's scope and requirements better with the
policies and purposes underlying the rule. The Commission has stated
that the 80% investment policy requirement ``will provide an investor
greater assurance that a [fund's] investments will be consistent with
its name.'' \38\ This requirement addresses circumstances in which a
fund's name may be materially deceptive or misleading, in exercise of
the Commission's rulemaking authority under section 35(d). The
amendments we are adopting address fund names that are not currently
within the scope of the rule, or where the current scope of the rule
has created interpretive issues.\39\ These names may entail a
[[Page 70440]]
capacity to deceive or mislead because they suggest a particular
investment focus, which in turn offers an important signal, or entry
point, to investors that are researching their investment options.\40\
For these names--like the names currently within the rule's scope--the
80% investment policy requirement would provide investors greater
assurance that these funds' investments are consistent with the manner
in which a fund defines the terms in its name, which must be consistent
with plain English or established industry use and disclosed in its
prospectus. We therefore anticipate that including these names in the
names rule's scope will bring more discipline to fund naming practices
and more meaningful names that convey the funds' investment focuses,
while allowing funds the flexibility to ascribe reasonable definitions
for the terms used in their names.\41\ That is, the decision to include
terms in a fund's name that suggest an investment focus, including a
focus in investments that have or whose issuers have particular
characteristics, will now require the fund to adopt an 80% investment
policy and to define the terms used in its name.\42\
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\38\ See 2001 Names Rule Adopting Release, supra footnote 8.
\39\ For example, 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. 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. See Proposing
Release, supra footnote 2, at paragraph accompanying n.23; see also
infra section II.A.1.
\40\ See In the Matter of the Private Investment Fund for
Governmental Personnel, Inc., Investment Company Act Release No.
2474 (Jan. 18, 1957) (the Commission has historically expressed
that, in considering whether a name is deceptive or misleading,
``[a]ctual deception of investors need not be shown, it is
sufficient if the name of the company is found to have a tendency or
capacity to deceive or mislead'').
\41\ See NASAA Comment Letter; see also CFA Institute Comment
Letter. But see, e.g., infra footnote 75 and accompanying text.
\42\ See infra sections II.A.1 and II.B.
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Similarly, these amendments are designed to promote greater
specificity in the operation of funds' 80% investment policies to
enhance investor protection by helping to ensure that funds' names are
not misleading as their portfolios may shift over time--either because
of inadvertent portfolio ``drift'' or intentional departures from the
80% requirement.\43\ When an investor chooses to invest in a fund, that
person has made an intentional decision to invest in, for example, the
type of asset class, industry, or sector in which the fund's name
suggests an investment focus. That investor has a reasonable
expectation that the fund's investments will generally remain focused
in the area that the fund's name indicates.\44\ We appreciate, however,
that a naming rule that requires unwavering adherence to a particular
investment threshold risks harming funds and investors.\45\ This
rigidity ultimately could result in investor harm if portfolio managers
were not permitted to depart from their 80% investment policy for a
limited time to manage their funds appropriately in response to
changing circumstances.\46\ The amended rule enhances investor
protection by requiring funds to conduct at least quarterly reviews of
their portfolio investments for consistency with the 80% investment
policy requirement, and by adopting time frames to remedy departures
from 80% that seek to balance investors' reasonable expectations with
appropriate flexibility for advisers, consistent with their fiduciary
duty, to manage funds' portfolios.
---------------------------------------------------------------------------
\43\ See, e.g., Consumer Federation of America Comment Letter
(discussing the risk of funds changing their portfolios such that
the portfolios are no longer accurately reflected by the funds'
names).
\44\ See, e.g., Center for American Progress Comment Letter
(stating that investors' expectations and investment practices often
assume that investments in a fund will remain consistent with the
name over the longer term, and investors who wish to change their
own mix of investments typically do so by changing funds).
\45\ See, e.g., ICI Comment Letter; J.P. Morgan Asset Management
Comment Letter; Comment Letter of Dimensional Fund Advisors LP (Aug.
16, 2022) (``Dimensional Comment Letter''); Comment Letter of
Dechert LLP (Aug. 16, 2022) (``Dechert Comment Letter''); see also
infra section II.A.2.
\46\ See, e.g., SIFMA AMG Comment Letter; T. Rowe Comment
Letter.
---------------------------------------------------------------------------
Our disclosure and reporting framework can provide additional
tools, in connection with technological developments over the past two
decades, to augment investors' and other market participants'
understanding of fund names and to increase transparency of how a
fund's investment portfolio reflects the investment focus that its name
suggests. In the years since the names rule was adopted, the Commission
has adopted requirements to modernize reporting requirements for
registered investment companies, which build on significant advances in
the technology that can be used to report and analyze information--
namely, the use of structured data language.\47\ We recognize that
there are many types of fund names for which understanding additional
detail about how name terms are defined, and about the types of
investments that the term describes, would provide greater clarity to
an investor about the fund's investment focus. This may be helpful if,
for example, fund names that incorporate terms that may reflect new
themes or technologies become more prevalent. The final rules' enhanced
prospectus disclosure and reporting provisions, which require
information to be disclosed in structured data language, are designed
to address this goal.
---------------------------------------------------------------------------
\47\ Investment Company Reporting Modernization, Investment
Company Act Release No. 32314 (Oct. 13, 2016) [81 FR 81870 (Nov. 18,
2016)] (``Investment Company Reporting Modernization Adopting
Release''); see also Amendments to the Timing Requirements for
Filing Reports on Form N-PORT, Investment Company Act Release No.
33384 (Feb. 27, 2019) [84 FR 7980 (Mar. 6, 2019)]; Proposing
Release, supra footnote 2, at n.115 and accompanying text (generally
discussing rules requiring funds registering on Forms N-1A and N-2
to submit certain information using Inline XBRL format).
---------------------------------------------------------------------------
Finally, we are incorporating certain updates to the names rule to
address industry and technological developments over the past two
decades, and to address names-rule-related recordkeeping.
C. Overview of the Final Rules
1. Final Rules' Principal Elements
We are adopting amendments to the names rule, as well as related
disclosure and reporting requirements, in consideration of the issues
discussed above.
<bullet> Expansion of Scope. We are adopting, substantially as
proposed, amendments to the names rule that expand the rule's 80%
investment policy requirement beyond its current scope, to apply to any
fund name with terms suggesting that the fund focuses in investments
that have, or investments whose issuers have, particular
characteristics. This coverage will include, for example, fund names
with terms such as ``growth'' or ``value,'' or terms indicating that
the fund's investment decisions incorporate one or more ESG factors.
These names will be added to the names that are currently within the
scope of the 80% investment policy requirement--that is, generally,
fund names that suggest a focus in a particular type of investment, or
investments in a particular industry or geographic focus, and fund
names suggesting that a fund's distributions are tax-exempt.
<bullet> Temporary Departures from the 80% Investment Requirement.
In a change from the proposal, under which funds would have been
permitted to depart from the fund's 80% investment policy only under
certain specified circumstances, the final amendments retain the names
rule's current requirements for a fund to invest in accordance with its
80% investment policy ``under normal circumstances'' (the ``80%
investment requirement''), and for the 80% investment requirement to
apply at the time a fund invests its
[[Page 70441]]
assets. Also, in a change from the proposal, the final amendments add a
new provision that requires a fund to review its portfolio assets'
inclusion in its ``80% basket'' at least quarterly.\48\ Like the
proposal, the final amendments include specific time frames--generally
90 days, as opposed to 30 days as proposed--for getting back into
compliance if a fund departs from the 80% requirement as a result of
drift or in other-than-normal circumstances.
---------------------------------------------------------------------------
\48\ See final rule 35d-1(g) (defining ``80% basket'' generally
as investments that are invested in accordance with the investment
focus that the fund's name suggests).
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<bullet> Derivatives. Consistent with the proposal, the final
amendments generally require funds to use a derivatives instrument's
notional amount to determine the fund's compliance with its 80%
investment policy, with certain adjustments. In a change from the
proposal, the final amendments include a limited modification to this
approach that would exclude certain currency hedges from the names rule
compliance calculation. As proposed, we are also amending the names
rule to address the derivatives instruments that a fund may include in
its 80% basket.
<bullet> Unlisted Registered Closed-End Funds and BDCs. Consistent
with the proposal, the final amendments generally prohibit an unlisted
registered closed-end fund or BDC that is required to adopt an 80%
investment policy from changing that policy without a shareholder vote.
In a modification from the proposal, the final amendments permit these
funds to change their 80% investment policies without such a vote if:
(1) the fund conducts a tender or repurchase offer with at least 60
days' prior notice of the policy change, (2) that offer is not
oversubscribed, and (3) the fund purchases shares at their net asset
value.\49\
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\49\ See infra footnote 292 (discussing the use of net asset
value in the event of a tender offer, as well as a repurchase
offer).
---------------------------------------------------------------------------
<bullet> Enhanced Prospectus Disclosure. Substantially as proposed,
we are adopting amendments to funds' prospectus disclosure requirements
that will require a fund to define the terms used in its name,
including the criteria the fund uses to select the investments that the
term describes.
<bullet> Plain English Requirements for Terms Used in Fund Names.
The final amendments to the names rule, as proposed, effectively
require that any terms used in the fund's name that suggest either an
investment focus, or that the fund's distributions are tax-exempt, must
be consistent with those terms' plain English meaning or established
industry use.
<bullet> Form N-PORT Reporting Requirements. Consistent with the
proposal, we are adopting amendments to Form N-PORT for funds to report
the value of the fund's 80% basket, and whether an investment is
included in the fund's 80% basket. In a change from the proposal, the
final amendments also include a new reporting item to include the
definition(s) of terms used in the fund's name. Funds will have to
report this information for the third month of every quarter, instead
of for each month as proposed.
<bullet> Recordkeeping. Consistent with the proposal (but with
conforming changes to address the final rules' approach to temporary
departures from the 80% investment requirement), the final rules
include recordkeeping provisions related to a fund's compliance with
the rule's requirements. The final rules do not, however, include the
proposed requirement for funds that do not adopt an 80% investment
policy to maintain a record of their analysis that such a policy is not
required.
2. Other Aspects of the Proposal
We are not taking action on the proposed approach regarding the use
of ESG terms in the names of ESG ``integration funds'' at this time.
Under the proposed approach, the names of ESG ``integration funds''
would have been defined as materially deceptive and misleading if the
name includes terms indicating that the fund's investment decisions
incorporate one or more ESG factors.\50\ Under the proposal,
integration funds were described as 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. Such funds may select
investments because those investments would meet other criteria applied
by the fund's adviser (e.g., investments selected on the basis of
macroeconomic trends or company-specific factors like price-to-earnings
ratio). This description of integration funds in the names rule
proposal mirrored the definition of an integration fund in the
Commission's ESG Disclosure Proposal.\51\
---------------------------------------------------------------------------
\50\ Proposed rule 35d-1(d).
\51\ 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) [87 FR 36654 (June 17, 2022)] (``ESG Disclosure
Proposal''), at section II.A.1.
---------------------------------------------------------------------------
The proposed approach to integration funds in the names rule was
designed to target misleading fund names by making clear that it would
be materially 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. The proposed approach
would have addressed the Commission's concern that such funds have the
potential to overstate the importance of ESG factors in the fund's
investment selection process.\52\
---------------------------------------------------------------------------
\52\ See Proposing Release, supra footnote 2, at section II.D.
---------------------------------------------------------------------------
Commenters offered mixed feedback on the names rule's proposed
approach to integration fund names. Some commenters that supported the
proposed approach stated that it would help prevent investors from
believing that ESG factors play a more significant role than they
actually do in the investment process--i.e., protect investors from
greenwashing.\53\ Other commenters, however, questioned the
Commission's proposed approach, stating that the proposed approach
could act as a disservice to investors because, for example, it could
result in investors believing that integration funds do not consider
ESG factors when they actually do, or that the proposed approach could
hinder innovation.\54\ Because the proposed provision in the names rule
mirrored the separate proposed definition of an integration fund in the
ESG Disclosure Proposal, we are continuing to consider comments and are
not adopting the proposed approach to integration fund names at this
time. As discussed above, however, the final amendments' expanded scope
of the 80% investment policy requirement includes fund names with terms
suggesting that the fund focuses in investments that have, or
investments whose issuers have, particular characteristics--including
terms
[[Page 70442]]
indicating that the fund's investment decisions incorporate one or more
ESG factors.\55\
---------------------------------------------------------------------------
\53\ See, e.g., Comment Letter of Ceres (Aug. 16, 2022) (``Ceres
Comment Letter''); Consumer Federation of America Comment Letter;
Comment Letter of Evergreen Action (Aug. 15, 2022) (``Evergreen
Action Comment Letter'').
\54\ See, e.g., Cato Institute Comment Letter; Comment Letter of
Mutual Fund Directors Forum (Aug. 16, 2022) (``MFDF Comment
Letter'') (suggesting that the marketplace has been dynamic in
developing different approaches to bringing an ESG lens to various
investment strategies, and that the proposed rule, as the commenter
understood it to largely limit the use of ESG terms in fund names to
funds that use inclusionary or exclusionary screens (as well as to
funds that employ impact or proxy-voting strategies), risks
hindering further innovation in the fund space as ESG strategies
continue to evolve); Comment Letter of Minerva Analytics (Aug. 16,
2022) (``Minerva Comment Letter'').
\55\ See supra section I.C.1; see also final rule 35d-1(a)(2).
---------------------------------------------------------------------------
II. Discussion
A. 80% Investment Policy Requirement
1. Names Suggesting an Investment Focus
Consistent with the proposal, we are adopting amendments that
broaden the scope of the names rule's 80% investment policy requirement
to apply also to fund names that include terms suggesting that the fund
focuses in investments that have, or whose issuers have, particular
characteristics.\56\ These amendments will apply in addition to the
existing 80% investment policy requirement for funds whose name
suggests a focus in a particular type of investment, industry, country,
or geographic region, or those whose name suggests certain tax
treatment. The purpose of the names rule is to prevent fund names from
misrepresenting the fund's investments and risks.\57\ The expanded
scope of the final amendments furthers this objective by ensuring that
a fund's investment activity is consistent with the investment focus
its name communicates.
---------------------------------------------------------------------------
\56\ As used in this release, consistent with 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.
\57\ See Proposing Release, supra footnote 2, at n.5 and
accompanying text.
---------------------------------------------------------------------------
a) General Discussion
The Commission proposed to expand the 80% investment policy
requirement to apply to fund names that include terms suggesting that
the fund focuses in investments that have, or whose issuers have,
particular characteristics, whether or not such terms connote an
investment strategy. In response to the proposal, commenters expressed
that the names rule, as currently constituted, fails to capture a large
segment of funds because the rule makes a distinction between terms
that reference a type of investment and an investment strategy.\58\
These commenters supported the proposed scope expansion, asserting that
terms in fund names that reference an investment strategy often
communicate to investors an investment focus, thus creating a
reasonable expectation among investors that the fund will hold
investments that support that focus.\59\ These commenters suggested
that expanding the scope of the rule to include any term in a fund's
name that communicates an investment focus, whether or not that term
references an investment strategy, is necessary to modernize the rule
and is a logical step to help ensure that investment companies cannot
circumvent the intent of the rule when naming funds.\60\ Some
commenters also asserted that the proposed expansion of the scope would
bring more ``discipline and clarity'' to fund naming practices and, in
turn, help investors make more informed investment decisions.\61\ In
particular, many commenters asserted that the expanded scope would
improve the ability of investors to discern between funds in the ESG
investment industry and better protect investors looking for exposure
to ESG investments.\62\ In addition, one commenter suggested that the
Commission provide more clarity on whether the expanded scope would
cover names suggesting a focus on ``thematic'' areas.'' \63\
---------------------------------------------------------------------------
\58\ See, e.g., Consumer Federation of America Comment Letter;
Center for American Progress Comment Letter; NASAA Comment Letter;
see also Proposing Release, supra footnote 2, at n.23 and
accompanying text (discussing that the Commission has historically
taken the position that fund names that incorporate terms that
connote an investment objective, strategy, or policy are not within
the scope of the 80% investment policy requirement).
\59\ See, e.g., NASAA Comment Letter; Comment Letter of
Principles for Responsible Investment (Aug. 16, 2022); (``PRI
Comment Letter''); Comment Letter of Soundboard Governance (Aug. 16,
2022) (``Soundboard Governance Comment Letter'') (focusing
particularly on the inclusion of ESG-related terms in the proposed
scope expansion).
\60\ See, e.g., Consumer Federation of America Comment Letter;
Center for American Progress Comment Letter.
\61\ See NASAA Comment Letter; Better Markets Comment Letter;
Consumer Federation of America Comment Letter.
\62\ See, e.g., Comment Letter of Sierra Club (Aug. 16, 2022)
(``Sierra Club Comment Letter''); Better Markets Comment Letter;
Evergreen Action Comment Letter.
\63\ See NASAA Comment Letter (expressing that funds with names
that suggest a focus on ``trendy'' thematic areas in particular
should be required to adopt an 80% investment policy and stating
that investors, funds, and regulators would ``be well served by
greater clarity'' on whether the proposed expansion would thematic
fund names); see also Comment Letter of Seward & Kissel LLP (Aug.
16, 2022) (``Seward & Kissel Comment Letter'') (stating that that
the tension between words suggesting a ``type of investment'' versus
those suggesting an ``investment strategy'' has resulted in the
[names rule] being inconsistently applied, especially with respect
to funds using thematic strategies.'').
---------------------------------------------------------------------------
In contrast, many commenters objected to the proposal because, in
their view, the expansion of the 80% investment policy requirement
would lead to interpretive challenges and added compliance costs for
fund advisers without providing commensurate benefit to investors.\64\
In particular, they stated that the expanded scope incorporates a vague
standard that is more subjective than the current scope of the names
rule which, in contrast with the proposal, they believed applies a more
objective and intuitive framework that sufficiently ensures that fund
assets are invested in accordance with reasonable expectations based on
a fund's name.\65\ They questioned whether the names included in the
expanded scope effectively communicate any real investment focus to
investors, absent further information about a fund's objectives.\66\
Because these names are vague, they asserted, investors would still
need to review a fund's disclosures to understand how the investment
strategy is executed for these newly included terms, limiting the value
of the rule.\67\ These commenters contended that the proposed expansion
of the 80% investment policy requirement has limited investor
protection benefits because it overemphasizes the importance of a
fund's name, and thus disincentivizes investors from looking beyond the
name to review information in fund prospectuses and related
disclosures.\68\ In addition, several commenters questioned whether the
Commission adequately articulated how terms that would be included in
the proposed scope have led to investor confusion, deception, or harm
such that they should be subject to the rule.\69\
---------------------------------------------------------------------------
\64\ See, e.g., Comment Letter of Stradley Ronon (Aug. 16, 2022)
(``Stradley Comment Letter''); SIFMA AMG Comment Letter; TIAA-Nuveen
Comment Letter; Comment Letter of Calamos Investments (Aug. 16,
2022) (``Calamos Comment Letter'').
\65\ See, e.g., Calamos Comment Letter; Invesco Comment Letter;
Comment Letter of Federated Hermes, Inc. (Aug. 16, 2022)
(``Federated Hermes Comment Letter''); MFS Comment Letter; Comment
Letter of Nationwide Funds Group (Aug. 16, 2022) (``Nationwide
Comment Letter''); Robertson-Fisch Comment Letter (discussing these
points in the context of ESG funds); T. Rowe Comment Letter; see
also PRI Comment Letter (supporting the proposed scope expansion,
but requesting that the Commission provide a definition of
``characteristics'' in the proposed language expanding the scope).
\66\ See, e.g., MFS Comment Letter; ICI Comment Letter; Capital
Group Comment Letter; Cato Institute Comment Letter.
\67\ See SIFMA AMG Comment Letter; ICI Comment Letter (comparing
the uniformity of an 80% investment policy for funds with ``equity''
in their name to the potential inconsistency in 80% investment
policies for funds with ``growth'' in their name).
\68\ See, e.g., MFS Comment Letter; Capital Group Comment
Letter; Cato Institute Comment Letter.
\69\ See, e.g., Comment Letter of WisdomTree Asset Management
(Aug. 16, 2022) (``WisdomTree Comment Letter''); SIFMA AMG Comment
Letter; Invesco Comment Letter; Dechert Comment Letter. Commenters
also pointed to the lack of enforcement cases charging rule 35d-1 or
shareholder suits in this area as a reason to not expand the scope.
See, e.g., Nationwide Comment Letter; Capital Group Comment Letter;
ICI Comment Letter IV.
---------------------------------------------------------------------------
[[Page 70443]]
Commenters also suggested that this vagueness would result in the
costs of implementation of the proposed amendments being high relative
to what they stated would be minimal value to investors. Commenters
stated that interpretive issues relating to the proposed scope's
vagueness would result in a number of adverse consequences, including
inconsistent application of the 80% investment policy requirement,
uncertainty in determining whether a term suggests a particular
investment focus, and, where a fund has adopted an 80% investment
policy, whether a particular investment is consistent with that
policy.\70\ Commenters also suggested that it would be challenging to
establish automated compliance monitoring solutions for terms in fund
names where subjective criteria are part of the decision-making
process.\71\ As a result, commenters expressed that funds would need
either to require portfolio managers to adhere to specific rigid
criteria, stifling innovative investment strategies, or to engage in
some level of manual review, significantly increasing the complexity
and compliance burdens for funds.\72\ Commenters also raised concerns
that, for funds that would be within the scope of the 80% investment
policy requirement, a portfolio manager's expectations with respect to
investments that would qualify for inclusion in the 80% basket may
ultimately prove wrong or change over time, which could make compliance
with the names rule challenging.\73\ Relatedly, commenters expressed
the concern that the expanded scope could lead to retroactive second-
guessing of portfolio managers' designations of investments by
Commission staff.\74\ To avoid these implementation problems,
commenters suggested funds may use broader, more generic names that
convey less information to investors in order to avoid adopting an 80%
investment policy.\75\
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\70\ See, e.g., ICI Comment Letter; SIFMA AMG Comment Letter;
Invesco Comment Letter; Dechert Comment Letter; Comment Letter of
Fidelity Management & Research Company LLC (Aug. 16, 2022)
(``Fidelity Comment Letter''); Ceres Comment Letter.
\71\ See, e.g., ICI Comment Letter; T. Rowe Comment Letter;
SIFMA AMG Comment Letter; Invesco Comment Letter. Scalable and
automatic compliance monitoring systems typically rely on third-
party data providers to tag investments but such providers could
vary their classification of investments and may not use the same
classification as the fund. See, e.g., Comment Letter of Freeman
Capital Management (July 24, 2022) (``Freeman Capital Management
Comment Letter''); Invesco Comment Letter; T. Rowe Comment Letter.
\72\ See, e.g., Dechert Comment Letter; Invesco Comment Letter;
TIAA-Nuveen Comment Letter; J.P. Morgan Asset Management Comment
Letter; T. Rowe Comment Letter; Wellington Comment Letter; ICI
Comment Letter; Invesco Comment Letter; Freeman Capital Management
Comment Letter.
\73\ See, e.g., SIFMA AMG Comment Letter; Fidelity Comment
Letter; J.P. Morgan Asset Management Comment Letter; Stradley
Comment Letter (stating that ```equity' and `fixed income'
investments do not change their categorization due to market
declines, cycles or volatility, as compared to a value stock, that,
if subjected to only objective criteria, can and does migrate from
one category to another'').
\74\ See, e.g., ICI Comment Letter; Federated Hermes Comment
Letter; J.P. Morgan Asset Management Comment Letter.
\75\ See, e.g., Dechert Comment Letter; ICI Comment Letter
(asserting that the proposed amendments could also incentivize
longer, more complex fund names that seek to capture the full range
of investments reflected in a fund's investment strategy).
---------------------------------------------------------------------------
Many commenters expressed particular concern with the inclusion of
the terms ``growth'' and ``value'' in the proposed scope.\76\
Commenters asserted that there are no precise definitions or
standardized criteria used to classify these types of investments.\77\
Rather, commenters expressed that portfolio managers have unique
qualitative and quantitative criteria that they evaluate when selecting
growth or value investments, some of which rely on more subjective
determinations that may vary among portfolio managers.\78\ A few
commenters suggested that investors invest in certain growth or value
funds because they believe in a manager's unique analysis and
conclusions for selecting investments.\79\ Some commenters expressed
that requiring growth or value funds to define terms in their name and
disclose the criteria used to select investments would lead to more
rigidity in investment selection, resulting in less flexibility for
managers to implement investment strategies that traditionally have
been managed with more nuance.\80\
---------------------------------------------------------------------------
\76\ See, e.g., ICI Comment Letter; Dechert Comment Letter; T.
Rowe Comment Letter.
\77\ See, e.g., Fidelity Comment Letter; Nationwide Comment
Letter; Stradley Comment Letter.
\78\ See, e.g., Wellington Comment Letter; MFS Comment Letter;
ICI Comment Letter.
\79\ See Stradley Comment Letter; SIFMA AMG Comment Letter.
\80\ See, e.g., Wellington Comment Letter; Nationwide Comment
Letter; Stradley Comment Letter.
---------------------------------------------------------------------------
To avoid these interpretative challenges and compliance burdens, a
number of commenters suggested narrowing the scope of the final rule to
that of the current rule or to exclude terms that do not readily reduce
to measurable characteristics, and for which evaluations, opinions, and
views reasonably may vary.\81\ Separately, some commenters urged the
Commission to require enhanced disclosure in a fund's registration
statement when its name indicates an investment strategy, rather than
expanding the scope to mandate an 80% investment policy for these
funds.\82\ Several commenters expressed that investor access to
disclosures and information about funds is widespread and easily
accessible, making an investor's need to rely on a fund name to
evaluate the fund's strategy less necessary than when the Commission
adopted the names rule.\83\
---------------------------------------------------------------------------
\81\ See, e.g., ICI Comment Letter; Invesco Comment Letter;
Federated Hermes Comment Letter; Dechert Comment Letter; TIAA-Nuveen
Comment Letter; see also Calamos Comment Letter (asserting that, if
the expanded scope is adopted, the Commission should consider
excluding existing funds from the rule's requirements because
compliance may be costly and have unanticipated effects for existing
funds that are not currently subject to the rule).
\82\ SIFMA AMG Comment Letter; Invesco Comment Letter; Comment
Letter of Calvert Research and Management (Aug. 16, 2022) (``Calvert
Comment Letter''); CFA Institute Comment Letter (recommending that
when a fund's name suggests an investment focus, the investment
focus must be consistent with the key factors in the principal
investment strategies that are disclosed in the fund's registration
statement). See also ICI Comment Letter IV (asserting that the
proposed amendments are unnecessary because existing prospectus
disclosure requirements and other regulatory obligations, such as
rules 482 and 156 under the Securities Act of 1933 and FINRA Rule
2210, provide a sufficient framework to ensure that fund
communications are clear and not misleading).
\83\ See SIFMA AMG Comment Letter; Dechert Comment Letter; T.
Rowe Comment Letter.
---------------------------------------------------------------------------
After considering comments, we are adopting, substantially as
proposed, amendments that expand the rule's 80% investment policy
requirement to apply to any fund with terms in its name that suggest
that the fund focuses in investments that have, or investments whose
issuers have, particular characteristics. We recognize that some
commenters expressed concerns about perceived vagueness associated with
the ``particular characteristics'' language in the proposed rule.\84\
The amended rule provides, as proposed, an illustrative parenthetical
that is designed to give non-exclusive examples of terms that suggest
that the fund focuses in investments that have, or whose issuers have,
particular characteristics. The parenthetical provides as examples the
terms ``growth'' or ``value,'' or terms indicating that the fund's
investment decisions incorporate one or more ESG factors.\85\ We are
not defining the term ``particular characteristics'' in the rule, as
suggested by a commenter, because we believe that this term will be
[[Page 70444]]
adequately understood to mean any feature, quality, or attribute.\86\
We are adopting this approach, rather than an approach that provides an
enumerated list of terms included in the expanded scope, in light of
the broad diversity of fund investment strategies and fund names, and
to ensure that the rule remains evergreen. Based on our understanding
of the fund industry and current practice, however, we anticipate that
the primary types of names that the expanded scope will cover will be
names that include the terms ``growth'' and ``value,'' terms with ESG-
or sustainability-related characteristics, or terms that reference a
thematic investment focus.
---------------------------------------------------------------------------
\84\ See, e.g., Stradley Comment Letter; TIAA-Nuveen Comment
Letter; Cato Institute Comment Letter.
\85\ See infra sections II.A.1.d) and II.D.
\86\ See supra footnote 65.
---------------------------------------------------------------------------
We recognize that many commenters opposed expanding the scope of
the rule, and the inclusion of terms such as ``growth'' and ``value''
in particular. While we appreciate these commenters' concerns, it is
important to balance these concerns with the investor protection goals
that underlie the names rule and section 35(d) of the Investment
Company Act. Although there have been limited Commission enforcement
cases citing section 35(d) of the Act, Commission and staff's
experience with the names rule over the past two decades and
developments in the fund industry during this time period, including
the increase in fund assets under management and the proliferation of
diverse fund strategies, lead us to modernize and enhance the names
rule to further the investor protection goals of section 35(d).\87\
---------------------------------------------------------------------------
\87\ See infra at footnote 494 and accompanying text (asserting
that the lack of Commission enforcement actions citing section 35(d)
of the Act is evidence that the general framework of the rule is
effective, not that further enhancements to the rule are
unnecessary).
---------------------------------------------------------------------------
We are adopting amendments that do not distinguish between a type
of investment and an investment strategy because 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. We understand that funds typically
include certain terms in their name to communicate an investment focus
and to appeal to investors choosing among available investment
options.\88\ As some commenters believed, the names included in the
expanded scope can serve as the initial bases upon which investors make
investment decisions and create reasonable expectations that funds that
use those terms will focus on investments and issuers that have the
specified characteristics that a fund's name suggests.\89\ For example,
terms like ``growth'' and ``value'' create reasonable expectations
among investors that funds with those terms in their name will invest
predominantly in companies that exhibit ``growth'' or ``value''
characteristics. By expanding the scope of the 80% investment
requirement to include these names, the final amendments will help
ensure that these types of funds have portfolios that reflect the
investment focus their name suggests. Further, the expanded scope in
the final amendments will reduce the existing inconsistencies in the
application of the rule by eliminating the need for fund managers to
determine whether their name references a type of investment or an
investment strategy.
---------------------------------------------------------------------------
\88\ For example, funds have increasingly chosen names that
include terms that reference popular industry themes, business
sectors, or investment strategies. See supra footnote 33 and
accompanying text (discussing the increase in filings over the last
few years by funds with names that reference popular industry themes
and business sectors, providing some evidence that investors are
attracted to these fund names). See also supra footnote 36
(suggesting that ESG terminology in fund names is effective in
attracting inflows).
\89\ See NASAA Comment Letter; Consumer Federation of America
Comment Letter; PIABA Comment Letter.
---------------------------------------------------------------------------
The Commission staff has observed an increase in filings by funds
that use ``thematic'' terms in their name.\90\ We understand that fund
managers and others would consider certain of these thematic names to
be included in the current scope of the names rule. For instance,
certain terms may be viewed as clearly suggesting a focus in a type of
industry or group of industries (e.g., terms suggesting a focus in
cybersecurity, health and wellness, or travel and tourism).\91\ There
could be reasonable questions, however, about whether other thematic
terms suggest a focus in a particular type of investment, or in
investments in a particular industry or group of industries. This could
occur, for example, because a thematic term may be narrower or more
expansive than an ``industry'' may be commonly understood (e.g.,
drones, ``smart cities,'' metaverse, ``big data''). And there are
certain thematic terms that we believe most practitioners would not
consider to suggest a focus in a type of investment, or a focus in a
particular industry or group of industries (e.g., terms suggesting
demographic characteristics such as ``millennial'' or ``Gen Z,'' or
political, economic, or historical themes such as ``biothreat,'' ``gig
economy,'' ``meme stocks,'' or ``post-Corona''). The effect of the
scope of the final amendments is that, to the extent a fund uses a term
in its name that suggests an investment focus, including any term that
references a thematic investment focus, the fund will be required to
adopt an 80% investment policy, which in turn will help ensure it will
invest in accordance with the investment focus its name suggests.
---------------------------------------------------------------------------
\90\ See supra footnote 33 and accompanying text.
\91\ In cases where certain terms that suggest a focus in a type
of industry have been coupled with the word ``strategy,'' some funds
have argued that the name suggests a focus in an investment strategy
and not a type of investment, and therefore should not be within the
scope of the 80% investment policy requirement. As discussed above,
the expansion of the scope of the 80% investment policy requirement
includes terms suggesting that the fund focuses in investments that
have, or whose issuers have, particular characteristics, whether or
not such terms connote an investment strategy.
---------------------------------------------------------------------------
We understand that certain terms used in fund names may have more
objective or standardized criteria than other terms. For instance the
term ``equity'' generally has a more standardized definition, whether
based on plain English principles or established industry use, compared
to terms like ``growth'' and ``value.'' However, not all names that
fall within the scope of the current rule have precise definitions or
standardized, objective criteria. For instance, for fund names that
reference a particular region or country, it is often not immediately
apparent based on the terms in a fund's name whether the fund invests
in issuers that are domiciled in the specific region, have a large
presence in the region, or have some other nexus to the region. An
investor may generally understand what constitutes ``Latin America,''
and seek out a ``Latin American'' fund, but different portfolio
managers may apply different definitions of what specifically ``Latin
America'' means in practice for their fund because definitions of
``Latin America,'' using plain English or industry use of the term, can
reasonably differ.
This variation is evident based on the principal investment
strategies disclosed in fund prospectuses. For example, a ``Latin
America'' fund offered by one adviser has an 80% investment policy to
invest in securities of issuers that derive at least 50% of revenue
from Latin American markets (defined to include Spanish-speaking
islands in the Caribbean), without consideration of the issuers'
domicile, headquarters, or primary trading market. In contrast, another
``Latin America'' fund managed by a different adviser has a policy to
invest at least 80% in securities of issuers that are domiciled in
Latin America (defined to exclude Mexico and Caribbean islands), that
derive significant revenues from Latin America, or the securities trade
on
[[Page 70445]]
exchanges located in Latin America. Each of these examples is
consistent with the plain English or industry use of the term and
demonstrates the flexibility the final amendments will provide to fund
managers in developing definitions of the terms used in a fund's name.
Moreover, given the proliferation of the diversity of fund investment
strategies and fund names since the rule was originally adopted,
retaining the current rule's scope or excluding terms that do not
always neatly reduce to measurable characteristics, as suggested by
commenters, would undermine the investor protection purposes of the
rule.
The final rule also is not as rigid as many commenters seem to
contend when, for example, they suggested that a rule that requires
pre-determined definitions of certain terms could lead to retroactive
second-guessing by Commission staff and result in funds adopting more
generic names or could create incentives for longer, more complex
names. The amended rule provides fund managers with flexibility to
ascribe reasonable definitions for the terms used in a fund's name and
flexibility to determine the specific criteria the fund uses to select
the investments that the term describes.\92\ We understand that
different funds and various third-party data providers may use
different definitions for the same term in order to best reflect a
particular investment strategy. The amended rule is designed for funds
to retain reasonable discretion in establishing their 80% investment
policies, which allows funds to implement nuanced and innovative
investment strategies.\93\ We also appreciate, for many terms, there
will be various reasonable means of implementing an 80% investment
policy that incorporates a definition or understanding of terminology
that differs from another fund whose name incorporates the same
terminology. For example, different funds may have ``growth'' in their
name, and each of these funds may have portfolio managers who have
different approaches to selecting investments that have growth
characteristics. In such circumstances, two funds would naturally have
different policies that reflect their portfolio managers' distinct
approaches to growth investing. In this example, each of these funds
would describe to investors how it defines ``growth,'' provided the
definitions are consistent with the term's plain English meaning or
established industry use, and then invest 80% of their investments in
accordance with their description.\94\
---------------------------------------------------------------------------
\92\ See infra section II.C. This flexibility also means a fund
would not be required to include proprietary information in its 80%
investment policy. See Stradley Comment Letter (asserting that
providing meaningful distinctions among funds may require over-
disclosing the criteria used to select investments, which investment
advisers may be hesitant to provide to avoid giving away proprietary
information).
\93\ As a result of this flexibility, we disagree with
commenters that asserted that the expanded scope would effectively
penalize funds that invest in a security that initially displays
particular characteristics but where those characteristics evolve
over time. See supra footnote 73. However, to the extent that a fund
identifies as part of the final rule's quarterly review requirement
that the characteristics of an existing investment in the fund's
portfolio are inconsistent with the fund's 80% investment policy as
a result of, for example, market declines, cycles, or volatility,
the fund must address this in accordance with the rule's
requirements for temporary departures from the 80% investment
requirement. See infra footnote 185 and accompanying paragraph; see
also section II.E.1.
\94\ See also infra paragraph accompanying footnotes 153-154;
infra paragraph accompanying footnotes 357-358.
---------------------------------------------------------------------------
In addition, we understand that the expansion of the rule's scope
will involve operational costs for many funds, particularly those that
are not currently subject to the rule.\95\ In a modification from the
proposal, however, the amended rule will no longer require a fund to
re-assess its portfolio investments continuously to determine
compliance with its 80% investment policy, but will instead require
reassessment of each portfolio investment on an at-least quarterly
basis.\96\ This modification will address concerns commenters raised
related to cost burdens associated with the proposed scope expansion,
to the extent that those concerns largely related to the costs of
continuous monitoring and assessment of a fund's 80% investment
policy.\97\ Moreover, considering that not all terms that fall within
the scope of the current rule have standardized and objective
definitions (e.g., ``Latin America'' funds as discussed above),
existing compliance monitoring for these funds likely necessitates some
form of manual review to ensure that investments are consistent with
the manner in which the fund defines a given term. The assessment that
funds would have to undertake to ensure that portfolio investments are
consistent with their 80% investment policies under the final rules
would entail this same aspect of current fund practices.\98\
---------------------------------------------------------------------------
\95\ See infra sections IV and V.
\96\ See infra section II.A.2.
\97\ See infra section IV.D.2.
\98\ See infra section II.A.2.a) (discussing compliance
monitoring and portfolio investment assessment and re-assessment
requirements under the final amendments and how these requirements
compare to current names rule requirements).
---------------------------------------------------------------------------
The final amendments' approach, which combines an expanded 80%
investment policy requirement with additional disclosure and reporting
requirements, reflects that certain terms used in a fund's name can
simultaneously communicate an investment focus while also reflecting
nuance that should be further discerned after reviewing the fund's
prospectus disclosure.\99\ The Commission has historically encouraged
investors to look beyond a fund's name and to review a fund's
underlying disclosures to gather information about the fund's
investment activity and objectives, and we continue to encourage
this.\100\ We understand that such disclosures are easily accessible
for most investors and that the current regulatory framework is
designed to help ensure that fund disclosures, marketing materials, and
other communications are clear, informative, and not misleading. We
agree, however, with commenters who stated that, despite this
accessibility, fund names can play a critical role in investment
decisions. Congress provided the Commission with rulemaking authority
to address materially deceptive or misleading fund names, recognizing
the concern that investors may focus on a fund's name and what it
communicates about the fund's investments and risks despite the
information included in fund prospectuses and related disclosures.\101\
Accordingly, the final amendments require funds that use terms that
communicate an investment focus to adopt an 80% investment policy, in
furtherance of the investor protection objectives of the names rule, to
provide greater assurance that a fund's investments will be consistent
with its name.
---------------------------------------------------------------------------
\99\ See infra sections II.B and II.E.
\100\ See supra footnote 9.
\101\ See supra footnote 7.
---------------------------------------------------------------------------
Separately, a few commenters questioned the Commission's authority
to adopt the proposed amendments under section 35(d) of the Investment
Company Act.\102\ For instance, one commenter asserted that the
Commission lacks authority to adopt the amendments, as ``[t]here is a
significant difference between a name based on investors' reasonable
expectations and a name that is materially deceptive or misleading.''
\103\ Another commenter suggested that neither the current rule nor the
proposed amendments are
[[Page 70446]]
consistent with the authority that section 35(d) grants, as neither
incorporates a finding by the Commission that a particular and
identified word or words are materially deceptive or misleading.\104\
Lastly, one commenter asserted that the proposed amendments would have
associated costs and burdens, and suggested that Congress did not
intend for section 35(d) to authorize the Commission to impose
significant burdens that would have a material economic impact on funds
and their investors.\105\
---------------------------------------------------------------------------
\102\ See, e.g., ICI Comment Letter; Stradley Comment Letter;
Seward & Kissel Comment Letter.
\103\ ICI Comment Letter I; see also ICI Comment Letter IV
(asserting that ``the Commission lacks authority to adopt the
[proposed amendments] under [section 35(d)]'' because the proposed
amendments are ``too vague and ambiguous,'' and do not satisfy the
``materiality'' requirement in section 35(d)).
\104\ Seward & Kissel Comment Letter (stating that ``[w]e think
the appropriate reading of Section 35(d) is that . . . funds subject
to the prohibitions of the statute (and any regulations adopted
thereunder) could provide, through the notice and comment process,
comments on the specific ``word or words'' proposed by the
Commission to be deemed materially deceptive or misleading'').
\105\ SIFMA AMG Comment Letter; see also Calamos Comment Letter.
---------------------------------------------------------------------------
We disagree with the views expressed by these commenters. Congress,
in enacting amended section 35(d) of the Act, reaffirmed its concern
that investors may focus on a fund's name to determine the fund's
investments and risks, and recognized that investor protection would be
improved by giving the Commission rulemaking authority to define
materially deceptive or misleading fund names.\106\ Before this
amendment, the Commission was required to ``declare by order that a
particular name was misleading and, if necessary, obtain a federal
court order prohibiting further use of the name.'' \107\ In light of
this ``cumbersome process,'' \108\ Congress gave the Commission the
power to act by ``rule, regulation, or order.'' \109\ Congress further
gave the Commission the authority to ``define such names or titles as
are materially deceptive or misleading,'' not ``list'' or another
similar word, and whether any ``word or words'' are materially
deceptive or misleading is a determination that necessarily is made
with reference to additional facts and circumstances.\110\
---------------------------------------------------------------------------
\106\ 2001 Names Rule Adopting Release, supra footnote 8, at
section I.
\107\ See id. at text proceeding footnote 3.
\108\ S. Rep. No. 293, 104th Cong., 2d Sess. 8-9 (1996)
(``Enforcing the Act entails a cumbersome process--the Commission
must first find, and declare by order, that a fund's name is
deceptive or misleading, and then bring an action in federal court
to enjoin the use of the name'').
\109\ 15 U.S.C. 80a-34(d).
\110\ Id. (emphasis added); see also 80a-34(a) & (b) (making it
unlawful for certain persons to ``represent or imply'' that a
security is guaranteed or approved by the U.S. government or a bank,
but not listing every specific statement that would do so).
---------------------------------------------------------------------------
Relying on this authority, the Commission in 2001 adopted the names
rule to ``address certain investment company names that are likely to
mislead an investor about a company's investment emphasis,'' which
would ``guard against the use of misleading investment company names,''
``provide an investor greater assurance that the company's investments
will be consistent with its name,'' and ``reduce confusion.'' \111\
Similarly here, the Commission in adopting rule amendments is
exercising its authority under section 35(d) to ``define,'' ``by
rule,'' ``such names or titles as are materially deceptive or
misleading'' and is doing so based on consideration of the broad public
input the Commission has received on fund names, our analysis of this
input, the Commission and staff's experience with the names rule over
the past two decades, and developments in the fund industry during this
time period.\112\ In the years since the Commission has adopted the
names rule, it has observed certain general trends--specifically as
discussed above, a significant broadening of fund investment options
currently available, the growth of fund assets in sector funds and
thematic strategies, and a growth in investor interest in funds with
ESG strategies--that have caused us to believe that targeted action in
this area is necessary.\113\
---------------------------------------------------------------------------
\111\ See id.
\112\ See supra section I.B; see also, e.g., Environmental
Defense Fund Comment Letter; Comment Letter of Sierra Club (Aug. 16,
2022) (``Sierra Club Comment Letter''); Ceres Comment Letter (all
discussing the proposed amendments as within the Commission's
authority to define materially deceptive and misleading names under
section 35(d) of the Act).
\113\ See supra footnote 33 and accompanying text.
---------------------------------------------------------------------------
Although we acknowledge that the final amendments may impose
additional costs and burdens relative to the current rule, we have made
changes to the proposed amendments that have the result of mitigating
the burdens associated with the final amendments compared to the
proposal. The costs and burdens associated with the final amendments
are carefully considered by the Commission, and such costs and burdens
are justified given the investor protection objectives that underlie
section 35(d) and that would be achieved through the amendments.
Further, another commenter asserted that application of the
proposed amendments to terms that suggest investments with particular
characteristics would violate the First Amendment, as this ``operates
as a restriction on funds' ability to speak through their names.''
\114\ We disagree that this aspect of the amendments violates the First
Amendment. As we have explained elsewhere in this release, as Congress
recognized by adopting section 35(d), fund names can provide important
information to investors regarding the nature of the fund and therefore
the nature of their potential investment. And names that do not
necessarily fall under the existing rule can create reasonable investor
expectations by suggesting a particular investment focus. The
amendments adopted today will help align fund names and investor
expectations by applying the 80% requirement to all names that suggest
a particular investment focus, reducing the extent to which funds can
choose names that are materially misleading or deceptive. Rather than
barring the use of any particular name, the amendment imposes certain
requirements when the name a fund has selected communicates specific
and important information about the fund. Further, the amendments allow
funds the flexibility to ascribe reasonable definitions for the terms
used in their names.\115\ The amendments are therefore appropriately
tailored to serve Congress's significant interest in preventing
investors from being deceived or misled.\116\
---------------------------------------------------------------------------
\114\ ICI Comment Letter IV.
\115\ See supra footnote 92 and accompanying text.
\116\ For similar reasons, we disagree with the commenter who
asserted that certain proposed reporting requirements on Form N-PORT
violate the First Amendment. ICI Comment Letter IV. These
requirements do not require reporting of ``subjective information on
which investment managers may appropriately disagree,'' (id.) but
instead provide important information to investors regarding whether
and how a fund's investments align with reasonable expectations
created by the fund's name and 80% investment policy.
---------------------------------------------------------------------------
b) Names That Do Not Suggest an Investment Focus
The 2022 Proposal acknowledged that 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.\117\ In
particular, the Commission stated that terms in a fund's name that
reference characteristics of the fund's portfolio as a whole, such as a
name indicating the fund seeks to achieve a certain portfolio
``duration'' or that the fund is ``balanced,'' would not require the
fund to adopt an 80% investment policy.\118\ The Commission stated that
in such cases a term may indicate a fund's objectives without
communicating to investors the specific type of investments, or the
particular characteristics of investments, that the
[[Page 70447]]
fund will acquire.\119\ Commenters generally agreed that such terms
would not require an 80% investment policy under the proposal and that
this treatment was appropriate.\120\
---------------------------------------------------------------------------
\117\ See Proposing Release, supra footnote 2, at n.49 and
accompanying text.
\118\ Id.
\119\ 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 includes section 35(d). Id. at n.50 and accompanying
text.
\120\ See, e.g., J.P. Morgan Asset Management Comment Letter;
Fidelity Comment Letter; ICI Comment Letter; SIFMA AMG Comment
Letter.
---------------------------------------------------------------------------
Many commenters, however, sought additional clarity on terms--such
as ``growth'' and ``value''--that commenters stated can reference
either the characteristics of a fund's investments or the intended
result of a fund's portfolio investments in the aggregate.\121\ One
commenter focused in particular on ESG ``uplift'' funds, where the fund
begins with a given universe of investments and does not add new
investments to this universe but systematically over-or underweights
investments within the given universe based on ESG criteria, with the
objective of achieving a more favorable ESG profile at an aggregate
fund level as compared to the benchmark or investment universe, within
a specific tracking error target.\122\ The fund is investing on a
relative basis at the portfolio level, rather than focusing its
investment in companies that objectively exhibit strong ESG
characteristics, and includes terms in the fund's name intended to
communicate this investment approach to investors (such as ESG
``Aware''). Commenters also expressed concern with the proposal's
discussion of maturity-related terms that describe certain bond funds'
holdings.\123\ These commenters agreed with the Commission that the
term duration should not require an 80% investment policy because it
refers to a portfolio-wide analysis; however, they further asserted
that terms like ``intermediate-term (or similar) bond'' are likewise
used by funds and understood by investors similarly to refer to the
portfolio's duration (i.e., the portfolio's sensitivity to interest
rate changes). Commenters also suggested that terms like ``global'' and
``international'' should continue to be outside of the scope of the 80%
investment policy requirement because these terms reference the
portfolio as a whole.\124\
---------------------------------------------------------------------------
\121\ See, e.g., TIAA-Nuveen Comment Letter; Calamos Comment
Letter; T. Rowe Comment Letter; WisdomTree Comment Letter; ICI
Comment Letter (stating that ``[t]erms that could refer to either a
particular investment or the portfolio as a whole are per se not
misleading or deceptive because they do not create an affirmative
impression in one way or another'').
\122\ See Comment Letter of BlackRock, Inc. (Dec. 19, 2022)
(``BlackRock Comment Letter''); see also Robertson-Fisch Comment
Letter (discussing ESG ``tilt'' strategies).
\123\ See ICI Comment Letter; SIFMA AMG Comment Letter; Invesco
Comment Letter.
\124\ See, e.g., Dechert Comment Letter; ICI Comment Letter;
Invesco Comment Letter; Seward & Kissel Comment Letter.
---------------------------------------------------------------------------
Conversely, several commenters urged that certain terms may not
connote particular characteristics of a fund's portfolio investments,
but nonetheless should require an 80% investment policy when those
terms clearly communicate that the fund is managed in a particular way
(e.g., terms like ``balanced,'' ``hedged,'' and ``managed risk'').\125\
Relatedly, one commenter suggested that the rule should explicitly
subject funds with allocation designations in their name (e.g., 60/40
Target Allocation Fund) to the 80% investment policy requirement.\126\
---------------------------------------------------------------------------
\125\ See Dogwhistle Comment Letter; PIABA Comment Letter (also
recommending that the rule prohibit the use of terms of well-known
organizations, affinity groups, or the reference to a specific
population of investors (e.g., ``veterans'' or ``municipal
employees'') in fund names). See also Consumer Federation of America
Comment Letter (additionally recommending that the rule should
prevent single-state tax exempt funds from investing substantially
in securities issued by another municipality). The Commission did
not propose amendments that addressed the scope of tax-exempt funds
whose names require them to adopt an 80% investment policy, or the
investments that would be included in a fund's 80% basket under such
policy, nor do the final amendments address these points. But see
infra footnote 155.
\126\ See Better Markets Comment Letter.
---------------------------------------------------------------------------
After considering comments, we continue to recognize that there are
certain terms that do not communicate to investors the particular
characteristics of investments that will make up the fund's portfolio
and for which an 80% investment policy will not be required. Such names
include, for instance, names that suggest a portfolio-wide result to be
achieved, such as ``real return,'' ``balanced,'' or ``managed risk,''
names that reference a particular investment technique, such as ``long/
short'' or ``hedged,'' and names that reference asset allocation
determinations that evolve over time, such as a retirement target date
or ``sector rotation'' funds.'' \127\ In each of these examples, the
fund's name communicates information to investors about the overall
characteristics of the fund's portfolio, rather than particular
investments in the portfolio, and therefore will not necessitate an 80%
investment policy under the amended rule. Likewise, terms like
``intermediate term (or similar),'' in describing a ``bond'' fund, also
will not require an 80% investment policy under the final amendments in
addition to the 80% investment policy that would be required due to the
fund's use of ``bond'' in its name in this example. We do not view
these types of names as being distinct from names that describe
portfolio-wide characteristics, such as names that describe portfolio
duration. Additionally, names including the terms ``global'' and
``international,'' without an additional term that suggests an
investment focus such as ``fixed income'' or ``growth,'' will not
require an 80% investment policy under the final rule. These terms
describe a fund's approach to constructing a portfolio, but do not
communicate the composition of the fund's portfolio with any
particularity (unlike, say, ``Japan'' or ``Europe'') and therefore on
their own suggest no particular investment focus.\128\ Therefore,
requiring such funds to adopt an 80% investment policy would produce
fewer investor protection benefits relative to names that communicate
to investors the particular characteristics of investments that will
compose the fund's portfolio. Names with terms that do not communicate
the particular characteristics of investments composing the fund's
portfolio will continue to be subject to section 35(d)'s prohibition on
materially misleading or deceptive names.\129\ Funds with these names
likewise will continue to be
[[Page 70448]]
subject to the anti-fraud provisions of the Federal securities laws
regarding disclosures to investors.
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\127\ A target date fund's name communicates an investment
approach to investors, but does not communicate the composition of
the fund's portfolio at any particular point in time, as the fund's
investments will change over time in accordance with the fund's
glide path. Similarly, ``sector rotation'' funds seek to shift their
portfolio in and out of sectors over time as the economy moves
through the different phases of a business cycle. In each of these
cases, an 80% investment policy would not be appropriate for the
fund because the fund's name connotes portfolio-wide asset
allocation determinations that evolve continuously over time.
\128\ Similarly, funds that use terms in their name that
indicate that the fund uses a negative or exclusionary screening
process for investments (e.g., ``fossil fuel-free'') may not require
an 80% investment policy because such terms generally provide
insight into what is precluded from the fund's portfolio, but these
terms do not communicate to investors the particular investment
focus of the fund's portfolio. In any case, a fund with a name like
``fossil fuel-free'' that indicates the fund will not invest at all
in fossil fuels in this example will be materially deceptive or
misleading for purposes of section 35(d) if the fund invests in
companies that are not fossil fuel-free as defined by the fund in
its prospectus (e.g., issuers with fossil fuel reserves).
\129\ For instance, terms used in fund names that reference
well-known organizations, affinity groups, or that reference a
specific population of investors may not communicate the particular
characteristics of investments composing the fund's portfolio and
therefore may not require an 80% investment policy under the amended
rule. Such funds, however, will continue to be subject to section
35(d)'s prohibition on materially misleading or deceptive names.
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In response to commenters seeking additional clarity about the
terms growth and value, we understand, based on staff review of fund
disclosure, that it is not typical in current practice for growth and
value funds to implement their strategies on a portfolio-wide basis, as
opposed to a selection process based on the growth or value
characteristics of the fund's component portfolio investments. If terms
in a fund's name can reasonably be understood to reference either the
characteristics of a fund's individual investments or the intended
result of a fund's portfolio investments in the aggregate, the fund
will be required to adopt an 80% investment policy, consistent with the
proposal. We disagree with the commenter who asserted that such terms
are per se not misleading.\130\ It would be confusing to investors if
the same term in a fund's name required an 80% investment policy in
some cases and not in others. In addition, the rule provides funds
sufficient flexibility to design and implement an 80% investment policy
in these circumstances. We do not agree that the ESG uplift strategies
identified by one commenter require an 80% investment policy, however,
because the particular strategies identified by the commenter are
solely executed on a relative basis at the portfolio level, as
described in more detail above, and include terms in the fund's name
associated with this investment strategy to signal this different
approach to investors.\131\
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\130\ ICI Comment Letter.
\131\ BlackRock Comment Letter.
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c) Investments Included in a Fund's 80% Basket
Regarding the application of the proposed amendments, the
Commission stated in the 2022 Proposal that when determining whether a
particular asset is invested in accordance with the investment focus
that the fund's name suggests (i.e., qualifies for inclusion in a
fund's 80% basket), there must be a meaningful nexus between the given
investment and the investment focus suggested by the name.\132\ The
Commission discussed that a fund may define the terms used in its name
in a reasonable way, allowing for flexibility in determining whether a
nexus exists between a given security and the focus the fund's name
suggests. For instance, the Commission stated it would be reasonable
for a fund to determine a sufficient nexus between certain securities
and a given industry if the securities are issued by companies that
derive more than 50% of their revenue or income from, or own
significant assets in, the industry. However, the Commission also
explained that the use of text analytics to assign issuers to
industries based on the frequency of particular terms in an issuer's
disclosures was not, in and of itself, sufficient to create a
reasonable nexus.
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\132\ See generally for this discussion Proposing Release, supra
footnote 2, at nn.51-52 and accompanying text.
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Commenters expressed that a 50% revenue test is not always the most
appropriate way to determine whether a company is part of a given
industry, particularly for new companies and nascent industries and
business sectors.\133\ These commenters urged the Commission to clarify
the reasonableness standard as it applies to designating investments in
a fund's 80% basket, urging that advisers need the flexibility to
evaluate investments based on a totality of criteria beyond revenue
tests. Some commenters asserted that funds with certain business or
industry-adjacent investment strategies face particular difficulties
adopting an 80% investment policy because their investments often vary
in terms of industries, capitalization ranges, revenue sources, asset
classes, geographies, and other key characteristics, making it
challenging to pinpoint confidently a reasonable nexus between the
fund's investments and the investment focus suggested by its name.\134\
Moreover, one commenter expressed particular concern with the
proposal's discussion of the processing of text analytics, suggesting
that the tool is a useful method for facilitating forward-looking
analysis of companies and industries.\135\ Separately, two commenters
suggested that the Commission should permit fund managers to use
forward-looking assessments or future-based methodologies to analyze
investments when determining whether they fit in a given industry or
sector, on the condition that such funds use a modifying indicator like
``emergent'' or ``future'' in their names to signal to investors that
their analysis of investments is not completely based on current
characteristics of the issuer.\136\
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\133\ See, e.g., SIFMA AMG Comment Letter; BlackRock Comment
Letter; Seward & Kissel Comment Letter; WisdomTree Comment Letter.
\134\ See, e.g., ICI Comment Letter; Dechert Comment Letter;
Minerva Comment Letter.
\135\ SIFMA AMG Comment Letter.
\136\ See SIFMA AMG Comment Letter; BlackRock Comment Letter.
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We appreciate commenters' concerns regarding potential challenges
in determining whether a particular asset is invested in accordance
with the investment focus that the fund's name suggests, particularly
with respect to thematic investment strategies. Consistent with the
2022 Proposal, the plain English and established industry use
requirements in the final amendments are intended to provide
flexibility for funds to determine what qualifies as a reasonable nexus
between a security and a given investment focus.\137\ Similar to the
Commission's discussion in the Proposing Release regarding the
application of the final amendments, it would generally be reasonable
for a fund to determine that a sufficient nexus exists between certain
securities and a given industry if the securities are issued by
companies that derive more than 50% of their revenue or income from, or
own significant assets in, the industry. There also 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). Further, the use of text analytics to assign
issuers to industries based on the frequency of particular terms in an
issuer's disclosures is not, in and of itself, sufficient to create a
reasonable nexus because it is not 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.\138\
These examples are not meant to serve as an exhaustive list of
acceptable methods of qualification in a fund's 80% basket. Given the
breadth of fund names and strategies, it is not possible to provide an
enumerated list of circumstances in which a nexus exists between a
security and an industry or a particular investment focus.
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\137\ See final rule 35d-1(a); see also infra section II.C.
\138\ The advent and growth of advanced technologies have made
increasing use of natural language processing that can significantly
enhance the scale and scope of text analytics. Funds may be able to
use these types of technologies to aid a determination that a nexus
exists between a given security and the focus that a fund's name
suggests that involves analysis going beyond the frequency with
which a word or phrase appears in a document.
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Further, as raised by commenters, advisers may offer funds with
strategies that seek exposure to long-term investment opportunities or
that seek to identify issuers that are likely to generate significant
amounts of revenue from certain industries or business sectors in the
future. As commenters expressed, it may be challenging for these types
of funds to find a reasonable
[[Page 70449]]
nexus between their investments and a given investment focus based on
current characteristics of the issuer. In these circumstances, funds
may signal to investors, through the use of ``emergent,'' ``future,''
or some other similar term in the fund's name, that the fund considers
some future-based methodology when assessing whether a nexus exists
between a given security and the investment focus suggested by the
fund's name (e.g., ``XYZ Emergent 3D Printing Technology Fund''). More
generally, we recognize that overall context is important in how an
investor interprets a fund's name. For instance, descriptive terms such
as ``aggressive,'' ``conservative,'' or ``strategic,'' when paired with
another term that is covered by the scope of the rule can modify an
investor's expectations with respect to the fund's investment focus.
The rule is designed to give fund managers reasonable discretion to
define terms in a fund's name, and to allocate investments reasonably
into the 80% basket in accordance with the investment focus the name
conveys, which can be dependent on the context of the terms in a name.
In particular, the final amended rule requires that terms within a
fund's name must be consistent with the plain English meaning or
established industry use. We are including these provisions in the
final amended rule to provide fund managers with sufficient
flexibility.
Separately, as discussed in the 2022 Proposal, when a fund's name
includes terms suggesting an investment focus that has multiple
elements, the fund's 80% investment policy must address all of the
elements in the name (as all of the elements would be reflected in the
investment focus that the fund's name suggests).\139\ The Commission
noted, however, that a fund can take a reasonable approach in
specifying how the fund's investments will incorporate each element.
Commenters expressed broad support for the Commission's approach,
asserting that it retains the appropriate level of flexibility for
advisers to determine how best to allocate investments under an 80%
investment policy.\140\ Where a fund's name suggests an investment
focus that has multiple elements, the fund's 80% investment policy must
address each of those elements. For instance, a fund with a name that
references two or more distinct investment focuses (e.g., ``XYZ
Technology and Growth Fund'') could have an investment policy that
provides that each security included in the 80% basket must be in both
the technology sector and meet the fund's growth criteria.
Alternatively, such a fund could instead have an investment policy that
provides that 80% of the value of the fund's assets will be invested in
a mix of technology investments and growth investments, with some
technology investments, some growth investments, and some investments
in both of these categories, with no minimum or maximum investment
requirements specified for either category. In addition, 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.
---------------------------------------------------------------------------
\139\ See Proposing Release, supra footnote 2, at nn.50-51 and
accompanying text; see also final rule 35d-1(a)(2) (this provision
reflects that a fund's name may include multiple ``terms''
suggesting that the fund focuses its investments in a particular
way).
\140\ Fidelity Comment Letter; CFA Institute Comment Letter;
Seward & Kissel Comment Letter.
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Moreover, 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. It would not be reasonable, however, for an acquiring fund in
these circumstances to ignore situations where the acquiring fund knows
that an underlying fund is not investing consistent with the acquiring
fund's investment focus.\141\ In such cases, the acquiring fund should
take actions to address this departure as it otherwise would to resolve
a temporary departure from the 80% requirement under the final
amendments.
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\141\ An acquiring fund is not required to continuously monitor
the investments of the underlying fund for purposes of compliance
with the amended names rule. For example, the XYZ Industrials Fund
may rely on the ABC Automotive Fund to comply with the ABC
Automotive Fund's 80% policy.
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d) ESG-Related Terms
Consistent with the proposal, the final amendments will apply the
requirement to adopt an 80% investment policy to fund names that
suggest an investment focus, including names with terms indicating that
the fund's investment decisions incorporate one or more ESG
factors.\142\ Many commenters supported the inclusion of ESG terms in
the expanded scope.\143\ Some of these commenters expressed concerns
related to ``greenwashing'' among funds that have, or purport to have,
ESG- or sustainability-related characteristics.\144\ Many of these
commenters asserted that given the developing market interest in, and
regulatory and public scrutiny of, funds that incorporate ESG factors
in their investment objectives, to the extent a fund uses an ESG-
related term in its name, the fund should be required to adopt an 80%
investment policy that ensures it will invest in accordance with the
investment focus its name suggests.\145\
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\142\ See final rule 35d-1(a)(2).
\143\ See, e.g., U.S. SIF Comment Letter; SIFMA AMG Comment
Letter; Sierra Club Comment Letter; Public Citizen Comment Letter;
Comment Letter of Bonwood Social Investment (Aug. 16, 2022)
(``Bonwood Comment Letter'').
\144\ See NASAA Comment Letter; J.P. Morgan Asset Management
Comment Letter; U.S. SIF Comment Letter; Comment Letter of LTSE
Services, Inc. (Aug. 16, 2022) (``LTSE Comment Letter''); CFA
Institute Comment Letter.
\145\ Id.
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Conversely, several commenters opposed including names with ESG
terms in the expanded scope of the 80% investment policy
requirement.\146\ Many of these commenters expressed similar concerns
to those discussed above opposing the expanded scope in general,
including potential interpretive issues resulting from the perceived
subjectivity of certain ESG-related terms, and potential increased
compliance burdens.\147\ Some commenters also articulated concerns that
are unique to funds that use ESG terms. For instance, several
commenters expressed that the Commission's ESG Disclosure Proposal
would be better suited to address investor understanding of ESG
considerations than the proposed names rule scope
[[Page 70450]]
expansion.\148\ These commenters generally expressed more support for a
disclosure-based framework rather than a mandated 80% investment policy
for fund names that communicate an ESG focus. In addition, a few
commenters expressed that certain terms, depending on the context, may
not be solely used for ESG investment strategies (e.g., ``sustainable''
or ``impact''), or when read together may provide a different meaning
than when presented individually (e.g., ``XYZ Sustainable Growth
Fund'').\149\
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\146\ See, e.g., ICI Comment Letter; Calvert Comment Letter;
Cato Institute Comment Letter; Invesco Comment Letter; Robertson-
Fisch Comment Letter.
\147\ See, e.g., TIAA-Nuveen Comment Letter; Calvert Comment
Letter; ICI Comment Letter, Robertson-Fisch Comment Letter. See
generally supra section II.A.1.a) (responding to concerns from
commenters related to interpretive challenges and compliance costs
connected to the proposed expansion of the 80% investment policy).
\148\ See ICI Comment Letter; TIAA-Nuveen Comment Letter.
\149\ See ICI Comment Letter; Dechert Comment Letter.
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We recognize that ``ESG'' and similar terms are expansive,
incorporating three broad categories of interest (environmental,
social, and governance issues) for investors and asset managers, with
differing levels of focus on each particular issue, and different
perspectives on what attributes of an issuer or investment fit within
this terminology.\150\ The breadth of ESG-related terms, as well as
evolving investor expectations around terms like ``sustainable'' or
``socially responsible,'' compound the possibility of investor
confusion and potential ``greenwashing'' in fund names.\151\ Moreover,
concerns regarding materially deceptive and misleading fund names are
particularly important for funds that incorporate ESG factors in their
investment decisions because, unlike many other non-ESG investment
strategies, some ESG-related strategies are not well-established or
commonly understood to the investing public.\152\ ESG terms in fund
names communicate to investors that the fund will invest in issuers
that have particular characteristics, like other terms that are covered
by the expanded scope. Accordingly, there is not a principled basis to
treat ESG terms differently than other terms that have the potential to
be materially deceptive and misleading, as suggested by a few
commenters that requested a purely disclosure-based framework for funds
that use ESG terms in their name. The final amendments thus require
funds that use ESG terms in their name to adopt an 80% investment
policy.
---------------------------------------------------------------------------
\150\ See Robertson-Fisch Comment Letter (arguing that because
ESG is a ``big tent'' term, the use of ESG terminology in fund names
``does not convey very much information'' to investors).
\151\ See supra footnote 37 and accompanying discussion.
\152\ See Center for American Progress Comment Letter (stating
that ``[t]here is more variability in investors' understanding of
what many ESG terms mean than with terms like ``growth'' or
``global'' because the use of ESG terms is relatively new and their
use often is not tied to specific information about their
meaning.'').
---------------------------------------------------------------------------
We recognize, as with fund names that do not include ESG terms,
that the general context of a name with terminology that could connote
an ESG focus is critical in how an investor interprets such a
name.\153\ For instance, a name such as ``XYZ Sustainable Growth Fund''
could reasonably be interpreted as a fund that employs a strategy that
seeks growth that is sustainable over time (i.e., growth that will be
maintained at a certain level), or a fund that incorporates ESG factors
into its decision making. In this example, the fund would require an
80% investment policy regardless, but the fund manager has discretion
to reasonably define the terms in the fund's name, and to allocate
investments into the 80% basket in accordance with the investment focus
the name suggests.\154\
---------------------------------------------------------------------------
\153\ See Robertson-Fisch Comment Letter (discussing different
hypothetical ESG-related funds that could deliver very different
results to investors, but could be presumably sold under the same
name).
\154\ See also supra footnote 94 and accompanying text; supra
paragraph accompanying footnote 132.
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2. Temporary Departures From the 80% Investment Requirement
The final rules we are adopting permit temporary departures from
the 80% investment requirement by allowing a fund temporarily to invest
less than the required 80% of the value of the fund's assets in
accordance with the investment focus or tax treatment its name
suggests.\155\ Under the final amendments, we are retaining the current
rule's requirement that a fund must determine at the time that it
invests whether the investment is in the fund's 80% basket (``time-of-
investment test'').\156\ We are adopting a new requirement that, at
least quarterly, funds subject to the 80% investment requirement must
review the fund's portfolio investments to determine whether the fund's
investments continue to be consistent with the fund's 80% investment
policy.\157\ Funds must comply with the 80% investment requirement
``under normal circumstances,'' leaving to funds the determination of
what constitutes something other than a normal circumstance. If,
subsequent to an investment, the 80% investment requirement is no
longer met, the fund's future investments (that is, any portfolio
assets it acquires) must be made in a manner that will bring the fund
into compliance with that requirement within the time period specified
in the rule.
---------------------------------------------------------------------------
\155\ The amendments to the temporary departure provision are
applicable not only to funds whose name suggest a particular
investment focus, but also to tax-exempt funds that are required to
invest their assets in accordance with the provisions of rule 35d-
1(a)(3).
\156\ See final rule 35d-1(b).
\157\ Final rule 35d-1(b)(1)(i).
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A fund may, in other-than-normal circumstances, choose to invest in
a manner that is not consistent with the fund's 80% investment
requirement for a limited period of time.\158\ The final amendments
include specific time frames--generally 90 consecutive days, as opposed
to 30 days as proposed--for getting back into compliance if a fund
departs from the 80% requirement, either intentionally in other-than-
normal circumstances, or as identified by the fund as a part of its
quarterly review or otherwise. Funds are permitted under the final
rules to temporarily depart from the 80% investment requirement in
connection with a reorganization (for which the final rule does not
specify a required time frame for accompanying temporary departures) or
a fund launch (departure not to exceed the period of 180 consecutive
days) or when a notice of a change in a fund's policy in certain
circumstances has been provided to fund shareholders.\159\
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\158\ Final rule 35d-1(b)(1)(ii).
\159\ Final rule 35d-1(b)(1)(iii); see also rule 35d-1(g)
(defining ``launch'' as a period, not to exceed 180 consecutive
days, starting from the date the fund commences operations).
---------------------------------------------------------------------------
Under the proposed amendments, funds would have been permitted to
depart from the fund's 80% investment policy only under certain
specified circumstances.\160\ When a fund departed under the specified
circumstances, the proposed amendments would have required funds to
come back into compliance with the 80% investment requirement within 30
consecutive days after the initial departure. Departures from names
rule compliance for fund launches would not have been permitted to
exceed a period of 180 consecutive days. The proposed amendments did
not specify a required time frame for temporary departures that were
the result of reorganizations or
[[Page 70451]]
where the 60-day notice has been provided to shareholders. In all
cases, the proposed amendments would have required that a fund would
have to come back into compliance as soon as reasonably practicable.
---------------------------------------------------------------------------
\160\ Temporary departures under the proposed amendments would
have been 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.
---------------------------------------------------------------------------
We received comment letters both supporting and opposing the
Commission's proposed approach for temporary departures. Among the
primary reasons commenters supported the proposal was their belief that
the proposed amendments brought more certainty to the current rule's
approach to temporary departures from 80% and would require funds to be
more vigilant with respect to their names rule compliance.\161\ In
particular, several commenters supported the goal of bringing the rule
in line with investors' expectations by ensuring that the investments
made by the fund remain consistent with the fund's name and the
investor's investment preferences over the long-term life of the
fund.\162\
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\161\ See, e.g., NASAA Comment Letter; PRI Comment Letter;
Consumer Federation of America Comment Letter; Environmental Defense
Fund Comment Letter.
\162\ See, e.g., Consumer Federation of America Comment Letter;
Center for American Progress Comment Letter; NASAA Comment Letter.
---------------------------------------------------------------------------
The Commission, however, did receive many comments requesting that
we reconsider the proposed approach to temporary departures. The
Proposing Release sought 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.\163\ Commenters, as discussed in
the next section, raised concerns that the proposed amendments were
overly prescriptive, lacked flexibility, and were too limited in the
amount of time funds would have to bring their investments back into
compliance. In response to comments received, we are adopting an
approach that modifies the proposed amendments, which seeks to balance
the concerns raised by commenters and the goals of the proposal.
---------------------------------------------------------------------------
\163\ See Proposing Release, supra footnote 2, at paragraph
following n.35.
---------------------------------------------------------------------------
a) Time-of-Investment Test and Quarterly Review
Under the final amendments, as under the current names rule, a fund
is required to determine at the time it invests whether the security is
appropriately included in the fund's 80% basket.\164\ This ``time-of-
investment test'' was originally adopted 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 (``drift'').\165\ The proposal would have removed the time-
of-investment test and instead would have required that a fund remedy
drift within 30 days of the initial departure. In effect, the proposed
rule would have required that funds engage in continual compliance
testing to reassess the characteristics of investments in the fund's
80% basket--or even daily testing and reassessment for those funds
making investments each trading day--to ensure that they observe and
correct any drift quickly in order to comply with the proposed
requirement that the fund come back into compliance with the names rule
within 30 days.
---------------------------------------------------------------------------
\164\ See final rule 35d-1(b).
\165\ See 2001 Names Rule Adopting Release, supra footnote 8, at
n.32 and accompanying text; see also 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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In response to comments we received, and as discussed in more
detail below, we are not adopting a requirement for continual or daily
monitoring to reassess the characteristics of the investments in the
fund's 80% basket and are instead maintaining a time-of-investment test
in the names rule. Under the final amendments, funds will instead be
required to reassess their portfolio assets' inclusion in the fund's
80% basket at least quarterly. This change means that portfolio
investments that are included in the 80% basket at the time of
investment will continue to be considered to be consistent with the
fund's 80% investment policy unless the fund identifies otherwise as
part of its required quarterly reassessments, or outside of its
required quarterly reassessments identifies that these investments'
characteristics are inconsistent with the fund's 80% investment policy.
This approach to assessing the characteristics of portfolio investments
in the 80% basket, however, does not change the requirement for funds
to maintain at least 80% of the value of their assets in 80% basket
assets (as determined at the time of investment), unless the fund
departs temporarily from 80% in accordance with the final amendments.
As an example, when a fund acquires Investment A, the fund must assess
the characteristics of that investment when the purchase is made to
determine whether it should be included in the 80% basket. When a fund
acquires a new investment, Investment B, the fund must assess the
characteristics of Investment B when it invests to determine whether it
should be included in the 80% basket. When determining whether 80% of
the fund's assets are invested in the 80% basket when Investment B is
made, the fund must consider the value of Investment A, but would not
have to re-assess the characteristics of Investment A. Each quarter,
the fund must re-assess the characteristics of Investments A and B for
consistency with the fund's 80% investment policy.
We received many comments supporting the retention of the time-of-
investment test and urging the Commission not to adopt an approach that
would require continual compliance monitoring.\166\ Several commenters
stated that the time-of-investment test is a standard that is used in
other portfolio compliance tests under the Investment Company Act and
that consistency with how fund holdings are measured across Investment
Company Act rules would therefore be a preferable approach in the
context of the names rule.\167\ The proposed approach, which would have
removed the time-of-investment test, would instead have effectively
required that fund managers reassess portfolio investments'
characteristics for consistency with the fund's 80% investment policy
every time the fund makes a new investment, and to take corrective
action almost immediately upon identifying any departure from 80%. The
time-of-investment test affords some flexibility to fund managers by
focusing on whether an asset is consistent with the fund's 80%
investment policy at the time of investment, rather than requiring
ongoing reassessments. In addition, commenters expressed concern that
limitations on fund manager discretion prevent investors from having
access to actively-managed funds that are subject
[[Page 70452]]
to the names rule.\168\ Commenters also supported retaining the time-
of-investment test so that in the event that a fund's portfolio
inadvertently drifts out of compliance with the 80% investment
requirement because the characteristics of portfolio investments
change, the fund would not be forced to sell a security that was
originally purchased in compliance with the names rule in order to come
back into compliance within a specific time frame (as proposed,
generally 30 days).\169\ Commenters were concerned the proposed
approach would potentially force sales or purchases of portfolio assets
at inopportune times with the potential to intensify the market
conditions that prompted these transactions in the first place.\170\
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\166\ See, e.g., ICI Comment Letter; Calamos Comment Letter;
Seward & Kissel Comment Letter; Fidelity Comment Letter; Dechert
Comment Letter; T. Rowe Comment Letter; Nationwide Comment Letter;
Cato Institute Comment Letter; Stradley Comment Letter; Dimensional
Comment Letter; WisdomTree Comment Letter; MFS Comment Letter;
Invesco Comment Letter; Capital Group Comment Letter.
\167\ For example, commenters pointed to time of acquisition
tests in the 1940 Act, including, section 5 the anti-pyramiding
provisions of section 12(d)(1) [15 U.S.C. 80a-12(d)(1)] and the
limitations on investments in securities-related issuers in section
12(d)(3) [15 U.S.C. 80a-12(d)(3)]. See, e.g., ICI Comment Letter;
Dechert Comment Letter; Seward & Kissel Comment Letter; Fidelity
Comment Letter; Calamos Comment Letter; Nationwide Comment Letter.
\168\ See Dechert Comment Letter; ICI Comment Letter.
\169\ See, e.g., Stradley Comment Letter; ICI Comment Letter;
Dechert Comment Letter; Seward & Kissel Comment Letter; Fidelity
Comment Letter; Calamos Comment Letter; Nationwide Comment Letter.
\170\ See, e.g., ICI Comment Letter; Dechert Comment Letter.
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Commenters also stated that there would be substantial burden on
funds, their sponsors, and their administrators to implement a
continual or daily program for re-assessing portfolio investments for
names rules compliance purposes.\171\ Commenters argued that the burden
of implementing a continual monitoring program is not warranted given
the asserted lack of identified significant harm to investors from
portfolio drift and the burden of creating and maintaining such a
program.\172\ These commenters stated that the burdens associated with
a continual monitoring program would be particularly high because
assessing portfolio investments' consistency with a fund's 80%
investment policy is not necessarily straightforward, particularly
given the expanded scope of the names rule, which would include terms
that are not readily quantifiable.\173\ For example, commenters stated
that some of the information that a fund would need to monitor whether
a particular investment should be included in a fund's 80% basket may
include metrics measured over a period of time that may be longer than
the period of a single day.\174\ Some funds, for instance, may adopt
investment strategies that involve a multi-year concept that commenters
stated cannot be assessed on a single day.\175\ Commenters therefore
urged the Commission to adopt a rule that would provide some discretion
to determine whether a particular investment, evaluated over a period
of time, is consistent with the fund's 80% policy.\176\ Similarly,
commenters raised concerns about continually monitoring compliance with
respect to certain securities, such as growth or value investments,
where the name characteristics could change frequently.\177\ For
example, securities may be bought that have characteristics meeting a
particular fund's standards for inclusion in the fund's 80% basket at
the time of purchase, but these characteristics may change from day to
day. Commenters stated that assessing these securities' characteristics
continually would require operational and compliance build-outs that
would be substantial.\178\
---------------------------------------------------------------------------
\171\ See, e.g., ICI Comment Letter; Dechert Comment Letter;
Seward & Kissel Comment Letter; WisdomTree Comment Letter.
\172\ See, e.g., Seward & Kissel Comment Letter, Nationwide
Comment Letter; Fidelity Comment Letter. But see Dogwhistle Comment
letter (suggesting an annual compliance testing requirement and that
daily compliance testing is too frequent, but a time-of-investment
test is not appropriate).
\173\ See, e.g., SIFMA AMG Comment Letter; J.P. Morgan Asset
Management Comment Letter; ICI Comment Letter; Dechert Comment
Letter; Wellington Comment Letter.
\174\ See, e.g., ICI Comment Letter; Wellington Comment Letter;
Capital Group Comment Letter; SIFMA AMG Comment Letter.
\175\ See, e.g., ICI Comment Letter; Wellington Comment Letter;
Capital Group Comment Letter; SIFMA Comment Letter.
\176\ See id.
\177\ See, e.g., ICI Comment Letter; Seward & Kissel Comment
Letter; WisdomTree Comment Letter.
\178\ See, e.g., ICI Comment Letter; Dechert Comment Letter;
Seward & Kissel Comment Letter; WisdomTree Comment Letter.
---------------------------------------------------------------------------
After considering comments, we are retaining the current rule's
time-of-investment test that requires a fund to determine, for purposes
of names rule compliance, whether an investment is within the fund's
80% basket at the time of investment. While the time-of-investment test
must be conducted only at the time that the investment is made, the
final rule incorporates a process for periodic reassessment of fund
investments in order to ensure that that the fund is invested
consistent with the focus the fund's name suggests. Rather than
adopting a rule that effectively would require daily or continual
compliance monitoring, the final rule requires that a fund review its
portfolio investments on an at-least quarterly basis to determine
whether it continues to comply with the 80% investment requirement.
The time-of-investment standard affords to the portfolio manager
more flexibility than the proposed amendments, as we acknowledge that
there may be certain fluctuations in a fund's portfolio and within the
80% basket that naturally occur over time, and that may not be outside
of investors' reasonable expectations. For example, a mid-cap equity
fund may hold securities that at the time of investment qualified under
the fund's 80% investment policy as mid-cap, but that may temporarily
move into the large-cap category and back again. We understand that
this type of drift is a natural fluctuation in a portfolio, as certain
characteristics of securities' may not be static. We also appreciate
that, for certain funds that are subject to the 80% investment
requirement, this drift may occur relatively frequently, and so a
standard that would require daily or continual compliance monitoring
could be particularly burdensome and require very frequent portfolio
re-balancing.\179\ While we recognize that drift may occur and that
portfolio managers should have discretion in managing their portfolio
in the best interest of the fund, we are adopting a quarterly review
requirement to help ensure portfolio adjustments so that drift does not
go unchecked. This quarterly time frame will require a fund to address
drift more quickly, which in turn will help ensure greater consistency
between the fund's investments and the focus its name suggests, as
compared to a review period based on a longer periodic time frame (for
example, an annual testing requirement as one commenter
suggested).\180\
---------------------------------------------------------------------------
\179\ See, e.g., SIFMA Comment Letter; J.P. Morgan Asset
Management Comment Letter.
\180\ See Dogwhistle Comment Letter.
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The combination of a time-of-investment test with a minimum
quarterly review requirement balances the dynamic nature of funds'
portfolio securities with compliance with the fund's 80% investment
policy. The required time frame for review is consistent with the final
rules' quarterly Form N-PORT reporting requirement, which requires
funds (except in the case of money-market funds and BDCs) to report on
Form N-PORT the value of the fund's 80% basket as well as each
investment that is included in the fund's 80% basket.\181\ The required
minimum quarterly review helps ensure that funds are reviewing their
portfolios for names rule compliance on a periodic basis so that
instances of drift can be identified without the burden of assessing
each investment's inclusion in the 80% basket every day. The final
amendments are designed to balance the costs associated with monitoring
fund investments' inclusion in the 80% basket with the harm to
investors that could result if a fund were permitted a longer time
frame for reviewing its
[[Page 70453]]
portfolio.\182\ The time-of-investment test coupled with a quarterly
portfolio review is designed to ensure that a fund's name more
accurately communicates to investors important information about the
fund's investments while providing funds with appropriate flexibility
within a time-limited period.
---------------------------------------------------------------------------
\181\ See infra section II.E.
\182\ See infra section IV.D.2.
---------------------------------------------------------------------------
One commenter also articulated concerns that are unique to funds
that use the term ``tax-exempt'' in their name.\183\ This commenter
requested clarification on how tax-exempt funds that apply the income
test under the names rule should measure compliance with the 80%
investment policy requirement under the proposed amendments.\184\
Specifically, this commenter urged the Commission to confirm that
compliance with the income test would be based solely on income that
the fund distributes. The final rule requires that a fund review its
portfolio at least quarterly to determine whether it continues to
comply with the 80% investment requirement. Accordingly, a tax-exempt
fund applying the income test will be required to assess its portfolio
on an at-least quarterly basis to determine whether the fund's assets
are invested 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.
---------------------------------------------------------------------------
\183\ ICI Comment Letter III. The commenter also suggested that
tax-exempt funds using an income test be permitted to count taxable
market discount toward their 80% baskets. The treatment of such
taxable market discount is outside the scope of this rulemaking, as
it was not addressed in the proposal, and, therefore, not addressed
in the final amendments.
\184\ The names rule currently allows, and the final amendments
will continue to allow, a fund with ``tax-exempt'' in its name to
adopt either an asset test or an income test to satisfy its 80%
investment policy requirement. The income test requires that a fund
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. See final rule 35d-1(a)(3)(i)(B).
---------------------------------------------------------------------------
b) Investing Consistent With 80% Investment Policy ``Under Normal
Circumstances''
The final amendments, like the current names rule, require a fund
to invest in accordance with its 80% investments policy ``under normal
circumstances.'' That is, under the final amendments, a fund's 80%
policy applies under normal circumstances, but funds may depart from
the fund's investment policy in other-than-normal circumstances. The
proposed rule would have, in place of the rule's current standard that
a fund's 80% investment policy apply ``under normal circumstances,''
included specific exceptions that address circumstances where
departures would be permitted.\185\ Unlike the proposal, funds have
flexibility under the final amendments to determine what constitutes
other-than-normal circumstances where the fund could depart
intentionally from the 80% requirement (for example, the reasons for
departures that the proposed amendments included, or other
circumstances where market conditions or fund operations are other-
than-normal).\186\ Under the final amendments, departure from the
fund's 80% policy in other-than-normal circumstances is time-limited to
90 consecutive days from the initial departure, whereas the proposal
would have required a fund to be back in compliance generally within 30
days.
---------------------------------------------------------------------------
\185\ Under the proposed rule, temporary departures would have
been 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 losses
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. See proposed rule 35d-1(b).
\186\ See supra footnote 160.
---------------------------------------------------------------------------
The Commission received some comments supporting the proposed
approach to change the current rule's ``under normal circumstances''
standard in favor of a more prescriptive approach. Commenters stated
that the current standard has led to more uncertainty and less
consistency in how fund investments correspond to a fund's name than
the proposed approach would over extended periods of time.\187\
Conversely, the Commission also received many comment letters opposing
the proposed approach of permitting departure from the 80% investment
requirement only under the circumstances that the proposed amendments
specified.\188\ Commenters stated that the proposed approach was overly
prescriptive and would unnecessarily curb the ability of a fund's
portfolio manager to act in the best interest of the fund.\189\ For
example, in an effort to bring a fund back into compliance within the
proposed 30-day period, fund managers may feel compelled either to
divest or purchase an investment that may not be strategically in the
best interest of the fund. In addition, a commenter argued that the
Proposing Release did not cite evidence that the ``under normal
circumstances standard'' has been abused or has resulted in the use of
materially deceptive or misleading names.\190\ Commenters also argued
that while the proposed amendments would permit departures from the 80%
requirement only in the circumstances that the amendments specified,
unforeseeable circumstances that the amendments did not contemplate--
and that any enumerated list of circumstances could not contemplate in
an evergreen way--may present reasons for departing that could be
appropriate in the interests of the fund and consistent with the goals
of the names rule.\191\
---------------------------------------------------------------------------
\187\ See, e.g., NASAA Comment Letter; Environmental Defense
Fund Comment Letter.
\188\ See, e.g., ICI Comment Letter; SIFMA AMG Comment Letter;
J.P. Morgan Asset Management Comment Letter; CFA Institute Comment
Letter; Comment Letter of U.S. Chamber of Commerce Center for
Capital Markets Competitiveness (Aug. 12, 2022) (``USCOC Comment
Letter''); Dimensional Comment Letter; WisdomTree Comment Letter;
Calamos Comment Letter; MFDF Comment Letter; MFS Comment Letter;
Capital Group Comment letter; Seward & Kissel Comment Letter;
Fidelity Comment Letter; Comment Letter of Nasdaq, Inc. (Aug. 16,
2022) (``Nasdaq Comment Letter''); Dechert Comment Letter; T. Rowe
Comment Letter; Nationwide Comment Letter; Cato Institute Comment
Letter.
\189\ See, e.g., ICI Comment Letter; SIFMA AMG Comment Letter;
J.P. Morgan Asset Management Comment Letter; Dimensional Comment
Letter; MFS Comment Letter; Capital Group Comment letter; Fidelity
Comment Letter; Dechert Comment Letter; T. Rowe Comment Letter;
Calamos Comment Letter; Nationwide Comment Letter.
\190\ See Cato Institute Comment Letter.
\191\ See, e.g., SIFMA AMG Comment Letter; Dechert Comment
Letter; Fidelity Comment Letter.
---------------------------------------------------------------------------
Fund managers are fiduciaries to the funds they manage. Commenters
advocated that, as such, portfolio managers should have discretion in
determining when a fund needs to depart from its 80% investment policy.
Some commenters supported retaining the current rule's ``under normal
circumstances'' standard in order to give portfolio managers
flexibility to act in the best interest of the fund and its
shareholders, which can include temporarily departing from the fund's
80% investment policy.\192\ In addition, some commenters stated that
they believe that some investors may prefer investing in funds where
the portfolio manager has discretion to depart from the investment
focus denoted by the fund's name when the portfolio manager
[[Page 70454]]
believes the departure is in the best interest of the fund.\193\
---------------------------------------------------------------------------
\192\ See, e.g., ICI Comment Letter; SIFMA AMG Comment Letter;
Dechert Comment Letter; CFA Institute Comment Letter; Stradley
Comment Letter; USCOC Comment Letter; Cato Institute Comment Letter;
Dimensional Comment Letter; Federated Comment Letter; T. Rowe
Comment Letter; WisdomTree Comment Letter.
\193\ See, e.g., SIFMA AMG Comment Letter; Dechert Comment
Letter; Nationwide Comment Letter; T. Rowe Comment Letter; MFS
Comment Letter; JP Morgan Asset Management Comment Letter.
---------------------------------------------------------------------------
Commenters suggested alternatives to the proposed approach, stating
that if the Commission adopts a prescriptive list of permissible
circumstances under which a fund may depart from the 80% policy, the
list should be expanded, for example to permit departure for
repositioning fund assets in connection with changes of sub-advisers
and/or portfolio managers, and in periods leading up to material
strategy changes.\194\ These commenters suggested the inclusion of a
``catch-all'' provision, as well, permitting any departures the
portfolio manager believes are reasonable. Commenters also provided
alternatives that would permit additional drift beyond the
circumstances that the proposed amendments specified, so long as the
fund provided additional disclosure for the reasons why the fund may
drift.\195\ Another suggested an alternative included allowing funds
that use the term ``managed'' in their name to have greater flexibility
to depart from the fund's 80% investment policy.\196\
---------------------------------------------------------------------------
\194\ See, e.g., ICI Comment Letter; Dechert Comment Letter;
SIFMA AMG Comment Letter.
\195\ See, e.g., Capital Group Comment Letter; Nationwide
Comment Letter.
\196\ See, e.g., ICI Comment Letter and SIFMA AMG Comment
Letter.
---------------------------------------------------------------------------
After considering comments, we are adopting amendments that retain
the current ``under normal circumstances'' provision. While we are
retaining the current ``under normal circumstances'' standard, we are
also adopting new limitations on how long a fund may depart from 80%
under this provision, discussed below, which addresses the concerns
raised by commenters that the current standard allows for investments
not consistent with the fund's name over extended periods of time.\197\
Retaining the current ``under normal circumstances'' provision is
designed to provide fund managers with flexibility to manage their
portfolios while requiring that funds normally invest 80% of their
assets consistent with their 80% investment policy.\198\
---------------------------------------------------------------------------
\197\ Prolonged drift could result in fund names that have a
tendency or capacity or deceive or mislead, regardless of whether
such drift has resulted in actual deception of investors. See, e.g.,
Cato Institute Comment Letter; see also supra footnote 40.
\198\ See 2001 Names Rule Adopting Release, supra footnote 8, at
nn.37-40 and accompanying text.
---------------------------------------------------------------------------
We acknowledge that there could be circumstances when it is in the
best interest of the fund and its investors for the portfolio manager
to have discretion to depart from the fund's 80% investment policy.
This interest must be balanced, however, with the need for a fund's
name to convey accurately to investors the underlying investments that
correspond with the focus the fund's name suggests. Rather than require
additional disclosure that acknowledges drift or to provide a separate
standard for funds that include the term ``managed'' in their name, we
are adopting a requirement to invest in accordance with the 80%
requirement ``under normal circumstances,'' combined with a set time
frame to come back to 80%, to balance these concerns. We are adopting,
therefore, a limit on the length of time that a fund may depart in
other-than-normal circumstances to 90 consecutive days after the
initial departure.
Although we are not adopting the proposed approach of delineating
the circumstances in which a fund may depart intentionally from the 80%
requirement, an intentional departure must be in other than ``normal''
circumstances, which could include but is not limited to the
circumstances included in the proposed approach. These circumstances
could include temporary departures that occur as a result of market
fluctuations, index rebalancing, cash flows/inflows, or temporary
defensive positions, among others.\199\ These circumstances do not,
however, represent the extent of events or circumstances where a fund,
in considering its obligations under the names rule and the
prohibitions of section 35(d), may determine that other-than-normal
circumstances exist, warranting a departure from 80%. The final rules'
approach provides flexibility to depart under circumstances that may
not have been included in the proposal's delineated reasons for
departures. Although the question of whether circumstances are
``normal'' is based on the facts and circumstances, if a fund were to
deviate in purportedly other-than-normal circumstances serially or
frequently, this may suggest that in fact those circumstances are
``normal'' and otherwise raise questions about the appropriateness of
the fund's name under section 35(d) if the fund's portfolio is not
invested consistent with its name for prolonged periods of time.\200\
When a fund deviates from the 80% investment requirement due to other-
than-normal circumstances, as we discuss below, the fund is required to
maintain a record documenting the date of the departure and the reason
for the departure.\201\
---------------------------------------------------------------------------
\199\ See 2001 Names Rule Adopting Release, supra footnote 8, at
text preceding footnote 39 (``[The ``under normal circumstances''
standard] will permit investment companies to take ``temporary
defensive positions'' to avoid losses in response to adverse market,
economic, political, or other conditions.'').
\200\ See infra section II.A.5 text accompanying footnotes 318-
321.
\201\ See infra section II.F (discussing the requirement under
the final amendments for funds to maintain records documenting the
reasons for each departure).
---------------------------------------------------------------------------
c) Time to Come Back Into Compliance
The final amendments require that funds come back into compliance
with the 80% investment requirement as soon as reasonably practicable
in the case of drift (i.e., where the fund identifies that its
investments are not consistent with this requirement under the names
rule, for example, as a result of inadvertent drift identified as part
of the fund's quarterly review).\202\ In all circumstances, a fund must
come back into compliance within 90 consecutive days, as measured from
the time that the fund identifies a departure from the 80% investment
policy (as part of its quarterly review or otherwise), or the time the
fund initially departs, in other-than-normal circumstances, from the
80% investment policy.\203\ Under the final amendments, consistent with
the current rule, where a fund identifies that the 80% requirement is
no longer met, the fund must make all future investments in a manner
that will bring the fund into compliance with the fund's 80% investment
policy. The Commission proposed to require funds to come back into
compliance with the 80% investment policy within 30 days from the
initial departure from 80%. We are modifying the proposed approach to
respond to concerns raised by commenters.
---------------------------------------------------------------------------
\202\ Final rule 35d-1(b).
\203\ Id. Although the temporal limits in the final amendments
start from the time that a departure is identified, a fund may not
avoid coming into timely compliance, if the fund failed to identify
departures because the fund did not perform the required quarterly
review, or if the fund failed to perform quarterly reviews that are
reasonably designed to identify departures.
---------------------------------------------------------------------------
The Commission received some support for the proposed period for
funds to come back into compliance.\204\ The Commission received many
comments, however, arguing that a 30-day period was not an appropriate
time limit on departures.\205\ While some
[[Page 70455]]
commenters stated that a 30-day period may be appropriate for some
asset classes or in certain market conditions, these commenters
contended that a 30-day period may be too short in certain market
conditions or in unanticipated extenuating circumstances.\206\ For
example, one commenter stated that while a fund may be able to remedy a
departure from the 80% investment policy that is the result of
unusually large flows within 30 days, a portfolio manager may need more
time when divesting securities to accommodate when an index rebalances
or where a strategy may need to be reconsidered given exogenous
events.\207\
---------------------------------------------------------------------------
\204\ See, e.g., PRI Comment Letter.
\205\ See, e.g., SIFMA AMG Comment Letter; ICI Comment Letter;
CFA Institute Comment Letter; Dechert Comment Letter; Cato Institute
Comment Letter; WisdomTree Comment Letter; NASAA Comment Letter;
MFDF Comment Letter; MFS Comment Letter; J.P. Morgan Asset
Management Comment Letter; Seward & Kissel Comment Letter; Fidelity
Comment Letter; Nationwide Comment Letter; Dimensional Comment
Letter; Wellington Comment Letter; Capital Group Comment Letter.
\206\ See, e.g., ICI Comment Letter; Dechert Comment Letter;
Stradley Comment Letter; T. Rowe Comment Letter; MFDF Comment
Letter; MFS Comment Letter; Invesco Comment Letter; SIFMA AMG
Comment Letter; WisdomTree Comment Letter; Dimensional Comment
Letter.
\207\ See J.P. Morgan Asset Management Comment Letter.
---------------------------------------------------------------------------
Commenters stated that the proposed 30-day time period may require
a fund to make forced purchases and sales at potentially undesirable
prices or at inappropriate times.\208\ For example, if a small-cap
security becomes a mid-cap security and therefore can no longer be
included in the small-cap fund's 80% basket, the fund may be required
to sell the holding within the proposed 30-day period, even though the
portfolio manager believes that it is in the best interest of the fund
to hold the security for a longer period.\209\ Commenters stated that
forced purchases or sales could lead to additional adverse consequences
for a fund, including the risks of front running from other market
participants, unwanted capital gains or assorted tax efficiency
implications, increased transaction costs, reduced diversification,
fire sales, homogenization across funds with similar names, and an
overall negative impact on fund performance, as well as market
liquidity and market stability more largely.\210\
---------------------------------------------------------------------------
\208\ See, e.g., ICI Comment Letter; SIFMA AMG Comment Letter;
J.P. Morgan Asset Management Comment Letter; Dechert Comment Letter;
Stradley Comment Letter; T. Rowe Comment Letter; USCOC Comment
Letter; Cato Institute Comment Letter; Dimensional Comment Letter;
Capital Group Comment Letter. Certain of these commenters stated
that the 2001 Names Rule Adopting Release stated that funds should
not be required to ``sell portfolio holdings that have increased in
value'' in order to reattain compliance with their 80% policy. See,
e.g., Dechert Comment Letter; ICI Comment Letter.
\209\ These circumstances would arise only where, in the given
example, the security grew sufficiently to become a mid-cap
security, the fund manager preferred to continue to hold the
security, and the fund manager had already made similar
determinations with respect to other securities which collectively
made up 20% of the value of the fund's assets.
\210\ See, e.g., Dechert Comment Letter; Stradley Comment
Letter; Nationwide Comment Letter; ICI Comment Letter; SIFMA AMG
Comment Letter; T. Rowe Comment Letter; Dimensional Comment Letter;
Nationwide Comment Letter; Fidelity Comment Letter; WidsomTree
Comment Letter; Wellington Comment Letter.
---------------------------------------------------------------------------
The current names rule effectively requires that funds make all
future investments consistent with the fund's 80% policy once the fund
identifies that its portfolio is out of compliance with the 80%
investment requirement. Some commenters urged the Commission to
reconsider the proposed 30-day period and instead maintain the current
standard.\211\ Additionally, commenters suggested alternative time
periods to require funds to come back into compliance with the 80%
investment policy, e.g., 180 days.\212\
---------------------------------------------------------------------------
\211\ See, e.g., Calamos Comment Letter; Nationwide Comment
Letter.
\212\ See, e.g., Fidelity Comment Letter.
---------------------------------------------------------------------------
Several commenters suggested an alternative approach that would
require funds to notify their board of directors if the fund falls out
of compliance with the 80% investment policy for more than a specified
period of time (e.g., 30, 60, or 90 days etc.).\213\ Some commenters
suggested that after a certain period of time following a departure
from 80%, a fund must provide a report to the board detailing how the
fund will come back into compliance. Commenters stated that other rules
under the Investment Company Act have similar board reporting
requirements, which recognize the value of a board's oversight of fund
management and the best interest of fund shareholders, and that the
names rule may benefit from such a requirement.\214\ Under this
alternative, commenters stated that they believed that funds would have
more flexibility than under the proposed approach and that the board
would be in the best position to judge whether a departure is
reasonable.\215\
---------------------------------------------------------------------------
\213\ See, e.g., ICI Comment Letter; Dechert Comment Letter;
Stradley Comment Letter; Dimensional Comment Letter; SIFMA AMG
Comment Letter; MDFS Comment Letter; MFS Comment Letter; Invesco
Comment Letter.
\214\ See ICI Comment Letter; SIFMA AMG Comment Letter; Dechert
Comment Letter; MFS Comment Letter; see also Investment Company
Liquidity Risk Management Programs, Investment Company Act Release
No. 32315 (Oct. 13, 2016) [81 FR 82142 (Nov. 18, 2016)] (``Liquidity
Adopting Release'') 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 Adopting Release'').
\215\ See, e.g., Dimensional Comment Letter; SIFMA AMG Comment
Letter; ICI Comment Letter.
---------------------------------------------------------------------------
The amendments we are adopting are designed to help ensure that a
fund will not stray from the investment focus its name suggests for a
protracted period of time, regardless of external events or other
circumstances that could affect the fund's portfolio investments.
Investors' expectations for funds' investment focuses may not depend on
whether market events negatively affect the investments in a fund's
portfolio. For example, investments in passively-managed funds, such as
index-based mutual funds and ETFs, have increased substantially in the
past two decades, indicating that investors seek investment products
that permit them to obtain specific types of investment exposure for
their portfolios.\216\ Although investors may have different
expectations regarding how long a fund may drift from the fund's
investment focus, a prolonged period of drift would be inconsistent
with the investor protection concerns that underlie the names rule and
section 35(d) of the Investment Company Act.
---------------------------------------------------------------------------
\216\ Proposing Release, supra footnote 2, at n.61 and
accompanying text. 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 money market instruments. See id.; see
also 2001 Names Rule Adopting Release, supra footnote 8, at n.8 and
accompanying text.
---------------------------------------------------------------------------
Taking these concerns into account, while considering comments
received, we are extending the proposed time period that funds have to
come back into compliance with the names rule from 30 to 90 consecutive
days after the fund either identifies a departure or, in other-than-
normal circumstances, departs from the 80% investment requirement. We
recognize, as certain commenters raised, that some investors may prefer
allowing a fund 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. The final amendments provide funds
with more flexibility and time both to recognize when a fund has
drifted out of compliance and to correct the departure. This 90-day
review period is also consistent with the quarterly Form N-PORT
reporting requirement discussed below. The final amendments require a
fund to assess whether the fund's portfolio is in compliance at least
quarterly and provide the fund with an additional quarter to rectify
any departure from the 80% investment requirement. At some point,
however, departures may begin to change the nature of the fund
fundamentally, which would undermine investor
[[Page 70456]]
expectations created by the fund's name. The time limits we are
adopting are designed to prevent such a fundamental change without
investor notification.
We are not adopting, as suggested by some commenters, a board
reporting obligation that would effectively provide additional time to
resolve departures from the 80% requirement. Rather, the final approach
directly provides funds with additional time, compared to the proposal,
both to identify drift in their portfolios and to rectify departures
from 80%. The increased flexibility for temporary departures that the
final amendments afford to funds, compared to the proposed approach,
addresses many of the concerns raised by commenters recommending that
we adopt a board reporting obligation instead of setting specified time
periods for funds to come back into compliance with the names rule.
These comments were generally framed in terms of providing additional
flexibility, as opposed to suggesting that a fund's board should have a
specific oversight role when a fund departs from 80% for an extended
period. The requirement that funds review their portfolios for names
rule compliance quarterly in addition to a 90-day period to come back
into compliance increases the flexibility of funds to accommodate
instances of fund drift and intentional departures. This requirement
also still includes a time certain for funds to resolve these
departures in recognition of investors' reasonable expectation that a
fund's investments will generally remain focused in the area that the
fund's name indicates. In addition, a fund can seek exemptive relief
from the Commission if the fund believes it would be appropriate and
consistent with the protection of investors for the fund to depart for
a limited additional period past 90 days. Any request for an exemptive
order will be evaluated based on its particular facts and circumstances
and must meet the standard under section 6(c) of the Investment Company
Act, including that the exemption is necessary or appropriate in the
public interest and consistent with the protection of investors.\217\
One example of an instance in which a fund might consider seeking
relief would be where the fund anticipates resolving the departure, but
cannot do so within 90 days and seeks to avoid changing the fund's name
only to change it again in a short period of time.
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\217\ See Investment Company Act section 6(c) (providing the
Commission with authority to conditionally or unconditionally exempt
persons, securities or transactions from any provision of the Act if
and to the extent that such exemption is necessary or appropriate in
the public interest and consistent with the protection of investors
and the purposes fairly intended by the policy and provisions of the
Act).
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In instances where the fund identifies that its investments are not
consistent with this requirement under the names rule (for example, as
a result of inadvertent drift identified as part of the fund's
quarterly review), we are retaining the requirement that a fund must
make all future investments in a manner that will bring the fund back
into compliance with the 80% investment policy. We are also adopting,
as proposed, the requirement that a fund must come back into compliance
``as soon as reasonably practicable'' (with a 90-day outer limit)
because we anticipate that most temporary departures caused by
portfolio drift could be remedied in substantially less than 90 days,
though this could depend on the specific facts and circumstances.\218\
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\218\ See also, e.g., J.P. Morgan Asset Management Comment
Letter (``Although temporary non-compliance in the ordinary course,
such as due to unusually large flows, should be readily fixable in
less than 30 days, there are also circumstances in which more
flexibility is warranted.''); MFDF Comment Letter (``While we agree
that in most circumstances, a fund should be able to return to
compliance within 30 days, it is difficult to anticipate every type
of market volatility or other extenuating circumstance that might
make this difficult to do while still protecting the interests of
the fund's shareholders.'').
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We recognize that there are certain circumstances under which a
fund may be unable to bring its portfolio back into compliance with the
fund's 80% investment policy within the required 90-day period. As
commenters stated, there may be events that preclude the ability of a
fund to make investments or sell assets that would not be in the best
interest of the fund but that may be required to come back into
compliance with the names rule. If such an event occurred, the fund
would need to change its name to better reflect the realities of its
portfolio and the fund must provide shareholders with a notice of that
change, which would provide information that would allow investors to
understand the nature of the fund's portfolio.\219\ The final
amendments, consistent with the proposal, effectively toll the time for
a fund to get back into compliance following a departure from 80% that
the rule otherwise would require, if a notice of a change in a fund's
policy has been provided to fund shareholders.\220\ Once such a notice
has been provided to shareholders, shareholders have a period of 60
days to determine whether they would like to redeem their shares before
the change in policy takes effect.
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\219\ See final rule 35d-1(a)(2)(ii), (b)(1)(iii), (d).
\220\ See proposed rule 35d-1(b)(iv); final rule 35d-
1(b)(1)(iii).
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(d) Fund Launches and Reorganizations
We are adopting final rule amendments that permit funds to invest
less than 80% of their assets in the 80% basket temporarily in order to
reposition or liquidate assets in connection with a reorganization or
to launch a fund.\221\ We are adopting these amendments substantially
as proposed. For fund launches, the final amendments provide funds with
a temporary period to depart from the 80% investment requirement that
is not to exceed 180 consecutive days starting from the day the fund
commences operations.\222\ The final rule amendments do not limit the
time of departures associated with fund reorganizations.
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\221\ Final rule 35d-1(b)(1)(iii); see also final rule 35d-1(g)
(defining the term ``launch'').
\222\ Final rule 35d-1(g).
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The Commission received comments requesting that we extend the
proposed period of time permitted for fund launches from 180 days to a
longer period.\223\ Commenters stated that certain funds, for example
``alts funds'' or certain illiquid funds, may have a longer ramp-up
period that can extend beyond 180 days.\224\ One commenter stated that
investors in these types of less-liquid funds will understand the
nature of the fund they are investing in and understand that coming
into compliance with the names rule within 180 days may not be in the
interest of the fund.\225\ Another commenter stated that it is in the
best interest of the fund manager to invest the assets of the fund and
to establish the fund as quickly as possible and that a fund manager
may reasonably need more than 180 days to come into compliance with the
names rule.\226\ The Commission received one comment supporting the
proposed approach to reorganizations and did not receive comments
opposing this aspect of the proposal.\227\
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\223\ See, e.g., SIFMA AMG Comment Letter; USCOC Comment Letter;
Invesco Comment Letter.
\224\ See, e.g., SIFMA AMG Comment Letter; USCOC Comment Letter.
\225\ See, e.g., SIFMA AMG Comment Letter.
\226\ See, e.g., USCOC Comment Letter.
\227\ See Fidelity Comment Letter.
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We understand that there may be variability in how long is needed
to launch a new fund depending on the types of investments in which the
fund seeks to invest. In some instances, it may be in shareholders'
interest for funds to take additional time beyond the otherwise-
required 90-day temporary departures period to invest in a manner
consistent with the fund's 80% investment policy, for example to avoid
[[Page 70457]]
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 are adopting the requirement that,
consistent with current guidance, such a period should not exceed 180
consecutive days.\228\ We understand, based on staff knowledge of
industry practice, that this time frame is generally sufficient for
funds to invest fully, consistent with their 80% investment policy,
after the fund commences operations.\229\ Further, the final amendments
generally require funds to be invested consistent with their 80%
investment policy ``as soon as reasonably practicable,'' which may be a
shorter time than 180 days. The amendments therefore do not permit any
fund to exceed 180 consecutive days to invest its assets consistent
with its 80% investment policy when launching a fund.
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\228\ See 2001 Names Rule Adopting Release, supra footnote 8, at
n.39 and accompanying text.
\229\ See also, e.g., PRI Comment Letter (supporting all of the
proposed time frames for getting back into compliance).
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We recognize 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. Both reorganizations and
launches may result in a fund holding assets in a way that is
inconsistent with its 80% investment policy in connection with these
fund life-cycle events. 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 the fund may hold cash in the interim.
While we anticipate that, for most funds, codifying a required 180-day
period for a fund to be fully invested consistent with its 80%
investment policy will not result in significant operational changes,
we acknowledge that may not be the case for all funds.
Planned reorganizations may take longer to complete than 30 days or
even 180 days. Moreover, such a planned action will be disclosed, and
the reorganization is likely to be a permanent change to the nature of
the investor's investment.\230\ Similarly, a change to a fund's 80%
investment policy will result in a permanent change to the fund's
investments, about which funds notify investors pursuant to the
provisions of the names rule. Thus, we do not believe that changes in
the fund's investment portfolio to support an 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 would still be required
to be resolved as soon as reasonably practicable, consistent with any
temporary departure under the rule.
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\230\ 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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3. Considerations Regarding Derivatives in Assessing Names Rule
Compliance
Consistent with the proposal, we are adopting amendments that
address the valuation of derivatives instruments for purposes of
determining compliance with a fund's 80% investment policy, as well as
the derivatives that a fund may include in its 80% basket. These
amendments are designed to reflect the investment exposure derivatives
investments create 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.\231\ The amendments are designed both to
allow funds to use names that may more effectively communicate their
investments and risks to investors, and to 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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\231\ See, e.g., Proposing Release, supra footnote 2, at nn.76-
78 and accompanying text.
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The proposed amendments included the requirement for funds to use a
derivatives instrument's notional amount, rather than its market value,
for the purpose of determining compliance with a fund's 80% investment
policy.\232\ The proposal also included amendments to address the
derivatives instruments that a fund may include in its 80% basket.\233\
As discussed below, commenters generally agreed that the names rule
should specifically address funds' use of derivatives, although some
commenters suggested modifications to the proposed approach.
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\232\ See proposed rule 35d-1(g).
\233\ See proposed rule 35d-1(b)(2).
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We are adopting the proposed amendments with certain changes in
response to comments. We discuss each element of the final amendments'
provisions addressing derivatives below.
Use of Derivatives' Notional Amounts, With Currency Hedging Exclusion
The final amendments generally require a fund to use notional
amounts to value derivatives in assessing whether it has invested 80%
of the value of its assets in accordance with the investment focus that
the fund's name suggests.\234\ In a change from the proposal, however,
the final amendments also require a fund to exclude from the
calculation certain derivatives that hedge the currency risk associated
with a fund's foreign-currency denominated investments. These
derivatives therefore will not be included in the calculation of the
fund's assets or the fund's 80% basket when determining if the fund is
complying with its 80% investment policy. A fund must exclude a
currency derivative if it: (1) is entered into and maintained by the
fund for hedging purposes, and (2) the notional amounts of the
derivatives do not exceed the value of the hedged investments (or the
par value thereof, in the case of fixed-income investments) by more
than 10 percent.
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\234\ See final rule 35d-1(g) (definitions of ``assets'' and
``derivatives instrument''). The final amendments' approach, like
the proposed approach, does not distinguish between derivatives
instruments that are assets and derivatives that are liabilities of
the fund. See Proposing Release, supra footnote 2, at n.83.
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The final amendments' approach of using notional amounts better
reflects the investment exposure that derivatives investments create
than the use of market values (as the Act would generally otherwise
require by operation of its definition of the term ``value''), because
a derivative instrument's market value may bear no relation to the
investment exposure that the derivatives instrument creates.\235\ 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.\236\ The use of notional amounts furthers
the goal of helping to ensure that a fund's investment activity is
consistent with the investment focus its name communicates.\237\
Notably, using a
[[Page 70458]]
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, or could result in a fund being in
compliance with its 80% investment policy despite having significant
exposure to investments that are not suggested by the fund's name.\238\
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\235\ See Proposing Release, supra footnote 2, at paragraph
accompanying nn.77-78; see also 15 U.S.C. 80a-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).
\236\ 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.
\237\ A fund's name may be materially deceptive or misleading
under section 35(d) of the Investment Company Act, however, even if
it complies with the 80% investment policy requirement (and uses
notional amounts as the final amendments require in performing its
compliance calculations). See infra section II.A.5.
\238\ See Proposing Release, supra footnote 2, at paragraphs
following n.78.
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Comments on the proposed mandatory approach to using notional
amounts were mixed. Some commenters supported the proposed approach,
stating that notional amounts are a more accurate reflection of funds'
economic exposure, as compared to market values, and that exposure is
likely what investors assume a fund name reflects.\239\ One commenter
also expressed appreciation that the proposal attempts to provide a
clear rule while also adjusting for accuracy in reflecting
exposure.\240\ Other commenters generally supported the use of notional
amounts but suggested changes to the proposed approach that would
permit the use of market values under certain circumstances.\241\ For
example, some commenters suggested that the rule should permit a fund
to value each derivatives instrument consistent with a ``reasonable
exposure metric'' and a method that best measures the economic exposure
the derivatives instrument obtains synthetically, so long as the fund
consistently applies the relevant metric and method.\242\ One commenter
suggested an alternative approach that would require the use of
notional amounts for derivatives that are included in a fund's 80%
basket, but that would permit the use of market values for derivatives
that are not included in the 80% basket, depending on the nature of the
particular derivative.\243\
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\239\ See Consumer Federation of America Comment Letter; Capital
Group Comment Letter; J.P. Morgan Asset Management Comment Letter;
Ceres Comment Letter; Environmental Defense Fund Comment Letter;
Comment Letter of Americans for Financial Reform Education Fund
(Aug. 15, 2022) (``AFREF Comment Letter''); see also Comment Letter
of Chris Barnard (June 8, 2022) (``Barnard Comment Letter'')
(expressing support for ``an economic consideration that would look
through the notional value of assets held in order to determine the
economic impact of the fund exposures'').
\240\ See Center for American Progress Comment Letter; see also
SIFMA AMG Comment Letter (stating that,
[…truncated; see source link]Indexed from Federal Register on October 11, 2023.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.