SEC Adopts Rule Enhancements to Prevent Misleading or Deceptive Investment Fund Names

Following a corresponding consultation in May 2022 (EventID 15777), the U.S. Securities and Exchange Commission (SEC) has now announced its final rule relating to the naming of investment funds. In this rule, the SEC describes the feedback it has received to its consultation and stipulates the final provisions as they will come into force two months following the rule’s publication in the Federal Register (FR). The application dates will vary based upon the total assets of a fund (group) as noted in the above timeline.
#### Background
In May 2022, the Commission launched a consultation in which it proposed, among others, changes to Rule 35d-1 under the Investment Company Act of 1940 which regulates the names used for registered investment funds. Specifically, in an effort to prevent the use of deceptive fund names and so to protect investors and given the importance of fund names in their conveying specific investment strategies, the Commission proposed to impose various requirements in relation to investment funds. These requirements concerned the naming itself of investments funds and corresponding investment limits in accordance with the name, permitted deviations from those limits, the valuation of derivatives as regards the compliance with those limits, notification requirements when the fund changes its name or strategy or no longer complies with the investment limits in accordance with its strategy, and various other matters. Details on the proposed modifications may be found in the above noted Event.
#### Feedback and final rules
As expected, there was a huge number of respondents to the consultation. Most commenters were grateful that the SEC is taking proactive steps to prevent deception and establish clear rules as to the naming of investment funds and relating investment strategies. However, there were various concerns, particularly as regards the use of „commonly understood terms“ in the names of funds, the time period for deviation from the 80% investment requirement in alignment with a funds name, and the costs arising from calculating the value of derivatives for purposes of meeting the 80% investment restriction.
Taking into account the feedback provided by respondents, the SEC will implement most changes as proposed with some changes to the draft version as described alongside the final provisions.
##### The key provisions of the new fund names restrictions and requirements are as follows:
– The use of terms in a fund’s name that suggest particular investment characteristics of a fund OR characteristics of issuers is considered deceptive or misleading unless the fund complies with the 80% investment restriction which requires that 80% of a fund’s total assets are invested in securities featuring such characteristics. The rule thereby particularly incorporates terms such as „growth“, „value“, or „ESG“ as terms suggesting a particular investment strategy. The final rule, however, will not prohibit – as proposed – integration funds to use ESG terms in their fund names. However, integration funds will still have to comply with the 80% investment policy restriction.
– Investment fund names suggesting a particular type of investment in accordance with the 80% investment rule must be consistent with the „plain English meaning or established industry use of those terms“.
– An investment fund that deviates from the 80% investment policy under „normal circumstances“ must return to compliance as soon as reasonably practicable, but no later than 90 days following the detection of non-compliance. In „exceptional circumstances“ as defined in the rule, a fund must align its investments to come back into compliance within 90 day from the time of departure. The rule also provides for a 180 day deadline for newly launched investment funds.
– As far as the treatment of derivatives for purposes of compliance with the 80% investment policy restriction is concerned, funds must now value each derivatives instrument using its notional amount with certain adjustments. Furthermore, funds are required to exclude derivatives transactions used to hedge currency risk associated with specific foreign-currency-denominated investments held by the fund provided that these currency derivatives are used for hedging purposes and their notional amounts don’t exceed the value of the hedged investments by more than 10 percent.
– Funds are also allowed to deduct cash, cash equivalents, and short-term U.S. Treasury securities from their assets for the 80% investment policy calculation up to the notional amounts of the fund’s derivatives instruments.
– Investment funds can also include derivatives instruments in their 80% investment basket, if they provide exposure to market risk factors associated with the investment focus suggested by the fund’s name in addition to those providing investment exposure to suggested investments.
– As far as prospectus requirements are concerned, investment funds that are subject to the 80% rule in view of their funds‘ names must now disclose in their prospectuses the definitions of the terms used in their names, along with any specific criteria used to select investments in accordance with the fund’s name.
– Finally, investment funds using fund names requiring compliance with the 80% rules must now additionally disclose in Form N-PORT which must be filed on a regular basis to provide information on a fund’s holdings and financial position, the following information:
– Information regarding whether each portfolio investment is part of the fund’s 80% basket.
– The value of the fund’s 80% basket, expressed as a percentage of the fund’s total assets.
– Clarifications on the terminology used in the fund’s name and any criteria linked to these terms.
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As these are only the key provisions provided in the final rule, please refer to the enclosed legal document for detailed, comprehensive information.