Citing current challenges to the existing “Names Rule,” the SEC is seeking comments on its requirements that restrict the use of potentially misleading fund names.
Since fund names are often the first piece of information investors see and can have a significant impact on an investment decision, the Commission is examining whether the current requirements are still effective and whether there are viable alternatives it should consider.
“This request for comment is another important step in our efforts to better inform and protect Main Street investors and improve the investor experience,” says SEC Chairman Jay Clayton. “We are looking to investors and market participants for input on how our framework can be improved to help ensure that fund names inform and do not mislead investors.”
In 2001, the Commission adopted the Names Rule (rule 35d-1 under the Investment Company Act of 1940) to prohibit funds from using materially deceptive or misleading names, but the rule has not been amended since then. It requires a registered investment company or business development company with a name suggesting that the fund focuses on a particular type of investment (e.g., stocks or bonds) to invest at least 80% of its assets accordingly.
The SEC staff and the industry, in the meantime, have identified various challenges regarding the rule’s application:
- Funds are increasingly using derivatives and other financial instruments, and because the rule is an asset-based test, it may not be well suited toderivatives investments that provide significant exposure to a “type of investment.”
- Funds are increasingly using certain hybrid financial instruments that have some, but not all, of the characteristics of more common asset types used in a fund’s name.
- The number of index-based funds is growing, and while funds are subject to the rule, indices are not investment companies and not subject to it.
- The number of funds with investment mandates that include various criteria, such as ESG factors, is growing.
- In an increasingly competitive environment, asset managers may have an incentive to use fund names as a way of differentiating new funds.
The Request for Comment includes an extensive list of questions and public comment will be due 60 days after publication in the Federal Register. The Commission welcomes engagement from funds, their advisers, investors and other market participants.
