On September 20, 2023, the U.S. Securities and Exchange
Commission (SEC) issued a final rule amending the so-called
"Names Rule" (found here) that is "designed
to modernize and enhance" protections under Rule 35d-1 of the
Investment Company Act of 1940. The final rule is part of the
SEC's holistic efforts to regulate environmental, social and
governance (ESG) matters, and is the SEC's latest attempt to
curb greenwashing in U.S. capital markets. The amendments require
registered investment funds that include ESG factors in their names
to place 80% of their assets in investments corresponding to those
factors, thereby extending to ESG funds the SEC's long-standing
approach of regulating the names of registered funds to ensure they
are marketed to investors truthfully. Fund complexes with more than
$1 billion in assets will have two years from the final rule's
effective date (60 days after publication in the Federal
Register) to comply, while fund complexes with less than $1
billion in assets will be given a compliance period of 30
months.
Chair Gary Gensler said "[t]he Names Rule reflects a basic
idea: A fund's investment portfolio should match a fund's
advertised investment focus. In essence, if a fund's name
suggests an investment focus, the fund in turn needs to invest
shareholders' dollars in a manner consistent with that
investment focus. Otherwise, a fund's portfolio might be
inconsistent with what fund investors desired when selecting a fund
based upon its name." The sole dissenting vote against the
rule modification, Commissioner Mark Uyeda, said "[w]ith these
amendments, the Commission overemphasizes the importance of a
fund's name, as if to suggest that investors and their
financial professionals need not look at the prospectus
disclosures." Commissioner Uyeda also expressed concern that
fund investors will bear the increased compliance costs associated
with the rule change.
The final rule release states that the use of ESG-related terms
such as "sustainable" or "green" presents
"particular investor protection concerns," as
"[f]unds 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 SEC originally proposed a rule change that would have made it
"materially deceptive" to include ESG factors in the name
of an "integration fund" that integrates ESG factors into
its investment process, but not in a way that is determinative
compared to other factors. However, the SEC omitted this
prohibition in the final rule and expressly decided not to adopt
the proposed approach "at this time." The removal of the
integration fund concept from the Names Rule may presage that the
corresponding concept in the still-pending ESG fund/adviser
disclosure rule may be pared back similarly (the proposing release
can be found here). We will monitor those
developments accordingly.
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