On September 20, 2023, the Securities and Exchange Commission
(the “SEC”) voted to adopt final amendments to modernize
Rule 35d-1 of the Investment Company Act of 1940, as amended (the
“1940 Act”).1 This rule, commonly referred to
as the “Names Rule”, regulates the use of names for
registered investment companies and business development companies
(“BDCs”)2 that may be materially misleading or
deceptive.
The amendments largely implement changes first proposed by the
SEC last year and are intended to address interpretive issues and
industry developments that have arisen since the Names Rule was
first adopted in 2001.3 In the adopting release for the
final amendments, the SEC highlighted growing interest in regulated
funds with a “thematic” investment focus, particularly
those that consider environmental, social, or governance
(“ESG”) factors in their investment decisions, as an area
of particular concern. The SEC noted that the breadth of
ESG-related terms used in the industry increases the risk of
investor confusion and potential “greenwashing” in fund
names. As described in the adopting release, the final amendments
are also designed to promote greater specificity in how regulated
funds comply with the portfolio requirements under the Names Rule
and to increase transparency for investors. Notably, the scope of
regulated funds subject to the Names Rule will likely increase as a
result of the amendments, while the compliance burden — both
from a monitoring and reporting perspective — will increase
meaningfully for regulated funds that fall within the scope of the
Names Rule.
I. Expanded Scope of the Names Rule
Currently, the Names Rule requires a regulated fund with a name
suggesting that the fund focuses on a particular type of
investment, a particular industry or a particular geographic area,
or whose name suggests a certain tax treatment, to adopt a policy
to invest, under normal circumstances, at least 80% of its assets
in the type of investments suggested by its name (the “80%
rule”, and with respect to such a policy, an “80%
policy”).
The final amendments expand the scope of the 80% rule to
additionally apply to any fund name with terms suggesting that the
regulated fund focuses in investments that have, or investments
whose issuers have, “particular characteristics”.
Notably, the SEC declined to specifically define this term in the
adopting release for the final amendments given its belief that the
term would be sufficiently understood to mean “any feature,
quality, or attribute,” and also to ensure that the Names Rule
remains evergreen. The adopting release instead provides a
non-comprehensive list of terms that the SEC believes have
particular characteristics: namely, terms such as
“growth” or “value,” and terms referencing a
thematic investment focus, including terms indicating that a
regulated fund’s investment strategy considers ESG factors.
The SEC noted that the final amendments generally will not apply
to certain other terms that have previously fallen outside the
scope of the Names Rule because they do not communicate to
investors the particular characteristics of a regulated fund’s
investments. This includes terms such as “global”,
“international”, “intermediate term” (or
similar) with respect to bond funds, and other terms that speak to
portfolio-wide characteristics rather than investment-specific
characteristics. Similarly, the SEC specifically identified certain
terms that do not communicate “particular
characteristics” of investments comprising a portfolio and
therefore do not require an 80% policy, including “real
return,” “balanced,” “managed risk,”
“long/short,” “hedged” and “sector
rotation.”
Notably, the final amendments codify the SEC’s historical
position that the Names Rule is not meant to be a safe harbor, and
that a fund’s name may still be materially deceptive or
misleading under Section 35(d) of the 1940 Act even if a regulated
fund adopts and implements an 80% policy. Examples of practices
that may violate Section 35(d) despite compliance with the 80% rule
include: a regulated fund investing in such a manner that the
source of a substantial portion of the fund’s risks or returns
is materially different from what an investor would reasonably
expect based on the fund’s name; or a regulated fund using an
index in its name where a meaningful nexus does not exist between
the underlying index’s components and the investment focus
suggested by the index’s name.
II. Quarterly Review Requirement and Temporary Departures from
an 80% Policy
The Names Rule amendments retain the current requirements for a
regulated fund to invest in accordance with its 80% policy
“under normal circumstances.” The SEC declined to
comprehensively define the scope of “other-than-normal”
circumstances in which funds may intentionally depart from their
80% policies, but the adopting release lists examples including
temporary departures that occur as a result of market fluctuations,
index rebalancing, cash flows/inflows, or temporary defensive
positions, among others.
The final amendments retain the current requirement that a
regulated fund must measure compliance with its 80% policy at the
time it invests its assets. However, under the amendments, a
regulated fund must now review its portfolio assets’ compliance
with its 80% policy at least quarterly.
Where a regulated fund identifies that its investments are not
consistent with its 80% policy as a result of drift, the amendments
require funds to come back into compliance as soon as reasonably
practicable and, in any event, within 90 consecutive days. Where a
regulated fund identifies that the 80% investment requirement is no
longer met, it must make all future investments in a manner that
will bring the fund into compliance with its 80% policy. In all
circumstances, a regulated fund must come back into compliance
within 90 consecutive days measured from the time that the fund
identifies a departure from its 80% policy (as part of its
quarterly review or otherwise), or the time the fund initially
departs from the policy in other-than-normal circumstances.
The amendments permit regulated funds to temporarily depart from
their 80% policy in connection with a reorganization or fund
launch. For fund launches, regulated funds may depart from the 80%
policy for a temporary period not to exceed 180 consecutive days
starting from the day the fund commences operations. There is no
limit prescribed on the time of departure for fund
reorganizations.
III. Enhanced Prospectus Disclosure, Form N-PORT Reporting,
Notice and Recordkeeping Requirements
Prospectus Disclosure
The amendments require regulated funds subject to the 80% rule
to include in their registration statements (specifically on Forms
N-1A, N-2, N-8B-2, and S-6) reasonable definitions of the terms
used in the funds’ names, as well as the criteria used to
select the investments that a term describes. Any terms used in a
regulated fund’s name that suggest an investment focus, or that
the fund’s distributions are tax-exempt, must also be
consistent with those terms’ plain English meaning or
established industry use of such terms.
Form N-PORT
Pursuant to Form N-PORT amendments, regulated funds subject to
the 80% rule (excluding money market funds and small business
investment companies) must report (1) whether each investment in
the fund’s portfolio is in the fund’s “80%
basket” for purposes of measuring compliance with its 80%
policy, (2) the value of the fund’s 80% basket, as a percentage
of the value of the fund’s assets, and (3) the definitions of
terms used in the fund’s name. As a result, any deviation by a
regulated fund from compliance with its 80% policy will be both
public and readily apparent.
Notice Requirement
The amendments retain the current Names Rule’s requirement
that, unless the 80% policy is a fundamental policy of a regulated
fund, 60 days’ notice must be provided to shareholders of any
change in the fund’s 80% policy. Such notice must now, however,
also describe any accompanying change in the regulated fund’s
name. The amendments also address regulated funds that use
electronic delivery methods for shareholder communication and
provide additional guidance on the content and delivery of
notices.
Recordkeeping Requirement
The final amendments require regulated funds subject to the 80%
rule to maintain certain records documenting their compliance with
the Names Rule for at least six years following the creation of
each record (or, in the case of notices, following the date the
notice was sent) in an easily accessible place for the first two
years.
IV. Derivatives-Related Considerations in Assessing Names Rule
Compliance
The Names Rule amendments address both (1) the derivatives that
a regulated fund may include in its 80% basket and (2) the method
of valuation of derivatives instruments.
The amendments permit a regulated fund to include in its 80%
basket a derivatives instrument that either provides investment
exposure suggested by the fund’s name or provides investment
exposure to one or more of the market risk factors associated with
the investment focus suggested by the fund’s name. In
determining whether a derivatives instrument provides this type of
exposure, the SEC suggests that regulated funds “generally
should consider whether the derivative provides investment exposure
to any explicit input that the fund uses to value its name assets,
where a change in that input would change the value of the
security.”
Pursuant to the amendments, regulated funds that invest in
derivatives must generally use the derivatives’ notional amount
(rather than their market value) for calculating compliance with
their 80% policy. Funds are required to make certain other
adjustments when performing such calculations, such as excluding
certain currency derivatives used as a hedge, converting interest
rate derivatives to their 10-year bond equivalents, and
delta-adjusting the notional amounts of options
contracts4, among certain other adjustments. Notably,
the inclusion of specific guidance regarding the treatment of
derivative instruments in the context of the Names Rule clarifies
an area that previously lacked definitive guidance.
V. Considerations Regarding Unlisted Registered Closed-End
Funds and BDCs
The amended Names Rule prohibits an unlisted registered
closed-end fund or BDC that is required to adopt an 80% policy from
changing that policy without a shareholder vote. However, such
funds are permitted 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. This change acknowledges the significant
growth of these types of unlisted regulated fund structures in
recent years, including both tender offer and interval funds, and
addresses concerns around shareholder liquidity in the event of a
shift in such a fund’s 80% policy without prior shareholder
approval.
VI. Compliance Dates
The Names Rule amendments will become effective 60 days after
publication in the Federal Register. Larger entities (i.e., fund
groups with net assets of $1 billion or more) will have 24 months
to comply with the amendments, and smaller entities (i.e., fund
groups with net assets of less than $1 billion) will have 30 months
to comply.
VII. Takeaways
- The final amendments are less stringent with respect to
compliance and monitoring than initially proposed. For example, the
proposed amendments would have required subject regulated funds to
implement continual or daily compliance monitoring and come back
into compliance with their respective 80% policies within 30 days
in cases of portfolio drift. Regulated funds that are subject to
the Names Rule should have a comparatively easier time complying
with the final amendments’ quarterly review requirement and the
more permissive 90 day period to get back into compliance, as
compared to the SEC’s initial proposal. However, the ongoing
compliance burden under the amended rule, coupled with the N-PORT
reporting requirements, reflect a significant shift from prior
practice and will likely discourage even temporary
“shifts” in portfolio composition that might deviate from
a regulated fund’s 80% policy, even if such a shift might
otherwise arguably be prudent from a market or investment
perspective. - Existing regulated funds that are not presently subject to the
Names Rule — particularly those with names including terms
such as “growth” or “value” and funds with
ESG‑related names — should review their names and
consider renaming if the terms used could be problematic because
they speak to “particular characteristics” of a
fund’s portfolio investments. - In line with the preceding bullet, we expect that a number of
existing regulated funds that will now become subject to the
amended Names Rule may take steps to modify their names in advance
of the effective date of the amendments in order to maintain the
investment flexibility they previously enjoyed. We believe that
this will likely be most prevalent among any non-listed registered
closed-end funds and BDCs that currently include terms such as
“growth” or “value” in their names, in view of
the new shareholder approval and liquidity requirements applicable
to future changes in a fund’s 80% policy under the amended
Names Rule. - Similarly, we expect that new regulated funds — and
particularly new non-listed registered closed-end funds and BDCs
— may refrain from including terms in their respective names
that could be viewed as speaking to “particular
characteristics” of a fund’s portfolio, absent a clear
marketing reason to do so. As a result, we may see the use of more
generic naming conventions for regulated funds moving forward
— particularly among funds with investment programs that
would not have previously raised Names Rule concerns, such as with
growth or value investing strategies.
Footnotes
1. Investment Company Names, Release No. IC-3500
(September 20, 2023).
2. Registered investment companies and BDCs are referred
to herein collectively as “regulated funds”.
3. Investment Company Names, Release No. IC-34593 (May
25, 2022).
4. Delta refers to the ratio of change in the value of an
option to the change in value of the asset into which the option is
convertible. Delta-adjusting an option means multiplying the
option’s unadjusted notional amount by the option’s delta.
See Use of Derivatives by Registered Investment Companies
and Business Development Companies, Release No. IC-34084 (November
2, 2020).
SEC Adopts Amendments To Fund Names Rule
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