The SEC’s “Names Rule” Amendments Address the Recent Trend of Misleading Investment Fund Names, with a Message to Public Companies

The SEC has expanded Rule 35d-1 of the Investment Company Act of 1940, known as the “Names Rule,” to require a fund to invest at least 80% of its assets in the manner suggested by its name, focusing on funds that advertise themselves as ESG or sustainable funds. Public companies should also hear the SEC’s message.

On September 20, 2023, the Securities and Exchange Commission adopted amendments to the Investment Company Act’s “Names Rule,” which prohibits registered investment companies and business development companies (commonly referred to as “funds”) from using names that are likely to mislead or deceive investors about a fund’s investments and risks.[1] The SEC’s amendments, in expanding the Names Rule’s scope and disclosure requirements, noted the proliferation of funds that imply that they incorporate environmental, social and governance (ESG)-related criteria into their investment strategies (by using names with terms such as “sustainable,” “green” or “socially responsible”), when in fact the funds do not substantially invest in such a manner.

SEC Chair Gary Gensler stated that “[t]oday’s final rules will help ensure that a fund’s portfolio aligns with a fund’s name. Such truth in advertising promotes fund integrity on behalf of fund investors.”  SEC Commissioner Caroline A. Crenshaw provided the amendments’ common sense rationale:

“Investment company names are far from the only area where Congress has recognized the special importance of the name of a product, and we are far from the only agency that prescribes standards for firms that want to use particular names. For example, in order for a substance to be marketed as ‘peanut butter,’ the substance must be at least 90% peanuts. In order for a fish to be sold as ‘catfish,’ the law requires that it be from the Ictaluridae family. And in order for a company to describe jewelry as ‘gold’ or ‘silver,’ it must ensure its product is nearly entirely made of that metal.

Just like consumers are guided by the term ‘peanut butter,’ but sometimes need to look at the ingredients in order to get specific details about what else is in the jar, we know the name on the ‘packaging’ of a fund is only one component of its disclosures. Even though consumers need to look at the ingredients to know what a jar of peanut butter contains besides peanuts, the name on the front is an important signal about what it contains, and for this reason it is especially important that the name means what it says. Likewise, we know the name of a fund is the first thing an investor will see, and so the name deserves a special focus even if we still expect investors to review the ‘ingredients’ elsewhere.”

In a similar statement, Commission Hester M. Peirce commented:

“When you walk up to a shop with a sign that reads in large neon letters, ‘Pizza Shop,’ you expect to be greeted by the comforting smell of baking dough, sauce and cheese. You know broadly what to expect. Whether it will be classics like pepperoni and cheese or something less conventional like coconut and banana, you have a general idea of what to expect when you walk into a pizza shop. You are not going to get sushi or tacos; you are going to get some sort of pizza.

The amendments to Rule 35d-1 . . . aim to provide the same experience to investors. The premise is that when investors see a fund’s name, they should have a good idea of what to expect.”

The Names Rule Amendments

Since its adoption in 2001, the SEC’s Names Rule has required registered investment companies whose names suggest a focus in a particular type of investment to adopt a policy to invest at least 80% of the value of their assets in those investments. The amendments to the Names Rule enhance the rule’s protections by requiring more funds to adopt an 80% investment policy, including funds with names suggesting a focus in investments with particular characteristics, for example, terms such as “growth” or “value,” or certain terms that reference a thematic investment focus, such as the incorporation of one or more ESG factors or, more recently, artificial intelligence, big data and health innovation. The amendments include a new requirement that a fund review its portfolio assets’ treatment under its 80% investment policy at least quarterly and include specific timeframes – generally 90 days – for getting back into compliance if a fund departs from its 80% investment policy.

The amendments include enhanced prospectus disclosure requirements for terminology used in fund names, including a requirement that any terms used in the fund’s name that suggest an investment focus such as “mid-cap,” “growth” or “value,” must be consistent with those terms’ plain English meaning or established industry usage, and otherwise require disclosure as to how the terms used in the fund’s name are defined. The amendments also include additional reporting and recordkeeping requirements for funds regarding compliance with the names-related regulatory requirements. Fund groups with net assets of $1 billion or more have 24 months to comply with the amendments, and fund groups with net assets of less than $1 billion have 30 months to comply with the amendments.

Message to Public Companies

According to the SEC’s press release for the Names Rule amendments, the SEC has seen a renaissance of investment funds. There are now more investment funds registered in the United States than there are public companies that are listed on U.S. stock exchanges. Investors frequently turn to funds allowing them to invest in particular “themes” rather than individual stocks, and an investor seeking a fund that provides exposure to a particular theme will likely first look at the fund’s name. As compared with a single public company, a fund’s ever changing pool or mix of individual investments makes it less transparent and comparable to other funds for an average investor.

Although the SEC’s Names Rule does not apply to names for individual public companies, the SEC’s message is a familiar one: if a public company’s name or the way it markets or advertises itself implies that the company focuses on a particular type of business, the company must mean what it says and conduct business consistent with such name and advertised focus.

Regulatory activity around misleading and deceptive advertising involving ESG issues such as through, for example, “greenwashing,” when a company makes an unsubstantiated claim to deceive consumers into believing that a company’s products are environmentally friendly, or “pinkwashing,” when a company uses the recognizable pink ribbon symbol to market a product without meaningfully supporting breast cancer research or awareness, has been gaining momentum. The SEC is expected to announce climate-related disclosure requirements later this month. For both investment funds and individual public companies, materially misleading and deceptive names are subject to the anti-fraud provisions of the U.S. federal securities laws regarding disclosures to investors. Public companies should hear the SEC’s message.

[1]       Investment Company Names, Release No. IC-3500 (September 20, 2023).

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