A Rose By Any Other Name: Statement on Proposed Amendments to the Names Rule

Source: Securities and Exchange Commission

As the saying goes – you should mean what you say, and say what you mean.  In some ways, this simple refrain summarizes the backbone of our disclosure regime and the impetus behind the Names Rule and today’s proposed amendments to that rule. 

As the adopting release notes:  “A fund’s name is often the first piece of fund information investors see and, while investors should go beyond the name itself and look closely at the fund’s underlying disclosures, a fund’s name can have a significant impact on their investment decisions.”[1]

Whether consciously or unconsciously, a thing’s name forms our expectations.  If you go to an ice cream truck on a hot summer day, and order a chocolate ice cream cone, you have a certain expectation of what you are going to get.  It will be cold; it will be sweet; it will probably be brown in color.  There may be variations of what the exact ingredients are, where they come from, or the exact measurements.  But we, the ice cream-consuming public, have a general idea of what we are going to get.

The same is true today of certain types of funds.  A “Growth Fund” brings with it an industry expectation of the types of investments that fund will make – investments in companies, (often emerging companies) seeking above-average growth through capital appreciation and reinvestment, with little or no expectation of dividends.[2]  As the adopting release notes, the word “Growth” appears in approximately 8.2% of fund names, and I suspect that investors in those Growth Funds have a certain expectation about what they are investing in.[3]  Likewise, a name can also bring an expectation about what a fund is not investing in.  Here, I suspect investors who put their money into a “Cat and Dog” fund are generally not expecting to be invested in guinea pigs and gerbils.  

Today’s proposed rule is a step in the right direction in bringing market practices in line with investor expectations.[4]  It does so in a number of ways.  For example,

  • Most prominently, where a fund’s name suggests a certain investment focus – such as “growth,” “value” or by reference to one or more ESG factors – that fund must adopt a policy requiring that 80% of the value of its assets be invested in a manner consistent with that fund’s name.  The funds captured by the proposed amendment today would join other types of funds required to adopt an 80% policy, including funds whose names indicate a focus in a particular type of investment, a particular industry, or a particular geographic focus.[5]  The rule also lays out when a fund can temporarily deviate from the 80% policy, and the parameters for coming back in line with the policy “as soon as reasonably practicable,” usually with a maximum departure of 30 days. 
  • The proposal requires that naming conventions that suggest an investment focus be in Plain English or in line with established industry use,[6] and that fund prospectuses define the terms used in its name. 
  • The proposed rule would add a new provision making clear that compliance with the Names Rule is no safe harbor against fraud.  Thus, a fund name can be materially misleading even if the fund technically complies with the Names Rule.[7] 
  • Further, the proposed amendment clarifies that it would be materially misleading for a fund to use an ESG factor in its name, if that factor does not play a central role in the fund’s investment strategy. 

The proposed rule also gives clarity to funds and managers by providing, for example, rules around the treatment of derivatives and by updating the provisions on notice, reporting and recordkeeping requirements, among other changes. 

The Names Rule has not been amended since its adoption in 2001.[8]  The industry has changed significantly in two decades.  The amount of money in registered investment companies has tripled; ETFs, alternative strategy funds, and indexed products have become commonplace in the portfolios of everyday investors; ESG and sustainable investing has taken a prominence previously unseen; and thematic investing, such as by reference to block chain or cybersecurity is growing.[9]  The need for clarity in the funds industry is more important than ever. 

***

“What is in a name?” Juliet famously asked in Shakespeare’s Romeo & Juliet.  “A rose by any other name would smell as sweet.”[10]  That is of course true, and perhaps even a poetically perfect line.  But in the world of investing – the world of retirement accounts, college savings accounts, and accounts for buying your first home – there is simply quite a lot riding on a name.  Here it is fair for investors to expect clarity, consistency and forthright naming conventions.  Simply put, investors should know what they are investing in.  Today’s proposed rule is a step in the right direction of bringing market practices in-line with investor expectations. 

I want to conclude by thanking all of the industry participants who wrote letters and contributed comments to the RFC put out by the Commission in 2020.  Your participation in our process is integral in helping my staff, staff in the Division of Investment Management, and me better understand industry practices and how we can improve our regulations to protect and serve investors.  And, now that we have a proposal, I again encourage all industry participants to do just that again – participate!  Please provide feedback on this proposal.

I also want to thank Chair Gensler and his staff for their leadership on today’s important proposed amendment.  Finally, and perhaps most importantly, I want to thank the staff in the Division of Investment Management, the Division of Economic and Risk Analysis, and the Office of General Counsel, who have worked tirelessly in drafting and editing not only today’s proposed rule, but many others over the past months.  I think the quality of today’s proposed rule reflects the high caliber of work ethic, professionalism and dedication of the staff, and we are very fortunate for your ongoing commitment to the agency and our mission.  Thank you.

 


[1] Investment Company Names, Investment Company Act Release No. IC-34593 at 5-6 (proposed May 25, 2022) [hereinafter the Proposed Release].  “Funds” as referred to herein, as well as in the Proposed Release refers to registered investment companies and business development companies.  Id. at 5, n. 1.

[2] Indeed, Oxford’s dictionary defines a growth fund as “a mutual fund that invests primarily in stocks that are expected to increase in capital value rather than yield high income.”  Oxford Languages, Oxford University Press (2022).

[3] Proposed Release at 119. 

[4] Section 35(d) of the Investment Company Act prohibits a registered investment company from using a name that the Commission finds materially misleading or deceptive.  Congress authorized the Commission to define by rule, regulation or order, what names would be materially deceptive or misleading.  15 U.S.C. 80a-34(d). 

[5] See Investment Company Names, Investment Company Act Release No. 24828 (Jan. 17, 2001).

[6] Plain English requirements can be found in many places in the securities laws, intending to make the statements of issuers and registrants more accessible to all investors.  See, e.g., 17 C.F.R. 240.13a-20 (requiring all reports filed under Section 13(a) of the Securities Exchange Act of 1934 to be “presented in a clear, concise and understandable manner.”)  The SEC, like industry participants, has Plain English obligations as well.  See The Plain Writing Act of 2010, P.L. 111-274.

[7] Funds and managers are subject to Investment Company Act Section 35(d) and the antifraud provisions of the securities laws. See, e.g., 15 U.S.C. 77q(a); 17 CFR 240.10b-5(b); 17 CFR 230.156; and 17 CFR 275.206(4)-8.

[8] See Investment Company Names, Investment Company Act Release No. 24828 (Jan. 17, 2001).

[9] Proposed Release at 12-13, nn.21-22 (noting developments and listing comment letters). 

[10] William Shakespeare, Romeo & Juliet, Act 2, Scene 2.