August 12, 2022

Volume XII, Number 224

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August 12, 2022

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SEC Proposes Amendments to Fund Names Rule

On May 25, 2022, the SEC issued a proposal to amend the investment company names rule, Rule 35d-1 under the Investment Company Act of 1940, in a manner intended to enhance and modernize the rule to reflect changes in industry practice since the initial adoption of the rule.

Under Section 35(d) of the Investment Company Act, it is unlawful for a registered fund to bear a name that includes words the SEC finds materially deceptive or misleading. In 2001, to implement this statutory provision, the SEC adopted Rule 35d-1. As adopted, the rule prohibits the use in a fund’s name of terminology suggesting that the fund or its securities are issued, guaranteed, sponsored, recommended, or approved by the U.S. government. The rule also provides that a fund’s name may not suggest that a fund invests its assets in a particular industry or group of industries, or in a particular country or geographic region, unless the fund adopts a policy to invest, under normal circumstances, at least 80% of its assets in the investments suggested by its name. This 80% investment policy must be either “fundamental,” meaning that it cannot be changed without shareholder approval, or one that can be changed only after at least 60 days’ prior notice has been given to shareholders. Finally, the rule provides that a fund’s name may not suggest that the fund’s distributions are exempt from federal or state income tax unless the fund adopts a fundamental policy either to invest at least 80% of its assets in securities producing tax-exempt income or to invest in assets 80% of the income from which is tax-exempt. Also in 2001, the SEC staff issued guidance in the form of frequently asked questions regarding the operation of Rule 35d-1 and further elaborating on what the staff viewed as materially deceptive or misleading fund naming conventions.

The proposed amendments to Rule 35d-1 would build on the existing names rule framework with the following modifications and additions:

  • The rule would be expanded to provide that a fund whose name suggests that it invests its assets in investments that have, or whose issuers have, particular characteristics would be required to adopt a policy to invest at least 80% of its net assets in the investments suggested by its name. This would bring within the scope of the names rule funds whose names suggest a focus on “growth” or “value” and funds whose names suggest that a consideration of environmental, social and governance (ESG) factors plays a role in the fund’s investment decisions.

  • The amended rule would specify the conditions under which a fund may deviate from its 80% investment policy, provided the fund returns to compliance as soon as reasonably practicable. Such a deviation would be permitted for a period of up to 30 consecutive days as a result of significant market fluctuations or other circumstances not involving the fund’s buying and selling of portfolio investments, as a result of significant cash inflows or redemptions or to take a temporary position in cash, cash equivalents or government securities to avoid losses in light of adverse market, political or other conditions. A fund would also be able to deviate from its 80% investment policy during its first 180 days of operation or to reposition its portfolio for a reorganization or in anticipation of a previously announced change to its 80% investment policy.

  • The amended rule would specify that derivative instruments that provide exposure to the investments suggested by a fund’s name as well as to one or more market risk factors associated with the investments suggested by the fund’s name may be used to determine compliance with the 80% investment policy. For this purpose, funds would be required to value derivatives at their notional amount rather than at market value.

  • Under the amended rule, the use of ESG terminology in a fund’s name would be deemed materially deceptive and misleading if the fund considers both ESG and non-ESG factors in making investment decisions in a manner such that ESG factors may not be determinative in decisions to include or exclude investments from the fund’s portfolio.

  • The amended rule would specify that a shareholder vote would be required to amend any 80% investment policy of a closed-end fund or business development company whose shares are not listed for trading on a national securities exchange.

  • Finally, the proposal would also impose certain enhanced disclosure requirements, including the definition in a fund’s prospectus of terms used in the fund’s name, and impose certain additional recordkeeping requirements regarding names rule compliance.

Comments on the proposal will be due 60 days after publication of the proposing release in the Federal Register.

The SEC’s proposing release is available here, and a fact sheet is available here.

    © 2022 Vedder PriceNational Law Review, Volume XII, Number 161
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    About this Author

    Jacob Tiedt,Vedder Price law firm investment services attorney
    Shareholder

    Jacob C. Tiedt is a Shareholder at Vedder Price and a member of the Investment Services group.

    Mr. Tiedt’s practice includes the representation of registered mutual funds, closed-end funds and exchange-traded funds; private funds; investment advisers; and other financial institutions on a broad range of regulatory, governance and compliance matters. Mr. Tiedt regularly counsels clients on matters relating to SEC registration, disclosure and compliance; shareholder solicitation; NYSE, Nasdaq and FINRA regulation; corporate governance; and board administration. Mr....

    312-609-7697
    Nathaniel Segal Investment Attorney Vedder Price Law Firm
    Counsel

    Nathaniel Segal is counsel at Vedder Price and a member of the Investment Services group. He focuses his practice on investment companies and investment advisers in connection with the organization and operation of investment products and services, including traditional mutual funds, closed-end investment companies (including interval funds and listed closed-end funds), variable insurance products and registered hedge funds, as well as mutual funds utilizing complex hedging and absolute return strategies. Mr. Segal has experience in conducting transactional due diligence...

    (312) 609 7747
    John Marten Investment Attorney Vedder Price Law FIrm
    Shareholder

    John S. Marten, a Shareholder in the Chicago office of Vedder Price, has substantial experience representing clients in the investment management industry.

    As a member of the firm’s Investment Services group, Mr. Marten counsels clients on a wide variety of matters involving the application of the federal securities laws to investment companies, investment advisers and broker-dealers. He has significant experience counseling investment company clients with respect to new products and was recently involved in the creation of two mutual funds...

    (312) 609 7753
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