(Article from Registered Funds Regulatory Update, July 2022)
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The SEC voted to propose amendments to Rule 35d-1 under the Investment Company Act, the so-called “Names Rule.” The existing Names Rule requires a fund with a name that suggests a focus in a particular type of investments or industry to adopt a policy to invest at least 80% of the value of its assets in accordance with the focus that the fund’s name suggests (an “80% test”). The existing rule has led to confusion as SEC staff have taken inconsistent positions as to whether certain terms connote a type of investment or investment in a particular industry (which would require an 80% test) or an investment strategy (which would not). The SEC acknowledged these determinations are subjective, not mutually exclusive, and prone to second guessing. Accordingly, the proposed amendments would broaden the scope of the Names Rule to require an 80% test for any fund that includes terms in its name suggesting that the fund focuses in investments that have, or whose issuers have, particular characteristics, including fund names with terms indicating that the fund’s investment decisions incorporate one or more ESG factors. Most importantly (and confusing), the proposal would apply the Names Rule to terms that do not have an obvious or widely-agreed definition, such as “value” and “growth,” and ESG-related terms, such as “sustainable,” “green,” or “socially responsible.” It would also apply to names that have not historically fallen under the Names Rule, such as “global,” “international,” and “income.”
Recordkeeping and Reporting: Funds that do not adopt an 80% investment policy would be required to maintain a written record of their analysis that such a policy is not required under the Names Rule. A fund that does adopt an 80% investment policy must define the terms used in its name that require the 80% investment policy and determine whether each investment in its portfolio counts toward its 80% bucket and report that holdings-level information monthly on Form N-PORT.
Derivatives: On a positive note, the proposal would require funds to use a derivative instrument’s notional amount, rather than its market value, for purposes of determining a fund’s compliance with its 80% investment policy. Under the proposed rule, a fund may include in its 80% basket the notional amount of derivatives instruments that provide exposure to (i) investments suggested by the fund’s name; or (ii) market risk factors associated with such investments.
Departures from an 80% policy: The current rule states that a fund must comply with its 80% test under “normal circumstances” and requires a fund to determine compliance with its 80% test when it enters into each new investment. The proposal, by contrast, imposes a continuous obligation for a fund to monitor compliance with its 80% test and only permits a fund to depart from its 80% policy under certain specified circumstances for no more than 30 consecutive days.
Unlisted CEFs and BDCs: Under the proposal, unlisted closed-end funds and BDCs would not be permitted to change their 80% investment policies without shareholder approval. Specifically, the proposal would require that unlisted CEFs adopt an 80% test under Section 8(b)(3) of the Investment Company Act. For BDCs, the proposal would require that the 80% test be changeable only by the vote of a majority of its outstanding voting securities.
Comments on the proposal are due August 16, 2022 and, if adopted, the rule amendments would have a one year implementation period. SEC Chair Gary Gensler and SEC Commissioners Allison Herren Lee and Caroline Crenshaw voted for the proposal, while SEC Commissioner Hester Peirce voted against.
Investment Company Names, SEC Rel. No. IC-34593 (May 25, 2022), available at: https://www.sec.gov/rules/proposed/2022/ic-34593.pdf.