The Securities and Exchange Commission (SEC) recently announced amendments to Rule 35d-1 under the Investment Company Act of 1940, colloquially known as the “Name Rule.” The rule compels certain funds to align their investment portfolios with their names. As the regulatory landscape evolves, it’s incumbent on Chief Compliance Officers (CCOs), Chief Operating Officers (COOs), and Chief Technical Officers (CTOs) to understand the implications of these changes.
Elevated Investor Protection
At its core, the amendment is an investor protection measure. It broadens the requirement for funds to invest at least 80 percent of assets in the investment focus their name suggests. This ensures transparency and lessens the likelihood of investor deception.
Key Changes and Their Implications
- Amendments to scope: Fund must now have a Name Rule policy if they include certain words
- Pre-trade evaluation: Funds must now determine if an investment falls within the “80% bucket” before executing a trade. This demands more robust systems for real-time monitoring.
- Batch monitoring frequency: Daily batch monitoring is no longer mandated. Nonetheless, adequate surveillance must be performed to maintain compliance.
- Quarterly testing: A new quarterly test will be administered. While no specific month has been suggested, firms must prepare their processes for compliance confirmation.
- Departures and cure periods: The rules account for both active and passive deviations from the 80% investment requirement. They afford a 60-day correction window to rectify noncompliance.
Amendments Scope:
- Broadened Scope: The 80% investment policy requirement now applies to any registered fund name suggesting a focus on particular characteristics or thematic investment.
- Previously Included: This includes registered fund names indicating investment decisions incorporating one or more ESG (Environmental, Social, Governance) factors.
ESG Terms Triggering 80% Requirement:
- Examples: “ESG,” “sustainable,” “green,” “socially responsible,” “ethical,” “impact,” and “good governance.”
- SEC Commentary: Terms should consider investor expectations and avoid confusion or “greenwashing.”
Extension of Existing Requirements:
- Newly Included Terms: Registered fund names with terms such as “growth” or “value.”
- SEC Explanation: These terms communicate the characteristics of investments in the fund’s portfolio.
- Previously Considered: Prior to amendments, these terms were viewed as investment strategies, not subject to the 80% requirement.
Excluded Terms:
- Omitted Proposal: Terms like “global” and “international” are not subject to the 80% requirement if not paired with additional investment focus terms like “fixed income” or “growth.”
- Reason: These terms indicate a fund’s portfolio construction approach without detailing its composition.
Calculation Revisions
- Derivatives inclusion: Certain derivatives can now count towards the fund’s 80% investments. Their inclusion relies on how closely they align with the fund’s naming.
- Notional value adjustments: The (delta-adjusted) notional value of derivatives may be used in the numerator. This is significant for funds that leverage derivatives heavily.
- Cash considerations: The rule permits the use of “cash” to lower the denominator in the 80% test equation, potentially easing compliance for certain funds.
New Reporting Mandates
Funds must disclose the following on Form N-PORT by the third month each quarter:
- Results of the 80% investment test.
- A listing of securities in the 80% basket.
- These reporting requirements ensure ongoing transparency and ease verification of compliance.
Beneath the Surface
The amendments extend beyond naming conventions. They include the methods for evaluating and reporting compliance, create more flexible monitoring systems, and alter the mechanics of investment calculations. These changes impact fund operations, requiring a recalibration of internal compliance systems and personnel training.
Conclusion
The SEC’s amendments reflect a commitment to investor well-being. This requires a reappraisal of internal processes by asset management firms. CCOs, COOs, and CTOs must ensure their systems and teams are prepared for these new obligations. This recalibration will likely enhance investor trust and fund market integrity. The rule took effect on December 10, 2023, leaving funds ample time to adapt and align with the new regulatory landscape.
The SEC’s release can be found at: U.S. Securities and Exchange Commission.
17 CFR Parts 230, 232, 239, 270 and 274
[Release No. 33-11238; 34-98438; IC-35000; File No. S7-16-22]
RIN: 3235-AM72
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