On September 20, 2023, the Securities and Exchange Commission (“Commission”) adopted amendments to the Names Rule under the Investment Company Act of 1940 (“1940 Act”) which addresses certain broad categories of investment company names that are likely to mislead investors about an investment company’s investments and risks.
These amendments to the Names Rule are the first since its adoption in 2001. The new amendments are designed to increase investor protection by improving and broadening the scope of the requirement for certain funds to adopt a policy to invest at least 80 percent of the value of their assets in accordance with the investment focus that the fund’s name suggests, updating the rule’s notice requirements, and establishing recordkeeping requirements.
The Commission is also adopting enhanced prospectus disclosure requirements for terminology used in fund names, and additional requirements for funds to report information on Form N-PORT regarding compliance with the names-related regulatory requirements.
The Necessity for the Amendments
Misleading fund names have been a concern in the investment world. They can inadvertently or purposely misguide investors about the actual composition or risk profile of the fund. This amendment is designed to tighten the criteria, ensuring that fund names align more closely with their actual investment strategies and risks.
The amendments include:
- Expansion of Scope: The 80% investment policy requirement will be broadened to cover any fund name suggesting a specific investment focus, like “growth” or “value”, or names implying environmental, social, and governance (ESG) factors in their decision-making.
- Temporary Departures from the 80% Investment Requirement: The finalized rule maintains the stipulation that a fund should typically adhere to its 80% investment policy. However, funds must now review their portfolio's alignment with this policy quarterly. If there's a deviation from the policy due to market shifts or other irregular circumstances, funds have 90 days to realign, extended from the originally proposed 30 days.
- Derivatives: The final amendments stipulate that funds should use the notional amount of a derivatives instrument to check compliance with the 80% investment policy, with some modifications. Notably, certain currency hedges are excluded from this compliance calculation. Additionally, the amendments clarify which derivative instruments can be included in a fund's 80% basket.
- Unlisted Registered Closed-End Funds and BDCs: These entities can't alter their 80% investment policy without shareholder approval unless specific conditions, like conducting a tender or repurchase offer with sufficient notice of the policy change, are met.
- Enhanced Prospectus Disclosure: Fund prospectuses will now need to clearly define terms used in fund names and the criteria for selecting associated investments.
Enhanced Prospectus Disclosure Requirements
Amendments have been adopted to fund registration forms including Form N-1A, Form N-2, Form N-8B-2, and Form S-6. These amendments mandate funds with an 80% investment policy to clarify terms used in their names within their prospectus, especially detailing the criteria for investment selections. This is intended to help investors understand the relationship between a fund's name and its investment strategy.
Increased Reporting on Form N-PORT
The amendments introduce additional requirements for funds regarding reporting on Form N-PORT. Specifically, funds must now report if each of their portfolio investments aligns with the fund's 80% investment policy and the value of the fund's 80% basket relative to the fund's total assets. This will ensure that funds are not only adhering to the rules but also regularly reporting their compliance.
- Plain English Requirements for Terms Used in Fund Names: Fund names should use terms that align with their plain English meaning or with well-established industry usage.
- Form N-PORT Reporting Requirements: Funds must report the value of their 80% basket and provide definitions for terms used in their names. Reporting is required for the third month of every quarter.
- Recordkeeping: Funds are obligated to maintain records demonstrating their adherence to the rule's directives. Contrary to the initial proposal, funds not implementing an 80% policy won't need to document their rationale for this decision.
The amendments will become effective 60 days after publication in the Federal Register. Fund groups with net assets of $1 billion or more will have 24 months to comply with the amendments, and fund groups with net assets of less than $1 billion will have 30 months to comply.
If you want to discuss what these new amendments mean to you or find out more about how PINE’s Compliance Service groups can support your business, reach out to your usual PINE contact or email@example.com.
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