The SEC issued a rule proposal earlier this year aimed at expanding the agency's efforts to prevent misleading fund names, prompting a host of concerns and pushback on how the new rule could impact the investment community.
The proposal, released in May, would amend the "Names Rule" under the Investment Company Act of 1940, which requires funds with certain names — such as those specifying a type of security, industry or geographic area — to invest 80% of their assets in the investments the name suggests. The new rule would expand that requirement to any fund names that have "particular characteristics," including those with the terms "growth" and "value," or those indicating the fund incorporates one or more environmental, social and governance investing factors.
"The challenge with that is that there's no definition of what a 'characteristic' is," said Clair E. Pagnano, Boston-based partner at K&L Gates LLP. She added that the proposal "essentially captures what has historically been excluded, which are investment strategies," and added that's "very contrary" to how the industry has operated for years. The previous iteration of the Names Rule excluded fund names with terms like "growth" and "value," which indicate investment strategies rather than types of investments, Ms. Pagnano said.
Industry players are worried about several aspects of the proposal, including a lack of clarity, focusing too much attention on funds' names, and that the rigidity of the rules could force managers into making fire sales.
The SEC released the new rule proposal in tandem with another proposal that aims to address greenwashing — when a company or fund overstates its commitments to sustainable investing. The latter proposal would require fund managers and investment advisers to disclose more information on ESG strategies in their fund prospectuses, annual reports and adviser brochures.
It is unclear how many funds would be impacted by the expanded Names Rule, though data compiled by Bloomberg found there are at least 121 exchange-traded funds with "growth" or "value" in their name as of Nov. 8.
Ms. Pagnano said that in the original Names Rule, "the SEC acknowledged that names aren't the only factor in an investor's decision to buy into a fund." However, the new proposal "almost emphasizes that the name is the only thing that's important, and that investors are making their decisions almost solely based upon a fund's name," she added.
Eric Pan, CEO and president of the Investment Company Institute, a Washington-based trade association representing regulated investment funds, echoed this.
"The proposal inappropriately elevates the importance of a fund's name and doesn't help investors," Mr. Pan said in a statement Aug. 16. "It will simply add needless expenses and force funds to change how they operate just to stay in compliance with the new rule."
In October, the SEC reopened the proposal's comment period until Nov. 1. While the opinions of those in the asset management industry vary, many have expressed concerns over various aspects of the expanded rule.