Fund Alert! Is Your Name Covered by the New Fund Names Rule?

This piece was written by Bo Howell and Irina Garcia Iglesias from FinTech Law

On September 20, 2023, the SEC adopted amendments to Rule 35d-1 (altogether the “Fund Names Rule”), which are intended to avoid the use of misleading names regarding the fund investment objective. As a result, over 2,200 funds will now need to comply with the Fund Names Rule, which totals 76% of registered investment companies, including mutual funds, ETFs, and closed-end funds.

This means that any registered investment company whose name suggests a focus on a particular investment, industry, country or geographic region, tax status, or that has strategy characteristics such as “ESG,” “growth,” or “value” must adopt an “80% investment policy” and perform periodic testing to ensure they are complying with their policy. If a fund's portfolio does not align with the policy, the fund has 90 days to get back into compliance or it will be deemed to have violated its policies and the Investment Company Act of 1940. The 80% investment policy applies to “net assets,” meaning assets plus the amount of any borrowings for investment purposes.

New terms that trigger an 80% investment policy include:

• Environmental, social, or governance (ESG) factors
• Sustainability
• Impact investing
• Corporate social responsibility
• Climate change
• Green
• Ethical
• Diversity and inclusion
• Emerging markets
• Frontier markets
• Large-cap stocks
• Midcap stocks
• Small-cap stocks
• Microcap stocks
• Sector investing
• Thematic investing
• Specific countries such as Brazil, China, Germany, Japan, Korea, United Kingdom
• Geographic regions such as Asia, Europe, Latin America, and North America

Terms that do not trigger the rule include “duration,” “balanced,” “managed risk,” “long/short,” “hedged,” “global,” and “international;” these terms suggest overall portfolio characteristics, and not specific investments. But terms such as United States, Japan, China, Europe, and Latin America would require an 80% investment policy because they focus on securities from specific countries or geographic regions.

Further, if a fund's name includes more than one element covered by the rule, then the 80% investment policy must cover all the elements. For example, the FTL Growth Equity Fund would need an investment policy that covers both “growth” and “equity.” Whereas the FTL Long/Short Japan Fund would only need a policy that covers “Japan.”

Managers should also note that fund-of-funds may need to look through their 80% investment policy to the underlying fund's investment policy to confirm the position complies with the rule.

There are also specific requirements for unlisted closed-end funds (e.g., interval funds) and business development companies (BDCs) and whether they must make their 80% investment policy a fundamental investment policy.

The New Rules apply to all funds, whether they are existing funds or new funds, but funds will have different compliance dates depending on their net assets:

1. Net assets of $1 billion or more–24 months compliance period (est. December 2025).
2. Net assets of less than $1 billion–30 months compliance period (est. June 2026).

What to Do Next?

Investment Advisers and legal counsel to a fund should meet to discuss the impact of the new rule on the fund. If needed, legal counsel should prepare amendments to the fund's disclosure documents that include an 80% investment policy; compliance may also need to update the adviser's and fund's compliance policies, and ultimately the board will need to approve any changes to the disclosure documents and compliance programs. Below is a list of activities that managers and funds should cover before the compliance date.

General

• Include prospectus and Form N-PORT disclosures defining the terms used in the fund's name.
• Funds with derivatives in their holdings must use the derivatives' notional amount rather than their market value for the purpose of compliance with the 80% investment policy.
• Provide a 60-day notice to the fund shareholders of any change in a fund's non-fundamental 80% investment policy, although the new 80% investment policy does not require pre-disclosure. (For unlisted closed-end funds that do not permit redemptions within a 60-day period, the 80% investment policy must either be a fundamental policy or a non-fundamental policy that requires shareholder approval to change it.)

Quarterly

• Review all fund's investments and confirm it is compliant with the 80% investment policy requirement.
• Maintain written records documenting compliance with the rule, indicating which portfolio holdings count towards the 80% requirement, the dates and reasons for any departure from this policy, and any notices to shareholders pursuant to the New Rule, all of which must also be included in Form N-PORT.

Post-implement, if the fund has departed from compliance with the 80% investment policy, then the fund should adjust its investment allocations and amend agreements with broker-dealers and other service providers as necessary within the 90-day compliance period. If compliance with the rule would imply losses to a fund investment allocation or will not be feasible within the 90-day period, the fund should consider (1) approving resolutions for a name change, (2) filing a supplement to the fund's registration statement to reflect the name change, and (3) sending the updated disclosure to shareholders.

If you have any questions about the application of the rule to your funds, don't hesitate to contact the FinTech Law team.