On May 25, 2022, the Securities and Exchange Commission (the “SEC”) announced proposed amendments (the “Proposal”) to Rule 35d-1 under the Investment Company Act of 1940 (the “Names Rule”), aimed at modernizing the Names Rule for today’s markets and preventing misleading or deceptive names of registered investment companies and business development companies (collectively, “Funds”).
Initially adopted by the SEC in 2001, the Names Rule establishes requirements intended to ensure that a Fund’s name does not misrepresent the Fund’s investments and risks. The Names Rule, in its current form, prohibits a registered investment company from including as part of its name any title or word that the SEC deems to be materially deceptive or misleading. Moreover, the Names Rule currently requires a Fund whose name suggests a focus on a particular type of investment, industry, or geographic region to adopt policies to invest at least 80% of the value of its assets in those investments, industries, or regions. The SEC, however, believes that the Names Rule needs to be updated to address certain interpretive issues with the current rule and to modernize the Names Rule to today’s markets.
A highlight of some of the key elements of the Proposal are described below:
Expansion of Scope
The Proposal, if adopted, would expand the Names Rule’s scope to apply to any Fund name containing a term suggesting the Fund focuses on investments or issuers that have particular characteristics. Specifically, and marking a change from the current Names Rule, the Proposal would extend the 80% investment policy requirement to Fund names that include terms such as “growth,” “value,” “international,” “income,” and “global” – each of which have generally been interpreted to fall outside the current Names Rule’s scope.
ESG Fund Names
The Proposal also addresses the use of ESG and ESG-related Fund names, specifically including Fund names containing terms indicating that a Fund’s investment decisions incorporate one or more ESG factors (e.g., “socially responsible investing,” “sustainable,” “green,” “ethical,” “impact,” etc.) as within the scope of the 80% investment policy requirement. The Proposal further provides that Fund names indicating that a Fund’s investment philosophy incorporates multiple factors must adopt a policy that addresses each element in the Fund name. For example, a Fund with “ESG” in its name would be required to adopt an 80% investment policy that addresses the E (environmental), the S (social), and the G (governance) elements of its name. The Proposal also states that use of an ESG or ESG-related name would be considered materially deceptive and misleading for Funds where ESG considerations do not play a central role in the Fund’s strategy, but are merely considered alongside other, non-ESG factors.
Temporary Departures from a Fund’s 80% Investment Policy
Currently, the Names Rule requires Funds to comply with the 80% investment policy “under normal circumstances,” allowing flexibility to deviate from the policy in certain market conditions or other circumstances.  However, the Proposal would limit temporary departures from a Fund’s 80% investment policy to four specified circumstances: (1) as a result of market fluctuations, or other circumstances where the temporary departure is not caused by the Fund’s purchase or sale of a security or the Fund’s entering into or exiting an investment; (2) to address unusually large cash inflows or unusually large redemptions; (3) to take a position in cash and cash equivalents or government securities to avoid a loss in response to adverse market, economic, political, or other conditions; or (4) to reposition or liquidate a Fund’s assets in connection with a reorganization, the launch of the Fund, or when notice of a change in the Fund’s 80% investment policy has been provided to Fund shareholders at least 60 days before the change.  In each of these circumstances, a Fund departing from its 80% investment policy would be required to come back into compliance with its policy as soon as reasonably practicable, but no later than after 30 consecutive days after departing from its policy (except in the case of a reorganization or fund launch).
Considerations Regarding Derivatives in Assessing Names Rule Compliance
The Proposal would clarify the Names Rule’s treatment of derivatives instruments. Under the Proposal, for purposes of compliance with the Names Rule (and applying the 80% test), a Fund must value each derivatives instrument using its notional amount, rather than its market value. Additionally, a Fund would reduce the value of its assets by excluding cash and cash equivalents up to the notional amounts of the derivatives instrument(s).
Under the current Names Rule, a Fund may include derivative instruments in the Fund’s 80% basket if the instrument has economic characteristics similar to the securities included in the 80% basket. Under the Proposal, however, a Fund may include in its 80% basket both: (i) derivatives instruments that provide investment exposure to the investments suggested by the Fund’s name; and (ii) derivatives instruments that provide exposure to one or more of the market risk factors associated with the investments suggested by the Fund’s name.
Unlisted Closed-End Funds and BDCs
The Proposal would require the 80% investment policy to be a fundamental policy for unlisted closed-end funds and business development companies (“BDCs”) whose shares are not listed on a national securities exchange. As a result, an unlisted closed-end fund or BDC could not change its 80% investment policy without shareholder approval.
Enhanced Prospectus Disclosure
The Proposal would require amendments to Funds’ registration forms (i.e., Form N-1A, Form N-2, Form N-8B-2, and Form S-6) that would require a Fund to include disclosures in its prospectus that define the “terms” used in its name, including the specific criteria the Fund uses to select the investments the “term” describes. For purposes of the Proposal, “terms” would mean any word or phrase used in a Fund’s name related to the Fund’s investment focus or strategies. Similarly, the Proposal would require that any “terms” used in the Fund’s name that suggest either an investment focus or that such Fund is a tax-exempt Fund be consistent with the “term’s” plain English meaning or established industry use.
If adopted as proposed, a one-year transition period would run from the date of publication of any final amendments to the Names Rule in the Federal Register, providing time for Funds to come into compliance with any new requirements.
If you have any questions about the Proposal, ESG-related items, the Names Rule, or about the regulation of investment advisers, broker-dealers, and registered investment companies generally, please feel free to contact us.
By the Investment Management and Broker-Dealer Team at Kilpatrick Townsend & Stockton
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 See SEC Proposed Rules, Investment Company Names, SEC Release Nos. IC-34593; S7-16-22; 3235-AM72, available at https://www.sec.gov/rules/proposed/2022/ic-34593.pdf (hereinafter, the “Proposal”); SEC Press Release, SEC Proposes Rule Changes to Prevent Misleading or Deceptive Fund Names, May 25, 2022, available at https://www.sec.gov/news/press-release/2022-91 (hereinafter, the “Press Release”).
 See 47 C.F.R. § 270.35d-1 (2001).
 Proposal at 8.
 Proposal at 8. The 80% investment policy is not a safe harbor for materially deceptive or misleading names, and “a name that would lead a reasonable investor to conclude that the fund invests in a manner that is inconsistent with the fund’s actual or intended investments or the risks of those investments would be deceptive or misleading even if the fund is in compliance with its 80 [percent] investment policy.” Id. at 11.
 See Proposal at 6, 13.
 See Proposal at 23-24.
 See Proposal at 14, 18.
 Proposal at 26.
 Proposal at 81.
 Proposal at 34.
 Proposal at 33–34.
 The Proposal provides exceptions to this 30-day compliance window in the case of fund launches (180 consecutive days), reorganizations (no time frame is specified), or where the 60-day notice has been provided to shareholders. See Proposal at 34.
 Proposal at 48.
 Proposal at 48.
 Proposal at 49.
 Proposal at 48.
 Proposal at 65.
 Proposal at 66.
 Proposal at 72.
 Proposal at 72.
 Proposal at 78.
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