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Thompson Hine LLP, a full-service business law firm with approximately 400 lawyers in 8 offices, was ranked number 1 in the category “Most innovative North American law firms: New working models” by The Financial Times and was 1 of 7 firms shortlisted for The American Lawyer’s inaugural Legal Services Innovation Award. The firm has been recognized by the National Law Journal as a Legal Technology Trailblazer and featured by Bloomberg for its innovative service delivery models, which drive accuracy and predictability. The firm’s commitment to innovation is embodied in Thompson Hine SmartPaTHTM – a smarter way to work – predictable, efficient and aligned with client goals. For more information, please visit ThompsonHine.com and ThompsonHine.com/SmartPaTH.

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In 2001, the SEC <a href="https://www.sec.gov/rules/final/ic-24828.htm">recognized</a> that a fund name is the often first piece of information that an investor receives about a potential investment. To protect investors, the SEC adopted the Names Rule and prohibited materially deceptive or misleading fund names. The Names Rule requires mutual funds and exchange-traded funds to invest at least 80% of their assets in the investment type, industry and geographic location their names suggest. For example, if a fund’s name includes “U.S. Bond,” the Names Rule requires it to invest at least 80% of its assets in domestic bonds. In recent years, SEC staff have invoked the Names Rule to disallow fund names suggesting protection from loss or diminished risk.

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The SEC has never amended the Names Rule even though mutual funds and exchange-traded funds have evolved greatly since 2001. The Names Rule does not address many risks that investors now face, leading SEC staff and industry professionals to find its application to be inconsistent and insufficient to protect investors.

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The Names Rule does not apply to derivatives and other financial instruments that provide leverage. A fund that invests a relatively small amount of its assets in derivatives could potentially have significant exposure to an investment type. The Names Rule focuses on a fund’s holdings but does not consider the potential risks of those holdings. Similarly, the Names Rule does not account for hybrid instruments, such as convertible securities, that have elements of several investment types. An investor in an “Equity Fund” may not appreciate the fund’s potential exposure to fixed income risks because of its holdings in convertible securities. Relatedly, it is difficult for funds focused on emerging industries to satisfy the 80% test of the Names Rule.

Index-based funds are growing in number, yet index constituents are not always closely tied to an index’s name and the Names Rule does not govern indices. If a fund name includes the name of an index, the Names Rule offers no protection. Fund names that include the names of well-known organization or affinity groups are also beyond the Names Rule’s reach, leaving investors wondering whether the fund is specifically tailored to members or available only to members of the named group. The Names Rule has no application to ticker symbols, which advisers commonly use to convey information about a fund’s holdings.

SEC staff have treated the increasingly popular environmental, social and governance-oriented (“ESG”) funds inconsistently. Some staff view ESG as an investment type covered by the Names Rule and others treat ESG as an investment strategy falling outside of its scope.

The SEC seeks help of interested parties and market participants with improving the Names Rule. The SEC requests their input on the following areas, among other items:

The comment period on these and related questions closes on May 5, 2020.

The SEC’s request for comment indicates a renewed focus on misleading fund names and heightened scrutiny on whether a fund’s name reflects what the fund is trying to accomplish. The push towards more standard naming conventions could lead to generic fund names which would require investors to do more research to understand what they are about. Ultimately, the effort to protect investors could lead to more investors being left in the dark.

Andrew J. Davalla 614.469.3353 <a href="mailto:Andrew.Davalla@ThompsonHine.com">Andrew.Davalla@ThompsonHine.com</a>

Philip B. Sineneng 614.469.3217 <a href="mailto:Philip.Sineneng@ThompsonHine.com">Philip.Sineneng@ThompsonHine.com</a>

This advisory bulletin may be reproduced, in whole or in part, with the prior permission of Thompson Hine LLP and acknowledgment of its source and copyright. This publication is intended to inform clients about legal matters of current interest. It is not intended as legal advice. Readers should not act upon the information contained in it without professional counsel.

This document may be considered attorney advertising in some jurisdictions.

https://admin.thompsonhine.com/wp-content/uploads/2022/05/Investment_Management_Update_-_SEC_Seeks_Comments_on_Amending_Names_Rule.pdf

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SEC Seeks Comment on Amending “Names Rule” to Eliminate Misleading Fund Names

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