While its "Money Market Fund Reform" proposal (see the Comments on MMF Reform here) is getting all the attention in the cash space, two new proposals from the Securities & Exchange Commission published last week could impact the sector as well. The SEC's proposed rule changes on both "Environmental, Social, and Governance Disclosures for Investment Advisers and Investment Companies" and "Investment Company Names" could force major changes to, or even eliminate, the nascent and fast-growing ESG & Social money market fund space. (Note: For those planning on attending our upcoming Money Fund Symposium, which is June 20-22, in Minneapolis, Minn, please make your hotel reservations ASAP! We fear the hotel may sell out very soon.)
The press release for the latter, entitled, "SEC Proposes Rule Changes to Prevent Misleading or Deceptive Fund Names," says, "The Securities and Exchange Commission today proposed amendments to enhance and modernize the Investment Company Act 'Names Rule' to address changes in the fund industry and compliance practices that have developed in the approximately 20 years since the rule was adopted. A fund's name is an important marketing tool and can have a significant impact on investors' decisions when selecting investments, and the Names Rule addresses fund names that are likely to mislead investors about a fund's investments and risks. The proposal follows a request for comment the SEC issued to gather public feedback on potential reforms to the rule in March 2020."
SEC Chair Gary Gensler comments, "A lot has happened in our capital markets in the past two decades. As the fund industry has developed, gaps in the current Names Rule may undermine investor protection. In particular, some funds have claimed that the rule does not apply to them -- even though their name suggests that investments are selected based on specific criteria or characteristics. Today's proposal would modernize the Names Rule for today's markets."
The release continues, "The Names Rule currently requires registered investment companies whose names suggest a focus in a particular type of investment (among other areas) to adopt a policy to invest at least 80 percent of the value of their assets in those investments.... The proposed amendments would enhance the rule's protections by requiring more funds to adopt an 80 percent investment policy. Specifically, the proposed amendments would extend the requirement to any fund name with terms suggesting that the fund focuses in investments that have (or whose issuers have) particular characteristics. This would include fund names with terms such as 'growth' or 'value' or terms indicating that the fund's investment decisions incorporate one or more environmental, social, or governance factors. The amendments also would limit temporary departures from the 80 percent investment requirement and clarify the rule's treatment of derivative investments."
The release on the ESG rule, "SEC Proposes to Enhance Disclosures by Certain Investment Advisers and Investment Companies About ESG Investment Practices," tells us, "The Securities and Exchange Commission today proposed amendments to rules and reporting forms to promote consistent, comparable, and reliable information for investors concerning funds' and advisers' incorporation of environmental, social, and governance (ESG) factors. The proposed changes would apply to certain registered investment advisers, advisers exempt from registration, registered investment companies, and business development companies."
Gensler says, "I am pleased to support this proposal because, if adopted, it would establish disclosure requirements for funds and advisers that market themselves as having an ESG focus. ESG encompasses a wide variety of investments and strategies. I think investors should be able to drill down to see what's under the hood of these strategies. This gets to the heart of the SEC's mission to protect investors, allowing them to allocate their capital efficiently and meet their needs."
The release also states, "The proposed amendments seek to categorize certain types of ESG strategies broadly and require funds and advisers to provide more specific disclosures in fund prospectuses, annual reports, and adviser brochures based on the ESG strategies they pursue. Funds focused on the consideration of environmental factors generally would be required to disclose the greenhouse gas emissions associated with their portfolio investments. Funds claiming to achieve a specific ESG impact would be required to describe the specific impact(s) they seek to achieve and summarize their progress on achieving those impacts. Funds that use proxy voting or other engagement with issuers as a significant means of implementing their ESG strategy would be required to disclose information regarding their voting of proxies on particular ESG-related voting matters and information concerning their ESG engagement meetings."
It adds, "Finally, to complement the proposed ESG disclosures in fund prospectuses, annual reports, and adviser brochures, the proposal would require certain ESG reporting on Forms N-CEN and ADV Part 1A, which are forms on which funds and advisers, respectively, report census-type data that inform the Commission's regulatory, enforcement, examination, disclosure review, and policymaking roles. The proposing release will be published in the Federal Register. The comment period will remain open for 60 days after publication in the Federal Register."
On Thursday, law firm K&L Gates published the update, "A Fund by Any Other Name: SEC Proposes Names Rule Amendments." The "U.S. Asset Management and Investment Funds Alert," explains, "On 25 May 2022, the U.S. Securities and Exchange Commission (the SEC) proposed amendments (the Proposed Amendments) to Rule 35d-1 (the Names Rule) under the Investment Company Act of 1940, as amended in its release entitled 'Investment Company Names' (the Proposing Release). The Proposed Amendments would significantly expand the scope of terms that the SEC considers materially deceptive and misleading in a registered investment company's (a fund) name without a corresponding policy to invest at least 80% of the value of the fund's net assets, plus the amount of any borrowings for investment purposes, in the manner suggested by the fund's name (an 80% Policy). Triggered in part by the rise of environmental, social, and governance (ESG) investing and concerns that investors may rely inordinately on a fund's name to understand its investments and risks, the Proposed Amendments are aimed at addressing perceived gaps in the Names Rule."
They write, "While the SEC is clearly motivated by concerns over 'greenwashing,' where disclosure of ESG considerations in fund offering materials does not align with actual investment practices, the Proposed Amendments would also capture other terms that historically have been considered investment strategy terminology outside the scope of the rule. This approach represents a significant departure from the SEC's long-standing position on the use of fund names by expanding the scope of the Names Rule to apply to fund names that include terms suggesting that the fund focuses in 'investments that have, or whose issuers have, particular characteristics.'"
K&L Gates' summary adds, "The Proposed Amendments include enhanced disclosure requirements for how a fund defines the terms in its name and selects investments for its 80% basket. The Proposed Amendments also go beyond enhancing disclosure requirements by limiting when funds may deviate from an 80% Policy, mandating how the Names Rule will be applied to derivatives exposure calculations, imposing specific requirements on unlisted closed-end funds and business development companies (BDCs), and requiring new or expanded notice, recordkeeping, and reporting requirements. The comment period for the Proposed Amendments is 60 days after publication in the Federal Register. If adopted, compliance with all elements of the Proposed Amendments will be required following a one-year transition period."
We asked K&L Gates Partner (and author of the above piece) Clair Pagnano whether this proposal would impact ESG & Social Money Market Funds. She tells us, "The short answer is 'yes.' The new 'Names' rule proposal, if adopted as proposed, would apply to MMFs. However, the SEC in its request for comments did ask: 'Consistent with the current names rule, the proposed amendments would generally apply to money market funds. 17 CFR 270.2a-7 ('rule 2a-7') also requires funds that use the term 'money market' in their names to comply with the requirements of that rule. Are the requirements of rule 2a-7 sufficient to prevent materially misleading or deceptive money market funds names, or should we continue to apply the names rule to those funds?' So there is ample opportunity for MMFs to push back on [the proposal's] application to MMFs, although I think likely some version of the Names rule will apply to them. I note that a number of the ancillary reporting requirements will not apply to MMFs (i.e. Form N-PORT disclosures, etc., as that is not something MMFs file)."
