The Securities and Exchange Commission (the “SEC”) has adopted important changes to Rule 35d-1 under the Investment Company Act of 1940, the rule that regulates the names used for registered investment companies (the “names rule”).¹ On September 20, 2023, the SEC amended the names rule to expand the types of names that could be considered materially deceptive or misleading if a fund does not adopt a policy to invest, under normal circumstances, at least 80% of the value of its assets in the investment focus that the name suggests. The amended rule now regards the use of terms that suggest the fund makes investments that have, or whose issuers have, particular characteristics as materially deceptive or misleading unless the fund satisfies the requirements of the rule. The rule text specifically refers to terms such as “growth” or “value” in the fund’s name, or terms indicating that the fund’s investment decisions incorporate one or more environmental, social or governance (“ESG”) factors as covered by the amendments. 

In its release adopting the amendments, the SEC observes how much the fund industry has developed since Rule 35d-1 was adopted in 2001,² but that the rule has not been amended since that time. During this period, the SEC notes, the size of assets in registered funds has grown from $7.15 trillion to $28.2 trillion (in 2022), and fund names have become much more diverse to reflect, among other things, “thematic” strategies, such as physical world, social, technology, artificial intelligence and big data, food, space and wellness, and sub-themes such as health innovation, next gen auto, millennials and Generation Z, cannabis, robotics, travel/tourism, and ESG. Nevertheless, the SEC indicates, there is general agreement that Rule 35d-1 has provided an effective regulatory framework for ensuring that fund names are not materially deceptive or misleading and has served to help investors understand what they can expect when they invest in a fund. Fundamentally, the names rule seeks to prevent the use of fund names that misrepresent the fund’s investments and risks.

In its adopting release, the SEC notes that funds with ESG-related terms in their names present particular challenges. The SEC states that given the significant investor interest in and growth of funds that offer ESG strategies, investment managers have sought to benefit by using terms in fund names, such as “sustainable,” “green,” and “socially responsible,” to suggest an ESG focus. The SEC states that approaches to ESG investing vary, however, and that funds that consider ESG factors have strategies that vary in the extent to which ESG factors are considered versus other factors. The SEC further observes that the breadth of ESG-related terms, as well as evolving investor expectations around terms like “sustainable” and “socially responsible,” compound the possibility of investor confusion and potential “greenwashing” in fund names.

The discussion in the release of use of ESG-related terms in fund names suggests that compliance with these requirements could be a focus of SEC administrative and enforcement action in the near future. This priority is underscored by statements by Commissioner Jaime Lizárraga, who noted that the Rule 35d-1 amendments are a direct response to the recent trend of the “broadening of fund investment options and growth in ESG investment strategies” since the SEC adopted the original version of the rule in 2001. SEC Chairman Gary Gensler has made similar statements, stating that the amendments “will help ensure that a fund’s portfolio aligns with a fund’s name” and will ultimately promote “fund integrity on behalf of fund investors.” The increased SEC emphasis on ESG-related investment products is also reflected in the SEC’s 2022 rule proposal to enhance disclosures by certain investment advisers and investment funds about ESG investment practices, although the SEC has yet to adopt these rules into law.³  A substantial increase in SEC enforcement actions in the ESG and anti-greenwashing space in the last few years also reflects the heighted SEC scrutiny in this area. Notably, in 2021, the SEC’s Division of Examination published a risk alert related to claims of investment advisers and investment funds about ESG investing,⁴ and that division subsequently declared that it would emphasize ESG investing as a focus area in its fund and adviser examination priorities.⁵

Beyond the expansion of the 80% investment policy, the amendments to Rule 35d-1 include the following other changes:

1. a fund must now review its portfolio’s assets inclusion in its 80% basket for compliance with Rule 35d-1 at least quarterly;
2. in the event of a fund’s departure from its 80% investment policy as a result of a drift or other-than-normal circumstances, the fund will now have ninety days to get back into compliance with the 80% investment policy requirement;
3. unlisted registered closed-end funds or business development companies are prohibited from changing their 80% investment policy without first obtaining shareholder approval, unless (a) a fund manager engages in a tender or repurchase offer prior to changing their 80% investment policy, (b) that offer is not oversubscribed, and (c) the fund purchases the shares at their net asset value;
4. the fund prospectus disclosure requirements have been updated and will now require funds to provide additional disclosure to define the terms used in its fund name, as well as the criteria the fund uses to select the investments that the term describes;
5. a fund must ensure that any terms used in its name that suggest either an investment focus or provide for tax-exempt distributions must be consistent with those terms’ plain English meaning or established industry use; and
6. a fund will be required to report information on Form N-PORT regarding its compliance with the names-related regulatory requirements.

The amendments to Rule 35d-1 will become effective sixty days following publication in the Federal Register. Fund groups with $1 billion or more in net assets will have twenty-four months to comply with the amendments, and fund groups with less than $1 billion will have thirty months to comply. The amendments are expected to have a significant impact, with SEC officials estimating that approximately 75% of all funds will be affected in some manner. While the names rule governs registered investment companies and does not specifically regulate private funds (i.e., funds not registered with the SEC such as hedge funds or private equity finds) by its terms, it might be prudent for such private funds and their advisers also to consider some level of compliance with the names rule in light of the recent increase in ESG scrutiny of the investment management industry and uptick in greenwashing litigation.

¹ SEC Rel. No. 33-11,238 (Sept. 20, 2023).

² SEC Rel. No. IC-24828 (Jan. 17, 2001).

³ SEC Rel. No. IA-6,034 (May 25, 2022).

⁴ SEC Division of Examinations, Risk Alert (Apr. 9, 2021).

⁵ SEC Division of Examinations, 2023 Examination Priorities.