What's in a name when it comes to investment funds?
The Securities and Exchange Commission's answer is: "a lot." In a 4-1 vote on Wednesday, the Wall Street watchdog approved moving forward with rule changes meant to provide advisors and investors with a little more assurance that the titles they see attached to individual funds actually shed some light on their investing priorities and strategies.
Various SEC commissioners and staff members argue that investors tend to put a lot of stock into fund names. Particular concerns have grown up around investments promising to give clients a means of furthering environmental, social and governance goals.
As ESG investing has grown in popularity, charges of "greenwashing" have become ever more common. Greenwashing refers to the practice of falsely claiming environmental benefits for a particular investing strategy.
SEC Chair Gary Gensler said the rule changes approved Wednesday will promote "truth in advertising."
"(A) fund's investment portfolio should match a fund's advertised investment focus," he said at a meeting held at the SEC's headquarters in Washington, D.C.
The rule changes approved by the SEC would extend the agency's 20-year-old "names rule" to a far larger swath of mutual funds and similar investment vehicles. In general, the rule requires funds to make sure at least 80% of the money they are entrusted with is being invested in a way that's consistent with their names.
The changes approved Wednesday would require fund managers to look quarterly to ensure they are still meeting this 80% requirement. If they've fallen out of compliance, they'll have 90 days to come back in — a time frame revised upward from the 30 days allowed in an earlier proposal.
Read more:
The majority of SEC commissioners said Wednesday that the changes are needed so that investors can know what they're getting into not only with ESG funds but also funds promising "value" or "growth" strategies. Gensler said the amended rule would also require managers to be mindful of how they use terms like "artificial intelligence" and "big data."
In most cases, fund managers will be required to use "plain English" definitions for the terms used in their prospectuses. But the commissioners acknowledged that certain terms, like value, have a special meaning in the investment world.
"Value investing" often refers to a strategy of looking for companies that are underpriced and whose shares can be bought for cheap. It's often contrasted with "growth" investing, which entails scouting for firms whose shares might be expected to rise sharply in coming years.
The SEC rule gives managers considerable leeway to define those terms how they want, as long as they disclose their reasoning to investors.
Mark Uyeda, the only commissioner to vote against the proposal Wednesday, said he's worried there's too much ambiguity around when it's acceptable to employ a term in the industry's sense and when managers will have to stick to common definitions.
"We've been down this road before, when the Funds Names Rule was initially adopted in 2001," Uyeda said. "The commission noted that a fund may, 'Use any reasonable definition of the term used in its names.' Well, hopefully, this time we mean it. If we construe these terms too rigidly, fund innovation and investor choice will suffer."
Kelley Howes, a partner and the co-chair of the investment management group at San Francisco-based Morrison Foerster, said she thinks the former version of the rule had offered strong protections to investors. She said the attempt at combatting "greenwashing" won't necessarily cause harm.
"But do I think that it's going to fix it?" Howes said. "Implicit in that is an assumption that it's rampant. I don't think that is the case. But clearly, that's not an opinion shared by all of the commission."
Groups like the Investment Company Institute, which represents mutual funds, have argued the SEC's rule change could give investors a false sense of assurance.
"Logically, a fund's name — given reasonable limits in length — can only be a starting point for investors and must be read in conjunction with other important, more detailed, information about a fund's investment objectives and strategies, fees and expenses, performance and other matters of importance to investors," according to a letter submitted the organization submitted to the SEC on Aug. 16, 2022.
Read more:
The SEC's original names rule had applied to funds mentioning particular assets like stocks and bonds, industries like healthcare or individual geographic reasons. The SEC estimates that extending it to names that include ESG-related terms or "value" and "growth" will increase the proportion of all firms flailing under its requirements to 76% from 60%.
Various investor advocate groups welcomed that prospect. Andrew Behar, the CEO of the "green" investing group As You Sow, said there are now dozens of funds that allude to ESG in their names and nonetheless put money into fossil-fuel companies and coal-fired utilities.
"When investors put their hard-earned savings into an 'ESG' or 'fossil free' fund, they expect to reduce their climate risk and not own big oil, coal and deforestation," Behar said. "These new rules will help provide needed truth in advertising and make a statement that financial greenwashing with misleading or deceptive ESG labels is not acceptable."
Better Markets, a market reform group, noted that investors who are trying to choose among various investment opportunities often put a good deal of stock in fund names.
"The SEC's names rule will help prevent funds from misleading investors with baseless if not false claims about ESG, climate, and sustainability," Stephen Hall, Better Markets legal director and securities specialist, said in a statement. "This long overdue modernization of the Names Rule is particularly relevant today as investors seek to invest in mutual funds and ETFs that focus on ESG and sustainability."
The changes the SEC approved to its Names Rule will take effect 60 days after appearing in the Federal Register. Funds managing less than $1 billion will have 30 months to comply, and those managing $1 billion or more will have 24 months.
