SEC Seeks To Crack Down On Fund Names

The U.S. Securities and Exchange Commission wants to tighten the rules governing what ETF and fund issuers can name their products, particularly when it comes to using factors or ESG-like monikers. 

One rule proposed Wednesday would expand how many exchange-traded funds would be required to follow the so-called 80% Rule if they use an investment strategy term in their names.  

Under existing rules, funds must concentrate 80% of their investments into securities suggested by its name, whether the name uses an investment factor, sector, geography or other investment style to denote what investors are buying. If it doesn’t meet that requirement, the fund managers have 30 days to bring the fund back above that 80% threshold. 

The SEC estimates approximately 82% of ETFs, mutual funds and similar products mention the 80% threshold in their prospectuses. 

Notably, the proposal would preclude issuers from using the term “ESG” or similar phrases to denote environmentally friendly investing if it’s used equally in tandem with another investing style such as value or growth stocks. 

“We believe it would be materially deceptive or misleading for the names of those funds to indicate to investors that consideration of ESG factors is a central part of their investment processes, particularly in light of information suggesting that the use of ESG terminology in fund names is effective in attracting inflows,” regulators said in their proposal. 

Fund issuers would also have to lay out exactly how they define environmental, social and governance and similar terms in their prospectuses, and how it selects securities in line with that philosophy. 

There are 109 ETFs on U.S. exchanges with ESG in their name, according to FactSet data. 

Regulators are also seeking to implement a “Plain English” rule that requires a fund to select securities based on metrics like revenue derived by specific activities, such as requiring a solar ETF to focus solely on companies that derive more than half their revenues from solar generation. 

However, the SEC said it wouldn’t consider the method of counting keywords in company filings as a way of determining if a company was, for example, a metaverse company. That could hamper thematic issuers that use textual analysis to build an investable universe instead of waiting for an index provider to define the list. 

It’s not clear how many ETFs may be affected by the rule changes. The SEC did not immediately respond to a request for comment. 

The move is a vast departure from the original naming rules issued in 2001, when specific strategies were exempt from the 80% Rule, said Clair Pagnano, a partner at K&L Gates representing registered investment companies. 

While naming a fund after a geography or sector is straightforward, ETF issuers will have to figure out how exactly to quantify a less-defined factor like growth or ESG for compliance purposes before launch. 

“This is going to be the first thing that you have to think about,” she said. “Is this a strategy that's in the name? And then how can we create an 80% policy around that strategy name, and then can we actually manage to that policy?” 

The SEC is taking public comment on the rule for the next 60 days. If eventually approved, fund managers would have one year to become compliant with the rule. 

 
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