LATEST DEVELOPMENTS: FUNDS
Final Rule: Investment Company Names
The SEC has adopted amendments to Rule 35d-1 (the Names Rule) under the Investment Company Act in order to address developments in the industry since the rule was adopted in 2001. The amendments will expand the scope of the Names Rule and require more funds to adopt a policy to invest at least 80% of the fund's assets in accordance with the investment focus that the fund's name suggests. Fund names that include the terms "growth", "value" or environmental, social, governance (ESG) terms will now be covered by the rule. In a change from the rule proposal, names that include the terms "global," "international," or "intermediate term (or similar)" in describing a bond fund, will not require an 80% investment policy under the amended rule. The SEC estimates that the amendment will subject an additional 2,200 funds to the 80% policy requirement.
80% Investment Policy Requirement
The Names Rule is intended to prevent funds from using names that misrepresent a fund's investments and risks. Prior to these amendments, the 80% investment policy requirement only applied to fund names that suggested a focus on a particular type of investment, industry, country or geographic region, or fund names that suggested a certain tax treatment. The new amendments expand the 80% requirement to funds whose names include terms suggesting that the fund focuses on investments that have, or whose issuers have, particular characteristics. The final rule does not define the term "particular characteristics" because the SEC believes the term is understood to mean any "feature, quality or attribute," such as "value," "growth," terms with ESG- or sustainability-related characteristics or terms that reference a "thematic investment focus" such as the internet, blockchain or cybersecurity. Terms that refer to the fund's portfolio as a whole (such as "balanced") or a particular investment technique (such as "long/short" or "hedged") will not fall under the amended rule.
The amended rule permits a fund to include in the 80% basket of investments any derivatives instruments that provide investment exposure to market risk factors associated with investments suggested by a fund's name. Funds must use each derivative instrument's notional amount to determine compliance with the 80% policy. Certain currency hedges are excluded from the compliance calculation.
Quarterly Monitoring; Time to Come Back into Compliance
In a departure from the proposal, the final rule does not require funds to reassess portfolio investments continuously to determine compliance with the 80% investment policy. Instead, a fund must review its portfolio on a quarterly basis. The amendments retain the current rule's requirement that a fund must comply with the 80% policy at the time of investment and "under normal circumstances." If a fund falls out of compliance with the rule, either intentionally in "other-than-normal" circumstances or otherwise, the fund has 90 days to get back into compliance. In a departure from the proposed rule, the final rule provides a fund with flexibility to determine what constitutes "other-than-normal" circumstances where the fund could intentionally depart from its 80% investment policy.
Prospectus Disclosure and Definitions
Each fund that is required to adopt an 80% policy must include disclosure in its prospectus that defines the terms used in its name. The disclosure must include the specific criteria that the fund uses to select the investments that the term describes. Terms used in fund names that suggest either an investment focus or tax-exempt status must be consistent with the terms' plain English meanings or an established industry use. In the final rule release, the SEC recommends that funds look to sources like industry codes or classifications, prior public disclosures, or a colloquial understanding of a term to satisfy this requirement. Terms may reasonably be defined differently, as long as the defined term is not inconsistent with the plain English meaning or established industry use.
Notice Requirement
The rule amendments retain the requirements that, unless a fund's 80% policy is a fundamental policy, the fund must provide 60 days' notice to shareholders before making any change to the 80% policy. The amendments do make several updates to the notice requirements to modernize and clarify aspects of the rule, including addressing electronic delivery.
Form N-PORT Reporting and Recordkeeping
As proposed, for funds that are required to file Form N-PORT and are required to adopt an 80% policy, the final amendments require those funds to report whether each investment in the fund's portfolio is in the fund's 80% basket. Those funds are also required to report the value of the 80% basket as a percentage of the value of the fund's assets. Funds will also be required to report the definitions of terms used in the fund's name, consistent with the prospectus disclosure.
Funds subject to an 80% policy will be required to maintain various records documenting their compliance with the Names Rule.
Compliance Dates; Next Steps
The rule amendments will become effective 60 days after publication in the Federal Register. Fund groups with net assets of $1 billion or more will have 24 months to comply with the amendments and fund groups with net assets of less than $1 billion will have 30 months to comply. Over the coming months, advisers and fund boards should discuss whether the amended Names Rule will require any changes in fund names, investment strategies, policies or disclosures as well as the compliance monitoring, filing and recordkeeping aspects of the rule.
Sources: SEC Adopts Rule Enhancements to Prevent Misleading or Deceptive Investment Fund Names, SEC Press Release 2023-188 (Sept. 20, 2023), available here; Investment Company Names, Release No. IC-3500 (Sept. 20, 2023), available here; Final Rules: Amendments to the Fund "Names Rule", SEC Fact Sheet (Sept. 20, 2023), available here.
LATEST DEVELOPMENTS: ADVISERS
Compliance Rule Amendments Require Documentation of Annual Review
The new Private Fund Adviser Reforms, discussed in more detail below, include amendments to the Advisers Act compliance rule and will require all SEC-registered advisers to document the annual review of their compliance policies and procedures in writing. Advisers have been required to undertake an annual review of their compliance policies and procedures since the compliance rule was adopted in 2003, but written documentation of the review was not mandatory. As amended, the compliance rule requires the adviser to document the adequacy of their compliance policies and procedures and the effectiveness of their implementation, no less frequently than annually.
The amended rule does not suggest specific elements that advisers must include in the written documentation of their annual review. The SEC stated in the adopting release that it intends the written documentation requirement to be "flexible to allow advisers to continue to use the review procedures they have developed and found most effective." Advisers may choose to document the annual review in a number of ways, including:
- In a quarterly report, with an aggregate report at year end;
- In a longer written report with supporting documents, prepared annually;
- In a written presentation to the board; or
- In a short memorandum or compilation of informal notes that summarizes the findings over the year.
The compliance date is November 13, 2023.
Source: Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews, Release No. IA-6383 (Aug. 23, 2023), available here.
SEC Risk Alert Highlights Criteria for Examination Selection and Scope
The SEC Division of Examinations (Division) recently published a risk alert providing information on the Division's examination selection process, which included a sample of the staff's typical initial request for documents and information.
The risk alert indicates that advisers can be chosen for examination because of one or more firm-specific risk factors, one or more factors relevant to the staff's annual priorities, or because of a tip, complaint or referral. Risk factors could include, among others:
- Business activities that create a risk for conflicts of interest, such as affiliated transactions;
- Length of time since the adviser's last exam;
- Prior exam observations of repetitive deficient practices; and
- Indications that the adviser may be vulnerable to financial or market stresses.
The risk alert notes that after the Division selects an adviser for examination, the scope of the exam and the documents requested are dictated by an additional risk assessment conducted by exam staff. While exams will be unique to each firm, most examinations typically include a review of the adviser's compliance practices, operations and disclosures across core areas of the adviser's business, including portfolio management, safekeeping of client assets, brokerage, and fees and expenses. It is important to remember that each regional office of the Division may apply its own risk factors in selecting advisers and in determining exam focus areas.
Source: Division of Examinations Risk Alert: Investment Advisers: Assessing Risks, Scoping Examinations, and Requesting Documents (Sept. 6, 2023), available here.
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