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SEC’s proposed changes to the ‘names rule’ to impact thematic and factor funds says CFRA’s Ullal


Aniket Ullal, Head of ETF Data & Analytics at CFRA, has issued a note on the SEC’s proposed changes to the ‘names rule’ and its likely impact on thematic and factor funds. 

Ullal writes that on May 25, 2022, the US Securities and Exchange Commission (SEC) proposed changes to Rule 35d-1(the ‘names rule’) applying to funds regulated under the Investment Company Act of 1940.


The names rule requires some funds to invest 80 per cent of their assets into securities consistent with the fund name. In the past, this rule had not applied to fund names centred on a particular investment objective or strategy, such as ‘growth’ or ‘value’ funds.


The new proposed rule would extend the 80 per cent investment rule to such names and any fund that implies an investment with specific characteristics, including those with ESG-themed names, Ullal explains.


“Importantly, the SEC will consider a fund’s name to be materially misleading if it includes ESG terminology, but ESG factors are not significant in determining the fund’s portfolio holdings. The SEC also notes that it is not reasonable for funds to solely use “text analytics” to assign issuers to industries based on the frequency of term utilisation in company disclosures.”


Ullal notes that the modified rules would also specify the criteria under which a fund can depart from the 80 per cent rule and clarifies how derivatives-based fund exposure will be treated in relation to compliance with the rule.


“The SEC is also proposing amendments to prospectus disclosure requirements that would require a fund to define the terms used in its name, including specifying the associated investment criteria. It also proposes to strengthen N-PORT reporting and recordkeeping requirements.”


Ullal writes that a significant number of ETFs and traditional mutual funds in the US are likely to be impacted by the proposed modified names rule. For example, as of May 27, 2022, there were 102 ETFs in the US with over USD72 billion in assets containing the term ‘ESG ’in their names, and 135 ETFs with USD335 billion in assets containing the term ‘dividend.’


Summary of the SEC’s Proposed Changes to Names Rule


On May 25, 2022, the U.S. Securities and Exchange Commission (SEC) proposed changes to specific rules that apply to funds regulated under the Investment Company Act of 1940. These changes focus on the naming and disclosure requirements of a fund in relation to its intended investment objective. The SEC will accept public comments for 60 days after the proposed rule is published in the Federal Register, though the deadline could be extended.

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