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SEC Proposes to Tighten Rules on Fund Labeling Including ESG

Investment fund names are part of investor education and need to be true to the fund’s objective and strategy. This is according to two SEC proposals that would require fund managers to use caution, and a dictionary, when titling funds. A fund with a name that suggests growth or value would have to maintain 80% of its investments in that category, under one of the proposals. Another example is funds titling themselves green, low-carbon, or sustainable would have to define how they achieve their environmental objectives.

“Investors should be able to drill down to see what’s under the hood of these funds.” SEC Chair Gary Gensler said in remarks at a commission meeting on May 25^th. “A fund’s name is often one of the most important pieces of information that investors use in selecting a fund,” the Chairman noted.

The SEC has been increasingly focused on ESG (environmental, social, and governance) investing. There are many funds that label themselves as ESG without disclosing or defining the label. The SEC is questioning these undefined labels. And they are willing to fine those they view as misleading. This week, mutual fund manager BNY Mellon Investment Advisers paid $1.5 million to settle SEC charges that it misrepresented the ESG review it made of investments.

SEC Proposals

The SEC endorsed two proposals on May 25. The first proposal updates a rule implemented in 2001, which states that 80% of a fund’s holdings should be invested in the type of assets suggested by the fund’s name. The “Names Rule” requires for example a biotech fund should hold biotech stocks, while an exchange-traded fund (ETF) named for an index must be 80% invested in the indexed stocks. Since 2001 when the rule was adopted, its application has become less stringent.

The new updates specify the Names Rule also cover fund names which seem to define strategies. Names reflecting a focus on environmental, social, and governance-related concerns could soon be required to maintain 80% of their holdings in assets chosen by a defined ESG criteria.

The second proposal governs disclosures by ESG funds. Gensler said that according to one estimate the universe of U.S. sustainable investment vehicles has grown to $17 trillion. Many investors are affected by these funds.

ESG strategies vary widely, said the SEC chairman. Under the ESG disclosure proposal, fund companies or investment managers that claim to consider ESG factors would have to detail the factors they consider as well as how they are implemented. For example, an ESG-focused fund that aims to affect greenhouse emissions would have to report emission metrics for its portfolio, and annual progress toward its ESG goals.

Image: SEC Chairman Gary Gensler (Twitter, March 1,2022)

Compliance

Mutual funds and ETFs would have to identify which holdings fall into the 80% required bucket. When positions fall below the 80% required, the fund would have 30 days to fill the gap. “Names matter,” said Chairman Gensler.

The Names Rule update could affect 75% of SEC-registered funds. For many funds, it will mean an extra cost upfront to rebrand or recreate the funds, and an ongoing cost from a compliance standpoint.

The reporting requirements are expected to discourage “greenwashing” by funds that claim to focus on ESG factors but may not. “What we’re trying to address is truth-in-advertising,” said Gensler, in a news conference after the meeting.

What’s Next?

Both SEC proposals now go out for public comment over the next 60 days. If fully adopted, money managers would have a year to comply. Compliance may require renaming funds, bolstering sales materials with specifics, changes to prospectuses, and the addition of analysts and compliance staff within the fund management industry.

Paul Hoffman

Managing Editor, Channelchek

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