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My Crypto Lawyer Sec Speeches Cryptocurrency Pizza or Pizza? Statement on Investment Company Names

My Crypto Lawyer

Sept. 20, 2023

Thank you, Mr. Chair.

When you walk up to a shop with a sign that reads in large neon letters, “Pizza Shop,” you expect to be greeted by the comforting smell of baking dough, sauce and cheese. You know broadly what to expect. Whether it will be classics like pepperoni and cheese or something less conventional like coconut and banana, you have a general idea of what to expect when you walk into a pizza shop. You are not going to get sushi or tacos; you are going to get some sort of pizza.

The amendments to Rule 35d-1(the “Names Rule”) aim to provide the same experience to investors. The premise is that when investors see a fund’s name, they should have a good idea of what to expect. To achieve this end, the amendments significantly expand the scope of the Names Rule. [1] This expansion seems to bring almost all funds under the names rule umbrella, which means they have to have a policy to invest 80% of their assets in the covered terms in the fund name. Naturally, this breadth of scope gave me pause.

Taken on its own, this requirement could greatly limit the types of names a fund can have, leading to funds having overly generic names and even chilling innovation. However, this provision is tempered by a requirement that funds provide enhanced prospectus disclosure in which they define the terms used in their name.

For over two decades, the disclosure review staff in the Division of Investment Management has been put in the position of being arbiters of fund names. This role takes a significant amount of staff time and allows staff to have an outsized role in how a fund can describe its investment strategies and define the terms used in its name.

The adopting release clearly gives fund managers the authority to define the terms used in the funds’ names. Staff will not place value judgments on any terms but instead allow funds to define what their names mean. As long as fund managers stick within the confines of plain English or industry usage, they have reasonable discretion to define terms in a fund’s name. Because fund managers have flexibility in interpreting terms, investors will know they need to look beyond a fund’s name to understand what types of investments are in the fund’s portfolio.

This requirement recognizes that names do matter but they should not be the only factor considered by investors when making an investment decision. When you walk into a pizza shop, you know you are getting pizza, but pizzas come in many varieties. Some are conventional; some are not. They can be gluten-free, laden with meat, or vegetarian. Some might have things like cold fish and caviar that might be more common in a sushi restaurant. To get precisely what I want, I have to read the menu and decide whether that pizza shop is for me. What investors do not always realize is that, likewise, funds that have the same name, can be very varied. This adopting release underscores that point. The Commission is acknowledging that there can be multiple reasonable definitions for the same term. For investors to know what they are “ordering,” they must read the prospectus.

I hope that the recommendation we are considering today will support fund names that convey to investors valuable information about the fund. Allowing fund managers the ability to define the terms in their name is critical to the successful implementation of this rule. The final rule before us today is better and more practical than what we proposed: it requires only quarterly review of investments for consistency with the 80% test and allows up to 90-day departures from the 80% test under other-than-normal circumstances. The N-Port requirements, while onerous and costly, could be a step towards modernizing the disclosure program by allowing more automation. I do worry about the cost, the potential ambiguities around what is covered and what is not and the absence of an option for fund boards to extend the 90-day departure. That said, I do support the rule.

Thank you to Director Birdthistle and your staff in the Division of Investment Management. I enjoyed our conversations about the rule, including the helpful insights of Michael Kosoff about how the Disclosure Review staff would implement the rule. Thanks also to the Division of Economic and Risk Analysis and the Office of General Counsel for your work on the rule. I look forward to working to ensure smooth implementation of the rule. I do have several questions:

  1. Currently, a term like mid-cap is interpreted differently across different fund complexes. Do you anticipate these different interpretations will persist under the amended rule?
  2. If two funds in the same fund complex classify the same investment differently, for example, one fund classifies it as a growth investment and another classifies the same security as a value investment, is one of these funds violating the names rule?
  3. If a fund has two terms in the name, how will the 80% test be applied? Will both terms be subject to the 80% test?
  4. When we talk about “established industry use,” are we talking about the fund industry or the industry in which the fund invests?
  5. The release states that “A fund’s use of reasonable definitions of the terms used in the fund’s name under the final rule, however, may not be inconsistent with their plain English meaning or established industry use.” Elsewhere, the release states “we are requiring that any terms used in the fund’s name that suggest either an investment focus or that such fund is a tax-exempt fund must be consistent with those terms’ plain English meaning or established industry use.” How can those statements be reconciled? One suggests that a term must be consistent with both plain English and established industry use, while the other suggests it must be consistent with one or the other.
  6. Now consider a fund that calls itself the Green Auto Fund. This fund only invests in companies that make fuel-efficient internal combustion engine cars, and does not do so with the intention of nudging them to transition to electric vehicles. The thesis of this fund—a thesis that is described in the prospectus—is that the environmental costs associated with mining the rare minerals that are necessary for electric batteries and the environmental costs associated with disposing of these batteries are greater than the costs associated with cars that have highly fuel-efficient internal combustion engines. May the fund retain its name—the Green Auto Fund?
  7. Does IM think we have addressed commenter concerns regarding the inclusion of terms such as growth, value, and ESG?
  8. On the one hand, I appreciate that the rule recognizes that a fund can define a term as it wishes within plain English or industry usage. On the other, I am concerned that we are overselling this rule to investors as an assurance that now they really will be able to rely on fund names. What are your plans for ensuring that investors understand that two funds with the same name might be doing very different things?
  9. The rule allows funds 90 days to correct departures from the 80% rule. If a fund needs 100 days, it must change its name. Why not allow fund boards the ability to override the 90-day limitation on departures from the 80% rule? One can imagine situations in which an illiquid security will take a couple extra weeks to sell. A board is well-positioned to think about the trade-offs between renaming the fund and remaining out of compliance with the 80% test for longer than 90 days.
  10. May a fund seek exemptive relief from the Commission if the fund believes it would be appropriate and consistent with the protection of investors for the fund to depart for a limited additional period past 90 days?
  11. How does the Division plan to process the likely influx of name changes under the new rule?
  12. I hope this rule is successful at better informing investors without increasing costs borne by investors. In five years, how will we measure whether the rule has been a success? What metrics should we consider in making our assessment of the rule?

[1] The scope of the rule is expanded from requiring an 80% test for names suggesting a focus in a particular investment, or in investments in a particular industry or geographic focus to names that suggest an investment focus, including a focus on investments that have or whose issuers have particular characteristics.

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