Monetary Policy: The Role of Reserve and Bank Capital Requirements
BY: Anthony Ramazani
On September 20, 2023, the Securities and Exchange Commission adopted amendments to the Investment Company Act, more commonly known as the “Names Rule.” The most essential feature of the rule is its 80% requirement. Prior to the 2023 amendments, this required any fund with a name suggesting investments of a particular type, or investments in certain industry, geographic area, country, or tax-exempt status, to invest a minimum of 80% of its assets in investments of the kind suggested. The recent amendments have broadened the rule to cover names conveying “particular characteristics” like “growth” and “value,” as well as names that suggest a thematic focus like “artificial intelligence” or “health innovation,” and ESG-based investment strategies.
The Names Rule is grounded in the idea that fund names should be accurate, specifically to prevent funds from taking advantage of unsophisticated investors. However, many critics believe that the recent amendments will have little effect on whether investors are hoodwinked. Some have even speculated that the amended rule will harm the group it intends to serve by producing a wave of compliance costs that will ultimately fall on investors.
One potential consequence of the new rule is that funds might adopt generic names to avoid suggesting any particular focus, which might happen over the course of several years after the rule’s implementation. Contrary to the rule’s purpose, this would create a situation where investors are unable to gather any information from fund names. There is also significant disagreement about whether “misleading” fund names actually pose a danger to investors. Indeed, some research suggests that changes in fund names usually reflect substantive changes in how their assets are deployed, and when they do not, only non-cosmetic changes have been found to attract increased asset flows. In other words, investors are sharp enough to detect and avoid funds with misleading names.
In terms of compliance costs, fund managers will need to fork over large sums to determine which funds are captured by the new rule. For funds within its scope, costs will be extended far into the future as funds are required to review whether they are in compliance with the 80% threshold on at least a quarterly basis. Other commenters estimate that the new rule might require a daily review of assets in some form. These costs are exacerbated by the fact that it may be challenging to establish automated compliance monitoring solutions for terms in fund names where subjective criteria are part of the decision-making process. In response, funds will have to either limit portfolio managers or engage in costly manual review. In an economic analysis, the SEC itself estimated a total aggregated cost of between $500 million and $5 billion for fund investors.
While the Names Rule amendments were adopted to further the underlying purpose of protecting investors, the actual effect of the amendments is uncertain. There is good reason to believe that investors will be harmed rather than protected.
Key Sources:
Gary Gensler, Statement on Updates to the Names Rule, Securities and Exchange Commission (Sept. 20, 2023).
Adriana Z. Robertson, Names Rule Comment (Apr. 20, 2023).
Inv. Co. Names, Release No. 11238 (Sept. 20, 2023) (citing ICI Comment Letter; T. Rowe Comment Letter; SIFMA AMG Comment Letter; Invesco Comment Letter).
Inv. Co. Names, Release No. 11238 (Sept. 20, 2023) (citing Dechert Comment Letter; Invesco Comment Letter; TIAA-Nuveen Comment Letter; J.P. Morgan Asset Management Comment Letter; T. Rowe Comment Letter; Wellington Comment Letter; ICI Comment Letter; Invesco Comment Letter; Freeman Capital Management Comment Letter).
ICI Names Rule Comment, (Aug. 16, 2022) (citing Release at footnote 6 of Table 1).