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SEC Open Meeting

Securities and Exchange Commission

Open Meeting

Wednesday, May 25, 2022

Topline

  • The Commissioners voted 3-1 to propose amendments to the Investment Company Names Rule and to rules and reporting forms for registered investment advisers, certain advisers exempt from registration, registered investment companies, and business development companies to provide standardized Environmental, Social, and Governance (ESG) disclosure to investors and the Commission.
  • Gensler acknowledged that a provision in the ESG rule goes beyond the ESG space and would require index funds to report the name and the legal identifier of the index.
  • Both proposals have 60-day comment periods.

ITEM 1: Investment Company Names Rule

The Commission voted 3-1 to propose amendments to the rule under the Investment Company Act that addresses investment company names that are likely to mislead investors about an investment company’s investments and risks and enhanced prospectus disclosure requirements for terminology used in investment company names, as well as public reporting regarding compliance with the new names-related requirements.

Staff Discussion
William Birdthistle discussed the Rule 35d-1, known as the Names Rule and potential enhancements to Rule. He then explained how competition among firms incentivizes using different fund names to attract investors and that improvements to the Names Rule are needed for investor protection purposes. He added that there are questions of what certain fund names imply and whether funds can depart overtime from what their names suggest. Birdthistle also said the Rule does not address issues of increasing use of derivatives and other concerns.

Mykaila DeLesDernier said the proposal would expand and modernize existing requirements that funds with certain names adopt a policy to invest eighty percent of their assets in the investments suggested by that name. She said the proposal would specify the particular circumstances where funds may depart from its eighty percent investment policy, including specific time frames for returning to eighty percent. She also said the proposal would prohibit certain registered funds whose shares are not listed on a national security exchange from changing their eighty percent investment policies without shareholder approval. She added that the proposal will include several amendments to certain forms to provide better information to investors and the Commission about how fund investments track their names over time. Lastly, she said the proposal would define the names of integration funds as materially deceptive or misleading if the name indicates the fund’s investment decisions incorporate one or more ESG factors.

Jessica Wachter discussed investment company names, how the incentives of fund managers do not always align with investors, and that investors may choose a fund based on name even though the fund’s incentives are not aligned with the investor’s. She added that the rule clarifies the eighty percent investment policy requirement to ensure that fund names align with their strategies and acknowledged the potential costs of the new rule on investment funds.

Commissioner Discussion

Commissioner Hester Peirce said she could not support the proposed amendments to the Names Rule. She said a perfectly fitting name only carries a small amount of information about a fund and that the Commission must encourage investors to look beyond names. She stated that the proposed rules may place unnecessary constraints on fund managers. Hester expressed concern that the application of the eighty percent investment policy requirement that a fund focus on investments with particular characteristics would result in subjective judgments. She also had concerns that the proposal would unduly constrain advisors’ ability to make decisions for the funds they manage and also the outright prohibition on integration funds. She said the prohibition could result in substantive changes in the way some funds are managed.

Commissioner Allison Herren Lee said the proposal would modernize the Names Rule and enhance investor protections. She said the proposal recognizes that investors often rely on fund names when deciding where to invest their savings. She also said the eighty percent policy is meant to reduce confusion, but twenty years of staff experience has brought up investor protection concerns, citing different names and terms causing confusion among investors. She added that what names convey to investors must be consistent with the choices of the fund.

Commissioner Caroline Crenshaw said the saying mean “what you say and say what you mean” summarizes the backbone of the SEC’s disclosure regime. She stated that a fund’s name can have a significant impact on investors decisions. She discussed growth funds and the expectations that come with those certain funds. She said the proposed rules are a step in the right direction in bringing market practices in line with investor expectations. She concluded by discussing the proposed amendment and said the need for clarity in the funds industry is more important than ever.

Commission Chair Gary Gensler said the proposal would modernize the Names Rule and explained the Congressional history of the Rule and how the market has changed in the past two decades, causing the current Rule to undermine investor protection and for some firms to claim that the rule does not apply to them — even though their name suggests that investments are selected based on specific criteria or characteristics. He then outlined how the proposal would modernize the Names Rule for today’s markets and make changes with respect to the growing ESG funds space. He concluded by expressing his anticipation for public feedback and said it is important to get feedback on what works here.

ITEM 2: ESG Disclosures for Investment Advisers and Investment Companies

The Commission voted 3-1 to propose amendments to rules and reporting forms for registered investment advisers, certain advisers exempt from registration, registered investment companies, and business development companies to provide standardized Environmental, Social, and Governance (ESG) disclosure to investors and the Commission.

Staff Discussion
William Birdthistle said investors lack consistent, comparable information on funds and advisers claiming they consider ESG factors. He also explained how a lack of adequate disclosure risks exaggeration of ESG.

Pamela Ellis said the proposal would require funds that consider ESG factors in their investment process to disclose additional information regarding their strategy. She said the amount of required disclosure depends on how central ESG factors are to a fund’s strategy adding that the amendments are designed to help investors make more informed choices about ESG investing. She said specifically the proposal would require additional disclosure regarding ESG strategies to investors on registration statements, annual reports, and advisor brochures. She also said the proposal would require an ESG fund to provide additional prospectus disclosures, require streamline disclosure for ESG integration funds, and require that all ESG related registration statements be tagged using inline business reporting language She concluded that advisors would also be required to disclose their ESG practices.

Jessica Wachter discussed integration as an umbrella term and that the proposal would require integration funds to explain how they integrate ESG factors. She also discussed ESG funds and how the proposal would require a more detailed description of how funds consider ESG factors. She explained that funds implement ESG strategies in a variety of ways and that investors would benefit from more information on these practices. She also discussed what she called an exaggeration problem and how investors focused on ESG could access metrics under the proposal that would apply across the range of funds that exist. She then said consistent information lowers search costs and decreases the potential for investor harm.

Commissioner Discussion

Commissioner Hester Peirce said the proposed rule misses the mark, adding that the proposal avoids explicitly defining ESG but implicitly uses disclosure requirements to induce substantive change in funds’ and advisors’ ESG practices. She said investors will pick up the tab for the latest ESG exploits without seeing much benefit. Peirce discussed the Commission’s refusal to define ESG and what the proposal lacks and said the proposal may result in companies implementing policies that are neither good for the environment nor for investors. She concluded by saying if demand of greenhouse disclosures are becoming the norm, let the standards and expectations development organically to allow investors to shape industry practices.

Commissioner Allison Herren Lee explained the need for consistent, comparable, reliable information to avoid green washing and improve the accuracy of disclosure.

Commissioner Caroline Crenshaw said in the absence of a specific disclosure regime, funds and advisors employing ESG practices do not have clear guidance as to what information should be disclosed and in what manner. She said in the absence of a cohesive framework, investors are left with unreliable ESG disclosures. Crenshaw stated that proposals strive to achieve the goal of accuracy and reliability among the various ESG management practices and products. She added that clear and standardized disclosures allow investors to compare products and accurately price risks and opportunities associated with ESG practices. She said the proposal also fits within the Commissions framework of requiring disclosure of material information to investor decision making. She discussed the rules neutrality as to the benefits and risks of ESG investing and concluded by saying investors have a right to know what they are investing in.

Commission Chair Gary Gensler said it is important that investors have consistent and comparable disclosures about asset managers’ ESG strategies so they can understand what data underlies funds’ claims and choose the right investments for them. He described an estimate saying that the “U.S. sustainable investment universe” has grown to $17.1 trillion, adding that ESG encompasses a wide range of investments and strategies. He said when investors read existing disclosures, it can be very difficult to understand what some funds mean when they say they are an ESG fund and that funds and investment advisers mislead investors by overstating their ESG focus. Gensler acknowledged, though, that there is a provision in the proposal going beyond the ESG space that would require index funds to report the name and the legal identifier of the index, which would be a disclosure about the index being tracked.

For more information on this hearing, please click here.

For an archive of past SIFMA hearing coverage, please click here.