What’s in a Name? SEC’s Amended “Names Rule” Cracks Down on Greenwashing
Tuesday, September 12, 2023
September 2023
What’s in a Name? SEC’s Amended “Names Rule” Cracks Down on Greenwashing

How the Names Rule will help investment companies say what they mean and mean what they say

By Alex Acosta, chief Compliance officer at Ethic

Key Points

  • The U.S. Securities and Exchange Commission’s (SEC) adopted Amendments to the Fund “Names Rule” increases the current rule’s protections by requiring more funds with certain characteristics to adopt an 80 percent investment policy.
  • Funds whose names contain terms signaling that their investments incorporate environmental, social, or governance factors are now included under the rule.
  • Implications for companies who don’t follow the rules are considerable — to continue using terms that aren’t aligned with a fund would be deemed materially deceptive and misleading by the SEC.

In last week’s installment of “Our Take: ESG, Regulations, and Legislation,” I wrote about how, after decades of voluntary reporting on sustainability disclosure, the U.S. Securities and Exchange Commission’s (SEC) landmark ESG Disclosures for Investment Advisers regulation will mean that wealth advisers and a bevy of other investment professionals will be required to adopt a standardized reporting structure with comparable disclosures of ESG-related information.

Today, I’ll discuss the SEC’s Amendments to the Fund “Names Rule.” This adopted rule differs from other regulations because it is not a new rule per se but rather a series of amendments to an existing rule. Nevertheless, it deserves just as much attention as it will impact any fund with “ESG,” “sustainable,” “green,” or any other term in its name that suggests it is a sustainability-focused fund.

The SEC adopted the Amendments to the “Names Rule” on September 20 and is expected to finalize and release the ESG disclosure rules in October. It’s worth taking a few moments to learn how they will impact our investment ecosystem.

What’s in a Name?

In 2001, the SEC adopted a new rule under the Investment Company Act of 1940 to require investment companies registered with the SEC whose names suggest a focus on a particular type of investment to adopt a policy to invest at least 80 percent of the value of their assets in that type of investment. This rule (the “Names Rule”) was designed to increase investor protection by ensuring that a registered investment company’s (fund’s) name accurately reflects that fund’s investments and risks by not being “materially deceptive or misleading.”  

Over 20 years have passed since the “Names Rule” went into effect, and a little modernization is now necessary to expand its scope of the terms the SEC believes are materially deceptive and misleading in a fund’s name. Prior to the adoption of the amendments yesterday, the rule’s conditions were limited to the type of investment, industry, or geographic area. The adopted enhancements increase the rule’s protections by requiring more funds with certain characteristics to adopt an 80 percent investment policy. Funds with the terms “growth” or “value,” for instance, or whose names contain words signaling that their investments incorporate environmental, social, or governance factors are included under the rule. The rule will become effective 60 days after publication in the Federal Register. Fund groups with net assets of $1 billion or more will have 24 months to comply with the amendments and fund groups with net assets of less than $1 billion will have 30 months to comply.

Why was it so important to update the “Names Rule?” In short, the name of a registered investment company serves as an important marketing tool that can impact the investment decisions made by investors.

Imagine how misleading it would be to have the word “green” in the name of a fund that is primarily made up of companies that directly contribute to massive amounts of carbon emissions. Ridiculous, right? But this is exactly what’s been happening right under our noses. “ESG” and other terms related to sustainability have been routinely exploited as a marketing ploy, leading to much investor confusion.


Say What You Mean, Mean What You Say

Fortunately, the SEC is cracking down on greenwashing.

Under the amended “Names Rule,” investment companies registered with the SEC whose names suggest a focus on a particular type of investment (i.e., “growth,” “sustainable,” “ESG”) will now need to adopt a policy to invest at least 80 percent of the value of their assets in those specific investments. This rule ensures that a fund’s name accurately reflects that fund’s investments and risks — and properly discloses the criteria used to select the investments described by their name.

In other words, companies will be required to say what they mean and mean what they say. For instance, the amended rule will maintain a requirement from the existing rule, which states that notice needs to be sent to shareholders concerning any changes in the fund’s 80 percent investment policy. But new additions to the rule will now require fund prospectus disclosure that clearly defines the terms used in a fund’s name, and companies will need to provide enhanced information to investors and the SEC about how the fund’s name is in line with its underlying investments.  

Repercussions for Rule-Breakers and Implications for the Industry

The repercussions for companies who don’t follow the rules are considerable — but this is also where it starts to get tricky. To understand the “Names Rule,” companies will also need to understand the proposed ESG Disclosures for Investment Advisers regulation, expected to be finalized and released next month.

Learn more about ESG funds and disclosures.

In the language of this regulation, there are three broadly defined types of ESG strategies: ESG Integration Funds, ESG-Focused Funds, and ESG Impact Funds. Under the proposed amended “Fund Names” rule, an ESG Integration Fund that considers ESG factors alongside non-ESG factors, but not as the primary factors of its investment decisions, would no longer be allowed to use the term “ESG.” To continue doing so would be deemed materially deceptive and misleading by the SEC. However, the SEC withdrew the proposed amendments that would have prohibited “ESG Integration Funds” from using ESG terminology in their names. SEC chair Gary Gensler has asked his staff to prepare recommendations to address how these funds could refer to ESG integration in their name.

It’s unclear how, exactly, funds will be impacted if they don’t comply with the new ESG disclosures or the stipulations of the amended “Names Rule.” But we can look to recent SEC crackdowns to see that the Commission means business.

In November 2022, the SEC charged Goldman Sachs Asset Management (GSAM) for failing to follow its own policies and procedures involving ESG research to select and monitor securities. GSAM agreed to pay a $4 million penalty — pocket change in comparison to the $6.44 billion the SEC ordered in civil penalties, disgorgement, and pre-judgment interest in 2022 (of which ESG-related enforcement efforts were only a part).

Fortunately for managers earnestly wanting to adhere to the new regulations and rules, the amended “Names Rule” leaves wiggle room for companies to temporarily depart from a fund’s 80 percent investment policy. For example, if the market suddenly fluctuates wildly and a fund dips below the 80 percent threshold, the final rule allows 90 days to come back into compliance (a deviation from the 30-day requirement in the proposed rule). And I suspect that the SEC may work with and guide funds as they catch up to speed.

Ethic believes that the new regulations and rules will help investors better understand their investment decisions — and this, in turn, will help us better serve our clients.

Don’t wait. Contact your relationship manager to learn more about how Ethic can help you and your clients prepare for the SEC’s upcoming regulations and amended rules impacting sustainable investments.

Updates to this article were made on September 21, 2023 to reflect the formal adoption of the enhancements to the “Names Rule.”

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Sources and footnotes

Ethic Inc. is a Registered Investment Adviser located in New York, NY. Registration of an investment adviser does not imply any level of skill or training. Information pertaining to Ethic Inc’s registration or to obtain a copy of Ethic Inc.’s current written disclosure statement discussing Ethic Inc.’s business operations, services and fees is available on the SEC’s Investment Adviser Public Information website – www.adviserinfo.sec.gov or from Ethic Inc. upon written request at support@ethicinvesting.com. Information provided herein is for informational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Any subsequent, direct communication by Ethic Inc. with a prospective client shall be conducted by a representative of Ethic Inc. that is either registered or qualifies for an exemption or exclusion from registration in the state where a prospective client resides. Information contained herein may be carefully compiled from third-party sources that Ethic Inc. believes to be reliable, but Ethic Inc. cannot guarantee the accuracy of any third-party information.

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Alex Acosta is Ethic's chief compliance officer. She holds a BBA from Florida International University and a JD from Fordham Law School. Throughout her career, she has worked in various legal and compliance positions within the asset management industry. Alex is licensed to practice law in New York.

Melissa Banigan is a content strategist with over 15 years of communications experience working with global companies and nonprofits. Also a journalist and author, her work appears in The Washington Post, CNN, the BBC, NPR, and the Independent, among other publications, and she's written three books for youth.

Travis Korte is the associate director of Sustainability Research & Data at Ethic. Previously, Travis organized civic-minded technologists at Hack for LA and advised a wide range of clients on data science, data policy, and quantitative methods. You can follow him on Twitter at @traviskorte.