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Three-quarters of US public investment funds will have to prove that the vast majority of their holdings match their names under a crackdown on deceptive marketing adopted by the Securities and Exchange Commission on Wednesday.
The commission voted 4-1 to require mutual and exchange traded funds that use terms such as “growth”, “value” and “artificial intelligence” or tout their use of “environmental, social and governance” factors to have 80 per cent of their assets in line with their names.
The far-reaching rule changes will affect funds that draw money from more than 120mn retail investors, or more than 55 per cent of American households. “It is truth in advertising,” said Gary Gensler, SEC chair. “This proposal benefits issuers and investors alike.”
Industry groups have strongly opposed the proposal, saying it violates free speech protections, adds unnecessary costs and would hamper stock picking.
“This will hurt American retail investors,” said Eric Pan, chief executive of the Investment Company Institute, the main fund industry group. “Portfolio managers won’t be able to make routine investments without the SEC second-guessing whether it fits neatly with the subjective terms that make up their fund’s name.”
The regulation updates a 20-year-old “names rule” that mainly applied to tangible terms in fund names including “equity”, “bond” and “Europe” and specifically excluded thematic investment strategies. The SEC said the rule will capture 76 per cent of funds, up from 60 per cent.
Consumer groups applauded the move, saying the stricter standards for use of ESG in names was particularly welcome.
“Retail investors — including workers saving for retirement — shouldn’t have to worry about putting their money in funds that don’t walk the walk,” said Natalia Renta, senior policy counsel for corporate governance and power at Americans for Financial Reform.
But Rajib Chanda, partner at Simpson Thacher, warned: “You could end up with names that have no meaning as a way of avoiding the regulations, and you could lose the benefit of having a name that gives investors an immediate understanding of what’s in the fund.”
The SEC’s final rule did include tweaks to its original proposal, issued in May 2022, which had called for giving funds 30 days to get back to the 80 per cent threshold. After fund managers said that could lead to fire sales in volatile markets, the SEC ruled that funds will instead have 90 days to get back into compliance.
The final version of the rule also dealt with industry concerns that different funds may interpret terms such as “growth” and “value” differently by allowing portfolio managers to set their own “reasonable” definitions up front and tell investors how they plan to comply with the 80 per cent rule.
The industry had also warned that applying the 80 per cent policy to “global” funds, as initially discussed by the SEC, would have been unworkable because it is not clear what counts as global. The final rule amendments exempt that term.
The SEC also dropped plans to require shareholder approval for closed-end funds that want to change their investment strategy. Such funds will be allowed to either seek a vote or offer to buy out existing shareholders.
These changes helped prompt Republican commissioner Hester Peirce to join Democrats in approving the rule. “The final rule is better and more practical than what we proposed,” she said.
Mark Uyeda, another Republican commissioner, said he believed that most investors rely on advisers to select funds and that they look beyond the fund name. He warned that the cost of complying with the rule could deter new fund formation.