Since our last IM Update, we have monitored the extensive number of COVID-19-related regulatory and legal developments affecting the mutual fund/investment management industry, which we covered in separate client Alerts and podcasts. The last section of this IM Update contains a short summary of, and a hyperlink to, the full text of (or transcript of), each of these Alerts and podcasts.
The Ropes & Gray Coronavirus Resource Center also maintains these Alerts and podcasts, as well as additional materials regarding a range of COVID-19-related issues.
The following summarizes other recent legal developments of note affecting the mutual fund/investment management industry:
SEC Extends Securities Offering Reforms to Closed-End Funds and Business Development Companies
On April 8, 2020, the SEC issued a release (the "Release") containing amended rules and forms intended to streamline the registration, communications and offering practices for business development companies ("BDCs") and registered closed-end investment companies ("registered CEFs"), including interval funds and tender offer funds (collectively, "Affected Funds"). The Release's rule and form amendments will permit Affected Funds, subject to limitations described below, to use the securities offering rules that are already available to operating companies. The Release will be discussed in a forthcoming Ropes & Gray Alert.
SEC Requests Comments on Fund Names and Rule 35d-1
On March 2, 2020, the SEC published Request for Comments on Fund Names (the "Release"), seeking public input on:
- Challenges presented by Rule 35d-1 under the 1940 Act (the "Names Rule"), especially in view of market changes since the 2001 adoption of the Names Rule, and
- Potential alternatives to the existing regulatory framework prohibiting the use of names by registered funds and business development companies (each, a "BDC") that are likely to deceive or mislead investors about a fund or BDC's investment risks.
A substantial portion of the Release summarized the history leading to the SEC's 1997 proposal of the Names Rule and its 2001 adoption of the rule, as well as the substantive requirements of the Names Rule. The Release notes that, at present, "fund names remain a common area for staff comment as part of the disclosure review process."
The Release described "factors" (or causes) that the SEC identifies as contributing to current challenges in applying the Names Rule. We summarize these factors below.
Causes of the Challenges in Applying the Names Rule
The Release identified the following five factors as contributing to current challenges in applying the Names Rule:
- According to the Release, because the Names Rule is an "asset-based" test, it may be poorly suited to funds that rely on derivatives to provide significant exposure to a "type of investment" (as specified in the Names Rule). The SEC stated that an asset-based test "may not provide an appropriate framework when the market values of derivative investments . . . are relatively small but the potential exposure is significant."
- The number of funds with investment mandates that require a qualitative assessment of certain issuer characteristics (such as ESG funds) has grown. These funds often include their mandate in their name. The SEC staff has observed that "some funds appear to treat terms such as 'ESG' as an investment strategy (to which the Names Rule does not apply) . . . while others appear to treat 'ESG' as a type of investment (which is subject to the Names Rule)."
- Funds are increasingly using certain hybrid financial instruments that have only some of the characteristics of more common asset types used in a fund's name.
- For competitive reasons, some funds adopt a name because it is more likely to attract assets (e.g., names suggesting various emerging technologies), but this practice may be inconsistent with the purpose of the Names Rule.
- Indices are not investment companies and not subject to the Names Rule. However, the SEC staff has seen instances of an index in a fund name notwithstanding the fact that the index's components are not closely related to the type of investment suggested by the index's name.
Procedures and Next Steps
The proposed fund derivatives rule (proposed Rule 18f-4) recognizes that value-at-risk (VaR) is a better measure of a fund's exposure from a derivatives transaction. That said, the SEC did not mention that rulemaking in the Release.
With respect to the Release's ESG-related issues, presumably, the rapid growth of ESG funds has the SEC staff looking for information and solutions from as many sources as possible. The responses that the Release generates—due at the SEC no later than May 5, 2020 (although that date may be extended)—may assist the SEC in determining how to proceed with any further regulation of ESG funds.
SEC Adopts Variable Products Summary Prospectus and "Notice and Access" for Underlying Fund Prospectuses—May Implicate Fund Prospectus Delivery Generally
In a March 10, 2020 adopting release (the "Release"), the SEC adopted Rule 498A under the Securities Act to permit, for the first time, the use of a summary prospectus to satisfy prospectus delivery obligations under Section 5 of the Securities Act for variable life and variable annuity contracts ("variable contracts") issued by an insurer's separate account.
- Rule 498A, which was adopted in substantially the same form as it was proposed, along with other rule and form amendments in the Release, also permits mutual funds that are investment options offered under variable contracts to satisfy prospectus delivery obligations by relying on an optional "notice and access" framework.
- In the underlying 2018 proposing release,1 the SEC discussed and solicited comments on certain parallel provisions of rule 498 and registration forms applicable to other types of registered investment companies. The Release states that the SEC staff is now considering the "comments received and reviewing the disclosure regime for investment companies as to these and other potential amendments as part of a broader modernization initiative." Therefore, the SEC may be contemplating additional changes to mutual fund prospectus delivery obligations as part of its modernization initiative.
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Originally published Apr 27, 2020.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.