Last year, my fellow NI advisor James Frazier wrote “Wall Street Wakes Up to SRI” on sustainable and responsible investments becoming a mainstream component of the financial services industry. Substantial asset flows into environmental, social, and governance (ESG)-labeled funds have prompted large conglomerates to buy up boutique socially responsible investing (SRI) companies in the SRI field. Additionally, the explosion of new or conventional funds re-labeled as sustainable or socially responsible mutual funds and exchange-traded funds (ETFs) has been difficult to track, even for an experienced shop such as Natural Investments.
For this reason, we are thrilled that the Securities and Exchange Commission (SEC) has finally come around to regulating the SRI industry with two proposed rules: naming of funds and disclosure of SRI practices. Our Managing Partner, Michael Kramer, breaks down the disclosure rule and our recommendations in his standing shareholder advocacy review this issue, while this article focuses on the nuances of the naming rule.
Back in 2001, the SEC established the “Names Rule” for all funds offered to investors in the public exchange. Although it should not be the only criteria, a fund’s name signals the overarching investment focus to an investor. It’s a truth-in-labeling rule.
A part of the current rule says the fund must “adopt a policy that will invest at least 80% of the value of its assets in the type of investment, industry, or focus suggested by the name.” This means a U.S. Large Cap Equity Fund will have at least 80% of holdings in the stocks of U.S.-based companies that are of $10 billion in market capitalization or greater, i.e., the types of firms found in the S&P 500.
The second major part of the rule requires that a fund gives at least a 60-day notice prior to any fundamental change in the policy.
We agree with our colleagues at As You Sow, which submitted a comment letter to the SEC, praising the inclusion of ESG language in the overall Names Rule without creating a separate set of ESG labeling standards. Furthermore, the proposed ESG naming rule requires that a fund’s name suggests a particular focus in the name. It “must actually prioritize such considerations in its investment decision-making” in plain English terms or established industry use.
For instance, if a fund name includes Ex-Fossil Fuels, then investors will not see any fossil fuel companies in the remaining 20% basket of companies. As You Sow additionally recommends that the rule state more clearly, “a fund using ESG terms in its name will be considered materially deceptive and misleading…if such ESG factors are not the principal purpose of the fund’s investment strategy” in the aforementioned 80% threshold.
From a compliance perspective, The Forum for Sustainable and Responsible Investment (US SIF) proposed that the SEC include flexibility for funds to restore good standing if they are found to have deviated from the 80% policy requirement. US SIF suggests that the fund return to compliance within 30 days; otherwise, it would submit a letter to its board of directors and shareholders explaining why it is unable to comply within the timeline and its plan to return into compliance. If the fund can’t meet the 80% compliance guideline within a reasonable period determined by the SEC, then the fund would need to change its name and notify its investors of the change.
When even an experienced group of SRI advisors are daunted while sifting through “ESG lite” from the deeper and more meaningful application of SRI in the current glut of ESG (or similar sustainability named) funds in the marketplace, this an important step in the SRI industry’s development. Natural Investments welcomes the Commission’s proposed steps in combating misleading and deceptive names to provide transparency and guidance for fund companies.