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The SEC (Securities and Exchange Commission, a major US watchdog in the financial space) is pushing for a significant change to rules on names for investment funds.
The general aim is to regulate the use of certain terms in fund names in order to ensure consumers know exactly where their money is going. Rules do already exist, but they mostly apply only to very clear labels such as ‘equity’ or ‘bond’. These new rules will instead target more ambiguous language which is becoming increasingly commonplace in the funds space – especially those terms related to matters of environmental, social and governance (ESG), a major trend across various industries.
Some of the terms that they are looking to regulate include:
More specifically, 80% of a fund’s portfolio would need to match (as subjective as that word is, as will be explained further into this article) the terms within the name of that fund. If they dip below this number, they have a set timeframe (30 days has been suggested) to bring their percentage back up before they face sanctions.
There are a number of other requirements being introduced in this area too. International law firm Dentons summarise those points here:
The rule change currently only applies to registered investment funds, not private funds (e.g. hedge funds or private equity funds), though managers of the latter type are likely to be following this story with keen interest, since any future expansion of these rules may seek to include them as well. Besides, more general trends in greenwashing litigation have made these risks greater even before the rule change.
For any particularly legally minded individuals looking for further reading and context, this rule change is being written into law under Rule 35d-1 of the Investment Company Act 1940.
Generally, genuine supporters of ESG-related activity have responded positively to the announcement. ‘Greenwashing’ has been a particularly hot topic as of late, and is defined by Investopedia as:
‘the process of conveying a false impression or misleading information about how a company’s [or investment fund’s] products are environmentally sound’
A classic example can be found in Volkswagen’s huge PR efforts to promote itself as a green car company, while later having been criticised (and heavily litigated against) for the diesel emissions scandal.
This is clearly applicable to the matter of fund naming, where the SEC have publicly stated that they believe the problem has become rife.
However, there has also been a great deal of criticism. The Investment Company Institute has stated in a public letter that the proposal might violate a right to free speech for investment fund managers. Law firm partner Rajob Chanda (of Simpson Thacher) recently told the FT that this may well cause problems.
Another law firm partner, George Raine (of Ropes & Gray), has raised queries over the 30-day deadline, since markets will often move for such extended periods of times. Being forced to sell at unfavourable rates as a result of your fund losing its 80% factor causes even more issues.
Other criticisms have surrounded how exactly the SEC will determine what constitutes a tick in the box towards the 80% goal. For example, if a fund uses the word ‘green’ in its name, what are the exact definitions of whether a certain stock might be ‘green’? Is a stock in Tesla green considering both sides of the coin (that the company both produces less polluting cars but also batteries that take a huge environmental toll)? These definitions tend to be very difficult to pin down, especially with larger companies (which many investment funds will be investing in).
It is unlikely that an oil company such as BP, to take another example, would come under the ‘green’ banner. However, they will need investment in order to transition to greener forms of energy (whether for ‘good reasons’ or not, many would feel that they should and need to make the transition for business reasons). In other words, the new rules might put companies in boxes so strictly defined that they inhibit any movement (e.g. ‘less’ to ‘more’ green) that those companies might make.
This story touches on a wide variety of points which aspiring lawyers will do well to draw upon within their applications (for example training contracts and vacation schemes for solicitors, and pupillages for barristers).
The SEC fund names rule change will affect the intersection of environmental law with financial areas such as funds, while at the same time drawing challenges from areas as far-flung as the freedom of speech debates (as those interested in public law will likely be on top of). Explaining how these components fit together is crucial throughout an interview or application form (especially for larger firms and chambers that have a tendency to cross-sell their practice areas to clients). A fund manager approaching your law firm to ask about how this rule change might affect them will likely expect a team to be assembled from across these different areas.
Commercial awareness is a hugely important feature of any applicant nowadays, and following news stories such as this one (as well as keeping up with others through sources such as the Financial Times and Economist) helps to develop that knowledge further, thus improving your chances of taking your next step towards becoming a lawyer.
Here’s our round-up of questions to challenge you to look more deeply into this topic and help you prepare for any upcoming interviews:
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