[Federal Register Volume 62, Number 46 (Monday, March 10, 1997)]
[Proposed Rules]
[Pages 10955-10962]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-5375]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 270
[Release No. IC-22530; File No. S7-11-97]
RIN 3235-AH11
Investment Company Names
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Securities and Exchange Commission is proposing a new rule
under the Investment Company Act of 1940 that would require a
registered investment company with a name suggesting that the company
focuses on a particular type of investment (e.g., an investment company
that calls itself the ABC Stock Fund, the XYZ Bond Fund, or the QRS
U.S. Government Fund) to invest at least 80% of its assets in the type
of investment suggested by its name. Under current positions of the
Commission's Division of Investment Management, these investment
companies generally must invest only 65% of their assets in the types
of investments suggested by their names. The proposed rule also would
address names that suggest an investment company focuses its
investments in a particular country or geographic region, names that
indicate a company's distributions are exempt from income tax, and
names that suggest a company or its shares are guaranteed or approved
by the U.S. government. The new rule is intended to address certain
broad categories of investment company names that are likely to mislead
investors about an investment company's investments and risks.
DATES: Comments must be received on or before June 9, 1997.
ADDRESSES: Comments should be submitted in triplicate to Jonathan G.
Katz, Secretary, Securities and Exchange Commission, 450 5th Street,
NW., Washington, DC. 20549-6009. Comments also may be submitted
electronically at the following E-mail address: [email protected].
All comment letters should refer to File No. S7-11-97; this file number
should be included on the subject line if E-mail is used. All comments
received will be available for public inspection and copying in the
Commission's Public Reference Room, 450 5th Street, NW., Washington,
DC. 20549-6009. Electronically-submitted comment letters will be posted
on the Commission's Internet site (http://www.sec.gov).
FOR FURTHER INFORMATION CONTACT: David U. Thomas, Senior Counsel, or
Elizabeth R. Krentzman, Assistant Director, (202) 942-0721, Office of
Disclosure and Investment Adviser Regulation, Division of Investment
Management, Securities and Exchange Commission, 450 5th Street, NW.,
Mail Stop 10-2, Washington, DC. 20549-6009.
SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission today
is proposing for comment new rule 35d-1 (17 CFR 270.35d-1) under the
Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.) (the
``Investment Company Act''). The new rule would apply to all registered
investment companies and would require an investment company with a
name that suggests that the company focuses on a particular type of
investment to invest at least 80% of its assets in the type of
investment suggested by its name. In addition, the rule would apply an
80% investment requirement to investment companies with names that
suggest the company focuses its investments in a particular country
(e.g., the ABC Japan Fund) or geographic region (e.g., the ABC Latin
America Fund) and investment companies with names that indicate the
company's distributions are exempt from federal income tax (e.g., the
XYZ Tax-Exempt Fund) or exempt from both federal and state income tax
(e.g., the XYZ New York Tax-Exempt Fund). The rule also would prohibit
an investment company from using a name that suggests that the company
or its shares are guaranteed or approved by the U.S. government.
In separate companion releases, the Commission is proposing two
initiatives designed to improve the disclosure provided to investors by
open-end management investment companies (``funds''). First, the
Commission is proposing significant amendments to the prospectus
disclosure requirements of Form N-1A (17 CFR 274.11A), the registration
statement used by funds.1 These amendments seek to minimize
prospectus disclosure about technical, legal, and operational matters
that generally are common to all funds and to focus prospectus
disclosure on essential information about a particular fund that would
assist an investor in deciding whether to invest in that fund. Second,
the Commission is proposing new rule 498 under the Securities Act of
1933 (15 U.S.C. 77a et seq.) and the Investment Company Act, which
would permit an investor to buy a fund's shares based on a summary
document, or ``profile,'' that contains key
[[Page 10956]]
information about the fund.2 Under this proposal, investors would
receive the fund's prospectus upon request or with the purchase
confirmation.
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\1\ Investment Company Act Release No. 22528 (Feb. 27, 1997)
(``Form N-1A Release'').
\2\ Investment Company Act Release No. 22529 (Feb. 27, 1997).
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TABLE OF CONTENTS
I. INTRODUCTION
II. DISCUSSION
A. General
1. Names Indicating an Investment Emphasis in Certain Securities
or Industries
2. Names Indicating an Investment Emphasis in Certain Countries
or Geographic Regions
3. Tax-Exempt Investment Companies
4. Applying the 80% Investment Requirement
B. Names Suggesting Guarantee or Approval by the U.S. Government
C. Other Investment Company Names
1. In General
2. Names and Average Weighted Portfolio Maturity and Duration
D. Effective Date
III. GENERAL REQUEST FOR COMMENTS
IV. SUMMARY OF INITIAL REGULATORY FLEXIBILITY ANALYSIS
V. STATUTORY AUTHORITY
VI. TEXT OF PROPOSED RULE
I. Introduction
Section 35(d) of the Investment Company Act, as amended by the
recently enacted National Securities Markets Improvement Act of 1996,
prohibits a registered investment company from using a name that the
Commission finds by rule to be materially deceptive or
misleading.3 Before section 35(d) was amended, the Commission was
required to declare by order that a particular name was misleading and,
if necessary, obtain a federal court injunction prohibiting further use
of the name. In adopting amended section 35(d), Congress reaffirmed its
concern that investors may focus on an investment company's name to
determine the company's investments and risks, and recognized that
investor protection would be improved by giving the Commission
rulemaking authority to address potentially misleading investment
company names.4
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\3\ 15 U.S.C. 80a-34(d); Pub. L. No. 104-290, sec. 208, 110
Stat. 3416, 3432 (1996).
\4\ See S. Rep. No. 293, 104th Cong., 2d Sess. 8-9 (1996).
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The Commission is proposing new rule 35d-1 to address certain
investment company names that are likely to mislead an investor about a
company's investment emphasis. The Commission believes that investors
should not rely on an investment company's name as the sole source of
information about a company's investments and risks.5 An
investment company's name, like any other single piece of information
about an investment, cannot tell the whole story about the investment
company.6 As Congress has recognized, however, the name of an
investment company may communicate a great deal to an investor.
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\5\ See generally ``Investor Protection: Tips from an SEC
Insider,'' Remarks by Arthur Levitt, Chairman, SEC, before the
Investors'' Town Meeting at the Houstonian Hotel, Washington, D.C.
(Apr. 12, 1995) (``An informed investor looks beyond the packaging
of a fund, and also sees what's inside.''); ``The SEC and the Mutual
Fund Industry: An Enlightened Partnership,'' Remarks by Arthur
Levitt, Chairman, SEC, before the General Membership Meeting of the
Investment Company Institute (``ICI'') at the Washington Hilton
Hotel, Washington, D.C. (May 19, 1995) (``some fund names can leave
investors with the wrong impression about [the fund's] safety.'').
\6\ See Millman, First pop the hood: A fund's name may tell you
nothing about how it acts, U.S. News & World Rep., Feb. 3, 1997, at
70.
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The proposed rule would apply to all registered investment
companies, including funds, closed-end investment companies, and unit
investment trusts, and would require an investment company with a name
that suggests a particular investment emphasis to invest in a manner
consistent with its name. The rule, for example, would require an
investment company with a name that suggests that the company focuses
on a particular type of security (e.g., an investment company that
calls itself the ABC Stock Fund, the XYZ Bond Fund, or the QRS U.S.
Government Fund) to invest at least 80% of its assets in the type of
security indicated by its name. An investment company seeking maximum
flexibility with respect to its investments would be free to select a
name that does not connote a particular investment emphasis.
Under current positions of the Division of Investment Management
(``Division'') an investment company with a name suggesting that the
company focuses on a particular type of investment generally is
required to invest only 65% of its assets in the type of investment
suggested by its name.7 Division positions with respect to
investment company names have evolved over time. Division guidelines
accompanying Form N-8B-1, a predecessor of Form N-1A, required a fund
to invest at least 80% of its assets in the type of investment
indicated by its name.8 When the Commission adopted Form N-1A in
1983, the Division instituted the 65% investment requirement to give
funds greater flexibility with respect to their names and
investments.9
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\7\ See, e.g., Guide 1 to Form N-1A (regarding certain names
used by funds). The Division also has addressed certain investment
company names in various ``Letters to Registrants'' (``GCLs'').
\8\ Investment Company Act Release No. 7221 (June 9, 1972) (37
FR 12790) (applying the 80% requirement with respect to a fund's
assets exclusive of cash, government securities, and short-term
commercial paper).
\9\ Investment Company Act Release No. 13436 (Aug. 12, 1983) (48
FR 37928) (applying the 65% requirement with respect to a fund's
total assets, but allowing funds to depart from the 65% requirement
based on adverse market conditions).
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The Commission is proposing the 80% investment requirement to guard
against the use of misleading investment company names and to implement
Congress's intent in amending section 35(d).10 Requiring an
investment company to invest at least 80% of its assets in the type of
investment suggested by its name would provide an investor greater
assurance that the company's investments will be consistent with its
name. The need for investment companies to invest in a manner
consistent with their names would appear to have become more important
in recent years as more and more investors have invested in investment
companies to meet their retirement goals. These investors typically
place greater emphasis on allocating their investment company holdings
in well-defined types of investments, such as stocks, bonds, and money
market instruments.11 Given the substantial growth of the
investment company industry over the last decade, investors face an
increasingly diverse universe of investment companies to evaluate when
choosing a company suitable for their investment needs.12
[[Page 10957]]
The proposed 80% investment requirement could help reduce confusion
when an investor selects an investment company for specific investment
needs and asset allocation goals.
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\10\ Rule 35d-1 would address misleading investment company
names. In contrast, fund professionals and others may categorize
investment companies based on a company's investment objectives or
strategies and actual portfolio holdings. A fund investing
principally in equity securities, for example, may be categorized as
an aggressive stock fund or a small-capitalization fund. These
categories develop over time and are used by industry and rating
services such as Lipper Analytical Services, Inc. and Morningstar,
Inc. Morningstar, Inc., for example, currently is revising its
investment company classification system to classify a company by
its portfolio holdings over a 3-year period (or life of the fund, if
shorter). Morningstar, Morningstar Introduces New Fund Categories
(Oct. 29, 1996) (press rel.).
\11\ See, e.g., Vickers, A Price of Success: An Unbalanced
Portfolio, N.Y. Times, Jan. 12, 1997, at F6; Glassman, With New
Year, Stock Up a 401(k) for the Long Term, Wash. Post, Jan. 1, 1997,
at C13. The amount of retirement assets invested in funds increased
145% between 1992 and 1995, with these assets totalling $1.01
trillion at the end of 1995. ICI, Mutual Fund Retirement Assets
(Dec. 6, 1996) (ICI News No. ICI-96-98). The ICI estimates that, in
1995, 84% of fund shareholders invested for retirement purposes. Id.
\12\ According to Division estimates based on data from the ICI
and Lipper Analytical Services, between September 1985 and November
1996, investment company assets increased from $591 billion to $4.0
trillion and the number of investment companies (including the
individual series of funds) increased from 9,200 to 24,661.
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The proposed rule would address certain broad categories of
investment company names that, in the Commission's view, are likely to
mislead investors about a company's investments and risks. The Division
would continue to evaluate investment company names not covered by
proposed rule 35d-1 (e.g., a name that includes words, such as
``international'' or ``global,'' that a reasonable investor may
conclude suggest more than one investment focus). In determining
whether a particular name is misleading, the Division would consider
whether the name would lead a reasonable investor to conclude that the
company invests in a manner that is inconsistent with the company's
intended investments or the risks of those investments.
II. Discussion
A. General
1. Names Indicating an Investment Emphasis in Certain Securities or
Industries
Proposed rule 35d-1 would require an investment company with a name
that suggests that the company focuses its investments in a particular
type of security (e.g., the ABC Stock Fund or XYZ Bond Fund) or in
securities of issuers in a particular industry (e.g., the ABC Utilities
Fund or the XYZ Health Care Fund) to invest at least 80% of its assets
in the indicated investment.13 The 80% requirement would allow an
investment company to maintain up to 20% of its assets in other
investments. In the case of funds, these assets, for example, could
include cash and cash equivalents that could be used to meet redemption
requests.
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\13\ Proposed rule 35d-1(a)(2). A fund that uses a name
suggesting that it is a money market fund would continue to be
subject to the maturity, quality, and diversification requirements
of rule 2a-7(b) under the Investment Company Act (17 CFR 270.2a-
7(b)).
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The proposed rule would require the 80% investment requirement to
be a fundamental policy of the investment company (i.e., a policy that
may not be changed without shareholder approval).14 Consistent
with other requirements under the Investment Company Act, the
requirement to adopt the 80% investment requirement as a fundamental
policy would prevent a company from changing its name and its
investment emphasis without the consent of shareholders.15 The
Commission requests comment on the proposed 80% investment requirement
and whether the 80% requirement should be a fundamental policy.
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\14\ See section 8(b)(3) of the Investment Company Act, 15
U.S.C. 80a-8(b)(3) (regarding policies deemed fundamental by an
investment company), and section 13(a)(3) of the Investment Company
Act, 15 U.S.C. 80a-13(a)(3) (requiring shareholder approval to
change a policy deemed fundamental under section 8(b)(3)). Under
current Division positions, only investment companies with names
suggesting that their distributions are exempt from tax are required
to adopt fundamental policies with respect to their investments or
distributions. See Guide 1 to Form N-1A (regarding tax-exempt
funds).
\15\ See section 13(a) of the Investment Company Act (requiring,
among other things, an investment company to obtain shareholder
approval to change its status from a diversified company to a
nondiversified company). See also infra note 49.
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Under the proposed rule, an investment company that includes the
words ``Treasury'' or ``government'' in its name (e.g., the ABC U.S.
Treasury Fund or the XYZ U.S. Government Fund) would be required to
invest, as applicable, at least 80% of its assets in U.S. Treasury
securities or U.S. government securities.16 The Commission
requests comment whether an investor may infer from a name that
includes the words ``Treasury'' that the investment company invests
exclusively in obligations backed by the full faith and credit of the
U.S. government. If so, should the proposed rule require these
investment companies to invest exclusively in U.S. Treasury
obligations?
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\16\ See section 2(a)(16) of the Investment Company Act (15
U.S.C. 80a-2(a)(16)) (defining government securities as those issued
or guaranteed by the U.S. government or any U.S. government agency
or instrumentality). The requirement to invest, as applicable, in
U.S. Treasury securities or U.S. government securities would apply
only to investment companies with names that connote investments in
U.S. obligations. An investment company with a name that suggests
the company invests in government obligations other than those of
the United States (e.g., the ABC French Government Fund) would be
required to invest at least 80% of its assets in the type of
government securities by its name.
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Under the proposed rule, an investment company with the word
``government'' in its name could satisfy the 80% investment requirement
by investing in government securities, which include many types of
instruments ranging, for example, from U.S. Treasury bonds to
derivative securities, such as Government National Mortgage Association
collateralized mortgage obligations. Investors may not anticipate the
extent to which the net asset value of an investment company that
invests in government securities may increase or decrease in response
to changes in interest rates. In 1994, certain funds with the word
``government'' in their names declined sharply in value in response to
interest rate changes.17 The Commission requests comment whether,
to address the degree of interest-rate sensitivity of the shares of
these companies, the rule should restrict the types of government
securities that may be used to satisfy the 80% requirement and, if so,
what restrictions would be appropriate. For example, the rule could
require an investment company with a name that includes the word
``government'' to invest at least 80% of its assets in U.S. Treasury
securities and other comparable government instruments. This approach,
however, could have the practical effect of subjecting investment
companies with the words ``government'' and ``Treasury'' in their names
to substantially the same 80% investment requirement and eliminate any
differences among these funds. In addition, these types of restrictions
would create a separate, narrower definition of ``government
securities'' for the purposes of the rule than that used in the
marketplace. Commenters favoring a limitation on the types of
instruments that could be used to meet the 80% requirement should
suggest specific limitations and discuss why those limitations would be
appropriate.18
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\17\ See Mutual Funds, Consumer Reports, June 1995, at 415 (a
fund with the words ``government income'' in its name that lost 28%
in 1994 ``seemed to imply that shareholders would be investing in
safe government bonds that produce income').
\18\ See also infra ``Names Suggesting Guarantee or Approval by
the U.S. Government.''
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2. Names Indicating an Investment Emphasis in Certain Countries or
Geographic Regions
The proposed rule would address investment companies with names
that suggest that they focus their investments in a particular country
(e.g., the ABC Japan Fund) or in a particular geographic region (e.g.,
the XYZ Latin America Fund) by requiring these companies to meet a two-
part 80% investment requirement.19 First, these companies would be
required to have a fundamental policy to invest, as applicable, at
least 80% of their assets in securities of issuers that are tied
economically to the particular country or geographic region indicated
by their names. Consistent with this requirement, a company also would
be required to invest in securities that meet any one of the following
criteria: (i) Securities of issuers that are organized under the laws
of the country or of a
[[Page 10958]]
country within the geographic region suggested by the company's name or
that maintain their principal place of business in that country or
region; (ii) securities that are traded principally in the country or
region suggested by the company's name; or (iii) securities of issuers
that, during the issuer's most recent fiscal year, derived at least 50%
of their revenues or profits from goods produced or sold, investments
made, or services performed in the country or region suggested by the
company's name or that have at least 50% of their assets in that
country or region. Substantially the same 3 criteria have been used to
date by the Division to determine whether names of investment companies
that focus their investments in particular countries or geographic
regions are consistent with section 35(d).20 Since these criteria
are relatively broad, the proposed rule would impose the general
requirement that a company's investments be tied economically to the
country or region indicated by its name.
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\19\ Proposed rule 35d-1(a)(3).
\20\ Letter to Registrants at II.A (Feb. 22, 1993) (using
substantially the same 3 criteria, but indicating that the Division
would consider other criteria).
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The Commission requests comment on the proposed approach. In
particular, the Commission requests comment on using specific criteria
alone to determine whether a company's investments are consistent with
its name and, if so, whether the proposed 3 criteria appropriately
describe investments in securities of a particular country or
region.21 Alternatively, the Commission requests comment whether
the rule should impose only the general requirement that a company
invest at least 80% of its assets in securities of issuers that are
tied economically to the country or geographic region indicated by the
company's name.22 This approach may give a company the flexibility
to invest in additional types of securities that are not addressed by
the 3 proposed (or other specific) criteria, but expose the company's
assets to the economic fortunes and risks of the country or geographic
region indicated by its name.23 The Commission requests comment
whether this result would be appropriate.
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\21\ See ``The Scope of the US Mutual Fund Industry: Its
Regulation and Industry Trends,'' Remarks by Isaac C. Hunt, Jr.,
Commissioner, SEC, before the Business Roundtable on ``The
Development of the Russian Mutual (Unit) Fund Industry and Related
Investment Opportunities'' at the General Consulate of the Russian
Federation, New York, New York (Sept. 20, 1996) (discussing St.
Petersburg Long Distance Telephone company, which is organized in
Canada and whose securities are traded outside of Russia). See also,
e.g., rule 3b-4 under the Securities Exchange Act of 1934 (17 CFR
240.3b-4) (defining a ``foreign issuer').
\22\ Under this approach, an investment company would describe
in its prospectus the specific criteria that it uses to select
investments that meet the general standard.
\23\ For example, an investment company may seek to replicate
the currency exposure associated with investing in a particular
country by investing in securities denominated in the currencies of
other countries.
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Tax-Exempt Investment Companies
The proposed rule would codify current Division positions
applicable to an investment company with a name that suggests that the
company's distributions are not subject to income tax. In particular,
rule 35d-1 would require a company that uses a name suggesting that its
distributions are exempt from federal income tax or from both federal
and state income taxes to adopt a fundamental policy: (i) To invest at
least 80% of its assets in securities the income from which is exempt,
as applicable, from federal income tax or from both federal and state
income tax; or (ii) to invest its assets so that at least 80% of the
income that it distributes will be exempt, as applicable, from federal
income tax or from both federal and state income tax.24 Consistent
with current Division positions, the proposed requirements would apply
to a company's investments or distributions that are exempt from
federal income tax under both the regular tax rules and the alternative
minimum tax rules.25
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\24\ Proposed rule 35d-1(a)(4).
\25\ Letter from Mary Joan Hoene, Deputy Director, Division of
Investment Management, SEC, to Matthew P. Fink, Senior Vice
President and General Counsel, ICI (Nov. 3, 1987).
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Applying the 80% Investment Requirement
The proposed 80% investment requirement would apply at the time a
company invests its assets.26 This approach would be consistent
with other investment requirements under the Investment Company
Act.27 Under the proposed approach, for example, an investment
company subject to the 80% investment requirement would not have to
sell portfolio holdings that have increased in value.28 The
proposed rule would require an investment company that no longer meets
the 80% investment requirement (e.g., as a result of changes in the
value of its portfolio holdings or other circumstances beyond its
control) to make future investments in a manner that would bring the
company into compliance with the 80% requirement. The Commission
requests comment on the proposed approach.
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\26\ Proposed rule 35d-1(b)(1).
\27\ See section 5(c) of the Investment Company Act (15 U.S.C.
80a-5(c)) (providing that a diversified investment company under
section 5(b)(1) of the Act will not lose its status as a diversified
company because of changes in the value of its investment since the
time of purchase).
\28\ Similarly, the proposed approach would enable a fund,
pending investment of its assets, to meet the 80% investment
requirement despite an influx of cash from new investors. Guide 1 to
Form N-1A, in contrast, requires a fund ``to have invested'' at
least 80% of its assets in a manner consistent with its name, which
could suggest that a fund would be required to sell portfolio
securities in order to maintain 80% of its assets in the type of
investment suggested by its name.
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The proposed 80% investment requirement would be based on a
company's net assets plus any borrowings that are senior securities
under section 18 of the Investment Company Act.29 Division
positions that require an investment company to invest at least 65% of
its assets in the type of investment suggested by its name apply the
65% requirement based on a company's total assets.30 Total assets
may include non-investment assets (such as receivables for shares sold
or expense reimbursements) and exclude liabilities that reduce the
amount of a company's investments. Certain types of routine
transactions, such as unsettled securities transactions and securities
loans, may increase a company's total assets because total assets do
not reflect certain liabilities.31 These transactions have no net
effect on a company's portfolio investments and may result in a company
failing to satisfy an 80% investment requirement based on total assets,
even though, in effect, 80% of the company's portfolio holdings would
be invested in a manner consistent with the company's name. Basing the
80% investment requirement on net assets rather than total assets is
intended to reflect more closely a company's portfolio investments.
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\29\ 15 U.S.C. 80a-18. See proposed rule 35d-1(b)(2)(ii)
(defining assets for the purposes of the 80% investment
requirement).
\30\ See Guide 1 to Form N-1A (also applying an 80% investment
requirement for tax-exempt funds based on a fund's net assets).
\31\ For example, when a company sells a security for settlement
in 3 days and simultaneously commits the sale proceeds to purchase
another security, the company's total assets would include as
receivables amounts for the security sold and the security
purchased, although, during the 3-day settlement period, the
company's total assets would not reflect the liability for the price
of the securities that the company is obligated to purchase.
Similarly, when a company lends its securities, total assets would
include a receivable for the security loaned and the collateral for
the loan, but not the corresponding payable for the loan.
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Net assets do not include liabilities such as a company's
borrowings, if any. The proposed rule would use net assets plus the
amount of any borrowings that are senior securities. This approach
seeks to prevent a company from circumventing the 80% investment
requirement by investing borrowed funds in securities that are not
[[Page 10959]]
consistent with the company's name.32 The Commission requests
comment on the proposed approach and whether there are other
transactions that, like borrowings, could increase the amount of assets
that a company could invest and should be added to net assets.
Alternatively, the Commission requests comment whether using total
assets excluding certain transactions, such as unsettled securities
transactions and securities loans, would be a more effective basis for
the 80% requirement and, if so, what transactions should be excluded
from total assets.
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\32\ Section 18 of the Investment Company Act restricts the
issuance of senior securities, which include borrowings (except bank
borrowings that satisfy certain asset coverage conditions).
Investment companies may borrow without being deemed to have created
a senior security by establishing a segregated account with liquid
assets that collateralize 100% of the market value of the borrowing.
See Investment Company Act Release No. 10666 (Apr. 18, 1979) (44 FR
25128); Merrill Lynch Asset Management, L.P. (pub. avail. July 2,
1996). For purposes of the rule, net assets would include only those
borrowings that are senior securities (i.e., any borrowings that are
not fully collateralized by amounts maintained in a segregated
account). By virtue of segregating assets to collateralize the
borrowing, an investment company should not be able to circumvent
the 80% requirement because the amount of company's assets available
for investment would not be increased.
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Consistent with current Division positions, the proposed rule would
contemplate that an investment company may take a ``temporary defensive
position'' to avoid losses in response to adverse market, economic,
political, or other conditions.33 When an investment company
assumes a temporary defensive position, the company would be permitted
to depart from the 80% requirement and invest in other securities. The
Commission requests comment on the proposed approach. In particular,
the Commission requests comment whether the Commission should provide
specific guidance on when an investment company could appropriately
assume a temporary defensive position.34 Commenters favoring this
approach should consider whether the rule should establish specific
time periods during which a company would be permitted to take a
temporary defensive position. Alternatively, the Commission requests
comment whether the rule should give investment companies greater
flexibility to assume temporary defensive positions. For example,
should an investment company simply disclose the circumstances under
which, and the potential length of time during which, the company may
assume a temporary defensive position and depart from the 80%
investment requirement?
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\33\ Proposed rule 35d-1(b)(3). See Letter to Registrants at
II.E (Feb. 25, 1994) (``1994 GCL'). See also Form N-1A Release,
supra note (proposing to require a fund to disclose, if applicable,
certain information in its prospectus about the possibility of
taking temporary defensive positions).
\34\ Many investment companies have the flexibility to assume
temporary defensive positions and depart from investment policies
unrelated to their names. See 1994 GCL, supra note (noting that
investment companies may depart from a policy to concentrate in a
particular industry or group of industries to avoid losses in
response to adverse market, economic, political, or other
conditions).
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The Commission also requests comment whether certain investment
companies may require more flexibility than others in meeting the 80%
investment requirement. For example, an investment company with a name
that suggests the company invests in securities associated with a
developing country may need the flexibility to invest significant
portions of its assets in other securities pending the availability of
suitable investments in the developing country indicated by its name.
The Commission requests comment whether and how these or other
circumstances should be addressed.
B. Names Suggesting Guarantee or Approval by the U.S. Government
Consistent with the requirements of section 35(a) of the Investment
Company Act, the proposed rule would prohibit an investment company
from using a name that suggests that the company or its shares are
guaranteed or approved by the U.S. government or any U.S. government
agency or instrumentality.35 The proposed rule also would codify a
Division position that prohibits an investment company from using a
name that includes the words ``guaranteed'' or ``insured'' or similar
terms in conjunction with ``United States'' or ``U.S. government.'' The
Division adopted this position to address concerns that names with
these terms may lead investors to conclude erroneously that the value
of an investment company's shares is guaranteed or insured by the U.S.
government.36
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\35\ Proposed rule 35d-1(a)(1). See section 35(a) of the
Investment Company Act [15 U.S.C. 80a-34(a)] (prohibiting an
investment company from representing or implying in any manner that
the company or its shares are guaranteed or approved by the U.S.
government).
\36\ See Letter from William R. McLucas, Director, Division of
Enforcement, and Gene A. Gohlke, Acting Director, Division of
Investment Management, SEC, to Registrants (Oct. 25, 1990). A
similar concern may be raised when an investment company has a name
that is the same as or similar to the name of a bank that advises
the company or through which the company's shares are sold. The
Division has taken the position that, absent disclosure informing
investors that the investment company is not federally insured,
these names are misleading because an investor is likely to believe
that an investment in the company is insured by the Federal Deposit
Insurance Corporation or otherwise protected against loss. See
Letter to Registrants from Barbara J. Green, Deputy Director,
Division of Investment Management, SEC (May 13, 1993). The proposed
amendments to Form N-1A would continue to require a fund with a name
that is the same as or similar to a bank's name to disclose that it
is not federally insured. See Form N-1A Release, supra note 1.
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U.S. government securities differ among themselves with respect to
the amount of credit support provided by the U.S. government. Including
the word ``guarantee'' or similar terms in an investment company's name
could be used to address the degree of credit risk associated with the
types of government securities in which a particular company invests.
For example, while U.S. Treasury bonds are supported by the full faith
and credit of the United States, government securities issued by the
Federal National Mortgage Association (``Fannie Mae'') are supported by
Fannie Mae's ability to borrow from the U.S. Treasury. The proposed
rule, however, would prohibit a company from using a name such as the
``ABC Fund for Investing in U.S. Guaranteed Assets,'' even though the
company invests at least 80% of its assets in government obligations
that are, in fact, guaranteed as to payment of principal and interest
by the full faith and credit of the U.S. government. The Commission
requests comment whether the proposed prohibition is appropriate. In
addition, since the fund industry distinguishes between Treasury and
other government funds and investors may understand the differences
between these funds, the Commission requests comment whether a
reasonable investor would understand that using terms such as
``guaranteed'' or ``insured'' in conjunction with the words ``U.S.
government'' reflect the credit risk of a company's investments.
Alternatively, would a reasonable investor be misled into believing
that names using these terms mean that an investment in the company is
guaranteed or insured by the U.S. government from any risk of loss,
including the risk that the value of the company's shares may decrease
in response to interest rate changes?
C. Other Investment Company Names
In General
The proposed rule would not codify Division positions with respect
to certain investment company names. The Division, for example, has
provided guidance in the past about the use of a name that includes
words such as ``balanced,'' ``index,'' ``small, mid, or large
capitalization,'' ``international,''
[[Page 10960]]
and ``global.'' 37 The Commission believes that a reasonable
investor could conclude that these names suggest more than one
investment focus. For example, while an investment company with a name
that includes the words ``international'' or ``global'' generally
suggests that the company invests in more than one country, these terms
may describe a number of investment companies that have significantly
different investment portfolios. Among other things, the number of
countries in which an ``international'' or ``global'' investment
company may invest at any one time may appropriately differ from
company to company.38
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\37\ See Guide 4 to Form N-1A (funds that use the word
``balanced'' in their names); Letter to Registrants at II.A (Jan.
17, 1992) (investment companies that include the word ``index'' in
their names); 1994 GCL, supra note 33, at II.D (investment companies
with names that include the terms ``small, mid, or large
capitalization''). The Commission does not license the use of a
particular investment company name, although the Division has
considered and would continue to address whether the use of a
particular name would be misleading because it is the same as or
similar to the name of an existing registered investment company.
See Guide 1 to Form N-1A.
\38\ In the past, the Division distinguished ``global'' and
``international'' investment companies by suggesting that an
investment company with ``global'' in its name invest in securities
of at least 3 different countries (which may include the United
States) and that an investment company with ``international'' in its
name invest in securities of at least 3 countries outside the United
States. Letter to Registrants at II.A.2 (Jan. 3, 1991). The Division
no longer distinguishes the terms ``global'' and ``international.''
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The Division would continue to give interpretive advice with
respect to investment company names not covered by the proposed
rule.39 In determining whether a particular name is misleading,
the Division would consider whether the name would lead a reasonable
investor to conclude that the company invests in a manner that is
inconsistent with the company's intended investments or the risks of
those investments.40
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\39\ As a general matter, an investment company should define
the terms used in its name in discussing its investment objectives
and strategies in the prospectus. See 1994 GCL, supra note 33, at
II.D (using this approach for investment companies that include the
words ``small, mid, and large capitalization'' in their names).
40 3See In re Alliance North Am. Gov't Income Trust, Inc.
Securities Litigation, No. 95 Civ. 0330 (LLM), 1996 U.S. Dist. LEXIS
14209, at *8 (S.D.N.Y. Sept. 27, 1996); The Private Investment Fund
for Governmental Personnel, Inc., 37 S.E.C. 484, 487-88 (1957). The
80% investment requirement generally would apply to a company's
investment focus as disclosed in the company's prospectus. The
Commission, however, recognizes that the 80% investment requirement
would not be appropriate in all cases (e.g., with respect to an
investment company that uses the word ``balanced'' in its name).
In connection with the proposed amendments to Form N-1A,
information about the organization and operations of investment
companies and Division interpretive positions is proposed to be
incorporated in a new ``Investment Company Registration Package,''
which would be prepared by the Division. See Form N-1A Release,
supra note 1. The Investment Company Registration Package would
include general guidance about avoiding the use of a name that is
the same as or similar to the name of another investment company and
about names that a reasonable investor may conclude suggest more
than one investment focus including, for example, use of names that
include the terms ``small, mid, or large capitalization.''
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2. Names and Average Weighted Portfolio Maturity and Duration
Investment companies investing in debt obligations often seek to
distinguish themselves by limiting the maturity of the instruments they
hold. These investment companies may call themselves, for example,
``short-term,'' ``intermediate-term,'' or ``long-term'' bond or debt
funds.41 The Division has required investment companies with these
types of names to have average weighted portfolio maturities of
specified lengths. The Division, for example, has required an
investment company that includes the words ``short-term,''
``intermediate-term,'' or ``long-term'' in its name to have a dollar-
weighted average maturity of, respectively, no more than 3 years, more
than 3 years but less than 10 years, or more than 10 years.42 The
Division no longer intends to use these criteria because it believes a
reasonable investor would not necessarily expect that investment
companies with these names would be limited in this manner.43 In
addition, the Division and Commission believe that the average weighted
maturity of an investment company's portfolio securities may not
accurately reflect the sensitivity of the company's share prices to
changes in interest rates.44
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\41\ The term ``bond,'' by itself, does not imply that the
security has a particular maturity. See also 1994 GCL, supra note,
33, at III.A (indicating that a fund should describe in its
prospectus what it considers to be a ``bond').
\42\ See Investment Company Act Release No. 15612 (Mar. 9, 1987)
[52 FR 8268, 8301] (proposing to codify these positions in a
guideline).
\43\ As in the case of other investment company names, the
Division would address these terms on a case-by-case basis in light
of the disclosure provided by the investment company.
\44\ In 1994, some investors did not anticipate how certain
investment companies would perform when interest rates declined over
a relatively short period of time. See, e.g., Antilla, A New Concept
in Fund Ads: Truth, N.Y. Times, July 10, 1994, at C13 (regarding the
performance of certain short-term bond funds).
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In view of the shortcomings associated with analyzing interest rate
volatility based on average weighted maturity, investment companies and
investment professionals increasingly evaluate bond portfolios based on
``duration,'' which reflects the sensitivity of an investment company's
returns to changes in interest rates.45 In a concept release on
improving risk disclosure, the Commission requested comment whether, if
an investment company's name or investment objective refers to
maturity, the maturity of the company's investments should be required
to be consistent with the duration of the company's portfolio.46 A
number of commenters supported this approach, and the Division is in
the process of developing recommendations relating to duration and the
maturity of an investment company's investments. As part of its
consideration of this issue, the Division requested the Investment
Company Institute (``ICI'') to consider various methods of calculating
duration and asked the ICI to report its findings.47 In response,
the ICI formed a committee to consider this issue and the committee has
agreed to inform the Division of its findings. As the Division
continues to consider this issue, the Commission requests further
comment whether the maturity of a company's portfolio suggested by the
company's name should be consistent with the portfolio's
duration.48 The Commission requests specific comment on an
appropriate method or methods to calculate portfolio duration.
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\45\ See, e.g., Rekenthaler, Duration Arrives, Morningstar
Mutual Funds 1-2 (Jan. 21, 1994).
\46\ Investment Company Act Release No. 20974 (Mar. 29, 1995)
(60 FR 17172, 17175-76).
\47\ Letter to Paul Schott Stevens, General Counsel, ICI, from
Barry P. Barbash, Director, Division of Investment Management, SEC
(Feb. 15, 1996) (File No. S7-10-95); Letter to Barry P. Barbash,
Director, Division of Investment Management, SEC, from Paul Schott
Stevens, Senior Vice President and General Counsel, ICI (Mar. 11,
1996) (File No. S7-10-95). See also Letter to Barry P. Barbash,
Director, Division of Investment Management, SEC, from Craig Tyle,
Vice President and Senior Counsel, ICI (Dec. 17, 1996) (enclosing
preliminary recommendations relating to a standardized methodology
for calculating portfolio duration) (File No. S7-10-95).
\48\ Pending further action on this issue, the Division would
consider, on a case-by-case basis, an investment company's use of
duration in connection with the maturity suggested by the company's
name.
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D. Effective Date
The Commission proposes to allow an investment company up to one
year from the effective date of the proposed rule to comply with the
rule's requirements. A one-year period is intended to give an
investment company sufficient time to make any necessary adjustments to
its portfolio holdings to comply with proposed rule 35d-1 or, if the
company does not wish to be bound by the requirements of the new rule,
to change its name.49 The
[[Page 10961]]
Commission requests comment on the proposed transition period.
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\49\ Certain investment companies have fundamental policies to
invest at least 65% of their assets in the type of investments
suggested by their names. The Investment Company Act does not
require shareholder approval to adopt a new fundamental policy. See
section 13(a)(3) of the Investment Company Act (requiring
shareholder approval to deviate from a fundamental policy). An
investment company that has a fundamental policy to invest at least
65% of their assets in the type of investment suggested by its name
generally would be expected to meet the higher 80% investment
requirement. A company would decide, based on its individual
circumstances, whether it is necessary to seek shareholder approval
to change its investment policy.
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III. General Request for Comments
The Commission requests that any interested persons submit comments
on proposed rule 35d-1, suggest additional changes (including changes
to related rules that the Commission is not proposing to amend), or
submit comments on other matters that might affect the proposed rule.
Commenters suggesting alternative approaches are encouraged to submit
proposed rule or form text. For purposes of the Small Business
Regulatory Enforcement Fairness Act of 1996 (5 U.S.C. 801 et seq.), the
Commission also is requesting information regarding the potential
impact of the proposed rule on the economy on an annual basis.
Commenters should provide empirical data to support their views.
IV. Summary of Initial Regulatory Flexibility Analysis
The Commission has prepared an Initial Regulatory Flexibility
Analysis (``Analysis'') in accordance with 5 U.S.C. 603 regarding
proposed rule 35d-1. The Analysis explains that the proposed rule would
require a registered investment company with a name suggesting that the
company focuses on a particular type of investment to invest at least
80% of its assets in the type of investment suggested by its name. The
Analysis also explains that the proposed rule is intended to address
investment company names that are likely to mislead investors about an
investment company's investments and risks.
The Analysis discusses the impact of the proposed rule on small
entities, which are defined, for the purposes of the Investment Company
Act, as investment companies with net assets of $50 million or less as
of the end of the most recent fiscal year (17 CFR 270.0-10). The
Commission estimates that approximately 3,846 investment companies
would be subject to the proposed rule. Of these, approximately, 771
(20%) are investment companies that would be small entities. The
Commission believes that there are no other duplicative, overlapping,
or conflicting federal rules.
Only those investment companies that have names suggesting a
particular investment emphasis would be required to comply with the
proposal. To comply with the proposed rule, an investment company with
a name that suggests the company focuses on a particular type of
investment would have to adopt a fundamental policy to invest at least
80% of its assets in the type of investment suggested by its name. The
80% requirement would allow an investment company to maintain up to 20%
of its assets in other investments. An investment company seeking
maximum flexibility with respect to its investments would be free to
use a name that does not connote a particular investment emphasis.
As stated in the Analysis, the Commission considered several
alternatives to proposed rule 35d-1 including, among others,
establishing different compliance or reporting requirements for small
entities or exempting them from all or part of the proposed rule.
Because an investment company could choose to use a name that does not
suggest a particular investment, the Commission believes that the
proposed rule would not impose additional burdens on small entities and
that separate treatment for small entities would be inconsistent with
the protection of investors.
The Commission encourages the submission of comment on the
Analysis, including specific comment on (i) the number of small
entities that would be affected by the proposed rule and (ii) the
discussion of the impact of the rule on small entities. Comments will
be considered in the preparation of the Final Regulatory Flexibility
Analysis if the proposed rule is adopted. A copy of the Analysis may be
obtained from John M. Ganley, Senior Counsel, Securities and Exchange
Commission, 450 5th Street, NW., Mail Stop 10-2, Washington, DC 20549-
6009.
V. Statutory Authority
The Commission is proposing rule 35d-1 under sections 5, 7, 8, 10,
and 19(a) of the Securities Act (15 U.S.C. 77e, 77g, 77h, 77j, and
77s(a)) and sections 8, 30, 35, and 38 of the Investment Company Act
(15 U.S.C. 80a-8, 80a-29, 80a-34, and 80a-37). The authority citations
for the rule precede the text of the amendments.
VI. Text of Proposed Rule
List of Subjects in 17 CFR Part 270
Investment companies, Securities.
For the reasons set out in the preamble, the Commission is
proposing to amend Chapter II, Title 17 of the Code of Federal
Regulations as follows:
PART 270--GENERAL RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF
1940
The authority citation for part 270 continues to read in part as
follows:
Authority: 15 U.S.C. 80a-1 et seq., 80a-37, and 80a-39 unless
otherwise noted;
* * * * *
2. Add Sec. 270.35d-1 to read as follows:
Sec. 270.35d-1 Investment company names.
(a) For purposes of section 35(d) of the Act (15 U.S.C. 80a-34(d)),
a materially deceptive and misleading name of a Fund includes:
(1) Names suggesting guarantee or approval by the U.S. government.
A name suggesting that the Fund or the securities issued by it are
guaranteed, sponsored, recommended, or approved by the U.S. government
or any U.S. government agency or instrumentality, including any name
that uses the words ``guaranteed'' or ``insured'' or similar terms in
conjunction with the words ``United States'' or ``U.S. government.''
(2) Names suggesting investment in certain securities or
industries. A name suggesting that the Fund focuses its investments in
a particular type of security or securities or in securities of issuers
in a particular industry or group of industries, unless the Fund has
adopted a fundamental policy under section 8(b)(3) of the Act (15
U.S.C. 80-8(b)(3)) to invest, as applicable, at least 80% of the value
of its Assets in the particular securities or in securities of issuers
in the particular industry or industries suggested by its name.
(3) Names suggesting investment in certain countries or geographic
regions. A name suggesting that the Fund focuses its investments in a
particular country or geographic region, unless the Fund has adopted a
fundamental policy under section 8(b)(3) of the Act to invest, as
applicable, at least 80% of the value of its Assets in securities of
issuers that are tied economically to the particular country or
geographic region suggested by its name. In meeting this requirement, a
Fund must invest, as applicable, in:
(i) Securities of issuers that are organized under the laws of the
country or of a country within the geographic region suggested by the
Fund's name or that maintain their principal place of business in that
country or region;
(ii) Securities that are traded principally in the country or
region suggested by the Fund's name; or
[[Page 10962]]
(iii) Securities of issuers that, during the issuer's most recent
fiscal year, derived at least 50% of their revenues or profits from
goods produced or sold, investments made, or services performed in the
country or region suggested by the Fund's name or that have at least
50% of their assets in that country or region.
(4) Tax-exempt Funds. A name suggesting that the Fund's
distributions are exempt from federal income tax or from both federal
and state income tax, unless the Fund has adopted a fundamental policy
under section 8(b)(3) of the Act:
(i) To invest at least 80% of the value of its Assets in securities
the income from which is exempt, as applicable, from federal income tax
or from both federal and state income tax; or
(ii) To invest its Assets so that at least 80% of the income that
it distributes will be exempt, as applicable, from federal income tax
or from both federal and state income tax.
(b)(1) The requirements of paragraphs (a)(2) through (4) of this
section apply at the time a Fund invests its Assets. If, subsequent to
an investment, these requirements are no longer met, the Fund's future
investments must be made in a manner that will bring the Fund into
compliance with those paragraphs.
(2) For purposes of this section:
(i) Fund means a registered investment company and any series of
the investment company.
(ii) Assets means net assets plus the amount of any borrowings of
the Fund that are senior securities under section 18 of the Act (15
U.S.C. 80a-18).
(3) Notwithstanding the requirements of paragraphs (a)(2) through
(4) of this section, a Fund may, to the extent permitted by its
fundamental policies, make other investments to avoid losses while
assuming a temporary defensive position in response to adverse market,
economic, political, or other conditions.
Dated: February 27, 1997.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-5375 Filed 3-7-97; 8:45 am]
BILLING CODE 8010-01-P