New SEC Fund Naming Rule Will Improve, Not Stop Misleading Labeling for Investors
SEC rule is a good first step yet lacks specifics to reduce risk in mutual funds and ETFs.
FOR IMMEDIATE RELEASE
MEDIA CONTACT: Stefanie Spear, [email protected], 216-387-1609
BERKELEY, CA—MAY 25, 2022—The long-awaited U.S. Securities Exchange Commission (SEC) draft rule on fund naming was released today requiring companies to improve the accuracy of names and prospectus language of mutual funds and ETFs. Based on a request for information in March of 2020, the new rule will not update the flawed “80/20 rule” which for nearly two decades has been abused by fund managers leading to investors’ inability to differentiate environmental, social, and governance (ESG) risk in many funds due to misleading names.
The new rule will improve prospectus language disclosures including ESG factors, climate risk, proxy voting, and provide machine-readable data. The framework for ESG disclosures will improve investors' ability to evaluate asset managers and the creation of “integration” and “focused” fund categories will help investment selection. The rules aim to assure that stated investing philosophies are reflected in the fundamental fund characteristics, risks, and methods of analysis. It does not require greenhouse gas emission disclosures at this time and commissioners asked for comments to advise on this.
“Right now ESG investing in mutual funds and ETFs is the Wild West due to the voluntary nature of ESG-related disclosures, absence of widely accepted terminology, and limited to no enforcement,” said As You Sow CEO Andrew Behar. “The proposed rules acknowledge the problem and are a good first step in stopping funds with ‘ESG’ in their names from continuing to hold dozens of fossil fuel companies and coal-fired utilities. However, the new rule continues to use the flawed 80/20 framework. On the plus side, fund managers will be required to define ESG in the prospectus, how they vote proxies, and use a very simple set of standardized definitions and categories. While a good first step, investors were hoping for a new structure to close loopholes and eliminate confusion and misleading marketing.”
The new rules did not follow recommendations made in the As You Sow January report “Identify ‘Greenwashing’ Funds Using NLP Firms’ Prospectuses,” written in collaboration with graduate students at the Rady School of Management at the University of California, San Diego. The study showed that of 90 mutual funds and ETFs with ESG in their names, 60 scored a “D” or “F” on As You Sow’s Invest Your Values ESG rating platform which in 2021 was named by Kiplinger as the “#1 tool for sustainable investors.” The new rule will allow this loophole to continue.
The current 80/20 rule was developed so that funds would be required to hold 80% of what is implied or stated in their name. This was developed so that, for example, a large-cap equity fund would be 80% large-cap equities and 20% cash. Fund managers abused this rule and created, for example, “fossil fuel reserves-free” funds with investments in dozens of fossil fuel companies that were under the 20% limit. This violated the spirit of the rule and will continue under the new rule. Naïve investors will still invest in “low-carbon” funds like Blackrock’s Low Carbon Transition Fund (LCTU), which has 33 fossil fuel companies representing 7.53% of holdings.
“The new rule acknowledges the problem but does not fully address it,” Behar said. “Investors still need clarity on exactly what ‘sustainable’ and other terms like ‘fossil-free,’ ‘low-carbon,’ and ‘ESG’ mean. It is critical that a fund’s prospectus reflects its philosophy and intent in alignment with its name and holdings. Fund managers like Trillium, Green Century, Pax, Walden, Parnassus, and others have been accurately disclosing and naming their funds for decades. The problem has grown over the past few years as fund managers have changed their fund names and not their holdings to attract fund flows. It’s time for the SEC to develop a new structure to remove the loopholes and level the playing field to make honest disclosure mandatory. We will review the details to see how the SEC plans to enforce these new rules and hope to see more fundamental structural changes to establish confidence in our investing systems.”
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As You Sow is the nation’s leading shareholder advocacy nonprofit, with a 30-year track record promoting environmental and social corporate responsibility and advancing values-aligned investing. Its issue areas include climate change, ocean plastics, pesticides, racial justice, workplace diversity, and executive compensation. Click here for As You Sow’s shareholder resolution tracker.