Federal Register / Vol. 62, No. 46 / Monday, March 10, 1997 / Proposed Rules 10955

1 Investment Company Act Release No. 22528

(Feb. 27, 1997) (‘‘Form N–1A Release’’).

(vi) How do I buy the Fund’s shares?

Provide information about how to

purchase the Fund’s shares, including

any minimum investment requirements.

If applicable, disclose any breakpoints

in or waivers of sales loads (referring to

sales loads as ‘‘sales fees (loads)’).

(vii) How do I sell the Fund’s shares?

Provide information about how to

redeem the Fund’s shares.

(viii) How are the Fund’s distributions

made and taxed? Describe how

frequently the Fund intends to make

distributions and what reinvestment

options (if any) are available to

investors. State, as applicable, that the

Fund intends to make distributions that

may be taxed as ordinary income and

capital gains or that the Fund intends to

distribute tax-exempt income. If a Fund,

as a result of its investment objectives

or strategies, expects its distributions

primarily to consist of ordinary income

(or short-term capital gains that are

taxed as ordinary income) or capital

gains, provide disclosure to that effect.

For a Fund that holds itself out as

investing in securities generating taxexempt income, provide, as applicable,

the information required by Item

7(d)(2)(ii) of Form N–1A or a general

statement to the effect that a portion of

the Fund’s distributions may be subject

to tax.

(ix) What other services are available

from the Fund? Summarize or list the

services available to the Fund’s

shareholders (e.g., any exchange

privileges or automated information

services), unless otherwise disclosed in

response to paragraphs (c)(2) (i) through

(viii) of this section.

(3) The Profile may include an

application that a prospective investor

can use to purchase the Fund’s shares

if the application presents with equal

prominence the option to invest in the

Fund or request the Fund’s prospectus.

(4) A Profile of a Fund available as an

investment option for participants in a

defined contribution plan that meets the

requirements for qualification under the

Internal Revenue Code of 1986 may

omit the information required by

paragraphs (c)(2) (vi) through (ix) of this

section. In lieu of the application

permitted by paragraph (c)(3) of this

section, the Fund may include the

plan’s enrollment form, which does not

have to be filed with the Commission.

By the Commission.

Dated: February 27, 1997.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 97–5376 Filed 3–7–97; 8:45 am]

BILLING CODE 8010–01–P

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.

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: rule-comments@sec.gov. 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
10956 Federal Register / Vol. 62, No. 46 / Monday, March 10, 1997 / Proposed Rules

2 Investment Company Act Release No. 22529

(Feb. 27, 1997).

3 15 U.S.C. 80a-34(d); Pub. L. No. 104–290, sec.

208, 110 Stat. 3416, 3432 (1996).

4See S. Rep. No. 293, 104th Cong., 2d Sess. 8–

9 (1996).

5See 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.’’).

6See 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.

7See, 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 shortterm 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).

10Rule 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.).

11See, 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.

12According 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

information about the fund.2 Under this

proposal, investors would receive the

fund’s prospectus upon request or with

the purchase confirmation.

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

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.

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

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
Federal Register / Vol. 62, No. 46 / Monday, March 10, 1997 / Proposed Rules 10957

investment companies (including the individual

series of funds) increased from 9,200 to 24,661.

13Proposed 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)).

14See 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).

15See 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.

16See 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.

17See 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’).

18See also infra ‘‘Names Suggesting Guarantee or

Approval by the U.S. Government.’’

19Proposed rule 35d–1(a)(3).

The proposed 80% investment

requirement could help reduce

confusion when an investor selects an

investment company for specific

investment needs and asset allocation

goals.

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.

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.

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?

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

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
10958 Federal Register / Vol. 62, No. 46 / Monday, March 10, 1997 / Proposed Rules

20Letter to Registrants at II.A (Feb. 22, 1993)

(using substantially the same 3 criteria, but

indicating that the Division would consider other

criteria).

21See ‘‘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’).

22Under this approach, an investment company

would describe in its prospectus the specific

criteria that it uses to select investments that meet

the general standard.

23For 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.

24Proposed rule 35d–1(a)(4).

25Letter 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).

26Proposed rule 35d–1(b)(1).

27See 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).

28Similarly, 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.

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).

30See Guide 1 to Form N–1A (also applying an

80% investment requirement for tax-exempt funds

based on a fund’s net assets).

31For 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.

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.

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.

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

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.

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.

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
Federal Register / Vol. 62, No. 46 / Monday, March 10, 1997 / Proposed Rules 10959

32Section 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.

33Proposed 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).

34Many 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).

35Proposed 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).

36See 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.

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.

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?

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

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,’’
10960 Federal Register / Vol. 62, No. 46 / Monday, March 10, 1997 / Proposed Rules

37See 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.’’

39As 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.’’

41The 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’).

42See Investment Company Act Release No.

15612 (Mar. 9, 1987) [52 FR 8268, 8301] (proposing

to codify these positions in a guideline).

43As 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).

45See, 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).

47Letter 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).

48Pending 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.

49Certain investment companies have

fundamental policies to invest at least 65% of their

assets in the type of investments suggested by their

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

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

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 dollarweighted 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

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.

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
Federal Register / Vol. 62, No. 46 / Monday, March 10, 1997 / Proposed Rules 10961

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.

Commission requests comment on the

proposed transition period.

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 § 270.35d–1 to read as follows:

§ 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
10962 Federal Register / Vol. 62, No. 46 / Monday, March 10, 1997 / Proposed Rules

(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]

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