what many ESG terms mean than with terms like ``growth'' or
``global'' because the use of ESG terms is relatively new and their
use often is not tied to specific information about their
meaning.'').
---------------------------------------------------------------------------

    We recognize, as with fund names that do not include ESG terms,
that the general context of a name with terminology that could connote
an ESG focus is critical in how an investor interprets such a
name.\153\ For instance, a name such as ``XYZ Sustainable Growth Fund''
could reasonably be interpreted as a fund that employs a strategy that
seeks growth that is sustainable over time (i.e., growth that will be
maintained at a certain level), or a fund that incorporates ESG factors
into its decision making. In this example, the fund would require an
80% investment policy regardless, but the fund manager has discretion
to reasonably define the terms in the fund's name, and to allocate
investments into the 80% basket in accordance with the investment focus
the name suggests.\154\
---------------------------------------------------------------------------

    \153\ See Robertson-Fisch Comment Letter (discussing different
hypothetical ESG-related funds that could deliver very different
results to investors, but could be presumably sold under the same
name).
    \154\ See also supra footnote 94 and accompanying text; supra
paragraph accompanying footnote 132.
---------------------------------------------------------------------------

2. Temporary Departures From the 80% Investment Requirement
    The final rules we are adopting permit temporary departures from
the 80% investment requirement by allowing a fund temporarily to invest
less than the required 80% of the value of the fund's assets in
accordance with the investment focus or tax treatment its name
suggests.\155\ Under the final amendments, we are retaining the current
rule's requirement that a fund must determine at the time that it
invests whether the investment is in the fund's 80% basket (``time-of-
investment test'').\156\ We are adopting a new requirement that, at
least quarterly, funds subject to the 80% investment requirement must
review the fund's portfolio investments to determine whether the fund's
investments continue to be consistent with the fund's 80% investment
policy.\157\ Funds must comply with the 80% investment requirement
``under normal circumstances,'' leaving to funds the determination of
what constitutes something other than a normal circumstance. If,
subsequent to an investment, the 80% investment requirement is no
longer met, the fund's future investments (that is, any portfolio
assets it acquires) must be made in a manner that will bring the fund
into compliance with that requirement within the time period specified
in the rule.
---------------------------------------------------------------------------

    \155\ The amendments to the temporary departure provision are
applicable not only to funds whose name suggest a particular
investment focus, but also to tax-exempt funds that are required to
invest their assets in accordance with the provisions of rule 35d-
1(a)(3).
    \156\ See final rule 35d-1(b).
    \157\ Final rule 35d-1(b)(1)(i).
---------------------------------------------------------------------------

    A fund may, in other-than-normal circumstances, choose to invest in
a manner that is not consistent with the fund's 80% investment
requirement for a limited period of time.\158\ The final amendments
include specific time frames--generally 90 consecutive days, as opposed
to 30 days as proposed--for getting back into compliance if a fund
departs from the 80% requirement, either intentionally in other-than-
normal circumstances, or as identified by the fund as a part of its
quarterly review or otherwise. Funds are permitted under the final
rules to temporarily depart from the 80% investment requirement in
connection with a reorganization (for which the final rule does not
specify a required time frame for accompanying temporary departures) or
a fund launch (departure not to exceed the period of 180 consecutive
days) or when a notice of a change in a fund's policy in certain
circumstances has been provided to fund shareholders.\159\
---------------------------------------------------------------------------

    \158\ Final rule 35d-1(b)(1)(ii).
    \159\ Final rule 35d-1(b)(1)(iii); see also rule 35d-1(g)
(defining ``launch'' as a period, not to exceed 180 consecutive
days, starting from the date the fund commences operations).
---------------------------------------------------------------------------

    Under the proposed amendments, funds would have been permitted to
depart from the fund's 80% investment policy only under certain
specified circumstances.\160\ When a fund departed under the specified
circumstances, the proposed amendments would have required funds to
come back into compliance with the 80% investment requirement within 30
consecutive days after the initial departure. Departures from names
rule compliance for fund launches would not have been permitted to
exceed a period of 180 consecutive days. The proposed amendments did
not specify a required time frame for temporary departures that were
the result of reorganizations or

where the 60-day notice has been provided to shareholders. In all
cases, the proposed amendments would have required that a fund would
have to come back into compliance as soon as reasonably practicable.
---------------------------------------------------------------------------

    \160\ Temporary departures under the proposed amendments would
have been permitted only: (1) as a result of market fluctuations, or
other circumstances, where the temporary departure is not caused by
the fund's purchase or sale of a security or the fund's entering
into or exiting an investment; (2) to address unusually large cash
inflows or unusually large redemptions; (3) to take a position in
cash and cash equivalents or government securities to avoid a loss
in response to adverse market, economic, political, or other
conditions; or (4) to reposition or liquidate a fund's assets in
connection with a reorganization, to launch the fund, or when notice
of a change in the fund's 80% investment policy has been provided to
fund shareholders at least 60 days before the change pursuant to the
rule.
---------------------------------------------------------------------------

    We received comment letters both supporting and opposing the
Commission's proposed approach for temporary departures. Among the
primary reasons commenters supported the proposal was their belief that
the proposed amendments brought more certainty to the current rule's
approach to temporary departures from 80% and would require funds to be
more vigilant with respect to their names rule compliance.\161\ In
particular, several commenters supported the goal of bringing the rule
in line with investors' expectations by ensuring that the investments
made by the fund remain consistent with the fund's name and the
investor's investment preferences over the long-term life of the
fund.\162\
---------------------------------------------------------------------------

    \161\ See, e.g., NASAA Comment Letter; PRI Comment Letter;
Consumer Federation of America Comment Letter; Environmental Defense
Fund Comment Letter.
    \162\ See, e.g., Consumer Federation of America Comment Letter;
Center for American Progress Comment Letter; NASAA Comment Letter.
---------------------------------------------------------------------------

    The Commission, however, did receive many comments requesting that
we reconsider the proposed approach to temporary departures. The
Proposing Release sought to permit appropriate flexibility to depart
temporarily from the 80% investment requirement in particular, time-
limited circumstances when doing so would be beneficial to the fund and
its shareholders, while providing additional parameters designed to
prevent a fund from investing inconsistently with its 80% investment
policy for an extended period of time.\163\ Commenters, as discussed in
the next section, raised concerns that the proposed amendments were
overly prescriptive, lacked flexibility, and were too limited in the
amount of time funds would have to bring their investments back into
compliance. In response to comments received, we are adopting an
approach that modifies the proposed amendments, which seeks to balance
the concerns raised by commenters and the goals of the proposal.
---------------------------------------------------------------------------

    \163\ See Proposing Release, supra footnote 2, at paragraph
following n.35.
---------------------------------------------------------------------------

a) Time-of-Investment Test and Quarterly Review
    Under the final amendments, as under the current names rule, a fund
is required to determine at the time it invests whether the security is
appropriately included in the fund's 80% basket.\164\ This ``time-of-
investment test'' was originally adopted to avoid requiring a fund to
rebalance its investments if the fund's portfolio were no longer
invested in accordance with the fund's 80% investment policy as a
result of, for example, market movements or an influx of cash from new
investors (``drift'').\165\ The proposal would have removed the time-
of-investment test and instead would have required that a fund remedy
drift within 30 days of the initial departure. In effect, the proposed
rule would have required that funds engage in continual compliance
testing to reassess the characteristics of investments in the fund's
80% basket--or even daily testing and reassessment for those funds
making investments each trading day--to ensure that they observe and
correct any drift quickly in order to comply with the proposed
requirement that the fund come back into compliance with the names rule
within 30 days.
---------------------------------------------------------------------------

    \164\ See final rule 35d-1(b).
    \165\ See 2001 Names Rule Adopting Release, supra footnote 8, at
n.32 and accompanying text; see also Investment Company Names,
Investment Company Act Release No. 22530 (Feb. 27, 1997) [62 FR
10955 (Mar. 10, 1997)], at n.28 and accompanying text.
---------------------------------------------------------------------------

    In response to comments we received, and as discussed in more
detail below, we are not adopting a requirement for continual or daily
monitoring to reassess the characteristics of the investments in the
fund's 80% basket and are instead maintaining a time-of-investment test
in the names rule. Under the final amendments, funds will instead be
required to reassess their portfolio assets' inclusion in the fund's
80% basket at least quarterly. This change means that portfolio
investments that are included in the 80% basket at the time of
investment will continue to be considered to be consistent with the
fund's 80% investment policy unless the fund identifies otherwise as
part of its required quarterly reassessments, or outside of its
required quarterly reassessments identifies that these investments'
characteristics are inconsistent with the fund's 80% investment policy.
This approach to assessing the characteristics of portfolio investments
in the 80% basket, however, does not change the requirement for funds
to maintain at least 80% of the value of their assets in 80% basket
assets (as determined at the time of investment), unless the fund
departs temporarily from 80% in accordance with the final amendments.
As an example, when a fund acquires Investment A, the fund must assess
the characteristics of that investment when the purchase is made to
determine whether it should be included in the 80% basket. When a fund
acquires a new investment, Investment B, the fund must assess the
characteristics of Investment B when it invests to determine whether it
should be included in the 80% basket. When determining whether 80% of
the fund's assets are invested in the 80% basket when Investment B is
made, the fund must consider the value of Investment A, but would not
have to re-assess the characteristics of Investment A. Each quarter,
the fund must re-assess the characteristics of Investments A and B for
consistency with the fund's 80% investment policy.
    We received many comments supporting the retention of the time-of-
investment test and urging the Commission not to adopt an approach that
would require continual compliance monitoring.\166\ Several commenters
stated that the time-of-investment test is a standard that is used in
other portfolio compliance tests under the Investment Company Act and
that consistency with how fund holdings are measured across Investment
Company Act rules would therefore be a preferable approach in the
context of the names rule.\167\ The proposed approach, which would have
removed the time-of-investment test, would instead have effectively
required that fund managers reassess portfolio investments'
characteristics for consistency with the fund's 80% investment policy
every time the fund makes a new investment, and to take corrective
action almost immediately upon identifying any departure from 80%. The
time-of-investment test affords some flexibility to fund managers by
focusing on whether an asset is consistent with the fund's 80%
investment policy at the time of investment, rather than requiring
ongoing reassessments. In addition, commenters expressed concern that
limitations on fund manager discretion prevent investors from having
access to actively-managed funds that are subject

to the names rule.\168\ Commenters also supported retaining the time-
of-investment test so that in the event that a fund's portfolio
inadvertently drifts out of compliance with the 80% investment
requirement because the characteristics of portfolio investments
change, the fund would not be forced to sell a security that was
originally purchased in compliance with the names rule in order to come
back into compliance within a specific time frame (as proposed,
generally 30 days).\169\ Commenters were concerned the proposed
approach would potentially force sales or purchases of portfolio assets
at inopportune times with the potential to intensify the market
conditions that prompted these transactions in the first place.\170\
---------------------------------------------------------------------------

    \166\ See, e.g., ICI Comment Letter; Calamos Comment Letter;
Seward & Kissel Comment Letter; Fidelity Comment Letter; Dechert
Comment Letter; T. Rowe Comment Letter; Nationwide Comment Letter;
Cato Institute Comment Letter; Stradley Comment Letter; Dimensional
Comment Letter; WisdomTree Comment Letter; MFS Comment Letter;
Invesco Comment Letter; Capital Group Comment Letter.
    \167\ For example, commenters pointed to time of acquisition
tests in the 1940 Act, including, section 5 the anti-pyramiding
provisions of section 12(d)(1) [15 U.S.C. 80a-12(d)(1)] and the
limitations on investments in securities-related issuers in section
12(d)(3) [15 U.S.C. 80a-12(d)(3)]. See, e.g., ICI Comment Letter;
Dechert Comment Letter; Seward & Kissel Comment Letter; Fidelity
Comment Letter; Calamos Comment Letter; Nationwide Comment Letter.
    \168\ See Dechert Comment Letter; ICI Comment Letter.
    \169\ See, e.g., Stradley Comment Letter; ICI Comment Letter;
Dechert Comment Letter; Seward & Kissel Comment Letter; Fidelity
Comment Letter; Calamos Comment Letter; Nationwide Comment Letter.
    \170\ See, e.g., ICI Comment Letter; Dechert Comment Letter.
---------------------------------------------------------------------------

    Commenters also stated that there would be substantial burden on
funds, their sponsors, and their administrators to implement a
continual or daily program for re-assessing portfolio investments for
names rules compliance purposes.\171\ Commenters argued that the burden
of implementing a continual monitoring program is not warranted given
the asserted lack of identified significant harm to investors from
portfolio drift and the burden of creating and maintaining such a
program.\172\ These commenters stated that the burdens associated with
a continual monitoring program would be particularly high because
assessing portfolio investments' consistency with a fund's 80%
investment policy is not necessarily straightforward, particularly
given the expanded scope of the names rule, which would include terms
that are not readily quantifiable.\173\ For example, commenters stated
that some of the information that a fund would need to monitor whether
a particular investment should be included in a fund's 80% basket may
include metrics measured over a period of time that may be longer than
the period of a single day.\174\ Some funds, for instance, may adopt
investment strategies that involve a multi-year concept that commenters
stated cannot be assessed on a single day.\175\ Commenters therefore
urged the Commission to adopt a rule that would provide some discretion
to determine whether a particular investment, evaluated over a period
of time, is consistent with the fund's 80% policy.\176\ Similarly,
commenters raised concerns about continually monitoring compliance with
respect to certain securities, such as growth or value investments,
where the name characteristics could change frequently.\177\ For
example, securities may be bought that have characteristics meeting a
particular fund's standards for inclusion in the fund's 80% basket at
the time of purchase, but these characteristics may change from day to
day. Commenters stated that assessing these securities' characteristics
continually would require operational and compliance build-outs that
would be substantial.\178\
---------------------------------------------------------------------------

    \171\ See, e.g., ICI Comment Letter; Dechert Comment Letter;
Seward & Kissel Comment Letter; WisdomTree Comment Letter.
    \172\ See, e.g., Seward & Kissel Comment Letter, Nationwide
Comment Letter; Fidelity Comment Letter. But see Dogwhistle Comment
letter (suggesting an annual compliance testing requirement and that
daily compliance testing is too frequent, but a time-of-investment
test is not appropriate).
    \173\ See, e.g., SIFMA AMG Comment Letter; J.P. Morgan Asset
Management Comment Letter; ICI Comment Letter; Dechert Comment
Letter; Wellington Comment Letter.
    \174\ See, e.g., ICI Comment Letter; Wellington Comment Letter;
Capital Group Comment Letter; SIFMA AMG Comment Letter.
    \175\ See, e.g., ICI Comment Letter; Wellington Comment Letter;
Capital Group Comment Letter; SIFMA Comment Letter.
    \176\ See id.
    \177\ See, e.g., ICI Comment Letter; Seward & Kissel Comment
Letter; WisdomTree Comment Letter.
    \178\ See, e.g., ICI Comment Letter; Dechert Comment Letter;
Seward & Kissel Comment Letter; WisdomTree Comment Letter.
---------------------------------------------------------------------------

    After considering comments, we are retaining the current rule's
time-of-investment test that requires a fund to determine, for purposes
of names rule compliance, whether an investment is within the fund's
80% basket at the time of investment. While the time-of-investment test
must be conducted only at the time that the investment is made, the
final rule incorporates a process for periodic reassessment of fund
investments in order to ensure that that the fund is invested
consistent with the focus the fund's name suggests. Rather than
adopting a rule that effectively would require daily or continual
compliance monitoring, the final rule requires that a fund review its
portfolio investments on an at-least quarterly basis to determine
whether it continues to comply with the 80% investment requirement.
    The time-of-investment standard affords to the portfolio manager
more flexibility than the proposed amendments, as we acknowledge that
there may be certain fluctuations in a fund's portfolio and within the
80% basket that naturally occur over time, and that may not be outside
of investors' reasonable expectations. For example, a mid-cap equity
fund may hold securities that at the time of investment qualified under
the fund's 80% investment policy as mid-cap, but that may temporarily
move into the large-cap category and back again. We understand that
this type of drift is a natural fluctuation in a portfolio, as certain
characteristics of securities' may not be static. We also appreciate
that, for certain funds that are subject to the 80% investment
requirement, this drift may occur relatively frequently, and so a
standard that would require daily or continual compliance monitoring
could be particularly burdensome and require very frequent portfolio
re-balancing.\179\ While we recognize that drift may occur and that
portfolio managers should have discretion in managing their portfolio
in the best interest of the fund, we are adopting a quarterly review
requirement to help ensure portfolio adjustments so that drift does not
go unchecked. This quarterly time frame will require a fund to address
drift more quickly, which in turn will help ensure greater consistency
between the fund's investments and the focus its name suggests, as
compared to a review period based on a longer periodic time frame (for
example, an annual testing requirement as one commenter
suggested).\180\
---------------------------------------------------------------------------

    \179\ See, e.g., SIFMA Comment Letter; J.P. Morgan Asset
Management Comment Letter.
    \180\ See Dogwhistle Comment Letter.
---------------------------------------------------------------------------

    The combination of a time-of-investment test with a minimum
quarterly review requirement balances the dynamic nature of funds'
portfolio securities with compliance with the fund's 80% investment
policy. The required time frame for review is consistent with the final
rules' quarterly Form N-PORT reporting requirement, which requires
funds (except in the case of money-market funds and BDCs) to report on
Form N-PORT the value of the fund's 80% basket as well as each
investment that is included in the fund's 80% basket.\181\ The required
minimum quarterly review helps ensure that funds are reviewing their
portfolios for names rule compliance on a periodic basis so that
instances of drift can be identified without the burden of assessing
each investment's inclusion in the 80% basket every day. The final
amendments are designed to balance the costs associated with monitoring
fund investments' inclusion in the 80% basket with the harm to
investors that could result if a fund were permitted a longer time
frame for reviewing its

portfolio.\182\ The time-of-investment test coupled with a quarterly
portfolio review is designed to ensure that a fund's name more
accurately communicates to investors important information about the
fund's investments while providing funds with appropriate flexibility
within a time-limited period.
---------------------------------------------------------------------------

    \181\ See infra section II.E.
    \182\ See infra section IV.D.2.
---------------------------------------------------------------------------

    One commenter also articulated concerns that are unique to funds
that use the term ``tax-exempt'' in their name.\183\ This commenter
requested clarification on how tax-exempt funds that apply the income
test under the names rule should measure compliance with the 80%
investment policy requirement under the proposed amendments.\184\
Specifically, this commenter urged the Commission to confirm that
compliance with the income test would be based solely on income that
the fund distributes. The final rule requires that a fund review its
portfolio at least quarterly to determine whether it continues to
comply with the 80% investment requirement. Accordingly, a tax-exempt
fund applying the income test will be required to assess its portfolio
on an at-least quarterly basis to determine whether the fund's assets
are invested so that at least 80% of the income that it distributes
will be exempt from federal income tax or from both federal and state
income tax.
---------------------------------------------------------------------------

    \183\ ICI Comment Letter III. The commenter also suggested that
tax-exempt funds using an income test be permitted to count taxable
market discount toward their 80% baskets. The treatment of such
taxable market discount is outside the scope of this rulemaking, as
it was not addressed in the proposal, and, therefore, not addressed
in the final amendments.
    \184\ The names rule currently allows, and the final amendments
will continue to allow, a fund with ``tax-exempt'' in its name to
adopt either an asset test or an income test to satisfy its 80%
investment policy requirement. The income test requires that a fund
invest its assets so that at least 80% of the income that it
distributes will be exempt from federal income tax or from both
federal and state income tax. See final rule 35d-1(a)(3)(i)(B).
---------------------------------------------------------------------------

b) Investing Consistent With 80% Investment Policy ``Under Normal
Circumstances''
    The final amendments, like the current names rule, require a fund
to invest in accordance with its 80% investments policy ``under normal
circumstances.'' That is, under the final amendments, a fund's 80%
policy applies under normal circumstances, but funds may depart from
the fund's investment policy in other-than-normal circumstances. The
proposed rule would have, in place of the rule's current standard that
a fund's 80% investment policy apply ``under normal circumstances,''
included specific exceptions that address circumstances where
departures would be permitted.\185\ Unlike the proposal, funds have
flexibility under the final amendments to determine what constitutes
other-than-normal circumstances where the fund could depart
intentionally from the 80% requirement (for example, the reasons for
departures that the proposed amendments included, or other
circumstances where market conditions or fund operations are other-
than-normal).\186\ Under the final amendments, departure from the
fund's 80% policy in other-than-normal circumstances is time-limited to
90 consecutive days from the initial departure, whereas the proposal
would have required a fund to be back in compliance generally within 30
days.
---------------------------------------------------------------------------

    \185\ Under the proposed rule, temporary departures would have
been permitted only: (1) as a result of market fluctuations, or
other circumstances where the temporary departure is not caused by
the fund's purchase or sale of a security or the fund's entering
into or exiting an investment; (2) to address unusually large cash
inflows or unusually large redemptions; (3) to take a position in
cash and cash equivalents or government securities to avoid losses
in response to adverse market, economic, political, or other
conditions; or (4) to reposition or liquidate a fund's assets in
connection with a reorganization, to launch the fund, or when notice
of a change in the fund's 80% investment policy has been provided to
fund shareholders at least 60 days before the change pursuant to the
rule. See proposed rule 35d-1(b).
    \186\ See supra footnote 160.
---------------------------------------------------------------------------

    The Commission received some comments supporting the proposed
approach to change the current rule's ``under normal circumstances''
standard in favor of a more prescriptive approach. Commenters stated
that the current standard has led to more uncertainty and less
consistency in how fund investments correspond to a fund's name than
the proposed approach would over extended periods of time.\187\
Conversely, the Commission also received many comment letters opposing
the proposed approach of permitting departure from the 80% investment
requirement only under the circumstances that the proposed amendments
specified.\188\ Commenters stated that the proposed approach was overly
prescriptive and would unnecessarily curb the ability of a fund's
portfolio manager to act in the best interest of the fund.\189\ For
example, in an effort to bring a fund back into compliance within the
proposed 30-day period, fund managers may feel compelled either to
divest or purchase an investment that may not be strategically in the
best interest of the fund. In addition, a commenter argued that the
Proposing Release did not cite evidence that the ``under normal
circumstances standard'' has been abused or has resulted in the use of
materially deceptive or misleading names.\190\ Commenters also argued
that while the proposed amendments would permit departures from the 80%
requirement only in the circumstances that the amendments specified,
unforeseeable circumstances that the amendments did not contemplate--
and that any enumerated list of circumstances could not contemplate in
an evergreen way--may present reasons for departing that could be
appropriate in the interests of the fund and consistent with the goals
of the names rule.\191\
---------------------------------------------------------------------------

    \187\ See, e.g., NASAA Comment Letter; Environmental Defense
Fund Comment Letter.
    \188\ See, e.g., ICI Comment Letter; SIFMA AMG Comment Letter;
J.P. Morgan Asset Management Comment Letter; CFA Institute Comment
Letter; Comment Letter of U.S. Chamber of Commerce Center for
Capital Markets Competitiveness (Aug. 12, 2022) (``USCOC Comment
Letter''); Dimensional Comment Letter; WisdomTree Comment Letter;
Calamos Comment Letter; MFDF Comment Letter; MFS Comment Letter;
Capital Group Comment letter; Seward & Kissel Comment Letter;
Fidelity Comment Letter; Comment Letter of Nasdaq, Inc. (Aug. 16,
2022) (``Nasdaq Comment Letter''); Dechert Comment Letter; T. Rowe
Comment Letter; Nationwide Comment Letter; Cato Institute Comment
Letter.
    \189\ See, e.g., ICI Comment Letter; SIFMA AMG Comment Letter;
J.P. Morgan Asset Management Comment Letter; Dimensional Comment
Letter; MFS Comment Letter; Capital Group Comment letter; Fidelity
Comment Letter; Dechert Comment Letter; T. Rowe Comment Letter;
Calamos Comment Letter; Nationwide Comment Letter.
    \190\ See Cato Institute Comment Letter.
    \191\ See, e.g., SIFMA AMG Comment Letter; Dechert Comment
Letter; Fidelity Comment Letter.
---------------------------------------------------------------------------

    Fund managers are fiduciaries to the funds they manage. Commenters
advocated that, as such, portfolio managers should have discretion in
determining when a fund needs to depart from its 80% investment policy.
Some commenters supported retaining the current rule's ``under normal
circumstances'' standard in order to give portfolio managers
flexibility to act in the best interest of the fund and its
shareholders, which can include temporarily departing from the fund's
80% investment policy.\192\ In addition, some commenters stated that
they believe that some investors may prefer investing in funds where
the portfolio manager has discretion to depart from the investment
focus denoted by the fund's name when the portfolio manager

believes the departure is in the best interest of the fund.\193\
---------------------------------------------------------------------------

    \192\ See, e.g., ICI Comment Letter; SIFMA AMG Comment Letter;
Dechert Comment Letter; CFA Institute Comment Letter; Stradley
Comment Letter; USCOC Comment Letter; Cato Institute Comment Letter;
Dimensional Comment Letter; Federated Comment Letter; T. Rowe
Comment Letter; WisdomTree Comment Letter.
    \193\ See, e.g., SIFMA AMG Comment Letter; Dechert Comment
Letter; Nationwide Comment Letter; T. Rowe Comment Letter; MFS
Comment Letter; JP Morgan Asset Management Comment Letter.
---------------------------------------------------------------------------

    Commenters suggested alternatives to the proposed approach, stating
that if the Commission adopts a prescriptive list of permissible
circumstances under which a fund may depart from the 80% policy, the
list should be expanded, for example to permit departure for
repositioning fund assets in connection with changes of sub-advisers
and/or portfolio managers, and in periods leading up to material
strategy changes.\194\ These commenters suggested the inclusion of a
``catch-all'' provision, as well, permitting any departures the
portfolio manager believes are reasonable. Commenters also provided
alternatives that would permit additional drift beyond the
circumstances that the proposed amendments specified, so long as the
fund provided additional disclosure for the reasons why the fund may
drift.\195\ Another suggested an alternative included allowing funds
that use the term ``managed'' in their name to have greater flexibility
to depart from the fund's 80% investment policy.\196\
---------------------------------------------------------------------------

    \194\ See, e.g., ICI Comment Letter; Dechert Comment Letter;
SIFMA AMG Comment Letter.
    \195\ See, e.g., Capital Group Comment Letter; Nationwide
Comment Letter.
    \196\ See, e.g., ICI Comment Letter and SIFMA AMG Comment
Letter.
---------------------------------------------------------------------------

    After considering comments, we are adopting amendments that retain
the current ``under normal circumstances'' provision. While we are
retaining the current ``under normal circumstances'' standard, we are
also adopting new limitations on how long a fund may depart from 80%
under this provision, discussed below, which addresses the concerns
raised by commenters that the current standard allows for investments
not consistent with the fund's name over extended periods of time.\197\
Retaining the current ``under normal circumstances'' provision is
designed to provide fund managers with flexibility to manage their
portfolios while requiring that funds normally invest 80% of their
assets consistent with their 80% investment policy.\198\
---------------------------------------------------------------------------

    \197\ Prolonged drift could result in fund names that have a
tendency or capacity or deceive or mislead, regardless of whether
such drift has resulted in actual deception of investors. See, e.g.,
Cato Institute Comment Letter; see also supra footnote 40.
    \198\ See 2001 Names Rule Adopting Release, supra footnote 8, at
nn.37-40 and accompanying text.
---------------------------------------------------------------------------

    We acknowledge that there could be circumstances when it is in the
best interest of the fund and its investors for the portfolio manager
to have discretion to depart from the fund's 80% investment policy.
This interest must be balanced, however, with the need for a fund's
name to convey accurately to investors the underlying investments that
correspond with the focus the fund's name suggests. Rather than require
additional disclosure that acknowledges drift or to provide a separate
standard for funds that include the term ``managed'' in their name, we
are adopting a requirement to invest in accordance with the 80%
requirement ``under normal circumstances,'' combined with a set time
frame to come back to 80%, to balance these concerns. We are adopting,
therefore, a limit on the length of time that a fund may depart in
other-than-normal circumstances to 90 consecutive days after the
initial departure.
    Although we are not adopting the proposed approach of delineating
the circumstances in which a fund may depart intentionally from the 80%
requirement, an intentional departure must be in other than ``normal''
circumstances, which could include but is not limited to the
circumstances included in the proposed approach. These circumstances
could include temporary departures that occur as a result of market
fluctuations, index rebalancing, cash flows/inflows, or temporary
defensive positions, among others.\199\ These circumstances do not,
however, represent the extent of events or circumstances where a fund,
in considering its obligations under the names rule and the
prohibitions of section 35(d), may determine that other-than-normal
circumstances exist, warranting a departure from 80%. The final rules'
approach provides flexibility to depart under circumstances that may
not have been included in the proposal's delineated reasons for
departures. Although the question of whether circumstances are
``normal'' is based on the facts and circumstances, if a fund were to
deviate in purportedly other-than-normal circumstances serially or
frequently, this may suggest that in fact those circumstances are
``normal'' and otherwise raise questions about the appropriateness of
the fund's name under section 35(d) if the fund's portfolio is not
invested consistent with its name for prolonged periods of time.\200\
When a fund deviates from the 80% investment requirement due to other-
than-normal circumstances, as we discuss below, the fund is required to
maintain a record documenting the date of the departure and the reason
for the departure.\201\
---------------------------------------------------------------------------

    \199\ See 2001 Names Rule Adopting Release, supra footnote 8, at
text preceding footnote 39 (``[The ``under normal circumstances''
standard] will permit investment companies to take ``temporary
defensive positions'' to avoid losses in response to adverse market,
economic, political, or other conditions.'').
    \200\ See infra section II.A.5 text accompanying footnotes 318-
321.
    \201\ See infra section II.F (discussing the requirement under
the final amendments for funds to maintain records documenting the
reasons for each departure).
---------------------------------------------------------------------------

c) Time to Come Back Into Compliance
    The final amendments require that funds come back into compliance
with the 80% investment requirement as soon as reasonably practicable
in the case of drift (i.e., where the fund identifies that its
investments are not consistent with this requirement under the names
rule, for example, as a result of inadvertent drift identified as part
of the fund's quarterly review).\202\ In all circumstances, a fund must
come back into compliance within 90 consecutive days, as measured from
the time that the fund identifies a departure from the 80% investment
policy (as part of its quarterly review or otherwise), or the time the
fund initially departs, in other-than-normal circumstances, from the
80% investment policy.\203\ Under the final amendments, consistent with
the current rule, where a fund identifies that the 80% requirement is
no longer met, the fund must make all future investments in a manner
that will bring the fund into compliance with the fund's 80% investment
policy. The Commission proposed to require funds to come back into
compliance with the 80% investment policy within 30 days from the
initial departure from 80%. We are modifying the proposed approach to
respond to concerns raised by commenters.
---------------------------------------------------------------------------

    \202\ Final rule 35d-1(b).
    \203\ Id. Although the temporal limits in the final amendments
start from the time that a departure is identified, a fund may not
avoid coming into timely compliance, if the fund failed to identify
departures because the fund did not perform the required quarterly
review, or if the fund failed to perform quarterly reviews that are
reasonably designed to identify departures.
---------------------------------------------------------------------------

    The Commission received some support for the proposed period for
funds to come back into compliance.\204\ The Commission received many
comments, however, arguing that a 30-day period was not an appropriate
time limit on departures.\205\ While some

commenters stated that a 30-day period may be appropriate for some
asset classes or in certain market conditions, these commenters
contended that a 30-day period may be too short in certain market
conditions or in unanticipated extenuating circumstances.\206\ For
example, one commenter stated that while a fund may be able to remedy a
departure from the 80% investment policy that is the result of
unusually large flows within 30 days, a portfolio manager may need more
time when divesting securities to accommodate when an index rebalances
or where a strategy may need to be reconsidered given exogenous
events.\207\
---------------------------------------------------------------------------

    \204\ See, e.g., PRI Comment Letter.
    \205\ See, e.g., SIFMA AMG Comment Letter; ICI Comment Letter;
CFA Institute Comment Letter; Dechert Comment Letter; Cato Institute
Comment Letter; WisdomTree Comment Letter; NASAA Comment Letter;
MFDF Comment Letter; MFS Comment Letter; J.P. Morgan Asset
Management Comment Letter; Seward & Kissel Comment Letter; Fidelity
Comment Letter; Nationwide Comment Letter; Dimensional Comment
Letter; Wellington Comment Letter; Capital Group Comment Letter.
    \206\ See, e.g., ICI Comment Letter; Dechert Comment Letter;
Stradley Comment Letter; T. Rowe Comment Letter; MFDF Comment
Letter; MFS Comment Letter; Invesco Comment Letter; SIFMA AMG
Comment Letter; WisdomTree Comment Letter; Dimensional Comment
Letter.
    \207\ See J.P. Morgan Asset Management Comment Letter.
---------------------------------------------------------------------------

    Commenters stated that the proposed 30-day time period may require
a fund to make forced purchases and sales at potentially undesirable
prices or at inappropriate times.\208\ For example, if a small-cap
security becomes a mid-cap security and therefore can no longer be
included in the small-cap fund's 80% basket, the fund may be required
to sell the holding within the proposed 30-day period, even though the
portfolio manager believes that it is in the best interest of the fund
to hold the security for a longer period.\209\ Commenters stated that
forced purchases or sales could lead to additional adverse consequences
for a fund, including the risks of front running from other market
participants, unwanted capital gains or assorted tax efficiency
implications, increased transaction costs, reduced diversification,
fire sales, homogenization across funds with similar names, and an
overall negative impact on fund performance, as well as market
liquidity and market stability more largely.\210\
---------------------------------------------------------------------------

    \208\ See, e.g., ICI Comment Letter; SIFMA AMG Comment Letter;
J.P. Morgan Asset Management Comment Letter; Dechert Comment Letter;
Stradley Comment Letter; T. Rowe Comment Letter; USCOC Comment
Letter; Cato Institute Comment Letter; Dimensional Comment Letter;
Capital Group Comment Letter. Certain of these commenters stated
that the 2001 Names Rule Adopting Release stated that funds should
not be required to ``sell portfolio holdings that have increased in
value'' in order to reattain compliance with their 80% policy. See,
e.g., Dechert Comment Letter; ICI Comment Letter.
    \209\ These circumstances would arise only where, in the given
example, the security grew sufficiently to become a mid-cap
security, the fund manager preferred to continue to hold the
security, and the fund manager had already made similar
determinations with respect to other securities which collectively
made up 20% of the value of the fund's assets.
    \210\ See, e.g., Dechert Comment Letter; Stradley Comment
Letter; Nationwide Comment Letter; ICI Comment Letter; SIFMA AMG
Comment Letter; T. Rowe Comment Letter; Dimensional Comment Letter;
Nationwide Comment Letter; Fidelity Comment Letter; WidsomTree
Comment Letter; Wellington Comment Letter.
---------------------------------------------------------------------------

    The current names rule effectively requires that funds make all
future investments consistent with the fund's 80% policy once the fund
identifies that its portfolio is out of compliance with the 80%
investment requirement. Some commenters urged the Commission to
reconsider the proposed 30-day period and instead maintain the current
standard.\211\ Additionally, commenters suggested alternative time
periods to require funds to come back into compliance with the 80%
investment policy, e.g., 180 days.\212\
---------------------------------------------------------------------------

    \211\ See, e.g., Calamos Comment Letter; Nationwide Comment
Letter.
    \212\ See, e.g., Fidelity Comment Letter.
---------------------------------------------------------------------------

    Several commenters suggested an alternative approach that would
require funds to notify their board of directors if the fund falls out
of compliance with the 80% investment policy for more than a specified
period of time (e.g., 30, 60, or 90 days etc.).\213\ Some commenters
suggested that after a certain period of time following a departure
from 80%, a fund must provide a report to the board detailing how the
fund will come back into compliance. Commenters stated that other rules
under the Investment Company Act have similar board reporting
requirements, which recognize the value of a board's oversight of fund
management and the best interest of fund shareholders, and that the
names rule may benefit from such a requirement.\214\ Under this
alternative, commenters stated that they believed that funds would have
more flexibility than under the proposed approach and that the board
would be in the best position to judge whether a departure is
reasonable.\215\
---------------------------------------------------------------------------

    \213\ See, e.g., ICI Comment Letter; Dechert Comment Letter;
Stradley Comment Letter; Dimensional Comment Letter; SIFMA AMG
Comment Letter; MDFS Comment Letter; MFS Comment Letter; Invesco
Comment Letter.
    \214\ See ICI Comment Letter; SIFMA AMG Comment Letter; Dechert
Comment Letter; MFS Comment Letter; see also Investment Company
Liquidity Risk Management Programs, Investment Company Act Release
No. 32315 (Oct. 13, 2016) [81 FR 82142 (Nov. 18, 2016)] (``Liquidity
Adopting Release'') and Use of Derivatives by Registered Investment
Companies and Business Development Companies, Investment Company Act
Release No. 34084 (Nov. 2, 2020) [85 FR 83162 (Dec. 21, 2020)]
(``Derivatives Adopting Release'').
    \215\ See, e.g., Dimensional Comment Letter; SIFMA AMG Comment
Letter; ICI Comment Letter.
---------------------------------------------------------------------------

    The amendments we are adopting are designed to help ensure that a
fund will not stray from the investment focus its name suggests for a
protracted period of time, regardless of external events or other
circumstances that could affect the fund's portfolio investments.
Investors' expectations for funds' investment focuses may not depend on
whether market events negatively affect the investments in a fund's
portfolio. For example, investments in passively-managed funds, such as
index-based mutual funds and ETFs, have increased substantially in the
past two decades, indicating that investors seek investment products
that permit them to obtain specific types of investment exposure for
their portfolios.\216\ Although investors may have different
expectations regarding how long a fund may drift from the fund's
investment focus, a prolonged period of drift would be inconsistent
with the investor protection concerns that underlie the names rule and
section 35(d) of the Investment Company Act.
---------------------------------------------------------------------------

    \216\ Proposing Release, supra footnote 2, at n.61 and
accompanying text. As another example, consistency in investment
companies' investments with their names and investors' reasonable
expectations may be particularly important to retirement plan and
other investors who place great emphasis on allocating their
investment company holdings in well-defined types of investments,
such as stocks, bonds, and money market instruments. See id.; see
also 2001 Names Rule Adopting Release, supra footnote 8, at n.8 and
accompanying text.
---------------------------------------------------------------------------

    Taking these concerns into account, while considering comments
received, we are extending the proposed time period that funds have to
come back into compliance with the names rule from 30 to 90 consecutive
days after the fund either identifies a departure or, in other-than-
normal circumstances, departs from the 80% investment requirement. We
recognize, as certain commenters raised, that some investors may prefer
allowing a fund to depart from its investment focus for longer than 30
days to avoid any losses that the fund may incur to come back into
compliance within that time period. The final amendments provide funds
with more flexibility and time both to recognize when a fund has
drifted out of compliance and to correct the departure. This 90-day
review period is also consistent with the quarterly Form N-PORT
reporting requirement discussed below. The final amendments require a
fund to assess whether the fund's portfolio is in compliance at least
quarterly and provide the fund with an additional quarter to rectify
any departure from the 80% investment requirement. At some point,
however, departures may begin to change the nature of the fund
fundamentally, which would undermine investor

expectations created by the fund's name. The time limits we are
adopting are designed to prevent such a fundamental change without
investor notification.
    We are not adopting, as suggested by some commenters, a board
reporting obligation that would effectively provide additional time to
resolve departures from the 80% requirement. Rather, the final approach
directly provides funds with additional time, compared to the proposal,
both to identify drift in their portfolios and to rectify departures
from 80%. The increased flexibility for temporary departures that the
final amendments afford to funds, compared to the proposed approach,
addresses many of the concerns raised by commenters recommending that
we adopt a board reporting obligation instead of setting specified time
periods for funds to come back into compliance with the names rule.
These comments were generally framed in terms of providing additional
flexibility, as opposed to suggesting that a fund's board should have a
specific oversight role when a fund departs from 80% for an extended
period. The requirement that funds review their portfolios for names
rule compliance quarterly in addition to a 90-day period to come back
into compliance increases the flexibility of funds to accommodate
instances of fund drift and intentional departures. This requirement
also still includes a time certain for funds to resolve these
departures in recognition of investors' reasonable expectation that a
fund's investments will generally remain focused in the area that the
fund's name indicates. In addition, a fund can seek exemptive relief
from the Commission if the fund believes it would be appropriate and
consistent with the protection of investors for the fund to depart for
a limited additional period past 90 days. Any request for an exemptive
order will be evaluated based on its particular facts and circumstances
and must meet the standard under section 6(c) of the Investment Company
Act, including that the exemption is necessary or appropriate in the
public interest and consistent with the protection of investors.\217\
One example of an instance in which a fund might consider seeking
relief would be where the fund anticipates resolving the departure, but
cannot do so within 90 days and seeks to avoid changing the fund's name
only to change it again in a short period of time.
---------------------------------------------------------------------------

    \217\ See Investment Company Act section 6(c) (providing the
Commission with authority to conditionally or unconditionally exempt
persons, securities or transactions from any provision of the Act if
and to the extent that such exemption is necessary or appropriate in
the public interest and consistent with the protection of investors
and the purposes fairly intended by the policy and provisions of the
Act).
---------------------------------------------------------------------------

    In instances where the fund identifies that its investments are not
consistent with this requirement under the names rule (for example, as
a result of inadvertent drift identified as part of the fund's
quarterly review), we are retaining the requirement that a fund must
make all future investments in a manner that will bring the fund back
into compliance with the 80% investment policy. We are also adopting,
as proposed, the requirement that a fund must come back into compliance
``as soon as reasonably practicable'' (with a 90-day outer limit)
because we anticipate that most temporary departures caused by
portfolio drift could be remedied in substantially less than 90 days,
though this could depend on the specific facts and circumstances.\218\
---------------------------------------------------------------------------

    \218\ See also, e.g., J.P. Morgan Asset Management Comment
Letter (``Although temporary non-compliance in the ordinary course,
such as due to unusually large flows, should be readily fixable in
less than 30 days, there are also circumstances in which more
flexibility is warranted.''); MFDF Comment Letter (``While we agree
that in most circumstances, a fund should be able to return to
compliance within 30 days, it is difficult to anticipate every type
of market volatility or other extenuating circumstance that might
make this difficult to do while still protecting the interests of
the fund's shareholders.'').
---------------------------------------------------------------------------

    We recognize that there are certain circumstances under which a
fund may be unable to bring its portfolio back into compliance with the
fund's 80% investment policy within the required 90-day period. As
commenters stated, there may be events that preclude the ability of a
fund to make investments or sell assets that would not be in the best
interest of the fund but that may be required to come back into
compliance with the names rule. If such an event occurred, the fund
would need to change its name to better reflect the realities of its
portfolio and the fund must provide shareholders with a notice of that
change, which would provide information that would allow investors to
understand the nature of the fund's portfolio.\219\ The final
amendments, consistent with the proposal, effectively toll the time for
a fund to get back into compliance following a departure from 80% that
the rule otherwise would require, if a notice of a change in a fund's
policy has been provided to fund shareholders.\220\ Once such a notice
has been provided to shareholders, shareholders have a period of 60
days to determine whether they would like to redeem their shares before
the change in policy takes effect.
---------------------------------------------------------------------------

    \219\ See final rule 35d-1(a)(2)(ii), (b)(1)(iii), (d).
    \220\ See proposed rule 35d-1(b)(iv); final rule 35d-
1(b)(1)(iii).
---------------------------------------------------------------------------

(d) Fund Launches and Reorganizations
    We are adopting final rule amendments that permit funds to invest
less than 80% of their assets in the 80% basket temporarily in order to
reposition or liquidate assets in connection with a reorganization or
to launch a fund.\221\ We are adopting these amendments substantially
as proposed. For fund launches, the final amendments provide funds with
a temporary period to depart from the 80% investment requirement that
is not to exceed 180 consecutive days starting from the day the fund
commences operations.\222\ The final rule amendments do not limit the
time of departures associated with fund reorganizations.
---------------------------------------------------------------------------

    \221\ Final rule 35d-1(b)(1)(iii); see also final rule 35d-1(g)
(defining the term ``launch'').
    \222\ Final rule 35d-1(g).
---------------------------------------------------------------------------

    The Commission received comments requesting that we extend the
proposed period of time permitted for fund launches from 180 days to a
longer period.\223\ Commenters stated that certain funds, for example
``alts funds'' or certain illiquid funds, may have a longer ramp-up
period that can extend beyond 180 days.\224\ One commenter stated that
investors in these types of less-liquid funds will understand the
nature of the fund they are investing in and understand that coming
into compliance with the names rule within 180 days may not be in the
interest of the fund.\225\ Another commenter stated that it is in the
best interest of the fund manager to invest the assets of the fund and
to establish the fund as quickly as possible and that a fund manager
may reasonably need more than 180 days to come into compliance with the
names rule.\226\ The Commission received one comment supporting the
proposed approach to reorganizations and did not receive comments
opposing this aspect of the proposal.\227\
---------------------------------------------------------------------------

    \223\ See, e.g., SIFMA AMG Comment Letter; USCOC Comment Letter;
Invesco Comment Letter.
    \224\ See, e.g., SIFMA AMG Comment Letter; USCOC Comment Letter.
    \225\ See, e.g., SIFMA AMG Comment Letter.
    \226\ See, e.g., USCOC Comment Letter.
    \227\ See Fidelity Comment Letter.
---------------------------------------------------------------------------

    We understand that there may be variability in how long is needed
to launch a new fund depending on the types of investments in which the
fund seeks to invest. In some instances, it may be in shareholders'
interest for funds to take additional time beyond the otherwise-
required 90-day temporary departures period to invest in a manner
consistent with the fund's 80% investment policy, for example to avoid

the potential for adverse impacts on the price of a targeted
investment, to scale up an investment, or to find a better investment
that corresponds to the investment focus relative to what is currently
available. Nonetheless, we are adopting the requirement that,
consistent with current guidance, such a period should not exceed 180
consecutive days.\228\ We understand, based on staff knowledge of
industry practice, that this time frame is generally sufficient for
funds to invest fully, consistent with their 80% investment policy,
after the fund commences operations.\229\ Further, the final amendments
generally require funds to be invested consistent with their 80%
investment policy ``as soon as reasonably practicable,'' which may be a
shorter time than 180 days. The amendments therefore do not permit any
fund to exceed 180 consecutive days to invest its assets consistent
with its 80% investment policy when launching a fund.
---------------------------------------------------------------------------

    \228\ See 2001 Names Rule Adopting Release, supra footnote 8, at
n.39 and accompanying text.
    \229\ See also, e.g., PRI Comment Letter (supporting all of the
proposed time frames for getting back into compliance).
---------------------------------------------------------------------------

    We recognize the likelihood that it can take longer for funds to
find investments during their start-up, particularly for funds that
invest in securities whose supply is limited. Both reorganizations and
launches may result in a fund holding assets in a way that is
inconsistent with its 80% investment policy in connection with these
fund life-cycle events. For example, at start-up it may take time for a
new fund to find and purchase available investments consistent with the
fund's investment focus, and the fund may hold cash in the interim.
While we anticipate that, for most funds, codifying a required 180-day
period for a fund to be fully invested consistent with its 80%
investment policy will not result in significant operational changes,
we acknowledge that may not be the case for all funds.
    Planned reorganizations may take longer to complete than 30 days or
even 180 days. Moreover, such a planned action will be disclosed, and
the reorganization is likely to be a permanent change to the nature of
the investor's investment.\230\ Similarly, a change to a fund's 80%
investment policy will result in a permanent change to the fund's
investments, about which funds notify investors pursuant to the
provisions of the names rule. Thus, we do not believe that changes in
the fund's investment portfolio to support an upcoming reorganization
would generally be inconsistent with investors' reasonable
expectations. As a result, we do not believe that an express time limit
is necessary for departures from the 80% investment requirement made in
connection with these actions. Such departures would still be required
to be resolved as soon as reasonably practicable, consistent with any
temporary departure under the rule.
---------------------------------------------------------------------------

    \230\ For example, when the board of an open-end fund determines
to approve a reorganization, the fund would supplement its
prospectus.
---------------------------------------------------------------------------

3. Considerations Regarding Derivatives in Assessing Names Rule
Compliance
    Consistent with the proposal, we are adopting amendments that
address the valuation of derivatives instruments for purposes of
determining compliance with a fund's 80% investment policy, as well as
the derivatives that a fund may include in its 80% basket. These
amendments are designed to reflect the investment exposure derivatives
investments create and to increase comparability, as some funds
currently value derivatives instruments using their notional amounts
for purposes of determining their compliance with the 80% test while
other funds use market values.\231\ The amendments are designed both to
allow funds to use names that may more effectively communicate their
investments and risks to investors, and to reduce the risk that a fund
may use derivatives to invest in a manner inconsistent with the
investment focus suggested by the fund's name.
---------------------------------------------------------------------------

    \231\ See, e.g., Proposing Release, supra footnote 2, at nn.76-
78 and accompanying text.
---------------------------------------------------------------------------

    The proposed amendments included the requirement for funds to use a
derivatives instrument's notional amount, rather than its market value,
for the purpose of determining compliance with a fund's 80% investment
policy.\232\ The proposal also included amendments to address the
derivatives instruments that a fund may include in its 80% basket.\233\
As discussed below, commenters generally agreed that the names rule
should specifically address funds' use of derivatives, although some
commenters suggested modifications to the proposed approach.
---------------------------------------------------------------------------

    \232\ See proposed rule 35d-1(g).
    \233\ See proposed rule 35d-1(b)(2).
---------------------------------------------------------------------------

    We are adopting the proposed amendments with certain changes in
response to comments. We discuss each element of the final amendments'
provisions addressing derivatives below.
Use of Derivatives' Notional Amounts, With Currency Hedging Exclusion
    The final amendments generally require a fund to use notional
amounts to value derivatives in assessing whether it has invested 80%
of the value of its assets in accordance with the investment focus that
the fund's name suggests.\234\ In a change from the proposal, however,
the final amendments also require a fund to exclude from the
calculation certain derivatives that hedge the currency risk associated
with a fund's foreign-currency denominated investments. These
derivatives therefore will not be included in the calculation of the
fund's assets or the fund's 80% basket when determining if the fund is
complying with its 80% investment policy. A fund must exclude a
currency derivative if it: (1) is entered into and maintained by the
fund for hedging purposes, and (2) the notional amounts of the
derivatives do not exceed the value of the hedged investments (or the
par value thereof, in the case of fixed-income investments) by more
than 10 percent.
---------------------------------------------------------------------------

    \234\ See final rule 35d-1(g) (definitions of ``assets'' and
``derivatives instrument''). The final amendments' approach, like
the proposed approach, does not distinguish between derivatives
instruments that are assets and derivatives that are liabilities of
the fund. See Proposing Release, supra footnote 2, at n.83.
---------------------------------------------------------------------------

    The final amendments' approach of using notional amounts better
reflects the investment exposure that derivatives investments create
than the use of market values (as the Act would generally otherwise
require by operation of its definition of the term ``value''), because
a derivative instrument's market value may bear no relation to the
investment exposure that the derivatives instrument creates.\235\ For
most types of derivatives instruments, the notional amount generally
serves as a measure of a fund's investment exposure to the underlying
reference asset or metric.\236\ The use of notional amounts furthers
the goal of helping to ensure that a fund's investment activity is
consistent with the investment focus its name communicates.\237\
Notably, using a

derivatives instrument's market value for purposes of assessing names
rule compliance could prevent a fund from using a name that effectively
communicates its investments, or could result in a fund being in
compliance with its 80% investment policy despite having significant
exposure to investments that are not suggested by the fund's name.\238\
---------------------------------------------------------------------------

    \235\ See Proposing Release, supra footnote 2, at paragraph
accompanying nn.77-78; see also 15 U.S.C. 80a-2(a)(41)(B) (defining
``value,'' in part, as the market value of securities for which
market quotations are readily available and, for all other
investments, as fair value as determined in good faith by the board
of directors).
    \236\ A total return swap, for example, can provide a return
that is the economic equivalent of a direct investment in the
derivative's reference asset.
    \237\ A fund's name may be materially deceptive or misleading
under section 35(d) of the Investment Company Act, however, even if
it complies with the 80% investment policy requirement (and uses
notional amounts as the final amendments require in performing its
compliance calculations). See infra section II.A.5.
    \238\ See Proposing Release, supra footnote 2, at paragraphs
following n.78.
---------------------------------------------------------------------------

    Comments on the proposed mandatory approach to using notional
amounts were mixed. Some commenters supported the proposed approach,
stating that notional amounts are a more accurate reflection of funds'
economic exposure, as compared to market values, and that exposure is
likely what investors assume a fund name reflects.\239\ One commenter
also expressed appreciation that the proposal attempts to provide a
clear rule while also adjusting for accuracy in reflecting
exposure.\240\ Other commenters generally supported the use of notional
amounts but suggested changes to the proposed approach that would
permit the use of market values under certain circumstances.\241\ For
example, some commenters suggested that the rule should permit a fund
to value each derivatives instrument consistent with a ``reasonable
exposure metric'' and a method that best measures the economic exposure
the derivatives instrument obtains synthetically, so long as the fund
consistently applies the relevant metric and method.\242\ One commenter
suggested an alternative approach that would require the use of
notional amounts for derivatives that are included in a fund's 80%
basket, but that would permit the use of market values for derivatives
that are not included in the 80% basket, depending on the nature of the
particular derivative.\243\
---------------------------------------------------------------------------

    \239\ See Consumer Federation of America Comment Letter; Capital
Group Comment Letter; J.P. Morgan Asset Management Comment Letter;
Ceres Comment Letter; Environmental Defense Fund Comment Letter;
Comment Letter of Americans for Financial Reform Education Fund
(Aug. 15, 2022) (``AFREF Comment Letter''); see also Comment Letter
of Chris Barnard (June 8, 2022) (``Barnard Comment Letter'')
(expressing support for ``an economic consideration that would look
through the notional value of assets held in order to determine the
economic impact of the fund exposures'').
    \240\ See Center for American Progress Comment Letter; see also
SIFMA AMG Comment Letter (stating that, while not all SIFMA AMG
members agree that notional value is the most appropriate valuation
for every derivatives instrument in all cases, many funds
``recognize the benefit of eliminating disparate valuation practices
among funds with an 80% investment policy'').
    \241\ See, e.g., Capital Group Comment Letter; Fidelity Comment
Letter; T. Rowe Comment Letter; Dechert Comment Letter; ICI Comment
Letter.
    \242\ See Dechert Comment Letter; ICI Comment Letter; see also
Capital Group Comment Letter.
    \243\ T. Rowe Comment Letter.
---------------------------------------------------------------------------

    Commenters suggesting these alternative approaches expressed
particular concern about using notional amounts for derivatives
transactions entered into to protect against risks posed by investments
not suggested by a fund's name (i.e., investments not included in the
80% basket).\244\ For example, a fund with ``U.S. equities'' in its
name might invest a limited percentage of its assets in non-U.S.
securities and then enter into derivatives to hedge risks associated
with those securities. To comply with the fund's 80% investment policy,
the value of the fund's U.S. equity investments in the fund's 80%
basket must represent at least 80% of the value of the fund's
``assets'' as defined in the rule. If the derivatives intended to hedge
risks associated with the non-U.S. equity securities in this example
were valued using notional amounts, however, this would increase the
value of the fund's ``assets'' and therefore could have a potentially
large impact on the denominator for purposes of names rule compliance,
causing the fund to drop below the required 80% threshold.\245\ These
commenters argued that this, in turn, could dissuade funds from
entering into certain derivatives transactions that funds use for
hedging or risk management purposes, whose impact on fund performance
might be insignificant. One commenter, on the other hand, argued
against an alternative approach that uses different valuation
approaches for different derivatives because this would be less
consistent and more complex than the proposed approach, which would
likely result in inconsistencies in treatment, would complicate funds'
compliance, and would raise examination challenges.\246\
---------------------------------------------------------------------------

    \244\ See Dechert Comment Letter; ICI Comment Letter; T. Rowe
Comment Letter.
    \245\ If the fund in this example had invested $80 in U.S.
equity securities and $20 in non-U.S. securities, and then hedged
risks associated with the non-U.S. securities with derivatives with
a notional amount of $20, the fund would no longer satisfy its 80%
investment policy. The fund's $80 in U.S. equity securities would
represent 67% of the fund's $120 in assets. See also Proposing
Release, supra note 2, at nn.75-76 and accompanying text.
    \246\ Consumer Federation of America Comment Letter.
---------------------------------------------------------------------------

    After analyzing comments, we continue to believe that notional
amounts are generally an appropriate measure of derivatives
instruments' economic exposure.\247\ This approach is designed to
provide a clear and consistent approach to derivatives valuation that
will simplify names rule compliance because all funds will have a
specific standard to follow when valuing derivatives for names rule
purposes. This approach also promotes names that effectively
communicate a fund's investments and risks because all funds will be
using the same calculation methodology. The final amendments'
requirement for funds to use notional amounts to value derivatives, in
the context of names rule compliance, reflects these goals.
---------------------------------------------------------------------------

    \247\ But see infra footnote 259. We believe that the term
``notional amount,'' which is also used in 17 CFR 270.18f-4 (``rule
18f-4''), is understood by market participants and used as a means
to reflect the market exposure a derivatives creates--meaning, for
example, that if a derivative provides a return based on the
leveraged performance of a reference asset, the notional amount must
reflect the application of the leverage factor. See Derivatives
Adopting Release, supra footnote 214, at text following n.496.
---------------------------------------------------------------------------

    However, we are adopting a modification to this approach in
consideration of commenters' concerns that the proposed approach could
limit the use of derivatives for hedging purposes. Take the example
discussed above, where a U.S. equity fund may invest up to 20% of its
assets in stocks of companies domiciled outside of the United States,
consistent with the names rule. The fund in this example would not
include the foreign stocks in its 80% basket, and therefore these
foreign stocks would be in the denominator in the calculation that the
fund would use to determine compliance with its 80% investment
policy.\248\ Any related currency derivative that the fund holds for
hedging purposes, therefore, also would be in the denominator. This
currency derivative could have a high notional amount, even though it
would be reducing, not increasing, the fund's exposure to risks
associated with the fund's foreign securities. Holding the currency
derivative therefore could significantly limit the extent to which the
fund could invest outside of its 80% basket. One commenter stated that
this approach could result in funds adopting more generic names, which
would permit them to use derivatives with fewer constraints.\249\ A
fund also could decide to leave its foreign-currency-denominated
investments unhedged in lieu of breaching its 80% investment policy,
increasing risks to the fund and its shareholders.
---------------------------------------------------------------------------

    \248\ See T. Rowe Comment Letter.
    \249\ See id.
---------------------------------------------------------------------------

    While we appreciate these concerns, we continue to believe the
names rule's

approach to derivatives must be clear and consistently applied, and
therefore we are not adopting a principles-based approach that, as some
commenters suggested, would permit a fund to use any appropriate
exposure metric when valuing derivatives in the context of names rule
compliance. Instead, the final amendments require a fund, in
calculating its assets for purposes of assessing names rule compliance,
to exclude certain currency derivatives instruments that hedge currency
risks associated with one or more specific foreign-currency-denominated
equity or fixed-income investments held by the fund. A fund must
exclude a currency derivative if it: (1) is entered into and maintained
by the fund for hedging purposes, and (2) the notional amounts of the
derivatives do not exceed the value of the hedged investments (or the
par value thereof, in the case of fixed-income investments) by more
than 10 percent.
    Excluding these derivatives from the names rule compliance
calculation addresses concerns that including certain derivatives at
their notional amounts in this calculation could limit the use of
derivatives for hedging purposes. Limiting this exclusion to currency
derivatives is designed to ensure that the exclusion will not result in
the names rule calculation excluding instruments that create economic
exposures that should be considered in assessing whether a fund's name
is materially deceptive and misleading in light of its portfolio. The
Commission has previously distinguished currency derivatives, when
directly matched to particular investments held by the fund, as
instruments that ``predictably and mechanically provide the anticipated
hedging exposure.'' \250\ The provision in the final rule requiring
that these derivatives must be entered into and maintained for hedging
purposes, and that the notional amounts of these derivatives must not
exceed the value of the hedged investments by more than 10 percent,
similarly reflects an approach the Commission has taken in the past to
define currency derivatives that qualify as hedges.\251\ These
instruments therefore would not generally create economic exposures
that could cause a fund's name to be materially deceptive or
misleading.
---------------------------------------------------------------------------

    \250\ See Derivatives Adopting Release, supra footnote 214, at
paragraph accompanying n.522. While the Commission's discussion in
the Derivatives Adopting Release also characterized interest rate
derivatives in this way, in addressing derivatives that may be
excluded when calculating derivative exposure to determine
eligibility for the limited derivatives user exception in rule 18f-
4, the policy considerations for interest rate derivatives in the
context of the names rule are unique as discussed below.
    \251\ See id. at paragraphs accompanying and following nn.523-
526.
---------------------------------------------------------------------------

    On the other hand, other types of hedging transactions executed
through derivatives are difficult to distinguish from transactions that
create exposures that contribute to (or detract from) the investment
focus that a fund's name suggests. For example, while a fund can use
derivatives to hedge the interest rate risk that exists in interest-
bearing assets, similar derivatives instruments can be used to
supplement a portfolio whose strategy reflects a particular conviction
about the movement of interest rates. It therefore would not be
appropriate to adopt an approach that requires exclusion of interest
rate derivatives in this example, as opposed to currency derivatives
whose hedging purpose under the final amendments is more
straightforward to determine. While no commenter suggested the specific
approach to currency derivatives that the final amendments include,
this approach addresses commenters' concerns about ways in which the
proposal could limit hedging activities, with one commenter
specifically discussing hedging involving currency derivatives.\252\
---------------------------------------------------------------------------

    \252\ See Dechert Comment Letter; ICI Comment Letter; T. Rowe
Comment Letter (discussing currency derivatives, as well as interest
rate derivatives).
---------------------------------------------------------------------------

    We acknowledge that commenters suggesting alternative approaches
generally favored the use of market values for certain derivatives, as
opposed to excluding these derivatives from the names rule calculation.
While derivatives' market values can often be quite low, such that the
use of their market values would be functionally equivalent to
excluding these derivatives from a names rule compliance calculation,
there are circumstances where the market value of a derivative could be
large.\253\ The use of market values under these circumstances, as well
as an approach that permits but does not require the exclusion of
currency derivatives used for hedging purposes, could therefore lead to
inconsistent compliance calculation outcomes.
---------------------------------------------------------------------------

    \253\ While the market value of a derivative almost never will
exceed its notional amount, as typically defined, a derivative can
equal it, for example in the case of deep in-the-money options.
---------------------------------------------------------------------------

Calculating Notional Amounts for Purposes of Names Rule Compliance
    In calculating notional amounts, the final amendments, as proposed,
will require a fund to convert interest rate derivatives to their 10-
year bond equivalents and to delta adjust the notional amounts of
options contracts.\254\ A simple way to convert an interest rate
derivative to its ten-year bond equivalent is to multiply the
derivative's unadjusted notional amount by the ratio of the
derivative's duration and the duration of the reference security. The
requirement to convert interest rate derivatives to 10-year bond
equivalents is designed to result in adjusted notional amounts that
better represent a fund's exposure to interest rate changes.\255\
Absent this adjustment, short-term interest rate derivatives can
produce large unadjusted notional amounts that may not correspond to
large exposures to interest rate changes. Similarly, a fund will delta
adjust an option by multiplying the option's unadjusted notional amount
by the option's delta (i.e., the ratio of change in the value of the
option to the change in value of the asset into which the option is
convertible).\256\ The requirement to delta adjust options is designed
to provide for a more tailored notional amount that better reflects the
exposure that an option creates to the underlying reference asset.
---------------------------------------------------------------------------

    \254\ See final rule 35d-1(g).
    \255\ See Proposing Release, supra footnote 2, at n.80 and
accompanying text; see also Derivatives Adopting Release, supra
footnote 214, at section II.E.1; AFREF Comment Letter (providing
numeric examples of the utility of the proposed adjustments).
    \256\ See Derivatives Adopting Release, supra footnote 214, at
n.500.
---------------------------------------------------------------------------

    Some commenters supported the proposed mandatory notional amount
adjustments, arguing that these adjustments are standardized practices
that will properly account for derivatives instruments' true
exposures.\257\ Other commenters argued that the names rule should
permit, but not require, the proposed adjustments.\258\ These
commenters stated that rule 18f-4 permits the adjustments but does not
require them, and therefore the names rule's approach would permit
funds to benefit from compliance and operational efficiencies.\259\ One
commenter also argued that there is no policy reason for different
treatment between the names rule and rule 18f-4 because the permissive
adjustments in rule 18f-4

``generate an accurate measure of the exposure created by a particular
derivatives transaction.'' \260\ Another stated that requiring the
proposed adjustments would prevent funds from ``taking a more
conservative approach'' by deciding not to scale down the notional
value of derivatives to their 10-year bond equivalents.\261\
---------------------------------------------------------------------------

    \257\ See AFREF Comment Letter; Center for American Progress
Comment Letter; see also Consumer Federation of America Comment
Letter (stating that it makes sense, for efficiency's sake, for the
names rule to apply the same approach with regards to derivatives
measurement that rule 18f-4 under the Act requires for purposes of
considering funds' derivatives exposure in the context of the rule's
limited derivatives user provision).
    \258\ See Dechert Comment Letter; ICI Comment Letter; SIFMA AMG
Comment Letter; Fidelity Comment Letter.
    \259\ See SIFMA AMG Comment Letter; Fidelity Comment Letter.
    \260\ SIFMA AMG Comment Letter.
    \261\ Fidelity Comment Letter.
---------------------------------------------------------------------------

    After considering comments, we are adopting the proposed mandatory
adjustments. We continue to believe that requiring these tailoring
adjustments is appropriate for purposes of the names rule in order for
a fund's 80% investment policy to best reflect the fund's investment
exposure, which in turn would help ensure that the investment focus a
fund's name communicates is not materially deceptive or
misleading.\262\ For example, a deep out-of-the money option can have a
large unadjusted notional amount, but will provide limited investment
exposure to the underlying reference asset. It would not be consistent
with the goal of requiring notional amounts when assessing names rule
compliance to permit the fund in this example to use such an option's
unadjusted notional amount to satisfy its 80% investment policy
because, even if the option's unadjusted notional amount equaled or
exceeded 80% of the value of the fund's assets, it is not providing a
commensurate degree of investment exposure at that time. While
permitting the adjustments rather than requiring them could allow a
fund to take a ``more conservative'' approach in certain specific cases
as one commenter suggested, it also could permit a fund to account for
derivatives in its names rule compliance in a way that could be
inconsistent with investors' expectations based on the fund's name.
Requiring these adjustments would prevent a fund, for example, from
including a deep out-of-the money option in its 80% basket to comply
with its 80% investment policy. In that case, the option's unadjusted
notional amount would not represent the exposure that the option
creates to the underlying reference asset at that time. This potential
gaming consideration is not applicable in the context of rule 18f-4,
because including high unadjusted notional amounts in a fund's
calculation of derivatives exposure for rule 18f-4 purposes could
result in the possibility only of increased regulatory burden (for a
fund not qualifying as a limited derivatives user under the rule).
---------------------------------------------------------------------------

    \262\ A fund's use of derivatives that results in a substantial
portion of the fund's risks or returns being materially different
from those which an investor reasonably would expect based on the
fund's name, regardless of the fund's compliance with the
requirements of the names rule (including the use of derivatives'
notional amounts and the required tailoring adjustments) could
render a fund's name to be materially deceptive or misleading. See
infra section II.A.5.
---------------------------------------------------------------------------

Reducing the Value of a Fund's Assets by Deducting Cash And Cash
Equivalents and Certain U.S. Treasury Securities
    The final amendments will permit a fund, in determining compliance
with its 80% investment policy, to deduct cash and cash equivalents and
U.S. Treasury securities with remaining maturities of one year or less
from assets (i.e., the denominator in the 80% calculation), up to the
notional amounts of the fund's derivatives instruments.\263\ This
represents a change from the proposal, which would have limited the
deduction to cash and cash equivalents and would have required, not
permitted, this deduction.
---------------------------------------------------------------------------

    \263\ Final rule 35d-1(g). The Commission has stated that items
commonly considered to be cash equivalents include certain Treasury
bills, agency securities, bank deposits, commercial paper, and
shares of money market funds. See Proposing Release, supra footnote
2, at n.86. U.S. Generally Accepted Accounting Principles (``U.S.
GAAP'') define cash equivalents as short-term, highly liquid
investments that are readily convertible to known amounts of cash
and that are so near their maturity that they present insignificant
risk of changes in value because of changes in interest rates.
Generally, only investments with original maturities of three months
or less qualify under that definition. See FASB Accounting Standards
Codification Master Glossary, available at https://asc.fasb.org/glossary.
---------------------------------------------------------------------------

    The Commission stated in the Proposing Release that funds that use
derivatives instruments to gain exposure to the markets in which they
invest may maintain portions of their assets in cash and cash
equivalents, which may not themselves provide market exposure. Rather,
such cash and cash equivalents may effectively function as low-risk
collateral for those derivatives instruments. Because the notional
amount of the derivatives instruments for which the cash and cash
equivalents effectively function as collateral is already included in
the denominator of the 80% investment test, including the cash and cash
equivalents held as such collateral could effectively ``double-count''
the fund's exposure.\264\
---------------------------------------------------------------------------

    \264\ See Proposing Release, supra footnote 2, at paragraphs
accompanying nn.84-86.
---------------------------------------------------------------------------

    Commenters that addressed this aspect of the proposal generally
supported it and encouraged the Commission to expand the types of
assets that funds may deduct beyond cash and cash equivalents.\265\
Some commenters stated that the Commission should extend the proposed
approach to allow funds to exclude any assets that they have posted as
collateral under derivatives instruments and certain other asset
types.\266\ These commenters provided examples of what this recommended
broader approach would encompass, including other U.S. government
securities such as U.S. Treasury securities with under five years to
maturity, investment-grade corporate bonds with under three years to
maturity, short-term bond fund shares, interests in other short-term
investment funds, and repurchase agreements on cash equivalents or any
of the foregoing types of instruments. One commenter discussed
circumstances in which cash and cash equivalents provide investment
exposure and therefore should not be deducted in a fund's 80%
investment policy calculation, and another commenter suggested that the
deduction of cash and cash equivalents be permissive instead of
mandatory as proposed.\267\
---------------------------------------------------------------------------

    \265\ See Dechert Comment Letter; ICI Comment Letter;
Dimensional Comment Letter.
    \266\ See Dechert Comment Letter; ICI Comment Letter.
    \267\ SIFMA AMG Comment Letter (stating that funds may employ
investment strategies that seek exposure to the U.S. government
through derivative instruments, as well as cash and cash
equivalents, and it would be appropriate to permit cash and cash
equivalents to be included in both the numerator and denominator of
a fund's 80% investment policy calculation when such investments
provide market exposure); T. Rowe Comment Letter (stating that if
the Commission were to adopt the commenter's suggested alternative
approach to the mandatory use of notional amounts, discussed in
supra footnote 243 and accompanying text, this approach would not
require the deduction of cash and cash equivalents to address
potential double-counting of a fund's exposure, but if the
Commission did not adopt the alternative approach, the deduction of
cash and cash equivalents should be permissive and not mandatory).
---------------------------------------------------------------------------

    We agree that the deduction of cash and cash equivalents should be
permissive and not mandatory. For funds that do not employ investment
strategies that seek exposure through investments in cash and cash
equivalents, the decision not to deduct cash and cash equivalents in a
fund's 80% investment policy calculation always would be more
conservative for purposes of meeting the required 80% threshold. That
is, the denominator in the calculation (the fund's assets as defined in
the names rule) for a fund that chooses not to deduct cash and cash
equivalents would always be larger compared to an equivalent fund that
chooses to deduct cash and cash equivalents from its assets. Choosing
not to deduct cash and cash equivalents therefore would require
proportionately more assets in the fund's 80% basket compared to an
equivalent fund that chooses to deduct cash and cash

equivalents. Moreover, permitting a fund to choose not to deduct cash
and cash equivalents reflects that there are circumstances in which
cash and cash equivalents provide investment exposure that is
consistent with the fund's name.
    We also agree that expanding the permissible deduction to encompass
all U.S. Treasury securities with remaining maturities of one year or
less (as opposed to those with original maturities of three months or
less, which would qualify as ``cash equivalents'' for purposes of U.S.
GAAP) would permit funds to exclude certain additional assets that
effectively function as low-risk collateral for derivatives instruments
but that do not introduce unexpected investment exposure or risk to the
portfolio.\268\ U.S. Treasury securities with remaining maturities of
one year or less have a significantly lower likelihood of a short-term
price change (and the magnitude of any price change is likely
significantly lower) than U.S. government securities with longer
original and/or remaining maturities.\269\
---------------------------------------------------------------------------

    \268\ See supra footnote 263.
    \269\ See ISDA, Initial Margin Non-Cleared Margin Rules/Eligible
Collateral Comparison by Jurisdiction (Jan. 5, 2023), available at
https://www.isda.org/a/EqxgE/Eligible-Collateral-Comparison-010523.pdf (haircuts on U.S. debt securities with under 1 year
residual maturity are substantially less than haircuts on U.S. debt
securities with longer maturities).
---------------------------------------------------------------------------

    We decline, however, to expand the permissible deduction beyond
cash and cash equivalents and U.S. Treasury securities with remaining
maturities of one year or less. We are concerned that this approach
could result in funds deducting investments from the names rule
calculation that could introduce unexpected investment exposure or risk
to the portfolio. For instance, if a fund with a name that suggests a
focus in bonds with very short-term maturities were to use derivatives
as part of its strategy, and held corporate bonds with longer
maturities than its name suggests, deducting those bonds from the names
rule calculation would result in deducting instruments that may be
riskier than the assets in which the fund's name suggests a focus. The
same consideration applies for Treasury securities with relatively long
original and/or remaining maturities, as these securities similarly can
introduce risk to a portfolio, in particular when interest rates rise.
The deduction of these types of assets could result in the fund's
investments providing investment exposure that is inconsistent with the
fund's name, but is not reflected in names rule compliance assessments,
which could mislead investors. The breadth of funds that could be
subject to the 80% investment policy requirement makes it challenging
to draw clear and consistent lines about what types of collateral--
other than cash and cash equivalents and U.S. Treasury securities with
remaining maturities of one year or less--would not result in
potentially misleading names if deducted from the names rule
calculation.
Deduction of Closed-Out Derivatives Positions
    In a change from the proposal, the final amendments provide that a
fund is permitted to exclude any closed-out derivatives positions when
calculating assets for purposes of determining compliance with its 80%
investment policy, if those positions result in no credit or market
exposure to the fund.\270\ The proposed amendments did not address
closed-out derivatives positions directly. However, the 2022 Proposal
included a request for comment asking whether it is sufficiently clear
that funds would eliminate from the names rule calculation closed-out
derivatives positions, that is, derivatives that were closed out with
the same counterparty and result in no credit or market exposure to the
fund, or instead whether the rule should address these positions.\271\
---------------------------------------------------------------------------

    \270\ Final rule 35d-1(g).
    \271\ See Proposing Release, supra footnote 2, at Request for
Comment #33.
---------------------------------------------------------------------------

    Several commenters discussed this request for comment and stated
that the Commission should exclude closed-out derivatives positions
from the names rule calculation, but should not limit the exclusion of
closed-out positions to those with the same counterparty.\272\ These
commenters contrasted their suggested treatment with the treatment of
closed-out positions in rule 18f-4 under the Act.\273\ Commenters
recognized that rule 18f-4 does not permit funds to exclude offsetting
positions across different counterparties in calculating derivatives
exposure for purposes of determining whether a fund qualifies as a
limited derivatives user.\274\ Commenters argued that the concerns
underlying the approach in rule 18f-4, however, do not apply for
purposes of the names rule, which is focused ``primarily on addressing
the alignment between the investment exposures suggested by a fund's
name and those resulting from the fund's investments and preventing the
use of misleading fund names.'' \275\ One commenter argued that
limiting excluded closed-out derivatives positions to those with the
same counterparty would lead to economic inefficiencies and could be
detrimental to a fund's returns.\276\
---------------------------------------------------------------------------

    \272\ See Dechert Comment Letter; ICI Comment Letter; T. Rowe
Comment Letter; see also SIFMA AMG Comment Letter.
    \273\ See rule 18f-4(a).
    \274\ See Derivatives Adopting Release, supra footnote 214, at
section II.E.
    \275\ Dechert Comment Letter; see also supra footnote 270.
    \276\ Dechert Comment Letter (suggesting that under the proposed
approach, ``a fund might be compelled to transact with the
counterparty with which it entered in the original derivatives
transaction on less favorable terms, including pricing, or which
poses more credit risk to the fund, than a different counterparty
with which it could enter into an offsetting position at the time it
needs to eliminate its exposure under the first transaction'').
---------------------------------------------------------------------------

    The final amendments permit funds to exclude closed-out derivatives
positions from the names rule calculation if those positions result in
no market exposure to the fund because these closed-out positions will
not affect the fund's risks or returns. We agree that the concerns
underlying rule 18f-4's provision on closed-out derivatives positions
are not the same concerns underlying the names rule. Rule 18f-4 does
not permit a fund to offset derivatives transactions with different
counterparties for purposes of determining whether a fund qualifies as
a limited derivatives user under that rule because netting these
derivatives transactions could result in a fund having a large volume
of open derivatives positions subject to their own margin and other
requirements with various counterparties. This, in turn, could involve
a scale of derivatives positions and related operational and
counterparty risks that the Commission has stated it believes funds
should manage as part of a derivatives risk management program. The
goals of the names rule, on the other hand, address whether the
exposures that a fund's portfolio creates align with the focus that the
fund's name suggests. Reflecting these exposures for purposes of
calculating names rule compliance does not depend on requiring offset
positions to have the same counterparties. The final amendments,
therefore, do not require that closed-out positions to be closed out
with the same counterparty in order for a fund to exclude them from the
calculation of its assets.
Derivatives Instruments Included in the 80% Basket
    The final amendments, substantially as proposed, permit a fund to
include in its 80% basket a derivatives instrument that provides
investment exposure to one or more of the market risk factors
associated with the investment focus

suggested by the fund's name.\277\ This approach recognizes that, in
addition to using derivatives as direct substitutes for cash market
investments, some funds use derivatives instruments to hedge exposures
or to obtain exposure to market risk factors associated with the fund's
investments (for example, interest rate risk and credit spread risk).
Those instruments may have very high notional amounts, and if the rule
did not allow funds to treat the notional amounts of those derivatives
instruments as investments that reflect the fund's investment focus,
the notional amounts of those derivatives instruments could cause a
fund to fall out of compliance with its 80% investment policy.\278\
---------------------------------------------------------------------------

    \277\ Rule 35d-1(b)(2).
    \278\ See Proposing Release, supra footnote 2, at paragraphs
following paragraph accompanying n.86. For example, if ABC Bond Fund
invested $100 in bonds, $100 in interest rate swaps, and held no
other assets, the fund would not satisfy its 80% investment policy
if the interest rate swaps were not included in the fund's 80%
basket ($100 in bonds/$100 in bonds + $100 in swaps = 50%).
---------------------------------------------------------------------------

    Commenters expressed support for the proposed approach, as it
recognizes that funds often use derivatives instruments to provide
complementary investment exposure to the investments suggested by a
fund's name, including exposure to the market risk factors associated
with such investments.\279\ Some commenters requested that the
Commission acknowledge that funds may consider all derivatives that
provide exposure to market risk factors associated with investments
suggested by a fund name when testing names rule compliance, not just
those enumerated risk factors discussed in the Proposing Release.\280\
Another commenter requested that the Commission expand the types of
derivatives hedging instruments that may be included in a fund's 80%
investment policy by allowing derivatives transactions that hedge the
risks associated with one or more securities held by a fund,
notwithstanding whether they are intended to hedge market risk factors
associated with the investments suggested by the fund's name.\281\ This
commenter provided as an example funds that invest in mortgage pass-
through securities, which commonly use U.S. Treasury futures and
options to hedge against the impact of mortgage prepayments on the
fund's duration (stating that using derivatives to manage duration in
this manner may not align with the investments suggested in a fund's
name or provide investment exposure to a market risk factor associated
with an investment suggested by a fund's name).
---------------------------------------------------------------------------

    \279\ See SIFMA AMG Comment Letter; Dechert Comment Letter;
Fidelity Comment Letter; ICI Comment Letter.
    \280\ See ICI Comment Letter; see also SIFMA AMG Comment Letter;
Dechert Comment Letter; see also Proposing Release, supra footnote
2, at section II.A.3 (discussing funds' use of derivatives to obtain
exposure to market risk factors associated with the fund's
investments, for example interest rate risk, credit spread risk, and
foreign currency risk).
    \281\ Fidelity Comment Letter.
---------------------------------------------------------------------------

    After considering comments, the final amendments do not expand the
derivatives that may be included in a fund's 80% basket beyond the
proposed approach. Under the proposed approach, the derivatives
instruments included in a fund's 80% basket would either be functioning
as a substitute for direct investments in the securities suggested by
the fund's name or (in the case of, for example, interest rate
derivatives) used to facilitate the fund's investment in those
securities by increasing or decreasing the fund's exposure to risk
factors associated with those securities. On the other hand,
derivatives used to manage the risks of the fund's portfolio as a whole
can involve more complex hedging activities than transactions that
provide investment exposure to one or more of the market risk factors
associated with investments suggested by the fund's name.\282\ This, in
turn, could create exposures that could be inconsistent with investors'
reasonable expectations of the fund's investment activity.\283\
---------------------------------------------------------------------------

    \282\ See Derivatives Adopting Release, supra footnote 194, at
n.530 and accompanying text.
    \283\ Including derivatives in the 80% basket to the extent that
they negate the primary market risk factor associated with the
assets in which the fund's name suggests an investment focus
similarly could result in a fund's name being materially deceptive
and misleading, notwithstanding the fund's adoption of an 80%
investment policy and compliance with the requirements of the names
rule. See supra footnote 262. For example, investors may reasonably
expect the investments in which the ``XYZ Corporate Bond Fund''
focuses to reflect exposure to certain risks, such as credit risk.
If this fund were to purchase credit default swaps or any other
derivatives instruments that resulted in the elimination of all
credit risk in its portfolio for an extended period of time, and
were to include these derivatives in the fund's 80% basket, the
fund's name could be materially deceptive and misleading because the
fund would have eliminated the primary market risk factor associated
with the assets in which the fund's name suggests a focus.
---------------------------------------------------------------------------

    We acknowledge that there may be transactions other than the ones
that the Commission specifically addressed in the Proposing Release
that provide investment exposure to one or more of the market risk
factors associated with investments suggested by the fund's name, and
the examples the Commission provided are not intended to be limiting.
To help determine whether a derivatives instrument provides investment
exposure to one or more of the market risk factors associated with a
fund's name assets, the fund generally should consider whether the
derivative provides investment exposure to any explicit input that the
fund uses to value its name assets, where a change in that input would
change the value of the security.\284\ For example, prepayment is an
explicit risk factor in the price of a mortgage security, and
therefore, in contrast to the concern that a commenter expressed, it
would generally be appropriate for a fund whose name indicates a focus
in mortgage securities to include derivatives in its 80% basket that
manage the prepayment risk of these securities.
---------------------------------------------------------------------------

    \284\ See Good Faith Determinations of Fair Value, Investment
Company Act Release No. 34128 (Dec. 3, 2020) [86 FR 748 (Jan. 6,
2021)] (for a general discussion of valuation practices with respect
to the fair value of a registered investment company or business
development company).
---------------------------------------------------------------------------

Treatment of Short Positions
    Under the final amendments and as proposed, if a fund were to use
derivatives instruments to obtain exposure to short positions in one or
more reference assets, the fund would have to use these derivatives
instruments' notional amounts for purposes of determining compliance
with its 80% investment policy. That is, these investments would be
valued at their notional amounts in the denominator in all cases, and
at their notional amounts in the numerator where the fund includes
investments that provide short exposure in the numerator. The final
amendments, in a change from the proposal, also specify that a fund
must value each physical short position using the value of the asset
sold short.\285\ For example, if a fund sold short one share of a
security for $100, the market value of the position would be $0 at that
time because the fund has $100 in short sale proceeds but also a
liability in the form of the obligation to return a share worth $100.
If the fund had obtained the same short exposure via a swap, the
notional amount would be $100. Valuing the physical short position at
$100 for purposes of the names rule--the value of the asset sold
short--provides comparable values for names rule purposes for the swap
and physical short sale in this example.
---------------------------------------------------------------------------

    \285\ Final rule 35d-1(g).
---------------------------------------------------------------------------

    The 2022 Proposal included a request for comment asking about
funds' current practices with respect to including short positions in
their 80% baskets, and also whether the Commission should address the
valuation of physical short sales for purposes of assessing names

rule compliance. Commenters who discussed these points advocated for
the Commission explicitly to permit funds to include short positions in
derivatives and physical short sales in their 80% baskets and to
address the valuation of physical short sales.\286\ They stated that
the Commission should adopt an approach that permits, but does not
require, funds to include in their 80% baskets short positions in
derivatives and physical short sales, where each of these provides
short exposure to the investments suggested by the fund's name or to
the market risk factors associated with those investments in their 80%
baskets, regardless of whether the fund's name specifically suggests
the use of short sales or short positions. Commenters stated that many
funds currently take this approach when assessing names rule
compliance.\287\ One commenter stated that funds use both long and
short positions to obtain exposures suggested by a fund's name, and
this commenter argued that the suggested approach would be consistent
with the proposed approach of including derivatives instruments that
provide investment exposure to a market risk factor associated with a
fund's name.\288\ In addressing the valuation of physical short
positions, commenters suggested that the Commission should permit funds
to use the absolute notional amount or the absolute market value of the
asset sold short under a physical short sale for purposes of valuing
such transaction for names rule compliance.\289\ In addition, they also
suggested a fund should be permitted to look through to the components
of its open short sale positions to offset their investment exposure
(i.e., the fund should be able to close out all or part of a short sale
position) for purposes of compliance with its 80% investment policy.
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    \286\ See ICI Comment Letter; SIFMA AMG Comment Letter; Dechert
Comment Letter.
    \287\ ICI Comment Letter; Dechert Comment Letter.
    \288\ ICI Comment Letter.
    \289\ ICI Comment Letter; Dechert Comment Letter; see also SIFMA
AMG Comment Letter (stating that, with respect to short positions,
whether accomplished through the use of derivatives instruments or
the physical short sale of a security or other asset, the Commission
should require that funds use the notional value of such positions
for purposes of determining names rule compliance).
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    We agree that short positions, under certain circumstances, may
qualify as investments that a fund may include in its 80% basket. For
example, if a fund's name indicates that its investment focus includes
short exposure to a particular type of investment, this inclusion would
be appropriate. In other circumstances, however, the inclusion of short
positions would not be appropriate where this would result in the
fund's economic exposure departing significantly from investors'
reasonable expectations based on the fund's name. For example, if a
fund were named the ``XYZ Equity Fund,'' and half of the value of its
80% basket were invested in long equity positions, and the other half
were invested in short equity positions, the portfolio's net exposure
would likely not be consistent with investors' expectations based on
the fund's name.
    We agree that, to better reflect the exposures that physical short
sales provide, the rule should address the valuation of physical short
sales and use an approach where their valuation is consistent with the
valuation of short positions obtained through a fund's use of
derivatives. We are therefore adopting a change to the proposed
definition of ``assets'' in the names rule, which specifies that a fund
must value each physical short position using the value of the asset
sold short.\290\ A fund would be able to reduce the value of its assets
by excluding any cash and cash equivalents, and U.S. Treasury
securities with remaining maturities of one year or less, up to the
notional amount of the value of asset(s) sold short, just as a fund
could exclude any cash and cash equivalents and such U.S. Treasury
securities up to the notional amount of the fund's derivatives
instruments, as discussed above.
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    \290\ This approach is consistent with the valuation of physical
short positions in rule 18f-4 under the Act. See definition of
``derivatives exposure'' in rule 18f-4(a).
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4. Unlisted Registered Closed-End Funds and BDCs
    The final rule will prohibit a registered closed-end fund or BDC
whose shares are not listed on a national securities exchange, and that
is required to adopt an 80% investment policy, from changing that
policy unless authorized by a vote of the majority of the outstanding
voting securities of the fund.\291\ However, in a modification from the
proposal, under the final amendments such funds will be permitted to
make changes to their 80% investment policies without this vote if the
fund conducts a tender or repurchase offer in advance of the change,
the fund provides at least 60 days' prior notice of any change in the
policy in advance of that offer, that offer is not oversubscribed, and
the fund purchases shares at their net asset value.\292\
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    \291\ Final rule 35d-1(f). This approach has the same practical
effect as the proposed approach, which would have required these
funds to adopt their 80% investment policies as fundamental policies
(policies that funds cannot change unless authorized by a vote of a
majority of its outstanding voting securities). See proposed rule
35d-1(a)(2)(ii); see also 15 U.S.C. 80a-13(a)(3).
    \292\ Final rule 35d-1(f)(4) (specifying that, in the event of a
tender offer, the fund purchases shares at their net asset value).
This provision in final rule 35d-1 addresses tender offers but does
not specifically address the price at which repurchase offers must
be conducted for a fund to be eligible for this exception because
the Investment Company Act rules already address the price (net
asset value) at which closed-end funds and business development
companies conducting periodic repurchase offers are required to
repurchase shares. See 17 CFR 270.23c-3 (``rule 23c-3''),
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    Some commenters voiced general support for this element of the
proposal, stating that it was an improvement from the current rule,
whereby investors in these products generally have limited or no ready
recourse if a fund were to change its investment policy, and that it
would empower investors.\293\ Conversely, other commenters raised
concerns regarding the proposed requirement, arguing that it would
impede the ability of funds to change their investment strategies
without conducting costly special shareholder votes.\294\ This,
according to commenters, could place these funds at a competitive
disadvantage relative to other funds.\295\ Furthermore, some commenters
expressed that the requirement was unnecessary because it did not seem
to address any identified harm to investors in these funds, stating
that many closed-end funds and BDCs currently offer tender offer and
repurchase programs as periodic sources of liquidity, and that
investors in these products are already on notice through existing
disclosures of any potential liquidity constraints.\296\ Some
commenters also suggested that a blanket requirement on BDCs to adopt a
fundamental policy was contrary to the congressional intent behind
exempting BDCs from Investment Company Act provisions that otherwise
require funds to disclose and have a shareholder vote on changes in
fundamental policies.\297\ Some commenters suggested alternative
approaches to address these concerns but also achieve the goals of the
proposed amendments. For example, commenters suggested that the
Commission require a vote only when all shareholders are not given an
opportunity to sell or tender their shares back to the issuer after
notice of a

change in the 80% investment policy, or require a shareholder vote only
in the event that the next tender offer or repurchase program after
such notice is oversubscribed.\298\
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    \293\ Better Markets Comment Letter; NASAA Comment Letter.
    \294\ See, e.g., ICI Comment Letter; Dechert Comment Letter;
SIFMA AMG Comment Letter; Comment Letter of Simpson Thacher and
Bartlett, LLP (Aug. 30, 2022) (``Simpson Thacher Comment Letter'').
    \295\ SIFMA AMG Comment Letter; Invesco Comment Letter.
    \296\ SIFMA AMG Comment Letter; Simpson Thacher Comment Letter.
    \297\ Stradley Comment Letter; Dechert Comment Letter.
    \298\ See Dechert Comment Letter; Simpson Thacher Comment
Letter.
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    As an alternative to the requirement to make their 80% policies
fundamental policies, the current names rule permits funds other than
tax-exempt funds to provide shareholders with 60 days' prior notice of
such changes. The Commission permitted funds to provide shareholders
advance notice, in lieu of adopting a fundamental policy, because the
advance notice would provide shareholders with sufficient time to
decide whether to redeem their shares in the event that a fund decides
to pursue a strategy involving a different investment focus.\299\
Unlike other funds subject to the rule, however, unlisted registered
closed-end funds and BDCs do not issue redeemable shares or list their
shares on a national securities exchange. As a result, shareholders in
the affected funds generally have no ready recourse, such as the
ability to redeem shares, if a fund were to change its investment
policy and the investment focus that the fund's name indicates.\300\ In
light of these investors' limited options to sell their shares readily,
the proposed fundamental policy requirement for unlisted registered
closed-end funds and BDCs aimed to ensure that investors in these funds
would be able to vote on any changes to a fund's investment policy.
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    \299\ 2001 Names Rule Adopting Release, supra footnote 8, at
n.19 and accompanying text.
    \300\ See also Proposing Release, supra footnote 2, at n.99. For
example, many of the tender offer and repurchase programs currently
offered by unlisted registered closed-end funds and BDCs are
periodic and limited, and are therefore unlikely to provide recourse
where a large percentage of a fund's investors disapprove of a
change.
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    After considering comments, we do not agree that extending the
notice period, as some commenters suggested, is a sufficient substitute
to respond to the concerns that the proposed approach was designed to
address.\301\ We recognize, however, that there could be alternative
approaches to the proposed requirement that could address the
Commission's concerns while decreasing the operational burdens that
would accompany a requirement to conduct a shareholder vote for every
instance in which a fund changes its 80% investment policy. We also
recognize that where a fund does in fact give its investors the
opportunity to sell their shares in connection with a fund's change of
its 80% investment policy, the fund alleviates the concern that
investors will be forced to hold investments that they wish to sell.
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    \301\ See, e.g., Invesco Comment Letter; ICI Comment Letter. But
see NASAA Comment Letter (stating that a longer notice period would
be insufficient as it would not provide investors a voice in these
decisions).
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    The final amendments include a limited exception to the shareholder
approval requirement for funds that conduct qualifying tender or
repurchase offers in advance of a proposed change in policy.\302\ This
exception is intended to function in a similar manner to the rule's
general notice alternative by giving investors in unlisted registered
closed-end funds and BDCs that use this alternative the opportunity to
exit the fund prior to a fund's change in investment policy. This
exception will provide funds with increased optionality in effecting
changes to their investment policies compared to the proposed approach,
and this approach is designed to mitigate commenter concerns that the
proposed fundamental policy requirement would have put unlisted
registered closed-end funds and BDCs at a competitive disadvantage
against other types of funds.
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    \302\ The final amendments do not frame the requirement to
obtain shareholder approval under certain circumstances as the
requirement to adopt a ``fundamental policy.'' See supra footnote
297 and accompanying text (discussing commenters' concerns about the
proposed approach that would require BDCs to adopt fundamental
policies). While the final amendments do retain the requirement to
obtain a shareholder vote under certain circumstances, which the
proposed approach effectively would have required, we believe that
this is an appropriate use of the Commission's authority under
section 35(d), and in light of the fact that the requirement to seek
a shareholder vote under the final amendments is triggered only
where a fund chooses a name that conveys a particular investment
focus. We also believe this is appropriate in the context of unique
investor protection concerns for investors in unlisted funds
including BDCs resulting from the general lack of readily available
liquidity.
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    To be eligible for this exception, a fund must conduct a tender or
repurchase offer in accordance with all applicable Commission rules
prior to any change in policy and provide shareholders with at least 60
days' prior notice of any change in such policy in advance of the
offer. In the case of tender offers, a fund must purchase shares at NAV
in order to be eligible for the exception. The exception applies only
insofar as the tender or repurchase offer is not oversubscribed.\303\
If a tender or repurchase offer is oversubscribed, suggesting that the
shareholders are not supportive of the change, a fund therefore would
then be required to conduct a shareholder vote prior to making the
change to its investment policy that the notice describes, in
accordance with the final rule. This change also gives a fund
discretion to determine the number of shares it is willing to
repurchase from shareholders after the notice of the change, in
accordance with all applicable Commission rules. This will permit fund
managers to weigh the risk of oversubscription, and the resulting need
to have a special shareholder meeting to vote on the change, against
the amount of liquidity they are willing to provide to shareholders.
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    \303\ ``Oversubscribed'' in this case means shareholders have
tendered or requested repurchase of a greater number of shares than
the fund has offered to purchase (or ultimately purchases) in
accordance with applicable Commission rules including rule 13e-4