SEC Proposes New Name Rule to Stamp Out Misleading Fund Names and “Greenwashing “

According to the SEC’s “Names Rule,” investment vehicles like ETFs should have names that accurately reflect the product. On May 25, 2022, the SEC announced proposed amendments to the Investment Company Act “Names Rule” that would ensure a fund’s name matched its underlying investments. This particularly applies to funds with words like “Growth” and “Value,” as well as ESG—which stands for Environmental, Social, and Governance. ESG funds have skyrocketed in popularity in recent years—in 2020, assets in ESG funds passed $35 million.

Under the proposed amendment to the rule, if a fund has the word “Sustainable,” or “ESG” in its title, at least 80% of the underlying funds should comprise investments with sustainability in mind.

ESG and Greenwashing

This new rule is a part of an effort to combat “greenwashing.” The SEC believes certain funds have taken advantage of an increased consumer interest in environmentally friendly financial products and purposefully chosen misleading names for their funds.

“ESG” is a buzzy term in the financial industry—it stands for Environmental, Social Governance and indicates the funds’ investments are with companies that consider their environmental and social impact. Investors who care about socially and environmentally responsible investing should be able to trust that their “ESG” investment product will reflect that goal.

According to SEC chair Gary Gensler, “…Some funds have claimed that the [Name Rule] does not apply to them—even though their name suggests that investments are selected based on specific criteria or characteristics. [The proposed amendment] would modernize the Names Rule for today’s markets.”

What Are ESG Funds?

Environmental, Social, and Governance funds should only include investments from companies that have demonstrated a dedication to sustainability, social issues, and/or corporate governance—although priorities may vary from fund to fund. ESGs that emphasize corporate governance might examine how a company treats their employees, customers, and stakeholders. Social issue ESGs might concern themselves with human rights and economic inequality.

There is plenty of room for interpretation. Each ESG can choose their area of interest and strategy. Because each ESG is different, ESG funds should clearly state how they plan to achieve their socially conscious and/or environmental goals.

Name Rule Violations

The SEC is investigating DWS Group over allegations that the asset manager overstated its investments’ ESG standards. DWG fired their sustainability chief before releasing an Annual Report that stated, “As a firm, we have placed ESG at the heart of everything we do.” In contrast, their sustainability chief Desiree Fixler gave a presentation underlining that the firm had “no clear ambition or strategy” that would support their ESG label. According to The Wall Street Journal, an internal assessment stated, “only a small fraction of the investment platform applies ESG integration.”

The Name Rule for ESG Funds

You might be surprised by which companies appear in a fund labeled “ESG.” For instance, in May 2022 the S&P’s 500 ESG Index kicked Tesla out of the fund, even though the company makes zero-emission products. Meanwhile, Exxon remained. (The fund stated that their reasoning had to do in part with the risks posed by Tesla and the fact that its peers in the electric vehicle market had done more to increase their ESG score.) Still, an investor would probably assume that following Exxon’s many environmental lawsuits, it would not appear in a fund focused on sustainability.

Growth and Value Funds: How Will the SEC Define a “Growth” Investment?

The amended rule would also apply to investments with words like “growth” or “value” in their name. It remains to be seen how the SEC will define those terms. According to Morningstar, over 1,200 mutual funds and ETFs bear the “value” or “growth” label. Hopefully, the SEC will clarify that investments that come with a high degree of risk or steep fees will be excluded from using these terms.

How Do I Know My ESG Funds Are Compliant?

Not all ETFs are transparent about their investments. It can be difficult for an investor to assess their underlying securities. Look for ESG funds with clear disclosures.

If you believe your broker recommended an ETF that did not fit your investing goals, consider contacting an investment lawyer for a free case evaluation. Reach one of our experienced securities attorneys at (877) 600-0098 or info@kurtalawfirm.com.