SEC ‘Names Rule' Spawns More Questions Than Answers for CRE Funds
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The U.S. Securities and Exchange Commission (SEC) recently introduced a significant new rule, raising numerous queries and concerns among market participants, not least among them commercial real estate syndications and other funds.
As per this official release, "The Names Rule currently requires that an investment company with a name suggesting that the company focuses on a particular type of investment... to adopt an 80 percent investment policy."
Such regulations always come with the intent to protect, but they may also be accompanied by various complications.
Intended Use of the New SEC Names Rule
The primary intent behind the rule change is to bolster transparency and protect investors. If a company's name suggests it invests in a particular sector, type, or geography, the rule mandates that at least 80% of its assets must genuinely align with that claim.
But well-intentioned as this may seem, complying with it technically has come with many more questions than answers.
Liam Krahe, managing attorney at Cohen Property Law Group, PLLC, a national commercial real estate and securities law firm based out of Miami, FL, shed light on this, saying, "When we're saying West Texas Qualified Opportunity Zone Fund, that indicates not only the location but also the unique aspect of that investment, which is the qualified opportunity zone."
Qualified Opportunity Zones are areas designated under the 2017 Tax Cuts and Jobs Act wherein investors may receive targeted incentives for investment in these locations.
Challenges in Implementation
However, the introduction of the rule has given rise to multiple challenges, particularly for investment firms:
- Misleading Terminology: A company might unintentionally mislead investors even if their intentions are right. As Krahe mentioned, "So if I was not investing in qualified opportunity zones in West Texas, I could see why that would be misleading."
- Generic Naming: Companies might opt for more generic names to avoid complications, but this could counteract the SEC's intentions. Krahe points out, "You're just gonna have generic names, people are not going to want to go over and above and try to identify their fund."
- Layered Investments: There is an issue with funds which invest in other funds, making it complex to track the 80% asset rule. Krahe adds, "So, what happens with funds of funds? You're getting into multiple layers and you might not necessarily have full control from a fund management standpoint on the allocation of those assets."
The SEC's rule was designed with good intentions in mind, but as with many regulatory shifts, there are cobra effects; unintended consequences that can cause more harm than the original problem.
A Work in Progress
The SEC names rule surely aims to protect investors by ensuring transparency in investment naming. But the challenges in its implementation, as highlighted by experts like Liam Krahe, suggest that many further clarifications and tweaks may be needed.
Firms and funds may need to rethink their naming strategies and assess their investment focus to stay compliant, but does strict compliance necessarily serve the interests of investors? The answer to this question is one the SEC may have to ask per instance if it is to implement it fairly.
Genesis of the SEC Names Rule
The names rule was implemented on the heels of investor concerns certain funds were misleading investors as to what they invested in, using terms such as ESG, healthcare, and technology, for example, when the vast majority of invested funds were not in these areas.
Many real estate funds, in particular, are named for certain geographic areas or property types but have disclosed to their investors in no uncertain terms how they will invest, without regard to the fund's name. This is standard for institutional-grade investments.
This is a far cry from a fund that calls itself an ESG fund but actually invests with few such concerns, however. Discerning between funds seeking to gain through deception and those simply choosing a marketable name while disclosing terms completely is the order of the day.
The Bottom Line Is Still Forthcoming
The SEC is currently mulling over broad swathes of questions from market participants regarding the minutiae involved in compliance with the names rule, and the jury is still out as to exactly how the rule will be interpreted to serve its intended purpose without causing needless machinations among those affected.
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