Kabosu, the Shiba inu dog, known as "Doge," was an internet meme sensation. This adorable dog whose likeness as an avatar on a gold coin represented the digital asset, Dogecoin, but the expression of the dog had absolutely nothing to do with the satirical cryptocurrency. As a way to mock Bitcoin, the founders of Dogecoin created this “meme coin” and was able to capitalize on the adorable pup’s expression and well-established internet notoriety. Over the last few years, Dogecoin has been riding a rollercoaster of popularity, which is usually re-peaked periodically due to Tik-Tok or Reddit campaigns. Almost as quickly as this “dog coin” rises to fame, the value of the digital asset’s value crashes just as quickly, leaving several investors as examples of those who failed to heed SEC warnings of due diligence beyond the “name” of a fund or digital asset. This is merely and hopefully a relatable example to those outside of the blockchain, and one which shows the public policy bases behind the 2023 amendments. The Securities Exchange Commission (SEC) is trying to protect investors from poor investment decisions made based on the assets name or what that name might represent the asset to be.
On October 13, 2023, the SEC adopted amendments to 17 CFR 270.35d–1 (“rule 35d–1”) under the Investment Company Act which goes into effect on December 11, 2023. These Amendments expand the scope of the existing rules in effect and will have a major impact on cryptocurrencies as well as traditional funds. These new rules have been designed to protect investors significantly. Digital currencies and traditional funds must toe the line with the new provisions and there appears to be no room for mistakes or oversight in its compliance requirements.
The 2023 amendments to the “name rule” expanded the rule's 80% investment policy requirement beyond its current scope. As of December 11, 2023, any newly registered asset or fund name with terms suggesting that it focuses on investments that have particular characteristics will be subject to these expanded rules. Fund names with terms such as “growth,” “value,” or the overused “greenwashed” ESG terms within the assets name and/or which indicate the fund's investment decisions to incorporate one or more ESG factors, must actually comport to the fund’s moniker. If a fund’s name suggests a focus on a particular type of investment, investments in a particular industry, a geographic focus, or that the fund's distributions are tax-exempt, the new rules mandate that those funds must show 80% of the assets comport to what is within the fund or assets name.
Future cryptocurrencies must be mindful of these amendments when picking their names, and anything misleading to the public and/or investors is subject to scrutiny and consequences by the SEC, especially if the funds do not actually put their money into what or where their name indicates they do. If a digital asset calls itself “Green Growth Coin”, it had better be investing 80% of its assets into growing green initiatives or something that matches the definitions found in its prospectus. Under the 2023 rules, beware of prospectus definitions that are misleading. For example, the prospectus could define “Green Growth” as a cannabis cultivation initiative and “Coin” as a physical coin rather than digital asset, but those definitions would not comply with the new “plain English” rules of definitions found in a prospectus.
This includes requirements that any terms used in the fund's name that suggest an investment focus or tax-exempt distribution must be consistent with those terms plain English meaning or established industry use. Funds must report the value of the fund's 80% basket, and if said funds in the basket actually match the definition(s) of terms used in the fund's name. All funds must report their findings on the third month of every quarter. The new rules include recordkeeping provisions related to a fund's compliance with this new rule's requirements.
The new compliance component requires funds to review its portfolio assets inclusion in its “80% basket” quarterly. Digital assets and cryptocurrencies must ensure that investments of these assets are “under normal circumstances” at the time a fund invests its assets. The fund only has 90 days to get back into compliance once it departs from the 80% requirement per the new rules. There are some exceptions to this rule, but none of those apply to digital assets.
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