On June 24, 2009, the Securities and Exchange Commission (SEC) proposed rule amendments designed to strengthen the regulatory framework for money market mutual funds, by making such funds more resilient to short-term market risks (the “Proposals”). The Proposals are intended to help prevent the kind of instability and shareholder runs that were experienced by money market funds last fall, when the Reserve Primary Fund’s net asset value fell below $1.00, or “broke the buck.” The proposed amendments to Rule 2a-7 under the Investment Company Act of 1940, as amended (the “1940 Act”), primarily seek to enhance the risk-limiting requirements of money market funds, increase the frequency of certain disclosures and promote the orderly and efficient liquidation of money market funds that may break the buck.
Specifically, the Proposals attempt to tighten the risk limiting conditions imposed on money market funds by:
- eliminating the ability of funds to purchase securities that are not of the highest quality (so-called “Second Tier Securities”)
- changing the weighted average maturity of money market funds to 60 days (from the current 90 days) and imposing a 120-day weighted average life limit
- increasing the liquidity of money market funds by:
- eliminating their ability to purchase illiquid securities (money market funds may currently invest up to 10 percent of their assets in illiquid securities)
- requiring funds to have certain minimum percentages of their assets in cash or securities that can be readily converted to cash to pay redeeming investors
- mandating “know your customer” requirements to determine which investors pose significant redemption risk
- requiring daily and weekly minimum stress tests
The Proposals also would increase the frequency with which portfolio holdings information is disclosed to both investors and the SEC. While money market funds are currently required to disclose such information on a quarterly basis (with information as old as 70 days permitted), the Proposals would require funds to disclose their portfolio holding information monthly, by posting it on their web sites and filing such information with the SEC. This information would need to be posted or filed within two business days following the end of each month.
In addition, the Proposals seek to lessen the negative impact on fund shareholders of a fund “breaking the buck” and deciding to liquidate. First, the Proposals would amend Rule 2a-7 to permit funds and their administrators to process purchase and redemption transactions at a price other than at a dollar. Second, the Proposals would permit money market fund directors to suspend redemptions if the fund breaks the buck and is facing a run on its assets. Third, the Proposals would remove the need for funds to seek no action assurances with respect to affiliate transactions concerning distressed assets (which are currently routinely approved) for those transactions that would be in the best interest of the fund.
In addition to the proposed rule amendments, the SEC has also asked for comments on more fundamental changes to money market regulation. These issues include:
- whether funds should be required to satisfy redemption requests in excess of a certain size through in-kind redemptions
- whether funds should effect shareholder transactions at the market-based net asset value (i.e., whether they should have “floating” rather than stabilized net asset values)
- an evaluation of the use of rating agencies in regard to portfolio securities
- whether funds should no longer be permitted to use the amortized cost method of valuation to maintain a stable net asset value of $1.00
While the SEC voted 5-0 to release the proposal for comment, there was disagreement regarding some facets of the amendments. Specifically, Commissioner Troy A. Paredes noted in his statements that he had reservations regarding the elimination of Second Tier Securities as a valid investment option for money market funds. Commissioner Paredes noted that he was “not aware of any evidence showing a causal link between Second Tier Securities and the stresses money market funds came under last year.” In addition, he also expressed concern regarding one of the issues raised for comment: whether money market funds should be required to disclose their market based net asset value per share (their “Shadow NAV”), which would differ from the $1 NAV that funds are required to maintain. The commissioner noted that the floating nature of the Shadow NAV would be a “major departure from the long-lasting stable $1 NAV.” In addition, Commissioner Kathleen Casey expressed “grave concern” regarding the continued reliance in the Proposals on NRSRO ratings. She noted that, in light of the discredited nature of these entities during the current crisis, we should be “acting to reduce investor and regulatory reliance on credit ratings…,” and not expand it.
The text of the proposed rules is not yet available and, accordingly, the descriptions provided in this special alert are based on the SEC press release and statements made by the commissioners and staff at the open meeting. The public comment period will run for 60 days following the publication of the proposals in the Federal Register.