This client alert, which addresses recent developments affecting money market funds, has been prepared by Jorden Burt's working group that is focusing on the current financial market dislocations.
Treasury Department's Implementation of Temporary Guarantee Program
The Treasury Department has now opened its temporary program to guarantee share values of money market funds. The program will be available to all publicly-offered money market funds that are registered with the SEC and seek to maintain a $1 share value in reliance upon Rule 2a-7 under the Investment Company Act. The program does not apply, however, to assets contributed to a fund after the close of business on September 19, 2008.
Participation in the program is not automatic, and funds wishing to participate must submit an application to the Treasury Department by October 8, 2008. Treasury has also now prescribed the fee that it will charge for participation in the program.
The Treasury Department has decided that, initially, the temporary guarantee program will last for only three months, after which Treasury will assess whether the program ought to be extended and, if so, on what terms. The program would not be extended beyond September 18, 2009, however.
Related Tax Issues
Tax exempt-money market funds may participate in the temporary guarantee program. The Treasury Department has indicated that the program will not be treated as a federal guarantee that jeopardizes the taxexempt treatment of distributions paid by tax-exempt money market funds.
Some in the industry have also raised a question about participation in the Treasury's temporary guarantee program by money market funds that support variable insurance products. Specifically, would such participation cause all of the money market fund's portfolio securities to be counted as "government securities" of a single issuer in violation of the diversification requirements of Internal Revenue Code Section 817(h)? We understand that the IRS has informally advised industry representatives that it would not view the program's share redemption value guarantee as making the Treasury the issuer of portfolio securities held by the money market fund. This conclusion is supported by the fact that the redemption value guarantee does not operate as a guarantee of payment of any security held by the money market fund, but effectively provides a form of "stable value" protection.
SEC Sweep of Money Market Funds
Last week the SEC's Office of Compliance, Inspections and Examinations issued "sweep" type examination letters to money market funds requesting information on any fall-out from the financial dislocations. The letters request information in advance of an on-site visit. The principal information that the SEC is requesting, for specified periods and dates, includes: the basic nature of a fund; shareholder subscriptions and redemptions; portfolio holdings; and trade blotters for transactions in securities and other financial instruments.
Alternative Eligible Securities
The seizing up of the market for mortgage-backed and other securities traditionally held by money market funds has pressed funds to seek out alternative eligible securities in pursuit of their investment objectives. This pressure comes at a time when, among other things, the SEC has proposed the elimination of reliance on the credit ratings of NRSROs in assessing the credit quality of eligible securities. Fund advisers and boards may find themselves, therefore, having to gear up to make more (and different) determinations of credit quality, as money market funds consider acquiring alternative eligible securities.
Money Market Fund Litigation
A recent complaint filed by Ameriprise Financial against the Reserve Primary Fund alleges, among other things, that the Reserve Primary Fund secretly "tipped" major institutional investors that the Fund was in serious danger of "breaking the buck" as a result of its exposure to debt securities issued by Lehman Brothers Holdings, Inc. Money market funds, therefore, may find it prudent to reassess their procedures for ensuring the confidentiality of any material non-public information about the identity of their holdings, the pricing of the fund's shares, or the valuation of the fund's assets. In response to such concerns, some money market funds are now making daily disclosure of their portfolio securities.
Prospectus/SAI Disclosure Revisions
Mutual funds, generally, are carefully considering whether recent developments require them to make any changes in their prospectus/SAI disclosure. Disclosures that money market funds, in particular, may need to consider include:
- Disclosure of the details of the Treasury's temporary guarantee program and the fact that the program is of limited duration and does not apply to assets contributed to a money market fund after September 19, 2008.
- Amended descriptions of Fannie Mae and Freddie Mac (including the nature and extent of government support of those institutions).
- Other recent developments in the markets for the instruments in which a money market fund invests, including any lack of securities available for purchase, illiquidity of portfolio investments or pronounced changes in yield.
- Changes in the types of securities in which the money market fund is investing, in light of market developments, and the related risks to which the fund is exposed.
- Any increased risk in decline in value of a money market fund's assets, as a result of financial instability of the particular entities in which the fund invests or the counterparties with which those entities or the fund itself has dealings.
- Any increased risk, in light of recent history, that a "run" of redemption requests could result in a decline of a money market fund's net asset value per share or delays in payment of redemption proceeds.
- In view of the limitations on the Treasury's temporary guarantee program, the risk that investors may be reluctant to make new investments in money market funds (or maintain current assets therein), and the implications of this for the future operations of the funds.