In the past 48 hours, the Department of the Treasury, Federal Reserve and the Securities and Exchange Commission have announced several emergency measures that are designed to restore order to the financial markets. The measures that directly affect mutual funds and/or hedge funds are discussed below along with details, as we know them, at the present time.
Insurance Program for Money Market Mutual Funds: This morning, the U.S. Treasury announced that it would establish a temporary one-year guaranty program to insure the holdings of any publicly offered retail or institutional money market mutual fund. All funds regulated by Rule 2a-7 of the Investment Company Act of 1940 are eligible to participate in the program; as announced, the program does not appear to cover privately offered “2a-7 like” funds. Funds must pay a fee to participate, although the premium amount is not currently known. The money will come from the $50 billion Exchange Stabilization Fund, established by the Gold Reserve Act of 1934 to help the Secretary of the Treasury formulate and implement U.S. international monetary and financial policy. The Fund is one way that the Treasury can spend money without the consent of Congress.
Financial Stock Short Selling Halted; SEC Issues Naked Short Selling Rules: The SEC • issued an emergency order, effective immediately, that temporarily bans short selling in financial companies. The ban covers 799 financial stocks. The order excepts registered market makers, block positioners or other market makers obligated to quote in the OTC market that are selling short as part of bona fide market making. It also excepts short sales that occur from the automatic exercise or assignment of an equity option held prior to the effectiveness of the emergency order due to expiration of the option.
Options market makers are excepted from the requirements of the order until 11:59 p.m. today when selling short as part of bona fide market making and hedging activities related directly to bona fide market making in derivatives on the financial securities. However, the SEC staff released a statement this afternoon saying that they recommended to the SEC that it modify the order to extend an exemption for hedging activities by exchange and over-the counter market makers in derivatives on the securities covered by the order. At this time, it is not known whether the SEC will adopt the staff’s recommendation.
The order, which can be found at http://www.sec.gov/rules/other/2008/34-58592.pdf, terminates at 11:59 p.m. ET on Oct. 2, 2008 but may be extended beyond 10 business days, but not for more than 30 calendar days in total duration. The U.K. Financial Services Authority took similar action yesterday.
In addition, earlier this week, the SEC issued another emergency order adopting new rules aimed at curbing naked short selling. The rules became effective yesterday and terminate at 11:59 p.m. on October 1 unless extended by the SEC. One requires short sellers and their broker-dealers to deliver securities by the close of business on the settlement date (T+3). If a short sale violates this close-out requirement, brokerdealers acting on the short seller’s behalf are prohibited from further short sales (for any customer) in the same security unless the shares are not only located but also preborrowed. The SEC is seeking comment during a 30-day period and expects further rulemaking at the end of that period.
The SEC also adopted Rule 10b-21, a short selling anti-fraud rule, which covers short sellers who deceive broker-dealers or other market participants. The rule makes clear that those who are deceptive about their intention or ability to deliver securities in time for settlement violate the law when they fail to deliver. The rule is not intended to limit or restrict the general antifraud provisions of other federal securities laws. The order for the rules can be found at http://www.sec.gov/rules/other/2008/34-58572.pdf.
Temporary Reporting of Short Selling by Institutional Money Managers Required: Institutional investment managers who filed or were required to file Form 13F for the calendar quarter ended June 30, 2008 under section 13(f) of the Securities Exchange Act of 1934 and Rule 13f-1(a) will now be required to file a report with the SEC on new Form SH to disclose their short positions. The form must be filed on the first business day of every calendar week immediately following a week in which the managers effected short sales.
The form, which must be filed electronically and will be publicly available on EDGAR, requires disclosure of: 1) the number and value of securities sold short for each section 13(f) security (except for short sales in options), 2) the opening and closing short positions, 3) the largest intraday short position, and 4) the time of the largest intraday short position during each calendar day of the prior week. The disclosure applies only to short sales effected after the effective date of the Order, 12:01 a.m. EDT September 22, 2008.
Filings will not be required when short sales of section 13(f) securities have not been effected since the prior Form SH filing. In addition, institutional investment managers do not need to report positions if 1) the short position in the section 13(f) securities is less than one-quarter of 1% of the class of the issuer’s section 13(f) securities issued and outstanding as reported most recently by the issuer to the SEC, unless the manager has reason to believe the information is inaccurate and 2) the fair market value of the short position is less than $1,000,000.
The first Forms SH are required to be filed on September 29, 2008; the Order terminates at 11:59 p.m. on October 2, 2008 unless further extended by the SEC. Form SH can be found at http://www.sec.gov/about/forms/formsh.pdf and the instructions can be found at http://www.sec.gov/about/forms/formsh_instructions.pdf.
Federal Reserve Will Lend to Banks to Meet Money Market Mutual Fund Redemption Demands: The Federal Reserve Board announced today that it will extend nonrecourse loans at the primary credit rate to U.S. depository institutions and bank holding companies to finance the purchase of high quality asset-backed commercial paper (“ABCP”) from money market mutual funds. In a statement, the Fed said that it anticipates that the loans will assist the funds in meeting demands for redemptions and foster liquidity in the ABCP markets.
Accounting for Capital Support Agreements: The SEC’s Office of the Chief Accountant clarified this week that a financial institution’s support of its money market mutual funds generally does not result in a requirement to present the fund on the institution’s balance sheet. The SEC believes that on-balance sheet accounting is not required if the bank does not absorb the majority of the expected future risk in connection with the fund’s assets – including interest rate, liquidity, credit and other risks that can affect money market net asset values. The SEC emphasized, however, that disclosure of the capital support provided was expected in the institution’s SEC filings. Finally, the SEC encouraged financial institutions to contact the Office of the Chief Accountant to discuss issues related to the presentation of money market mutual funds in the financial statements if the nature of the support would expose the institution to a majority of the expected risk.