November 2009
Inside this issue:
IDC Task Force Issues
Report on Board Oversight
of Compliance............................ 1
ICI/IDC Overviews Relationships
Between Mutual Funds and
Financial Intermediaries............. 4
SEC Proposes Changes to NYSE
Governance Requirements........ 6
IDC Task Force Issues Report on
Board Oversight of Compliance
A special task force of the Independent Directors Council (IDC) recently
published a report that seeks to “explore how funds have developed and
implemented their compliance programs.” The report also highlights “what
the task force believes to be certain core characteristics of a successful
compliance function.” According to the task force, there is not a “one size fits
all” approach when it comes to compliance. The report explains that the goal of
the task force was “to prompt critical thought and greater awareness of the
differing practices that permeate the compliance landscape.”
IDC Comments on Governance
Disclosure Proposal................... 7
SEC Removes Rating References
from Some Rules, Seeks
Comment Regarding Others ...... 8
IDC Weighs In on Money Market
Common Themes Regarding Compliance
The report notes that “there seem to be some common themes among fund
groups regarding the mission of compliance and the philosophy that drives it.”
According to the task force, examples of these themes include:
•
“Compliance is everyone’s responsibility. Employees of the fund’s adviser
and other service providers, including portfolio management and back office
personnel, represent, effectively, the front lines of all parts of the business,
including compliance. While compliance personnel oversee the compliance
program, each business unit should ‘own’ the portion of the compliance
program that is applicable to it;
•
Compliance should be structured as a collaborative function that enhances
fund operations, rather than as a ‘gotcha’ function whose goal is to
seek out and punish outliers. [T]he manner in which each [compliance]
concern is identified and each solution is pursued could have long-term
implications for the way in which compliance is perceived in the
organization. When compliance is approached in a constructive manner,
even when confrontation may be required, it likely will be more effective
than when approached punitively;
•
Compliance should be proactive and anticipatory. [A] compliance program
that relies on a thoughtfully developed testing program, is ever-evolving, and
seeks to accommodate changing circumstances and anticipate tomorrow’s
concerns today, can help prevent compliance issues; and
•
Compliance should seek to educate. CCOs should engage with business
units on initiatives to maintain an appropriate level of compliance awareness
regarding the fund complex. This is especially important as the fund
organization changes, the business and regulatory environment evolves or
becomes more complex, and new or existing staff take on new
responsibilities.”
Fund Proposal ........................... 9
SEC Adopts Temporary Rule on
Disclosure of Money Market Fund
Portfolio Holdings..................... 11
SEC Announces New Division
of Risk, Strategy and
Financial Innovation................. 12
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offices located in North America, Europe,
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represents capital markets participants,
entrepreneurs, growth and middle
market companies, leading FORTUNE
100 and FTSE 100 global corporations
and public sector entities. For more
information, please visit
www.klgates.com.
Suggestions for Boards
•
The task force report includes specific
suggestions and questions that boards can
consider in evaluating and overseeing various
aspects of compliance. These suggestions and
questions include:
Does management appropriately consider and
. . . implement compliance-related
recommendations made by the CCO;
•
Is the CCO free to speak with employees,
including senior management, and conduct
reviews and investigations or inquiries when
he or she deems it necessary; and
•
Does the CCO feel subject to undue influence
from the adviser regarding his or her
communications with the board or potential
findings of material compliance matters?”
Helping to define the mission and goals
of compliance
•
“Maintaining an ongoing dialogue with
management and the fund CCO regarding the
board’s expectations, including how to
address those expectations, and the level of
resources available to the CCO;
•
Emphasizing the need to maintain a strong
culture of compliance that focuses on
adherence to both the letter and spirit of
the law;
•
Providing meaningful feedback on the
compliance program and the CCO’s
performance, including when approving the
CCO’s compensation; and
•
Inquiring about the processes in place
to address compliance problems when
they arise.”
Matters that boards can address with the fund
CCO in executive session
•
“Material Compliance Matters. [I]t can be
helpful for the board and CCO to discuss the
circumstances under which a matter may be
deemed ‘material’ as well as the extent to
which the board should play a role in that
determination;
•
Significant compliance matters. Frequently,
boards want to know about matters that may
not rise to the level of ‘material’ but may
nevertheless be important;
•
Potential and existing conflicts of interest.
Regulators have persistently emphasized the
need for CCOs and boards to focus on
existing or potential conflicts of interest.
Often, compliance challenges arise in
connection with these conflicts;
•
The CCO’s staffing and support. The
executive session offers the board the
opportunity to hear the CCO’s views
regarding the adequacy of the staffing and
support the CCO receives in fulfilling his or
her duties;
•
The CCO’s relationship with the adviser’s
management. [T]he board and CCO [may]
discuss the effectiveness of the CCO’s
reporting relationships within the advisory
organization, access to the investment
adviser’s operations and personnel, and other
elements of the CCO’s relationship with the
adviser’s management; and
•
Confirmation that the CCO has not been
subject to undue influence.”
Evaluating management’s “tone at the top”
•
“What are the amount and quality of resources
that the adviser dedicates to compliance and
are they effectively utilized;
•
How effectively do the various areas of the
organization that are most related to
compliance interact with compliance
personnel;
•
How well do the CCO and compliance
personnel interact with the service providers;
•
Is the compliance function treated as an
important and legitimate part of the business
or a necessary evil;
•
How has the adviser responded to and
resolved previous compliance violations;
•
Has the adviser fulfilled in a timely fashion
all commitments it has made relating to
compliance;
•
2
How does the adviser’s senior management
team . . . interact with the fund CCO;
November 2009
Investment Management Update
Evaluating a compliance program
•
•
•
•
“The nature and frequency of significant or
material compliance matters. A board can
gauge the efficacy of a compliance program
by considering how compliance violations are
identified, the seriousness of those violations,
how frequently they arise, and whether they
seem to recur within a specific business unit
or arise more broadly in different parts of
the organization;
The existence of a thoughtful testing protocol.
[A] director’s reliance on the CCO’s
evaluation has to be based on a rule of reason.
As such, it is important for directors to have a
fundamental understanding of and comfort
with the CCO’s testing and other due
diligence, including, for example, site visits to
or reasonable reliance on certifications from
service providers or auditor reports that forms
the basis of the CCO’s conclusions;
•
•
The formulation of an effective risk
assessment. Risk-based compliance
programs… can often anticipate and help
prevent compliance problems by virtue of the
resources and attention that are focused on
parts of the organization that are deemed to
involve the highest risk; and
The results of regulatory examinations and
responses to findings. The soundness of a
compliance program can be considered
against the backdrop of the results of recent
regulatory examinations and a fund service
provider’s response to those results.”
Evaluating the CCO
•
o
“Expertise and effectiveness, including:
o
whether the CCO appears to be
sufficiently familiar with the
operations of the fund and its service
providers and with applicable law;
o
the CCO’s success in identifying and
addressing compliance concerns;
o
the CCO’s ability to identify and
monitor conflicts of interest;
o
whether the CCO is proactive or
reactive in fulfilling his or her
responsibilities; and
•
the quality and appropriate focus of
testing conducted by the CCO of the
fund’s, adviser’s, and other service
providers’ policies and procedures.
Communications with and reporting to the
board, including:
o
the substance and organization of the
CCO’s written and oral reports to the
board;
o
whether the CCO responds
appropriately to questions and
concerns raised by the board; and
o
whether the CCO is proactive in
communicating with the independent
chair… between board meetings.
Leadership and management skills, including:
o
the CCO’s ability to work with
management and effectively use the
resources available to him or her;
o
the CCO’s leadership skills and
ability to develop and/or work within
a team;
o
the CCO’s organizational and
managerial skills; and
o
the CCO’s integrity and ability to
remain composed and measured
under pressure.
Independence.”
Defining Success
While warning that there is “no one ‘right’
approach to compliance,” the task force
outlined several characteristics that “evidence a
strong compliance regime.” These include:
•
“Tone at the top. The hallmark of a good
compliance program is a strong, ethical, and
compliance-oriented tone emanating from the
adviser’s leadership team and the fund’s
board;
•
Collaboration. CCOs who are able to
undertake their role and responsibilities in a
collaborative manner earn the board’s
confidence, garner management’s respect,
and run compliance programs that identify
3
and address difficult compliance matters in a
professional and effective manner;
•
Risk-based compliance. While every fund
group’s compliance program is tailored to
monitor adherence to applicable laws and
regulations, an effective compliance function
is based on an understanding that fund
compliance requires a continuous and
thoughtful appraisal of risk areas that are
specific to the fund and the adviser’s business;
•
Transparency and candor. Transparency and
candor are important in any discourse about
compliance, whether it is between the CCO
and the board, the CCO and management, or
among all three. Anything short of it may
detract from a relationship of trust; and
•
Effective people and resources.
Conscientious, knowledgeable, and
resourceful compliance personnel (including
the CCO), armed with appropriate resources,
are key contributors to an effective
compliance program. Indeed, many of the
other characteristics of a strong compliance
regime are achieved, in part, through the
actions and leadership of highly effective
compliance personnel.”
Readers can access the report in its entirety by
visiting the Investment Company Institute website
at http://www.ici.org/pressroom/news/09_news_
idc_cco_paper.
___________________________________
ICI/IDC Overviews
Relationships Between
Mutual Funds and Financial
Intermediaries
In early October, the Investment Company
Institute (ICI) and IDC issued a White Paper
entitled Navigating Intermediary Relationships
(White Paper), which explores “the operational
interaction between mutual fund complexes and
intermediaries selling funds and servicing
shareholders.” The ICI and IDC explain that
boards of directors are generally responsible
for oversight of a fund’s financial
4
November 2009
intermediaries, and should have “a general
understanding” of fund methods for distribution
and shareholder servicing as well as the
compensation paid to any intermediary carrying
out those functions.
The white paper was “developed primarily to
provide fund directors with background
information about intermediaries and funds’
relationships with them,” and, to that end, focuses
on the following themes: types of financial
intermediaries participating in the mutual fund
industry; processing efficiencies and interaction
points between funds and their intermediaries;
monitoring of intermediary activities;
intermediary compensation; and regulatory and
other compliance concerns.
Role of the Intermediary. Financial
intermediaries, including broker/dealers, banks,
fund supermarkets, insurance companies,
financial advisers, fund platforms, and retirement
plans – all explored in detail in the ICI/IDC
White Paper – provide shareholder services, such
as investment advice and trade execution.
Intermediaries, the white paper acknowledges,
offer investors the “convenience of a single point
of contact for financial planning expertise and
other services for all of their investments,” a wide
variety of investment options, and “cost-effective
trade, account maintenance, and communications
support.” Intermediaries also assist funds by
helping with account maintenance, tax, and
compliance services, and sometimes dividend and
capital gains disbursements to shareholders.
Accordingly, intermediaries can serve as an
important “bridge between mutual funds and
their shareholders.”
The White Paper explains that, fundamentally,
the relationship between funds and intermediaries
is a “bidirectional exchange of information”
relating to shareholder transactions. In the United
States, this exchange occurs principally through
two automated facilities: the National Securities
Clearing Corporation’s “Fund/SERV” system for
financial transactions as investor purchases and
redemptions, and its “Networking” system for
non-financial transactions like changes to
shareholder account details. Both of these
automated processing systems – and the
important differences between the individual and
Investment Management Update
omnibus accounts they service – also are
discussed in detail in the White Paper.
Oversight and Compliance. Because financial
intermediaries “perform a vital range of
compliance functions for funds,” directors’
oversight of them may require consideration of
the “adequacy and effectiveness of an
intermediary’s compliance controls.” The White
Paper urges that the focus of fund boards of
directors and fund managements in overseeing
financial intermediaries should be the
achievement of “greater levels of
transparency” with respect to transaction
processing, beneficial shareholder information,
and assurances regarding compliance controls.
The White Paper emphasizes that certain
automated tools are available to assist directors
and fund advisers in their oversight of financial
intermediaries, including the ICI’s omnibus
attestation compliance framework, the Client Data
Share initiative, and the Standardized Data
Reporting system, which was developed in
response to the redemption fee requirements of
Rule 22c-2 under the Investment Company Act
of 1940 (1940 Act).
Compensation. Financial intermediaries, the
White Paper states, are paid “for performing
services that would otherwise need to be provided
by the fund complex,” with many funds
compensating intermediaries directly or indirectly
through the fund transfer agent or another fund
affiliate, such as its distributor. According to the
White Paper, the compensation structure
between a fund complex and an intermediary is
self-determined, governed only by the
intermediary’s “unique business model and the
competitive forces within the industry.”
The White Paper discusses the various forms of
intermediary compensation paid by mutual funds
and/or their affiliates, including fees under Rule
12b-1 under the 1940 Act, finders’ fees, and
revenue sharing programs. It also describes the
compensation paid by fund shareholders through
front-end or contingent deferred sales charges, as
well as the methods for calculating intermediary
compensation: asset-based and transaction-based
fees; fixed-amount and scaled, or tiered, servicing
fees; and negotiated compensation.
Trends and Issues. Recent movement in the
mutual fund industry towards defined
contribution plans and aggregated, or omnibus,
shareholder accounts, “reduce the number of
individual accounts on fund complexes’ books
relative to all shareholder accounts and leave fund
complexes with less information about the
accounts and activities of beneficial
shareholders.” The ICI and IDC suggest that in
order to address such trends, fund management
and intermediaries should “work together to
seek alternatives for data exchange to meet
shareholder servicing, fund administration,
and compliance needs and requirements,” to
create “an appropriate and cost-effective control
environment for the protection of shareholder
interests” and to ensure “adherence to regulatory,
prospectus, and other fund-mandated
obligations.”
The White Paper explains that, because
intermediaries are not usually affiliates of a fund
group, fund complexes often have “limited
input” on the “business model, processing and
procedural routines, computer systems, vendors,
and target market” of their intermediaries.
Directors thus need to be aware of the “legal,
regulatory, and contractual requirements, as
well as competitive market forces” that do
constrain the choices and activities of financial
intermediaries.
Questions for Directors. To assist boards of
directors in complying with their legal obligations
and regulatory requirements, the White Paper sets
forth a number of questions to assist directors in
their oversight of financial intermediaries:
•
What types of intermediaries sell the fund’s
shares?
•
What is the distribution strategy associated
with each of the intermediary partners?
•
What services are provided to fund
shareholders by each type of intermediary?
•
How are the intermediaries compensated?
Do the distributor, adviser, and/or any other
party pay additional fees to the intermediaries
through revenue sharing payments? If so,
what is the purpose of the revenue sharing
payments, and how are they calculated?
5
•
securities first trade on the NYSE, rather
than the date the securities first are listed.
The requirements include: (1) each audit
committee member must be an independent
member of the board of directors; (2) the
committee must oversee the work of any
public accounting firm engaged to issue audit
reports; (3) the committee must have
authority to engage independent counsel and
other advisers; (4) the committee must have
procedures for receipt of complaints; and (5)
the committee must determine appropriate
compensation for auditors and advisers.
What are the processes for monitoring
intermediaries’ compliance with regulations
and fund policies, for example, redemption
fee policies under Rule 22c-2?
The White Paper is available at
http://www.ici.org/
pdf/ppr_09_nav_relationships.pdf.
___________________________________
SEC Proposes Changes to
NYSE Governance
Requirements
•
Phase-in of Audit Committee. Companies
listing in conjunction with an IPO may phase
in audit committee membership by having
one independent director by the date the
company’s securities first trade on the
NYSE, a second member within 90 days of
the listing date, and the third within one
year of the listing date. Current regulations
require that companies have at least a threeperson committee by the listing date, which
can allow companies to appoint interested
directors to the audit committee to satisfy the
three-person requirement.
•
Closed-End Fund Exemptions. The proposals
retain existing exemptions for closed-end
funds, which need not:
The Securities and Exchange Commission
(SEC) is considering proposed changes to the
corporate governance requirements set forth in
the Listed Company Manual of the New York
Stock Exchange (NYSE).
The proposed changes that would affect closedend funds and ETFs traded on the NYSE include:
•
Required Discussion of Fund Performance.
Currently, a listed company’s audit committee
must: (1) annually review the auditor’s report
on the firm’s internal quality-control
procedures and its relationships with the listed
company; and (2) review and discuss with
management and the auditor the company’s
audited financial statements, including
“Management Discussion and Analysis”
disclosures in its shareholder reports.
Although closed-end funds are not required to
provide MD&A disclosure, the proposed rules
state that if a closed-end fund voluntarily
includes a section on “Management
Discussion of Fund Performance” in its
shareholder report, its audit committee
must review and discuss it.
•
Streamlined Certification Requirements. A
listed company must notify the NYSE after
any executive officer becomes aware of any
non-compliance. Currently, they need only
report “material non-compliance.”
•
Audit Committee Requirements. Companies
listing in conjunction with an IPO must
comply with several audit committee
requirements by the date the company’s
6
November 2009
o
Comply with director
independence requirements. The
manual states that a director is not
independent, if the director: (a) is an
employee of the company; (b)
received more than $120,000 in direct
compensation from the company
during any twelve-month period in
the last three years, excluding fees
and deferred compensation; (c) is a
partner at the company’s auditing
firm; (d) in the last three years was an
executive officer of another company
where any current officers of the
listed company served on a
compensation committee; or (e) is
employed by a company that earned
or spent the greater of $1 million or
2% of the company’s gross revenues
to purchase property from, or sell it
to, the listed company.
Investment Management Update
o
o
Disclose a determination of a
director’s simultaneous service on
multiple audit committees.
Currently, a board must determine
that simultaneous service on three or
more audit committees “would not
impair the ability of such member to
effectively serve on the listed
company’s audit committee” and
disclose this determination in an
annual report or proxy statement.
However, given the common
practice of directors serving on
multiple boards within a fund
complex, a director’s service on the
audit committees of multiple boards
in the same fund complex will be
counted as membership on only one
committee for purposes of this
requirement.
“specific experience, qualifications,
attributes, or skills that qualify [a] person to
serve as a director and as a member of any
committee that the person serves on or is
chosen to serve on (if known).” The IDC
stated that “disclosure of objective, factual
information, such as the experience of a
director or nominee, may be informative to
investors,” but objected to the inclusion of
“subjective matters of opinion, such as the
‘qualifications,’ ‘attributes’ or ‘skills’ of
the director or nominee,” in any new
disclosure requirements. According to the
IDC, those terms “suggest that certain
qualities or personality traits are preferable
for a fund board” and could “inadvertently
regulat[e] the composition of fund boards.”
•
New disclosure about board leadership
structure. The SEC’s proposal would require
a fund to disclose whether its board chair is
an “interested person” of the fund, and if so,
whether the board has a lead independent
director and what that person’s role is. The
IDC supported this disclosure requirement,
stating that “mandating disclosure as to
whether boards have an independent chair
would be preferable to mandating that all
fund boards elect one.” The IDC noted that
“this approach appropriately permits boards
to have the discretion to determine for
themselves the leadership structure that works
best for them and the funds they oversee,”
urging the SEC to “take formal action to
close the pending issue of whether boards are
required to elect an independent chair.”
•
New disclosure about board role in the risk
management process. The IDC opposed the
SEC’s proposed disclosure requirement
relating to the board’s role in the risk
management process, stating that the
proposal “improperly implies that the fund
boards should have a hands-on role in a
fund’s day-to-day risk management
function.” The IDC stated that it “firmly
believes that this should not be the case and is
inconsistent with the oversight role of the
board.” IDC also noted that “the proposal
fails to take into account the business model
of investment companies and the risk
disclosures that they already provide.”
Make its audit committee charter
available on its website.
Comments on the proposals were due October 5.
If the SEC approves the changes, they
are expected to become effective
January 1, 2010.
___________________________________
IDC Comments on
Governance Disclosure
Proposal
The Independent Directors Council recently
commented on the SEC’s proposal to “enhance
the compensation and governance disclosures
required by . . . investment companies.” The IDC
“strongly supports the [SEC’s] efforts to enhance
the quality of disclosures made to investors,” but
objects to certain elements of the proposal that
“would not provide useful information to
investors or would inappropriately suggest board
involvement beyond oversight in fund
management level activities, such as risk
management.” The IDC offered the following
specific comments:
•
Enhanced director and nominee disclosure.
The SEC proposed to require disclosure of the
7
•
Application and location of new disclosure.
The IDC agreed with the SEC’s proposal to
include any new disclosure requirements in
fund proxy statements and statements of
additional information.
The comment period for the proposed rules
expired on September 15.
___________________________________
SEC Removes Rating
References from Some
Rules, Seeks Comment
Regarding Others
The SEC recently eliminated references to
credit ratings provided by nationally
recognized statistical rating organizations
(NRSROs) from several securities rules and
forms. Yet, in a companion release, the SEC
deferred action on similar proposals to other rules
and instead reopened the comment period for
those proposals.
Adopted Proposals
Stating that “the references to credit ratings in
these rules and forms are no longer warranted
as serving their intended purposes,” the SEC
removed the references to NRSROs from certain
1940 Act Rules, among others. The SEC
explained that the existing credit rating
references “could create the appearance that
the Commission had, in effect, given its ‘official
seal of approval’ on ratings, which could
adversely affect the quality of due diligence and
cause undue reliance on NRSRO ratings.”
The adopted changes affect the following
1940 Act rules:
Rule 10f-3. Section 10(f), which prohibits fund
purchases of securities from a syndicate in which
a fund affiliate serves as principal underwriter, is
intended to prevent “dumping” of unmarketable
securities on affiliated funds. Generally, Rule
10f-3 permits funds to purchase “eligible
municipal securities” from the syndicate as long
as these securities are of a sufficient quality to
assure marketability, which the rule defined as
8
November 2009
having an investment grade rating from at least
one NRSRO.
The amendment redefines “eligible municipal
securities” as “securities that are sufficiently
liquid that they can be sold at or near their
carrying value within a reasonably short period of
time,” and are “(1) subject to no greater than
moderate credit risk; or (2) if they are less
seasoned securities, subject to a minimal or low
amount of credit risk.”
The new rule requires boards of directors to
determine if eligible municipal securities are
sufficiently liquid and carry a low amount of
credit risk. But according to the SEC, the new
definition of eligible municipal securities
“require[s] a level of liquidity and credit quality
that is very similar to that of the current rule, but
without the reference to NRSRO ratings.” The
SEC added that removal of the NRSRO reference
“may possibly benefit funds by enabling them to
acquire a wider range of securities, including
unrated securities, that present attractive
investment opportunities and the requisite level of
credit quality, even though they do not meet the
current rule’s ratings requirement.”
Responding to concerns that the new standard is
less precise and could “increase the time and
costs of the board of directors’ oversight” and
produce less consistent board assessments, the
SEC stated that boards “may incorporate ratings,
reports, analyses, opinions and other assessments
issued by third-parties, including NRSROs,
although an NRSRO rating, by itself, could not
substitute for the evaluation performed by the
board.” The SEC states that a board could
incorporate use of third-party assessments it
deems reliable into its procedures for evaluating a
security’s credit risk and liquidity. As such, the
SEC states, “[t]he ability to incorporate outside
assessments may mitigate the potential
increased burdens.”
Rule 5b-3. The current rule allows a fund to treat
an acquisition of refunded securities as an
acquisition of U.S. government securities for
purposes of the 1940 Act’s diversification
requirements if: (1) an independent accountant
certifies to an escrow agent that the government
securities will satisfy all scheduled payments on
the refunded security, or (2) the refunded security
Investment Management Update
received the highest debt rating category from
an NRSRO.
Under the new rule, “the accountant
certification condition would apply uniformly
to all refunded securities, regardless of the
securities’ credit rating.” The SEC stated that
“a fund could satisfy the certification requirement
of Rule 5b-3 by determining that . . . an NRSRO
. . . already has determined that an independent
accountant provided the required certification to
the escrow agent,” and, as such, “it will not be
difficult or expensive for fund managers to
confirm that the certification has been
provided to the escrow agent.”
letter, however, objected to certain aspects of
the proposal that would potentially expand the
role of the fund board, noting that it is
“troubled that the proposal perpetuates past
tendencies of the [SEC] to address perceived
regulatory gaps by assigning to fund boards
specific, management-level responsibilities.”
According to the IDC, the board’s role should be
“to provide appropriate and meaningful oversight,
and not cross the line into management of the
fund.”
The following were among the topics addressed
by the IDC’s letter:
•
Distinguishing institutional and retail funds.
The SEC proposed to add a liquidity standard
to the money market fund rule, which would,
among other things, establish different
minimum daily and weekly liquidity
requirements for “institutional” and “retail”
funds and make fund boards responsible for
determining whether a fund is “institutional”
for these purposes. Although the IDC
supports adding a liquidity standard,
“it strongly objects to the proposal to
make fund boards responsible for the
institutional fund determination,”
suggesting instead that “it should be the
adviser, which has the expertise, and not the
board, that makes the determination for this
purpose.”
•
Stress testing. The SEC proposed requiring
money market fund boards to adopt
procedures for periodic stress testing of a
fund’s ability to maintain a stable NAV based
upon certain hypothetical events. The IDC
supported a stress testing requirement but
suggested that the fund, rather than the
board, be responsible for adopting the
procedures, noting that the distinction “is
important to reflect the board’s appropriate
oversight role.”
•
Credit rating agencies. The SEC sought
comment on whether to eliminate references
to credit rating agencies in the money market
fund rule and whether fund boards should
designate three or more rating agencies that
the fund would look to for determining
whether a security is an eligible security.
The IDC objected to both proposals, noting
The amended rules take effect
November 12, 2009.
Deferred Proposals
Citing “regulatory developments, comments
received on the proposals, and the continuing
public interest in the Proposing Releases,
particularly in light of recent economic
events,” the SEC declined to take action on
similar proposals to remove credit rating
references from other rules including the money
market fund rule (Rule 2a-7 under the 1940 Act).
The SEC is soliciting comments, in part, on
whether there are “other objective measures of
credit risk, and should they be used in place of
NRSRO ratings to address the concerns
addressed by the rules.” The reopened comment
period will extend through December 8, 2009.
___________________________________
IDC Weighs In on Money
Market Fund Proposal
The Independent Directors Council recently
commented on the SEC’s proposed amendments
to the money market fund rule, which were
summarized in the August edition of this
newsletter. The IDC generally supported the
SEC’s objective to “increase money market funds’
resilience to short-term market risks and provide
greater protections for shareholders of a money
market fund that is unable to maintain a stable net
asset value per share.” The IDC’s comment
9
that it “continue[s] to believe that removing
the [credit rating agency] requirement
would weaken the investor protections
embodied in [the rule], to the detriment of
fund shareholders.” The IDC also stated
that “[w]hile the designation of a limited
number of [credit rating agencies] for
purposes of a money market fund’s
compliance with [the rule] may be advisable,
IDC objects to the proposal to involve fund
boards in this operational function.”
•
•
•
10
Asset-backed securities. The SEC requested
comment on whether the rule should explicitly
require fund boards (or their delegates) to
evaluate whether a structured investment
vehicle or other asset-backed security includes
any committed line of credit or other liquidity
support and whether there are other factors the
SEC should require fund boards to evaluate
when determining whether such a security
poses minimal credit risks. The IDC
recommended that the SEC not adopt
amendments requiring boards to evaluate
such specific factors, noting that “such
detailed direction from the [SEC] could
suggest that fund boards be involved in an
inappropriate level of credit analysis,
inconsistent with their oversight role.”
Repurchase agreements. The SEC proposed
requiring that a money market fund board (or
its delegate) to evaluate the creditworthiness
of the counterparty to a repurchase agreement,
regardless of whether the repurchase
agreement is collateralized fully. The IDC
recommended that the proposed amendment
not be adopted, believing that it is
“unnecessary, in light of the determination
that must already be made that a security
presents minimal credit risks.”
Transaction processing. The SEC proposed
that each fund’s board be required to
determine annually in good faith that the fund
(or its transfer agent) has the operational
capacity to “break the buck” and continue to
process investor transactions in an orderly
manner. The IDC supported amending the
rule to require the fund to have the requisite
capacity but objected to requiring the board to
make the proposed determination.
November 2009
•
Authority to suspend redemptions. The
IDC expressed support for the SEC’s
proposal to permit a money market fund that
has “broken the buck” to suspend
redemptions to allow for the orderly
liquidation of fund assets, noting that “it
would better protect the interests of the
fund’s shareholders, including nonredeeming shareholders.”
•
Floating NAV and redemptions in kind. The
SEC also requested comment on more “farreaching changes” it is considering, including
whether money market funds should, like
other types of mutual funds, have “floating”
rather than stabilized NAVs and whether
money market funds should be required to
satisfy redemption requests in excess of a
certain size through redemptions in kind. The
IDC strongly objected to both ideas, believing
that “they would have a negative impact on
fund shareholders.” According to the IDC,
“moving to a floating NAV would
undermine the benefits to shareholders of
money market funds” and “could lead a
substantial number of investors to move to
other investment vehicles.”
The comment period for the SEC’s proposed
changes expired on September 8.
___________________________________
SEC Adopts Temporary
Rule on Disclosure
of Money Market Fund
Portfolio Holdings
On September 18, 2009, the SEC adopted an
interim final temporary rule under the 1940 Act
that requires a money market fund to report its
portfolio holdings and valuation information to
the SEC under certain circumstances. The new
rule requires the reporting of information
substantially similar to the information required
under the Temporary Guarantee Program for
Money Market Funds previously established by
the Treasury Department, which has expired.
Investment Management Update
Applicability and Reporting Requirements
•
The new rule, Rule 30b1-6T under the 1940
Act, applies only to money market funds that
have a market-based net asset value (NAV) per
share below $0.9975. It requires such funds to
provide the SEC with both fund-specific and
security-specific information on a weekly basis.
The most recent market-based price
(including the value of any capital support
agreement), or appropriate substitute for such
price, in which case the portfolio schedule or
an exhibit to it must describe with reasonable
specificity the appropriate substitute;
•
The most recent market-based price
(excluding the value of any capital support
agreement), or appropriate substitute for such
price, in which case the portfolio schedule or
an exhibit to it must describe with reasonable
specificity the appropriate substitute;
•
The amortized cost value of the security; and
•
In the case of a tax-exempt security, whether
there is a demand feature.”
Each fund subject to the rule must provide a
portfolio schedule that includes:
•
“The name of the money market fund;
•
The fund’s SEC file number;
•
The net asset value per share used to effect
shareholder transactions;
•
The most recent market-based net asset value
(including the value of any capital support
agreement);
•
The most recent market-based net asset value
(excluding the value of any capital support
agreement);
•
The date as of which the most recent marketbased net asset value was calculated;
•
The total assets of the fund;
•
The total net assets of the fund; and
•
The number of shares outstanding.”
With respect to each security held in the
fund’s portfolio, the portfolio schedule also
must include:
•
“The name of the security;
•
CUSIP number (if any);
•
Principal amount;
•
Maturity date;
•
Final maturity date, if different from the
maturity date as determined under Rule 2a-7;
•
Categorization of the security’s status as a
‘First Tier Security,’ ‘Second Tier Security’
or a security that is no longer an ‘Eligible
Security’ under Rule 2a-7;
Timing of Reports and Procedural
Requirements
Money market funds subject to the rule must
notify the SEC by electronic mail and provide a
portfolio schedule to the SEC no later than the
next business day. Once the reporting obligation
is triggered, a fund must report its portfolio
schedule, in Microsoft Excel format, as of the
last business day of the week, and submit it no
later than the second day of the following
week, until its market-based NAV at the end of
the week is $0.9975 or greater. The information
submitted to the SEC under the rule “will be
nonpublic to the extent permitted by law.”
Compliance Dates
The rule is effective from September 18, 2009
through September 17, 2010.
The full text of the new rule can be found on the
SEC’s website at
http://www.sec.gov/rules/final/2009/ic28903.pdf.
___________________________________
11
SEC Announces New
Division of Risk,
Strategy and Financial
Innovation
On September 16, 2009, SEC Chairman Mary L.
Schapiro announced the establishment of the
Commission’s Division of Risk, Strategy and
Financial Innovation. The new Division
encompasses a number of Commission
functions, including the Office of Economic
Analysis (OEA) and the Office of Risk
Assessment (ORA), and is designed “to provide
the Commission with sophisticated analysis
that integrates economic, financial and legal
disciplines.” The Division will be led by Henry
T. C. Hu, a University of Texas School of Law
Professor, who has written extensively on topics
pertaining to risk and financial products.
Gregg Berman, who most recently served as head
of the global risk business at RiskMetrics
Group, will serve as Professor Hu’s Senior
Policy Advisor.
According to Chairman Schapiro, the new
Division “will enhance our capabilities and help
identify developing risks and trends in the
markets…[it] will foster a fresh approach to
exchanging ideas and upgrading agency
expertise.” The Division will take on the
responsibilities of the OEA and ORA, and also
will be charged with: performing strategic and
long-term analysis; identifying systemic risk and
other trends and developments in the financial
markets; making recommendations to the
Commission “as to how these new developments
and trends affect the Commission’s regulatory
activities,” providing research and analysis to
support the Commission’s other divisions and
offices; and training Commission staff with
respect to market developments and trends and
other matters.
The Division of Risk, Strategy and Financial
Innovation, the first SEC division created since
1972, comes at a time when the Commission is
trying cases involving credit-default swaps and is
contemplating a variety of new regulations,
including a proposal to eliminate flash orders on
all exchanges and trading systems.
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12
November 2009