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MEMORANDUM
TO:
Clients and Friends
FROM:
Kirkpatrick & Lockhart LLP
DATE:
September 12, 2001
SUBJECT:
Client Advisory - Emergency Planning
This week’s extraordinary events have raised a number of regulatory issues that will need
to be addressed by mutual fund groups over the next few days, some of which are common to
many funds. We have identified a number of these below and have suggested approaches for
dealing with them, which we have reviewed with the SEC staff. Each fund group will have its
own particular circumstances to address, and we are available to discuss them with you and with
the SEC staff, if appropriate.
1.
Pricing and Redemption. When the NYSE is closed, funds are permitted to
suspend redemptions pursuant to Section 22(e) of the 1940 Act. Although your prospectus may
contain some fine distinctions between redemptions and pricing, the SEC has said that funds are
not expected to calculate NAV if they are not selling or redeeming shares.
Your prospectus may dictate that orders received after Monday’s close be executed at the
NAV next determined. However, you may wish to contact investors to determine whether they
wish to withdraw their orders, in light of the dramatically changed situation since then.
2.
Liquidity. The SEC staff has indicated, based on informal inquiries, that fund
purchase orders currently appear to exceed redemption orders. Nevertheless, to the extent that
liquidity concerns may arise for funds, the staff anticipates that the funds will do whatever they
can to pursue all available alternatives not raising regulatory issues, particularly in light of the
efforts of the federal government to address liquidity issues through support of the banking
system. These might include taking advantage of the 1940 Act provisions permitting funds to
delay payments on redemptions (but not the formal redemptions themselves) for up to seven
days; or suspending the ability to do electronic redemptions and thereby slowing down the
process (and hopefully discouraging market timers).
Borrowing from affiliates. Failing that, the staff would not object if a fund
borrowed from its investment adviser or one of its other affiliates, provided that the transaction
fell within standard commercial terms or better from the fund’s perspective. The staff indicated
that it would not require formal requests under Section 17 prior to entering into these types of
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transactions but would like telephone requests so they can be made aware of these transactions,
to the extent possible.
Interfund Lending. Funds that previously received exemptive relief permitting
interfund lending and are considering increasing the amount would be permitted to do so. The
SEC would be receptive to allowing others to use interfund lending even if they have not
previously received exemptive relief to do so, if they have the procedures and systems in place
enabling them to satisfy the conditions of the exemptive relief provided to others, and do satisfy
those conditions.
3.
Suspension of Redemption Requests. The staff indicated that it has not received
requests to suspend redemptions and would be reluctant to go that route. Obviously, funds with
no alternatives should approach the staff directly.
4.
Money Market Fund Credit Risk Analysis. This week’s events may impact
some issuers of money market instruments, guarantees, or demand features. Your special
attention may be required on the issue of whether certain firms with significant risks or
operations in the worst-affected areas, remain 2a-7 eligible and continue to present “minimal
credit risk.”
Minimal Risk Determinations. Rule 2a-7 requires that money market funds
make minimal risk determinations upon acquisition or rollover of a security. Individual funds
may wish to make determinations on these issuers irrespective of whether an acquisition or
rollover is imminent.
Special Minimal Credit Risk Determinations. Rule 2a-7 requires an “on-going
review of . . . continued minimal credit risks” for securities for which maturity is determined by
reference to demand features. If the demand feature is a conditional demand feature, a minimal
credit analysis of the issuer must also be performed. That review is not limited to financial data.
For money market funds that are relying on demand features to meet Rule 2a-7’s maturity tests,
an assessment must be made that the demand feature continues to present minimal credit risks.
Options If a Security Does Not Continue to Have Minimal Credit Risk. If a
security does not continue to present minimal credit, several options are available. The fund
may:
•
Sell the security as soon as practicable consistent with achieving an orderly disposition of
the security by sale, exercise of a demand feature or otherwise;
•
Have the Board consider whether the disposal of the portfolio security would not be in
the best interests of the fund. The Board may consider the market conditions that could
affect the orderly disposition of the portfolio security;
•
Have the adviser purchase the security in accordance with Rule 17a-9 under the 1940 act;
or
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•
Have the adviser issue a put for the security in accordance with the Keycorp and
American Century line of no-action letters. If the adviser does not have the requisite
credit quality or ratings, the adviser may purchase a standby letter of credit from a third
party that does have the requisite credit ratings.
Similar actions would be taken in the event of default or insolvency of the issuer. The staff has
expressed a willingness to be flexible in assessing specific situations on a case-by-case basis on
inquiry. The staff is relying heavily on its Y2K planning measures and other procedures
developed for emergency situations.
Prompt Consideration of Deviation. Money market funds are required to
calculate the deviation between the market-based net asset value per share and amortized cost net
asset value per share. If the deviation exceeds ½ of 1%, the fund’s Board must promptly
consider what action, if any, should be taken. If the deviation is likely to result in dilution or
other unfair results to investors or existing shareholders, the Board must take action to eliminate
or reduce to the extent reasonably practicable such dilution or unfair results.
Notice to the Commission. Notice to the SEC is only required if there is an event
of default or insolvency of an issuer of a security, demand feature or guarantee and the default
represents ½ of 1% of the fund’s total assets.
5.
Emergency Board Actions. To the extent that issues arise requiring Board
action on an issue normally calling for in-person meetings, such as Rule 15a-4 procedures to
replace a subadviser that may be unable to function, the staff expressed willingness to permit the
Board to meet by telephone.
6.
Other Board Actions. You may want to convene a telephonic Board meeting in
the near future simply to keep the Board apprised of the ways in which these events may be
affecting the funds. They obviously have duties to the funds and their shareholders when
extraordinary situations arise, and should be advised that you are dealing with the issues
effectively.
We will keep you apprised of additional issues as they develop. Please let us know if you
have further questions.
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THIS NEWSLETTER IS FOR INFORMATIONAL PURPOSES ONLY. NOTHING HEREIN
IS INTENDED OR SHOULD BE CONSTRUED AS LEGAL ADVICE OR A LEGAL
OPINION APPLICABLE TO ANY PARTICULAR SET OF FACTS OR TO ANY
INDIVIDUAL’S OR ENTITY’S GENERAL OR SPECIFIC CIRCUMSTANCES.
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