Investment Management Alert
July 2009
Authors:
Clair E. Pagnano
clair.pagnano@klgates.com
+1.617.261.3246
George P. Attisano
george.attisano@klgates.com
+1.617.261.3240
Joanne A. Skerrett
joanne.skerrett@klgates.com
+1.617.261-3263
K&L Gates is a global law firm with
lawyers in 33 offices located in North
America, Europe, Asia and the Middle
East, and represents numerous GLOBAL
500, FORTUNE 100, and FTSE 100
corporations, in addition to growth and
middle market companies,
entrepreneurs, capital market
participants and public sector entities.
For more information, visit
www.klgates.com.
SEC Proposes Revisions to Money Market
Fund Rules
The Securities and Exchange Commission (“SEC”) has proposed amendments to the
rules governing money market mutual funds (“money funds”) registered under the
Investment Company Act of 1940 (the “1940 Act”). ∗ In response to the extreme
turbulence in the money fund sector in 2007 and 2008, the amendments seek to
reduce money funds’ vulnerability to loss. Significantly, the SEC would permit a
money fund that has “broken the buck” (i.e., priced its securities below a stable net
asset value per share (“NAV”), typically $1.00), to suspend redemptions, thereby
allowing the orderly liquidation of the fund’s assets. The proposals also would
increase money funds’ reporting obligations. The SEC states that the proposed
amendments are designed to make money funds more resilient to certain short-term
market risks, and to provide greater investor protection if a fund is unable to
maintain a stable NAV.
The proposals generally follow the recommendations made by the ICI Money
Market Working Group and submitted to the SEC on March 17, 2009. Importantly,
what the proposals do not eliminate the stable $1.00 NAV for money funds. This
was suggested as a possible option in the Obama Administration’s White Paper on
Financial Regulatory Reform, issued on June 17, 2009. In that White Paper, the
President’s Working Group on Financial Markets was tasked with addressing this
issue, in a report scheduled to be issued in September 2009. The SEC’s proposing
release does note that the SEC has been working in coordination with the President’s
Working Group in the formulation of these proposed rules, but does not suggest
whether the elimination of the $1.00 stable NAV has been taken off the table. The
SEC says it expects to benefit from the comments it receives on this point before
deciding whether to propose changes.
The SEC did not address the questions of whether it supported a permanent federal
insurance program for investors in money funds. On September 19, 2008, the
Treasury Department instituted the Temporary Guarantee Program for Money
Market Funds, a temporary program that would cover any losses for any assets in
accounts in the fund as of September 19, 2008. This program is scheduled to expire
on September 18, 2009. The SEC also did not address whether money funds should
be required to maintain access to private emergency liquidity facilities, which the
President’s Working Group report is expected to address.
The SEC is seeking comments on these new and revised rules, as well as other
possible regulatory initiatives in this area. Comments should be received on or
before September 8, 2009. A summary of the key proposed amendments follows.
Click here to see a chart of a “Summary of Money Market Fund Regulatory
Proposals” comparing the amended or new proposals to the existing rules, as
discussed below.
∗
Money Market Fund Reform, Investment Company Act Release No. 28807 (June 30, 2009),
available at http://www.sec.gov/rules/proposed/2009/ic-28807.pdf.
Investment Management Alert
Fund Liquidation — New Rule 22e-3
New rule 22e-3 would permit money funds to
suspend redemptions to facilitate an orderly
liquidation. The new rule would replace rule 22e3T, a temporary rule that provides a similar
exemption for participants in the Treasury
Department’s Money Market Fund Guarantee
Program. Under the new rule, a money fund could
suspend redemptions upon breaking the buck with
the approval of the board, including a majority of the
independent directors. The SEC must be given prior
notice of the fund’s decision to suspend redemptions
and liquidate. The new rule is intended to reduce the
likelihood of a run on a money fund, and minimize
the potential for disruption to the securities markets.
The new rule would permit the SEC to rescind or
modify the relief provided by the rule (thus requiring
the fund to resume honoring redemptions).
(rather than the three currently permitted)
categories, in order to more narrowly limit
credit risk exposure. Boards would be required
to determine that such a security is “of
comparable quality” to a rated security.
•
Credit Reassessments. Consistent with the
elimination of second tier securities as “eligible
securities,” amended rule 2a-7 would require
the board to reassess whether a security
continues to present minimal credit risks only
if, subsequent to its acquisition, the adviser
becomes aware that any NRSRO has rated the
security below the highest short-term category.
Currently, boards must make this assessment if:
(i) the security is no longer a first tier security;
or (ii) the adviser becomes aware that any
NRSRO has rated an unrated or second tier
security below the second highest short-term
category.
•
Asset-Backed Securities. The SEC is
requesting comment on whether and how it
should amend rule 2a-7 to address risks
presented by asset-backed securities (“ABSs”),
and structured investment vehicles (“SIVs”).
Rule 2a-7 revisions
To seek to reduce risk, the SEC proposes to limit
money fund investments to the highest quality
securities.
•
•
•
First Tier Securities only. Money funds would
be required to invest only in first tier securities.
The definition of “eligible securities” would be
revised to include only securities with the
highest short-term debt rating (rather than the
highest two ratings) from the requisite
Nationally Recognized Statistical Rating
Organizations (“NRSROs”). Money funds
would no longer be permitted to invest in second
tier securities, which potentially present
substantially more risk than first tier securities.
NRSROs. The SEC is requesting comment on
whether an earlier proposal to eliminate the use
of NRSRO ratings, and instead rely solely on
the manager’s credit risk determinations, would
provide safeguards comparable to the continued
inclusion of NRSRO references in the rule, and
what other alternatives it could adopt to
encourage more independent credit risk analysis.
Long-Term Unrated Securities. The SEC
proposes to permit money funds to acquire an
unrated long-term security (with a remaining
maturity of 397 calendar days or less) only if the
security has long-term ratings in the highest two
Portfolio Maturity
The SEC proposes changing rule 2a-7’s maturity
limits to reduce exposure to certain risks, including
interest rate risk:
•
Weighted Average Maturity (“WAM”). The
SEC proposes to reduce a fund’s maximum
dollar-weighted average maturity from 90 to
60 days.
•
Weighted Average Life. A new maturity test
would limit a fund’s weighted average life to
120 days (which, unlike WAM, is measured
without regard to a security’s interest re-set
dates), thereby reducing the fund’s exposure to
interest rate and credit risk.
•
Government Securities. The amendment would
delete a provision of the rule that currently
permits a fund that relies exclusively on the
penny-rounding method of pricing to acquire
U.S. government securities with remaining
July 2009
2
Investment Management Alert
requirement. The proposal prohibits the
acquisition of any securities other than U.S.
Treasury securities or securities (including
repurchase agreements) that mature in five
days or are subject to a five-day demand
feature (together with cash, “weekly liquid
assets”) if, immediately thereafter, weekly
liquid assets comprise: (i) less than 15% of
retail fund’s total assets; or (ii) less than
30% of an institutional fund’s total assets.
maturities of up to 762 days, rather than the 397day limit otherwise imposed by the rule.
•
Other Securities. Comments are requested on
whether the maximum maturity for nonGovernment securities should be reduced from
397 days to, for example, 270 days.
Portfolio Liquidity
The SEC believes that, in light of recent events, rule
2a-7 should be amended to address liquidity risks, in
an effort to improve money funds’ ability to meet
significant redemption demands.
•
Prohibition on Acquisition of Illiquid Securities.
Money funds would be prohibited from
acquiring securities unless, at the time acquired,
the securities are liquid.
•
New Cash Test. New liquidity tests would be
based on the fund’s legal right to receive cash
rather than the ability to find a buyer for the
security. The amount of liquidity needed will
vary by fund, depending on cash flows.
•
Proposed Daily and Weekly Standards.
a.
Minimum Daily Liquidity Requirement
(Taxable Money Funds only). Taxable
retail funds would be required to invest at
least 5% of assets in cash, U.S. Treasury
securities, or securities with daily liquidity.
Taxable institutional funds would be
required to hold, immediately after
acquiring a security, at least 10% of assets
in daily liquid assets. The board would be
required to determine, at least annually,
whether the fund is an institutional fund for
liquidity requirement purposes, based on the
nature of the fund’s shareholders, minimum
investment requirements, and historical cash
flows. The SEC proposes new definitions
for retail and institutional funds and seeks
comments on whether the proposed
definitions capture all of the characteristics
necessary for fund managers to distinguish
between such funds.
b. Minimum Weekly Liquidity Requirement
(All Money Funds). All money market
funds (including tax exempt funds) would
be subject to a minimum weekly liquidity
c.
•
General Liquidity Requirement. A money
fund would at all times be required to hold
highly liquid securities sufficient to meet
reasonably foreseeable redemptions under:
(i) its 1940 Act obligations; and (ii) any
commitments made to shareholders, such as
paying redemptions in less than seven days.
Stress Testing. Amended rule 2a-7 would
require the board of a money fund using the
amortized cost method to adopt procedures for
periodic stress testing of the fund’s portfolio,
i.e., testing the ability to maintain a stable NAV
based upon certain hypothetical events, at
intervals that the board determines appropriate
and reasonable in light of prevailing market
conditions.
Diversification
Rule 2a-7 requires a money fund’s portfolio to be
diversified, both as to the issuers and as to the
guarantors of those securities. The SEC is seeking
comments on whether it should further restrict the
diversification limits of the rule. It asks whether the
5% diversification limit for issuers should be
reduced to, for example, 3%.
Repurchase Agreements
The SEC proposes two amendments that would
affect a money fund’s investment in repurchase
agreements (“repos”). The first seeks to limit
investment to repos collateralized by cash or
Government securities in order to obtain special
treatment under the diversification provisions of
rule 2a-7 that, e.g., permit the fund not to treat the
counterparty as an issuer. The limitation would
make it less likely that, in the event of counterparty
default, a money fund would experience losses upon
the sale of collateral that had become illiquid. The
July 2009
3
Investment Management Alert
SEC also seeks to require the board or its delegate to
evaluate the creditworthiness of the counterparty,
whether or not the repo is collateralized fully.
Disclosure of Portfolio Information
The SEC proposed several new disclosure
requirements for money funds, including increased
frequency of reports.
•
Public Website. The SEC proposes to amend
rule 2a-7 to require money funds to disclose
information about their portfolio holdings each
month on their websites and maintain the
information for at least a year.
•
Monthly SEC Reports. Proposed new rule
30b1-6 would require money funds to submit a
monthly electronic filing to the SEC on new
Form N-MFP with detailed portfolio holdings
information, enabling the SEC to create a central
database of portfolio holdings, and enhance its
ability to oversee money funds and respond to
market events.
•
Amended Rule 30b1-5. Money funds would be
exempt from filing schedules of investments
pursuant to Form N-Q.
Processing of Transactions
The SEC proposes that each money fund’s board
determine in good faith, at least annually, that the
fund (or its transfer agent) has the capacity to
redeem and sell its securities at a price based on the
current NAV. This proposed amendment would
require money funds to have the operational
capacity to “break the buck” and continue to process
investor transactions in an orderly manner,
including the capacity to sell and redeem shares at
prices that do not correspond to the stable NAV.
The SEC seeks comment on this proposal.
Exemption for Purchases by Affiliates
The SEC proposes to amend rule 17a-9 to permit a
money fund’s affiliates to purchase a distressed
portfolio security from the fund, even if the security
continues to be an “eligible security.” The
requirement that a security no longer be “eligible”
in order to qualify for rule 17a-9 compelled a
number of money fund managers to seek no-action
relief from the SEC staff during the height of the
crisis last year. The proposed amendment would
eliminate the need for affiliates to seek no-action
relief from the SEC staff when the delay would not
be in the best interests of shareholders. When a
money fund’s affiliate purchases securities in
reliance on rule 17a-9, the fund must promptly
notify the SEC of the transaction by e-mail. The
SEC also proposes to revise the rule to permit an
affiliate, for any reason, to purchase a security from
a money fund for cash at the greater of amortized
cost or market value, provided that the affiliate
promptly remits to the fund any profit it realizes
from the later sale of the security.
Anchorage Austin Beijing Berlin Boston Charlotte Chicago Dallas Dubai Fort Worth Frankfurt Harrisburg Hong Kong London
Los Angeles Miami Newark New York Orange County Palo Alto Paris Pittsburgh Portland Raleigh Research Triangle Park
San Diego San Francisco Seattle Shanghai Singapore Spokane/Coeur d’Alene Taipei Washington, D.C.
K&L Gates is a global law firm with lawyers in 33 offices located in North America, Europe, Asia and the Middle East, and represents numerous
GLOBAL 500, FORTUNE 100, and FTSE 100 corporations, in addition to growth and middle market companies, entrepreneurs, capital market
participants and public sector entities. For more information, visit www.klgates.com.
K&L Gates comprises multiple affiliated partnerships: a limited liability partnership with the full name K&L Gates LLP qualified in Delaware and
maintaining offices throughout the U.S., in Berlin and Frankfurt, Germany, in Beijing (K&L Gates LLP Beijing Representative Office), in Dubai,
U.A.E., in Shanghai (K&L Gates LLP Shanghai Representative Office), and in Singapore (K&L Gates LLP Singapore Representative Office); a
limited liability partnership (also named K&L Gates LLP) incorporated in England and maintaining offices in London and Paris; a Taiwan general
partnership (K&L Gates) maintaining an office in Taipei; and a Hong Kong general partnership (K&L Gates, Solicitors) maintaining an office in Hong
Kong. K&L Gates maintains appropriate registrations in the jurisdictions in which its offices are located. A list of the partners in each entity is
available for inspection at any K&L Gates office.
This publication is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon
in regard to any particular facts or circumstances without first consulting a lawyer.
©2009 K&L Gates LLP. All Rights Reserved.
July 2009
4