List of Rule 2a-7 Proposals
Summary of Rule 2a-7 Proposals

Money Market Fund Reform: SEC Proposes Rule Amendments and Seeks Comment on Fundamental Issues

On June 30, 2009, the SEC proposed amendments to Rule 2a-7 (the Rule), the money market fund rule under the Investment Company Act of 1940. The amendments were designed to increase the resilience of money market funds to economic stresses, reduce the risks of runs on the funds, facilitate the orderly liquidation of a money market fund that breaks the dollar and liquidates, and improve the SEC’s oversight of money market funds. Among other things, the proposed amendments would:

• tighten quality, maturity and liquidity requirements (including imposing new requirements for repurchase agreements)

• require monthly Web site disclosure of portfolio holdings and additional monthly reporting to the SEC

• require each money market fund Board to determine that the money market fund has the capacity to process share transactions at other than $1.00 (that is, after the fund has broken the dollar)

• expand permission for affiliates to “bail out” troubled money market funds

• allow each money market fund Board to suspend redemptions when the money market fund liquidates

The SEC’s release (the release) also requests public comment on possible fundamental reform of money market funds; more specifically, whether the stable $1.00 share price should be abandoned in favor of a floating net asset value (NAV) per share and whether money market funds should be required to satisfy redemption requests in excess of a certain size through in-kind redemptions.

Each proposal is set forth in one of three ways:

• recommendations for specific revisions to language in the Rule (specific proposals)

• requests for comment on possible revisions with no specific Rule language suggested (inquiry proposals)

• in the case of the fundamental reforms only, questions as to whether the SEC should continue to explore the reform

The abundance of inquiry proposals in the release creates a sense that the reforms are still, in large measure, a work in progress on which the SEC hopes to draw substantial public comment.

The specific proposals generally track the recommendations of the Investment Company Institute (ICI) in its Report of the Money Market Working Group (the ICI Report) released March 17, 2009. The SEC apparently thoroughly considered those industry recommendations in crafting the proposals, as the release cites the ICI Report about 60 times. The specific proposals do, however, include certain recommendations that were not addressed by the ICI, such as distinguishing between retail and institutional funds with regard to liquidity requirements (which the ICI specifically opposed and which is likely to be a flashpoint for comment), tightening the requirements for repurchase agreement collateral, forbidding a fund from holding any illiquid security, creating a new form to be filed with the SEC to provide monthly disclosure of holdings and instituting a requirement that a fund be capable of processing share transactions at other than $1.00 (after the fund breaks the dollar). Further, most of the inquiry proposals, and also the fundamental reforms, go beyond the ICI Report recommendations. But the fact that these topics are posed as concepts for comment rather than as specific proposals may indicate that the SEC is treading cautiously before advocating these changes that have not been vetted with the industry and that, in some cases, have been opposed by the industry (more specifically, a suggestion to remove ratings requirements from the Rule and both fundamental reforms). The release alludes to a possible reason for caution: changes to money market funds could have far-reaching ripple effects throughout the economy generally as a result of the central role that money market funds play as a source of short-term funding to businesses and municipalities and as a vehicle for cash management.

On the other hand, an SEC staff member stated at the open meeting at which the SEC considered the proposals (the open meeting) that the SEC could, in fact, adopt the inquiry proposals even though specific language was not provided. With regard to the fundamental reforms, however, the SEC has sidestepped for now the concept of abandoning the stable $1.00 share value and requiring redemptions in kind. The release states that the SEC will review the comments on those changes “before deciding whether to propose these changes.” Thus, the industry will have an additional opportunity to comment on these more fundamental reforms before they are imposed.

Besides tracking the ICI Report, the specific proposals also echo the Obama administration’s money market fund proposals set forth in the Report on Financial Regulatory Reform released June 17, 2009 (Administration Report). The Administration Report states that the President’s Working Group (PWG) on Financial Markets should complete a report by Sept. 15, 2009, addressing the more fundamental aspects of money market fund reform, which “could include” abandoning the stable NAV or requiring access to private emergency liquidity facilities. The SEC is a member of the PWG, and SEC Chairman Mary Schapiro said that the SEC will share with the PWG the comments submitted to the SEC on the proposed amendments. Comments are due on or before Sept. 8, 2009.

A WORK IN PROGRESS
The release poses multiple questions on every aspect of the proposals—literally hundreds of specific questions on which the SEC hopes to receive guidance. (This plethora of questions is significantly more extensive in proportion to the length of the release than the number of questions posed by the SEC in 1990 and 1993, when the SEC last proposed major revisions to the Rule). The nature of the questions evidences that the SEC is treading a fine line between enhancing safety of money market funds and allowing them to continue as a competitive product that provides an important source of short-term funding. For example, the SEC solicits views not only on whether various proposals would effectively mitigate risk but also on whether the proposals would impact yield or cause investors to shift to alternative products.

The industry is likely to submit substantial comments on the fundamental reforms and certain of the other proposals, particularly those that create interpretive “gray” areas. For example, the requirement to distinguish between retail and institutional funds and the requirements to implement stress testing may raise interpretive questions. Even the more “straightforward” proposals that raise fewer interpretive questions, could elicit substantial comment. For example, the single proposal to require calculation of weighted average life occupies five pages of the release and includes 15 separate questions on which the SEC solicits comment.

IMPLEMENTATION
The ICI has recommended that money market funds seek to implement the ICI Report’s recommendations by Sept. 18, 2009 (when the authorization for the Treasury Temporary Guarantee Program for money market funds expires), in order to provide additional assurance to investors and help facilitate an orderly transition out of the Guarantee Program. When the ICI introduced the ICI Report, it urged the SEC to require funds to disclose that the fund did not implement the proposals pending enactment of a final rule. The SEC did not include that requirement in the proposed amendments. Each fund is free to analyze whether advance compliance for any particular proposal (and disclosure of compliance) is in the fund’s interest, in light of the fact that the proposals are a “moving target” and that industry practices may evolve. Certain funds have announced publicly that they are incompliance with at least certain parts of the proposals. Further, Robert Plaze, the associate director of the SEC Division of Investment Management, when asked at the open meeting about the transition to compliance, said that he has the sense that “funds are already there.”

Funds that wish to take action on any of the proposals before the amendments are enacted may choose an approach along a continuum of possible early responses: begin considering how the proposed amendments would affect their portfolios; discuss with their Boards the anticipated effect of the proposed amendments; or begin complying on an internal, informal basis with the proposals that do not require substantial modification of the portfolio. Funds are unlikely to self-impose formal procedural amendments at this point, given that the landscape may shift.

It appears that there should not be a rush to modify portfolios either before or after the amendments are finalized. Mr. Plaze said during the open meeting that he anticipated that when and if the proposals are adopted, the effective date would allow time for noncompliant holdings to mature, so a fund would not need to sell holdings to achieve compliance.

NEW BOARD REVIEWS; NEW PROCEDURES
Money market fund Boards are already responsible for overseeing the stability of share value and liquidity, but some of the proposed amendments would require the Boards to review additional reports and make additional determinations in carrying out those oversight responsibilities. The proposals that relate specifically to new Board reviews are highlighted below with a bolded, capitalized reference to “BOARD” for ease of reference. (The SEC did not follow the ICI’s recommendation to modernize the Rule by eliminating Board duties that, in practice, are almost always delegated to the investment adviser).

In some cases, the proposed amendments would require money market funds to adopt new procedures (not only revisions to tighten existing amortized cost procedures). The proposals that relate to new procedures are highlighted below with a bolded, capitalized reference to “PROCEDURES” for ease of reference.

Click on the links below for a list of the proposals and also for a summary of each proposal:

List of Rule 2a-7 Proposals
Summary of Rule 2a-7 Proposals

Given the vast range of possibilities covered by the SEC’s request for comment, the summary does not include every possible alternative version of each proposal suggested by the SEC, but only the more significant ones.

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