July 7, 2009

The Securities and Exchange Commission made public last week a proposal that would require money market fund boards to decide whether their funds sell to “retail” or “institutional” investors. The SEC revealed the proposal as part of a nearly 200-page document of money fund reforms posted on the Commission’s Web site Tuesday. In the document, the SEC said if the liquidity requirements it is calling for now had been in place during this past fall’s crisis, funds would have been able to satisfy more than 90% of the demands presented to them for redemptions without having to sell portfolio securities.

The proposal would require institutional funds to have twice as much liquidity as retail funds. The new split level liquidity requirement would mean retail funds would have a greater percentage of assets free to be placed in longer term securities, likely resulting in a better return for them, Joan Swirsky, of counsel at &Stradley Ronon Stevens & Young in Philadelphia, told FD sister publication Fund Action. That would give institutional investors a strong incentive to find loopholes to switch their dollars into retail.

For boards, the proposed requirement is more than just another burden to carry, say industry insiders. Even though the rule proposal provides criteria boards can use, the facts could be interpreted by different boards in different ways, according to industry lawyers.

Lawyers cautioned if the proposal were to be enforced, directors would need to step up oversight ahead of a possible increase in litigation in the area.

For example, boards could be sued if a fund they labeled “retail” were to break the buck because institutional money was allowed in and then bailed out in a crisis situation. “To put it all on the board, to turn them loose in the wilderness, does not seem in their best interest,” a fund company lawyer told said.

Susan Wyderko, executive director of the Mutual Fund Directors Forum, said the organization disagrees with the proposal. “It strikes me that the rule might better reflect the core competency of the board if it required the board to oversee management’s making that sort of determination.”