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Vote Scheduled for Money Market Fund Rule Changes

The SEC has scheduled a vote to consider adopting final rules to reform money market mutual funds. The changes are expected to be based upon an August 2013 rule proposal that has faced strong opposition from fund managers.

The SEC is scheduled to vote on its much-delayed rules to address risks in money market mutual funds on July 23, 2014.

The changes are expected to be based on the proposal in Release No. 33-9408,¬†Money Market Fund Reform,¬†from last August, which was widely criticized by fund managers. The industry’s opposition has stalled the SEC’s efforts to revamp the regulatory regime for money funds for three years.

The agency also said it’s considering issuing for a second time proposed changes to Rule 2a-7 of the Investment Company Act of 1940, which governs the operation of money funds. The market regulator wants to address the rule’s provisions for investment diversification and the manner in which the rule relies upon securities that carry credit ratings from one of the rating agencies.

Regulators have worried about money funds’ safety since the 2008 failure of the $62 billion Reserve Primary Fund. After Lehman Brothers Holdings Inc. went bankrupt, the Reserve Fund, which held some Lehman debt, saw its share price, or net asset value (NAV), fall below $1, a phenomenon called “breaking the buck.” Institutional investors and corporations quickly withdrew their holdings in a massive run on the market that stabilized only after the Treasury Department guaranteed the funds.

After a failed attempt by then-SEC Chairman Mary Schapiro in 2012 to propose a floating NAV or a capital buffer, Schapiro’s successor Mary Jo White, in June 2013, proposed the changes in Release No. 33-9408 to address the industry’s vulnerability, including a requirement to float the share price of prime institutional funds.

Prime funds invest in a range of high-quality securities, including U.S. Treasury bills. Institutional funds typically include only other large investors or businesses as shareholders and exclude retail investors.

Schapiro had wanted to impose a floating NAV or a capital buffer, but opposition from Republican Commissioners Daniel Gallagher and Troy Paredes and Democratic Commissioner Luis Aguilar blocked the plan. In November 2012, the Financial Stability Oversight Council (FSOC), which is chaired by the secretary of the treasury, urged the SEC to develop a new proposal and proposed rules similar to Schapiro’s. After the agency’s staff studied the market, the opponents showed some willingness to compromise.

Paredes left the SEC in 2013 and was replaced by Michael Piwowar.

Gallagher said he opposed floating the NAV previously because the proposal only allotted 33 pages to the issue, and he felt it merited much more attention. Release No. 33-9408, discusses the floating NAV provision for 106 pages and offers some detailed analysis. The entire document runs 698 pages.

Still, the fund industry, led by the Investment Company Institute (ICI) and the U.S. Chamber of Commerce, oppose a floating NAV, citing the cost funds will incur implementing it. Fund managers view the fixed $1 NAV as a hallmark of money funds’ stability and an important attribute that helps shareholders complete transactions.

Reformers call the fixed NAV a fiction that gives shareholders a false impression that money funds are as stable and secure as bank deposits when the investments underlying them are riskier than bank assets.

SEC officials and bank regulators view the floating NAV as important because it would reduce incentives for shareholders to redeem their holdings in times of stress, increase transparency, and highlight investment risk.

The vast majority of the more than 1,400 comment letters responding to Release No. 33-9408, said a floating NAV would destroy a fundamental reason why the funds have become the preferred cash management vehicle for many Americans.

They also argue that adopting a floating NAV would create accounting, tax, and administrative nightmares by tracking minute increases or decreases in share prices each time shares are bought or sold.

Opponents say the cost, time, systems, and personnel needed for a floating NAV will be too expensive and will force investors to seek less attractive or unregulated alternatives for short-term, cash-like investments.

The fund industry says an alternative solution offered in Release No. 33-9408 is the best course of action for the SEC to pursue if a slight modification is made to it.

Under this plan, a 2 percent liquidity fee would be required if a nongovernment fund’s level of weekly liquid assets fell below 15 percent of its total assets, unless the fund’s board determined that the fee wasn’t in the fund’s best interest. After falling below the 15 percent threshold, the fund’s board could suspend redemptions for up to 30 days or “gate” the fund. The industry would prefer to lower the liquidity fee to 1 percent.

ICI members support liquidity fees and temporary gates because they promise to slow or stop significant fund outflows. The fees and gates would be triggered only when a fund is facing abnormal conditions.

In response to questions about what the final rule will entail during an event in Washington on July 15, Piwowar said he expected the final rule to be based upon the proposed changes from Release No. 33-9408.

Despite industry opposition, Peter Crane, president and CEO of Crane Data LLC, a research firm, speculated that the final rule may be a combination of the floating NAV for prime institutional funds and redemption fees and gates for either all prime or prime institutional funds.

“I’m guessing that the floating NAV was modified in order to get enough votes for it to pass,” Crane said.

The SEC is proposing that prime funds price and transact their shares to the fourth decimal place, with a target NAV of $1.0000. The rule proposal said this level of precision is necessary to convey risks to investors.