SEC passes money fund rules – but wait, the buck could still break

Divided vote on changes exclude most retail funds from capital requirements

Jul 23, 2014 @ 12:41 pm

By Trevor Hunnicutt

SEC, money markets, net asset value, institutional investors
+ Zoom
(Bloomberg News)

Many advisers expect that their clients will continue to be able to rely on stable money market funds after the Securities and Exchange Commission on Wednesday passed a slate of reforms that include a broad carve-out for products sold to retail investors.

But some industry experts cautioned that the reforms, which bring to a close for now a divisive, nearly six-year public debate, were not likely to fully resolve the risk of a run on the conservatively invested mutual funds.

Among the reforms, which passed on a 3-2 vote, money market funds that serve institutional clients and invest in private debt will now be required to let their share price fluctuate from $1 a share. They’ll also be allowed to prevent some redemptions or charge fees for doing so in times of market stress.

“Today’s reforms will fundamentally change the way that most money market funds operate,” said SEC Chairman Mary Jo White. “This strong reform package will make our financial system more resilient and enhance the transparency and fairness of these products for America’s investors.”

But funds sold directly to individual investors by firms such as Fidelity Investments, the Charles Schwab Corp. and the Vanguard Group will be exempt, according to the SEC. The main thrust of the reforms, therefore, will only affect an estimated $1 trillion of the $2.7 trillion market.

Many advisers said they were happy that the funds will be preserved as they are now, priced at $1 a share for retail investors.

“This is a solution looking for a problem,” Artie Green, principal of Cognizant Wealth Advisors, said of the SEC vote. “In the future, when [interest] rates sort of normalize, I will be going back to money market funds, and I have no concerns that, even during a period of stress, clients should be keeping their money in money market funds."

Mr. Green said money market funds “serve a very valuable purpose to get people who otherwise are very afraid of investing” into the markets.

The SEC’s proposal broadly defines retail funds as any fund with policies restricting ownership to “natural persons,” a status fund companies might be able to verify with Social Security numbers.

And the SEC also plans, as a result of Wednesday’s vote, to propose a new exemption for broker-dealers which would otherwise have to provide written notification of money market transactions.

The SEC received many comments on the treatment of broker-dealers, which complained that the reforms complicated the process. Many broker-dealers aggregate trades of many mom-and-pop investors in single, institutional “omnibus” accounts, raising questions about whether they would be considered institutional investors. The SEC proposal appeared to be worded in such a way that broker-dealer accounts could be exempted.

“Our goal throughout this debate has been to preserve the viability of money market funds for retail investors — it appears to us, at first blush, that the commission shared that goal and have adopted a rule that will allow retail investors access to the products,” said David T. Bellaire, the top lawyer at the Financial Services Institute Inc.

The broker-dealer lobby opposed elements of the reforms earlier, arguing that changing rules for institutional investors could raise costs for retail investors and raised questions about how omnibus accounts would be treated.

The FSI needs time to digest the details of the proposal to understand if those concerns remain, Mr. Bellaire said.

Fund houses will have up to two years to comply with the new regulations.

The reforms are intended to make money market funds less likely to succumb to runs, but even some commissioners said Wednesday that the reforms were unlikely to fully prevent that risk.

Investors fled money funds in 2008 after the $62.5 billion Reserve Primary Fund, which was invested in Lehman Brothers debt, "broke the buck," falling below $1 a share when that investment bank collapsed.

Fund companies argued it was primarily institutional investors who fled the funds, eliminating the need to change how retail funds work.

But a number of fund managers and observers said the reforms were unlikely to prevent a run. In a letter this week, two executives from Goldman Sachs Asset Management said carve-outs for retail funds and broker-dealers could lead to a run in the future.

“The broker-dealer, adviser or bank would continue to have every incentive to redeem to avoid the reputational and financial costs experienced by some prominent broker-dealers in 2008,” they wrote. “The next money fund to ‘break the buck’ may well be a ‘retail fund,’ whose investors may today be more prone to redeem quickly than they were in 2008 because, among other things, they will have significantly more information about the fund’s portfolio and the experience of 2008.”

While the reforms passed Wednesday are seen broadly as a victory for firms serving primarily retail clients, those working with institutional clients including some broker-dealers may pursue legal action against the decision.

Many investors use money-market funds as a way to park cash they don’t want to invest in risky assets but near-zero interest rates have depressed the yields on the funds. That, combined with the reform efforts, have led some fund firms to start pitching other products, like very short-term debt funds, as alternatives to money market funds.

In an interview after the commission meeting, Jerome M. Schneider, a portfolio manager for the Pacific Investment Management Co., said that interest in the firm’s actively managed short-term debt products has been driven in part by institutional investors reconsidering their allocations to money market funds since the Reserve Primary Fund "broke the buck" in Sept. 2008. He said the firm may consider other products as a result of the change to a floating net asset value. “Much of what they’ve done is really created an inflection point for these institutional managers of cash to think about ways to manage liquidity and capital preservation going forward,” Mr. Schneider said of the SEC.

Meanwhile, some advisers are telling their clients that there was nothing to worry about. On a radio show before the commission’s meeting, adviser Ric Edelman said his clients are invested only in funds that invest in government securities, which are seen as less risky.

“Don’t let anybody use this news as a scare tactic to convince you to move your money somewhere else away from the money market fund and into some other product like an absolute return mutual fund or a structured note or a bank CD or a fixed annuity or any such nonsense,” Mr. Edelman said. “Leave your money where it is; it’s perfectly fine.”


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