SEC, ICI: Rules on money funds contain flaws

The Securities and Exchange Commission and the Investment Company Institute agree that changes need to be made to the agency’s rules governing money market funds, but they don’t necessarily agree on what those changes should be.

Both groups said during the Washington-based ICI’s Mutual Funds and Investment Management Conference last week in Palm Desert, Calif., that they think the rules are flawed.

And money funds pose “systemic risk” to the market,” Robert E. Plaze, associate director of the Division of Investment Management at the SEC, said during a panel discussion at the conference.

On Sept. 16, the Reserve Primary Fund, advised by Reserve Management Co. Inc. of New York, saw its net asset value fall below $1, becoming the second money fund in history to “break the buck.”

That created a run on money funds and precipitated a money fund meltdown. The crisis was contained, thanks to swift government action, Mr. Plaze said.

One way to address the risk that money funds pose to the entire market is to separate investors in retail money funds from those in institutional money funds, he said.

Retail investors, who tend to move their assets fairly slowly during periods of market volatility, would be allowed to invest in funds with longer-dated maturities.

But institutional investors — which as a group tend to move their money more quickly — would be allowed to invest only in funds with more-liquid, shorter maturities, the idea being that such funds can better withstand swings in cash flow.

The concept was debated by the ICI’s Money Market Working Group, which was established late last year, Brian Reid, chief economist for the ICI, said during the panel discussion.

But the working group abandoned the idea as unworkable be-cause of the difficulty in separating retail from institutional investors, he said.

In a 224-page report released March 17, however, the ICI suggested that money funds disclose “client concentration levels” by client type, said Laura J. Merianos, senior counsel for The Vanguard Group Inc. of Malvern, Pa. That way, investors would be able to tell what percentage of a fund’s shares were held by retail and institutional investors, she said.

“My question is, is that enough?” Mr. Plaze said.

The ICI thinks it is, and it isn’t alone.

There is no way to separate retail and institutional investors practically, said Peter Crane, president of Crane Data LLC, a Westborough, Mass.-based research firm focused on the money fund industry. He did not attend the ICI meeting.

The biggest users of money funds are intermediaries “trading on behalf of smaller investors,” Mr. Crane said in a telephone interview.

The issue of whether to separate retail and institutional investors, however, isn’t the only factor that separates the SEC and the ICI.

For example, the working group recommends that within five business days of announcing a suspension of redemptions and liquidation, a money fund’s board must approve, and the fund must announce to shareholders, its plan of liquidation.

The idea behind the proposal is to give money funds “flexibility,” Stephen A. Keen, a partner with Reed Smith LLP of Pittsburgh, said during the panel discussion.

But Mr. Plaze expressed skepticism that such flexibility is necessary.

Despite such differences, he said that he could see the SEC adopting many of the working group’s recommendations.

Its proposals include requiring, for the first time, daily and weekly minimum-liquidity requirements for money funds. Such requirements are important because the more liquid a fund, the less likely it is to break the buck.

The ICI also recommends that credit quality standards be in-creased.

For example, its recommendations “would require funds to create a new products committee to review new investment vehicles,” Paul Schott Stevens, the ICI’s president and chief executive, said during his opening remarks at the conference.

There are other recommendations, all of which the nine fund groups represented on the working group — which includes mutual fund heavyweights such as Vanguard and Fidelity Investments — “signaled their willingness to adopt voluntarily,” he said.

The ICI’s board of governors called on other firms to follow suit.

Specifically, the ICI urged that funds act before Sept. 18 — the last day that the Department of the Treasury has legal authority to operate the money fund Temporary Guarantee Program.

“That will provide fund investors with additional assurance and to facilitate an orderly transition out of that program,” Mr. Stevens said.

E-mail David Hoffman at [email protected].