SEC to propose major overhaul of money funds

The Securities and Exchange Commission is considering a list of regulations for money market funds that goes far beyond proposed reforms issued in March by the Investment Company Institute.

The SEC, which is expected to issue its proposed rules this month, is considering guidelines that would make clear a fund's responsibility to turn away influxes of cash from institutional investors that may cause large swings in the fund's assets.

The ICI, the mutual fund industry's powerful lobbying group in Washington, in March released a list of proposed reforms for money market funds. The list includes setting minimum levels of liquidity, shortening duration and avoiding lower-rated securities.

Beyond those measures, the SEC is considering a rule change that would require funds to disclose regularly the market value of their underlying assets. Currently, money market funds are required to disclose their holdings quarterly, without assigning a market value to those holdings.

The SEC is unlikely to endorse the idea of a so-called floating net asset value, which would untie money market funds from their $1-a-share value, according to a source with knowledge of the commission's deliberations, who asked not to be identified.

Proponents of a floating NAV say that such a structure would make a fund's NAV more sensitive to losses and gains in the portfolio, thereby reducing instances of sudden shifts in yield.

The mutual fund industry has opposed the idea moving to a floating net asset value, arguing that investors like money market funds because they stick close to the $1 NAV.

FLOATING NET ASSET VALUE

“The $1 [per share net asset value] holds vast psychological importance,” said Peter Crane, president of Crane Data LLC of Westborough, Mass., a research firm that tracks money market mutual funds. “Moving to any other number may shake the faith in the product.”

Unlike mutual funds that invest in stocks, money market funds are not marked to market on a daily basis.

Instead, money market funds are allowed to use the purchase price of the securities held in their portfolio, which remains set.

For investors, that means: “You bought it at a dollar, and you're selling it at a dollar,” said Lance Pan, director of investment research at Capital Advisors Group Inc. in Newton, Mass., an institutional-fixed-income advisory firm that manages $7 billion.

Requiring more disclosures of underlying assets is likely to be controversial.

“That would be a very bad idea,” Mr. Crane said. Values of assets in money market funds fluctuate constantly, he said.

“An investor would see a $0.999 [net asset value] and panic, thinking, "Oh my God, it's not $1.' It would allow for arbitrage, and it [would] be dangerous in the hands of some investors,” Mr. Crane said.

By all accounts, the SEC is likely to stand behind the ICI's proposals, according to industry observers.

“They're going to do [primarily] what the ICI recommended,” Mr. Crane predicted.

SEC Chairman Mary Schapiro has said that the commission this month will consider rule proposals to strengthen money market funds. The focus of those proposals, she said, will be ensuring that the $4 trillion in the funds is relatively safe and in liquid investments.

In addition, the ICI suggested in its report that there be explicit requirements that money market fund managers know more about their customer base to form a better assessment of the risk that institutional clients pose by yanking money out of the funds too quickly.

Another proposal by the ICI would allow fund boards to suspend redemptions without explicit permission from the SEC in the event that a money market fund “broke the buck” by falling significantly below the $1 net asset value.

Funds could be unwound faster than is currently the case, and all investors would be treated the same, said Karrie McMillan, the ICI's general counsel.

“You would take away that need to rush to the door. You're going to get the same amount of money” regardless of when they redeemed shares, Ms. McMillan said.

Taken together, the recommendations will “provide a whole new level of protection that funds have not been required to have before,” she said.

Many money market fund experts argue that the SEC should go further than the ICI recommendations.

Different types of money market funds should be offered for retail and institutional investors, according to Kenneth Froot, professor of business administration at Harvard University's Graduate School of Business Administration in Boston. Funds that offer only U.S. Treasury securities could be offered to retail investors with guarantees from the U.S. government.

Money funds used by institutional investors could be put into separate groups and traded as exchange traded funds, Mr. Froot said. “Nobody should be responsible for providing that guarantee,” he said.

The scrutiny on money market funds comes in the wake of the collapse of the Primary Reserve Fund, which exposed investors to huge losses.

For example, on Sept. 16, the 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.

E-mail Sara Hansard at [email protected].