SEC Staff Issues Money Market Fund Reform Frequently Asked Questions

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The Staff of the Division of Investment Management (Staff) of the U.S. Securities and Exchange Commission (SEC or Commission) has published responses to frequently asked questions (FAQs) regarding the SEC’s 2014 amendments (Amendments)1 to the rules governing money market funds.2 This Dechert OnPoint briefly discusses the background and the events leading up the FAQs and describes key responses from the Staff in the FAQs.

Background

At the open meeting at which the Amendments were adopted, SEC Chair Mary Jo White stated that the Amendments will “fundamentally change the way that most money market funds operate.” In light of the sweeping nature of the changes, money market funds and other industry participants raised a number of questions regarding the Amendments. On April 22, 2015, the Staff issued the FAQs in an effort to answer some of the most frequently asked questions posed by the industry, and to provide further guidance in areas that were not fully addressed in the Adopting Release.

Form N-CR (FAQs Nos. 2 and 3)

Provision of Financial Support (FAQ No. 2)

Under the Amendments, money market funds are required to report to the SEC on new Form N-CR upon the occurrence of certain material events, including the provision of “financial support” to a fund by an affiliate or sponsor. Among other things, the term financial support excludes any action that the board of directors of the money market fund determines is not reasonably intended to increase or stabilize the value or liquidity of the fund’s portfolio.

In the FAQs, the Staff acknowledged that, in connection with a capital contribution by a money market fund’s investment adviser to remedy a net asset value (NAV) error, “a fund board might determine that the purpose of the action is to remedy an operational error, and not to stabilize the value or liquidity of the fund’s portfolio due to investment losses.” Accordingly, a money market fund will not have to report on Form N-CR, if its board determines that the capital contributed to the fund to correct an NAV error is not reasonably intended to stabilize the value or liquidity of the fund’s portfolio.

Capital Contributions Relating to Voluntary Reorganizations (FAQ No. 3)

The Staff observed that, in connection with a voluntary reorganization “in the ordinary course of business,” a capital contribution by a money market fund’s affiliate to “top up” the fund’s NAV would normally result in a reportable event on Form N-CR. However, the Staff noted that a one-time reorganization made pursuant to the exemptive relief provided in the Adopting Release is intended to bring a money market fund into compliance with the Amendments. As a result, the Staff took the position that it would not object if capital contributions that are designed to avoid unfair results or dilutions in connection with such reorganizations are not reported as financial support on Form N-CR. The Staff emphasized, however, that “topping up” a money market fund after the compliance date of the Amendments, whether or not done in connection with a reorganization, would result in a reportable event on Form N-CR.

Form N-1A (FAQ No. 6)

In the Adopting Release, the Commission stated that a money market fund must update its registration statement to incorporate material changes related to the Amendments, by means of a post-effective amendment under Rule 485 or a prospectus supplement pursuant to Rule 497 under the Securities Act of 1933 (Securities Act). However, in the FAQs, the SEC Staff stated that:

based on the materiality and breadth of the disclosure related to a fund’s transition to a floating NAV and a fund’s ability to impose fees and gates, a money market fund may find it appropriate to update its registration statement to incorporate this disclosure by filing a post-effective amendment pursuant to Rule 485(a) under the Securities Act.3

Accordingly, a money market fund may wish to consider whether disclosure changes relating to its (1) ability to impose a liquidity fee and/or redemption gate or (2) transition to a floating NAV, are material enough to require a post-effective amendment filed under Rule 485(a). Such an amendment would become effective no sooner than 60 days after filing and would afford the Staff an opportunity to review and comment on the disclosure. A money market fund should factor this consideration into its planning, as a Rule 485(a) filing could complicate the fund’s annual update process and result in additional costs and delays.

In addition, the Staff stated that, with respect to historical disclosure regarding the imposition of liquidity fees and redemption gates and/or the receipt of financial support as required pursuant to new Item 16(g) of Form N-1A, such disclosure would be a “routine Form N-1A item.” However, while referring to this disclosure as “routine,” the Staff nonetheless stated its belief that a money market fund should include any new disclosure in response to Item 16 as part of a post-effective amendment filed under Rule 485(a). In light of this statement and absent any further guidance, money market funds may wish to consider incorporating new disclosures in response to Item 16 of Form N-1A in a post-effective amendment filed under Rule 485(a).

Website Disclosure (FAQ No. 8)

The Amendments require both stable and floating NAV money market funds to prominently disclose on their website the fund’s market-based NAV per share, calculated before applying the amortized cost method of valuation and/or penny rounding pricing (as applicable). Although a floating NAV money market fund may no longer use amortized cost to maintain a stable NAV per share, the fund may use amortized cost to value individual portfolio securities that have a remaining maturity of 60 days or less as long as the fund can reasonably conclude, each time it values its portfolio, that the amortized cost value of each such portfolio security is approximately the same as the fair value of the security as determined without the use of amortized cost valuation.

Based on this guidance, which was included in the Adopting Release, the Staff expressed the view that it would be inappropriate for a floating NAV money market fund to use amortized cost to value a portfolio security that matures in 60 days or less, if that valuation were to result in a difference between the fund’s NAV used to transact in fund shares (Transaction NAV) and the fund’s market-based NAV per share calculated without the use of amortized cost (Market-based NAV). Under this position, if a floating NAV money market fund were to use amortized cost to value a portfolio security that matures in 60 days or less and the size of the fund’s position in that security was large enough that the use of amortized cost caused the fund’s Transaction NAV to differ from its Market-based NAV by as little as a single basis point, the fund would not be permitted to use amortized cost to value that security.4

Funds that Invest Only in Securities that Mature in 60 Days or Less (FAQ No. 9)

As discussed in the Adopting Release and in the FAQs, a floating NAV money market fund may use the amortized cost method of valuation to value certain portfolio securities with a remaining maturity of 60 days or less. However, in the FAQs, the Staff cautioned that a floating NAV money market fund may not disclose in its advertising, sales literature or prospectus that it will seek to maintain a stable NAV per share by investing only in securities with a remaining maturity of 60 days or less and valuing those securities using the amortized cost method of valuation. The Staff stated its belief that such a statement would be misleading to investors because “there will be market circumstances that may require a floating NAV money market fund’s share price to fluctuate, regardless of how it limits its investment duration or its use of amortized cost for certain portfolio securities.” Moreover, under Form N-1A, a floating NAV money market fund must disclose that its share price will fluctuate. The Staff expressed concern over the potential contradictions between this disclosure and a statement by a floating NAV fund that it will seek to maintain a stable NAV.

Amortized Cost Guidance (FAQ No. 10)

The Adopting Release provided guidance on the use of the amortized cost method of valuation to value individual portfolio securities that mature in 60 days or less. Certain fund groups had questioned the scope of this guidance. The FAQs clarified that this guidance would generally not be relevant to stable NAV money market funds, given that those funds are allowed by Rule 2a-7 to use amortized cost to value their entire portfolio, and not just individual securities. This guidance is, however, relevant to floating NAV money market funds, as well as to non-money market funds, that use the amortized cost method of valuation to value individual portfolio securities that mature in 60 days or less.

Retail Money Market Funds (FAQs Nos. 15, 17, 18 and 19)

Beneficial Ownership of Fund Shares (FAQ No. 15)

Under the Amendments, a retail money market fund is defined as a fund that has policies and procedures reasonably designed to ensure that all beneficial owners of the fund’s shares are natural persons. The Adopting Release cited to Rules 13d-3 and 16a-1(a)(2) under the Securities Exchange Act of 1934 (Exchange Act) when referring to “beneficial ownership.” Although Rule 16a-1(a)(2) ties beneficial ownership to having a direct or indirect “pecuniary interest” in a security, the Staff stated in the FAQs the belief that beneficial ownership should not be “determined based on entitlement to funds alone (i.e., using the direct or indirect pecuniary interest test), without having sole or shared voting and/or investment power.” Therefore, in accordance with this position, when determining whether a natural person is a beneficial owner, a money market fund should determine whether the person has sole or shared voting and/or investment power, as determined under Rule 13d-3, without regard to whether the person has a pecuniary interest.

Estates of Natural Persons (FAQ No. 17)

The Staff indicated that estates would be allowed to invest in retail money market funds, “because the interests of the natural person and its estate are aligned.”

Seed Capital (FAQ No. 18)

The Staff stated that it “would not object if a non-natural person affiliate beneficially owns shares of a retail money market fund to provide initial seed capital or financial support, so long as these investments solely are intended to facilitate fund administration and operations.”

Master-Feeder Money Market Funds (FAQ No. 19)

The Staff stated “that a master money market fund may consider itself a retail money market fund,” if “all of its feeder funds are qualified retail money market funds and the master fund relies on the policies and procedures of the feeder funds to ensure that all of the feeder fund’s beneficial owners are natural persons.” However, although this guidance permits a master fund to look through to a feeder fund’s investors, the guidance does not appear to apply outside of the master-feeder context. For example, in the fund of funds context, it is unclear whether a retail money market fund would be permitted to look through another type of investing fund (whether another money market fund or other type of fund) even if the investing fund has policies and procedures reasonably designed to ensure that all of its beneficial owners are natural persons.

Transitions, Reorganizations and Involuntary Redemptions (FAQs Nos. 20, 36, 37, 38 and 39)

The Adopting Release provided exemptive relief from Sections 17, 18 and 22 of the 1940 Act to permit money market funds to engage in “one-time” reorganizations in order to comply with the Amendments. Under this relief, money market funds may, subject to certain board findings, reorganize a single share class (e.g., institutional shares) of the fund into a new money market fund or, for a single class money market fund, split the fund into two or more money market funds.5 Moreover, under this relief, a money market fund may involuntarily redeem certain shareholders that will no longer be eligible to invest in the newly established or existing money market fund, subject to certain notification requirements (i.e., giving 60 days prior written notice of the intent to redeem). However, according to the Staff, a money market fund may not involuntarily exchange the redeemed shares for shares of another money market fund.

In the FAQs, the Staff stated it would not object if a “retail money market fund involuntarily redeemed investors who it determines do not meet the eligibility requirements set forth in the retail fund’s prospectus without obtaining separate exemptive relief, even outside the context of a one-time reorganization.” This response essentially allows retail money market funds to involuntarily redeem non-natural person shareholders at any time, outside of the context of a reorganization, as long as this ability is properly disclosed and appropriate notice (i.e., 60 day prior written notice) of the redemptions is given to shareholders. For example, a money market fund that has a limited number of institutional shareholders could simply involuntarily redeem those shareholders in order to qualify as a retail money market fund, without conducting any further reorganization of the fund.

Insurance Company Separate Accounts (FAQs Nos. 21, 22 and 23)

The Staff made it clear that a retail money market fund “may ‘look through’ an insurance company separate account to a natural person who beneficially owns such a contract.” However, the Staff stated that a retail money market fund would not be able to look through an insurance company “fund of funds to the individual contract owners as the beneficial owners,” since the “underlying natural person [would] not retain direct investment power over the bottom-tier fund.”

In addition, with respect to the imposition of liquidity fees, the Staff “believes that [such] fees are not fees that the insurance companies are themselves imposing pursuant to the contract between the insurance company and the variable contract owner.” Instead, the Staff stated that liquidity fees “are fees that the funds underlying the separate accounts are imposing.” Therefore, the Staff believes that liquidity fees (like redemption fees) are not subject to any of the limitations that may apply in a variable insurance product contract, since an insurance company is not imposing any fees on the account based on the contract.

Finally, with respect to the imposition of a redemption gate, the Staff stated that, if a money market fund underlying an insurance company unit investment trust separate account imposes a redemption gate, this would likely create an “emergency” for the subaccount for purposes of the contract between the insurance company and the contract holder. As a result, the Staff stated its belief that it would be impracticable for the subaccount to redeem its shares in the money market fund during the period when the redemption gate is in effect.

Liquidity Fees and Redemption Gates (FAQs Nos. 24, 25, 26, 27 and 28)

Treatment of Redemption Orders (FAQs No. 24 and 28)

Under the Amendments, money market funds (except for government money market funds) must have the ability to impose liquidity fees and redemption gates. The Staff stated that, if a redemption gate is imposed, shareholders who submit a redemption order while the gate is in effect “must submit a new redemption order after the gate is lifted for the order to be effective.” However, if a redemption request was verifiably submitted to a money market fund or its agent before the fund imposed a liquidity fee or redemption gate, the Staff noted that it would not object if the money market fund’s board chose to honor checks or other written redemption orders, as long as the fund can verify that the redemption order was submitted to the fund’s agent before the fee or gate was imposed.

Treatment of Purchase Orders (FAQ No. 25)

Item 11(b) of Form N-1A requires a mutual fund to disclose the procedures for purchasing its shares. The Staff stated that a money market fund could choose to include in this disclosure procedures for how it would handle purchase orders received, but not yet processed, at the time investors are notified of the imposition of a liquidity fee or redemption gate. The Staff stated its belief that a fund may adopt procedures that could either (1) treat the unprocessed order as cancelled unless reconfirmed by the investor or (2) treat the unprocessed purchase order as a valid purchase and process it normally.

Timing of the Imposition of Fees or Gates (FAQs No. 26 and 27)

The Staff indicated that while “a fee or gate may not immediately come into effect due to practical considerations, in the [S]taff’s view, a fund should begin to implement a fee or gate immediately after the board’s determination to impose one.” However, the Staff also recognized that a fund’s board “may need to consider the practical limitations on the capacity of intermediaries and systems when implementing a liquidity fee or gate.” Accordingly, once the board of a money market fund decides to impose a liquidity fee or a redemption gate, the fund should take all practical steps to impose the fee or gate as soon as possible, taking into account practical concerns arising from the applicable systems of the fund, its transfer agent and the intermediaries through which its shares are held.

Finally, the Staff stated that, if a liquidity fee is imposed intraday, an intermediary that receives both purchase and redemption orders from a single underlying accountholder may net the purchases against the redemptions and apply the liquidity fee to the net amount , even if some or all of the purchase orders were received prior to the time the liquidity fee went into effect.

Government Money Market Funds (FAQs Nos. 31, 32 and 35)

Under the Amendments, a “government money market fund” must invest at least 99.5% of its total assets in cash, “government securities” (as defined in Section 2(a)(16) of the 1940 Act) and/or  repurchase agreements that are “collateralized fully” (as defined in Rule 2a-7 under the 1940 Act).6 The Staff clarified that a government money market fund should determine compliance with this test each time that it acquires a portfolio security. For example, according to the FAQ, if a government money market fund’s qualifying assets fall below 99.5% of total assets due to a redemption, the fund should not purchase non-qualifying assets until its qualifying assets exceed 99.5% of total assets. However, the Staff clarified that such a fund would not immediately lose its status as a “government money market fund” due to such redemptions.

The Staff also confirmed that repurchase agreements issued under the New York Federal Reserve Bank’s Overnight Reverse Repurchase Agreement Program, whether or not collateralized fully, may be considered “government securities” under Section 2(a)(16), based on the status of the New York Fed as an instrumentality of the U.S. government in its capacity as administrator of the Program.

Finally, according to the FAQs, notwithstanding Rule 35d-1 under the 1940 Act, a money market fund that invests at least 80% of its net assets in government securities would not be able to call itself a “government” money market fund without also complying with the requirement under amended Rule 2a-7(a)(16) to invest at least 99.5% of its total assets in cash, government securities and/or repurchase agreements that are collateralized fully.

Cash Items for Purposes of Investment Company Status (FAQ No. 41)

Under Section 3(a)(1)(C) of the 1940 Act, an “investment company” means any issuer that is engaged, or proposes to engage, in the business of investing, reinvesting, owning, holding, or trading in securities, and owns or proposes to acquire “investment securities” having a value exceeding 40% of the value of the issuer’s total assets (excluding government securities and cash items). In the FAQs, the Staff expressed the view that an issuer may, “under normal circumstances,” treat the shares of a floating NAV money market fund as “cash items” for purposes of this definition. However, the Staff cautioned that an issuer “may wish to consider events that may give rise to credit and liquidity issues for money market funds and reassess whether such investments continue to appropriately reflect ‘cash items.’”

Performance Record (FAQ No. 46)

According to the Staff, a money market fund that is reorganizing into a separate retail fund (with a stable NAV) and a separate institutional fund (with a fluctuating NAV), solely to comply with amended Rule 2a-7, may continue to include the original fund’s historical performance in each fund’s performance disclosures and marketing materials.

Conclusion

The FAQs provided Staff guidance on many of the issues that have arisen under the Amendments and will undoubtedly have a profound effect on how the money market fund industry implements the Amendments. Although compliance with the most significant provisions of the Amendments – the floating NAV requirement and the imposition of liquidity fees and redemption gates – will not be required until October 14, 2016, money market fund advisers and their boards would be well-advised to consider the FAQs and the issues discussed above in advance of the compliance dates, in order to make sure that their funds are on track to comply with the Amendments by those dates.

Footnotes

1) Money Market Fund Reform; Amendments to Form PF, Investment Company Act Release No. 31166 (July 23, 2014) (Adopting Release). For further information regarding the Amendments, please refer to Dechert OnPoint, U.S. SEC Approves Sweeping Amendments to Rules Governing Money Market Funds (August 2014).

2) 2014 Money Market Fund Reform Frequently Asked Questions, Division of Investment Management (April 22, 2015).

3) According to the Staff, “a fund imposing a fee or gate would generally find it appropriate to file a prospectus supplement pursuant to Rule 497 of the Securities Act disclosing that a fee or gate is currently in place.”

4) See FAQ No. 9, stating that:

as discussed in question 8 above, if a disparity were to arise between the amortized price of a security that matures in 60 days or less and the fair value of such a security that was large enough that it would affect the fund’s NAV, then the staff believes that the use of amortized cost in that situation would not be compatible with the guidance provided in the Adopting Release as the amortized cost value of the portfolio security would not be “approximately the same” as the fair value of the security determined without the use of amortized cost valuation.

5) However, under this guidance, money market funds may not merge or otherwise combine share classes into a new or existing fund. In FAQs, the Staff noted, however, that such a combination could be effected through a fund merger pursuant to Rule 17a-8 under the 1940 Act.

6) Rule 2a-7 defines “collateralized fully” by reference only to a portion of the definition of that term in Rule 5b-3(c)(1) under the 1940 Act, with the result that, under Rule 2a-7, a repurchase agreement is considered to be “collateralized fully” only if the collateral consists entirely of cash items or government securities.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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We reserve the right to change this Privacy Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our Privacy Policy will become effective upon posting of the revised policy on the Website. By continuing to use our Website and Services following such changes, you will be deemed to have agreed to such changes.

Contacting JD Supra

If you have any questions about this Privacy Policy, the practices of this site, your dealings with our Website or Services, or if you would like to change any of the information you have provided to us, please contact us at: privacy@jdsupra.com.

JD Supra Cookie Guide

As with many websites, JD Supra's website (located at www.jdsupra.com) (our "Website") and our services (such as our email article digests)(our "Services") use a standard technology called a "cookie" and other similar technologies (such as, pixels and web beacons), which are small data files that are transferred to your computer when you use our Website and Services. These technologies automatically identify your browser whenever you interact with our Website and Services.

How We Use Cookies and Other Tracking Technologies

We use cookies and other tracking technologies to:

  1. Improve the user experience on our Website and Services;
  2. Store the authorization token that users receive when they login to the private areas of our Website. This token is specific to a user's login session and requires a valid username and password to obtain. It is required to access the user's profile information, subscriptions, and analytics;
  3. Track anonymous site usage; and
  4. Permit connectivity with social media networks to permit content sharing.

There are different types of cookies and other technologies used our Website, notably:

  • "Session cookies" - These cookies only last as long as your online session, and disappear from your computer or device when you close your browser (like Internet Explorer, Google Chrome or Safari).
  • "Persistent cookies" - These cookies stay on your computer or device after your browser has been closed and last for a time specified in the cookie. We use persistent cookies when we need to know who you are for more than one browsing session. For example, we use them to remember your preferences for the next time you visit.
  • "Web Beacons/Pixels" - Some of our web pages and emails may also contain small electronic images known as web beacons, clear GIFs or single-pixel GIFs. These images are placed on a web page or email and typically work in conjunction with cookies to collect data. We use these images to identify our users and user behavior, such as counting the number of users who have visited a web page or acted upon one of our email digests.

JD Supra Cookies. We place our own cookies on your computer to track certain information about you while you are using our Website and Services. For example, we place a session cookie on your computer each time you visit our Website. We use these cookies to allow you to log-in to your subscriber account. In addition, through these cookies we are able to collect information about how you use the Website, including what browser you may be using, your IP address, and the URL address you came from upon visiting our Website and the URL you next visit (even if those URLs are not on our Website). We also utilize email web beacons to monitor whether our emails are being delivered and read. We also use these tools to help deliver reader analytics to our authors to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

Analytics/Performance Cookies. JD Supra also uses the following analytic tools to help us analyze the performance of our Website and Services as well as how visitors use our Website and Services:

  • HubSpot - For more information about HubSpot cookies, please visit legal.hubspot.com/privacy-policy.
  • New Relic - For more information on New Relic cookies, please visit www.newrelic.com/privacy.
  • Google Analytics - For more information on Google Analytics cookies, visit www.google.com/policies. To opt-out of being tracked by Google Analytics across all websites visit http://tools.google.com/dlpage/gaoptout. This will allow you to download and install a Google Analytics cookie-free web browser.

Facebook, Twitter and other Social Network Cookies. Our content pages allow you to share content appearing on our Website and Services to your social media accounts through the "Like," "Tweet," or similar buttons displayed on such pages. To accomplish this Service, we embed code that such third party social networks provide and that we do not control. These buttons know that you are logged in to your social network account and therefore such social networks could also know that you are viewing the JD Supra Website.

Controlling and Deleting Cookies

If you would like to change how a browser uses cookies, including blocking or deleting cookies from the JD Supra Website and Services you can do so by changing the settings in your web browser. To control cookies, most browsers allow you to either accept or reject all cookies, only accept certain types of cookies, or prompt you every time a site wishes to save a cookie. It's also easy to delete cookies that are already saved on your device by a browser.

The processes for controlling and deleting cookies vary depending on which browser you use. To find out how to do so with a particular browser, you can use your browser's "Help" function or alternatively, you can visit http://www.aboutcookies.org which explains, step-by-step, how to control and delete cookies in most browsers.

Updates to This Policy

We may update this cookie policy and our Privacy Policy from time-to-time, particularly as technology changes. You can always check this page for the latest version. We may also notify you of changes to our privacy policy by email.

Contacting JD Supra

If you have any questions about how we use cookies and other tracking technologies, please contact us at: privacy@jdsupra.com.

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This website uses cookies to improve user experience, track anonymous site usage, store authorization tokens and permit sharing on social media networks. By continuing to browse this website you accept the use of cookies. Click here to read more about how we use cookies.