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Money Market Fund Reform; Amendments to Form PF

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Start Preamble Start Printed Page 47736

AGENCY:

Securities and Exchange Commission.

ACTION:

Final rule.

SUMMARY:

The Securities and Exchange Commission (“Commission” or “SEC”) is adopting amendments to the rules that govern money market mutual funds (or “money market funds”) under the Investment Company Act of 1940 (“Investment Company Act” or “Act”). The amendments are designed to address money market funds' susceptibility to heavy redemptions in times of stress, improve their ability to manage and mitigate potential contagion from such redemptions, and increase the transparency of their risks, while preserving, as much as possible, their benefits. The SEC is removing the valuation exemption that permitted institutional non-government money market funds (whose investors historically have made the heaviest redemptions in times of stress) to maintain a stable net asset value per share (“NAV”), and is requiring those funds to sell and redeem shares based on the current market-based value of the securities in their underlying portfolios rounded to the fourth decimal place (e.g., $1.0000), i.e., transact at a “floating” NAV. The SEC also is adopting amendments that will give the boards of directors of money market funds new tools to stem heavy redemptions by giving them discretion to impose a liquidity fee if a fund's weekly liquidity level falls below the required regulatory threshold, and giving them discretion to suspend redemptions temporarily, i.e., to “gate” funds, under the same circumstances. These amendments will require all non-government money market funds to impose a liquidity fee if the fund's weekly liquidity level falls below a designated threshold, unless the fund's board determines that imposing such a fee is not in the best interests of the fund. In addition, the SEC is adopting amendments designed to make money market funds more resilient by increasing the diversification of their portfolios, enhancing their stress testing, and improving transparency by requiring money market funds to report additional information to the SEC and to investors. Finally, the amendments require investment advisers to certain large unregistered liquidity funds, which can have many of the same economic features as money market funds, to provide additional information about those funds to the SEC.

DATES:

Effective Date: October 14, 2014.

Compliance Dates: The applicable compliance dates are discussed in section III.N. of the Release titled “Compliance Dates.”

Start Further Info

FOR FURTHER INFORMATION CONTACT:

Adam Bolter, Senior Counsel; Amanda Hollander Wagner, Senior Counsel; Andrea Ottomanelli Magovern, Senior Counsel; Erin C. Loomis, Senior Counsel; Kay-Mario Vobis, Senior Counsel; Thoreau A. Bartmann, Branch Chief; Sara Cortes, Senior Special Counsel; or Sarah G. ten Siethoff, Assistant Director, Investment Company Rulemaking Office, at (202) 551-6792, Division of Investment Management, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-8549.

End Further Info End Preamble Start Supplemental Information

SUPPLEMENTARY INFORMATION:

The Commission is adopting amendments to rules 419 [17 CFR 230.419] and 482 [17 CFR 230.482] under the Securities Act of 1933 [15 U.S.C. 77a-z-3] (“Securities Act”), rules 2a-7 [17 CFR 270.2a-7], 12d3-1 [17 CFR 270.12d3-1], 18f-3 [17 CFR 270.18f-3], 22e-3 [17 CFR 270.22e-3], 30b1-7 [17 CFR 270.30b1-7], 31a-1 [17 CFR 270.31a-1], and new rule 30b1-8 [17 CFR 270.30b1-8] under the Investment Company Act of 1940 [15 U.S.C. 80a], Form N-1A under the Investment Company Act and the Securities Act, Form N-MFP under the Investment Company Act, and section 3 of Form PF under the Investment Advisers Act [15 U.S.C. 80b], and new Form N-CR under the Investment Company Act.[1]

Table of Contents

I. Introduction

II. Background

A. Role of Money Market Funds

B. Certain Economic Features of Money Market Funds

1. Money Market Fund Investors' Desire To Avoid Loss

2. Liquidity Risks

3. Valuation and Pricing Methods

4. Investors' Misunderstanding About the Actual Risk of Investing in Money Market Funds

C. Effects on Other Money Market Funds, Investors, and the Short-Term Financing Markets

D. The Financial Crisis

E. Examination of Money Market Fund Regulation Since the Financial Crisis

1. The 2010 Amendments

2. The Eurozone Debt Crisis and U.S. Debt Ceiling Impasses of 2011 and 2013

3. Continuing Consideration of the Need for Additional Reforms

III. Discussion

A. Liquidity Fees and Redemption Gates

1. Analysis of Certain Effects of Fees and Gates

2. Terms of Fees and Gates

3. Exemptions to Permit Fees and Gates

4. Amendments to Rule 22e-3

5. Operational Considerations Relating to Fees and Gates

6. Tax Implications of Liquidity Fees

7. Accounting Implications

B. Floating Net Asset Value

1. Introduction

2. Summary of the Floating NAV Reform

3. Certain Considerations Relating to the Floating NAV Reform

4. Money Market Fund Pricing

5. Amortized Cost and Penny Rounding for Stable NAV Funds

6. Tax and Accounting Implications of Floating NAV Money Market Funds

7. Rule 10b-10 Confirmations

8. Operational Implications of Floating NAV Money Market Funds

9. Transition

C. Effect on Certain Types of Money Market Funds and Other Entities

1. Government Money Market Funds

2. Retail Money Market Funds

3. Municipal Money Market Funds

4. Implications for Local Government Investment Pools

5. Unregistered Money Market Funds Operating Under Rule 12d1-1

6. Master/Feeder Funds—Fees and Gates Requirements

7. Application of Fees and Gates to Other Types of Funds and Certain Redemptions

D. Guidance on the Amortized Cost Method of Valuation and Other Valuation Concerns

1. Use of Amortized Cost Valuation

2. Other Valuation Matters

E. Amendments to Disclosure Requirements

1. Required Disclosure Statement

2. Disclosure of Tax Consequences and Effect on Fund Operations—Floating NAV

3. Disclosure of Transition to Floating NAV

4. Disclosure of the Effects of Fees and Gates on Redemptions

5. Historical Disclosure of Liquidity Fees and Gates

6. Prospectus Fee Table

7. Historical Disclosure of Affiliate Financial Support

8. Economic Analysis

9. Web site Disclosure

F. Form N-CR

1. Introduction

2. Part B: Defaults and Events of Insolvency

3. Part C: Financial Support

4. Part D: Declines in Shadow Price Start Printed Page 47737

5. Parts E, F, and G: Imposition and Lifting of Liquidity Fees and Gates

6. Part H: Optional Disclosure

7. Timing of Form N-CR

8. Economic Analysis

G. Amendments to Form N-MFP Reporting Requirements

1. Amendments Related to Rule 2a-7 Reforms

2. New Reporting Requirements

3. Clarifying Amendments

4. Public Availability of Information

5. Operational Implications of the N-MFP Amendments

H. Amendments to Form PF Reporting Requirements

1. Overview of Proposed Amendments to Form PF

2. Utility of New Information, Including Benefits, Costs, and Economic Implications

I. Diversification

1. Treatment of Certain Affiliates for Purposes of Rule 2a-7's Five Percent Issuer Diversification Requirement

2. ABS—Sponsors Treated as Guarantors

3. The Twenty-Five Percent Basket

J. Amendments to Stress Testing Requirements

1. Overview of Current Stress Testing Requirements and Proposed Amendments

2. Stress Testing Metrics

3. Hypothetical Events Used in Stress Testing

4. Board Reporting Requirements

5. Dodd-Frank Mandated Stress Testing

6. Economic Analysis

K. Certain Macroeconomic Consequences of the New Amendments

1. Effect on Current Investors in Money Market Funds

2. Efficiency, Competition and Capital Formation Effects on the Money Market Fund Industry

3. Effect of Reforms on Investment Alternatives, and the Short-Term Financing Markets

L. Certain Alternatives Considered

1. Liquidity Fees, Gates, and Floating NAV Alternatives

2. Alternatives in the FSOC Proposed Recommendations

3. Alternatives in the PWG Report

M. Clarifying Amendments

1. Definitions of Daily Liquid Assets and Weekly Liquid Assets

2. Definition of Demand Feature

3. Short-Term Floating Rate Securities

4. Second Tier Securities

N. Compliance Dates

1. Compliance Date for Amendments Related to Liquidity Fees and Gates

2. Compliance Date for Amendments Related to Floating NAV

3. Compliance Date for Rule 30b1-8 and Form N-CR

4. Compliance Date for Diversification, Stress Testing, Disclosure, Form PF, Form N-MFP, and Clarifying Amendments

IV. Paperwork Reduction Act

A. Rule 2a-7

1. Asset-Backed Securities

2. Retail and Government Funds

3. Board Determinations—Fees and Gates

4. Notice to the Commission

5. Stress Testing

6. Web Site Disclosure

7. Total Burden for Rule 2a-7

B. Rule 22e-3

C. Rule 30b1-7 and Form N-MFP

1. Discussion of Final Amendments

2. Current Burden

3. Change in Burden

D. Rule 30b1-8 and Form N-CR

1. Discussion of New Reporting Requirements

2. Estimated Burden

E. Rule 34b-1(a)

F. Rule 482

G. Form N-1A

H. Advisers Act Rule 204(b)-1 and Form PF

1. Discussion of Amendments

2. Current Burden

3. Change in Burden

V. Regulatory Flexibility Act Certification

VI. Update to Codification of Financial Reporting Policies

VII. Statutory Authority

Text of Rules and Forms

I. Introduction

Money market funds are a type of mutual fund registered under the Investment Company Act and regulated pursuant to rule 2a-7 under the Act.[2] Money market funds generally pay dividends that reflect prevailing short-term interest rates, are redeemable on demand, and, unlike other investment companies, seek to maintain a stable NAV, typically $1.00.[3] This combination of principal stability, liquidity, and payment of short-term yields has made money market funds popular cash management vehicles for both retail and institutional investors. As of February 28, 2014, there were approximately 559 money market funds registered with the Commission, and these funds collectively held over $3.0 trillion of assets.[4]

Absent an exemption, as required by the Investment Company Act, all registered mutual funds must price and transact in their shares at the current NAV, calculated by valuing portfolio instruments at market value or, if market quotations are not readily available, at fair value as determined in good faith by the fund's board of directors (i.e., use a floating NAV).[5] In 1983, the Commission codified an exemption to this requirement allowing money market funds to value their portfolio securities using the “amortized cost” method of valuation and to use the “penny-rounding” method of pricing.[6] Under the amortized cost method, a money market fund's portfolio securities generally are valued at cost plus any amortization of premium or accumulation of discount, rather than at their value based on current market factors.[7] The penny rounding method of pricing permits a money market fund when pricing its shares to round the fund's NAV to the nearest one percent (i.e., the nearest penny).[8] Together, these valuation and pricing techniques create a “rounding convention” that permits a money market fund to sell and redeem shares at a stable share price without regard to small variations in the value of the securities in its portfolio.[9] Other types of mutual funds not regulated by rule 2a-7 generally must calculate their daily NAVs using market-based factors and cannot use penny rounding.

When the Commission initially established the regulatory framework allowing money market funds to Start Printed Page 47738maintain a stable share price through use of the amortized cost method of valuation and/or the penny rounding method of pricing (so long as they abided by certain risk-limiting conditions), it did so understanding the benefits that stable value money market funds provided as a cash management vehicle, particularly for smaller investors, and focused on minimizing dilution of assets and returns for shareholders.[10] At that time, the Commission was persuaded that deviations of a magnitude that would cause material dilution generally would not occur given the risk-limiting conditions of the exemptive rule.[11] As discussed throughout this Release, our historical experience with these funds, and the events of the 2007-2009 financial crisis,[12] has led us to re-evaluate the exemptive relief provided under rule 2a-7, including the exemption from the statutory floating NAV for some money market funds.

Under rule 2a-7, money market funds seek to maintain a stable share price by limiting their investments to short-term, high-quality debt securities that fluctuate very little in value under normal market conditions. In exchange for the ability to rely on the exemptions provided by rule 2a-7, money market funds are subject to conditions designed to limit deviations between the fund's $1.00 stable share price and the market-based NAV of the fund's portfolio.[13] Rule 2a-7 requires that money market funds maintain a significant amount of liquid assets and invest in securities that meet the rule's credit quality, maturity, and diversification requirements.[14] For example, a money market fund's portfolio securities must meet certain credit quality standards, such as posing minimal credit risks.[15] The rule also places restrictions on the remaining maturity of securities in the fund's portfolio to limit the interest rate and credit spread risk to which a money market fund may be exposed. A money market fund generally may not acquire any security with a remaining maturity greater than 397 days, the dollar-weighted average maturity of the securities owned by the fund may not exceed 60 days, and the fund's dollar-weighted average life to maturity may not exceed 120 days.[16] Money market funds also must maintain sufficient liquidity to meet reasonably foreseeable redemptions, generally must invest at least 10% of their portfolios in assets that can provide daily liquidity, and invest at least 30% of their portfolios in assets that can provide weekly liquidity, as defined under the rule.[17] Finally, rule 2a-7 also requires money market funds to diversify their portfolios by generally limiting the funds to investing no more than 5% of their portfolios in any one issuer and no more than 10% of their portfolios in securities issued by, or subject to guarantees or demand features (i.e., puts) from, any one institution.[18]

Rule 2a-7 also includes certain procedural standards overseen by the fund's board of directors. These include the requirement that the fund periodically calculate the market-based value of the portfolio (“shadow price”) [19] and compare it to the fund's stable share price; if the deviation between these two values exceeds 1/2 of 1 percent (50 basis points), the fund's board of directors must consider what action, if any, should be taken by the board, including whether to re-price the fund's securities above or below the fund's $1.00 share price (an event colloquially known as “breaking the buck”).[20]

Different types of money market funds have been introduced to meet the different needs of money market fund investors. Historically, most investors have invested in “prime money market funds,” which generally hold a variety of taxable short-term obligations issued by corporations and banks, as well as repurchase agreements and asset-backed commercial paper.[21] “Government money market funds” principally hold obligations of the U.S. government, including obligations of the U.S. Treasury and federal agencies and instrumentalities, as well as repurchase agreements collateralized by government securities. Some government money market funds limit their holdings to only U.S. Treasury obligations or repurchase agreements collateralized by U.S. Treasury securities and are called “Treasury money market funds.” Compared to prime funds, government and Treasury money market funds generally offer greater safety of principal but historically have paid lower yields. “Tax-exempt money market funds” primarily hold obligations of state and local governments and their instrumentalities, and pay interest that is generally exempt from federal income tax.[22]

We first begin by reviewing the role of money market funds and the benefits they provide investors. We then review the economics of money market funds. This includes a discussion of several features of money market funds that, when combined, can create incentives for fund shareholders to redeem shares during periods of stress, as well as the potential impact that such redemptions can have on the fund and the markets that provide short-term financing.[23] We Start Printed Page 47739then discuss money market funds' experience during the financial crisis against this backdrop. We next analyze our 2010 reforms and their impact on the heightened redemption activity during the 2011 Eurozone sovereign debt crisis and 2011 and 2013 U.S. debt ceiling impasses.

We used the analyses available to us, including the critically important analyses contained in the report responding to certain questions posed by Commissioners Aguilar, Paredes, and Gallagher (“DERA Study”),[24] in designing the reform proposals that we issued in 2013 for additional regulation of money market funds.[25] The 2013 proposal sought to address certain features in money market funds that can make them susceptible to heavy redemptions, by providing money market funds with better tools to manage and mitigate potential contagion from high levels of redemptions, increasing the transparency of their risks, and improving risk sharing among investors, and also to preserve the ability of money market funds to function as an effective and efficient cash management tool for investors.[26]

We received over 1,400 comments [27] on the proposal from a variety of interested parties including money market funds, investors, banks, investment advisers, government representatives, academics, and others.[28] As discussed in greater detail in each section of this Release below, these commenters expressed a diversity of views. Many commenters expressed concern about the consequences of requiring a floating NAV for certain money market funds, suggesting, among other reasons, that it was a significant reform that would remove one of the most desirable features of these funds, and would impose numerous costs and operational burdens. However, others expressed support, noting that it was a targeted solution aimed at curbing the risks associated with the money market funds most susceptible to destabilizing runs. Most commenters supported requiring the imposition of liquidity fees and redemption gates in certain circumstances, suggesting that they would prevent runs at a minimal cost. However, commenters also noted that fees and gates alone would not resolve certain of the features of money market funds that can incentivize heavy redemptions. Many commenters opposed combining the two alternatives into a single package, arguing that requiring money market funds to implement both reforms could decrease the utility of money market funds to investors. Commenters generally supported many of the other reforms we proposed, such as enhanced disclosure, new portfolio reporting requirements for large unregistered liquidity funds, and amendments to fund diversification requirements.

Today, after consideration of the comments received, we are removing the valuation exemption that permits institutional non-government money market funds (whose investors have historically made the heaviest redemptions in times of market stress) to maintain a stable NAV, and are requiring those funds to sell and redeem their shares based on the current market-based value of the securities in their underlying portfolios rounded to the fourth decimal place (e.g., $1.0000), i.e., transact at a “floating” NAV. We also are adopting amendments that will give the boards of directors of money market funds new tools to stem heavy redemptions by giving them discretion to impose a liquidity fee of no more than 2% if a fund's weekly liquidity level falls below the required regulatory amount, and are giving them discretion to suspend redemptions temporarily, i.e., to “gate” funds, under the same circumstances. These amendments will require all non-government money market funds to impose a liquidity fee of 1% if the fund's weekly liquidity level falls below 10% of total assets, unless the fund's board determines that imposing such a fee is not in the best interests of the fund (or that a higher fee up to 2% or a lower fee is in the best interests of the fund). In addition, we are adopting amendments designed to make money market funds more resilient by increasing the diversification of their portfolios, enhancing their stress testing, and increasing transparency by requiring them to report additional information to us and to investors. Finally, the amendments require investment advisers to certain large unregistered liquidity funds, which can have similar economic features as money market funds, to provide additional information about those funds to us.[29]

II. Background

A. Role of Money Market Funds

As we discussed in the Proposing Release, the combination of principal stability, liquidity, and short-term yields offered by money market funds, which is unlike that offered by other types of mutual funds, has made money market funds popular cash management vehicles for both retail and institutional investors.[30] Money market funds' ability to maintain a stable share price contributes to their popularity. The funds' stable share price facilitates their role as a cash management vehicle, provides tax and administrative convenience to both money market funds and their shareholders, and enhances money market funds' attractiveness as an investment option.[31] Due to their popularity with investors, money market fund assets have grown over time, providing them with substantial amounts of cash to invest. As a result, money market funds have become an important source of financing in certain segments of the short-term financing markets. As a result, rule 2a-7, in addition to Start Printed Page 47740facilitating money market funds' maintenance of stable share prices, also benefits investors by making available an investment option that provides an efficient and diversified means for investors to participate in the short-term financing markets through a portfolio of short-term, high-quality debt securities.[32]

In order for money market funds to use techniques to value and price their shares generally not permitted to other mutual funds, rule 2a-7 imposes additional protective conditions on money market funds.[33] As discussed in the Proposing Release, these additional conditions are designed to make money market funds' use of the valuation and pricing techniques permitted by rule 2a-7 consistent with the protection of investors, and more generally, to make available an investment option for investors that seek an efficient way to obtain short-term yields.

We understand, and considered when developing the final amendments we are adopting today, that money market funds are a popular investment product and that they provide many benefits to investors and to the short-term financing markets. Indeed, it is for these reasons that we designed these amendments to make the funds more resilient, as discussed throughout this Release, while preserving, to the extent possible, the benefits of money market funds. But as discussed in section III.K.1 below, we recognize that these reforms may make certain money market funds less attractive to some investors.

B. Certain Economic Features of Money Market Funds

As discussed in detail in the Proposing Release, the combination of several features of money market funds can create an incentive for their shareholders to redeem shares heavily in periods of market stress. We discuss these factors below, as well as the harm that can result from such heavy redemptions in money market funds.

1. Money Market Fund Investors' Desire To Avoid Loss

Investors in money market funds have varying investment goals and tolerances for risk. Many investors use money market funds for principal preservation and as a cash management tool, and, consequently, these funds can attract investors who are less tolerant of incurring even small losses, even at the cost of forgoing higher expected returns.[34] Such investors may be loss averse for many reasons, including general risk tolerance, legal or investment restrictions, or short-term cash needs. These overarching considerations may create incentives for money market fund investors to redeem and would be expected to persist, even if the other incentives discussed below, such as those created by money market fund valuation and pricing, are addressed.

The desire to avoid loss may cause investors to redeem from money market funds in times of stress in a “flight to quality.” For example, as discussed in the DERA Study, one explanation for the heavy redemptions from prime money market funds and purchases in government money market fund shares during the financial crisis may be a flight to quality, given that most of the assets held by government money market funds have a lower default risk than the assets of prime money market funds.[35]

2. Liquidity Risks

When investors begin to redeem a substantial amount of shares, a fund can experience a loss of liquidity. Money market funds, which offer investors the ability to redeem shares upon demand, often will first use internal liquidity to satisfy substantial redemptions. A money market fund has three sources of internal liquidity to meet redemption requests: cash on hand, cash from investors purchasing shares, and cash from maturing securities. If these internal sources of liquidity are insufficient to satisfy redemption requests on any particular day, money market funds may be forced to sell portfolio securities to raise additional cash.[36] And because the secondary market for many portfolio securities is not deeply liquid, funds may have to sell securities at a discount from their amortized cost value, or even at fire-sale prices,[37] thereby incurring additional losses that may have been avoided if the funds had sufficient internal liquidity.[38] This alone can cause a fund's portfolio to lose value. In addition, redemptions that deplete a fund's most liquid assets can have incremental adverse effects because the fund is left with fewer liquid assets, necessitating the sale of less liquid assets, potentially at a discount, to meet further redemption requests.[39] Knowing that such liquidity costs may occur, money market fund Start Printed Page 47741investors may have an incentive to redeem quickly in times of stress to avoid realizing these potential liquidity costs, leaving remaining shareholders to bear these costs.

3. Valuation and Pricing Methods

Money market funds are unique among mutual funds in that rule 2a-7 permits them to use the amortized cost method of valuation and the penny-rounding method of pricing for their entire portfolios. As discussed above, these valuation and pricing techniques allow a money market fund to sell and redeem shares at a stable share price without regard to small variations in the value of the securities in its portfolio, and thus to maintain a stable $1.00 share price under most market conditions.

Although the stable $1.00 share price calculated using these methods provides a close approximation to market value under normal market conditions, differences may exist when market conditions shift due to changes in interest rates, credit risk, and liquidity.[40] The market value of a money market fund's portfolio securities also may experience relatively large changes if a portfolio asset defaults or its credit profile deteriorates.[41] Today, unless the fund “breaks the buck,” market value differences are reflected only in a fund's shadow price, and not the share price at which the fund satisfies purchase and redemption transactions.

Deviations that arise from changes in interest rates and credit risk are temporary as long as securities are held to maturity, because amortized cost values and market-based values converge at maturity. But if a portfolio asset defaults or an asset sale results in a realized capital gain or loss, deviations between the stable $1.00 share price and the shadow price become permanent. For example, if a portfolio experiences a 25 basis point loss because an issuer defaults, the fund's shadow price falls from $1.0000 to $0.9975. Even though the fund has not broken the buck, this reduction is permanent and can only be reversed internally in the event that the fund realizes a capital gain elsewhere in the portfolio, which generally is unlikely given the types of securities in which money market funds typically invest and the tax requirements for these funds.[42]

If a money market fund's shadow price deviates far enough from its stable $1.00 share price, investors may have an economic incentive to redeem their shares. For example, investors may have an incentive to redeem shares when a fund's shadow price is less than $1.00.[43] If investors redeem shares when the shadow price is less than $1.00, the fund's shadow price will decline even further because portfolio losses are spread across the remaining, smaller asset base. If enough shares are redeemed, a fund can “break the buck” due, in part, to heavy investor redemptions and the concentration of losses across a shrinking asset base.[44] In times of stress, this alone provides an incentive for investors to redeem shares ahead of other investors: early redeemers get $1.00 per share, whereas later redeemers may get less than $1.00 per share even if the fund experiences no further losses.[45]

We note that although defaults in assets held by money market funds are low probability events, the resulting losses can lead to a fund breaking the buck if the default occurs in a position that is greater than 0.5% of the fund's assets, as was the case in the Reserve Primary Fund's investment in Lehman Brothers commercial paper in September 2008.[46] And as discussed further in section III.C.2.a of this Release, money market funds hold significant numbers of such larger positions.[47]

4. Investors' Misunderstanding About the Actual Risk of Investing in Money Market Funds

Lack of investor understanding and lack of complete transparency concerning the risks posed by particular money market funds can contribute to heavy redemptions during periods of stress. This lack of investor understanding and complete transparency can come from several different sources.

First, if investors do not know a fund's shadow price and/or its underlying portfolio holdings (or if previous disclosures of this information are no longer accurate), investors may not be able to fully understand the degree of risk in the underlying portfolio.[48] In such an environment, a default of a large-scale commercial paper issuer, such as a bank holding company, could accelerate redemption activity across many funds because investors may not know which funds (if any) hold defaulted securities. Investors may respond by initiating redemptions to avoid potential rather than actual losses in a “flight to transparency.[49] Start Printed Page 47742Because many money market funds hold securities from the same issuer, investors may respond to a lack of transparency about specific fund holdings by redeeming assets from funds that are believed to be holding the same or highly correlated positions.[50]

Second, money market funds' sponsors on a number of occasions have voluntarily chosen to provide financial support for their money market funds.[51] The reasons that sponsors have done so include keeping a fund from re-pricing below its stable value, protecting the sponsors' reputations or brands, and increasing a fund's shadow price if its sponsor believes investors avoid funds that have low shadow prices. Prior to the changes that we are adopting today, funds were not required to disclose instances of sponsor support outside of financial statements; as a result, sponsor support has not been fully transparent to investors and this, in turn, may have lessened some investors' understanding of the risk in money market funds.[52]

Instances of discretionary sponsor support were relatively common during the financial crisis. For example, during the period from September 16, 2008 to October 1, 2008, a number of money market fund sponsors purchased large amounts of portfolio securities from their money market funds or provided capital support to the funds (or received staff no-action assurances in order to provide support).[53] But the financial crisis is not the only instance in which some money market funds have come under strain, although it is unique in the number of money market funds that requested or received sponsor support.[54] As noted in the Proposing Release, since 1989, 11 other financial events have been sufficiently adverse that certain fund sponsors chose to provide support or to seek staff no-action assurances in order to provide support, potentially affecting 158 different money market funds.[55]

Finally, the government assistance provided to money market funds during the financial crisis may have contributed to investors' perceptions that the risk of loss in money market funds is low.[56] If investors perceive that money market funds have an implicit government guarantee, they may believe that money market funds are safer investments than they in fact are and may underestimate the potential risk of loss.[57]

C. Effects on Other Money Market Funds, Investors, and the Short-Term Financing Markets

In this section, we discuss how stress at one money market fund can be positively correlated across money market funds in at least two ways. Some market observers have noted that if a money market fund suffers a loss on one of its portfolio securities—whether because of a deterioration in credit quality, for example, or because the fund sold the security at a discount to its amortized-cost value—other money market funds holding the same security may have to reflect the resultant discounts in their shadow prices.[58] Any resulting decline in the shadow prices of other funds could, in turn, lead to a contagion effect that could spread even further as investors run from money market funds in general. For example, some commenters have observed that many money market fund holdings tend to be highly correlated, making it more likely that multiple money market funds will experience contemporaneous decreases in shadow prices.[59]

As discussed above, in times of stress, if investors do not wish to be exposed to a distressed issuer (or correlated issuers) but do not know which money market funds own these distressed securities at any given time, investors may redeem from any money market fund that could own the security (e.g., redeeming from all prime funds).[60] A Start Printed Page 47743fund that did not own the security and was not otherwise under stress could nonetheless experience heavy redemptions which, as discussed above, could themselves ultimately cause the fund to experience losses if it does not have adequate liquidity.

As was experienced by money market funds during the financial crisis, liquidity-induced contagion may have negative effects on investors and the markets for short-term financing of corporations, banks, and governments. This is in large part because of the significance of money market funds' role in the short-term financing markets.[61] Indeed, money market funds had experienced steady growth before the financial crisis, driven in part by growth in the size of institutional cash pools, which grew from under $100 billion in 1990 to almost $4 trillion just before the financial crisis.[62] Money market funds' suitability for cash management operations also has made them popular among corporate treasurers, municipalities, and other institutional investors, some of which rely on money market funds for their cash management operations because the funds provide diversified cash management more efficiently due both to the scale of their operations and the expertise of money market fund managers.[63] For example, according to one survey, approximately 16% of organizations' short-term investments were allocated to money market funds (and, according to this survey, this figure is down from almost 40% in 2008 due in part to the reallocation of cash investments to bank deposits following temporary unlimited Federal Deposit Insurance Corporation deposit insurance for non-interest bearing bank transaction accounts, which expired at the end of 2012).[64]

Money market funds' size and significance in the short-term markets, together with their features that can create an incentive to redeem as discussed above, have led to concerns that money market funds may contribute to systemic risk. Heavy redemptions from money market funds during periods of financial stress can remove liquidity from the financial system, potentially disrupting other markets. Issuers may have difficulty obtaining capital in the short-term markets during these periods because money market funds are focused on meeting redemption requests through internal liquidity generated either from maturing securities or cash from subscriptions, and thus may be purchasing fewer short-term debt obligations.[65] To the extent that multiple money market funds experience heavy redemptions, the negative effects on the short-term markets can be magnified. Money market funds' experience during the financial crisis illustrates the impact of heavy redemptions, as we discuss in more detail below.

Heavy redemptions in money market funds may disproportionately affect slow-moving shareholders because, as discussed further below, redemption data from the financial crisis show that some institutional investors are likely to redeem from distressed money market funds far more quickly than other investors and to redeem a greater percentage of their prime fund holdings.[66] This likely is because some institutional investors generally have more capital at stake, along with sophisticated tools and professional staffs to monitor risk. Because of their proportionally larger investments, just a few institutional investors submitting redemption requests may have a significant effect on a money market fund's liquidity, while it may take many more retail investors, with their typically smaller investments sizes, to cause similar negative consequences. Slower-to-redeem shareholders may be harmed because, as discussed above, redemptions at a money market fund can concentrate existing losses in the fund or create new losses if the fund must sell assets at a discount to obtain liquidity to satisfy redemption requests. In both cases, redemptions leave the fund's portfolio more likely to lose value, to the detriment of slower-to-redeem investors.[67] Retail investors—who tend to be slower moving—also could be harmed if market stress begins at an institutional money market fund and spreads to other funds, including funds composed solely or primarily of retail investors.[68]

D. The Financial Crisis

The financial crisis in many respects demonstrates the various considerations discussed above in sections B and C, including the potential implications and harm associated with heavy redemption Start Printed Page 47744from money market funds.[69] On September 16, 2008, the day after Lehman Brothers Holdings Inc. announced its bankruptcy, The Reserve Fund announced that its Primary Fund—which held a $785 million (or 1.2% of the fund's assets) position in Lehman Brothers commercial paper—would “break the buck” and price its securities at $0.97 per share.[70] At the same time, there was turbulence in the market for financial sector securities as a result of other financial company stresses, including, for example, the near failure of American International Group (“AIG”), whose commercial paper was held by many prime money market funds.[71]

Heavy redemptions in the Reserve Primary Fund were followed by heavy redemptions from other Reserve money market funds,[72] and soon other institutional prime money market funds also began to experience heavy redemptions.[73] During the week of September 15, 2008 (the week that Lehman Brothers announced it was filing for bankruptcy), investors withdrew approximately $300 billion from prime money market funds or 14% of the assets in those funds.[74] During that time, fearing further redemptions, money market fund managers began to retain cash rather than invest in commercial paper, certificates of deposit, or other short-term instruments.[75] Short-term financing markets froze, impairing access to credit, and those who were still able to access short-term credit often did so only at overnight maturities.[76]

Figure 1, below, provides context for the redemptions that occurred during the financial crisis. Specifically, it shows daily total net assets over time, where the vertical line indicates the date that Lehman Brothers filed for bankruptcy, September 15, 2008. Investor redemptions during the financial crisis, particularly after Lehman's failure, were heaviest in institutional share classes of prime money market funds, which typically hold securities that are less liquid and of lower credit quality than those typically held by government money market funds. The figure shows that institutional share classes of government money market funds, which include Treasury and government funds, experienced heavy inflows.[77] The aggregate level of retail investor redemption activity, in contrast, was not particularly high during September and October 2008, as shown in Figure 1.[78]

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On September 19, 2008, the U.S. Department of the Treasury (“Treasury Department”) announced a temporary guarantee program (“Temporary Guarantee Program”), which would use the $50 billion Exchange Stabilization Fund to support more than $3 trillion in shares of money market funds, and the Board of Governors of the Federal Reserve System authorized the temporary extension of credit to banks to finance their purchase of high-quality asset-backed commercial paper from money market funds.[79] These programs successfully slowed redemptions in prime money market funds and provided additional liquidity to money market funds. As discussed in the Proposing Release, the disruptions to the short-term markets detailed above could have continued for a longer period of time but for these programs.[80]

E. Examination of Money Market Fund Regulation Since the Financial Crisis

1. The 2010 Amendments

After the events of the financial crisis, in March 2010, we adopted a number of amendments to rule 2a-7.[81] These amendments were designed to make money market funds more resilient by reducing the interest rate, credit, and liquidity risks of fund asset portfolios.[82] More specifically, the amendments decreased money market funds' credit risk exposure by further restricting the amount of lower quality securities that funds can hold.[83] The amendments, for the first time, also required that money market funds maintain liquidity buffers in the form of specified levels of daily and weekly liquid assets.[84] These liquidity buffers provide a source of internal liquidity and are intended to help funds withstand high levels of redemptions during times of market illiquidity. The amendments also reduce money market funds' exposure to interest rate risk by decreasing the maximum weighted average maturities of fund portfolios from 90 to 60 days.[85]

In addition to reducing the risk profile of the underlying money market fund portfolios, the reforms increased the amount of information that money market funds are required to report to the Commission and the public. Money market funds are now required to submit to the Commission monthly information on their portfolio holdings using Form N-MFP.[86] This information allows the Commission, investors, and third parties to monitor compliance with rule 2a-7 and to better understand and monitor the underlying risks of money market fund portfolios. Money market funds also are now required to post portfolio information on their Web sites each month, providing investors with important information to help them make better-informed investment decisions.[87]

Finally, the 2010 amendments require money market funds to undergo stress tests under the direction of the board of Start Printed Page 47746directors on a periodic basis.[88] Under this stress testing requirement, each fund must periodically test its ability to maintain a stable NAV per share based upon certain hypothetical events, including an increase in short-term interest rates, an increase in shareholder redemptions, a downgrade of or default on portfolio securities, and widening or narrowing of spreads between yields on an appropriate benchmark selected by the fund for overnight interest rates and commercial paper and other types of securities held by the fund. This reform was intended to provide money market fund boards and the Commission a better understanding of the risks to which the fund is exposed and give fund managers a tool to better manage those risks.[89]

2. The Eurozone Debt Crisis and U.S. Debt Ceiling Impasses of 2011 and 2013

Several significant market events since our 2010 reforms have permitted us to evaluate the efficacy of those reforms. Specifically, in the summer of 2011, the Eurozone sovereign debt crisis and an impasse over the U.S. Government's debt ceiling unfolded, and during the fall of 2013 another U.S. Government debt ceiling impasse occurred.

While it is difficult to isolate the effects of the 2010 amendments, these events highlight the potential increased resilience of money market funds after the reforms were adopted. Most significantly, no money market fund needed to re-price below its stable $1.00 share price. As discussed in greater detail in the Proposing Release, as a result of concerns about exposure to European financial institutions, in the summer of 2011, prime money market funds began experiencing substantial redemptions.[90] But unlike September 2008, money market funds did not experience meaningful capital losses in the summer of 2011 (or as discussed below, in the fall of 2013), and the funds' shadow prices did not deviate significantly from the funds' stable share prices. Also unlike in 2008, money market funds had sufficient liquidity to satisfy investors' redemption requests, which were submitted at a lower rate and over a longer period than in 2008, suggesting that the 2010 amendments acted as intended to enhance the resiliency of money market funds.[91]

In 2013, another debt ceiling impasse took place,[92] although over a longer time period and without the Eurozone crisis as a backdrop. During the worst two-week period of the 2013 crisis, October 3rd through October 16th, government and treasury money market funds experienced combined outflows of $54.4 billion, which was 6.1% of total assets, with approximately 1.5% of assets flowing out of these funds on October 11th, the single worst day for outflows of the 2013 impasse. Importantly, despite these outflows, fund shadow prices were largely unaffected during this time period. Once the impasse was resolved, assets flowed back into these funds, returning government and treasury money market funds to a pre-crisis asset level before the end of the year, indicating their resiliency.[93]

Although money market funds' experiences differed in 2008 and in the Eurozone crisis, the heavy redemptions money market funds experienced in both periods appear to have negatively affected the markets for short-term financing in similar ways. Academics researching these issues have found, as detailed in the DERA Study, that “creditworthy issuers may encounter financing difficulties because of risk taking by the funds from which they raise financing”; “local branches of foreign banks reduced lending to U.S. entities in 2011”; and that “European banks that were more reliant on money funds experienced bigger declines in dollar lending.” [94] Thus, while such redemptions often exemplify rational risk management by money market fund investors, they can also have certain contagion effects on the short-term financing markets. Again, despite these similar effects, the 2010 reforms demonstrated that money market funds are potentially more resilient today than in 2008.

3. Continuing Consideration of the Need for Additional Reforms

As discussed in greater detail in the Proposing Release, when we adopted the 2010 amendments, we acknowledged that money market funds' experience during the financial crisis raised questions of whether more fundamental changes to money market funds might be warranted.[95] The DERA Study, discussed throughout this Release, has informed our consideration of the risks that may be posed by money market funds and our formulation of today's final rules and rule amendments. The DERA Study contains, among other things, a detailed analysis of our 2010 amendments to rule 2a-7 and some of the amendments' effects to date, including changes in some of the characteristics of money market funds, the likelihood that a fund with the maximum permitted weighted average maturity (“WAM”) would “break the buck” before and after the 2010 reforms, money market funds' experience during the 2011 Eurozone sovereign debt crisis and the 2011 U.S. debt-ceiling impasse, and how money market funds would have performed during September 2008 had the 2010 reforms been in place at that time.[96]

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In particular, the DERA Study found that under certain assumptions the expected probability of a money market fund breaking the buck was lower with the additional liquidity required by the 2010 reforms.[97] For example, funds in 2011 had sufficient liquidity to withstand investors' redemptions during the summer of 2011.[98] The fact that no fund experienced a credit event during that time also contributed to the evidence that funds were able to withstand relatively heavy redemptions while maintaining a stable $1.00 share price. Finally, using actual portfolio holdings from September 2008, the DERA Study analyzed how funds would have performed during the financial crisis had the 2010 reforms been in place at that time. While funds holding 30% weekly liquid assets are more resilient to portfolio losses, funds will “break the buck” with near certainty if capital losses of the fund's non-weekly liquid assets exceed 1%.[99] The DERA Study concludes that the 2010 reforms would have been unlikely to prevent a fund from breaking the buck when faced with large credit losses like the ones experienced in 2008.[100] Based on the DERA Study, we believe that, although the 2010 reforms were an important step in making money market funds better able to withstand heavy redemptions when there are no portfolio losses (as was the case in the summer of 2011 and the fall of 2013), these reforms do not sufficiently address the potential future situations when credit losses may cause a fund's portfolio to lose value or when the short-term financing markets more generally come under stress.

After consideration of this data, as well as the comments we received on the proposal, we believe that the reforms we are adopting today should further help lessen money market funds' susceptibility to heavy redemptions, improve their ability to manage and mitigate potential contagion from high levels of redemptions, and increase the transparency of their risks, while preserving, as much as possible, the benefits of money market funds.

III. Discussion

A. Liquidity Fees and Redemption Gates

Today, we are adopting amendments to rule 2a-7 that will authorize new tools for money market funds to use in times of stress to stem heavy redemptions and avoid the type of contagion that occurred during the financial crisis. These amendments provide money market funds with the ability to impose liquidity fees and redemption gates (generally referred to herein as “fees and gates”) in certain circumstances.[101] Today's amendments will allow a money market fund to impose a liquidity fee of up to 2%, or temporarily suspend redemptions (also known as “gate”) for up to 10 business days in a 90-day period, if the fund's weekly liquid assets fall below 30% of its total assets and the fund's board of directors (including a majority of its independent directors) determines that imposing a fee or gate is in the fund's best interests.[102] Additionally, under today's amendments, a money market fund will be required to impose a liquidity fee of 1% on all redemptions if its weekly liquid assets fall below 10% of its total assets, unless the board of directors of the fund (including a majority of its independent directors) determines that imposing such a fee would not be in the best interests of the fund.[103]

These amendments differ in some respects from the fees and gates that we proposed, which would have required funds to impose a 2% liquidity fee on all redemptions, and would have permitted the imposition of redemption gates for up to 30 days in a 90-day period, after a fund's weekly liquid assets fell below 15% of its total assets. In addition, under our proposal, a fund's board (including a majority of independent directors) could have determined not to impose the liquidity fee or to impose a lower fee. A large number of commenters supported, to varying degrees and with varying caveats, our fees and gates proposal.[104] Many other commenters, on the other hand, expressed their opposition to fees and gates.[105] Comments on the proposal are discussed in more detail below.

1. Analysis of Certain Effects of Fees and Gates [106]

a. Background

As discussed previously, shareholders redeem money market fund shares for a number of reasons.[107] Shareholders may redeem shares because the current rounding convention in money market fund valuation and pricing can create incentives for shareholders to redeem shares ahead of other investors when the market-based NAV per share of a fund is lower than $1.00 per share.[108] Shareholders also may flee to quality, liquidity, or transparency (or combinations thereof) during adverse economic events or financial market conditions.[109] Furthermore, in times of stress, shareholders may simply need or want to withdraw funds for unrelated reasons. In any case, money market funds may have to absorb quickly high levels of redemptions that exceed internal sources of liquidity. In these instances, funds will need to sell portfolio securities, perhaps at a loss either because they incur transitory liquidity costs or they must sell assets at “fire sale” prices.[110] If fund managers deplete their funds' most liquid assets first, this may impose future liquidity costs (that are not reflected in a $1.00 share price based on current amortized cost valuation) on the non-redeeming shareholders because later redemption requests must be met by selling less liquid assets. These effects may be heightened if many funds sell assets at the same time, lowering asset prices. During the financial crisis, for example, securities sales to meet heavy redemptions in money market funds and sales of assets by other investors Start Printed Page 47748created downward price pressure in the market.[111]

Liquidity fees and redemption gates have been used successfully in the past by certain non-money market fund cash management pools to stem redemptions during times of stress.[112] Liquidity fees provide investors continued access to their liquidity (albeit at a cost) while also reducing the incentives for shareholders to redeem shares. Liquidity fees, however, will not outright stop redemptions. In contrast to fees, redemption gates stop redemptions altogether, but do not offer the flexibility of fees.[113] Because redemption gates prevent investors from accessing their investments for a period of time, a fund may choose to first impose a liquidity fee and then, if needed, impose a redemption gate.

The fees and gates amendments we are adopting today are designed to address certain issues highlighted by the financial crisis. In particular, the amendments should allow funds to moderate redemption requests by allocating liquidity costs to those shareholders who impose such costs on funds through their redemptions and, in certain cases, stop heavy redemptions in times of market stress by providing fund boards with additional tools to manage heavy redemptions and improve risk transparency. We understand that based on the level of redemption activity that occurred during the financial crisis, many money market funds would have faced liquidity pressures sufficient to cross the liquidity thresholds we are adopting today that would allow the use of fees and gates. Although no one can predict with certainty what would have happened if money market funds had operated with fees and gates during the financial crisis, we believe that money market funds would have been better able to manage the heavy redemptions that occurred and limit contagion, regardless of the reason for the redemptions.[114]

Fees and gates are just one aspect of the overall package of reforms we are adopting today. We recognize that fees and gates do not address all of the factors that may lead to heavy redemptions in money market funds. For example, fees and gates do not fully eliminate the incentive to redeem ahead of other investors in times of stress [115] or fully prevent investors from redeeming shares (except during the duration of a temporary gate) to invest in securities with higher quality, better liquidity, or increased transparency.[116] Fees and gates also do not address the shareholder dilution that results when a shareholder is able to redeem at a stable NAV that is higher than the market value of the fund's underlying portfolio securities.[117] Nonetheless, for the reasons discussed in this Release, fees and gates provide funds and their boards with additional tools to stem heavy redemptions and avoid the type of contagion that occurred during the financial crisis by allocating liquidity costs to those shareholders who impose such costs on funds and by stopping runs.

i. Liquidity Fees

During the financial crisis, some funds experienced heavy redemptions. Shareholders who redeemed shares early bore none of the economic consequences of their redemptions. Shareholders who remained in the funds, however, faced a declining NAV and an increased probability that their funds would “break the buck.” As discussed in the Proposing Release and suggested by commenters, investors may have re-assessed their redemption decisions during the crisis if money market funds had imposed liquidity fees because they would have been required to pay at least some of the costs of their redemptions.[118] It is possible that some investors would have made the economic decision not to redeem because the liquidity fees imposed by the fund and incurred by an investor would have been certain, whereas potential future losses would have been uncertain.[119]

In addition, liquidity fees would have helped offset the costs of the liquidity provided to redeeming shareholders and potentially protected the funds' NAVs because the cash raised from liquidity Start Printed Page 47749fees would create new liquidity for the funds.[120] Additionally, to the extent that liquidity fees imposed during the crisis could have reduced redemption requests at the margin, they would have allowed funds to generate liquidity internally as assets matured. By imposing liquidity costs on redeeming shareholders, liquidity fees, as noted by commenters, also treat holding and redeeming shareholders more equitably.[121]

Liquidity fees, which we believe would rarely be imposed under normal market conditions, are designed to preserve the current benefits of principal stability, liquidity, and a market yield, but reduce the likelihood that, in times of market stress, costs that ought to be attributed to a redeeming shareholder are externalized on remaining shareholders and on the wider market.[122] Even if a liquidity fee is imposed, fund investors continue to have the flexibility to access liquidity (albeit at a cost). The Commission believes, and commenters suggested, that if funds could have imposed liquidity fees during the crisis, they would likely have been better able to manage redemptions, thereby ameliorating their impact and reducing contagion effects.[123]

ii. Redemption Gates

We believe that funds also could have benefitted from the ability to impose redemption gates during the crisis.[124] Like liquidity fees, gates are designed to preserve the current benefits of money market funds under most market conditions; however, if approved and monitored by their boards, funds can use gates to respond to a run by directly halting redemptions. If funds had been able to impose redemption gates during the crisis, they would have had available to them a tool to stop temporarily mounting redemptions,[125] which if used could have generated additional internal liquidity while gates were in place.[126] In addition, gates may have allowed funds to invest the proceeds of maturing assets in short-term securities for the duration of the gate, protecting the short-term financing market, and supporting capital formation for issuers. Gates also would have allowed funds to directly and fully control redemptions during the crisis, providing time for funds to better communicate the nature of any stresses to shareholders and thereby possibly mitigating incentives to redeem shares.[127]

b. Benefits of Fees and Gates

i. Fees and Gates Address Concerns Related to Heavy Redemptions

As noted above, a large number of commenters supported our fees and gates proposal.[128] The primary benefit cited by commenters in favor of fees and/or gates is that they would address run risk and/or systemic contagion risk.[129] Commenters also argued that fees and gates would protect the interests of all fund shareholders, particularly non- or late-redeeming shareholders, treating them more equitably.[130] Commenters supported our view that redemption restrictions could provide a “cooling off” period to temper the effects of short-term investor panic,[131] and that fees or gates could Start Printed Page 47750preserve and help restore the liquidity levels of a money market fund that has come under stress.[132] Commenters also echoed our view that fees and/or gates could reduce or eliminate the likelihood that funds would be forced to sell otherwise desirable assets and engage in “fire sales.” [133] Additionally, commenters noted that gates would provide boards and advisers with crucial additional time to find the best solution in a crisis, instead of being forced to make decisions in haste.[134]

We are adopting reforms that will give a fund the ability to impose either a liquidity fee or a redemption gate because we believe, and some commenters suggested, that fees and gates, while both aimed at helping funds to better and more systematically manage high levels of redemptions, do so in different ways and thus with somewhat different tradeoffs.[135] Accordingly, we believe that both fees and gates should be available to funds and their boards to provide maximum flexibility for funds to manage heavy redemptions.[136] Liquidity fees are designed to reduce shareholders' incentives to redeem shares when it is abnormally costly for funds to provide liquidity by requiring redeeming shareholders to bear at least some of the liquidity costs associated with their redemption (rather than transferring all of those costs to remaining shareholders).[137] Liquidity fees increase the cost of redeeming shares, which may reduce investors' incentives to sell them. Likewise, fees help reduce investors' incentives to redeem shares ahead of other investors, especially if fund managers deplete their funds' most liquid assets first to meet redemptions, leaving later redemption requests to be met by selling less liquid assets.

Several commenters noted that liquidity fees could “re-mutualize” risk-taking among investors and provide a way to recover costs of liquidity in times of stress.[138] This is because liquidity fees allocate at least some of the costs of providing liquidity to redeeming rather than non-redeeming shareholders and protect fund liquidity by requiring redeeming shareholders to repay funds for liquidity costs incurred.[139] To the extent liquidity fees exceed such costs, they also can help increase the fund's net asset value for remaining shareholders which would have a restorative effect if the fund has suffered a loss. As one commenter has said, a liquidity fee can “provide a strong disincentive for investors to make further redemptions by causing them to choose between paying a premium for current liquidity or delaying liquidity and benefitting from the fees paid by redeeming investors.” [140] This explicit pricing of liquidity costs in money market funds should offer significant benefits to funds and the broader short-term financing market in times of potential stress because it should lessen both the frequency and effect of shareholder redemptions, which might otherwise result in the sale of fund securities at “fire sale” prices.[141]

In contrast, redemption gates will provide fund boards with a direct and immediate tool for stopping heavy redemptions in times of stress.[142] Unlike liquidity fees, gates are designed to directly stop a run by delaying redemptions long enough to allow (1) fund managers time to assess the condition of the fund and determine the appropriate strategy to meet redemptions, (2) liquidity buffers to grow organically as securities in the portfolio (many of which are very short-term) mature and produce cash, and (3) shareholders to assess the liquidity and value of portfolio holdings in the fund and for any shareholder or market panic to subside.[143] As contemplated by today's amendments, gates definitively stop runs for funds that impose them by blocking all redemptions for their duration.

We recognize that redemption gates, if they are ever imposed, will inhibit the full, unfettered redeemability of money market fund shares, a principle embodied in section 22(e) of the Investment Company Act.[144] However, as discussed in section III.A.3 below, section 22(e) of the Investment Company Act is aimed at preventing funds and their advisers from interfering with shareholders' redemption rights for improper purposes, such as preservation of management fees. Consistent with that aim, redemption gates under today's amendments are designed to benefit the fund and its shareholders and may be imposed only when a fund's board determines that doing so is in the best interests of the fund.[145] We also note that, in response to commenter concerns regarding investor access to their investments and the proposed duration of redemption gates, under today's amendments, gates will be limited to up to 10 business days in any 90-day period (rather than 30 days in a 90-day period as proposed).[146] As such, the extent to which today's amendments inhibit the redeemability of money market fund shares is limited.

In fact, we note that money market funds are currently permitted to delay payments on redemptions for up to Start Printed Page 47751seven days.[147] In addition, money market funds currently may suspend redemptions after obtaining an exemptive order from the Commission,[148] or in accordance with rule 22e-3, which requires a fund's board of directors to determine that the fund is about to “break the buck” (specifically, that the extent of deviation between the fund's amortized cost price per share and its current market-based NAV per share may result in material dilution or other unfair results to investors).[149] Under today's amendments, money market fund boards will be able to temporarily suspend redemptions after a fund falls below the same threshold that funds must cross for boards to impose liquidity fees.[150] Accordingly, we believe that the gating allowed by today's amendments extends and formalizes the existing gating framework, clarifying for investors when a money market fund potentially may use a gate as a tool to manage heavy redemptions and thus prevents any investor confusion on when gating may apply.

Fees and gates also may have different levels of effectiveness under different stress scenarios.[151] For example, we expect that the imposition of liquidity fees when a fund faces heavy redemptions should be able to reduce the harm to non-redeeming shareholders and thus the likelihood of additional redemptions that might have been made in response to that harm. To the extent that a fund does not need to engage in fire sales and depress prices because of the imposition of fees, the possibility of broader market contagion is reduced. We also note that research in behavioral economics suggests that liquidity fees may be particularly effective in dampening a run because, when faced with two negative options, investors tend to prefer the option that involves only possible losses rather than the option that involves certain losses, even when the amount of possible loss is significantly higher than the certain loss.[152] Unlike gates, which temporarily prevent shareholders from redeeming shares altogether, once imposed, liquidity fees will present investors with an economic decision as to whether to redeem or remain in a fund. Investors fearing that a money market fund may suffer losses may prefer to stay in the fund and avoid paying a liquidity fee (despite the possibility that the fund might suffer a future loss) rather than redeem and lock in payment of the liquidity fee.[153]

It is possible, however, that liquidity fees might not be fully effective during a market-wide crisis because, for example, shareholders might redeem shares irrespective of the level of their fund's true liquidity costs and the imposition of a liquidity fee.[154] In those cases, gates will be able to function as circuit breakers, creating time for funds to rebuild their own internal liquidity and shareholders to reconsider whether redemptions are still desired or warranted.[155]

ii. Management-Related Advantages

We are also mindful that permitting fund boards to impose fees and/or gates after a fund has fallen below a particular threshold, and requiring funds to impose liquidity fees at a lower designated threshold (absent a board finding that the fee is not in the best interests of the fund), may offer certain benefits to funds with respect to management of liquidity and redemption activity. Some commenters suggested that, even during non-stress periods, fees and gates could provide fund managers with an incentive to carefully monitor shareholder concentration and shareholder flow to lessen the chance that the fund might have to impose fees or gates (because larger redemptions are more likely to cause the fund to breach the threshold).[156] The fees and gates amendments also may have the additional effect of encouraging portfolio managers to more closely monitor fund liquidity and hold more liquid securities to increase the level of daily and weekly liquid assets in the fund, as it would tend to lessen the likelihood of a fee or gate being imposed.[157] Such an approach could also lead to greater investor participation in money market funds to the extent investors seek to invest in a product with low liquidity risk, thereby increasing the supply of capital available to invest in commercial paper. We recognize, however, that such an approach could perhaps shrink the market for riskier or longer-term commercial paper, or have a negative effect on yield.[158]

We also note that funds may take alternate approaches to managing liquidity and imposing fees and gates, Start Printed Page 47752which may differentially affect the short-term funding markets. For example, a fund that imposes a fee or gate may decide to immediately build liquidity by investing all maturing securities in highly liquid assets, particularly if the fund wants to remove the fee or gate as soon as possible. Another fund may plan to impose a fee or gate for a set period of time, in which case, there would be no reason to stop investing in less liquid short-term commercial paper provided it matured while the fee or gate was in place. The first strategy would likely have the capital formation effect of lowering participation in short-term funding markets, whereas the second strategy may defer the impact until a later time, possibly after market conditions have improved.

iii. Transparency

We recognize, and certain commenters noted,[159] that the prospect of fees and gates being implemented when a fund is under stress should help make the risk of investing in money market funds more salient and transparent to investors, which may help sensitize them to the risks of investing in money market funds. On the other hand, we note that other commenters argued that fees and gates would not improve transparency of risk for investors.[160] Having considered these comments, however, we believe that there will be an appreciable increase in transparency as a result of our fees and gates amendments. The disclosure amendments we are adopting today will require funds to provide disclosure to investors regarding the possibility of fees and gates being imposed if a fund's liquidity is impaired. We believe such disclosure will benefit investors by informing them further of the risks associated with money market funds, particularly that money market funds' liquidity may, at times, be impaired.[161] In addition, as noted above, fees and gates also could encourage shareholders to monitor funds' liquidity levels and exert market discipline over the fund to reduce the likelihood that the imposition of fees or gates will become necessary in that fund.[162]

c. Concerns Regarding Fees and Gates

i. Pre-Emptive Runs and Broader Market Concerns

We acknowledge the possibility that, in market stress scenarios, shareholders might pre-emptively redeem shares if they fear the imminent imposition of fees or gates (either because of the fund's situation or because other money market funds have imposed redemption restrictions).[163] A number of commenters suggested investors would do so.[164] Some commenters also suggested that sophisticated investors in particular might be able to predict that fees and gates may be imposed and may redeem shares before this occurs.[165]

While we recognize that there is risk of pre-emptive redemptions, the benefits of having effective tools in place to address runs and contagion risk leads us to adopt the proposed fees and gates reforms, with some modifications. We believe several of the changes we are making in our final reforms will mitigate this risk and dampen the effects on other money market funds and the broader markets if pre-emptive redemptions do occur.

As discussed below, the shorter maximum time period for the imposition of gates and the smaller size of the default liquidity fee that we are adopting in these final amendments, as compared to what we proposed, are expected to lessen further the risk of pre-emptive runs.[166] We understand that the potential for a longer gate or higher liquidity fee before a restriction is in place may increase the incentive for investors to redeem at the first sign of any potential stress at a fund or in the markets.[167] We believe that by limiting the maximum time period that gates may be imposed to 10 business days in any 90-day period (down from the proposed 30 days), investor concerns regarding an extended loss of access to cash from their investment should be mitigated. Indeed, some money market funds today retain the right to delay payment on redemption requests for up to seven days, as all registered investment companies are permitted to do under the Investment Company Act, and we are not aware that this possibility has led to any pre-emptive runs historically.[168] In addition, we note that under section 22(e), the Commission also has the authority to, by order, suspend the right of redemption or allow the postponement of payment of redemption requests for more than seven days. The Commission used this authority, for example, with Start Printed Page 47753respect to the Reserve Primary Fund. To our knowledge, this authority also has not historically led to pre-emptive redemptions. We believe that the gating allowed by today's amendments extends and formalizes this existing gating framework, clarifying for investors when a money market fund potentially may use a gate as a tool to manage heavy redemptions and thus prevents any investor confusion on when gating may apply.

We believe that the maximum 10 business day gating period we are adopting today is a similarly short enough period of time (as compared to the seven days a fund may delay payment on redemption requests) that many investors may not be unduly burdened by such a temporary loss of liquidity.[169] Thus, these investors may have less incentive to redeem their investments pre-emptively before the imposition of a gate. For similar reasons, the reduction in the default liquidity fee to 1% (down from the proposed 2%), discussed further below, may also lessen shareholders' incentives to redeem pre-emptively as fewer investors may consider it likely that a liquidity fee will result in an unacceptable loss on their investment.[170]

In addition, we expect that the additional discretion we are granting fund boards to impose a fee or gate at any time after a fund's weekly liquid assets have fallen below the 30% required minimum, a much higher level of remaining weekly liquid assets than proposed, should mitigate the risk of pre-emptive redemptions. This board discretion should reduce the incentive of shareholders from trying to pre-emptively redeem because they will be able to less accurately predict specifically when, and under what circumstances, fees and gates will be imposed.[171] Board discretion also should allow boards to act decisively if they become concerned liquidity may become impaired and to react to expected, as well as actual, declines in liquidity levels, given their funds' investor base and other characteristics.

Likewise, increased board discretion should lessen the likelihood that sophisticated investors can preferentially predict when a fee or gate is going to be imposed because sophisticated investors, like any other investor, will not know what specific circumstances a fund board will deem appropriate for the imposition of fees or gates.[172] We recognize that sophisticated investors may monitor the weekly liquid assets of funds and seek to redeem before a fund drops below the 30% weekly liquid asset threshold. We believe, however, that a sophisticated investor may be dissuaded from redeeming in these circumstances because the fund still has a substantial amount of internal liquidity. In addition, redemptions when the fund still has this much internal liquidity would not lead to fire sales or other such adverse effects.

We also believe that increased board flexibility will reduce the occurrence of pre-emptive redemptions by shareholders who seek to redeem because another money market fund has imposed a fee or gate. Increased board flexibility will likely result in different funds imposing different redemption restrictions at different times, particularly considering that after crossing the 30% threshold each fund's board will be required to make a best interests determination with respect to the imposition of a fee or gate.[173] As such, it will be less likely that investors can predict whether any particular fund will impose a fee or gate, even if another fund has done so, and thus perhaps less likely they will redeem assuming that one fund imposing such a restriction means other funds may soon do so.

Moreover, we believe that funds' ability to impose fees and gates once weekly liquid assets drop below 30% will substantially mitigate the broader effects of pre-emptive runs, should they occur. A money market fund that imposes a fee or gate with substantial remaining internal liquidity is in a better position to bear those redemptions without a broader market impact because it can satisfy those redemption requests through existing or internally generated cash and not through asset sales (other than perhaps sales of government securities that tend to increase in value and liquidity in times of stress). Thus, pre-emptive runs, if they were to occur, under these circumstances are less likely to generate adverse contagion effects on other money market funds or the short-term financing markets.

We note some commenters suggested that concerns about pre-emptive run risks from fees and gates are likely overstated.[174] One commenter noted that the “element of uncertainty inherent in a board's discretion to impose a fee or gate” would diminish any possible gaming by investors.[175] Another commenter further noted that “appropriate portfolio construction and daily transparency” would reduce the likelihood of anticipatory redemptions.[176] For example, as discussed below, our amendments require that each money market fund disclose daily on its Web site its level of weekly liquid assets. This means that if one money market fund imposes a fee or gate, investors in other money market funds will have the benefit of full transparency on whether the money market fund in which they are invested is similarly experiencing liquidity stress and thus is likely to impose a fee or gate. Pre-emptive redemptions and contagion effects due to a lack of transparency Start Printed Page 47754(which may have occurred in the crisis) may therefore be reduced. Some commenters also have previously indicated that a liquidity fee or gate should not accelerate a run, stating that such redemptions would likely trigger the fee or gate and that, once triggered, the fee or gate would then lessen or halt redemptions.[177]

Additionally, we note that while many European money market funds are able to suspend redemptions and/or impose fees on redemptions, we are not aware that their ability to do so has historically led to pre-emptive runs. Most European money market funds are subject to legislation governing Undertakings for Collective Investment in Transferable Securities (“UCITS”), which also covers other collective investments, and which permits them to suspend temporarily redemptions of units.[178] For example, in Ireland, UCITS are permitted to temporarily suspend redemptions “in exceptional cases where circumstances so require and suspension is justified having regard to the interest of the unit-holders.” [179] Similarly, many money market funds in Europe are also permitted to impose fees on redemptions.[180]

We also note that a commenter discussed a paper by the staff of the Federal Reserve Bank of New York (“FRBNY”) entitled “Gates, Fees, and Preemptive Runs.” [181] The FRBNY staff paper constructs a theoretical model of fees or gates used by a financial intermediary and finds “that rather than being part of the solution, redemption fees and gates can be part of the problem.” [182] This commenter argued that this paper fails to consider numerous restrictions in bank products similar to fees and gates that do not appear to have triggered pre-emptive runs on banks.[183] In particular, the commenter noted that all banks are required “to retain contractual authority as to most deposits to postpone withdrawals (gating) or impose early redemption fees and to reserve the right to impose restrictions—either gates or fees or both—on redemptions of all bank deposits other than demand deposit accounts. . . .” [184]

We note that the model of fees or gates in the FRBNY staff paper has a number of features and assumptions different than the reforms we are adopting today. For example, the paper's model assumes the fees or gates are imposed only when liquid assets are fully depleted. In contrast, under our reforms fees or gates may be imposed while the fund still has substantial liquid assets and, as discussed above, we believe investors may be dissuaded from pre-emptively redeeming from funds with substantial internal liquidity because the fund is more likely to be able to readily satisfy redemptions without adversely impacting the fund's pricing.[185] Moreover, under our reforms (unlike the model), a fund board has discretion in the decision of when to impose fees or gates, which as discussed above should reduce the incentive for investors to run, because they will be able to less accurately predict specifically when, and under what circumstances, fees or gates will be imposed.[186] Another significant difference is that our reforms include a floating NAV for institutional prime money market funds, which constitute a sizeable portion of all money market funds, but the model assumes a stable NAV. As discussed below, we believe the floating NAV requirement may encourage those investors who are least able to bear risk of loss to redirect their investments to other investment opportunities (e.g., government money market funds), and this may have the secondary effect of removing from the funds those investors most prone to redeem should a liquidity event occur for which fees or gates could be imposed. Furthermore, the paper also assumes that no investor could foresee the possibility of a shock to a money market fund that reduces the fund's value or liquidity despite the events of 2008 that should have informed investors that fund NAVs can change over time and that liquidity levels may fluctuate. In addition, under our floating NAV reforms, price levels of institutional prime money market funds likely will fluctuate, and today's reforms will also require additional disclosures that will convey important information to investors about the fund's value which in turn may help prevent run behavior to the extent it is based on uninformed decision-making.

These differences in our reforms as compared to the model in the FRBNY staff paper, along with the additional disclosures that we are adopting today that will convey important information to investors about the fund's value, should in our view significantly mitigate any potential for substantial investor runs before fees and gates are imposed. Accordingly, the FRBNY staff paper's findings regarding the risks of pre-emptive redemptions, because they rely on different facts and assumptions than are being implemented in today's reforms, are not likely to apply to money market funds following today's reforms.

As noted above, the new daily transparency to shareholders on funds' levels of weekly liquid assets should provide additional benefits, including helping shareholders to understand if their fund's liquidity is at risk and thus a fee or gate more likely and, therefore, should lessen the chance of contagion from shareholders redeeming indiscriminately in response to another fund imposing a fee or gate. Investors will be able to benefit from this disclosure when assessing each fund's circumstances, rather than having to infer information from, or react to, the problems observed at other funds. Nevertheless, investors might mimic other investors' redemption strategies even when those other investors' decisions are not necessarily based on superior information.[187] General stress Start Printed Page 47755in the short-term markets or fear of stress at a particular fund could trigger redemptions as shareholders try to avoid a fee or gate. As noted above, however, even if investors redeem, their redemptions eventually could cause a fee or gate to come down, thereby lessening or halting redemptions and mitigating contagion risk.[188] In sum, we are persuaded that fees and gates are important tools that can be used to halt redemptions and prevent contagion during periods of market stress.

ii. Impact on a Fund After Imposing a Fee or Gate

Commenters have suggested that once fees and gates are imposed, they may not be easily lifted without triggering a run.[189] Similarly, other commenters warned that imposing a fee or gate would not help a fund recover from a crisis but rather force it into liquidation because investors would lose trust in the fund and seek to invest in a money market fund that has not imposed a fee or gate.[190] We acknowledge that there is a risk that investors may redeem from a fund after a fee or gate is lifted. We believe this is less likely following the imposition of a fee, however, because investors will continue to have the ability to redeem while a fee is in place and, therefore, may experience less disruption and potentially less loss in trust. In any event, we believe that it is important that money market funds have these tools to give funds the ability to obtain additional liquidity in an orderly fashion if a liquidity crisis occurs, notwithstanding the risk that the imposition of a fee or gate may cause some subsequent loss in trust in a fund or may lead to a resumption in heavy redemptions once a fee or gate is lifted. Further, we think it is important to observe that whenever a fee or gate is imposed, the fund may already be under stress from heavy redemptions that are draining liquidity, and the purpose of the fees and gates amendments is to give the fund's board additional tools to address this external threat when the board determines that using one or both of the tools is in the fund's best interests.

Further, to the extent that commenters' concerns about potential loss in trust or risk of a run when a fee or gate is lifted is tied to investor concerns about the sufficiency of the fund's liquidity levels, we note that, under today's amendments, funds will be required to disclose information regarding their liquidity (e.g., daily and weekly liquid assets) on a daily basis. Such disclosure, assuming adequate liquidity, may help ameliorate concerns that investors will run or shift their investment elsewhere after a fund lifts its redemption restrictions because investors will be able to see that a fund is sufficiently liquid. To the extent heavy redemptions resume after a fund lifts a fee or gate, we also note that a fund board may again impose a fee, or gate if the fund has not yet exceeded the 10 business day maximum gating period, if it is in the best interests of the fund.[191] Additionally, while we recognize that fees and gates may cause some investors to leave a fund once it has lifted a fee or gate (or, in the case of a fee, while the fee is in place), which may affect efficiency, competition, and capital formation, we believe it is possible that some investors, particularly those that were not seeking to redeem during the imposition of the fee or gate, may choose to stay in the fund. In this regard, we note that, as discussed above, a liquidity fee would benefit those investors who were not seeking to redeem while a fund's liquidity was under stress by more equitably allocating liquidity costs among redeeming and non-redeeming shareholders.[192] In addition, to the extent a fund's drop in weekly liquid assets was the result of an external event, if such event resolves while a fee or gate is place, some investors may choose to stay in the fund after the fee or gate is lifted.

In addition, we recognize that a fund board may determine to close a fund and liquidate after the fund has imposed a fee or temporary gate (or instead of imposing a fee or temporary gate) pursuant to amended rule 22e-3.[193] We note, however, that even if a fund ultimately liquidates, its disposition is likely to be more orderly and efficient if it previously imposed a fee or gate. In fact, imposing a fee or gate should give a fund more time to generate greater liquidity so that it will be able to liquidate with less harm to shareholders. Additionally, to the extent a fund's board determines to close the fund and liquidate after the fund has imposed a fee or temporary gate, we anticipate that this would more commonly occur because the imposition of the fee or gate was the result of idiosyncratic stresses on the fund.[194] In this regard, we note that at least one commenter who suggested that a money market fund would likely be forced to liquidate after imposing a fee or gate, also noted that “in a systemic crisis” where many funds may be faced with heavy redemptions and thus the possibility of imposing fees and gates, money market funds “may have a greater likelihood of avoiding liquidation after the systemic crisis [has] subsided.” [195]

iii. Investors' Liquidity Needs

A number of commenters expressed concern that fees or gates could impair money market funds' use as liquid investments, in particular because redemption restrictions (especially gates) would limit or deny shareholders ready access to their funds.[196] Commenters noted such a lack of liquidity could have detrimental consequences for investors, including, for example, corporations and institutions using liquidity accounts for cash management,[197] retail investors needing immediate access to cash such as in a medical emergency or when purchasing a home,[198] and state and local governments that need to make payroll or service bond payments when due.[199]

We recognize that liquidity fees and redemption gates could affect shareholders by potentially limiting, partially or fully (as applicable), the redeemability of money market fund shares under certain conditions, a principle embodied in the Investment Start Printed Page 47756Company Act.[200] In our view, however, these reforms should not unreasonably impede the use of money market funds as liquid investments. First, under normal circumstances, when a fund's liquidity is not under stress, the fees and gates amendments will not affect money market funds or their shareholders. Fees and gates are tools for funds to use in times of severe market or internal stress. Second, even when a fund experiences stress, the fees and gates amendments we are adopting today do not require money market funds to impose fees and gates when it is not in the best interests of the fund. Accordingly, we believe these tools can assist funds facing liquidity shortages during periods of unusual stress, while preserving the benefits of money market funds for investors and the short-term funding markets by not affecting the day-to-day operations of a fund in periods without stress. In fact, a number of commenters observed that fees and gates would be the most effective option of achieving the Commission's reform goals,[201] and would preserve as much as possible the current benefits of money market funds and/or be less onerous day-to-day on funds and investors.[202]

With respect to liquidity fees, we also note that investors will not be prohibited from redeeming their investments; rather, they may access their investments at any time, but their redemptions will be subject to a fee that is designed to make them bear at least some of the costs associated with their access to liquidity rather than externalizing those costs to the remaining fund shareholders. With respect to gates, we recognize that they will temporarily prevent investors from redeeming their investments when imposed. However, we believe gates (as well as fees) will rarely be imposed in normal market conditions. In our view, in those likely rare situations where a gate would be imposed, investors would (in the absence of the gating mechanism) potentially be left in worse shape if the fund were, for example, forced to engage in the sale of assets and thus incur permanent losses; or worse, if the fund were forced to liquidate because of a severe liquidity crisis. Thus, we believe that allowing fund boards to impose gates should not be viewed as detrimental to funds, but rather should be viewed as an interim measure boards can employ in worse case scenarios where the alternative would likely be a result potentially more detrimental to investors' overall interests. To the extent that some investors may be sufficiently concerned about their ability to access their investment to meet certain obligations, such as payroll or bills, we believe they may choose to manage their money market fund investments so as to be able to meet these obligations if a redemption gate should be imposed.[203]

While we recognize these commenter concerns regarding liquidity, we believe that the overall benefits and protections that are provided by the fees and gates amendments to all investors in these money market funds outweigh these concerns. Furthermore, we note that the final amendments have been modified and tailored to mitigate some potentially disruptive consequences of fees and gates. For example, under the final amendments, gates cannot be imposed for more than 10 business days in any 90-day period, so, to the extent an investor's access to his/her money is inhibited, it is for a limited period of time, which may allow an investor to better prepare for and withstand a possible gate. We also note, as discussed above, that funds are currently permitted to impose permanent redemption gates in certain circumstances.[204] Therefore, we believe that the gating allowed by today's amendments extends and formalizes the existing gating framework, clarifying for investors when a money market fund potentially may use a gate as a tool to manage heavy redemptions and thus prevents any investor confusion on when gating may apply. While we recognize that the permanent redemption gates allowed under rule 22e-3 have not yet been used by money market funds, we note that investors have widely utilized money market funds as cash management vehicles even with the possibility of these permanent gates under an existing rule. Moreover, to the extent an investor wants to invest in a money market fund without the possibility of fees and/or gates, it may choose to invest in a government money market fund, which is not subject to the fees and gates requirements.[205]

iv. Investor Movement Out of Money Market Funds

Some commenters expressed concern that the possibility of fees and gates being imposed could result in diminished investor appeal and/or utility of affected money market funds, and could cause investors to either abandon or severely restrict use of affected money market funds.[206] For example, commenters suggested that fees and gates would drive sweep account money out of money market funds.[207] Commenters warned that fees and gates may cause investors to shift investments into other assets, government money market funds, FDIC-insured accounts and other bank products, riskier and/or less regulated investments, or other alternative stable value products.[208] Conversely, other commenters predicted only minor effects on investor demand and/or that investor demand would decrease less under the proposed fees and gates alternative than under the proposed floating NAV alternative.[209]

We recognize that, as suggested by certain commenters, our amendments could cause some shareholders to redeem their prime money market fund shares and move their assets to alternative products that do not have the ability to impose fees or gates because the potential imposition of a fee or gate could make investment in a money market fund less attractive due to less Start Printed Page 47757certain liquidity.[210] As noted above, this could affect efficiency, competition, and capital formation. We agree with one commenter that suggested it is difficult to estimate the extent to which assets might shift from prime funds to government funds or other alternatives.[211] As discussed above, some investors may determine they are comfortable investing in money market funds that may impose fees and gates, because fees and gates will likely be imposed only during times of stress and should not affect the daily operations of money market funds during normal market conditions.[212] Other investors, however, may reallocate their assets to investment alternatives that are not subject to fees and gates, such as government money market funds.[213]

One potential issue related to market efficiency that several commenters raised was a potential shortage of eligible government securities if investors reallocate assets from funds that are subject to fees and gates into government funds.[214] We anticipate that any increase in demand for eligible government securities because of the fees and gates requirement would likely be accompanied by an additional increase in demand arising from investors that reallocate assets from institutional prime funds because of the floating NAV requirement. As such, we discuss the reforms' joint impact on the demand for eligible government securities and possible repercussions on the economy and capital formation in section III.K below.

In addition, a number of commenters noted that a possible shift out of affected money market funds could ultimately lead to a decrease in the funding of, or other adverse effects on, the short-term financing markets.[215] The Commission recognizes the expected benefits from today's amendments may be accompanied by adverse effects on issuers that access the short-term financing markets with consequent effects on competition and capital formation. As discussed in greater detail in section III.K below, the magnitude of these effects, including any effects on competition, efficiency, and capital formation, will depend on the extent to which investors reallocate their investments within or outside the money market fund industry and which alternatives investors choose.

Some commenters also suggested that fees and gates could motivate money market funds to hold securities of even shorter-term duration, which could encourage issuers to fund themselves with shorter-term debt.[216] Shortening debt maturity would increase the frequency at which issuers would need to refinance, leaving both issuers and the broad financial system more vulnerable to refinancing risk.[217] One such commenter further noted that basing the threshold for fees and gates on weekly liquid assets will “discourage[e] prime money market funds from drawing down on their buffers of liquid assets [due to fear of crossing below the fees and gates thresholds] precisely when they should do so from a system-wide perspective, i.e., in a system-wide liquidity and funding crisis.” [218] In addition, some commenters were concerned about a loss of funding or other adverse impacts on state and local governments as a result of the fees and gates amendments.[219] We discuss these concerns in section III.K below.

2. Terms of Fees and Gates

As discussed above, we are adopting provisions that, unlike the proposal, will allow a money market fund the flexibility to impose fees (up to 2%) [220] and/or gates (up to 10 business days in a 90-day period) [221] after the fund's weekly liquid assets have crossed below 30% of its total assets, if the fund's board of directors (including a majority of its independent directors) determines that doing so is in the best interests of the fund.[222] We are also adopting amendments that will require a money market fund, if its weekly liquid assets fall below 10% of its total assets, to impose a 1% liquidity fee on each shareholder's redemption, unless the fund's board of directors (including a Start Printed Page 47758majority of its independent directors) determines that such a fee would not be in the best interests of the fund, or determines that a lower or higher fee (not to exceed 2%) would be in the best interests of the fund.[223] The proposal would have required funds (absent a board determination otherwise) to impose a 2% liquidity fee on all redemptions, and would have permitted the imposition of redemption gates for up to 30 days in a 90-day period, after a fund's weekly liquid assets fell below 15% of its total assets. In addition, unlike in the proposal, today's amendments will allow a fund to impose a fee or gate at any point throughout the day after a fund's weekly liquid assets have dropped below 30%.[224]

As in the proposal, any fee or gate imposed under today's amendments must be lifted automatically after the money market fund's level of weekly liquid assets rises to or above 30%, and it can be lifted at any time by the board of directors (including a majority of independent directors) if the board determines to impose a different redemption restriction (or, with respect to a liquidity fee, a different fee) or if it determines that imposing a redemption restriction is no longer in the best interests of the fund.[225] As amended, rule 22e-3 also will permit the permanent suspension of redemptions and liquidation of a money market fund if the fund's level of weekly liquid assets falls below 10% of its total assets.[226]

a. Thresholds for Fees and Gates

i. Discretionary Versus Mandatory Thresholds

As proposed, a fund would have been required (unless the board determined otherwise) to impose a default liquidity fee, and would have been permitted to impose a gate, after the fund's weekly liquid assets dropped below 15% of its total assets. In addition, a fund would have had to wait to impose a fee or gate until the next business day after it crossed below the 15% threshold.

Commenters ranged widely over whether and to what extent the trigger for fees and gates should be an objective test or left to the discretion of fund boards. On one hand, a group of commenters expressed concern about giving money market fund boards discretion to impose fees and gates.[227] For example, some commenters noted that board discretion could create uncertainty among investors,[228] and that boards might be reticent, due to the possible impact of the decision, to act in a time of crisis.[229]

On the other hand, a large group of commenters generally argued in favor of giving boards more discretion over whether to impose a fee or gate.[230] For example, a number of commenters expressly noted that fees should be at the discretion of fund boards instead of being automatically triggered at a particular liquidity threshold.[231] A number of other commenters argued more generally that, when heavy redemptions are already underway or clearly foreseeable, boards should be able to impose fees and gates even before a set liquidity threshold or some other objective threshold has been crossed.[232]

We continue to believe that a hybrid approach that at some point imposes a default fee that boards can opt out of or change best ensures that fees and gates will be imposed when it is appropriate. Based on commenter feedback, however, we believe that such a hybrid approach could benefit from the default fee acting more as a floor for board consideration when liquidity has been significantly depleted and from additional board discretion to impose fees and gates in advance of that point.[233] Thus, our final approach—while still a hybrid approach—is significantly more discretionary than under our proposal. As we indicated in the Proposing Release, we believe a hybrid approach offers the possibility of achieving many of the benefits of both a purely discretionary trigger and a fully automatic trigger. We recognize that a discretionary trigger allows a fund board the flexibility to determine when a restriction is necessary, and thus allows the board to trigger the fee or gate based on current market conditions and the specific circumstances of the fund.

A purely discretionary trigger, however, creates the risk that a fund board may be reluctant to impose restrictions, even when they would benefit the fund and the short-term financing markets. As commenters indicated,[234] a board may choose not to impose a fee or gate for commercial reasons—for example, out of fear that doing so would signal trouble for the individual fund or fund complex (and thus may incur significant negative business and reputational effects) or could incite redemptions in other money market funds in the fund complex in anticipation that fees may be imposed in those funds as well. We are also concerned that purely discretionary triggers could cause some funds to use fees and gates when they are not under stress and in contravention of the principles underlying the Investment Company Act. If, for example, a fund's NAV began to fall due to losses incurred in the portfolio, a board with full discretion to impose fees on fund redemptions could impose a fee solely to recover those losses and repair the fund's NAV, even if that fund's liquidity is not being stressed.

As discussed in the Proposing Release, we recognize that although an automatic trigger set by the Commission may mitigate some of the potential concerns associated with a fully discretionary trigger, it also may create the risk of imposing costs on shareholders, such as those related to board meetings or liquidity fees themselves, when funds are not truly distressed or when liquidity is not abnormally costly. As indicated by a number of commenters and discussed above, an automatic trigger also could result in shareholders pre-emptively redeeming their shares to avoid a fee or Start Printed Page 47759gate.[235] In addition, commenters suggested that a fund's liquidity could quickly evaporate once heavy redemptions begin and that a fund board should not have to wait until the fund's weekly liquid assets breach the default liquidity fee threshold or until the next business day in order to act.[236]

In light of these risks and in response to the comments discussed above, we have determined to increase the amount of board discretion under the fees and gates amendments so that funds may impose fees or gates before the default liquidity fee threshold is reached and so they can better tailor the redemption restrictions to their particular circumstances. Additionally, the amendments will allow fund boards to impose fees and gates the same day that a fund experiences or foresees heavy redemptions and, thus, funds will not have to wait until the next day to act.[237] This increased flexibility should better allow fund boards to prevent or stem heavy redemptions before they occur, or as soon as possible after they begin or are anticipated.[238]

ii. Threshold Levels

As discussed above, funds will be permitted to impose fees and gates after a fund's weekly liquid assets have dropped below 30%, and will be required to impose a liquidity fee after a fund's weekly liquid assets drop below 10%, unless the fund's board determines such fee is not in the best interests of the fund. As proposed, the threshold for the imposition of fees and gates would have been a drop below 15% weekly liquid assets and a fund's board could have determined that a fee would not be in the best interests of the fund.

Various commenters proposed modifications or substitutes to the proposed 15% weekly liquid assets threshold. For example, one commenter, citing a survey of its members, suggested fund boards be given discretion to impose a liquidity fee when weekly liquid assets fall below a specified threshold, and that a default liquidity fee could be imposed at a specified lower level of weekly liquid assets (unless the board determines otherwise).[239] Another commenter proposed a blended trigger for the imposition of gates at 30% weekly liquid assets or a drop in NAV below $0.995, whichever comes first.[240]

As discussed in this section, we have been persuaded by commenters that boards should be allowed some flexibility to impose a fee or gate when heavy redemptions are underway or clearly foreseeable. As was suggested by a commenter,[241] we are adopting a tiered threshold for the imposition of fees and gates, with a higher threshold for discretionary fees and gates and a lower threshold for default liquidity fees. We believe this tiered approach will allow boards to determine with greater flexibility the best line of defense against heavy redemptions and to tailor that defense to the specific circumstances of the fund. We also believe this tiered approach will allow boards to act quickly to stem heavy redemptions. This approach also recognizes, however, that at a certain point (under the amended rule, a drop below 10% weekly liquid assets), boards should be required to consider what, if any, action should be taken to address a fund's liquidity.

We are adopting a threshold of less than 30% weekly liquid assets at which fund boards will be able to impose discretionary fees and gates, as was suggested by a commenter.[242] As 30% weekly liquid assets is the minimum required under rule 2a-7, we believe it is an appropriate threshold at which fund boards should be able to consider fees and gates as measures to stop heavy redemption activity that may be building in a fund.[243] A drop in weekly liquid assets below the regulatory minimum could indicate current or future liquidity problems or forecast impending heavy redemptions, or it could be the result of idiosyncratic stresses that may be resolved without intervention—in either case, the money market fund's board, in consultation with the fund's investment adviser, is best suited to determine whether fees and gates can address the situation.[244]

Some commenters recommended that the default liquidity fee threshold be lowered to 10% weekly liquid assets.[245] These commenters generally argued that a 10% threshold, rather than a 15% threshold, would produce fewer “false positives”—instances when a money market fund is, in fact, not experiencing stress on its liquidity but is nonetheless required (absent a board finding) to impose a liquidity fee—which should prevent unnecessary board meetings that would not be in the interest of shareholders or market stability.[246] As was discussed in the Proposing Release, the threshold for a default liquidity fee should indicate distress in a fund and be a threshold few funds would cross in the ordinary course of business. Commission staff analysis shows that from March 2011 through October 2012, there was only one month that any funds reported weekly liquid assets below 15% and only one month that a fund reported weekly liquid assets below 10%.[247]

Start Printed Page 47760

In light of commenters' concerns and the Commission staff analysis, and in recognition of the increased board discretion to impose fees and gates that we are adopting in today's amendments, we have determined that a threshold of 10% weekly liquid assets (down from the proposed 15%) is an appropriate threshold for the imposition of a default liquidity fee. We believe that the flexibility in today's amendments justifies a decrease in the default liquidity fee threshold, particularly because fund boards will be allowed to impose discretionary fees and gates, if it is in the best interests of a fund, at any time after a fund's weekly liquid assets drop below 30%—i.e., before the default liquidity fee threshold is reached.[248] Our proposal, which, as noted above, set a higher threshold for the default liquidity fee or the imposition of a gate, did not include board discretion to use these tools prior to reaching this threshold. Under today's amendments, however, the 10% default liquidity fee threshold is designed effectively as a floor to require fund boards to focus on a fund's liquidity and to consider what action to take, if any, before liquidity is further depleted. Additionally, Commission staff analysis shows that a 10% threshold for the default liquidity fee is also a threshold few funds would cross in the ordinary course of business.[249]

Some commenters on the fees and gates threshold suggested moving away from weekly liquid asset levels as the triggering mechanism.[250] One commenter noted that the most appropriate rules-based threshold would be if the shadow price fell to $0.9975 or below.[251] Another commenter also suggested that, to the extent the Commission moved forward with a rules-based threshold, “defaults, acts of insolvency, significant downgrades or determinations that a portfolio security no longer presents minimum credit risk” should be added to the situations in which a board could impose a fee or gate.[252]

We do not believe a drop in a fund's NAV (or shadow price, to the extent the money market fund is a stable value fund), or a default, act of insolvency, significant downgrade or determination that a portfolio security no longer presents minimum credit risk, would be the appropriate threshold for the imposition of fees and gates. First, as we discussed in the Proposing Release, we are concerned that a money market fund being able to impose a fee only when the fund's NAV or shadow price has fallen by some amount may in certain cases come too late to mitigate the potential consequences of heavy redemptions on a fund's liquidity and to fully protect investors.[253] Heavy redemptions can impose adverse economic consequences on a money market fund even before the fund actually suffers a loss. They can deplete the fund's most liquid assets so that the fund is in a substantially weaker position to absorb further redemptions or losses. Second, the thresholds we are adopting today are just that—thresholds. If it is not in the best interests of a fund, a board is not required to impose a liquidity fee or redemption gate when the fund's weekly liquid assets have fallen below 30% or 10%, respectively. Moreover, once a fund has crossed below a weekly liquid asset threshold, a board is not prevented from taking into account whether the fund's NAV or shadow price has deteriorated in considering whether to impose fees or gates. Finally, the fees and gates amendments are intended to address the liquidity of the fund and its ability to meet redemptions, not to address every possible circumstance that may adversely affect a money market fund and its holdings. However, if a particular circumstance, such as a default, act of insolvency, significant downgrade, or increased credit risk, affects the liquidity of a fund such that its weekly liquid assets drop below the 30% threshold for imposition of fees and gates, a fund could then impose a fee or gate.

Another commenter suggested basing the threshold for redemption gates on the level at which a money market fund's liquidity would force it to sell assets.[254] This particular commenter was concerned that a threshold based on 15% weekly liquid assets might otherwise cause funds close to the threshold to start selling assets to avoid crossing the threshold, which could have a larger destabilizing effect on the markets.[255] We appreciate the commenter's concerns and believe that the higher weekly liquid asset threshold for the imposition of fees and gates and the increased board flexibility included in today's amendments should lessen such a risk. In particular, as discussed above in section III.A.1.c.i, we believe that the 30% weekly liquid assets threshold will allow a money market fund to impose a fee or gate while it still has substantial remaining internal liquidity, thus putting it in better position to bear redemptions without a broader market impact because it can satisfy redemption requests through internally generated cash and not through asset sales (other than perhaps sales of government securities that tend to increase in value and liquidity in times of stress). In addition, the board flexibility in today's amendments could result in funds imposing gates at different times and, thus, to the extent funds determine to dispose of their assets to raise liquidity, it could also result in funds disposing assets at different times, lessening any potential strain on the markets.

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b. Board Determinations

In the Proposing Release, we discussed a number of factors that a fund's board of directors may want to consider in determining whether to impose a liquidity fee or redemption gate.[256] We received a variety of comments related to these factors and, more generally, about board determinations regarding fees and gates. Some commenters suggested that the Commission provide additional guidance on the nature and scope of the findings that boards can make.[257] A commenter asked the Commission to provide an expanded list of examples and a non-exclusive list of factors to be considered by boards with respect to imposing a fee or gate.[258] The commenter added that the Commission should clarify that boards need to consider only those factors they reasonably believe to be relevant, not all factors or examples that the Commission might generally suggest.[259]

In contrast, another commenter, an industry group representing fund directors, supported the Commission providing only minimal guidance on what factors boards might consider.[260] This commenter argued that “providing any guidance on what factors boards should consider (beyond the very general and non-exclusive examples in the Proposing Release) is likely to be counter-productive.” [261] The commenter also suggested that the Commission clarify that a “best interests of the fund” standard would not demand that boards place significant emphasis on the broader systemic effects of their decision.[262]

The “best interests” standard in today's amendments recognizes that each fund is different and that, once a fund's weekly liquid assets have dropped below the minimum required by rule 2a-07, a fund's board is best suited, in consultation with the fund's adviser, to determine when and if a fee or gate is in the best interests of the fund.[263] The factors we set forth in the Proposing Release were intended only as possible factors a board may consider when making a best interests determination. They were not meant to be a one-size-fits-all or exhaustive list of factors. We agree with the commenter who suggested an exclusive list of factors could be counter-productive. We recognize that there are differences among funds and that the markets are dynamic, particularly in a crisis situation. Accordingly, an exhaustive list of factors may not address each fund's particular circumstances and could quickly become outdated. Instead, we believe a fund board should consider any factors it deems appropriate when determining whether fees and/or gates are in the best interests of a fund. We note that these factors may include the broader systemic effects of a board's decision, but point out that the applicable standard for a board's determination under the amended rule is whether a fee or gate is in the fund's best interests.

Nonetheless, we believe it is appropriate to provide certain guideposts that boards may want to keep in mind, as applicable and appropriate, when determining whether a fund should impose fees or gates and are providing such guidance in this Release. As recognized in the Proposing Release, there are a number of factors a board may want to consider. These may include, but are not limited to: relevant indicators of liquidity stress in the markets and why the fund's weekly liquid assets have fallen (e.g., Have weekly liquid assets fallen because the fund is experiencing mounting redemptions during a time of market stress or because a few large shareholders unexpectedly redeemed shares for idiosyncratic reasons unrelated to current market conditions or the fund?); the liquidity profile of the fund and expectations as to how the profile might change in the immediate future, including any expectations as to how quickly a fund's liquidity may decline and whether the drop in weekly liquid assets is likely to be very short-term (e.g., Will the decline in weekly liquid assets be cured in the next day or two when securities currently held in the fund's portfolio qualify as weekly liquid assets?); [264] for retail and government money market funds, whether the fall in weekly liquid assets has been accompanied by a decline in the fund's shadow price; [265] the make-up of the fund's shareholder base and previous shareholder redemption patterns; and/or the fund's experience, if any, with the imposition of fees and/or gates in the past.

Some commenters urged the Commission to affirm that a board's deliberations would be protected by the business judgment rule.[266] One commenter was particularly concerned about the threat of litigation if boards were not protected by the rule, as it could “chill the board's ability to act in a manner that would be highly counterproductive in times of market stress.” [267] While sensitive to this commenter's concerns, we do not believe it would be appropriate for us to address the application of the business judgment rule because the business judgment rule is a construct of state law and not the federal securities laws.

Other commenters proposed that boards should be permitted to reasonably determine and commit themselves in advance to a policy to not allow a fee or gate to ever be imposed on a fund.[268] We disagree. A blanket decision on the part of a fund board to not impose fees or gates, without any knowledge or consideration of the particular circumstances of a fund at a given time, would be flatly inconsistent with the fees and gates amendments we are adopting today, which, at a minimum, require a fund to impose a liquidity fee when its weekly liquid assets have dropped below 10%, unless the fund's board affirmatively finds that such fee is not in the best interests of the fund. As discussed above, we believe that when a fund falls below 10% weekly liquid assets, its liquidity is sufficiently stressed that its board should be required to consider, based on the facts and circumstances at that time, what, if any, action should be taken to address a fund's liquidity. We regard fees and gates as additional tools for boards to employ when necessary and appropriate to protect the fund and its shareholders. We note, however, that our amendments do not require funds to impose fees and gates when it is not in a fund's best interests.

Certain commenters cited operational challenges with respect to fees and gates and board quorum requirements, given that in a crisis a board's independent Start Printed Page 47762board members may not be readily available on short notice.[269] Commenters thus proposed that the quorum requirement be relaxed to require only the approval of a majority of independent directors available rather than of all independent directors.[270]

We have not made the requested change. The requirement that a majority of independent directors make a determination with respect to a fund matter is not unique to today's amendments. This requirement is widely used in the Investment Company Act and its rules, including a number of other exemptive rules.[271] As we have emphasized, independent directors are the “independent watchdogs” of a fund, and the Investment Company Act and its rules rely on them to protect investor interests.[272] A determination with respect to fees and gates by less than a majority of independent directors would not provide the level of independent oversight we are seeking in today's amendments, or in carrying out the purposes of the Investment Company Act. The decision to impose redemption restrictions on a fund's investors has significant ramifications for shareholders, and it is one that we believe should be entrusted only to a fund's board, including its independent directors. We note, however, that today's amendments do not require a best interests determination to be made at an in-person meeting and, thus, fund boards, including their independent directors, could hold meetings telephonically or through any other technological means by which all directors could be heard.[273]

Some commenters asserted that a fund's adviser or sponsor should have greater input regarding the imposition of a fee or gate.[274] For example, one commenter urged the Commission to recognize that “the primary role of the board is oversight” and acknowledge “both the ability and practical necessity of delegating day-to-day decision-making functions to a fund's officers and investment adviser/administrator pursuant to procedures approved by the board.” [275] A few other commenters suggested that the Commission provide guidance that an adviser must provide the board certain information, guidance or a recommendation on whether to impose a fee or gate.[276]

We believe that a fund's board, and not its adviser, is the appropriate entity to determine (within the constructs of the rule) when and how a fund will impose liquidity fees and/or redemption gates. As discussed above, given the role of independent directors, a fund's board is in the best position to determine whether a fee or gate is in the best interests of the fund.[277] The Investment Company Act and its rules require many other fund fees and important matters to be approved by a fund's board, including a majority of independent directors, and we do not believe that liquidity fees and redemption gates should be treated differently.[278]

We note that although the final rule amendments contemplate that information from a fund's adviser will inform the board's determination involving a fee or gate,[279] we are not charging a fund's adviser with specific duties under today's amendments. As the board is the entity charged with overseeing the fund and determining whether a fee or gate is in the fund's best interests, we believe the board should dictate the information and analysis it needs from the adviser in order to inform its decision. Nonetheless, as a matter of course and in light of its fiduciary duty to the fund, an adviser should provide the board with necessary and relevant information to enable the board to make the determinations under the rule.

c. Size of Liquidity Fee

Today's amendments will permit a money market fund to impose a discretionary liquidity fee of up to 2% after its weekly liquid assets drop below 30% of its total assets. We are also adopting a default liquidity fee of 1% that must be imposed if a fund drops below 10% weekly liquid assets, unless a fund's board determines not to impose such a fee, or to impose a lower or higher fee (not to exceed 2%) because it is in the best interests of the fund.[280] As proposed, the amendments would have required funds to impose a default liquidity fee of 2% after a fund's weekly liquid assets dropped below 15% of its total assets, although (as under our final amendments) fund boards could have determined not to impose the fee or to lower the fee.

We received a wide range of comments on the size and structure of the proposed liquidity fee.[281] A few commenters expressly supported a default fee of 2%.[282] One commenter expressed concern that a maximum 2% fee may be insufficient in times of crisis and urged the Commission to permit greater flexibility in setting an even higher fee if necessary.[283]

Other commenters explicitly argued against a default fee of 2%.[284] One commenter noted that 2% would be excessive “since it is far higher than the actual cost of liquidity paid by money market funds even at the height of the financial crisis.” [285] Other commenters described a 2% fee as punitive [286] and arbitrary.[287] A number of commenters favored instead a default fee of 1% while also allowing boards discretion to set a higher or lower fee.[288]

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As suggested by commenters, the amendments we are adopting today will impose a default liquidity fee of 1%, that may be raised or lowered (or not imposed at all) by a fund's board. As discussed below, we are persuaded by commenters that 2% may be higher than most liquidity costs experienced when selling money market securities in a crisis, and may thus result in a penalty for redeeming shareholders over and above paying for the costs of their liquidity.[289] We are also persuaded by commenters that fund boards may be reluctant to impose a fee that is lower than the default liquidity fee for fear of being second-guessed—by the market, the Commission, or otherwise.[290] Accordingly, commenters supporting the 1% default fee have persuaded us that 1% is the correct default fee level.

Furthermore, analysis by Commission staff of liquidity costs of certain corporate bonds during the financial crisis further confirms that a reduced default fee of 1% is appropriate.[291] DERA staff estimated increases in transaction spreads for certain corporate bonds that occurred during the financial crisis.[292] Relative to transaction spreads observed during the pre-crisis period from January 2, 2008 to September 11, 2008, average transaction spreads increased by 54.1 bps for Tier 1 eligible securities and by 104.4 bps for Tier 2 eligible securities during the period from September 12, 2008 to October 20, 2008. These estimates indicate that market stress increases the average cost of obtaining liquidity by an amount closer to 1% than 2%.[293]

We received a number of comments on DERA's analysis of liquidity costs.[294] Some commenters agreed that DERA's analysis supports a default liquidity fee of 1% and that 1% is the appropriate level for the fee.[295] Other commenters, however, took issue with DERA's methodology in examining liquidity costs and, one commenter suggested a default fee “as low as” 0.50% may be appropriate.[296]

As discussed in the Proposing Release, we have attempted to set the default liquidity fee high enough to deter shareholder redemptions so that funds can recoup costs of providing liquidity to redeeming shareholders in a crisis and so that the fund's liquidity is not depleted, but low enough to permit investors who wish to redeem despite the cost to receive their proceeds without bearing disproportionate costs.[297] Based on the comments we received on the proposal, we believe that a default fee of 1% strikes this balance. Although we have looked to the DERA study as confirming our decision based on comments we received supporting the 1% fee, we recognize commenters' critiques of the methodology used in the DERA analysis. We also note, however, that DERA acknowledged in its memorandum that its samples were not perfectly analogous to money market fund holdings, but that the samples nevertheless “provide estimates for costs of liquidity during market stress since the selected securities have similar time-to-maturity and credit risk characteristics as those permitted under Rule 2a-7.” [298] Moreover, at least one commenter who took issue with DERA's samples agreed, based on its own independent analysis, that a default liquidity fee of 1% is appropriate.[299] Furthermore, because we recognize that establishing any fixed fee level may not precisely address the circumstances of a particular fund in a crisis, we are permitting (as in the proposal) fund boards to alter the level of the default liquidity fee and to tailor it to the specific circumstances of a fund. As amended, rule 2a-7 will permit fund boards to increase (up to 2%), decrease (to, for example, 0.50% as suggested by a commenter), or not impose the default Start Printed Page 477641% liquidity fee if it is in the best interests of the fund.

As proposed and supported by commenters,[300] we are limiting the maximum liquidity fee that may be imposed by a fund to 2%. As with the default fee, we seek to balance the need for liquidity costs to be allocated to redemptions with shareholders' need to redeem absent disproportionate costs. We also believe setting a limit on the level of a liquidity fee provides notice to investors about the extent to which a liquidity fee could impact their investment. In addition, as recognized by at least one commenter,[301] the staff has noted in the past that fees greater than 2% raise questions regarding whether a fund's securities remain “redeemable.” [302] We note that if a fund continues to be under stress even with a 2% liquidity fee, the fund board may consider imposing a temporary redemption gate under amended rule 2a-7 or liquidating the fund pursuant to amended rule 22e-3.

As recognized in the Proposing Release, there are a number of factors a board may want to consider in determining the level of a liquidity fee. These may include, but are not limited to: changes in spreads for portfolio securities (whether based on actual sales, dealer quotes, pricing vendor mark-to-model or matrix pricing, or otherwise); the maturity of the fund's portfolio securities; changes in the liquidity profile of the fund in response to redemptions and expectations regarding that profile in the immediate future; whether the fund and its intermediaries are capable of rapidly putting in place a fee of a different amount from a previously set liquidity fee or the default liquidity fee; if the fund is a floating NAV fund, the extent to which liquidity costs are already built into the NAV of the fund; and the fund's experience, if any, with the imposition of fees in the past. We note that fund boards should not consider our 1% default liquidity fee as creating the presumption that a liquidity fee should be 1%. If a fund board believes based on market liquidity costs at the time or otherwise that a liquidity fee is more appropriately set at a lower or higher (up to 2%) level, it should consider doing so. Once a liquidity fee has been imposed, the fund's board would likely need to monitor the imposition of such fee, including the size of the fee, and whether it continues to be in the best interests of the fund.[303]

Other commenters argued for even more flexible approaches and/or entirely different standards for setting a fee.[304] For example, a commenter argued against having any default fee and instead supported allowing the board to tailor the fee to encompass the cost of liquidity to the fund.[305] Different commenters similarly argued that liquidity fees should be carefully calibrated in relation to a fund's actual cost of liquidity.[306] A commenter noted this calibration could be achieved by, rather than setting a fixed fee in advance, delaying redemptions for up to seven days to allow the fund to determine the size of the fee based on actual transaction costs incurred on each day's redemptions.[307] Finally, a commenter proposed a flexible redemption fee whereby redemptions would occur at basis point NAV (i.e., NAV to the fourth decimal place) plus 1%.[308]

As discussed above, the amendments we are adopting today incorporate substantial flexibility for a fund board to determine when and how it imposes liquidity fees. We believe that including in the amended rule a 1% default fee that may be modified by the board is the best means of directing fund boards to a liquidity fee that may be appropriate in stressed market conditions, while at the same time providing flexibility to boards to lower or raise the liquidity fee if a board determines that a different fee would better and more fairly allocate liquidity costs to redeeming shareholders. We would encourage a fund board, if practicable given any timing concerns, to consider the actual cost of providing liquidity when determining if the default liquidity fee is in the fund's best interests. In addition, we note that under today's amendments, a fund board also could, as suggested by a commenter, determine that the default fee is not in the best interests of the fund and instead gate the fund for a period of time, possibly later imposing a liquidity fee.

Furthermore, we have determined not to explicitly tie the default liquidity fee to market indicators. As discussed in the Proposing Release, we believe there are certain drawbacks to such a “market-sized” liquidity fee.[309] First, it may be difficult for money market funds to rapidly determine precise liquidity costs in times of stress when the short-term financing markets may generally be illiquid.[310] Similarly, the additional burdens associated with computing a market-sized liquidity fee could make it more difficult for funds and their boards to act quickly and proactively to stem heavy redemptions. Second, a market-sized liquidity fee does not signal in advance the size of the liquidity fee shareholders may have to pay if the fund's liquidity is significantly stressed.[311] This lack of transparency may hinder shareholders' ability to make well-informed investment decisions because investors may invest funds without realizing the extent of the costs they could incur on their redemptions.

Finally, commenters proposed various potential exemptions from the default Start Printed Page 47765liquidity fee. For example, a commenter suggested an exemption for all shareholders to redeem up to $1 million for incidental expenditures without a fee.[312] Other commenters argued that a fee should not be imposed on newly purchased shares.[313] For several independent reasons, we do not currently believe that there should be exemptions to the default liquidity fee. First, because the circumstances under which liquidity becomes expensive historically have been infrequent, we believe the imposition of fees and gates will also be infrequent. As long as funds' weekly liquid assets are above the regulatory threshold (i.e. 30%), fund shareholders should continue to enjoy unfettered liquidity for money market fund shares.[314] The likely limited and infrequent use of liquidity fees leads us to believe exemptions are generally unnecessary. Second, liquidity fees are meant to impose at least some of the cost of liquidity on those investors who are seeking liquidity by redeeming their shares. Allowing exemptions to the default liquidity fee would run counter to this purpose and permit some investors to avoid bearing at least some of their own costs of obtaining liquidity and could serve to further harm the liquidity of the fund, potentially requiring the imposition of a liquidity fee for longer than would otherwise be necessary. Third, as suggested by commenters and discussed in section III.C.7.a below, exemptions to the default liquidity fee would increase the cost and complexity of the amendments for funds and intermediaries because funds would have to develop the systems and policies to track, for example, the amount of each shareholder's redemption, and could facilitate gaming on the part of investors because investors could attempt to fit their redemptions within the scope of an exemption.[315]

d. Duration of Fees and Gates

We are adopting, as proposed, a requirement that any fee or gate be lifted automatically once the fund's weekly liquid assets have risen to or above 30% of the fund's total assets. We are also adopting, with certain modifications from the proposal as discussed below, a requirement that a money market fund must lift any gate it imposes within 10 business days and that a fund cannot impose a gate for more than 10 business days in any 90-day period. As proposed, the amendments would have allowed funds to impose a gate for up to 30 days in any 90-day period.

Several commenters noted positive aspects of the Commission's proposed duration for fees and gates.[316] Some commenters, however, suggested that the duration of liquidity fees, like the duration of redemption gates, should be limited to a number of days.[317] We continue to believe that the appropriate duration limit on a liquidity fee is the point at which a fund's assets rise to or above 30% weekly liquid assets. Thirty percent weekly liquid assets is the minimum required under rule 2a-7 and thus a fee (or gate) would appear to no longer be justified once a fund's level of weekly liquid assets has risen to this level. If we were to limit the imposition of liquidity fees to a number of days, a fund might have to remove a liquidity fee while it is still under stress and thus it would not gain the full benefits of imposing the fee.[318] Additionally, if a fund was required to remove the fee while it was still under stress, it may have to re-impose the fee shortly thereafter, which could cause investor confusion.[319] We note that a fund's board can always determine that it is in the best interests of the fund to lift a fee before the fund's level of weekly liquid assets is restored to 30% of its total assets.

We also received a number of comments on the duration of redemption gates.[320] For example, some commenters described the maximum 30-day term for gating as reasonable,[321] including a commenter that noted it would not be in favor of a shorter time period.[322] Another commenter stated its support for the Commission's proposed 30-day time limit for redemption gates.[323] In addition, an industry group commented that although its members had varying views, some stressed the importance of the maximum 30-day period to allow the fund adequate time to replenish its liquidity as securities mature.[324]

On the other hand, in response to our request for comment on the appropriate duration of redemption gates, including our request for comment on a 10-day maximum gating period, some commenters raised concerns with the proposed 30-day maximum gating period.[325] For example, one commenter noted that “denying investors access to their cash for more than a brief period” would “create serious hardships.” [326] This commenter expressed doubt that it would take boards “much more than a week to resolve what course of action would best serve the interest of their shareholders” and suggested an alternate maximum gating period of up to 10 calendar days.[327] A second Start Printed Page 47766commenter added that the potential total loss of liquidity for up to 30 days could further exacerbate pre-emptive runs and even be destabilizing to the short-term liquidity markets, and suggested an alternative maximum gating period of up to 10 calendar days.[328] Additionally, some members of an industry group suggested that gating for a shorter period of time would be more consistent with investors' liquidity needs and the requirements of the Investment Company Act.[329]

We have carefully considered the comments we received, both on the duration of gates and on the possibility of pre-emptive runs as a result of potential gates, and have been persuaded that gates should be limited to a shorter time period of up to 10 business days.[330] As discussed in the Proposing Release and reiterated by commenters,[331] we recognize the strong preference embodied in the Investment Company Act for the redeemability of open-end investment company shares.[332] Additionally, as was echoed by a number of commenters,[333] we understand that investors use money market funds for cash management and a lack of access to their investment for a long period of time can impose substantial costs and hardships. Indeed, many shareholders in the Reserve Primary Fund informed us about these costs and hardships during that fund's lengthy liquidation.[334] As discussed above, it remains one of our goals to preserve the benefits of money market funds for investors. Accordingly, upon consideration of the comments received, we have modified the final rules to limit the redeemability of money market fund shares for a shorter period of time.[335]

Some commenters suggested that the longer a potential redemption gate may be imposed, the greater the possibility that investors may try to pre-emptively redeem from a fund before the gate is in place.[336] We recognize this concern and believe that if gates are limited to 10 business days, investors may be less inclined to try to redeem before a gate is imposed because 10 business days is a relatively short period of time and after that time investors will have access to their investment.[337]

We also believe that by limiting gates to 10 business days, investors may be better able to account for the possibility of redemption gates when determining their investment allocations and cash management policies. For example, an employer may determine that money market funds continue to be a viable cash management tool because even if a fund imposes a gate, the employer could potentially still meet its payroll obligations, depending on its payroll cycle. Similarly, a retail investor may determine to invest in a money market fund for cash management purposes because a money market fund's potential for yield as compared to the interest on a savings or checking account outweighs the possibility of a money market fund imposing a gate and delaying payment of the investor's bills for up to 10 business days.

While we believe temporary gates should be limited to a short period of time, we also recognize that gates may be the most effective, and probably only, way for a fund to stop a run for the duration of the gating period. As one commenter stated, “[s]uspending redemptions would allow a [b]oard to deal with large-scale redemptions directly, by effectively calling a ‘time out’ until the [b]oard can decide how to deal with the circumstances prompting the redemptions.” [338] Accordingly, we believe gates, even those that are limited to up to 10 business days, will be a valuable tool for funds to limit heavy redemptions in times of stressed liquidity.[339]

We also recognize, as suggested by some commenters,[340] that temporary gates should provide a period of time for funds to gain internal liquidity. In this regard, we note that weekly liquid assets generally consist of government securities, cash, and assets that will mature in five business days,[341] and that once a fund has dropped below 30% weekly liquid assets (the required regulatory minimum, and the threshold for the imposition of gates), the fund can purchase only weekly liquid assets.[342] Accordingly, because the securities a fund may purchase once it has imposed a gate will mature, in large part, in five business days, we believe a limit of 10 business days for the imposition of a gate should provide a fund with an adequate period of time in which to generate internal liquidity.[343]

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We further recognize that 10 business days is not significantly longer than the seven days funds are already permitted to delay payment of redemption proceeds under section 22(e) of the Investment Company Act. We note, however, that while section 22(e) allows funds to delay payment on redemption requests, it does not prevent shareholders from redeeming shares. Even if a fund delays payment on redemptions pursuant to section 22(e), redemptions can continue to mount at the fund.[344] Unlike payment delays under section 22(e), the temporary gates we are adopting today will allow a fund a cooling off period during which redemption pressures do not continue to mount while the fund builds additional liquidity, and the fund's board can continue to evaluate the best path forward. Additionally, temporary gates may also provide a cooling off period for shareholders during which they may gather more information about a fund, allowing them to make more well-informed investment decisions after a gate is lifted.

Finally, one commenter asked the Commission to clarify that the time limit for redemption gates may “occur in multiple separate periods within any ninety-day period (as well as consecutively), and if so, whether the ninety-day period is a rolling period which is recalculated on a daily basis.” [345] As indicated in the Proposing Release, the intent of the 90-day limit on redemption gates is to ensure that funds do not circumvent the time limit on redemption gates [346] —for example, by reopening on the 9th business day for one business day before re-imposing a gate for potentially another 10 business day period. Accordingly, when determining whether a fund has been gated for more than 10 business days in a 90-day period, the fund should account for any multiple separate gating periods and assess compliance with the 90-day limit on rolling basis, calculated daily.

3. Exemptions to Permit Fees and Gates

The Commission is adopting, as proposed, exemptions from various provisions of the Investment Company Act to permit a fund to institute liquidity fees and redemption gates.[347] In the absence of an exemption, imposing gates could violate section 22(e) of the Act, which generally prohibits a mutual fund from suspending the right of redemption or postponing the payment of redemption proceeds for more than seven days, and imposing liquidity fees could violate rule 22c-1, which (together with section 22(c) and other provisions of the Act) requires that each redeeming shareholder receive his or her pro rata portion of the fund's net assets. The Commission is exercising its authority under section 6(c) of the Act to provide exemptions from these and related provisions of the Act to permit a money market fund to institute liquidity fees and redemption gates notwithstanding these restrictions.[348] As discussed in the Proposing Release and in more detail below, we believe that such exemptions do not implicate the concerns that Congress intended to address in enacting these provisions, and thus they are necessary and appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the Act.

We do not believe that the temporary gates we are allowing in today's amendments will conflict with the purposes underlying section 22(e), which was designed to prevent funds and their investment advisers from interfering with the redemption rights of shareholders for improper purposes, such as the preservation of management fees.[349] Rather, under today's amendments, the board of a money market fund can impose gates to benefit the fund and its shareholders by making the fund better able to protect against redemption activity that would harm remaining shareholders, and to allow time for any market distress to subside and liquidity to build organically.

In addition, gates will be limited in that they can be imposed only for limited periods of time and only when a fund's weekly liquid assets are stressed. This aspect of gates, therefore, is akin to rule 22e-3, which also provides an exemption from section 22(e) to permit money market fund boards to suspend redemptions of fund shares to protect the fund and its shareholders from the harmful effects of a run on the fund, and to minimize the potential for disruption to the securities markets.[350]

We are also providing exemptions from rule 22c-1 to permit a money market fund to impose liquidity fees because such fees can benefit the fund and its shareholders by providing a more systematic and equitable allocation of liquidity costs.[351] In addition, based on the level of the liquidity fee imposed, a fee may secondarily benefit a fund by helping to repair its market-based NAV.

We are permitting money market funds to impose fees and gates in limited situations because they may provide substantial benefits to money market funds, the short-term financing markets for issuers, and the financial system, as discussed above. However, we are adopting limitations on when and for how long money market funds can impose these restrictions because we recognize that fees and gates may impose hardships on investors who rely on their ability to freely redeem shares (or to redeem shares without paying a fee).[352] We did not receive comments suggesting changes to the proposed exemptions and, thus, we are adopting them as proposed.[353]

4. Amendments to Rule 22e-3

Currently, rule 22e-3 allows a money market fund to permanently suspend redemptions and liquidate if the fund's board determines that the deviation between the fund's amortized cost price per share and its market-based NAV per Start Printed Page 47768share may result in material dilution or unfair results to investors or existing shareholders.[354] Today, we are amending rule 22e-3 to also permit (but not require) the permanent suspension of redemptions and liquidation of a money market fund if the fund's level of weekly liquid assets falls below 10% of its total assets.[355] As proposed, the amendments would have allowed for permanent suspension of redemptions and liquidation after a money market fund's level of weekly liquid assets fell below 15%.[356]

Commenters generally supported our proposed retention of rule 22e-3 [357] and did not suggest changes to our proposed amendments. We are making a conforming change in the proposed weekly liquid asset threshold below which a fund may permanently gate and liquidate, however, in order to correspond to other changes in the proposal related to weekly liquid asset thresholds for fees and gates. For the reasons discussed above, we have determined to raise the initial threshold below which a fund board may impose fees and gates, but lower the threshold for imposition of a default liquidity fee. Due to the absolute and significant nature of a permanent suspension of redemptions and liquidation, we believe the lower default fee threshold would also be the appropriate threshold for board action under rule 22e-3.[358] A permanent suspension of redemptions could be considered more draconian because there is no prospect that the fund will re-open—instead the fund will simply liquidate and return money to shareholders. Therefore, we do not believe that the 30% weekly liquid asset threshold for discretionary fees and gates, which is designed to provide boards with significant flexibility to restore a fund's liquidity in times of stress, would be an appropriate threshold under which fund boards could permanently close a fund.

Amended rule 22e-3 will allow all money market funds, not just those that maintain a stable NAV as currently contemplated by rule 22e-3, to rely on the rule when the fund's liquidity is significantly stressed. A money market fund whose weekly liquid assets have fallen below 10% of its total assets (whether that fund has previously imposed a fee or gate, or not) may rely on the rule to permanently suspend redemptions and liquidate.[359] Under amended rule 22e-3, stable value funds also will continue to be able to suspend redemptions and liquidate if the board determines that the deviation between its amortized cost price per share and its market-based NAV per share may result in material dilution or other unfair results to investors or existing shareholders.[360] Thus, a stable value money market fund that suffers a default will still be able to suspend redemptions and liquidate before a credit loss leads to redemptions and a fall in its weekly liquid assets.

5. Operational Considerations Relating to Fees and Gates

a. Operational Costs

As discussed in the Proposing Release, we recognize that money market funds and others in the distribution chain (depending on the structure) will incur some operational costs in establishing or modifying systems to administer a liquidity fee or temporary gate.[361] These costs may relate to the development of procedures and controls for the imposition of liquidity fees or updating systems for confirmations and account statements to reflect the deduction of a liquidity fee from redemption proceeds.[362] Additionally, these costs may relate to the establishment of new or modified systems or procedures that will allow funds to administer temporary gates.[363] We also recognize that money market funds may incur costs in connection with board meetings held to determine if fees and/or gates are in the best interests of a fund.

In addition, operational costs may be incurred by, or spread among, a fund's transfer agents, sub-transfer agents, recordkeepers, accountants, portfolio accounting departments, and custodian.[364] Funds also may seek to modify contracts with financial intermediaries or seek certifications from intermediaries that they will apply a liquidity fee on underlying investors' redemptions. Money market fund shareholders also may be required to modify their own systems to prepare for possible future liquidity fees, or to manage gates, although we expect that only some shareholders will be required to make these changes.[365]

A number of commenters suggested that the operational costs and burdens of implementing and administrating fees and gates would be manageable.[366] Some commenters noted that liquidity fees and redemption gates would be more practicable, and less costly and burdensome to implement and maintain than the other proposed reform alternative (floating NAV).[367] Another commenter added that the systems modifications for fees and gates, especially absent a requirement to net each shareholder's redemptions each day, would be “far less costly and onerous” than the operational challenges posed by the floating NAV reform alternative.[368] One commenter estimated that implementing fees and gates would require only “minimal enhancements” to its core custody/fund accounting systems at “minimal costs.” [369] This commenter further noted that most systems enhancements would likely be required with respect to the systems of transfer agents and Start Printed Page 47769intermediaries, although their systems would likely already include “basic functionality to accommodate liquidity fees and gates.” [370] Similarly, another commenter noted that the operational issues of fees and gates could be solved if the industry and all its stakeholders were given sufficient implementation time.[371] This commenter cited its ongoing efforts to implement liquidity fees at its Dublin-domiciled money market fund complex as an example that the operational challenges and costs would not be prohibitive.[372]

Conversely, a number of commenters expressed concern over the operational burdens and related administrative costs with the fees and gates requirements.[373] Some commenters argued that the implementation and administration of fees and gates would present significant operational challenges, in particular with respect to omnibus accounts, sweep accounts, intermediaries and the investors that use them.[374] One commenter argued that, to reduce operational burdens, a liquidity fee should be applied to each redemption separately—rather than net redemptions—in an affected money market fund.[375] This commenter also expressed concern that intermediaries would not know whether their sweeps would be subject to a liquidity fee or temporary gate until after the daily investment is made.[376] For example, the possibility of a liquidity fee would require intermediaries to develop trading systems to ensure that for each transaction “the investor has sufficient funds to cover the trade itself plus the possibility of a liquidity fee.” [377] Commenters also suggested that a fee or gate could not be uniformly applied within omnibus accounts,[378] and certain commenters expressed concern over transparency with respect to fees and gates for shareholders investing through omnibus accounts.[379]

We understand that the implementation of fees and gates (as with any new regulatory requirement) is not without its operational challenges; however, we have sought to minimize those challenges in the amendments we are adopting today. Based on the comments discussed above, we now recognize that a liquidity fee could either be applied to each redemption separately or on a net basis. As indicated by the relevant commenter, our proposal contemplated net redemptions as an investor-friendly manner of applying a liquidity fee.[380] However, in light of the comments, we are persuaded that such an approach may be too operationally difficult and costly for funds to apply and, thus, we are not requiring funds to apply a liquidity fee on a net basis.[381]

We also recognize commenters' concerns regarding the application of fees and gates in the context of sweep accounts. We note that during normal market conditions, fees and gates should not impact sweep accounts' (or any other investor's) investment in a money market fund.[382] We also note that, unlike our proposal, the amendments we are adopting today will allow fund boards to institute a fee or gate at any time during the day.[383] To the extent a sweep account's daily investment is made at the end of the day, we believe this change should reduce concerns that the sweep account holder will find out about a redemption restriction only after it has made its daily investment and may lessen the difficulty and costs related to developing a trading system that can ensure an account has sufficient funds to cover the trade itself plus the possibility of a liquidity fee.

With respect to omnibus accounts, we continue to believe that liquidity fees should be handled in a manner similar to redemption fees, which currently may be imposed to deter market timing of mutual fund shares.[384] As discussed in the Proposing Release, we understand that financial intermediaries themselves generally impose redemption fees to record or beneficial owners holding through that intermediary.[385] We recognize commenters' concerns regarding the uniform application of liquidity fees through omnibus accounts. We believe, however, that the benefits and protections afforded to funds and their investors by the fees and gates amendments justify the application of these amendments in the context of omnibus accounts. In this regard, we note, as we did in the Proposing Release, that funds or their transfer agents may contract with intermediaries to have them impose liquidity fees. As we also noted in the Proposing Release, we understand that some money market fund sponsors may want to review their contractual arrangements with their funds' financial intermediaries and service providers to determine whether any contractual modifications are necessary or advisable to ensure that liquidity fees are appropriately applied to beneficial owners of money market fund shares. We further understand that some money market fund sponsors may seek certifications or other assurances that these intermediaries and service providers will apply any liquidity fees to the beneficial owners of money market fund shares. We also recognize that money market funds and their transfer agents and intermediaries may need to engage in certain communications regarding a liquidity fee.

With respect to those commenters who expressed concern over the transparency of fees and gates for omnibus investors, we note that fees and gates will be equally transparent for all investors. Investors, both those that invest directly and those that invest through omnibus accounts, should have access to information about a fund's weekly liquid assets, which will be Start Printed Page 47770posted on the fund's Web site. All money market fund investors also should receive copies of a fund's prospectus, which will include disclosure on fees and gates.

We note that some commenters expressed concern about the costs and burdens associated with the combination of fees and gates and a floating NAV requirement for institutional prime funds.[386] As we stated in the Proposing Release, we do not expect that there will be any significant additional costs from combining the two approaches that are not otherwise discussed separately with respect to each of the fees and gates and floating NAV reforms.[387] As we discussed in the Proposing Release, it is likely that implementing a combined approach will save some percentage over the costs of implementing each alterative separately as a result of synergies and the ability to make a variety of changes to systems at a single time. We do not expect that combining the approaches will create any new costs as a result of the combination itself.[388] Accordingly, we estimate, as we did in the proposal, that the costs of implementing a combined approach would at most be the sum of the costs of each alternative, but may likely be less.

b. Cost Estimates

As we indicated in the Proposing Release, the costs associated with the fees and gates amendments will vary depending on how a fee or gate is structured, including its triggering event and the level of a fee, as well as on the capabilities, functions and sophistication of the systems and operations of the funds and others involved in the distribution chain, including transfer agents, accountants, custodians and intermediaries. These costs relate to the development of procedures and controls, systems' modifications, training programs and shareholder communications and may vary among funds, shareholders and their service providers.

In the Proposing Release, we estimated a range of hours and costs that may be required to perform activities typically involved in making systems modifications, such as those described above. We estimated that a money market fund (or others in the distribution chain) would incur one-time systems modification costs that range from $1,100,000 to $2,200,000.[389] We further estimated that the one-time costs for entities to communicate with shareholders about the liquidity fee or gate would range from $200,500 to $340,000.[390] In addition, we estimated that the costs for a shareholder mailing would range between $1.00 and $3.00 per shareholder.[391]

We also recognized in our proposal that depending on how a liquidity fee or gate is structured, mutual fund groups and other affected entities already may have systems that can be adapted to administer a fee or gate at minimal cost, in which case the costs may be less than the range we estimated above. For example, some money market funds may be part of mutual fund groups in which one or more funds impose deferred sales loads under rule 6c-10 or redemption fees under rule 22c-2, both of which require the capacity to administer a fee upon redemptions and may involve systems that could be adapted to administer a liquidity fee. We estimated that a money market fund shareholder whose systems required modifications to account for a liquidity fee or gate would incur one-time costs ranging from $220,000 to $450,000.[392]

Some of the comments we received regarding the costs of fees and gates included alternate estimates of implementation costs.[393] For example, one commenter indicated that its costs for implementing fees and gates would likely be in the range of $400,000 to $500,000.[394] This commenter further explained that cost of the fees and gates alternative “reflects the ability of the affected entity to custom-design its own approach to implementation, as well as the fact that the necessary changes would not be for use in day-to-day operations, but only for rare occasions.” [395]

A number of other commenters, however, expressed concern that the fees and gates amendments would impose significant costs and burdens, higher than those estimated in the Proposing Release.[396] For example, one commenter estimated that it would cost it a total of approximately $11 million in largely one-time costs, reflecting costs of $9 million to implement fees and gates as well as $2 million for the related modifications in disclosure.[397] Another commenter indicated that the implementation costs of fees and gates would be an estimated $1,697,000.[398] Similarly, an industry group conducting a survey of its members found that the Start Printed Page 47771implementation costs relating to liquidity fees would likely be $2 million or more, according to 36% of survey respondents.[399] The group also noted that initial costs would be particularly significant for distributors and intermediaries, with 60% of respondents estimating initial costs at $2 million or more.[400] In addition, the survey found initial costs associated with gates to range from $1 million to $10 million.[401]

Based on the information provided by commenters, as well as the operational changes in the final rule, we are increasing our estimates for implementation costs for fees and gates. Three of the four commenters who provided estimates suggested that the implementation costs would be around $2,000,000 or more.[402] In addition, we estimate that a fund's ability to impose a fee or gate intra-day (as opposed to the end of the day, as contemplated by the proposal) may result in increased operational costs related to the implementation of fees and gates. Accordingly, we have increased our original estimate of $1,100,000 to $2,200,000 [403] for one-time systems modification costs to a higher estimate of $1,750,000 to $3,000,000.[404] We continue to estimate that the one-time costs for entities to communicate with shareholders (including systems costs related to communications) about fees and gates would range from $200,500 to $340,000. In addition, we are increasing the estimated cost for a shareholder mailing from between $1.00 and $3.00 per shareholder to between $2.00 and $3.00 per shareholder, recognizing that it is unlikely such a mailing would cost $1.00. We continue to estimate one-time costs of $220,000 to $450,000 for a money market fund shareholder whose systems (including related procedures and controls) required modifications to account for a liquidity fee or redemption gate.

We recognized in our proposal that adding new capabilities or capacity to a system will entail ongoing annual maintenance costs and understand these costs generally are estimated as a percentage of initial costs of building or expanding a system. We also recognized that ongoing costs related to fees and gates may include training costs. In the proposal, we estimated that the costs to maintain and modify the systems required to administer a fee or gate (to accommodate future programming changes), to provide ongoing training, and to administer the fee or gate on an ongoing basis would range from 5% to 15% of the one-time costs. We understand that funds may impose varying liquidity fees and that the cost of varying liquidity fees could exceed this range, but because such costs depend on to what extent the fees might vary, we do not have the information necessary to provide a reasonable estimate of how much more (if any) varying fees might cost to implement.

One commenter indicated a lower estimate of approximately $164,000 for annual ongoing costs.[405] Another commenter, an industry group that surveyed its members, indicated that ongoing annual costs of implementing a liquidity fee are likely to range from 10% to 20% of initial costs.[406] The same commenter indicated that ongoing annual costs related to redemption gates were estimated as 10% to 20% of initial cost by 33% of survey respondents.[407] Based on these estimates, which are largely similar to our estimates of 5-15% in the Proposing Release, we continue to believe our estimates in the Proposing Release are appropriate.

We also recognize that funds may incur costs in connection with board meetings held to determine if fees and/or gates are in the best interests of the fund. In the Proposing Release, we estimated an average annual time cost of approximately $9,895 per fund in connection with each such board meeting.[408] We did not receive comments on this estimate. As discussed in section IV.A.3 herein, we are revising our estimate from $9,895 per fund to $10,700 as result of updated industry data.[409]

Although we have estimated the costs that a single affected entity would incur, we anticipate that many money market funds, transfer agents, and other affected entities may not bear the estimated costs on an individual basis. Instead, the costs of systems modifications likely would be allocated among the multiple users of the systems, such as money market fund members of a fund group, money market funds that use the same transfer agent or custodian, and intermediaries that use systems purchased from the same third party. Accordingly, we expect that the cost for many individual entities may be less than the estimated costs due to economies of scale in allocating costs among this group of users.

6. Tax Implications of Liquidity Fees

As discussed in the Proposing Release, we understand that liquidity fees may have certain tax implications for money market funds and their shareholders.[410] We understand that for federal income tax purposes, shareholders of mutual funds that impose a redemption fee pursuant to rule 22c-2 under the Investment Company Act generally treat the redemption fee as offsetting the shareholder's amount realized on the redemption (decreasing the shareholder's gain, or increasing the shareholder's loss, on redemption).[411] Start Printed Page 47772Consistent with this characterization, funds generally treat the redemption fee as having no associated tax effect for the fund.[412] We understand that a liquidity fee will be treated for federal income tax purposes consistently with the way that funds and shareholders treat redemption fees under rule 22c-2.

If, as described above, a liquidity fee has no direct federal income tax consequences for the money market fund, that tax treatment will allow the fund to use 100% of the fee to help repair a market-based NAV per share that was below $1.00. If redemptions involving liquidity fees cause a stable value money market fund's shadow price to reach $1.0050, however, the fund may need to distribute to the remaining shareholders sufficient value to prevent the fund from breaking the buck on the upside (i.e., by rounding up to $1.01 in pricing its shares).[413] We understand that any such distribution would be treated as a dividend to the extent that the money market fund has sufficient earnings and profits. Both the fund and its shareholders would treat these additional dividends the same as they treat the fund's routine dividend distributions. That is, the additional dividends would be taxable as ordinary income to shareholders and would be eligible for deduction by the funds.

In the absence of sufficient earnings and profits, however, some or all of these additional distributions would be treated as a return of capital. Receipt of a return of capital would reduce the recipient shareholders' basis (and thus could decrease a loss, or create or increase a gain for the shareholder in the future when the shareholder redeems the affected shares). Thus, in the event of any return of capital distributions, as we noted in the Proposing Release, there is a possibility that the fund, other intermediaries, and the shareholders might become subject to tax-reporting or tax-payment obligations that do not affect stable value money market funds currently operating under rule 2a-7.[414]

Commenters were concerned with this possibility—that investors may have to recognize capital gains or reduced losses if a fund makes a distribution to shareholders in order to avoid “breaking the buck” on the upside as a result of excessive fees.[415] Commenters noted that such distributions and the resulting capital gains or losses upon disposition of investors' shares would require funds and intermediaries to start tracking investors' basis in shares of a fund.[416] In order to avoid such basis tracking, commenters suggested that the Treasury Department and the Internal Revenue Service (“IRS”) issue guidance stating that when a money market fund is required to make a payment of excess fees in order to avoid breaking the buck, the fund should be deemed to have sufficient earnings and profits to treat the distribution as a taxable dividend.[417]

Although these events are hypothetically possible, the scenario that would lead to a payment of excess fees to fund shareholders without sufficient earnings and profits is subject to many contingencies that make it unlikely to occur. First, as we discussed above, under normal market conditions, we believe funds will rarely impose liquidity fees. Second, we believe it is highly unlikely that shareholders would redeem with such speed and in such volume that the redemptions would create a danger of breaking the buck on the upside before a fund could remove a fee. Third, the distributions to avoid breaking the buck might not exceed the fund's earnings and profits. For this purpose, we understand that the fund's earnings and profits take into account the fund's income through the end of the taxable year. Thus, unless the additional distribution occurs very close to the end of the taxable year, some of the money market fund's subsequent income during the year will operate to qualify these distributions as dividends.[418]

Finally, as discussed in the Proposing Release, we understand that the tax treatment of a liquidity fee may impose certain operational costs on money market funds and their financial intermediaries and on shareholders. However, we have been informed that the Treasury Department and the IRS today will propose new regulations exempting all money market funds from certain transaction reporting requirements.[419] This exemption is to be formally applicable for calendar years beginning on or after the date of publication in the Federal Register of a Treasury Decision adopting those proposed regulations as final regulations. The Treasury Department and the IRS have informed us, however, that the text of the proposed regulations will state that persons subject to transaction reporting may rely on the proposed exemption for all calendar years prior to the final regulations' formal date of applicability. Therefore, the Treasury Department and IRS relief described above is available immediately.

Thus, even in the unlikely event that some shareholders' bases in their shares change due to non-dividend distributions, neither fund groups nor their intermediaries will need to track the tax bases of money market fund shares. On the other hand, if there are any non-dividend distributions by money market funds, the affected shareholders will need to report in their annual tax filings any resulting gains [420] or reduced losses upon the sale of affected money market fund shares. We are unable to quantify with any specificity the tax and operational costs discussed in this section because we are unable to predict how often liquidity fees will be imposed by money market funds and how often redemptions Start Printed Page 47773subject to liquidity fees would cause the funds to make returns of capital distributions to the remaining shareholders (although, as noted above, we believe such returns of capital distributions are unlikely). Commenters did not provide any such estimates.

7. Accounting Implications

A number of commenters questioned whether an investment in a money market fund subject to a possible fee or gate, or in a money market fund that in fact imposes a fee or gate, would continue to qualify as a “cash equivalent” for purposes of U.S. Generally Accepted Accounting Principles (“U.S. GAAP”).[421] We understand that classifying money market fund investments as cash equivalents is important because, among other things, investors may have debt covenants that mandate certain levels of cash and cash equivalents.[422] To remove any uncertainty, several commenters requested that the Commission, the Financial Accounting Standards Board (“FASB”) and/or Government Accounting Standards Board (“GASB”) issue guidance to clarify whether investments in money market funds will continue to qualify as cash equivalents under U.S. GAAP.[423] Various commenters on our proposal, including the American Institute of Certified Public Accountants (“AICPA”) and each of the “Big Four” accounting firms, stated that a money market fund's ability to impose fees and gates should not preclude an investment in the fund from being classified as a “cash equivalent” under U.S. GAAP.[424]

Current U.S. GAAP defines cash equivalents as “short-term, highly liquid investments that are readily convertible to known amounts of cash and that are so near their maturity that they present insignificant risk of changes in value because of changes in interest rates.” [425] U.S. GAAP includes an investment in a money market fund as an example of a cash equivalent.[426] The Commission's position continues to be that, under normal circumstances, an investment in a money market fund that has the ability to impose a fee or gate under rule 2a-7(c)(2) qualifies as a “cash equivalent” for purposes of U.S. GAAP.[427] However, as is currently the case, events may occur that give rise to credit and liquidity issues for money market funds. If such events occur, including the imposition of a fee or gate by a money market fund under rule 2a-7(c)(2), shareholders would need to reassess if their investments in that money market fund continue to meet the definition of a cash equivalent. A more formal pronouncement (as requested by some commenters) to confirm this position is not required because the federal securities laws provide the Commission with plenary authority to set accounting standards, and we are doing so here.[428]

If events occur that cause shareholders to determine that their money market fund shares are not cash equivalents, the shares would need to be classified as investments, and shareholders would have to treat them either as trading securities or available-for-sale securities.[429] For example, during the financial crisis, certain money market funds experienced unexpected declines in the fair value of their investments due to deterioration in the creditworthiness of their assets and, as a result, portfolios of money market funds became less liquid. Investors in these money market funds would have needed to determine whether their investments continued to meet the definition of a cash equivalent.

B. Floating Net Asset Value

1. Introduction

As discussed earlier in this Release, absent an exemption specifically provided by the Commission from various provisions of the Investment Company Act, all registered mutual funds must price and transact in their shares at the current NAV, calculated by valuing portfolio instruments at market value, in the case of securities for which market quotations are readily available, or, at fair value, as determined in good faith by the fund's board of directors, in the case of other securities and assets (i.e., use a floating NAV).[430] Under rule 2a-7, the Commission has exempted money market funds from this floating NAV requirement, allowing them to price and transact at a stable NAV per share (using the amortized cost and penny rounding methods), provided that they follow certain risk-limiting conditions.[431] In doing so, the Commission was statutorily required to find that such an exemption was in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of the Investment Company Act.[432] Accordingly, when providing this exemption in 1983, the Commission considered the benefits of a stable value product as a cash management vehicle for investors, but also imposed a number of conditions designed to minimize the risk inherent in a stable value fund that some shareholders may redeem and receive more than their shares are actually worth, thus diluting the holdings of remaining shareholders.[433] At the time, the Commission was persuaded that deviations in value that could cause material dilution to investors generally would not occur, given the risk-limiting Start Printed Page 47774conditions of the rule.[434] Experience, however, has shown that deviations in value do occur, and at times, can be significant.

As discussed above, money market funds' sponsors on a number of occasions have voluntarily chosen to provide financial support for their money market funds for various reasons, including to keep a fund from re-pricing below its stable value, suggesting that material deviations in the value in money market funds have not been a rare occurrence.[435] This historical experience, combined with the events of the financial crisis, has caused us to reconsider the exemption from the statutory floating NAV requirement for money market funds in light of our responsibilities under the Act in providing this exemption. In doing so, we again took into account the benefits of money market funds as a stable value cash management product for investors, but also considered all of the historical and empirical information discussed in section I above, the Investment Company Act's general obligation for funds to price and transact in their shares at the current NAV, and developments since 1983.

We considered the many reasons shareholders may engage in heavy redemptions from money market funds—potentially resulting in the dilution of share value that the Investment Company Act's provisions are designed to avoid—and have tailored today's final rules accordingly. In particular, while many investors may redeem because of concerns about liquidity, quality, or lack of transparency—and our fees and gates, disclosure, and reporting reforms are primarily intended to address those incentives—an incremental incentive to redeem is created by money market funds' current valuation and pricing methods. As discussed below, this incremental incentive to redeem exacerbates shareholder dilution in a stable NAV product because non-redeeming shareholders are forced to absorb losses equal to the difference between the market-based value of the fund's shares and the price at which redeeming shareholders transact. For the reasons discussed below, we believe that this incentive exists largely in prime money market funds because these funds exhibit higher credit risk that make declines in value more likely (compared to government money market funds).[436] We further believe history shows that, to date, institutional investors have been significantly more likely than retail investors to act on this incentive.[437] Thus, given the tradeoffs involved in requiring that any money market fund transact at a floating NAV, we are limiting this reform (and thus the repeal of the special exemptive relief allowing these funds to price other than as required under the Investment Company Act) to institutional prime funds.

As discussed previously, the first investors to redeem from a stable value money market fund that is experiencing a decline in its NAV benefit from a “first mover advantage” as a result of rule 2a-7's current valuation and pricing methods, which allows them to receive the full stable value of their shares even if the fund's portfolio value is less.[438] One possible reason that institutional prime funds may be more susceptible to rapid heavy redemptions than retail funds is that their investors are often more sophisticated, have more significant money at stake, and may have a lower risk tolerance due to legal or other restrictions on their investment practices.[439] Institutional investors may also have more resources to carefully monitor their investments in money market funds. Accordingly, when they become aware of potential problems with a fund, institutional investors may quickly redeem their shares among other reasons, to benefit from the first mover advantage.[440] When many investors try to redeem quickly, whether to benefit from the first mover advantage or otherwise, money market funds may experience significant stress. As discussed above, even a few high-dollar redemptions by institutional investors (because of their greater capital at stake) may have a significant adverse effect on a fund as compared with retail investors whose investments are typically smaller and would therefore require a greater number of redemptions to have a similar effect.[441] This can lead to the very dilution of fund shares that we were concerned about when we first provided the exemptions in rule 2a-7 permitting funds to use different valuation and pricing methods than other mutual funds to facilitate maintaining a stable value.[442]

As discussed in the previous section, our fee and gate reform is designed to address some of the risks associated with money market funds that we have identified in this Release, but does not address them all. In particular, fees and gates are intended to enhance money market funds' ability to manage and mitigate potential contagion from high levels of redemptions and make redeeming investors pay their share of the costs of the liquidity that they receive. But those reforms do not address the incremental incentive to redeem from a fund with a shadow price below $1.00 that is at risk of breaking the buck. As a result of their sophistication, risk tolerance, and large investments, institutional investors are more likely to redeem at least in part due to this first mover advantage.[443]

This has led to us re-evaluate our decision to provide an exemption allowing amortized cost valuation and penny rounding pricing for money market funds with these specific kinds of investors.[444] As discussed above, this exemption was originally premised on our expectation that funds that followed the requirements of rule 2a-7 would be unlikely to experience material deviations from their stable value. With respect to prime funds in particular, this expectation has proven inaccurate with enough regularity to cause concern, especially given the potentially serious consequences to investors and the markets that can and has resulted at times. Accordingly, for the reasons discussed above and in other sections of this Release,[445] we no longer believe that exempting institutional prime Start Printed Page 47775money market funds under section 6(c) of the Act is appropriate—i.e., we find that such an exemption is no longer in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of the Investment Company Act.[446] As discussed in detail in the sections that follow, we are now rescinding the exemption that allows institutional prime funds to maintain a stable NAV and are requiring them to price and transact in their shares at market-based value, like all other mutual funds.[447]

This reform is intended to work in concert with the liquidity fees and gates reforms discussed above (as well as other reforms discussed in section III.K.3). The floating NAV requirement, applicable only to institutional prime funds, balances concerns about the risks of heavy redemptions from these funds in times of stress and the resulting negative impacts on short-term funding markets and potential dilution of investor shares, with the desire to preserve, as much as possible, the benefits of money market funds for investors.[448] Consistent with a core objective of the Investment Company Act, the floating NAV reform may also lessen the risk of unfairness and potential wealth transfers between holding and redeeming shareholders by mutualizing any potential losses among all investors, including redeeming shareholders. We do not intend, and the floating NAV reform does not seek, to deter redemptions that constitute rational risk management by shareholders or that reflect a general incentive to avoid loss.[449] Instead, as discussed below, the requirement is designed to achieve two independent objectives: (1) To reduce the first mover advantage inherent in a stable NAV fund due to rule 2a-7's current valuation and pricing methods by dis-incentivizing redemption activity that can result from investors attempting to exploit the possibility of redeeming shares at the stable share price even if the portfolio has suffered a loss; and (2) to reduce the chance of unfair investor dilution, which would be inconsistent with a core principle of the Investment Company Act. An additional motivation for this reform is that the floating NAV may make it more transparent to certain of the impacted investors that they, not the fund sponsors or the federal government, bear the risk of loss. Many commenters suggested that, among the reform alternatives proposed, the floating NAV reform is the most meaningful.[450]

2. Summary of the Floating NAV Reform

The liquidity fees and gates amendments apply to all money market funds (with the exception of government money market funds). Today we are also adopting a targeted reform designed to address the specific risks associated with institutional prime money market funds.[451] We are doing so by amending rule 2a-7 to rescind certain exemptions that have permitted these funds to maintain a stable price by use of amortized cost valuation and/or penny-rounding pricing—as a result, institutional prime money market funds will transact at a floating NAV.[452]

Under our reform, institutional prime money market funds will value their portfolio securities using market-based factors and will sell and redeem shares based on a floating NAV.[453] Under the final rules, and as we proposed, institutional prime funds will round prices and transact in fund shares to four decimal places in the case of a fund with a $1.00 target share price (i.e., $1.0000) or an equivalent or more precise level of accuracy for money market funds with a different share price (e.g., a money market fund with a $10 target share price could price its shares at $10.000). Institutional prime money market funds will still be subject to the risk-limiting conditions of rule 2a-7.[454] Accordingly, they will continue to be limited to investing in short-term, high-quality, dollar-denominated instruments, but will not be able to use the amortized cost or penny rounding methods to maintain a stable value. Finally, funds subject to the floating NAV reform will be subject to the other reforms discussed in this Release.

As discussed in section III.B.9 below, institutional prime money market funds will have two years to comply with the floating NAV reform. Although some commenters, including some sponsors of money market funds, expressed general support for the floating NAV reform as it was proposed,[455] the majority of commenters generally opposed requiring institutional prime money market funds to implement a floating NAV.[456] Below, we address the principal considerations and requirements of the floating NAV reform, discuss comments received, and how if applicable, the amendments have been revised to address commenter concerns.

3. Certain Considerations Relating to the Floating NAV Reform

a. A Reduction in the Incentive To Redeem Shares

When a money market fund's shadow price is less than the fund's $1.00 share price, shareholders have an economic incentive to redeem shares ahead of other investors. In the Proposing Release, we noted that the size of institutional investors' holdings and their resources for monitoring funds provide the motivation and means to act on this incentive, and observed that institutional investors redeemed shares at a much higher rate than retail investors from prime money market funds in both September 2008 and June 2011.[457] We also noted, as some market Start Printed Page 47776observers had suggested, that the valuation and pricing techniques currently permitted by rule 2a-7 may underlie this incentive to redeem ahead of other shareholders and to obtain $1.00 per share when investors become aware (or expect) that the actual value of the fund's shares is below (or will fall below) $1.00.[458] As discussed below, to address this incentive, the floating NAV reform mandates that institutional prime funds transact at share prices that reflect current market-based factors (not amortized cost or penny rounding, as currently permitted) and therefore remove investors' incentives to redeem early to take advantage of transacting at a stable value.

Some commenters agreed that a floating NAV mitigates the first mover incentive to redeem ahead of other shareholders that results from current rule 2a-7's valuation and pricing methods.[459] Two commenters also noted that requiring institutional prime funds to adopt a floating NAV would force investors who cannot tolerate any share price movement into other products that better match their risk tolerances.[460] According to these commenters, investors who remain in floating NAV funds may have a greater tolerance for loss and may be less likely to redeem quickly in times of market stress.[461]

Several commenters generally objected to our reasoning that our floating NAV reform (by addressing the economic incentive inherent in rule 2a-7) would reduce the incentive for shareholders to redeem ahead of other investors in times of market stress, observing that a floating NAV may not eliminate investors' incentive to redeem to the extent that it results from the desire to move to investments of higher quality or greater liquidity.[462] Both the DERA Study and Proposing Release discussed this concern.[463] As the DERA Study noted, the incentive for investors to redeem ahead of other investors may be heightened by liquidity concerns—when cash levels are insufficient to meet redemption requests, funds may be forced to sell portfolio securities into illiquid secondary markets at discounted or even fire-sale prices.[464] The floating NAV reform may not fully address the incentive to redeem because market-based pricing may not capture the likely increasing illiquidity of a fund's portfolio as it sells its more liquid assets first during a period of market stress to defer liquidity pressures as long as possible.[465]

We acknowledge that a floating NAV does not eliminate the incentive to redeem in pursuit of higher quality or greater liquidity—indeed, we intend to address the risks associated with these incentives primarily through our fees and gates reform. However, we continue to believe that a floating NAV should mitigate the incentive to redeem due to the mismatch between the stable NAV price and the actual value of fund shares because shareholders will receive a market value for their shares rather than a fixed price when they redeem. Importantly, the complementary liquidity fees and gates aspect of our money market reforms would also apply to institutional prime funds that are subject to a floating NAV. As discussed previously, while not intended to stem investors' desire to move to more liquid or higher quality investments, liquidity fees are specifically designed to ensure that redeeming investors pay the costs of the liquidity they receive, and redemption gates are designed as a tool to allow funds to manage heavy redemptions in times of stress and thus reduce the chance of harm to the fund and investors. In this way, we believe that the totality of our money market fund reforms addresses comprehensively many features of money market funds, including the characteristics of their investor base that can make them susceptible to heavy redemptions, and gives fund boards new tools for addressing a loss of liquidity that may develop in funds.[466]

One commenter submitted a white paper concluding that (i) liquidity fees and gates, if implemented effectively, could stop and prevent runs; and (ii) although a variable NAV would not stop a run, it could mitigate the first mover advantage associated with the motivation to run that results from small shadow price departures from $1.00.[467] The authors of the paper concluded further that the ability of a variable NAV to mitigate this first mover advantage is overstated when viewed in light of the real-world costs of moving between investments that investors will face and, in a significant stress event, such effect is a minor determinant of behavior.[468] We acknowledge this view and agree, as discussed above, that a floating NAV cannot stop redemptions when (as assumed in the paper) investors are redeeming in a flight to quality due to a continuing deterioration of the credit risk in a fund's portfolio. However, the floating NAV reform reduces the benefit from redeeming ahead of others to at most one half of a hundredth of a cent per share [469] —100 times less than it is currently—which investors would weigh against the cost of switching to an alternative investment.[470] As we discuss above, the floating NAV reform is designed to supplement the fees and gates reform only for those funds that are more vulnerable to credit events (compared to government funds) and that have an investor base more likely to engage in heavy redemptions (compared to retail investors) because of, among other reasons, the first mover advantage created by the funds' current valuation and pricing practices. Specifically, compared to the current stable NAV environment, a variable NAV will significantly limit the value of the first mover advantage. Although this first mover advantage may not be the main driver of investor decisions to redeem, it strengthens the incentive to redeem for those investors with the most at stake from a decline in a fund's value, which increases the chance of unfair investor dilution in contravention of a core principle of the Investment Company Act. We continue to believe that a floating NAV will, for institutional prime funds, reduce the impact of the first mover advantage associated with money market funds' current valuation and pricing practices and thus is consistent with our Start Printed Page 47777obligation to seek to prevent investor dilution of fund shares (as discussed in more detail in the section below).

A few commenters also suggested that shareholders in a floating NAV fund would have the same incentive to redeem if a floating NAV fund deviates far enough from the typical historical range for market-based pricing, particularly if they believe the fund may continue to drop in value.[471] We note, however, that the floating NAV reform, one part of our broader reforms to money market funds, is designed to address a particular structural incentive that exists as a result of existing valuation and pricing methodologies under rule 2a-7. As we stated in our proposal and in this Release, the floating NAV reform is not intended to deter redemptions that constitute rational risk management by shareholders or that reflect a general incentive to avoid loss.

Several commenters argued that shareholders may choose not to redeem from a stable NAV money market fund during times of stress to avoid contributing to the likelihood that their fund breaks the buck.[472] Although this may be the case for some shareholders, as shown during the financial crisis, other shareholders do redeem from stable value money market funds, regardless of the impact on the fund.[473] It is the actions of those shareholders that have led to our re-evaluation of the appropriateness of exempting all money market funds from the valuation and pricing provisions that apply to all other mutual funds.

One commenter also argued that rule 2a-7 already places a number of detailed remedial obligations on the board of a money market fund, in the event a credit event occurs, that are designed to prevent any first mover advantage related to money market funds' current valuation and pricing methods.[474] This commenter discussed, for example, the existing requirement that fund boards periodically calculate the fund's shadow price and take action in the event it deviates from the market-based NAV per share by more than 50 basis points. We note, however, that the floating NAV reform is designed to proactively address a structural feature of money market funds that may incentivize heavy redemptions in times of market stress (and the resulting shareholder inequities) before a significant credit event occurs or the fund re-prices its shares using market-based values (i.e., breaks the buck). Under current rule 2a-7, there remains a first mover advantage until the fund breaks the buck and re-prices its shares using market-based valuations. One commenter also noted that any reduction in the incentive to redeem early from the fund's stable pricing would be marginal and contingent upon the type of stress experienced.[475] We note that the floating NAV reform is targeted towards the funds that have been most susceptible to heavy redemptions in the past. We believe that the risks associated with these funds have shown that the first mover advantage that results from current rule 2a-7's valuation and pricing methods needs to be addressed. This is particularly true in light of the Investment Company Act mandate to ensure that investors are treated fairly and the impact that the first mover advantage has on investor dilution.

Finally, a number of commenters suggested that the evidence of heavy redemptions in European floating NAV money market funds and U.S. ultra-short bond funds during 2008, taken together, may be the best means available to predict whether a floating NAV will reduce shareholder incentives to redeem shares in times of stress.[476] These commenters suggest, therefore, that a floating NAV alone likely would not stop investors from redeeming shares.[477] We recognize that many European floating NAV money market funds and U.S. ultra short bond funds experienced heavy redemptions during the financial crisis.[478] We note that, as discussed above, the floating NAV reform is not intended to wholly prevent heightened redemptions or deter redemptions that constitute rational risk management by shareholders or that reflect a general incentive to avoid loss. Instead, our floating NAV reform is intended to address the incremental incentive to redeem created by money market funds' current valuation and pricing methods (and not incentives to redeem that relate to flights to quality and liquidity) and that exacerbates shareholder dilution.

b. Risks of Investor Dilution

As discussed earlier, one of the Commission's most significant concerns when originally providing the exemption permitting the use of amortized cost valuation and penny rounding pricing for money market funds was to minimize the risks of investor dilution.[479] A primary principle underlying the Investment Company Act is that sales and redemptions of redeemable securities should be effected at prices that are fair and do not result in dilution of shareholder interests or other harm to shareholders.[480] Absent an exemption, a mutual fund must sell and redeem its redeemable securities only at a price based on its current net asset value, which equals the value of the fund's total assets minus the amount of the fund's total liabilities.[481] A mutual fund generally must value its assets at their market value, in the case of securities for which market quotations are readily available, or at fair value, as determined in good faith by the fund's board of Start Printed Page 47778directors, in the case of other securities and assets.[482]

A fund that prices and transacts in fund shares valued at amortized cost value and rounded to the nearest penny poses a risk of dilution of investor shares because investors may redeem for the stable value of their shares even where the underlying market value of the fund's portfolio may be less. If such a redemption occurs, the value of the remaining shareholders' shares can be diluted, as remaining shareholders effectively end up paying redeeming shareholders the difference between the stable value and the underlying market value of the fund's assets.[483] This result is illustrated in the example provided in the Proposing Release, where we discussed how redeeming shareholders can concentrate losses in a money market fund.[484]

This risk of dilution is magnified by the “cliff effect” that can occur if a stable value fund is required to re-price its shares. If, due to heavy redemptions, losses embedded in a fund's portfolio cause it to re-price its shares from its stable value, remaining money market fund investors will receive at most 99 cents for every share remaining, while redeeming investors received the full $1.00, even if the market value of the fund's portfolio had not changed. In a mutual fund that transacts using a floating NAV, this cliff effect is minimized because (assuming pricing to four decimal places) the “cliff” is a 1/100th the size compared to when a money market fund is priced using penny rounding. In other words, in a floating NAV fund the risk of investor dilution is far less, in part, because the cliff occurs earlier and is significantly smaller (at $0.9999 cents, or one hundred times sooner and smaller than a stable value fund that drops from $1.00 to 99 cents). Thus, the “cliff effect” is significantly mitigated in a floating NAV fund that prices and rounds share prices to four decimal places.

As we discuss in more detail below, applying a floating NAV only to institutional investors investing in prime funds and allowing retail investors to continue to invest in a stable value product recognizes the historical differences between these types of investors, and cordons off some of the risks, reducing the chance that heavy redemptions by institutions will result in disruption or material dilution of retail investors' shares.[485] We also recognize that institutional investors are not always similarly situated, with some institutions having more or less investment at risk, resources to monitor their investments, tolerance for losses, or proclivity to redeem, which makes certain institutional investors less likely to be among the first movers.[486] A floating NAV should also help reduce the risks of material dilution to this subset of institutional investors, as it will reduce the first mover advantage associated with current rule 2a-7's valuation and pricing methods, which can prompt heavy redemptions and can have the effect of diluting the shares of slower-to-redeem institutional investors.[487]

A floating NAV might also prompt investors who are the least tolerant of losses, and thus the most likely to redeem early to avoid a decline in a fund's NAV per share, to shift into other investment products, such as government money market funds or other stable value products that may more appropriately match their risk profile. Such a shift would further reduce the risks of dilution for the remaining investors, mitigating the chances that rapid heavy redemptions will result in negative outcomes for these funds and their investors.

We recognize that our liquidity fees and gates reforms also address the risks of dilution to some extent. However, fees and gates may not address the incentives that cause rapid heavy redemptions to occur in certain money market funds in the first place (although they should help manage the results). They also are not primarily designed to address the risks associated with deviations in a fund's NAV caused by portfolio losses or other credit events; rather, they are designed to ensure that investors pay the costs of their liquidity and allow funds time to manage heavy redemptions. A floating NAV requires redeeming investors to receive only their fair share of the fund when there are embedded losses in the portfolio (avoiding dilution of remaining shareholders), even in cases where the fund has sufficient liquidity such that fees or gates would not be permitted. We believe that the risks associated with institutional prime money market funds—including the incentives associated with the first mover advantage that results from current rule 2a-7's valuation and pricing methods, and associated heavy redemptions that can worsen a decline in a fund's stable NAV—are significant enough that they need to be addressed through the targeted reform of a floating NAV.

c. Enhanced Allocation of Principal Volatility Risk

Today, the risks associated with the principal volatility of a money market fund's portfolio securities can be obscured by the pricing and valuation methods that allow these funds to maintain a stable NAV. In non-money market funds, investors may look to historical principal volatility as an indicator of fund risk because changes in the principal may be the dominant source of the total return.[488] Historical principal volatility in money market funds may not have been as fully appreciated by investors, because they do not experience any principal volatility unless the fund breaks the buck (even if such volatility has in fact occurred).[489]

Some commenters suggested, and we agree, that transacting at prices based on current market values means that institutional investors who invest in floating NAV funds will be more aware of, and willing to tolerate, occasional fluctuations in fund share prices (largely resulting from volatility in principal that had been previously obscured).[490] This may result in more efficient allocation of risk through a “sorting effect” whereby institutional investors in prime funds either remain in a floating NAV money market fund and accept the risks of regular principal Start Printed Page 47779volatility [491] or move their assets into alternative investment products better suited to their actual risk tolerance.[492] Accordingly, the shareholders who remain in institutional prime money market funds must be prepared to experience gains and losses in principal on a regular basis, which may result in those remaining investors being less likely to redeem at the first sign that a money market fund may experience such principal volatility.

Some commenters recognized that making principal gains and losses more apparent to investors could recalibrate investors' perceptions of the risks inherent in money market funds.[493] A number of commenters argued, however, that institutional investors who invest in money market funds that will be subject to a floating NAV are well aware of the risks of money market funds and that money market fund shares may fluctuate in value.[494] But contrary to institutional investors' purported existing knowledge of those risks, when the reality of potential principal losses became more apparent during the financial crisis, many of them redeemed heavily from money market funds.[495] Our floating NAV reform, by requiring that investors experience any gains or losses in principal when they transact in money market fund shares, will more fully reveal the risk from changes in the fund's principal value to shareholders.

Finally, some commenters also suggested that enhanced disclosure (including daily Web site reporting of shadow NAVs), rather than a floating NAV, would be a more efficient and less costly way to achieve the same goal.[496] We agree that daily disclosure of funds' shadow NAVs does improve visibility of risk to some degree, by making the information about NAV fluctuations available to investors should they choose to seek it out. But the mere availability of this information cannot provide the same effect that is provided by institutions experiencing actual fluctuations in the value of their investments (or acknowledging, through their investment in a fully disclosed floating NAV investment product, their willingness to accept daily fluctuations in share price value), which will be provided by a floating NAV.

4. Money Market Fund Pricing

Having determined to adopt the floating NAV reform for institutional prime funds, there is a separate (albeit related) issue of how to price the shares for transactions. Today, for the reasons discussed previously in this section, we are amending rule 2a-7 to eliminate the exemption that currently permits institutional prime funds to maintain a stable NAV through amortized cost valuation and/or penny rounding pricing.[497] We are also adopting, as proposed, an additional requirement that these money market funds value their portfolio assets and price fund shares by rounding the fund's current NAV to four decimal places in the case of a fund with a $1.0000 share price or an equivalent or more precise level of accuracy for money market funds with a different share price (e.g., a money market fund with a $10 target share price could price its shares at $10.000).[498] Accordingly, the final amendments change the rounding convention for money market funds that are required to adopt a floating NAV—from penny rounding (i.e., to the nearest one percent) to “basis point” rounding (i.e., to the nearest 1/100th of one percent), which is a more precise standard than other mutual funds use today.

We proposed to require that institutional prime funds use basis point rounding and we noted that basis point rounding appeared to be the level of sensitivity that would be required if gains and losses were to be regularly reflected in the share price of money market funds in all market environments, including relatively stable market conditions. We also noted that this level of precision may help more effectively inform investor expectations regarding the floating nature of their shares.[499] In money market funds today, there is no principal volatility unless the fund breaks the buck, and thus this indicator of risk may not have always been readily apparent.[500]

As discussed in the Proposing Release, we considered, as an alternative to the basis point rounding requirement that we are adopting today (which is a condition for relying on rule 2a-7 for institutional prime money market funds), requiring institutional prime funds to price and transact in fund shares at a precision of 1/10th of one percent (which is typically the equivalent of three decimal places at $10.00 share price) (“10 basis point rounding”), like other mutual funds. But in the Proposing Release, we noted our concern that 10 basis point rounding may not be sufficient to ensure that investors can regularly observe the investment risks that are present in money market funds, particularly if funds manage themselves in such a way that their NAVs remain constant or nearly constant.[501]

In considering whether to require basis point rounding or, instead, to allow 10 basis point rounding, we have looked to the potential for price Start Printed Page 47780fluctuations under the two approaches. Based on our staff analysis of Form N-MFP data between November 2010 and November 2013, 53% of money market funds have fluctuated in price over a twelve-month period with a NAV priced using basis point rounding, compared with less than 5% of money market funds that would have fluctuated in price using 10 basis point rounding.[502] We recognize that, either way, this limited fluctuation in prices is the result of the nature of money market fund portfolios, whose short duration and/or high quality generally results in fluctuations in value primarily when there is a credit deterioration or other significant market event.[503] Because of the nature of money market fund portfolios, pricing with the accuracy of basis point rounding should better reflect the nature of money market funds as an investment product by regularly showing market gains and losses in an institutional prime money market fund's portfolio.[504]

After considering the results of the staff's analysis, we are persuaded to require basis point rounding. We believe that some of the institutional investors in these funds may not appreciate the risk associated with money market funds.[505] As for this subset of institutional investors, we believe that the basis point rounding requirement may accentuate the visibility of the risks in money market funds by causing these shareholders to experience gains and losses when the funds' value fluctuates by 1 basis point or more.[506] We further believe this may, in turn, have two potential effects that are consistent with our overall goal of addressing features in money market funds that can make them susceptible to heavy redemption. First, to the extent that some of these investors become more aware of the risks, they may develop an increased risk tolerance that could help make them less prone to run.[507] Second, by helping make the risk more apparent through periodic price fluctuations, basis point rounding may help signal to those investors who cannot tolerate the risk associated with the fluctuating NAV that they should migrate to other investment options, such as government funds.[508] Because basis point rounding is, as the staff's study demonstrated, more likely to produce price fluctuations than 10 basis point rounding, we believe it is more likely to have these desired effects.[509]

a. Other Considerations

We recognize that 10 basis point rounding would provide certain benefits. For example, it could provide consistency in pricing among all floating NAV mutual funds and this could reduce investors' incentives to reallocate assets into other potentially riskier floating NAV mutual funds (e.g., ultra-short bond funds) that some commenters suggested may appear to present less volatility. A number of commenters argued for this alternative, suggesting that money market funds should not be required to use a more precise rounding convention than what is required of other mutual funds.[510]

Notwithstanding these potential benefits, as discussed above we believe there are sufficient countervailing considerations that make it appropriate to require basis point rounding for institutional prime money market funds. Further, we are requiring this additional level of precision because institutional prime money market funds are distinct from other mutual funds in their regulatory structure, purpose, and investor risk tolerance, as well as the risks they pose of investor dilution and to well-functioning markets. Accordingly, we believe on balance that it is appropriate to require these money market funds to use a more precise pricing and rounding convention than used by other mutual funds.

Some commenters also argued that enhanced disclosure (including daily Web site reporting of shadow NAVs), would be a more efficient and less costly way to achieve the same goal.[511] We agree that daily disclosure of funds' shadow NAVs does improve visibility of risk to some degree, by making the information about NAV fluctuations available to investors should they choose to seek it out. But we are skeptical that, as to the subset of institutional investors who are less aware of the risks, the mere availability of this information can provide the same level of impact than is provided by actually experiencing fluctuations in the investment value (or acknowledging, through these investors' investment in a fully disclosed floating NAV investment product, their willingness to accept daily fluctuations in share price value), which will be provided by a floating NAV priced using basis rounding. In a similar vein, one commenter suggested that, as an alternative to a floating NAV, we consider a modified penny-rounding pricing method whereby a money market fund would be permitted to calculate an unrounded NAV once each Start Printed Page 47781day and therefore, absent a significant market event, use the previous day's portfolio valuation for any intraday NAV calculations.[512] Under this approach, money market funds would disclose their basis-point rounded price, but only transact at the penny-rounded price.[513] Although we recognize that such an approach would likely retain the efficiencies associated with amortized cost valuation, this alternative is not without other risks, including the use of potentially stale valuation data. More significantly, unlike our floating NAV reform, this alternative does not address the first-mover advantage or risks of investor dilution discussed above.[514]

Several commenters argued that basis point rounding is an artificial means to increase the volatility of floating NAV funds and would mislead investors by exaggerating the risks of investing in money market funds compared to ultra-short bond funds, and suggested that instead we should adopt 10 basis point rounding.[515] For example, one commenter noted that basis point rounding is so sensitive that it might produce price distinctions among funds that result merely from the valuation model used by a pricing service, rather than from a difference in the intrinsic value of the securities (“model noise”).[516] We do not believe that basis point rounding will mislead investors, nor do we believe that price changes at the fourth decimal place will generally be a result of “model noise” rather than reflecting changes in the market value of the fund's portfolio.[517] We note that today many money market funds are voluntarily disclosing their shadow price with basis point rounding, and they are prohibited from doing so if the shadow price was misleading to investors. Funds have also been required to report their shadow NAVs to us on Form N-MFP priced to the fourth decimal place since the inception of the form, and we have found the shadow NAVs priced at this level useful and relevant in our risk monitoring efforts. For example, reporting of shadow prices to four decimal places provides a level of precision (as compared with three decimal place rounding) needed for our staff to fully evaluate and monitor the impact of credit events on money market fund share prices.[518]

Some commenters also stated that ultra-short bond funds priced using 10 basis point rounding might appear less volatile than money market funds priced using basis point rounding.[519] As a result, these commenters noted what they viewed as the undesirable effect that investors might be incentivized to move their assets into ultra-short bond funds that have similar investment parameters to money market funds but are not required to adhere to the risk-limiting conditions of rule 2a-7.[520] Based on our staff analysis of Morningstar data between November 2010 and November 2013, 100% of ultra-short bond funds have fluctuated in price over a twelve-month period with a NAV priced using 10 basis point rounding, compared with 53% of money market funds that would have fluctuated in price using basis point rounding.[521] Accordingly, we do not believe that it is likely investors will view ultra-short bond funds as less volatile than money market funds priced using basis point rounding. We also note, however, that because floating NAV money market funds and ultra-short bond funds invest in different securities and are subject to different regulatory requirements (including risk-limiting conditions), investors may consider these factors when evaluating the risk profile of these different investment products.[522] Existing disclosure requirements, along with the amendments to money market fund disclosure requirements we are adopting today, are designed to help investors understand these differences and the associated risks.

b. Implementation of Basis Point Rounding

One commenter noted that basis point rounding “should be relatively straightforward for the industry to accommodate.” [523] A number of commenters, however, objected to our proposed amendment to require that floating NAV money market funds price and transact their shares at the fourth decimal place. Commenters stated that pricing and transacting at four decimal places (as opposed to reporting only their shadow price at four decimal places) would be operationally expensive and overly burdensome because money market fund systems are typically designed for processing all mutual funds,[524] which generally process and record transactions rounded to the nearest penny (which is typically the equivalent of three decimal places at a $10.00 share price).[525] We acknowledge that money market funds, intermediaries, and shareholders will likely incur significant costs in order to modify their systems to accommodate pricing and transacting in fund shares rounded to four decimals. We discuss these costs in section III.B.8.a below. We understand, however, that because virtually all mutual funds (including money market funds), regardless of price, round their NAV to the nearest penny, these system change costs will be incurred if we require money market funds to float their NAV, regardless of whether we require the use of basis point rounding (unless funds were to re-price to $10.00 per share).[526]

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A few commenters also noted that although basis point rounding may convey the risk of a floating NAV to investors more clearly by reflecting very small fluctuations in value, it does so at a significant cost—increasing the tax and accounting burdens associated with the realized gains and losses that would result from more frequent changes in a money market fund's NAV per share.[527] As discussed in section III.B.6.a below, however, the Treasury Department and IRS are today proposing a new regulation that would permit investors to elect to use a “simplified aggregate mark-to-market method” to determine annual realized gains or losses and therefore eliminate the need to track purchase and sale transactions. Therefore, it is unlikely that there will be increased operational burdens that result from tax or accounting costs associated with more frequent realized gains or losses.[528]

c. Economic Analysis

Under our final amendments, and as we proposed, institutional prime funds will round prices and transact in fund shares to four decimal places in the case of a fund with a $1.00 target share price (i.e., $1.0000) or an equivalent or more precise level of accuracy for money market funds with a different share price. During normal market conditions, rounding prices and transacting in fund shares at four decimal places will provide investors an opportunity to better understand the risks of institutional prime funds as an investment option and will provide investors with improved transparency in pricing. This should positively affect competition. During times of stress, it will reduce much of the economic incentive for shareholders to redeem shares ahead of other investors at a stable net asset value when the market value of portfolio holdings fall and will reduce shareholder dilution. As such, the risk of heavy share redemptions should decrease, and shareholders will be treated more equitably as they absorb their proportionate share of gains, losses, and costs. In addition, rounding prices and transacting in fund shares at four decimal places may help to further reduce the incentive for shareholders to redeem shares ahead of other investors by helping less informed investors better understand the inherent risks in money market funds. As such, the risk of heavy share redemptions may decrease as investors experience greater information efficiency and allocative efficiency by better understanding the risks more closely and directing their investments accordingly. Reducing the risk of heavy share redemptions by removing the first-mover advantage should promote capital formation by making money market funds a more stable source of financing for issuers of short-term credit instruments. We recognize, however, that as discussed below in section II.K, to the extent that money flows out of institutional prime floating NAV funds and into alternative investment vehicles, capital formation may be adversely affected.

5. Amortized Cost and Penny Rounding for Stable NAV Funds

As discussed above, all money market funds that are not subject to our targeted floating NAV reform may continue to price fund shares as they do today and use the amortized cost method to value portfolio securities.[529] This approach differs from our 2013 proposal, in which we proposed to eliminate the use of the amortized cost method of valuation for all money market funds. At that time, we stated that amortized cost valuation or penny rounding pricing alone effectively provides the same 50 basis points of deviation from a fund's shadow price before the fund must “break the buck” and re-price its shares. Accordingly, and in light of the fact that, under our proposal, all money market funds (including stable NAV funds) would be required to disclose on a daily basis their fund share prices with their portfolios valued using market-based factors (rather than amortized cost), we proposed to eliminate the use of amortized cost for stable NAV funds (but to continue to permit penny rounding pricing).[530]

A number of commenters objected to eliminating amortized cost valuation for stable NAV funds.[531] Most significantly, commenters argued that prohibiting the use of amortized cost valuation would hinder money market funds' ability to provide for intraday purchases and redemptions and same-day settlement because of the increased time required to strike a market-based price.[532] One commenter noted, for example, that if a money market fund prices at the close of the New York Stock Exchange, the fund may not be able to complete the penny rounding process, wire redemption proceeds, and settle fund trades before the close of the Fedwire.[533] Commenters also argued that substituting penny rounding pricing for amortized cost valuation would increase costs and operational complexity without providing corresponding benefits.[534] A few commenters also suggested that, in assessing whether to eliminate amortized cost valuation for securities that mature in more than 60 days, we should consider the broader systemic implications of a potential shift in money market fund portfolio holdings towards securities that mature within 60 Start Printed Page 47783days (in order to avoid the need to use market-based values).[535]

We no longer believe that, as we stated in the Proposing Release, there would be little additional cost to funds if we eliminated amortized cost valuation (and permitted only penny rounding) for all money market funds (including stable NAV money market funds). Our belief was, in part, based on the fact that, as proposed (and as we are adopting today), all money market funds would be required to post on their Web sites daily shadow prices (determined using market-based values) rounded to four decimal places. Because, under our proposal money market funds would be required to obtain daily market-based valuations in order to post daily shadow prices to fund Web sites, we believed that funds would have this information readily available (and therefore not require the use of amortized cost). Notwithstanding this, commenters noted, however, the ability to use amortized cost valuation provides a significant benefit to money market funds when compared to penny rounding pricing—the ability to provide intraday liquidity to shareholders in a cost-effective and efficient manner. We agree with commenters that eliminating amortized cost valuation would likely hinder the ability of funds to provide frequent intraday liquidity to shareholders and may impose unnecessary costs and operational burdens on stable NAV money market funds. This is particularly true in light of the fact that under existing regulatory restrictions and guidance, a material intraday fluctuation would still have to be recognized in fair valuing the security. We therefore believe that eliminating amortized cost valuation in the context of stable NAV funds would be contrary to a primary goal of our rulemaking—to preserve to the extent feasible, while protecting investors and the markets, the benefits of money market funds for investors and the short-term funding markets by retaining a stable NAV alternative.

Accordingly, we are not adopting the proposed amendments that would prohibit stable NAV money market funds from using amortized cost to value portfolio securities. Rather, under the final amendments, stable NAV funds may continue to price fund shares as they do today, using the amortized cost method to value portfolio securities and/or the penny rounding method of pricing. Given the continued importance of amortized cost valuation under our final rules, we are providing expanded valuation guidance related to the use of amortized cost and other related valuation matters in section III.D.

6. Tax and Accounting Implications of Floating NAV Money Market Funds

a. Tax Implications

In the Proposing Release, we discussed two principal tax consequences of requiring certain money market funds to implement a floating NAV, potentially causing shareholders to experience taxable gains or losses. First, under tax rules applicable at the time of the Proposing Release, floating NAV money market funds (or their shareholders) would be required to track the timing and price of purchase and sale transactions in order to determine and report capital gains or losses. Second, floating NAV funds would be subject to the “wash sale” rule, which postpones the tax benefit of losses when shareholders sell securities at a loss and, within 30 days before or after the sale, buy substantially identical securities. These tax consequences generally do not exist today, because purchases and sales of money market fund shares at a stable $1.00 share price do not generate gains or losses. Because we are today adopting the floating NAV requirement for certain money market funds as part of our reforms, we have continued to analyze the related tax effects. As discussed below, the Treasury Department and IRS will address these tax concerns to remove almost all tax-related burdens associated with our floating NAV requirement.

i. Accounting for Net Gains and Losses

As we discussed in the Proposing Release, we expected taxable investors in floating NAV money market funds, like taxable investors in other types of mutual funds, to experience gains and losses. Accordingly, we expected shareholders in floating NAV money market funds to owe tax on any realized gains, to receive tax benefits from any realized losses, and to be required to determine those amounts. However, because it is not possible to predict the timing of shareholders' future transactions and the amount of NAV fluctuations, we were not able to estimate with any specificity the amount of any increase or decrease in shareholders' tax burdens. Because we expect that investors in floating NAV money market funds will experience relatively small fluctuations in value, and because many money market funds may qualify as retail and government money market funds, any changes in tax burdens likely would be minimal.

In the Proposing Release, we also noted that tax rules generally require mutual funds or intermediaries to report to the IRS and shareholders certain information about sales of shares, including sale dates and gross proceeds. If the shares sold were acquired after January 1, 2012, the fund or intermediary would also have to report basis and whether any gain or loss is long or short term.[536] At the time of the Proposing Release, Treasury regulations excluded sales of stable value money market funds from this transaction reporting obligation.[537] We noted that mutual funds and intermediaries (and, we anticipated, floating NAV money market funds) are not required to make reports to certain shareholders, including most institutional investors. The regulations call these shareholders “exempt recipients.” [538]

We have been informed that the Treasury Department and the IRS today will propose new regulations to make all money market funds exempt from this transaction reporting requirement, and the exemption is to be formally applicable for calendar years beginning on or after the date of publication in the Federal Register of a Treasury Decision adopting those proposed regulations as final regulations. Importantly, the Treasury Department and the IRS have informed us that the text of the proposed regulations will state that persons subject to transaction reporting may rely on the proposed exemption for all calendar years prior to the final regulations' formal date of applicability. Therefore, the Treasury and IRS relief described above is available immediately.

We noted in the Proposing Release our understanding that the Treasury Department and the IRS were considering alternatives for modifying forms and guidance: (1) To include net transaction reporting by the funds of realized gains and losses for sales of all mutual fund shares; and (2) to allow summary income tax reporting by shareholders. Many commenters argued that this potential relief does not go far enough and noted that, because institutions are exempt recipients, these Start Printed Page 47784investors would still incur costs to build systems to track and report their own basis information and calculate gains and losses.[539] We recognized in the Proposing Release the limitations of this potential tax relief.

We have been informed that the Treasury Department and the IRS today will propose new regulations that will provide more comprehensive and effective relief than the approaches described in the Proposing Release. These regulations will, as suggested by one commenter,[540] make a simplified aggregate method of accounting available to investors in floating NAV money market funds and are proposed to be formally applicable for taxable years ending after the publication in the Federal Register of a Treasury Decision adopting the proposed regulations as final regulations. Importantly, the Treasury Department and the IRS have informed us that the text of the proposed regulations will state that taxpayers may rely on the proposed rules for taxable years ending on or after the date that the proposed regulations are published in the Federal Register. That is, because investors may use this method of accounting before final regulations are published, the Treasury Department and IRS relief is available as needed before then.

The simplified aggregate method will allow money market fund investors to compute net capital gain or loss for a year by netting their annual redemptions and purchases with their annual starting and ending balances. Importantly, for shares in floating NAV money market funds, the simplified aggregate method will enable investors to determine their annual net taxable gains or losses using information that is currently provided on shareholder account statements and—most important—will eliminate any requirement to track individually each share purchase, each redemption, and the basis of each share redeemed. We expect that the simplified aggregate method will significantly reduce the burdens associated with tax consequences of the floating NAV requirement because funds will not have to build new tracking and reporting systems and shareholders will be able to calculate their tax liability using their existing shareholder account statements, rather than tracking the basis for each share. We have also considered the effect of this relief on the tax-related burdens associated with accounting for net gains and losses in our discussion of operational implications below.[541]

The Treasury Department and IRS have informed us of their intention to proceed as expeditiously as possible with the process of considering comments and issuing final regulations regarding the simplified aggregate method of accounting for floating NAV money market funds. We note that money market funds and their shareholders may begin using the simplified method of accounting as needed before the regulations are finalized. Were the Treasury Department and IRS to withdraw or materially limit the relief in the proposed regulations, the Commission would expect to consider whether any modifications to the reforms we are adopting today may be appropriate.

ii. Wash Sales

As discussed in the Proposing Release, the “wash sale” rule applies when shareholders sell securities at a loss and, within 30 days before or after the sale, buy substantially identical securities.[542] Generally, if a shareholder incurs a loss from a wash sale, the loss cannot be recognized currently and instead must be added to the basis of the new, substantially identical securities, which postpones the loss recognition until the shareholder recognizes gain or loss on the new securities.[543] Because many money market fund investors automatically reinvest their dividends (which are often paid monthly), virtually all redemptions by these investors would be within 30 days of a dividend reinvestment (i.e., purchase) and subject to the wash sale rule.

Subsequent to our proposal, the Treasury Department issued for comment a proposed revenue procedure under which redemptions of floating NAV money market fund shares that generate losses below 0.5% of the taxpayer's basis in those shares would not be subject to the wash sale rule (de minimis exception).[544] Many commenters noted, however, that the de minimis exception to the wash sale rule does not mitigate the tax compliance burdens and operational costs that would be required to establish systems capable of identifying wash sale transactions, determining if they meet the de minimis criterion, and adjusting shareholder basis when they do not.[545]

We understand that these concerns will not be applicable to floating NAV money market funds. First, under the simplified aggregate method of accounting described above, taxpayers will compute aggregate gain or loss for a period, and gain or loss will not be associated with any particular disposition of shares. Thus, the wash sale rule will not affect any shareholder that chooses to use the simplified aggregate method. Second, for any shareholder that does not use the simplified aggregate method, the Treasury Department and the IRS today will release a revenue procedure that exempts from the wash sale rule dispositions of shares in any floating NAV money market fund. This wash-sale tax relief will be available beginning on the effective date of our floating NAV reforms (60 days after publication in the Federal Register). We have also considered the effect of this relief from the tax-related burdens associated with the wash sale rule in our discussion of operational implications below.[546]

b. Accounting Implications

In the Proposing Release, we noted that some money market fund shareholders may question whether they can treat investments in floating NAV money market funds as “cash equivalents” on their balance sheets. As we stated in the Proposing Release, and as we discuss below, it is the Commission's position that, under normal circumstances, an investment in a money market fund with a floating NAV under our final rules meets the definition of a “cash equivalent.” [547]

Many commenters agreed with our position regarding the treatment of investments in floating NAV money market funds as cash equivalents.[548] Most of these commenters, however, suggested that the Commission issue a more formal pronouncement and/or requested that FASB and GASB codify our position.[549] A few commenters Start Printed Page 47785suggested that our floating NAV requirement raises uncertainty about whether floating NAV money market fund shares could continue to be classified as cash equivalents,[550] and one commenter disagreed and suggested that it is likely that under present accounting standards investors would have to classify investments in shares of floating NAV money market funds as trading securities or available-for-sale securities (rather than as a cash equivalent).[551] We have carefully considered commenters' views and, for the reasons discussed below, our position continues to be that an investment in a floating NAV money market fund under our final rules, under normal circumstances, meets the definition of a “cash equivalent.” A more formal pronouncement (as requested by some commenters) is not required because the federal securities laws provide the Commission with plenary authority to set accounting standards, and we are doing so here.[552] We reiterate our position below.[553]

The adoption of a floating NAV alone for certain rule 2a-7 funds will not preclude shareholders from classifying their investments in money market funds as cash equivalents, under normal circumstances, because fluctuations in the amount of cash received upon redemption would likely be small and would be consistent with the concept of a `known' amount of cash. As already exists today with stable share price money market funds, events may occur that give rise to credit and liquidity issues for money market funds so that shareholders would need to reassess if their investments continue to meet the definition of a cash equivalent.

7. Rule 10b-10 Confirmations

Rule 10b-10 under the Securities Exchange Act of 1934 (“Exchange Act”) addresses broker-dealers' obligations to confirm their customers' securities transactions.[554] Under Rule 10b-10(a), a broker-dealer generally must provide customers with information relating to their investment decisions at or before the completion of a securities transaction.[555] Rule 10b-10(b), however, provides an exception for certain transactions in money market funds that attempt to maintain a stable NAV and where no sales load or redemption fee is charged. The exception permits broker-dealers to provide transaction information to money market fund shareholders on a monthly basis (subject to certain conditions) in lieu of immediate confirmations for all purchases and redemptions of shares of such funds.[556]

Because share prices of institutional prime money market funds likely will fluctuate, absent exemptive relief, broker-dealers will not be able to continue to rely on the current exception under Rule 10b-10(b) for transactions in floating NAV money market funds.[557] Instead, broker-dealers will be required to provide immediate confirmations for all such transactions. We note, however, that contemporaneous with this Release, the Commission is providing notice and requesting comment on a proposed order that, subject to certain conditions, would grant exemptive relief from the immediate confirmation delivery requirements of Rule 10b-10 for transactions effected in shares of any open-end management investment company registered under the Investment Company Act that holds itself out as a money market fund operating in accordance with rule 2a-7(c)(1)(ii).[558]

In the Proposing Release, we requested comment on whether, if the Commission adopted the floating NAV requirement, broker-dealers should be required to provide immediate confirmations to all institutional prime money market fund investors. Commenters generally urged the Commission not to impose such a requirement, arguing that there would be significant costs associated with broker-dealers providing immediate confirmations.[559] Commenters noted that there would be costs of implementing new systems to generate confirmations and ongoing costs related to creating and sending trade-by-trade confirmations.[560] We estimate below the costs to broker-dealers associated with providing securities transaction confirmations for floating NAV money market funds.[561]

We believe that the initial one-time cost to implement, modify, or reprogram existing systems to generate immediate confirmations (rather than monthly statements) will be approximately $96,650 on average per affected broker-dealer, based on the costs that the Commission has estimated in a similar context of developing internal order and trade management systems so that a registered security-based swap entity could electronically process transactions and send trade acknowledgments.[562] In addition, we estimate that 320 broker-dealers that are clearing customer transactions or carrying customer funds and securities would be affected by this requirement because they would likely be the broker-dealers responsible for providing trade confirmations.[563] As a result, the Start Printed Page 47786Commission estimates initial costs of $30,928,000 for providing immediate confirmations for shareholders in institutional prime money market funds.[564]

To estimate ongoing costs of providing immediate confirmations, one commenter stated that, based on the data it had gathered, the median estimated ongoing annual cost associated with confirmation statements would constitute between 10% and 15% of the initial costs.[565] To be conservative, we have estimated that the ongoing annual costs would constitute 15% of the initial costs. Applying that figure to the initial costs, the Commission estimates ongoing annual costs of $4,639,200 for providing immediate confirmations for shareholders in institutional prime money market funds.[566]

The Commission notes that benefits related to the immediate trade confirmation requirements under Rule 10b-10 with respect to institutional prime money market funds are difficult to quantify as they relate to the additional value to investors provided by having more timely confirmations with respect to funds that we expect will experience relatively small fluctuations in value. While the Commission did not receive any comments regarding these potential benefits, given that institutional prime money market funds likely will fluctuate in price, some investors may find value in receiving information relating to their investment decisions at or before the completion of a securities transaction.[567]

8. Operational Implications of Floating NAV Money Market Funds

a. Operational Implications to Money Market Funds and Others in the Distribution Chain

In the Proposing Release, we stated that we expect that money market funds and transfer agents already have laid the foundation required to use floating NAVs because they are required under rule 2a-7 to have the capacity to redeem and sell fund shares at prices based on the funds' current NAV pursuant to rule 22c-1 rather than $1.00, i.e., to transact at the fund's floating NAV.[568] Intermediaries, although not subject to rule 2a-7, typically have separate obligations to investors with regard to the distribution of proceeds received in connection with investments made or assets held on behalf of investors.[569] We also noted that before the Commission adopted the 2010 amendments to rule 2a-7, the ICI submitted a comment letter detailing the modifications that would be required to permit funds to transact at the fund's floating NAV.[570]

Commenters noted, as we recognized in the Proposing Release, however, that some funds, transfer agents, intermediaries, and others in the distribution chain may not currently have the capacity to process constantly transactions at floating NAVs, as would be required under our proposal.[571] Accordingly, consistent with our views reflected in the Proposing Release and as discussed below, we continue to expect that sub-transfer agents, fund accounting departments, custodians, intermediaries, and others in the distribution chain would need to develop and overlay additional controls and procedures on top of existing systems in order to implement a floating NAV on a continual basis.[572] In each case, the procedures and controls that support the accounting systems at these entities would have to be modified to permit those systems to calculate a money market fund's floating NAV periodically each business day and to communicate that value to others in the distribution chain on a permanent basis.

Some commenters noted that our floating NAV requirement would adversely affect cash sweep programs, in which customer cash balances are automatically “swept” into investments in shares of money market funds (usually through a broker-dealer or other intermediary). For example, one commenter suggested that sweep programs cannot accommodate a floating NAV because such programs are predicated on the return of principal.[573] Another commenter suggested that the substantial cost and complexity associated with intraday pricing makes it likely that many intermediaries will discontinue offering floating NAV institutional prime money market funds as sweep options, and instead turn to alternative investment products, including stable NAV government funds.[574] Although we do not know to Start Printed Page 47787what extent, if at all, intermediaries will continue to offer sweep accounts for floating NAV money market funds, we acknowledge that there are significant operational costs involved in order to modify sweep platforms to accommodate a floating NAV product. Accordingly, we anticipate that sweep account assets currently invested in institutional prime money market funds will likely shift into government funds that will maintain a stable NAV under our final rules. We discuss in the Macroeconomic Effects section below potential costs related to a migration of assets away from floating NAV funds into alternative investments, including stable NAV money market funds such as government funds. Because the amount of sweep account assets currently invested in institutional prime money market funds is not reported to us, nor are we aware of such information in the public domain, we are not able to provide a reasonable estimate of the amount of sweep account assets that may shift into alternative investment products.

In the Proposing Release, we also estimated additional costs under our floating NAV reform that would be imposed on money market funds and other recordkeepers to track portfolio security gains and losses, provide “basis reporting,” and monitor for potential wash-sale transactions. As discussed above, we have been informed that, today, the Treasury Department and the IRS will propose new regulations that will eliminate the need for money market funds and others to track portfolio gains and losses and basis information, as well as issue today a revenue procedure that exempts money market funds from the wash-sale rules. Accordingly, our cost estimates for the floating NAV reform have been revised from our proposal to reflect this fact.[575]

We understand that the costs to modify a particular entity's existing controls and procedures will vary depending on the capacity, function and level of automation of the accounting systems to which the controls and procedures relate and the complexity of those systems' operating environments.[576] Procedures and controls that support systems that operate in highly automated operating environments will likely be less costly to modify while those that support complex operations with multiple fund types or limited automation or both will likely be more costly to change. Because each system's capabilities and functions are different, an entity will likely have to perform an in-depth analysis of the new rules to calculate the costs of modifications required for its own system. While we do not have the information necessary to provide a point estimate [577] of the potential costs of modifying procedures and controls, we expect that each entity will bear one-time costs to modify existing procedures and controls in the functional areas that are likely to be impacted by the floating NAV reform.

In the Proposing Release, we estimated that the one-time costs of implementation for an affected entity would range from $1.2 million (for entities requiring less extensive modifications) to $2.3 million (for entities requiring more extensive modifications) and that the annual costs to keep procedures and controls current and to provide continuing training would range from 5% to 15% of the one-time costs.[578] In addition, we noted that we expect money market funds (and their intermediaries) would incur additional costs associated with programs and systems modifications necessary to provide shareholders with access to information about the floating NAV per share online, through automated phone systems, and on shareholder statements and to explain to shareholders that the value of their money market funds shares will fluctuate.[579] We estimated that the costs for a fund (or its transfer agent) or intermediary that may be required to perform these activities would range from $230,000 to $490,000 and that the ongoing costs to maintain automated phone systems and systems for processing shareholder statements would range from 5% to 15% of the one-time costs.[580] In sum, we estimated that the total range of one-time implementation costs to money market funds and others in the distribution chain would be approximately $1,430,000 to $2,790,000 per entity, with ongoing costs that range between 5% to 15% of these one-time costs.[581]

Commenters did not generally disagree with the type and nature of costs that we estimated will be imposed by our floating NAV reform. One commenter noted that the costs required to make the necessary systems changes would not be prohibitive and could be completed within two to three years.[582] A number of commenters, however, provided a wide range of estimated operational costs to money market funds, intermediaries, and others in the distribution chain. These commenters suggested that estimated one-time implementation costs would be between $350,000 to $3,000,000, depending on the affected entity.[583] One commenter estimated that it could cost up to $2,300,000 per fund, transfer agent, or intermediary, to modify systems procedures and controls to implement a floating NAV.[584] Another commenter estimated that it would cost each back office processing service provider $1,725,000 in one-time costs to implement a floating NAV.[585] We also received from commenters some cost estimates provided on a fund complex level. Two fund complexes estimated their total one-time costs to implement a floating NAV to be between $10,000,000 to $11,000,000, and one of the largest money market fund sponsors approximated its one-time costs to be $28,000,000. Averaged across the number of money market funds offered, these one-time implementation costs Start Printed Page 47788range from $306,000 to $718,000.[586] Another commenter provided survey data stating that 40% of respondents (asset managers and intermediaries) estimated that it would cost $2,000,000 to $5,000,000 in one-time costs to implement a floating NAV.[587] Finally, a few commenters estimated the one-time costs to the entire fund industry related to implementing our floating NAV reform.[588]

We estimated in the Proposing Release that it would cost each money market fund, intermediary, and other participant in the distribution chain approximately $1,430,000 (for less extensive modifications) to $2,790,000 (for more extensive modifications) in one-time costs to implement a floating NAV.[589] Based on staff analysis and experience, we are revising the estimated operational costs for our floating NAV reform downward by 15% to reflect the tax relief discussed above.[590] In addition, as discussed above (and, in a change from our proposal), our final rules will permit retail and government money market funds to continue to maintain a stable NAV as they do today and to use amortized cost valuation and/or penny-rounding pricing. A number of commenters noted that eliminating the ability of stable NAV funds to use amortized cost valuation, as we proposed, would impose significant operational costs on these funds.[591] Accordingly, based on staff analysis and experience, we are also revising the estimated operational costs downward by 5% to reflect the ability of stable NAV funds to continue to use amortized cost valuation as they do today. We therefore estimate that it will cost each money market fund, intermediary, and other participant in the distribution chain approximately $1,144,000 (for less extensive modifications) to $2,232,000 (for more extensive modifications) in one-time costs to implement the floating NAV reform.[592]

We believe that this range of estimated costs generally fits within the range of costs suggested by commenters as described above (after accounting for estimated costs savings related to tax relief and the increased availability of amortized cost valuation, not contemplated by commenters in their estimates). We note, however, that many money market funds, transfer agents, custodians, and intermediaries in the distribution chain may not bear the estimated costs on an individual basis and therefore will likely experience economies of scale. Accordingly, we expect that the cost for many individual entities that would have to process transactions at a floating NAV will likely be less than these estimated costs.[593]

In addition to the estimated one-time implementation costs, we estimate that funds, intermediaries, and others in the distribution chain will incur annual operating costs of approximately 5% to 15% of initial costs. Accordingly, we estimate that funds and other intermediaries will incur annual operating costs as a result of the floating NAV reform that range from $57,200 to $334,800.[594] Most commenters that addressed this issue directly did not disagree with our estimate of ongoing costs, although we note that a few commenters estimated the new annual operating costs to the entire fund industry related to implementing our floating NAV reform.[595] One commenter provided survey data showing that 66% of respondents (asset managers and intermediaries) estimated that annual costs would approximate 10% to 15% of initial costs.[596] Another commenter, however, disagreed with our estimate of annual operating costs of approximately 5% to 15% of initial costs and suggested that the annual costs to fund sponsors will actually be close to the costs of initial implementation. We disagree. This commenter noted that most of the ongoing cost would result from the elimination of amortized cost accounting (generally) and more frequent price calculations using market-based factors.[597] Because stable NAV money market funds may continue to use amortized cost valuation under our final rules (unlike our proposal), we believe this commenter has overstated the ongoing costs under our final rules.[598] Therefore, we believe consistent with the comments received, that it is more appropriate to continue to estimate the ongoing operational Start Printed Page 47789costs as approximately 5% to 15% of the initial implementation costs and are not revising the ongoing cost estimates from our proposal.

b. Operational Implications to Money Market Fund Shareholders

In addition to money market funds and other entities in the distribution chain, each money market fund shareholder will also likely be required to analyze our floating NAV proposal and its own existing systems, procedures, and controls to estimate the systems modifications it would be required to undertake. Because of this, and the variation in systems currently used by institutional money market fund shareholders, we do not have the information necessary to provide a point estimate of the potential costs of systems modifications. We describe below the types of activities typically involved in making systems modifications and estimate a range of hours and costs that we anticipate will be required to perform these activities. We sought comment in the Proposing Release regarding the potential costs of system modifications for money market fund shareholders, and the comments we received, along with the differences between our proposal and the final rules, have informed our estimates.

In the Proposing Release, we prepared ranges of estimated costs, taking into account variations in the functionality, sophistication, and level of automation of money market fund shareholders' existing systems and related procedures and controls, and the complexity of the operating environment in which these systems operate. In deriving our estimates, we considered the need to modify systems and related procedures and controls related to recordkeeping, accounting, trading, and cash management, and to provide training concerning these modifications. We estimated that a shareholder whose systems (including related procedures and controls) would require less extensive modifications would incur one-time costs ranging from $123,000 to $253,000, while a shareholder whose systems (including related procedures and controls) would require more extensive modifications would incur one-time costs ranging from $1.4 million to $2.9 million.[599]

Most commenters did not disagree with our cost estimates. One commenter stated that it expects at least 50% of institutional investors in money market funds will require some systems development to be able to invest in a floating NAV money market fund. This commenter also noted that having sufficient time to implement the changes is a more important factor than cost in determining the extent to which corporate treasurers, for example, would use a floating NAV fund product.[600] Another commenter acknowledged our range of estimated costs and suggested that while these estimates may not appear substantial at first glance, when viewed in the context of current money market fund returns, such costs represent a significant disincentive to continued investment in institutional prime funds.[601] Although we acknowledge that the costs to money market fund shareholders may make investing in floating NAV money market funds uneconomical given the current rates of return, we note that we are adopting a two-year compliance period that may, to the extent that interest rates return to more typical levels, counter any disincentive that may exist currently.[602]

The TSI Report [603] provided ranges of costs that it expects would be imposed on floating NAV money market fund shareholders. These costs ranged from $250,000 for a U.S. business that invests in floating NAV money market funds and makes the fewest changes possible, to $550,000 for a government-sponsored entity money market fund shareholder.[604] We have carefully considered this range of costs to shareholders provided by the commenter and the changes from the proposal to the rule that we are adopting today, and we now believe that it is appropriate to decrease our cost estimates from the proposal. Accordingly, we estimate that a shareholder whose systems (including related procedures and controls) would require less extensive modifications would incur one-time costs ranging from $212,500 to $340,000, while a shareholder whose systems (including related procedures and controls) would require more extensive modifications would incur one-time costs ranging from $467,500 to $850,000. We believe that these estimates better reflect the changes in our final rules from those that we proposed.[605] We also recognize that these estimates are more consistent with the range of cost estimates provided by this commenter. We estimate that the annual maintenance costs to these systems and procedures and controls, and the costs to provide continuing training, will range from 5% to 15% of the one-time implementation costs.[606]

c. Intraday Liquidity and Same-Day Settlement

As discussed below, we believe that floating NAV money market funds should be able to continue to provide shareholders with intraday liquidity and same-day settlement by pricing fund shares periodically during the day (e.g., at 11 a.m. and 4 p.m.). In the Proposing Release, we noted that money market funds' ability to maintain a stable value also facilitates the funds' role as a cash management vehicle and provides other operational efficiencies for their shareholders. Shareholders generally are able to transact in fund shares at a stable value known in advance, which permits money market fund transactions to settle on the same day that an investor places a purchase or sell order and determine the exact value of his or her money market fund shares (absent a liquidation event) at any time. These features have made money market funds an important component of systems for processing and settling various types of transactions.

Some commenters have expressed concern that intraday liquidity and/or same-day settlement would not be available to investors in floating NAV money market funds. These commenters point to, for example, operational challenges such as striking the NAV multiple times during the day while needing to value each portfolio security using market-based values.[607] A few commenters also noted that pricing services may not be able to provide periodic pricing throughout the day.[608] Some commenters also raised concerns about the additional costs involved with striking the NAV multiple times per Start Printed Page 47790day, including, for example, costs for pricing services to provide multiple quotes per day and for accounting agents to calculate multiple NAVs.[609] On the other hand, one commenter who provides pricing services noted that, while providing intraday liquidity and same-day settlement for floating NAV funds would require some investment, they believe that calculating NAVs multiple times per day is feasible within our proposed two-year compliance period.[610] A few commenters further noted that transfer agents will need to enhance their systems to account for floating NAV money market funds and condense their reconciliation and audit processes (which may, for example, increase the risk of errors).[611]

A few commenters also asserted that if floating NAV funds are unable to provide same-day settlement, this could affect features that are particularly appealing to retail investors, such as ATM access, check writing, and electronic check payment processing services and products.[612] First, as discussed below, we believe that many floating NAV money market funds will continue to be able to provide same-day settlement. Second, we note that under the revised retail money market fund definition adopted today, retail investors should have ample opportunity to invest in a fund that qualifies as a retail money market fund and thus is able to maintain a stable NAV. As a result, this should significantly alleviate concerns about the costs of altering these features and permit a number of funds to continue to provide these features as they do today. Nonetheless, we recognize that not all funds with these features may choose to qualify as retail money market funds, and therefore, some funds may need to make additional modifications to continue offering these features. We have included estimates of the costs to make such modifications below.

We understand that many money market funds currently permit same-day trading up until 5 p.m. Eastern Time. These funds do so because amortized cost valuation allows funds to calculate their NAVs before they receive market-based prices (typically provided at the end of the day after the close of the Federal Reserve Cash Wire). We recognize that, under the floating NAV reform, closing times for same-day settlement will likely need to be moved earlier in the day to allow sufficient time to calculate the NAV prior to the close of the Federal Reserve Cash Wire. One commenter suggested that it will take a minimum of three to four hours to strike a market-based NAV price.[613] As a result, investors in floating NAV money market funds may not have the ability to redeem shares late in the day, as they can today. We also recognize that floating NAV money market funds may price only once a day, at least until such time as pricing vendors are able to provide continuous pricing throughout the day.[614] We considered these potential costs as well as the benefits of our floating NAV reform and believe that, as discussed above, it is appropriate to address, through the floating NAV reform, the incremental incentive that exists for shareholders to redeem in times of stress from institutional prime money market funds. We note, however, that because stable NAV money market funds may continue to use amortized cost as they do today (as revised from our proposal), these same-day settlement concerns raised by commenters here would be limited to institutional prime funds—the only money market funds subject to the floating NAV reform.[615]

We sought comment in the Proposing Release on the costs associated with providing same-day settlement and for pricing services to provide prices multiple times each day. One commenter provided survey data that estimated the range of costs for floating NAV funds to offer same-day settlement. Seventy-five percent of respondents estimated the one-time costs to be approximately $500,000 to $1 million, and 25% of respondents estimated the one times costs to be approximately $1 million to $2 million.[616] Sixty-six percent of respondents approximated ongoing costs that would range between 10-15% of initial costs.[617] We did not receive other quantitative estimates specifically on the costs associated with modifying systems to allow for same-day settlement by floating NAV funds.[618] We have carefully considered this survey data with respect to same-day settlement issues in arriving at our aggregate operational cost estimates discussed above in section III.B.8.a.[619]

9. Transition

We are providing a two-year compliance date (as proposed) for money market funds to implement the floating NAV reform. A long compliance period will give more time for funds to implement any needed changes to their investment policies and train staff, and also will provide more time for investors to analyze their cash management strategies. This compliance period will also give time for retail money market funds to reorganize their operations and establish new funds. Importantly, this compliance period will allow additional time for the Treasury Department and IRS to consider finalizing rules addressing certain tax issues relating to a floating NAV described above and for the Start Printed Page 47791Commission to consider final rules removing NRSRO ratings from rule 2a-7,[620] so that funds could make several compliance-related changes at one time.

We acknowledge, as discussed in the Proposing Release and as noted by some commenters, that a transition to a new regulatory regime could itself cause the type of heavy redemptions that the amendments, including the floating NAV reform, are designed to prevent.[621] In the proposal, we noted that our proposed two-year compliance period would benefit money market funds and their shareholders by allowing money market funds to make the transition to a floating NAV at the optimal time and potentially not at the same time as all other money market funds. In addition, we stated our belief that money market fund sponsors would use the relatively long compliance period to select an appropriate conversion date that would minimize the risk that shareholders may pre-emptively redeem shares at or near the time of conversion if they believe that the market value of their shares will be less than $1.00. Several commenters reiterated this concern, with one commenter noting that shareholders in floating NAV money market funds may be incentivized to redeem in order to avoid losses or realize gains, depending on the expected NAV at the time of conversion.[622] A few commenters suggested that money market funds will likely be unwilling or unable to stagger their transitions over our proposed two-year transition period, but did not provide any survey data or other support for their beliefs.[623]

We continue to believe that an extended compliance period (as adopted, two years) should help mitigate potential pre-emptive redemptions by providing money market fund shareholders with sufficient time to consider the reforms and decide, if they determine that a floating NAV investment product is not appropriate or desirable, to invest a stable NAV retail or government money market fund or an alternative investment product. We recognize that, although money market funds may comply with the rule amendments at any time between the effective date and the compliance date, in practice, money market funds may implement amendments relating to floating NAV near the end of the transition period, which may further cause the potential for widespread redemptions prior to the transition. Although a few commenters suggested as much,[624] we did not receive any survey data and we are not able to reasonably estimate the extent to which money market funds may or may not stagger their transition to a floating NAV.

We note, however, that in order to mitigate this risk, money market fund managers could take steps to ensure that the fund's market-based NAV is $1.00 or higher at the time of conversion and communicate to shareholders the steps that the fund plans to take ahead of time in order to mitigate the risk of heavy pre-emptive redemptions, though funds would be under no obligation to do so. Even if funds took such steps, investors may pre-emptively withdraw their assets from money market funds that will transact at a floating NAV to avoid this risk. We note, however, that while a two-year compliance period does not eliminate such concerns, we expect, as discussed above, that providing a two-year compliance period will allow money market funds time to prepare and address investor concerns relating to the transition to a floating NAV, and therefore possibly mitigate the risk that the transition to a floating NAV, itself, could prompt significant redemptions. In addition, the liquidity fees and gates reforms will be effective and therefore available to fund boards as a tool to address any heightened redemptions that may result from the transition to a floating NAV.[625]

C. Effect on Certain Types of Money Market Funds and Other Entities

1. Government Money Market Funds

The fees and gates and floating NAV reforms included in today's Release will not apply to government money market funds, which are defined as a money market fund that invests at least 99.5% of its total assets in cash, government securities,[626] and/or repurchase agreements that are “collateralized fully” (i.e., collateralized by cash or government securities).[627] In addition, under today's amendments, government money market funds may invest a de minimis amount (up to 0.5%) in non-government assets,[628] unlike our proposal and under current rule 2a-7, which permits government money market funds to invest up to 20% of total assets in non-government assets.[629]

Additionally, as proposed, a government money market fund will not be required to, but may, impose a fee or gate if the ability to do so is disclosed in a fund's prospectus and the fund complies with the fees and gates requirements in the amended rule.[630]

With respect to the floating NAV reform, most commenters supported a reform that does not apply to government money market funds.[631] Start Printed Page 47792Commenters noted that government funds pose significantly less risk of heavy investor redemptions than prime funds, have low default risk and are highly liquid even during market stress, and experienced net inflows during the financial crisis.[632] Also, few commenters explicitly supported or opposed excluding government funds from the fees and gates reforms. Of these commenters, a few supported a narrowly tailored fees and gates reform that does not apply to government money market funds,[633] and a few commenters argued that all types of money market funds—including government money market funds—should have the ability to apply a fee or gate.[634]

We continue to believe that government money market funds should not be subject to the fees and gates and floating NAV reforms. As discussed in the Proposing Release, government money market funds face different redemption pressures and have different risk characteristics than other money market funds because of their unique portfolio composition.[635] The securities primarily held by government money market funds typically have a lower credit default risk than commercial paper and other securities held by prime money market funds and are highly liquid in even the most stressful market conditions.[636] As noted in our proposal, government funds' primary risk is interest rate risk; that is, the risk that changes in the interest rates result in a change in the market value of portfolio securities.[637] Even the interest rate risk of government money market funds, however, is generally mitigated because these funds typically hold assets that have short maturities and hold those assets to maturity.[638]

As discussed in the DERA Study and below, government money market funds historically have experienced inflows, rather than outflows, in times of stress.[639] In addition, the assets of government money market funds tend to appreciate in value in times of stress rather than depreciate.[640] Most government money market funds always have at least 30% weekly liquid assets because of the nature of their portfolio (i.e., the securities they generally hold, by definition, are weekly liquid assets). Accordingly, with respect to fees and gates, the portfolio composition of government money market funds means that these funds are less likely to need to use these tools.

We have also determined not to impose the fees and gates and floating NAV reforms on government money market funds in an effort to facilitate investor choice by providing a money market fund investment option that maintains a stable NAV and that does not require investors to consider the imposition of fees and gates. As noted above, we expect that some money market fund investors may be unwilling or unable to invest in a money market fund that floats its NAV and/or can impose a fee or gate.[641] By not subjecting government money market funds to the fees and gates and floating NAV reforms, fund sponsors will have the ability to offer money market fund investment products that meet investors' differing investment and liquidity needs.[642] We also believe that this approach preserves some of the current benefits of money market funds for investors. Based on our evaluation of these considerations and tradeoffs, and the more limited risk of heavy redemptions in government money market funds, we believe it is preferable to tailor today's reforms and not apply the floating NAV requirement to government funds, but to permit them to implement the fees and gates reforms if they choose.[643]

We also sought comment on the appropriate size of the non-government basket. Notwithstanding the relative safety and stability of government money market funds, we noted our concern that a credit event in this 20% basket or a shift in interest rates could trigger a decline in a fund's shadow price and therefore create an incentive for shareholders to redeem shares ahead of other investors (similar to that described for institutional prime funds subject to the floating NAV reform). We stated in the Proposing Release our preliminary belief that the benefits of retaining a stable share price money market fund option and the relative safety in a government money market fund's 80% basket appropriately counterbalances the risks associated with the 20% portion of a government money market fund's portfolio that may be invested in non-government securities.[644]

A number of commenters, however, raised concerns that the proposed definition of government money market fund would permit these funds to invest up to 20% of their portfolio in non-government assets, and, contrary to the goals of our money market fund reforms, potentially increase risk as stable NAV government funds may use this 20% basket to reach for yield.[645] One Start Printed Page 47793commenter noted that, notwithstanding the current 20% non-government security basket, its government money market funds invest 100% of fund assets in government securities because doing so meets the expectations of government money market fund investors.[646]

We agree with commenters who suggested that permitting government funds to invest potentially up to 20% of fund assets in riskier non-government securities may promote a type of hybrid money market fund that presents new risks that are not consistent with the purposes of the money market reforms adopted today.[647] One commenter suggested that without a 20% basket, there may be an oversupply of commercial paper that disrupts corporate funding (presumably a result of a shift of assets out of institutional prime funds required to adopt our floating NAV reform).[648] As a result, this commenter suggested that the Commission wait until after final rules are adopted to evaluate the use of the 20% basket, including the effects on commercial paper supply, and then consider phasing the 20% basket out over time, if appropriate. We disagree. As stated above, the reason for not applying our fees and gates and floating NAV reforms to government money market funds is, in part, a recognition of the relative stability of this type of money market fund, through its lack of credit risk. It would limit the effectiveness of our floating NAV reform, for example, to allow a hybrid government fund to develop and potentially present credit risk to institutional investors seeking greater yield, while keeping the benefit of a stable NAV.

As noted above, many commenters suggested completely eliminating the 20% basket.[649] One commenter suggested a smaller de minimis basket, for example 5%.[650] Our approach includes a 0.5% de minimis basket in which government funds may invest in non-government securities. In order to evaluate an appropriate de minimis amount of non-government securities, Commission staff, using Form N-MFP data, analyzed the exposure of government money market funds to non-government securities between November 2010 and November 2013.[651]

This analysis showed, among other things, that as of November 2013, approximately 17% of all money market funds were government funds and that average total net assets of government funds remained fairly constant at near $500 billion since March of 2012.[652] An analysis of the data also showed that, between November 2010 and November 2013, government money market funds generally invested between 0.5% and 2.5% of their total amortized cost dollar holdings in non-government securities and, more recently closer to 0.5% in non-government securities from November 2012 to November 2013.[653] For example, the 90th percentile of reporting government money market funds demonstrates that investments in non-government securities declined from 12.7% (representing 11 funds) in November 2010 to nearly zero in November 2013.[654]

A few commenters suggested that this analysis is flawed because it inappropriately focuses on the historical use of the non-government securities basket to predict future use of the 20% basket, when we cannot accurately predict how investors will react following the adoption of proposed regulatory changes, such as a floating NAV.[655] One commenter further suggested that the analysis instead should address the potential systemic risk posed by a hybrid fund.[656] As other commenters noted, however, we recognize the potential for increased investor interest in hybrid government money market funds, and as discussed above, we are concerned that continuing to permit government money market funds to invest potentially up to 20% of fund assets in non-government securities presents risks that are contrary to goals of this rulemaking. In fact, the concern raised by these commenters, suggesting that the historical use of the 20% basket is irrelevant in the context of a future regulatory regime that includes a floating NAV reform, further supports our concern that retaining the 20% non-government securities basket is likely to result in increased risk taking by Start Printed Page 47794institutional prime fund investors who move to government money market funds in search of greater yield (but with the continued benefit of a stable NAV). We also note that our staff's analysis of the historical use of the 20% basket establishes the baseline (i.e., the extent to which government money market funds have used the 20% basket) for our economic analysis discussed below.

One commenter stated its belief that allowing government money market funds to invest up to 20% in non-government securities will not materially increase the risks of these funds to investors or the financial system and that such a fund would have adequate liquidity to satisfy any increased redemption pressure that results from a credit event in the 20% basket.[657] This commenter cites to our statement in the Proposing Release, where we characterized as “minimal” the risk of government money market funds that maintain at least 80% of their total assets in cash, government securities, or repurchase agreements that are collateralized by cash or government securities.[658] We continue to believe, however, as we also stated in the Proposing Release, that “a credit event in [the] 20% portion of the portfolio or a shift in interest rates could trigger a drop in the shadow price, thereby creating incentives for shareholders to redeem shares ahead of other investors.” [659] Even if we assume that a government fund had sufficient liquidity from its 80% basket of government securities to cover adequately increased redemptions that result from a credit event in the 20% basket, we note that the structural incentives that exist in stable NAV money market funds, and the associated first mover advantage and potential shareholder dilution concerns, still exist.[660] And, indeed, after our floating NAV reform takes effect, the incentives could be even more pronounced in government funds if those institutional investors who are the most sensitive to risk move to government funds.

Based on the staff's analysis, we expect that the 0.5% non-conforming basket is consistent with current industry practices and strikes an appropriate balance between providing government money market fund managers with adequate flexibility to manage such funds while preventing them from taking on potentially high levels of risk associated with non-government assets. We therefore are revising the definition of a government fund to require that such a fund invest at least 99.5% (up from 80% in the proposal) of its assets in cash, government securities, and/or repurchase agreements that are collateralized by cash or government securities. A money market fund may not call itself or include in its name “government money market fund” or similar names unless the fund complies with this requirement.[661]

Because we believe that the de minimis basket we are adopting is consistent with current industry practice, we do not believe that government funds will experience any material reduction in yield, based on current interest rates, as a result of our amendments. In addition, we do not believe that government funds will be required to make any systems modifications as a result of changing to a 0.5% de minimis basket because funds are already required to monitor compliance with the existing 20% non-government basket requirement. As discussed below, however, we do expect that money market funds may need to amend their policies and procedures to reflect the changes we are adopting today, including the new 0.5% de minimis basket.[662] We estimate that it will cost each money market fund complex approximately $2,580 in one-time costs to amend their policies and procedures.[663]

Because staff analysis shows that our 0.5% non-conforming basket is consistent with industry practice, we believe that any effect on efficiency, competition, or capital formation should be minimal. In addition, any government money market funds that do currently use the 20% basket could roll out of any excess exposure to non-government assets by the time that funds are required to comply with the amended rule, given rule 2a-7's maturity limits on portfolio securities. Nevertheless, reducing the size of the basket could affect efficiency, competition, or capital formation in the future because decreasing the size of the basket reduces a government fund's flexibility to invest in non-government assets in the future. For example, decreasing the size of the basket could lead to a loss of efficiency if government funds are unable to invest in securities that government funds are currently permitted to purchase. Reducing the basket size could also restrict competition among money market funds because government funds would not be able to invest more than 0.5% in non-government assets and thus will have a reduced ability to compete with other money market funds based on yield. Finally, capital formation in the commercial paper market could be hindered by reducing the 20% basket and reducing these funds' ability to invest in commercial paper. We do not expect any such effect to be substantial, however, given the very small extent to which government funds have recently used the non-government basket.

We also recognize the potential for a significant inflow of money market fund assets into government money market funds from institutional prime investors (seeking a stable NAV alternative) and investors that are unable or unwilling to invest in a product that may restrict liquidity (through our liquidity fees and gates reform). As we discuss in section III.K below, we do not anticipate that the impact from the final rule amendments, including those related to our floating NAV reform, will be large enough to constrain government funds and their potential investors.

2. Retail Money Market Funds

As was proposed, our fees and gates reform will apply to retail money market funds, but our floating NAV reform will not. However, as discussed more below, we are revising the definition of a retail money market fund from our proposal to address concerns raised by commenters. As amended, a retail money market fund means a money market fund that has policies and procedures reasonably designed to limit all beneficial owners of the fund to natural persons.[664]

As discussed in the Proposing Release and the DERA Study, retail investors historically have behaved differently from institutional investors in a crisis, being less likely to make large redemptions quickly in response to the first sign of market stress. During the financial crisis, institutional prime money market funds had substantially larger redemptions than prime money market funds that self-identify as retail.[665] As noted in the Proposing Release, for example, approximately 4-5% of retail prime money market funds had outflows of greater than 5% on each Start Printed Page 47795of September 17, 18, and 19, 2008, compared to 22-30% of institutional prime money market funds.[666] Similarly, in late June 2011, institutional prime money market funds experienced heightened redemptions in response to concerns about their potential exposure to the Eurozone debt crisis, whereas retail prime money market funds generally did not experience a similar increase.[667] Studies of money market fund redemption patterns in times of market stress also have observed this difference.[668] As we noted in the Proposing Release and discussed above, we believe that institutional shareholders tend to respond more quickly than retail shareholders to potential market stresses because generally they have greater capital at risk and may be better informed about the fund through more sophisticated tools to monitor and analyze the portfolio holdings of the funds in which they invest.[669] We discuss below our fees and gates and floating NAV reforms and their application to retail money market funds, as defined by our amendments adopted today.

a. Fees and Gates

Largely for the reasons discussed above, several commenters argued that our fees and gates reforms should not apply to retail money market funds, in the same way that our floating NAV reform would not apply to retail funds.[670] More specifically, commenters argued that retail investors behave differently than institutional investors and, therefore, retail money market funds are insulated from runs and sudden losses of liquidity.[671]

Although, as discussed above, the evidence suggests that retail investors historically have exhibited much lower levels of redemptions or a slower pace of redemptions in times of stress,[672] we cannot predict future investor behavior with certainty and, thus, we cannot rule out the potential for heavy redemptions in retail funds in the future. Empirical analyses of retail money market fund redemptions during the financial crisis show that at least some retail investors eventually began redeeming shares.[673] Similarly, we note that when the Reserve Primary Fund, which was a mixed retail and institutional money market fund, “broke the buck” as a result of the Lehman Brothers bankruptcy, almost all of its investors ran—retail and institutional alike. Additionally, we note that it is possible that the introduction of the Treasury Temporary Guarantee Program on September 19, 2008 (a few days after institutional prime money market funds experienced heavy redemptions) lessened the incentive for shareholders to redeem from retail money market funds. Moreover, as we recognized in the Proposing Release, retail prime money market funds, unlike government money market funds, generally are subject to the same credit and liquidity risks as institutional prime money market funds.[674] As such, absent fees and gates, there would be nothing to help manage or prevent a run on retail prime money market funds in the future.

As noted in the Proposing Release, we also believe there is a difference in the anticipated shareholder behaviors we are trying to address by the fees and gates requirements and floating NAV requirement as applied to retail funds.[675] The floating NAV requirement is specifically designed to address shareholders' incentive to redeem to take advantage of pricing discrepancies between a money market fund's market-based NAV per share and its stable share price. As discussed above, we believe this incentive likely is greatest among institutional investors because they are more likely to have significant sized investments at stake and the sophistication and resources to monitor actively such discrepancies.[676] While retail investors are unlikely to be motivated to a substantial degree by the first-mover advantage created by money market funds' stable pricing convention, they may be motivated to redeem heavily in flights to quality, liquidity, and transparency (even if they may do so somewhat slower than institutional investors). Fees and gates are designed to address these types of redemptions.[677] We also note that retail money market funds today operate with the potential for gates under rule 22e-3, which allows a fund board to permanently gate and liquidate a money market fund under certain circumstances. Today's amendments include a number of disclosure reforms that are designed to ensure that retail investors will understand this new additional fee and gate regime for money market funds.[678]

In addition, the floating NAV requirement will affect a shareholder's experience with an institutional prime money market fund on a daily basis. It thus is a significant reform that is targeted only at those investors that we consider most likely to be motivated to redeem at least in part on the basis of pricing discrepancies in the fund. In contrast, and as discussed above, the fees and gates requirements will not affect a money market fund on a day-to-day basis; its effect will be felt only if the fund's weekly liquid assets fall below 30% of its total assets—i.e., unless it comes under potential stress—and even then, only if the board determines that a fee and/or gate is in Start Printed Page 47796the best interests of the fund. Further, while we recognize that a retail money market fund may be less likely to experience strained liquidity (and thus less likely to need to impose a fee or gate), we believe there is still a sufficient risk of this occurring that we should allow such funds to impose a fee or gate to manage any related heavy redemptions when the weekly liquid assets fall below 30% and doing so is in the fund's best interests. For the same reasons, we believe requiring a fund to impose a liquidity fee when weekly liquid assets fall below 10% is also appropriate, unless the board determines otherwise based on the fund's best interests. Accordingly, retail money market funds will be subject to the fees and gates reform.

b. Floating NAV

i. Definition of Retail Money Market Fund

As we proposed, however, we are not imposing the floating NAV reform on retail money market funds. For purposes of the floating NAV reform, we are defining a retail money market fund to mean a money market fund that has policies and procedures reasonably designed to limit all beneficial owners of the fund to natural persons (“retail funds”).[679]

Many commenters generally supported not applying a floating NAV requirement to retail money market funds, noting, for example, retail investors' moderate redemption activity during the financial crisis as compared with institutional prime funds and the importance of retaining a stable NAV investment product for retail investors that facilitates cash management, particularly where there are few alternatives offering diversification, stability, liquidity, and a market-based rate of return for these investors.[680] Some commenters, however, objected to, or expressed concerns about not applying a floating NAV to retail funds. These commenters noted, for example, that (i) retail investors in the future may not behave the way we observed in 2008; (ii) increases in sophistication of retail investors (for example, through technological advancements) may lead retail investors to act more like institutional investors over time; and (iii) any differentiation between retail and institutional funds provides opportunities for gaming behavior by institutional investors.[681]

We recognize, as discussed above, that we cannot be certain how retail investors would have reacted during the financial crisis had the Treasury Temporary Guarantee Program not been implemented. Similarly, we cannot predict whether retail investors, in light of new tools to manage liquidity (e.g., fees and gates) and enhanced disclosure and transparency, will behave more like institutional investors in the future. But the evidence to date suggests that retail investors do not present the same risks associated with high levels of redemptions posed by institutional investors.[682] We continue to believe that the significant benefits of providing an alternative stable NAV fund option justify the risks associated with the potential for a shift in retail investors' behavior in the future, particularly given that retail money market funds will be able to use fees and gates as tools to stem heavy redemptions should they occur. We also note that, as discussed below, our revised approach to defining a retail fund based on shareholder characteristics should minimize the potential for gaming behavior by institutional investors.

As of February 28, 2014, funds that self-report as retail money market funds held nearly $998 billion in assets, which is approximately one-third of all assets held in money market funds.[683] Unlike under our proposal, which would have required retail funds generally to value portfolio securities using market-based factors rather than amortized cost, money market funds that qualify as retail funds may continue to offer a stable value as they do today—and facilitate their stable price by use of amortized cost valuation and/or penny-rounding pricing of their portfolios. As discussed below, our definition of a retail fund reflects several modifications from our proposal (in which a retail fund was defined as a fund that limits redemptions to $1 million in a single business day) and reflects an approach suggested by a number of commenters.[684]

We proposed to define a fund as retail, and thus not subject to the floating NAV reform, if it is a fund that restricts a shareholder of record from redeeming more than $1 million in any one business day. We explained our belief that this approach should be relatively simple to implement because it would only require a fund to establish a one-time, across-the-board redemption policy, unlike other approaches based on shareholder characteristics that would require ongoing monitoring by the fund. We also stated our belief that our proposed approach would reduce the risk that a retail fund would experience heavier redemption requests than it could effectively manage in a crisis because it would limit the total amount of redemptions a fund can experience in a single day and therefore provide the fund time to better predict and manage its liquidity.

In the Proposing Release, we selected a $1 million redemption limit because we expected this amount would be high enough to make money market funds a viable cash management tool for retail investors, but low enough that institutional investors would likely self-select out of these funds because it would not satisfy their operational needs.[685] Under the proposed retail fund definition, a fund would be able to permit an “omnibus account holder” to Start Printed Page 47797redeem more than $1 million in a single business day provided the fund has policies and procedures reasonably designed to allow the conclusion that the omnibus account holder does not permit any beneficial owner to directly or indirectly redeem more than $1 million in a single day.[686] The Proposing Release also considered and sought comment on other ways to distinguish a retail fund from an institutional fund, including applying limitations based on maximum account balance, shareholder concentration, or shareholder characteristics (e.g., a social security number that would identify the shareholder as an individual person and not an institution).[687] We discuss below comments received on these alternative means for distinguishing retail funds from institutional funds.

A number of commenters supported (some with suggested scope modifications) our proposed approach to define a retail investor by means of a daily redemption limit.[688] Many commenters, however, raised concerns with defining a retail fund as a fund that imposes a daily redemption limit on its investors, stating, for example, that the $1 million daily redemption limit would (i) unduly limit liquidity by prohibiting transactions by shareholders whose behavior does not present run risk; (ii) restrict full liquidity not only in times of market stress, but also when the markets are operating effectively; and (iii) be costly and difficult to implement, monitor, and enforce.[689] As noted above, however, a number of commenters have suggested defining a retail money market fund as a fund that seeks to limit beneficial ownership interest to natural persons.[690] After analyzing the comments received, we agree that defining a retail fund as a fund that has policies and procedures reasonably designed to limit beneficial ownership to natural persons (“natural person test”) provides a simpler and more cost-effective way to accomplish our goal of targeting the floating NAV reform to the type of money market fund that has exhibited greater tendencies to redeem first in times of market stress and has the investors most likely to seek to take advantage of any pricing discrepancies and therefore dilute the interests of remaining shareholders.[691] We discuss below the operation of the natural person test and its economic effects.

ii. Operation of the Natural Person Test

As discussed in the Proposing Release, it currently is difficult to distinguish precisely between retail and institutional money market funds, given that funds generally self-report this designation, there are no clear or consistent criteria for classifying funds, and there is no common regulatory or industry definition of a retail investor or a retail money market fund. We noted that the operational challenges of defining a retail fund are numerous and complex. In addition, as discussed below, drawing a distinction between retail and institutional investors is complicated by the extent to which shares of money market funds are held by investors through omnibus accounts and other financial intermediaries. We also recognize that any distinction between retail and institutional funds could result in “gaming behavior” whereby investors having the general attributes of an institution might attempt to fit within the confines of whatever retail fund definition we craft. We believe, however, that defining a retail fund using the natural person test will, as a practical matter, significantly reduce opportunities for gaming behavior because we believe that most funds will use social security numbers as part of their compliance process to limit beneficial ownership to natural persons, and institutional investors are not issued social security numbers.

A money market fund that has policies and procedures reasonably designed to limit beneficial owners to natural persons will not be subject to the floating NAV reform. We expect that a fund that intends to qualify as a retail money market fund would disclose in its prospectus that it limits investments to accounts beneficially owned by natural persons.[692] Funds will have flexibility in how they choose to comply with the natural person test. As noted by commenters, we expect that many funds will rely on social security numbers to confirm beneficial ownership by a natural person. The social security number is one well-established method of identification, issued to natural persons who qualify under the Social Security Administration's requirements. Because social security numbers are in nearly all cases obtained as part of the account-opening process (for natural persons) and are populated in transfer agent and intermediary recordkeeping systems, this approach should reduce significantly the required enhancements to systems, processes, and procedures that would be required under alternative approaches, including our proposed daily redemption limit.[693] In addition, for intermediaries using omnibus account registrations where the beneficial owners are natural persons (e.g., retail brokerage accounts, certain trust accounts, and defined contribution plan accounts), a social security number is a key component of customer account-opening procedures and compliance and therefore should allow intermediaries to distinguish retail from institutional investors (and therefore assist retail funds in satisfying the retail fund definition).[694] In many cases, funds and intermediaries already collect this data to comply with “know your customer” practices and anti-money laundering laws and should easily be Start Printed Page 47798able to identify if a beneficial owner is a natural person.[695]

As commenters noted, defining a retail fund in this way encompasses a large majority of individual investors who use retail accounts today.[696] For example, we understand that many tax-advantaged savings accounts and ordinary trusts are beneficially owned by natural persons, and therefore would likely qualify under the natural person test.[697] We understand that, often, in these types of accounts, natural persons are responsible for making the decision to redeem from a fund during a time of crisis (rather than an institutional decision maker). We acknowledge, however, that a fund may still qualify as a retail money market fund notwithstanding having an institutional decision maker (e.g., a plan sponsor in certain retirement arrangements, or an investment adviser managing discretionary investment accounts) that could eliminate or change an investment option, such as offering or investing in a money market fund. We also recognize that there is a potential risk that an institutional decision maker may react differently in times of market stress than the individuals that we expect will invest in retail money market funds as defined under our amended rule. We believe that in many instances, however, this risk can be mitigated. A number of commenters noted, for example, that under section 3(34) of ERISA, the plan sponsor of a defined contribution plan can eliminate or change an investment option without providing notice of the change, but stated that the plan sponsor would likely provide 30 days' notice of any change in order to obtain the benefit of the fiduciary safe harbor in section 404(c) of ERISA.[698] To the extent that there remains a risk that an institutional decision maker associated with a qualifying retail fund makes decisions inconsistent with how we understand retail funds generally behave, we believe that our approach appropriately balances this potential risk against the substantial benefits of providing a simple and cost-effective way to distinguish retail funds and provide a targeted floating NAV requirement.

As noted above, funds that intend to satisfy the retail fund definition will be required to adopt and implement policies and procedures reasonably designed to restrict beneficial ownership to natural persons.[699] For example, funds could have policies and procedures that will help enable the fund to “look through” these types of accounts and reasonably conclude that the beneficial owners are natural persons. A fund's policies and procedures could, for example, require that the fund reasonably conclude that ownership is limited to natural persons and do so (i) directly, such as when the investor provides a social security number to the fund adviser, when opening a taxable or tax-deferred account through the adviser's transfer agent or brokerage division; or (ii) indirectly, such as when a social security number is provided to the fund adviser in connection with recordkeeping for a retirement plan, or a trust account is opened with information regarding the individual beneficiaries. We note that our definition of a retail money market fund provides a fund with the flexibility to develop policies and procedures that best suit its investor base and does not require that the fund use social security numbers to reasonably conclude that investors are natural persons. For example, a money market fund or the appropriate intermediary could determine the beneficial ownership of a non-U.S. natural person by obtaining other government-issued identification, for example, a passport.[700]

In the Proposing Release, we discussed as an alternative to the daily redemption limit approach requiring that funds consider shareholder characteristics, such as whether the investor has a social security number or a taxpayer identification number. We noted our concern, however, that social security numbers do not necessarily correlate to an individual, and taxpayer identification numbers do not necessarily correlate to a business (for example, businesses operated as pass-through entities).[701] One commenter reiterated this concern.[702] We note, however, that the definition of a retail fund does not rely solely on each investor having a social security number. Rather, our approach recognizes that in most cases, a fund or intermediary may often satisfy the natural person test by implementing policies and procedures that require verifying a social security number at the time of account opening. But, the fund or intermediary may, for example, determine that a non-U.S. investor who does not have a social security number is a natural person (e.g., using a passport).

Finally, we note that, currently, it is not uncommon for a money market fund to be owned by both retail and institutional investors, typically through a retail and institutional share class, respectively.[703] In order to qualify as a retail money market fund, funds with separate share classes for different types of investors (as well as single-class funds for both types of investors) will need to reorganize into separate money market funds for retail and institutional investors, which may be separate series of the fund.[704] In the case of a money market fund with retail and institutional Start Printed Page 47799share classes, two commenters suggested that the Commission provide relief from section 18(f)(1) of the Act (designed, in part, to prohibit material differences among the rights of shareholders in a fund) [705] to allow the fund to reorganize the classes into separate money market funds.[706]

We recognize that a reorganization of a share class of a money market fund into a new series may implicate section 18 of the Investment Company Act, as well as section 17(a) of the Investment Company Act (section 17(a) prohibits, among other things, certain transactions between a fund and an affiliated person of the fund to prevent unfairness to the fund or overreaching by the affiliated person).[707] Notwithstanding the prohibitions in sections 17(a) and 18(f)(1) and 18(i) of the Act, in the context of distinguishing between retail and institutional money market funds when implementing the reforms we are adopting today, the Commission is of the view that a reorganization of a class of a fund into a new fund may take place without separate exemptive relief, provided that the fund's board of directors, including a majority of the directors who are not interested persons of the fund, determines that the reorganization results in a fair and approximately pro rata allocation of the fund's assets between the class being reorganized and the class remaining in the fund.[708] As is the case with any board determination, the basis for the fund board's determination should be documented fully in the fund's corporate minutes.[709] We believe that a reorganization accomplished in this manner would be consistent with the investor protection concerns in sections 17(a) and 18 of the Act in this context. More specifically, we believe that this board determination, in the context of a one-time reorganization related specifically to effectuating a split of separate share classes in order to qualify as a retail money market fund, addresses the primary concerns that sections 17 and 18 of the Act are intended, in part, to address—to ensure that shareholders in a fund are treated fairly and prohibit overreaching by affiliates.

The Commission's position is that, as part of implementing a reorganization in response to the amendments we are adopting today, a money market fund may involuntarily redeem certain investors that will no longer be eligible to invest in the newly established or existing money market fund. We recognize that such an involuntary redemption (or cancellation) of fund shares may implicate section 22(e) of the Act, which, among other things, generally prohibits a fund from suspending (or postponing) the right of redemption for any redeemable security for more than seven days after tender of such shares.[710] Our staff has, in the past, however, provided no-action relief under section 22(e) of the Act in similar situations (e.g., where an investor's account balance falls below a certain value, provided shareholders are notified in advance).[711] Notwithstanding the prohibitions in section 22(e) of the Act, in the context of a one-time reorganization to distinguish between retail and institutional money market funds (either in separating classes into new funds or in ensuring that an existing fund only has retail or institutional investors), the Commission's position is that a fund may involuntarily redeem investors who no longer meet the eligibility requirements in a fund's retail and/or institutional money market funds without separate exemptive relief, provided that the fund notifies in writing such investors who become ineligible to invest in a particular fund at least 60 days before the redemption occurs.

Accordingly, the Commission is exercising its authority under section 6(c) of the Act to provide exemptions from these provisions of the Act to permit a money market fund to reorganize a class of a fund into a new fund in order to qualify as a retail money market fund and make certain involuntary redemptions as discussed above.[712] As discussed above, we believe that such exemptions do not implicate the concerns that Congress intended to address in enacting these provisions, and thus they are necessary and appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the Act. We discuss the potential costs of reorganizing funds below.[713]

iii. Omnibus Account Issues

As we discussed in the Proposing Release, most money market funds do Start Printed Page 47800not have the ability to look through omnibus accounts to determine the characteristics of their underlying investors. An omnibus account may consist of holdings of thousands of small investors in retirement plans or brokerage accounts, just one or a few institutional accounts, or a mix of the two. Omnibus accounts typically aggregate all the customer orders they receive each day, net purchases, net redemptions, and they often present a single buy and single sell order to the fund. Accordingly, omnibus accountholders may make it more difficult for a money market fund to assure itself that it is able to operate as a retail fund.[714]

A money market fund that seeks to qualify as a retail fund must have policies and procedures that are reasonably designed to limit the fund's beneficial owners to natural persons. Because an omnibus accountholder is the shareholder of record (and not the beneficial owner), retail funds will need to determine that the underlying beneficial owners of the omnibus account are natural persons. We are not prescribing the ways in which a fund may seek to satisfy the retail fund definition, including how the fund will reasonably conclude that underlying beneficial owners of an omnibus account are natural persons.[715] There are many ways for a fund to effectively manage their relationships with their intermediaries, including contractual arrangements or periodic certifications. Funds may manage these relations in the manner that best suits their circumstances. We note that a fund's policies and procedures could include, for example, relying on periodic representations of a third-party intermediary or other verification methods to confirm the individual's ownership interest, such as when a fund is providing investment only services to a retirement plan or an omnibus provider is unable or unwilling to share information that would identify the individual. Regardless of the specific policies and procedures followed by a fund in reasonably concluding that the underlying beneficial owners of an omnibus account are natural persons, we expect that a fund will periodically review the adequacy of such policies and procedures and the effectiveness of their implementation.[716] Accordingly, such periodic reviews would likely assist funds in detecting and correcting any gaps in funds' policies and procedures, including a fund's ability to reasonably conclude that the underlying beneficial owners of an omnibus account are natural persons. As discussed below in the economic analysis, we have included in our aggregate cost estimate costs for funds to establish policies and procedures with respect to omnibus accounts, but we expect that funds generally will rely on financial intermediaries to implement such policies (rather than, for example, entering into contractual arrangements).

iv. Economic Analysis

In addition to the costs and benefits discussed above, implementing any reform that distinguishes between retail and institutional money market funds will likely have similar effects on efficiency, competition, and capital formation, regardless of how we define a retail money market fund (or retail investor). We discussed these effects in the Proposing Release and they are described below.[717] To the extent that retail investors prefer a stable NAV money market fund, our floating NAV reform (that does not apply to retail funds) helps to maintain the utility of such a money market fund investment product. However, to the extent that funds seek to maintain a stable NAV by qualifying as a retail fund, there may be an adverse effect on capital formation if the associated costs incurred by funds are passed on to shareholders. Funds that choose to qualify as retail money market funds will incur some operational costs (discussed below) and, depending on their magnitude, these costs might affect capital formation and competition (depending on the varied ability of funds to absorb these costs).

To the extent that retail investors prefer a stable NAV product and funds seek to qualify as retail money market funds under the amended rules, there may be negative effects on competition by benefitting fund groups with large percentages of retail investors relative to other funds. The Commission estimates that, as of February 28, 2014, 39 fund complexes (or 46% of all fund complexes) have 75% or more of their total assets self-reported as “retail.” [718] There also could be a negative effect on competition to the extent that certain fund groups already offer separate retail and institutional money market funds and thus might not need to reorganize an existing money market fund into two separate funds (retail and institutional). The Commission estimates that, as of February 28, 2014, there are approximately 76 fund complexes that currently offer separately designated retail and institutional money market funds (or series).[719] On the other hand, as discussed above, we believe that the majority of money market funds currently are owned by both retail and institutional investors (although many funds are separated into retail and institutional classes), and therefore relatively few funds would benefit from an existing structure that includes separate retail and institutional funds.

Two commenters also suggested that a bifurcation of existing assets in money market funds into retail and institutional funds might lead to a significant reduction in scale and therefore some funds may become uneconomical to operate, leading to further consolidation in the industry and a reduction in competition.[720] As noted above, many fund complexes already operate under structures that separate retail and institutional investors, either by established funds, series, or classes, and therefore demonstrate that doing so is not uneconomical. We recognize, however, that to the extent there are money market funds or fund groups that determine that it would not be economical to operate separate retail and institutional individual money market funds, there may be a reduction in competition. We believe that such effects would be relatively small, as discussed in section III.K below. Finally, we note that there may be an adverse effect on competition to the extent that large money market funds are able, based on information from broker-dealers and other intermediaries, to receive full transparency into Start Printed Page 47801beneficial owners. In this way, larger money market funds may find it easier to comply with their policies and procedures (and, in particular, with regard to omnibus account holders) to qualify as retail money market funds.

To the extent that money market funds are not able to distinguish effectively institutional from retail shareholders, it may have negative effects on efficiency by permitting “gaming behavior” by shareholders with institutional behavior patterns who nonetheless invest in retail funds. As discussed above, however, we believe the natural person test we are adopting reduces significantly the opportunity for “gaming behavior” when compared with our proposal. We also recognize that establishing qualifying retail money market funds may also negatively affect fund efficiency to the extent that a fund that currently separates institutional and retail investors through different classes instead would need to create separate and distinct funds, which may be less efficient.[721] The costs of such a re-organization are discussed below.

The costs and benefits of the natural person test are discussed above. In the Proposing Release, we also quantified the operational costs that money market funds, intermediaries, and money market fund service providers might incur in implementing and administering a $1 million daily redemption limit.[722] As commenters noted, however, we expect that the approach we are adopting today, based on limiting beneficial ownership to natural persons, is a simpler and more cost-effective way to achieve our goals. Commenters noted that the natural person approach provides a front-end qualifying test that effectively requires intermediaries and/or fund advisers to verify the nature of each investor only once. As a result, the natural person test reduces operational complexity and eliminates some of the need for costly programming and ongoing monitoring.[723] These commenters also noted that, although this approach will require some refinements to existing systems, these modifications will be significantly less costly than building a new system for tracking and aggregating daily shareholder redemption activity (as would be required under our proposal). Below, we quantify the estimated operational costs associated with implementing the natural person test.[724]

The Commission estimates that based on those money market funds that self-report as “retail,” approximately 195 money market funds are likely to seek to qualify as a retail money market fund under our amended rules.[725] We have estimated the ranges of hours and costs associated with the natural person test that may be required to perform activities typically involved in making systems modifications, implementing fund policies and procedures, and performing related activities.[726] Although we do not have the information necessary to provide a point estimate of the potential costs associated with the natural person test, these estimates include one-time and ongoing costs to establish separate funds (or series) if necessary, modify systems and related procedures and controls, update disclosure in a fund's prospectus, as well as ongoing operational costs. All estimates are based on the staff's experience, commenter estimates, and discussions with industry representatives. We expect that only funds that determine that the benefits of qualifying as a retail money market fund justify the costs would seek to qualify and thus bear these costs. Otherwise, they would incur the costs of implementing a floating NAV generally or decide to liquidate the fund.

As discussed above, many money market funds currently are owned by both retail and institutional investors, although they often are separated into retail and institutional share classes. A fund that seeks to qualify as a retail money market fund under our amended rules will need to be structured to limit beneficial ownership to only natural persons, and thus any money market fund that currently has both retail and institutional shareholders would need to be reorganized into separate retail and institutional money market funds. One-time costs associated with this reorganization would include costs incurred by the fund's counsel to draft appropriate organizational documents and costs incurred by the fund's board of directors to approve such documents. One-time costs also would include the costs to update the fund's registration statement and any relevant contracts or agreements to reflect the reorganization, as well as costs to update prospectuses and to inform shareholders of the reorganization. In addition, funds may have one-time costs to obtain shareholder approval to the extent that a money market fund's charter documents and/or applicable state law require shareholder approval to effect a reorganization into separate retail and institutional money market funds.[727] Funds and intermediaries also may incur one-time costs in training staff to understand the operation of the fund and effectively implement the natural person test.

In order to qualify as a retail money market fund, a fund will be required to adopt and implement policies and procedures reasonably designed to restrict beneficial owners to natural persons. Adopting such policies and procedures and modifying systems to identify an investor as a natural person who is eligible for investment in the fund also would involve one-time costs for funds and intermediaries. Regarding omnibus accounts, the rule does not prescribe the way in which funds should determine that underlying beneficial owners of an omnibus account are natural persons. We note that a fund may require (as a matter of doing business) that its intermediaries implement its policies, including those related to qualification as a retail fund. However, there are also other ways for a fund to manage their relationships with their intermediaries, such as entering into a contractual arrangement or obtaining certifications from the omnibus account holder. In preparing Start Printed Page 47802the following cost estimates, we assumed that funds will generally rely on financial intermediaries to implement their policies without undergoing the costs of entering into a contractual arrangement with the financial intermediaries because funds and intermediaries would typically take the approach that is the least expensive. However, some funds may choose to undertake voluntarily the costs of obtaining an explicit contractual arrangement despite the expense.[728]

In our proposal, we estimated that the initial costs would range from $1,000,000 to $1,500,000 for each fund that seeks to satisfy the retail money market fund definition (as proposed, using a daily redemption limit).[729] One commenter provided specific cost estimates related to our proposal to define a retail money market fund based on a $1,000,000 daily redemption limit, estimating that it would cost the fund complex $11,200,000, or $311,000 per fund.[730]

Based on staff experience and review of the comments received, as well as the changes to the retail definition in the final amendments, we estimate that the one-time costs necessary to implement policies and procedures and/or for a fund to qualify as a retail money market fund under our amended rules, including the various organizational, operational, training, and other costs discussed above, will range from $830,000 to $1,300,000 per entity.[731] Our estimates represent a decrease of $170,000 on the low end, and a decrease of $200,000 on the high end from our proposed range of estimated operational costs.[732] Our revised cost estimates reflect, as noted by commenters, a more cost-effective way to define a retail money market fund. Accordingly, our cost estimates take into account the fact that most money market funds will largely be able to satisfy the natural person test using information that funds already collect and have readily available, and reduce the estimated amount of resources necessary, for example, to program systems capable of tracking and aggregating daily shareholder redemption activity (that would have been required under our proposal).[733]

In addition to these one-time costs, as discussed above, funds may have one-time costs to obtain shareholder approval to the extent that a money market fund's charter documents and/or applicable state law require shareholder approval to effect a reorganization into separate retail and institutional money market funds. One commenter provided survey data that estimated the one-time costs would be between $1,000,000 to $5,000,000.[734] We note, however, that the survey respondents are asset managers, many of whom may be responsible for fund complexes, and it is not clear whether these cost estimates represent costs to a fund complex or to a single fund. Although the Commission does not have the information necessary to estimate the number of funds that may seek shareholder approval to effect a reorganization, we estimate that it will cost, on average, approximately $100,000 per fund in connection with a shareholder vote.[735] Finally, money market funds that seek to qualify as retail funds will be required to adopt policies and procedures that are reasonably designed to limit beneficial owners of the fund to natural persons. As discussed in section IV.A.2 (Retail Funds) below, we estimate that the initial time costs associated with adopting policies and procedures will be $492,800 for all fund complexes.

Funds that intend to qualify as retail money market funds will also incur ongoing costs. These ongoing costs would include the costs of operating two separate funds (retail and institutional) instead of separate classes of a single fund, such as additional transfer agent, accounting, and other similar costs. Other ongoing costs may include systems maintenance, periodic review and updates of policies and procedures, and additional staff training. Finally, our estimates include ongoing costs for funds to manage and monitor intermediaries' compliance with fund policies regarding omnibus accounts. Accordingly, we continue to estimate, as we did in the proposal, that money market funds and intermediaries likely will incur ongoing costs related to implementation of a retail money market fund definition of 20%-30% of the one-time costs, or between $166,000 and $390,000 per year.[736] We received no comments on this aspect of our proposal.

3. Municipal Money Market Funds

Both the fees and gates reform and floating NAV reform will apply to municipal money market funds (or tax-exempt funds [737] ). We discuss below the Start Printed Page 47803key characteristics of tax-exempt funds, commenter concerns regarding our proposal (and final amendments) to apply the fees and gates and floating NAV reforms to tax-exempt funds, and an analysis of potential economic effects. We note, as addressed below, that the majority of the comments received relating to tax-exempt funds were given in the context of our floating NAV reform.[738]

a. Background

Tax-exempt funds primarily hold obligations of state and local governments and their instrumentalities, which pay interest that generally is exempt from federal income taxes.[739] Thus, the majority of investors in tax-exempt money market funds are those investors who are subject to federal income tax and therefore can benefit from the funds' tax-exempt interest. As discussed below, state and local governments rely in part on tax-exempt funds to fund public projects.[740] As of February 28, 2014, tax-exempt funds held approximately $279 billion of assets, out of approximately $3.0 trillion in total money market fund assets.[741]

Industry data suggests institutional investors hold approximately 29% ($82 billion) of municipal money market fund assets.[742] This estimate is likely high, as omnibus accounts (which often represent retail investors) are often categorized as institutional by third-party researchers. One commenter, for example, surveyed its institutional tax-exempt money market funds, and found that approximately 50% of the assets in these “institutional” funds were beneficially owned by institutions.[743]

On average, over 70% of tax-exempt funds' assets (valued based upon amortized cost) are comprised of municipal securities issued as variable-rate demand notes (“VRDNs”).[744] The interest rates on VRDNs are typically reset either daily or every seven days.[745] VRDNs include a demand feature that provides the investor with the option to put the issue back to the trustee at a price of par value plus accrued interest.[746] This demand feature is supported by a liquidity facility such as letters of credit, lines of credit, or standby purchase agreements provided by financial institutions.[747] The interest-rate reset and demand features shorten the duration of the security and allow it to qualify as an eligible security under rule 2a-7. Tax-exempt funds also invest in tender option bonds (“TOBs”), which typically are floating rate securities that provide the holder with a put option at par, supported by a liquidity facility provided by a commercial bank.[748]

b. Discussion

In the Proposing Release, we noted that because most municipal money market funds tend to be owned by retail investors, who are among the greatest beneficiaries of the funds' tax advantages, most tax-exempt funds would qualify under our proposed definition of retail money market fund and therefore would continue to offer a stable share price.[749] We stated that, although there are some tax-exempt money market funds that self-classify as institutional funds, we believed these funds' shareholder base typically is comprised of omnibus accounts with underlying individual investors. As noted by commenters and discussed below, we now understand that only some (and not all) of these funds' shareholder base is comprised of omnibus accounts with underlying individual investors. We also stated our belief that, like many securities in prime funds, municipal securities present greater credit and liquidity risk than U.S. government securities and could come under pressure in times of stress.

Many commenters suggested that we not apply our floating NAV reform [750] or our fees and gates reform [751] to municipal money market funds. Commenters raised specific concerns about the ability and extent to which tax-exempt funds would qualify as retail money market funds as proposed (and therefore be permitted to maintain a stable NAV). Several commenters noted that high-net-worth individuals, who often invest in tax-exempt funds because of the tax benefits, engage in periodic transactions that exceed the proposed $1 million daily redemption limit, which would effectively disqualify them from investing in a retail municipal fund, as proposed.[752] We are addressing these concerns by adopting a definition of retail money market fund that will allow many of these individuals to invest in tax-exempt funds that offer a stable NAV. Funds that wish to qualify as retail money market funds will be required to limit beneficial ownership interests to “natural persons” (e.g., individual accounts registered with social security numbers). Because the retail money market fund definition is not conditioned on a daily redemption limitation, but instead requires that retail money market funds restrict beneficial ownership to natural persons, high-net-worth individuals will not be subject to a redemption limit and thus should be able to continue investing in tax-exempt funds much like they do today.[753]

Several commenters expressed concern that a number of municipal money market funds would not qualify as retail money market funds, as proposed, because institutional investors hold them. Commenters noted that approximately 30% (and historically between 25% and 40%[754] ) of tax-exempt funds currently self-report as institutional funds.[755] We understand that some but not all of these funds' shareholder base is comprised of Start Printed Page 47804omnibus accounts with underlying individual investors. A number of commenters supported the view that most investors in tax-exempt funds are individuals.[756] One commenter stated its belief, however, that institutions rather than individuals or natural persons beneficially own a significant, if not majority, portion of the assets invested in these self-reported institutional tax-exempt funds.[757] Although we understand that some omnibus accounts may be comprised of institutions without underlying individual beneficial owners, the lack of a statutory or regulatory definition of institutional and retail funds, along with a lack of information regarding investor attributes in omnibus accounts, prevents us from estimating with precision the portion of investors and assets in tax-exempt funds that self-report as institutional that are beneficially owned by institutions. As discussed above, however, industry data suggests that approximately 30% of municipal money market fund assets are held by institutional investors—investors that may not qualify to invest in a retail municipal money market fund.[758]

Several commenters argued that tax-exempt funds should not be subject to the fees and gates and floating NAV reforms because the municipal money market fund industry is not systemically risky. In support, commenters pointed to the relatively small amount of assets managed by municipal money market funds, the stability of tax-exempt funds during recent periods of market stress, and the diversity of the municipal issuer market.[759] As discussed above, we acknowledge that the current institutional municipal money market fund industry is small relative to the overall money market fund industry. Despite its relatively small size, however, we are concerned that institutional investors that currently hold prime funds might be incentivized to shift assets from prime funds to municipal money market funds as an alternative stable NAV investment. This could undermine the goals of reform with respect to the floating NAV requirement by providing an easy way for institutional investors to keep stable value pricing while continuing to invest in funds with assets that, relatively speaking, have a risk character that is significantly closer to prime funds than government funds.[760]

Commenters argued that historical shareholder flows in municipal money market funds, as well as their past resiliency, demonstrate that they are not prone to runs or especially risky.[761] They pointed out that shareholder flows from tax-exempt funds were moderate during times of recent market stress compared to significant outflows from institutional prime money market funds.[762] A review of money market fund industry asset flows during the market stress in 2008 and 2011 shows that tax-exempt funds remained relatively flat and tracked investor flows in other retail prime funds.[763] We believe that some of this stability may be attributable to municipal money market funds' significant retail investor base rather than low portfolio risk.[764] In this regard, we note that although investors did not flee municipal funds in times of market stress, they also did not move assets into municipal funds as they did into government funds.[765] Accordingly, it appears that those investors did not perceive the risk characteristics of municipal funds to be similar to those of government funds. Consistent with this observation, our analysis indicates that the shadow price of tax-exempt funds is distributed more similarly to that of prime funds than government funds.[766] Specifically, the volatility of the distribution of municipal money market fund shadow prices is significantly larger than the volatility of government funds.[767] In addition, our staff's analysis of historical shadow prices shows that tax-exempt funds are more likely than government funds to experience large losses.[768] Thus, we believe municipal funds are more similar in nature to prime funds than government funds for purposes of the floating NAV reform.

Several commenters noted that the diversity of the municipal issuer market reduces the risks associated with municipal money market funds.[769] We note that although there is some diversity among the direct issuers of municipal securities, the providers of most of the demand features for the VRDNs, most of which are financial services firms, are highly concentrated.[770] This is a significant countervailing consideration because VRDNs comprise the majority of tax-exempt funds' portfolios.[771] This level of concentration increases municipal funds' exposure to financial sector risk relative to, for example, government funds.[772] And, in this regard, we are mindful of the potential for increased sector risk to the financial services firms that provide the demand features if investors reallocate assets to tax-exempt funds that are not subject to the fees and gates and floating NAV reforms.

A number of commenters cited the resilient portfolio construction of municipal money market funds and Start Printed Page 47805argued that the liquidity risk, interest rate risk, issuer risk, and credit/default risk of tax-exempt funds are more similar to government funds than prime funds.[773] As discussed above, however, staff analysis shows that the distribution of fluctuations in the shadow NAV of tax-exempt funds is more similar to that of prime funds than government funds.[774] Municipal securities typically present greater credit and liquidity risk than government securities.[775] We believe that recent municipal bankruptcies have highlighted liquidity concerns related to municipal money market funds and note that, although municipal money market funds have previously weathered these events, there is no guarantee that they will be able to do so in the future.

Further, although we recognize that the structural features of VRDNs may provide tax-exempt funds with higher levels of weekly liquid assets and reduced interest rate risk as compared with prime funds, we do not find that on balance that warrants treating municipal funds more like government funds than prime funds. This is so because, among other things, the liquidity risk, interest rate risk, and credit risk characteristics result from concentrated exposure to VRDNs, and not because the municipal debt securities underlying the VRDNs or the related structural support are inherently liquid, free from interest rate risk, or immune from credit risks in the way that government securities generally are.[776] Indeed, long-term municipal debt securities underlie most VRDNs, and these securities infrequently trade.[777] Instead, the liquidity is provided through the demand feature to a concentrated number of financial institutions, and money market funds have experienced problems in the past when a large number of puts on securities were exercised at the same time.[778]

In fact, when we adopted the 2010 amendments to rule 2a-7, we cited to commenter concerns regarding the market structure of VRDNs and heavy reliance of tax-exempt funds on these security investments in determining not to require that municipal money market funds meet the 10% daily liquid asset requirement that other money market funds must satisfy.[779] Commenters did not generally support adding such a requirement, but the lack of a mandated supply of daily liquid assets leaves these funds more exposed to potential increases in redemptions in times of fund and market stress.[780] As a result, the portfolio composition of some tax-exempt funds may change and present different risks in the future. In addition, because of the daily liquidity issues associated with VRDNs and the fact that tax-exempt money market funds are not required to maintain 10% daily liquid assets,[781] these funds in particular may experience stress on their liquidity necessitating the use of fees and gates to manage redemptions (even with respect to the lower level of redemptions expected in a tax-exempt retail money market fund as compared to an institutional prime fund).

Several commenters also argued that certain structural features of tax-exempt funds make them more stable than prime money market funds and therefore these commenters believe that the floating NAV reform should not apply to tax-exempt funds. For example, these commenters observed that a tax-exempt fund's investments, primarily VRDNs, and, to a lesser extent, TOBs,[782] have structural features (e.g., contractual credit enhancements or liquidity support provided by highly rated banks and one-to-seven day interest rate resets) that facilitate trading at par in the secondary market.[783] We agree that these features lower the risk of portfolio holdings as compared to prime money market funds, but also recognize that holding municipal money market funds presents higher risks than those associated with government or Treasury funds. Not all VRDNs have credit support,[784] and tax-exempt funds present credit risk.[785] Accordingly, we Start Printed Page 47806do not agree with commenters that, as noted above, suggest that the credit risk of tax-exempt funds is more similar to government funds than prime funds.

For all of the above reasons, we believe that tax-exempt funds should be subject to the fees and gates and floating NAV reforms. As discussed, the risk profile of institutional municipal money market funds more closely approximates that of prime funds than government funds. Tax-exempt funds present credit risk, typically rely on a concentrated number of financial sector put or guarantee providers, and have portfolios comprised largely of a single type of structured investment product—all of which may present future risks that may be exacerbated by a potential migration of investors from prime funds that are unable or unwilling to invest in a floating NAV money market fund or money market fund that may impose fees and gates. Accordingly, we believe that tax-exempt funds should be subject to the fees and gates and floating NAV reforms adopted today.[786]

c. Economic Analysis of FNAV

Although we expect that many tax-exempt funds will qualify as retail money market funds and therefore be able to maintain a stable NAV (as they do today), there are, as we discussed above, some institutional investors in municipal money market funds that may be unable or unwilling to invest in a floating NAV fund.[787] To the extent that institutional investors continue to invest in a floating NAV municipal money market fund, the benefits of a floating NAV discussed in section III.B extend to these types of funds. Because a floating NAV requirement may reduce investment in those funds, however, we recognize that there will likely be costs for the sponsors of tax-exempt funds, the institutions that invest in these types of funds, and tax-exempt issuers. These costs are the same as those described in section III.B for institutional prime funds and the costs described in section III.I for corporate issuers.

To the extent that institutions currently invest in tax-exempt funds and are unwilling to invest in a floating NAV tax-exempt fund, the demand for municipal securities, for example, may fall and the costs of financing for municipalities may rise.[788] We anticipate the impact, however, will likely be relatively small. As of the last quarter of 2012, tax-exempt funds held approximately 7% of the municipal debt outstanding.[789] Of that 7%, institutional investors, who might divest their municipal fund assets if they do not want to invest in a floating NAV fund, held approximately 30% of municipal money market fund assets.[790] Accordingly, we estimate institutional tax-exempt funds hold approximately 2% of the total municipal debt outstanding and thus 2% is at risk of leaving the municipal debt market.[791] Although this could impact capital formation for municipalities, there are several reasons to believe that the impact would likely be small (including minimal impact on efficiency and competition, if any). First, institutional investors that currently invest in municipal funds likely value the tax benefits of these funds and many may choose to remain invested in them to take advantage of the tax benefits even though they might otherwise prefer stable to floating NAV funds. Second, to the extent that institutional investors divesting municipal funds lead to a decreased demand for municipal debt instruments, other investors may fill the gap. As discussed in the Proposing Release, “Between the end of 2008 and the end of 2012, money market funds decreased their holdings of municipal debt by 34% or $172.8 billion.[792] Despite this reduction in holdings by money market funds, municipal issuers increased aggregate borrowings by over 4% between the end of 2008 and the end of 2012. Municipalities were able to fill the gap by attracting other investor types. Other types of mutual funds, for example, increased their municipal securities holdings by 61% or $238.6 billion.” [793]

Although institutional municipal funds represent a relatively small portion of the municipal debt market, we recognize that these funds represent a significant portion of the short-term municipal debt market.[794] According to Form N-MFP data, municipal money market funds held $256 billion in VRDNs and short-term municipal debt as of the last quarter of 2013.[795] Effectively, municipal money market funds absorbed nearly 100% of the outstanding VRDNs and short-term municipal debt. Considering that institutional tax-exempt funds represented approximately 30% of the municipal money market fund market, it follows that institutional tax-exempt funds likely held about $77 billion in VRDNs and short-term municipal debt. Any reduction in municipal funds therefore could have an appreciable impact on the ability of municipalities to obtain short-term lending. That said, this impact could be substantially mitigated because, as discussed above, other market participants may buy these securities or municipalities will adapt to a changing market by, for example, altering their debt structure. As discussed in the Proposing Release, “[t]o make their issues attractive to alternative lenders, municipalities lengthened the terms of some of their debt securities,” [796] in the face of changing market conditions in recent years. To the extent that other market participants step in and fill the potential gap in demand, competition may increase. To the extent other market participants do not step in and fill the gap, capital formation may be adversely affected. Finally, if municipalities are required to alter their debt structure to foster demand for their securities (e.g., Start Printed Page 47807because demand declined as a result of our amendments), there may be an adverse effect on efficiency. Although we discuss above ways in which the short-term municipal debt market may adapt to continue to raise capital as it does today, we acknowledge that our floating NAV reform will impact institutional investors in tax-exempt funds and therefore likely impact the short-term municipal markets. On balance, however, we believe that realizing the goals of this rulemaking, including recognizing the concerns discussed above with respect to the risks presented by tax-exempt funds, justifies the potential adverse effects on efficiency, competition, and capital formation.

4. Implications for Local Government Investment Pools

As we discussed in the Proposing Release, we recognize that many states have established local government investment pools (“LGIPs”), money market fund-like investment pools that invest in short-term securities,[797] which are required by law or investment policies to maintain a stable NAV per share.[798] Accordingly, as we discussed in the Proposing Release, the floating NAV reform may have implications for LGIPs, including the possibility that state statutes and policies may need to be amended to permit the operation of investment pools that adhere to amended rule 2a-7.[799] In addition, some commenters suggested that our floating NAV reform, as well as the liquidity fees and gates requirement, may result in outflows of LGIP assets into alternative investments that provide a stable NAV and/or do not restrict liquidity.[800]

A few commenters noted that it is the GASB reference to “2a-7 like” funds that links LGIPs to rule 2a-7, and not state statutes.[801] Some commenters noted that our money market fund reforms do not directly affect LGIPs because the decision as to whether LGIPs follow our changes to rule 2a-7 is determined by GASB and the states, not the Commission.[802] Some commenters suggested that, in response to our floating NAV reform, GASB and the states might decouple LGIP regulation from rule 2a-7 and continue to operate at a stable value.[803] A few commenters suggested that we make clear that the changes we are adopting to rule 2a-7 are not intended to apply to LGIPs,[804] and also reiterated concerns similar to those raised by other commenters on our floating NAV reform more generally (e.g., concerns about using market-based valuation, rather than amortized cost).[805]

We acknowledge, as noted by commenters, that there may be effects and costs imposed on LGIPs as a result of the reforms we are adopting today. We expect it is likely that GASB will reevaluate its accounting standards in light of the final amendments to rule 2a-7 that we are adopting today and take action as it determines appropriate.[806] We do not, however, have authority over the actions that GASB may or may not take, nor do we regulate LGIPs under rule 2a-7 or otherwise. In order for certain investors to continue to invest in LGIPs as they do today, state legislatures may determine that they need to amend state statutes and policies to permit investment in investment pools that adhere to rule 2a-7 as amended (unless GASB were to de-couple LGIP accounting standards from rule 2a-7). GASB and state legislatures may address these issues during the two-year compliance period for the fees and gates and floating NAV reforms.[807] As noted above, a few commenters suggested that state statutes and investment policies may need to be amended, but did not provide us with information regarding how various state legislatures and other market participants might react. Accordingly, we remain unable to predict how various state legislatures and other market participants will react to our reforms, nor do we have the information necessary to provide a reasonable estimate of the impact on LGIPs or the potential effects on efficiency, competition, and capital formation.[808]

5. Unregistered Money Market Funds Operating Under Rule 12d1-1

Several commenters expressed concern regarding amended rule 2a-7's effect on unregistered money market funds that choose to operate under certain provisions of rule 12d1-1 under the Investment Company Act.[809] Rule 12d1-1 permits investment companies (“acquiring investment companies”) to acquire shares of registered money market funds in the same or in a different fund group in excess of the limitations set forth in section 12(d)(1) of the Investment Company Act.[810] In Start Printed Page 47808addition to providing an exemption from section 12(d)(1) of the Investment Company Act, rule 12d1-1 also provides exemptions from section 17(a) and rule 17d-1, which restrict a fund's ability to enter into transactions and joint arrangements with affiliated persons.[811] A fund's investments in unregistered money market funds is not restricted by section 12(d)(1).[812] Nonetheless, these investments are subject to the affiliate transaction restrictions in section 17(a) and rule 17d-1 and therefore require exemptive relief from such restrictions.[813] Rule 12d1-1 thus permits a fund to invest in an unregistered money market fund without having to comply with the affiliate transaction restrictions in section 17(a) and rule 17d-1, provided that the unregistered money market fund satisfies certain conditions in rule 12d1-1.

Unregistered money market funds typically are organized by a fund adviser for the purpose of managing the cash of other investment companies in a fund complex and operate in almost all respects as a registered money market fund, except that their securities are privately offered and thus not registered under the Securities Act.[814] For purposes of investments in an unregistered money market fund, the rule 12d1-1 exemption from the affiliate transaction restrictions is available only for investments in an unregistered money market fund that operates like a money market fund registered under the Investment Company Act. To be eligible, an unregistered money market fund is required to (i) limit its investments to those in which a money market fund may invest under rule 2a-7, and (ii) undertake to comply with all other provisions of rule 2a-7.[815] Therefore, unless otherwise exempted, unregistered money market funds choosing to operate under rule 12d1-1 would need to comply with the amendments to rule 2a-7 we are adopting today.

Several commenters argued that unregistered money market funds that currently conform their operations to the requirements of rule 12d1-1 should not be required to comply with certain provisions of our amendments to rule 2a-7, particularly our floating NAV and liquidity fees and gates amendments,[816] and no commenters argued otherwise. Some of these commenters argued that the ability to invest in unregistered money market funds is a valuable tool for investment companies, because such unregistered money market funds are designed to accommodate the daily inflows and outflows of cash of the acquiring investment company, and can be operated at a lower cost than registered investment companies.[817] Some of these commenters also argued that requiring unregistered money market funds to adopt a floating NAV would reduce the attractiveness of unregistered money market funds and possibly eliminate the unregistered fund as a cash management tool for an acquiring investment company.[818]

Although we recognize the benefits of using unregistered money market funds for these purposes, we do not believe that these types of funds are immune from the risks posed by money market funds generally. Several commenters argued that unregistered money market funds relying on rule 12d1-1 do not present the type of risk that our amendments are designed to reduce.[819] These commenters also argued that, given that unregistered money market funds often are created solely for investment by acquiring investment companies and typically have the same sponsor, there is little concern of unforeseeable large-scale redemptions or runs on these funds.[820]

We disagree, and we believe that if registered funds invest in unregistered money market funds in a different fund complex, these unregistered funds are equally susceptible to the concerns that our amendments are designed to address, including concerns about the risks of investors' incentives to redeem ahead of other investors in times of market stress and the resulting potential dilution of investor shares. For example, if multiple registered funds are investing in an unregistered money market fund in a different fund complex, a registered fund in one fund complex may have an incentive to redeem shares in times of market stress prior to the redemption of shares by funds in other fund complexes. This redemption could have a potentially negative impact on the remaining registered funds that are investing in the unregistered money market and could increase the risk of dilution of shares for the remaining registered funds.

We also believe that unregistered money market funds that are being used solely as investments by investment companies in the same fund complex remain susceptible to redemptions in times of fund and market stress. For example, if multiple registered funds are invested in an unregistered money market fund in the same fund complex, a portfolio manager of one registered fund may have an incentive to redeem shares in times of market stress, which could have a potentially negative impact on the other registered funds that may also be invested in the unregistered fund. After further consideration regarding the comparability of risk in these funds, we believe that it is appropriate that our floating NAV Start Printed Page 47809amendments apply to unregistered money market funds that conform their operations to the requirements of rule 12d1-1.[821]

Some commenters also argued that our liquidity fees and gates amendments are ill-suited for unregistered money market funds.[822] Specifically, these commenters noted that under rule 12d1-1, the adviser typically performs the function of the unregistered fund's board for purposes of compliance with rule 2a-7.[823] Therefore, these commenters argued, if fees and gates are implemented, the adviser would be called upon to make decisions about liquidity fees and gates, which could present a potential conflict of interest in situations when an affiliated investment company advised by the same adviser would be the redeeming shareholder.[824]

We recognize that in many cases the adviser to an unregistered money market fund typically performs the function of the fund's board,[825] and that this may create conflicts of interest. We continue to believe that, as discussed above in section III.A.2.b and given the role of independent directors, a fund's board is in the best position to determine whether a fee or gate is in the best interests of the fund. However, when there is no board of directors, we believe that it is appropriate for the adviser to the fund to determine when and how a fund will impose liquidity fees and/or redemption gates. We have previously stated that, in order for a registered fund to invest in reliance on rule 12d1-1 in an unregistered money market fund that does not have a board of directors (because, for example, it is organized as a limited partnership), the unregistered money market fund's investment adviser must perform the duties required of a money market fund's board of directors under rule 2a-7.[826] In addition, we note that investment advisers are subject to a fiduciary duty, which requires them, when faced with conflicts of interest, to fully disclose to clients all material information, a duty that is intended “to eliminate, or at least expose, all conflicts of interest which might include an investment adviser—consciously or unconsciously—to render advice which was not disinterested.” [827] While we cannot determine whether a conflict of interest exists in every case of an adviser advising both a registered fund and unregistered money market fund under rule 12d1-1, we note that the adviser is subject to the requirement to adopt and implement written policies and procedures reasonably designed to prevent violation of the Advisers Act and the rules thereunder, as required by rule 206(4)-7 under the Advisers Act.[828]

6. Master/Feeder Funds—Fees and Gates Requirements

We are adopting, as suggested by a commenter, a provision specifying the treatment of feeder funds in a master/feeder fund structure under the fees and gates requirements.[829] This provision will not allow a feeder fund to independently impose a fee or gate in reliance on today's amendments.[830] However, under the amended rule, a feeder fund will be required to pass through to its investors a fee or gate imposed by the master fund in which it invests.[831] In response to our request for comment on whether particular funds or redemptions should not be subject to fees and gates, a commenter recommended that we permit a master fund and its board, but not a feeder fund and its board, to impose and set the terms of a fee or gate.[832] The feeder fund would then have to “institute” the fee or gate on its redemptions “at the times and in the amounts instituted by the master fund.” [833] Another commenter suggested, however, that fund boards should be given discretion to impose fees and/or gates on either or both a master or feeder fund(s).[834]

We have considered the comments received and have been persuaded that a feeder fund in a master/feeder structure should only be permitted to pass through the fees and gates imposed by the master fund.[835] The master/feeder structure is unique in that the feeder fund serves as a conduit to the master fund—the master fund being the fund that actually invests in money market securities. As a commenter pointed out, “the master feeder structure comprises one pool of assets, managed by the master fund's investment adviser, under the oversight of the master fund's board of directors.” [836] Because the feeder fund's investments consist of the master fund's securities, its liquidity is determined by the master fund's liquidity. Accordingly, because a feeder fund's liquidity is dictated by the liquidity of the master fund, we believe the master fund and its board are best suited, in consultation with the master fund's adviser, to determine whether liquidity is under stress and a fee or gate should be imposed. We note that we took a similar approach with respect to master/feeder funds in rule 22e-3.[837]

7. Application of Fees and Gates to Other Types of Funds and Certain Redemptions

We have determined that all money market funds, other than government money market funds and feeder funds in a master/feeder fund structure, should be subject to the fees and gates requirements. We received a number of comments suggesting types of funds that should not be subject to the fees and gates requirements.[838] In addition to the comments we received regarding the application of fees and gates to the types of funds discussed above, commenters also proposed other specific types of funds or entities that should not be subject to the fees and gates requirements, including, for example, money market funds with assets of less than $25 billion under management,[839] or securities lending cash collateral reinvestment pools.[840]

Because of the board flexibility and discretion included in the fees and gates amendments we are adopting today, as well as for the reasons discussed Start Printed Page 47810below,[841] we are requiring all funds, other than government money market funds and feeder funds in a master/feeder structure (for the reasons discussed above),[842] to comply with the fees and gates requirements. As noted above, the fees and gates amendments do not require a fund to impose fees and gates if it is not in the fund's best interests. Thus, even if a particular type of fund is subject to the fees and gates provisions, it does not have to impose fees and gates. Rather, a fund's board may use fees and gates as tools to limit heavy redemptions and must act in the best interests of the fund in determining whether fees and gates should be imposed.

In addition, we note that the fees and gates amendments will not affect a money market fund's investors unless the fund's weekly liquid assets fall below 30% of its total assets—i.e., the fund shows possible signs of heavy redemption pressure—and even then, it is up to the board to determine whether or not such measures are in the best interests of the fund. Allowing specific types of money market funds (other than government funds and feeder funds for the reasons discussed above) to not be subject to the fees and gates requirements could leave funds and their boards without adequate tools to protect shareholders in times of stress. Also, allowing funds not to comply with the fees and gates requirements would merely relieve a fund during normal market conditions of the costs and burdens created by the prospect that the fund could impose a fee or gate if someday it was subject to heavy redemptions.[843] In considering these risks, costs, and burdens, as well as the possibility of unprotected shareholders and broader contagion to the short-term funding markets, we believe it is appropriate to subject all money market funds (other than government funds and feeder funds for the reasons discussed above) to the fees and gates requirements.

In addition to the reasons discussed above, we describe more fully below our rationale for subjecting particular types of funds and redemptions to the fees and gates amendments.

a. Small Redemptions and Irrevocable Redemptions

Some commenters suggested that small redemptions should not be subject to fees and gates because they are less likely to materially impact the liquidity position of a fund.[844] As discussed in the Proposing Release, we also have considered whether irrevocable redemption requests (i.e. requests that cannot be rescinded) that are submitted at least a certain period in advance should not be subject to fees and gates as the fund should be able to plan for such liquidity demands and hold sufficient liquid assets.[845] We are concerned, however, that shareholders could try to “game” the fees and gates requirements if we took such an approach with respect to these redemptions, for example, by redeeming small amounts every day to fit under a redemption size limit or by redeeming a certain irrevocable amount every week and then reinvesting the redemption proceeds immediately if the cash is not needed.[846] We also remain concerned that allowing certain redemptions to not be subject to fees and gates could add cost and complexity to the fees and gates requirements both as an operational matter (e.g., fund groups would need to be able to separately track which shares are subject to a fee or gate and which are not, and create the system and policies to do so) and in terms of ease of shareholder understanding without providing substantial benefits.[847]

b. ERISA and Other Tax-Exempt Plans

Many commenters raised concerns regarding the application of fees and gates to funds offered in Employee Retirement Income Security Act (“ERISA”) and/or other tax-exempt plans.[848] Some commenters expressed concern that fees and gates would create issues for these plans.[849] For example, commenters were worried about potential violations of certain minimum required distribution rules that could be impeded by the imposition of a gate,[850] potential taxation as a result of an inability to process certain mandatory refunds on a timely basis,[851] problems arising in plan conversions or rollovers in the event of a fee or gate,[852] possible conflicts with the Department of Labor's (“DOL”) qualified default investment (“QDIA”) rules,[853] and certain general fiduciary requirements on plan fiduciaries with respect to adequate liquidity in their plan.[854]

As an initial point, we note that money market funds are currently permitted to use a redemption gate and liquidate under rule 22e-3, and they still continue to be offered as investment options under tax-qualified plans. However, in light of the commenters' concerns, we have consulted the DOL's Employee Benefits Security Administration (“EBSA”) regarding potential issues under ERISA. With respect to general fiduciary requirements on plan fiduciaries obligating them to prudently manage the anticipated liquidity needs of their plan, EBSA staff advised our staff that a money market fund's liquidity and its potential for redemption restrictions is just one of many factors a plan fiduciary would consider in evaluating the role that a money market fund would play in assuring adequate liquidity in a plan's investment portfolio.

Additionally, we believe that certain other potential concerns presented by commenters, such as concerns regarding QDIAs and the imposition of a fee or Start Printed Page 47811gate within 90 days of a participant's first investment, are unlikely to materialize. We understand that the imposition of a liquidity fee or gate would have to relate to a liquidation or transfer request within this 90-day period in order to create an issue with QDIA fiduciary relief. Even if this occurred with respect to a specific participant, steps may be taken to avoid concerns with the QDIA. We understand, for instance, that a liquidity fee otherwise assessed to the account of a plan participant or beneficiary could be paid by the plan sponsor or a service provider, and not by the participant, beneficiary or plan.[855] In addition, a plan sponsor or other party in interest could loan funds to the plan for the payment of ordinary operating expenses of the plan or for a purpose incidental to the ordinary operation of the plan to avoid the effects of a gate.[856] We understand that if necessary, other steps may also exist.

DOL staff has also advised the SEC that the “substantial restrictions” requirement, contained in Prohibited Transaction Exemptions 2004-16 [857] and 2006-06,[858] does not apply to money market funds.[859] DOL staff further indicated to us, however, that a liquidity fee could raise issues under the conditions of these prohibited transaction exemptions that require that the IRA owner be able to transfer funds to another investment or another IRA “within a reasonable period of time after his or her request and without penalty to the principal amount of the investment.” [860] We understand that while a gate of no longer than 10 business days would not amount to an unreasonable period of time under the conditions, DOL staff has advised us that, in order for a fiduciary to continue to rely on the exemptions for the prohibited transactions arising from the initial decision to roll over amounts to a money market fund that is sponsored by or affiliated with the fiduciary, additional steps would need to be taken to protect the principal amount rolled over in the event that a liquidity fee is imposed. We understand that examples of such additional steps would include a contractual commitment by the fiduciary or its affiliate to pay any liquidity fee otherwise assessed to the IRA, to the extent such fee would be deducted from the principal amount rolled over. Additionally, to the extent plan fiduciaries do not wish to take such steps, they can instead select government money market funds, which are not subject to the fees and gates amendments, or other funds that do not create prohibited transactions issues.

Staff at EBSA have communicated that they will work with staff at the SEC to provide additional guidance as needed.

With respect to the minimum distribution requirement and the ability to process certain mandatory distributions or refunds on a timely basis, we understand that although gates can hypothetically prevent required distributions or refunds, in practice it will be unlikely to occur as participants are unlikely to have their entire account invested in prime money market funds or, more precisely, one or more prime money market funds that determine to impose a gate at the same time.[861] In addition, to the extent a gate does prevent a timely minimum distribution or refund, we understand that there are potential steps an individual or plan/IRA can take to avoid the negative consequences that may result from failure to meet the minimum distribution or refund requirements. For example, with respect to the minimum distribution requirement, an individual who fails to meet this requirement as a result of a gate is entitled to request a waiver with respect to potential excise taxes by filing a form with the IRS that explains the rationale for the waiver.[862] In addition, with respect to plan qualification issues that may arise in the event a plan does not make timely minimum required distributions or refunds as a result of a gate, we understand that a plan sponsor may obtain relief pursuant to the Employee Plans Compliance Resolution System (“EPCRS”).[863]

c. Insurance Funds

A few commenters requested special treatment for money market funds underlying variable annuity contracts or other insurance products, citing contractual and state law restrictions affecting insurance and annuity products that would conflict with the ability of a money market fund's board to impose a fee or gate.[864] Some commenters further noted that money market funds underlying variable contract separate accounts are not prone to runs.[865] Another commenter noted that most insurance products have “free-look” provisions, allowing an owner to return his/her contract for full value if he/she is not satisfied with its terms.[866] During such initial periods, insurance companies typically keep client funds in money market funds, which might be incompatible with fees and gates.[867]

We have determined not to provide special treatment for money market funds underlying variable annuity contracts or other insurance products for the fees and gates requirements. We recognize money market funds underlying variable annuity contracts or other insurance products may be indirectly subject to certain restrictions or requirements that do not apply to other money market funds. We note, however, that these same funds currently are permitted to suspend redemptions pursuant to rule 22e-3 and their ability to do so has not prevented them from being offered in connection with variable annuity and other insurance products. In addition, to the extent today's fees and gates amendments are incompatible with contractual or state law, or with free look provisions, we note that an insurance company can instead offer a government money market fund as an investment option under its contract(s).[868] Moreover, fees and gates will not affect the everyday activities of money market funds. They are instead Start Printed Page 47812designed to be used during times of potential stress.[869] If the market or a money market fund is experiencing stress, an insurance company could choose not to place contract holders' investments into a money market fund during free look periods, subject to contractual provisions and prospectus disclosures.

D. Guidance on the Amortized Cost Method of Valuation and Other Valuation Concerns

After further consideration, and as suggested by a number of commenters, our final rules will permit stable NAV money market funds (i.e., government and retail money market funds) to maintain a stable NAV by using amortized cost valuation and/or the penny rounding method of pricing.[870] In addition, all other registered investment companies and business development companies (including floating NAV money market funds under our amendments) may, in accordance with Commission guidance, continue to use amortized cost to value debt securities with remaining maturities of 60 days or less if fund directors, in good faith, determine that the fair value of the debt securities is their amortized cost value, unless the particular circumstances warrant otherwise.[871] Accordingly, even for floating NAV money market funds, amortized cost will continue to be an important part of the valuation of money market fund portfolio securities.[872]

We believe the expanded valuation guidance, discussed below, will help advance the goals of our money market fund reform rulemaking, because, among other things, stronger valuation practices may lessen a money market fund's susceptibility to heavy redemptions by decreasing the likelihood of sudden portfolio write-downs that may encourage financially sophisticated investors to redeem early. We provide below expanded guidance on the use of amortized cost valuation as well as other related valuation issues.[873]

1. Use of Amortized Cost Valuation

We consider it important, for a number of reasons, that funds and their investment advisers and boards of directors have clear guidance regarding amortized cost valuation. Typically, money market funds hold a significant portion of portfolio securities with remaining maturities of 60 days or less,[874] and therefore, a floating NAV money market fund may use the amortized cost method to value these portfolio securities if the fund's board determines that the amortized cost value of the security is fair value. In addition, managers of floating NAV money market funds may have an incentive to use amortized cost valuation whenever possible in order to help stabilize the funds' NAV per share.

As noted above, under existing Commission guidance, funds would not be able to use amortized cost valuation to value certain debt securities when circumstances dictate that the amortized cost value of the security is not fair value.[875] The Commission's guidance in the Proposing Release construed the statute to effectively limit the use of amortized cost valuation to circumstances where it is the same as valuation using market-based factors.[876] Some commenters objected to this interpretation and suggested that the Commission more generally clarify this guidance.[877]

We recognize that existing valuation guidance may not be clear on how frequently funds should compare a debt security's amortized cost value to its fair value determined using market-based factors and what extent of deviation between the two values is permissible. We generally believe that a fund may only use the amortized cost method to value a portfolio security with a remaining maturity of 60 days or less when it can reasonably conclude, at each time it makes a valuation determination,[878] that the amortized Start Printed Page 47813cost value of the portfolio security is approximately the same as the fair value of the security as determined without the use of amortized cost valuation. Existing credit, liquidity, or interest rate conditions in the relevant markets and issuer specific circumstances at each such time should be taken into account in making such an evaluation.

Accordingly, it would not be appropriate for a fund to use amortized cost to value a debt security with a remaining maturity of 60 days or less and thereafter not continue to review whether amortized cost continues to be approximately fair value until, for example, there is a significant change in interest rates or credit deterioration. We generally believe that a fund should, at each time it makes a valuation determination, evaluate the use of amortized cost for portfolio securities, not only quarterly or each time the fund produces financial statements. We note that, under the final rules, each money market fund will be required to value, on a daily basis, the fund's portfolio securities using market-based factors and disclose the fund's share price (or shadow price) rounded to four decimal places on the fund's Web site. As a result, we believe that each money market fund should have readily available market-based data to assist it in monitoring any potential deviation between a security's amortized cost and fair value determined using market-based factors. We believe that, in certain circumstances, such as intraday, a fund may rely on the last obtained market-based data to assist it when valuing its portfolio securities using amortized cost. To address this, a fund's policies and procedures could be designed to ensure that the fund's adviser is actively monitoring both market and issuer-specific developments that may indicate that the market-based fair value of a portfolio security has changed during the day, and therefore indicate that the use of amortized cost valuation for that security may no longer be appropriate.

2. Other Valuation Matters

Rule 2a-4 under the Investment Company Act provides that “[p]ortfolio securities with respect to which market quotations are readily available shall be valued at current market value, and other securities and assets shall be valued at fair value as determined in good faith by the board of directors of the registered company.” As we discussed in the Proposing Release, the vast majority of money market fund portfolio securities do not have readily available market quotations because most portfolio securities such as commercial paper, repos, and certificates of deposit are not actively traded in the secondary markets.[879] Accordingly, most money market fund portfolio securities are valued largely based upon “mark-to-model” or “matrix pricing” estimates.[880] In matrix pricing, portfolio asset values are derived from a range of different inputs, with varying weights attached to each input, such as pricing of new issues, yield curve information, spread information, and yields or prices of securities of comparable quality, coupon, maturity, and type.[881] Money market funds also may consider evaluated prices from third-party pricing services, which may take into account these inputs as well as prices quoted from dealers that make markets in these instruments and financial models.[882]

We received a number of comments regarding the utility of market-based valuation for money market securities and other securities that do not frequently trade in secondary markets. We also received comments discussing certain other valuation matters more generally, such as the use of pricing services in valuing such securities. Together, these comments indicated to us the need for further guidance in this area, which we provide below.

a. Fair Value for Thinly Traded Securities

First, some commenters suggested that market-based valuations of money market fund portfolio securities are not particularly meaningful, given the infrequent trading in money market fund portfolio securities and the use of matrix or model-based pricing or evaluated prices from third-party pricing services.[883] One commenter stated that “it does not follow that the normal arguments for using actual market prices for calculating mutual fund NAVs apply to using noisy guesstimates of true value of non-traded assets.” [884] Another commenter stated that, with regard to matrix-priced money market fund portfolio securities, “[m]arket-based valuations are not more accurate valuations than amortized cost.” [885]

We acknowledge that matrix pricing and similar pricing methods involve estimates and judgments—and thus may introduce some “noise” into portfolio security prices, and therefore into the fund's NAV per share when rounded to one basis point. However, we do not agree that market-based prices of portfolio securities do not provide meaningful information or that amortized cost generally provides better or more accurate values of securities that do not frequently trade or that may or may not be held to maturity given the fund's statutory obligation to investors to satisfy redemptions within seven days (and a fund's disclosure commitment to generally satisfy redemptions much sooner).[886] Indeed, many debt securities held by other types of funds do not frequently trade, but our long-standing guidance on the use of amortized cost valuation is limited to debt securities with remaining maturities of 60 days or less and even then only if the amortized cost value of these securities is fair value.[887] This guidance was based on our concern that “the use of the amortized cost method i[n] valuing portfolio securities of registered investment companies may result in overvaluation or undervaluation of the portfolios of such Start Printed Page 47814companies, relative to the value of the portfolios determined with reference to current market-based factors.” [888] Such guidance is based on a preference embodied in the Investment Company Act that funds value portfolio securities taking into account current market information.[889]

Because most money market fund portfolio securities are not frequently traded and thus are not securities for which market quotations are readily available, we understand that they are typically fair valued in good faith by the fund's board.[890] As a general principle, the fair value of a security is the amount that a fund might reasonably expect to receive for the security upon its current sale.[891] Determining fair value requires taking into account market conditions existing at that time. Accordingly, funds holding debt securities generally should not fair value these securities at par or amortized cost based on the expectation that the funds will hold those securities until maturity, if the funds could not reasonably expect to receive approximately that value upon the current sale of those securities under current market conditions.[892] We recognize that valuing thinly traded debt securities can be more complicated and time-consuming than valuing liquid equity securities based on readily available market quotations or than valuing debt securities using the amortized cost method. However, given the redeemable nature of mutual fund shares and the mandates of the Investment Company Act to sell and redeem fund shares at prices based on the current net asset values of those shares, we believe it is important for funds to take steps to ensure that they are properly valuing fund shares and treating all shareholders fairly.

b. Use of Pricing Services

As noted above, many funds, including many money market funds, use evaluated prices provided by third-party pricing services to assist them in determining the fair values of their portfolio securities. Some commenters have raised concerns that money market funds will place undue reliance on a small market of third-party pricing vendors, even though they acknowledge that they provide only “good faith” opinions on valuation.[893] A few commenters argued that eliminating amortized cost valuation for money market funds and requiring market-based pricing could provide third-party pricing services with a much greater degree of influence on fund's portfolio valuation, which could increase operational complexity and risks.[894]

We recognize that pricing services employ a wide variety of pricing methodologies in arriving at the evaluated prices they provide, and the quality of those prices may vary widely. We note that the evaluated prices provided by pricing services are not, by themselves, “readily available” market quotations or fair values “as determined in good faith by the board of directors” as required under the Investment Company Act.[895] To the extent that certain money market funds are no longer permitted to use the amortized cost method to value all of their portfolio securities and all money market funds will be required to perform daily market-based valuations, funds may decide to rely more heavily on third parties, such as pricing services, to provide market-based valuation data. Accordingly, we believe it is important to provide guidance to funds and their boards regarding reliance on pricing services.

We note that a fund's board of directors has a non-delegable responsibility to determine whether an evaluated price provided by a pricing service, or some other price, constitutes a fair value for a fund's portfolio security.[896] In addition, we have stated that “it is incumbent upon the [fund's] Board of Directors to satisfy themselves that all appropriate factors relevant to the value of securities for which market quotations are not readily available have been considered,” and that fund directors “must . . . continuously review the appropriateness of the method used in valuing each issue of security in the [fund's] portfolio.” [897] Although a fund's directors cannot delegate their statutory duty to determine the fair value of fund portfolio securities for which market quotations are not readily available, the board may appoint others, such as the fund's investment adviser or a valuation committee, to assist them in determining fair value, and to make the actual calculations pursuant to the fair valuation methodologies previously approved by the directors.[898]

Before deciding to use evaluated prices from a pricing service to assist it in determining the fair values of a fund's portfolio securities, the fund's board of directors may want to consider the inputs, methods, models, and assumptions used by the pricing service to determine its evaluated prices, and how those inputs, methods, models, and assumptions are affected (if at all) as market conditions change. In choosing a particular pricing service, a fund's board may want to assess, among other things, the quality of the evaluated prices provided by the service and the extent to which the service determines its evaluated prices as close as possible to the time as of which the fund calculates its net asset value. In addition, the Start Printed Page 47815fund's board should generally consider the appropriateness of using evaluated prices provided by pricing services as the fair values of the fund's portfolio securities where, for example, the fund's board of directors does not have a good faith basis for believing that the pricing service's pricing methodologies produce evaluated prices that reflect what the fund could reasonably expect to obtain for the securities in a current sale under current market conditions.[899]

E. Amendments to Disclosure Requirements

We are amending a number of disclosure requirements related to the liquidity fees and gates and floating NAV requirements adopted today, as well as other disclosure enhancements discussed in the proposal. These disclosure amendments improve transparency related to money market funds' operations, as well as their overall risk profile and any use of affiliate financial support. In the sections that follow, we first discuss amendments to rule and form provisions applicable to various disclosure documents, including disclosures in money market funds' advertisements, the summary section of the prospectus, and the statement of additional information (“SAI”).[900] Next, we discuss amendments to the disclosure requirements applicable to money market fund Web sites, including information about money market funds' liquidity levels, shareholder flows, market-based NAV per share (rounded to four decimal places), imposition of liquidity fees and gates, and any use of affiliate sponsor support.

1. Required Disclosure Statement

a. Overview of Disclosure Statement Requirements

As discussed in the Proposing Release, and as modified to reflect commenters' concerns, we are adopting amendments to rule 482 under the Securities Act and Item 4 of Form N-1A to revise the disclosure statement requirements concerning the risks of investing in a money market fund in its advertisements or other sales materials that it disseminates (including on the fund Web site) and in the summary section of its prospectus (and, accordingly, in any summary prospectus, if used).

Money market funds are currently required to include a specific statement concerning the risks of investing in their advertisements or other sales materials and in the summary section of the fund's prospectus (and, accordingly, in any summary prospectus, if used).[901] In the Proposing Release, we proposed to modify the format and content of this required disclosure. Specifically, we proposed to require money market funds to present certain disclosure statements in a bulleted format. The content of the proposed disclosure statements would have differed under each of the proposed reform alternatives. Under each reform alternative, the proposed statement would have included identical wording changes designed to clarify, and inform investors about, the primary risks of investing in money market funds generally, including new disclosure emphasizing that money market fund sponsors are not obligated to provide financial support. Additionally, the proposed statement under the fees and gates alternative would have included disclosure that would call attention to the risks of investing in a money market fund that could impose liquidity fees or gates, and the proposed statement under the floating NAV alternative would have included disclosure to emphasize the particular risks of investing in a floating NAV money market fund.

Comments regarding the amended disclosure statement were mixed. Two commenters generally supported the proposed amendments to the disclosure statement under both alternatives, and one commenter expressed general support for the proposed disclosure under the fees and gates alternative.[902] Two commenters generally opposed the proposed disclosure statement, arguing that it would overstate the risks relative to other mutual funds and overwhelm investors with standardized mandated legends, which investors might ignore as “boilerplate.” [903] Some commenters expressed concerns with particular aspects of the proposed disclosure, such as the required disclosure regarding sponsor support.[904] These comments are discussed in more detail below.

Today we are adopting amendments to the requirements for disclosure statements that must appear in money market funds' advertisements or other sales materials, and in the summary section of money market funds' statutory prospectus. As discussed in more detail below, these amendments are being adopted largely as proposed, but with some modifications to the proposed format and content. These modifications respond to comments we received and also reflect that we are adopting a liquidity fees and gates requirement for all non-government money market funds, including municipal money market funds, as well as a floating NAV requirement for institutional prime funds. As we stated in the Proposing Release, we are modifying the current disclosure requirements because we believe that enhancing the disclosure required to be included in fund advertisements and other sales materials, and in the summary section of the prospectus, will help change the investment expectations of money market fund investors, including any erroneous expectation that a money market fund is a riskless investment.[905] In addition, without such modifications, we believe that investors may not be fully aware of potential restrictions on fund redemptions or, for floating NAV funds, the fact that the value of their money market fund shares will, as a result of Start Printed Page 47816these reforms, increase and decrease as a result of the changes in the value of the underlying securities.[906]

Specifically, we are requiring money market funds that maintain a stable NAV to include the following disclosure statement in their advertisements or other sales materials and in the summary section of the statutory prospectus:

You could lose money by investing in the Fund. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it cannot guarantee it will do so. The Fund may impose a fee upon the sale of your shares or may temporarily suspend your ability to sell shares if the Fund's liquidity falls below required minimums because of market conditions or other factors.[907] An investment in the Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The Fund's sponsor has no legal obligation to provide financial support to the Fund, and you should not expect that the sponsor will provide financial support to the Fund at any time.[908]

Funds with a floating NAV will also be required to include a similar disclosure statement in their advertisements or other sales materials and in the summary section of the statutory prospectus, modified to account for the characteristics of a floating NAV, as follows:

You could lose money by investing in the Fund. Because the share price of the Fund will fluctuate, when you sell your shares they may be worth more or less than what you originally paid for them. The Fund may impose a fee upon the sale of your shares or may temporarily suspend your ability to sell shares if the Fund's liquidity falls below required minimums because of market conditions or other factors. An investment in the Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The Fund's sponsor has no legal obligation to provide financial support to the Fund, and you should not expect that the sponsor will provide financial support to the Fund at any time.[909]

Below we describe in detail the ways in which the format and content of the required disclosure statement that we are adopting today differ from that which we proposed, as well as the reasons for these differences.

b. Format of the Statement

We have decided not to adopt the proposed requirement that funds provide the statement in a bulleted format. One commenter argued that prescribing a specific graphical format is not necessary and might be difficult to execute in certain forms of advertising, such as social media.[910] We agree. We also believe that refraining from requiring funds to provide the disclosure statement in a bulleted format, in combination with other modifications discussed below that shorten the disclosure statement, addresses concerns raised by commenters that the length of the proposed disclosure statement could draw attention away from other important information in an advertisement or sales materials.[911]

c. Disclosure Concerning General Risk of Investment Loss

As proposed, the required disclosure statement would have included a bulleted statement providing: “You could lose money by investing in the Fund.” We are adopting identical content in the required disclosure statement. As discussed in the proposal, we have taken into consideration investor preferences for clear, concise, and understandable language in adopting the required disclosure and also have considered whether strongly-worded disclaimer language would more effectively convey the particular risks associated with money market funds than more moderately-worded language would.[912] We received one comment on this language arguing that it is duplicative with other language in the required disclosure statement.[913] We have responded to this comment by shortening and modifying the required disclosure statement.[914]

d. Disclosure Concerning Fees and Gates

As proposed, the required disclosure statement would have included bulleted statements providing: “The Fund may impose a fee upon sale of your shares when the Fund is under considerable stress” and “The Fund may temporarily suspend your ability to sell shares of the Fund when the Fund is under considerable stress.” Instead of including these bullet points in the required disclosure, we are adopting similar content in the required disclosure statement providing: “The Fund may impose a fee upon the sale of your shares or may temporarily suspend your ability to sell shares if the Fund's liquidity falls below required Start Printed Page 47817minimums because of market conditions or other factors.” One commenter, while generally supporting the proposed statement, suggested that the statement be amended to say that the fund could impose a fee or a gate “in order to protect shareholders of the Fund.” [915] One commenter expressed concerns about requiring the inclusion of statements about fees and gates in advertisements or other sales materials, arguing that the description of circumstances and conditions under which fees and gates might be imposed is difficult to reduce to a brief statement.[916] No commenters explicitly supported the inclusion of the term “considerable stress,” and several commenters argued that this term was not clear, and may cause investors to believe that funds could impose fees and gates arbitrarily or, conversely, only during extreme market events.[917] To address this concern, one commenter suggested requiring a different term than “considerable stress,” arguing that this term overstates the prospect for imposing fees or gates.[918] Other commenters suggested that the disclosure state explicitly that a fee or gate could be imposed as a result of a reduction in the fund's liquidity.[919] Commenters also suggested that any disclosure regarding fees and gates could be combined into a single statement.

After considering the comments, we continue to believe that disclosure about fees or gates should be included in advertisements, sales materials, and the summary section of the prospectus. Even some commenters that expressed concerns about including the disclosure in advertisements acknowledged that the possible imposition of fees and gates is information that is likely to be important to investors.[920] As we stated in the Proposing Release, we are concerned that investors will not be fully aware of potential restrictions on fund redemptions. To address commenters' concerns regarding the ambiguity of the term “considerable stress,” we have revised the statement, as suggested by commenters, to make clear that funds could impose a fee or gate in response to a reduction in the fund's liquidity. The statement does not include a reference that a fee or gate could be imposed “to protect investors of the fund,” as suggested by one commenter. We believe that including the additional suggested language could detract from the statement's emphasis that a fee or gate could be imposed, which could in turn diminish shareholders' awareness of potential restrictions on fund redemptions. The language we have adopted reflects commenter suggestions that any disclosure regarding fees or gates be combined into a single statement. We believe that the adopted language also responds to commenter concerns about the difficulty of briefly describing the conditions under which fees and gates might be imposed by providing that fees and gates could be imposed if “the Fund's liquidity falls below required minimums because of market conditions or other factors.”

e. Disclosure Concerning Sponsor Support

As proposed, the required disclosure statement would have included a bulleted statement providing: “The Fund's sponsor has no legal obligation to provide financial support to the Fund, and you should not expect that the sponsor will provide financial support to the Fund at any time.” We are adopting identical content in the required disclosure statement. Several commenters opposed the inclusion of a reference to sponsor support in the required disclosure statement.[921] Some commenters argued that the disclosure would raise sponsor support to an unwarranted level of prominence, noting that there have not been any studies to determine whether investors actually rely on the potential for sponsor support as a factor when determining whether to invest in a money market fund.[922] Commenters also were concerned that investors will not understand the disclosure in fund advertisements, since advertisements will not afford space or opportunity to explain to investors who the fund's “sponsor” is and what “financial support” means.[923]

We continue to believe that the disclosure statement should include a statement that the fund's sponsor has no obligation to provide financial support. In the Proposing Release, we recognized that particular instances of sponsor support were not particularly transparent to investors in past years because sponsor support generally was not immediately disclosed, and was not required to be disclosed by the Commission.[924] But although investors might not have known of particular instances of sponsor support, we believe that many investors, particularly institutional investors, have historically understood that there was a possibility of financial support from the money market fund's sponsor and that this possibility has affected investors' perceptions about the level of risk in investing in money market funds.[925] We therefore disagree with the commenter who suggested that investors were generally unaware of this practice preceding and during the financial crisis.[926] For this reason, we believe that it is important to emphasize to investors that they should not expect a fund sponsor to provide financial support to the fund.

For similar reasons, we disagree with one commenter who argued that requiring this disclosure is at odds with the requirement that funds publicly disclose instances of sponsor support.[927] As discussed below, we are requiring funds to disclose current and historical instances of sponsor support because we believe that such disclosure will help investors better understand the risks of investing in the funds.[928] This reporting, which should help investors understand instances when the fund has come under stress, provides historical information about the fund. The required disclosure statement, on the other hand, is a forward-looking risk statement that reminds current and prospective investors that sponsors do not have an obligation to provide sponsor support and that investors should not expect that sponsors will provide support in the future.

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Finally, we are not persuaded that the disclosure regarding sponsor support should not appear in advertisements because this disclosure will not be understood by investors. We recognize that upon reading the disclosure statement, investors might have questions regarding financial support from sponsors, as commenters indicated, including questions regarding who the fund's “sponsor” is, or what constitutes “financial support.” [929] We believe, however, that funds can address this issue through more complete disclosure elsewhere in the fund prospectus if they believe it is necessary.

f. Disclosure for Floating NAV Funds

As proposed, the required disclosure statement for floating NAV funds would have included bulleted statements providing: “You should not invest in the Fund if you require your investment to maintain a stable value” and “The value of the Fund will increase and decrease as a result of changes in the value of the securities in which the Fund invests. The value of the securities in which the Fund invests may in turn be affected by many factors, including interest rate changes and defaults or changes in the credit quality of a security's issuer.” Instead of including these bullet points in the required disclosure, we are adopting similar content in the required disclosure statement providing: “Because the share price of the Fund will fluctuate, when you sell your shares they may be worth more or less than what you originally paid for them.” While one commenter questioned whether the proposed disclosure was necessary for investors in institutional prime funds,[930] we believe it is important to emphasize to investors the potential impact of a floating NAV.[931] In response to suggestions by commenters,[932] we have decided not to require that the disclosure statement include the proposed statement that investors that require a stable value not invest in the fund. We were persuaded by commenters that the term “stable value” is often used by financial advisers when referring to certain investment products, at least some of which do have a variable NAV.[933] We are also not including in the disclosure requirements the proposed statements about the relationship between the fund share price and the value of the fund's underlying securities and the risk factors that can affect the value of the fund's underlying securities. We were persuaded by one commenter who noted that discussion of specific risk factors will be addressed in other areas of the prospectus, including the summary prospectus.[934] We also believe that not including these statements addresses more general concerns expressed by commenters regarding the length and efficacy of the proposed disclosure statement.[935]

2. Disclosure of Tax Consequences and Effect on Fund Operations—Floating NAV

As discussed in the Proposing Release, the requirement that institutional prime money market funds transition to a floating NAV will entail certain additional tax- and operations-related disclosure, but these disclosure requirements do not necessitate rule and form amendments.[936] As noted above, taxable investors in institutional prime money market funds, like taxable investors in other types of mutual funds, may now experience taxable gains and losses.[937] Currently, funds are required to describe in their prospectuses the tax consequences to shareholders of buying, holding, exchanging, and selling the fund's shares.[938] Accordingly, we expect that, pursuant to current disclosure requirements, floating NAV money market funds would include disclosure in their prospectuses about the tax consequences to shareholders of buying, holding, exchanging, and selling the shares of the floating NAV fund. In addition, we expect that a floating NAV money market fund would update its prospectus and SAI disclosure regarding the purchase, redemption, and pricing of fund shares, to reflect any changes resulting from the fund's use of a floating NAV.[939] We also expect that a fund that intends to qualify as a retail money market fund would disclose in its prospectus that it limits investment to accounts beneficially owned by natural persons.[940] The Proposing Release requested comment on the disclosure that we expect floating NAV money market funds would include in their prospectuses about the tax consequences to shareholders of buying, holding, exchanging, and selling shares of the fund, as well as the effects (if any) on fund operations resulting from the transition to a floating NAV. We received no comments directly discussing this disclosure.

3. Disclosure of Transition to Floating NAV

Currently, a fund must update its registration statement to reflect any material changes by means of a post-effective amendment or a prospectus supplement (or “sticker”) pursuant to rule 497 under the Securities Act.[941] As discussed in the Proposing Release, we would expect that, to meet this existing requirement, at the time that a stable NAV money market fund transitions to a floating NAV (or adopts a floating NAV in the course of a merger or other reorganization), it would update its registration statement to include relevant related disclosure, as discussed in sections III.E.1 and III.E.2 of this Release, by means of a post-effective amendment or a prospectus supplement. Two commenters explicitly supported that such disclosures be made when transitioning to a floating NAV.[942] We continue to believe that a money market fund must update its registration statement by means of a post-effective amendment or “sticker” Start Printed Page 47819to reflect relevant disclosure related to a transition to a floating NAV.

4. Disclosure of the Effects of Fees and Gates on Redemptions

As we discussed in the proposal, pursuant to the existing requirements in Form N-1A, funds must disclose any restrictions on fund redemptions in their registration statements.[943] As discussed in more detail below, we expect that, to comply with these existing requirements, money market funds (other than government money market funds that are not subject to the fees and gates requirements pursuant to rule 2a-7(c)(2)(iii) and that have not chosen to rely on the ability to impose liquidity fees and suspend redemptions) will disclose in the registration statement the effects that the potential imposition of fees and/or gates, including a board's discretionary powers regarding the imposition of fees and gates, may have on a shareholder's ability to redeem shares of the fund. This disclosure should help investors evaluate the costs they could incur in redeeming fund shares—one of the goals of this rulemaking.

Commenters generally agreed that this disclosure would help investors understand the effects of fees and gates on redemptions.[944] One commenter specifically agreed that Items 11(c)(1) and 23 of Form N-1A would require money market funds to fully describe the circumstances under which liquidity fees could be charged or redemptions could be suspended or reinstated.[945] In addition, two commenters noted that the prospectus should include disclosure of a board's discretionary powers regarding the imposition of fees and gates, which would serve to emphasize further the nature of money market funds as investments subject to risk.[946] The Proposing Release requested comment on the utility of including additional disclosure about the operations and effects of fees and redemption gates, including (i) requiring information about the basic operations of fees and gates to be disclosed in the summary section of the statutory prospectus (and any summary prospectus, if used) and (ii) requiring details about the fund's liquidation process. One commenter argued against the utility of such additional disclosure in helping investors to understand the effects of fees and gates on redemptions.[947] We agree and decided against making any changes to the rule text in this regard.

As discussed in the Proposing Release, we expect money market funds to explain in the prospectus the various situations in which the fund may impose a liquidity fee or gate.[948] For example, money market funds would briefly explain in the prospectus that if the fund's weekly liquid assets fall below 30% of its total assets and the fund's board determines it is in the best interests of the fund, the fund board may impose a liquidity fee of no more than 2% and/or temporarily suspend redemptions for a limited period of time.[949] We also expect money market funds to briefly explain in the prospectus that if the fund's weekly liquid assets fall below 10% of its total assets, the fund will impose a liquidity fee of 1% on all redemptions, unless the board of directors of the fund (including a majority of its independent directors) determines that imposing such a fee would not be in the best interests of the fund or determines that a lower or higher fee (not to exceed 2%) would be in the best interests of the fund.[950]

As discussed in the Proposing Release, we expect money market funds to incorporate additional disclosure in the prospectus or SAI, as the fund determines appropriate, discussing the operations of fees and gates in more detail. Prospectus disclosure regarding any restrictions on redemptions is currently required by Item 11(c)(1) of Form N-1A. In addition to the disclosure required by Item 11(c)(1), we believe that funds could determine that more detailed disclosure about the operations of fees and gates, as further discussed in this section, would appropriately appear in a fund's SAI, and that this more detailed disclosure is responsive to Item 23 of Form N-1A (“Purchase, Redemption, and Pricing of Shares”). In determining whether and/or to what extent to include this disclosure in the prospectus or SAI, money market funds should rely on the principle that funds should limit disclosure in prospectuses generally to information that “would be most useful to typical or average investors in making an investment decision.” [951] Detailed or highly technical discussions, as well as information that may be helpful to more sophisticated investors, dilute the effect of necessary prospectus disclosure and should be placed in the SAI.[952]

Based on this principle, we anticipate that funds generally would consider the following disclosure to be appropriate for the prospectus, as disclosure regarding redemption restrictions provided in response to Item 11(c)(1) of Form N-1A: (i) Means of notifying shareholders about the imposition and lifting of fees and/or gates (e.g., press release, Web site announcement); (ii) timing of the imposition and lifting of fees and gates, including (a) an explanation that if a fund's weekly liquid assets fall below 10% of its total assets at the end of any business day, the next business day it must impose a 1% liquidity fee on shareholder redemptions unless the fund's board of directors determines that doing otherwise is in the best interests of the fund, (b) an explanation that if a fund's weekly liquid assets fall below 30% of its total assets, it may impose fees or gates as early as the same day, and (c) an explanation of the 10 business day limit for imposing gates; (iii) use of fee proceeds by the fund, including any possible return to shareholders in the form of a distribution; (iv) the tax consequences to the fund and its shareholders of the fund's receipt of liquidity fees; and (v) general description of the process of fund liquidation[953] if the fund's weekly liquid assets fall below 10%, and the fund's board of directors determines that it would not be in the best interests of the fund to continue operating.[954]

In addition, we expect that a government money market fund that is not subject to the fees and gates Start Printed Page 47820requirements pursuant to rule 2a-7(c)(2)(iii), but that later decides to rely on the ability to impose liquidity fees and suspend redemptions, would update its registration statement to reflect the changes by means of a post-effective amendment or a prospectus supplement pursuant to rule 497 under the Securities Act. In addition, a government fund that later opts to rely on the ability to impose fees and gates provided in rule 2a-7(c)(2)(iii) should consider whether to provide any additional notice to its shareholders of that election.[955]

5. Historical Disclosure of Liquidity Fees and Gates

We are amending Form N-1A, generally as proposed, but with certain modifications as discussed below, to require that money market funds provide disclosure in their SAIs about historical occasions in which the fund has considered or imposed liquidity fees or gates.[956] As proposed, we would have required funds to disclose: (i) The length of time for which the fund's weekly liquid assets remained below 15%: (ii) the dates and length of time for which the fund's board of directors determined to impose a liquidity fee and/or temporarily suspend the fund's redemptions; and (iii) a short discussion of the board's analysis supporting its decision to impose a liquidity fee (or not to impose a liquidity fee) and/or temporarily suspend the fund's redemptions.[957] As discussed below, we are adopting modified thresholds for imposing fees and gates from what was proposed; consequently, the amendments we are adopting to Form N-1A to require historical disclosure of liquidity fees and gates have been modified from the proposed amendments to conform to these amended threshold levels. In addition, in a change from the proposed historical disclosure requirements, the Form N-1A amendments we are adopting require a fund to disclose the size of any liquidity fee imposed during the specified look-back period. We have also determined not to adopt the proposed requirement to disclose “a short discussion of the board's analysis supporting its decision to impose a liquidity fee (or not to impose a liquidity fee) and/or temporarily suspend the fund's redemptions” for the reasons detailed below.

Specifically, we are amending Form N-1A to require that money market funds (other than government money market funds that are not subject to the fees and gates requirements pursuant to rule 2a-7(c)(2)(iii)) [958] provide disclosure in their SAIs regarding any occasion during the last 10 years (but not for occasions that occurred before the compliance date of these amended rules) [959] on which (i) the fund's weekly liquid assets have fallen below 10%, and with respect to each such occasion, whether the fund's board of directors determined to impose a liquidity fee and/or suspend the fund's redemptions, or (ii) the fund's weekly liquid assets have fallen below 30% (but not less than 10%) and the fund's board of directors determined to impose a liquidity fee and/or suspend the fund's redemptions.[960] With respect to each occasion, we are requiring funds to disclose: (i) The length of time for which the fund's weekly liquid assets remained below 10% (or 30%, as applicable); (ii) the dates and length of time for which the fund's board of directors determined to impose a liquidity fee and/or temporarily suspend the fund's redemptions; and (iii) the size of any liquidity fee imposed.[961]

We proposed to require a fund to provide disclosure in its SAI regarding any occasion during the last 10 years (but not before the compliance date) in which the fund's weekly liquid assets had fallen below 15%, and with respect to each such occasion, whether the fund's board of directors determined to impose a liquidity fee and/or suspend the fund's redemptions.[962] As discussed previously, the final amendments contain modified thresholds for imposing fees and gates from what was proposed,[963] and we are therefore modifying the disclosure requirements to conform to these amended threshold levels.

As proposed, the SAI disclosure requirements would not have directly required a fund to disclose the size of any liquidity fee imposed. We are modifying the SAI disclosure requirements to require a fund to disclose the size of any liquidity fee it has imposed during the specified look-back period. As discussed below in the context of the Form N-CR disclosure requirements we are adopting, because we are revising the default liquidity fee from the proposed 2% to 1%, and thus we expect that there may be instances where liquidity fees are above or below the default fee (rather than just lower as permitted under the proposal), we are requiring that funds disclose the size of the liquidity fee, if one is imposed.[964]

One commenter specifically supported the proposed 10-year “look-back” period for the historical disclosure, noting that a 10-year period should capture a number of different market stresses delivering a meaningful sample.[965] Another commenter suggested limiting SAI disclosure to a five-year period prior to the effective date of the registration statement incorporating the SAI disclosure, although this commenter did not provide specific reasons why this shortened look-back period would be appropriate.[966] After further consideration, and given that commenters did not provide any specific reasons for implementing a shortened look-back period, we continue to believe that a 10-year look-back period provides shareholders and the Commission with a historical perspective that would be long enough to provide a useful understanding of past events. We believe that this period would provide a meaningful sample of stresses faced by individual funds and in the market as a whole, and to analyze patterns with respect to fees and gates, but would not be so long as to include circumstances that may no longer be a relevant reflection of the fund's management or operations.

As discussed in the Proposing Release, we continue to believe that money market funds' current and prospective shareholders should be informed of historical occasions in which the fund's weekly liquid assets Start Printed Page 47821have fallen below 10% and/or the fund has imposed liquidity fees or redemption gates. While we recognize that historical occurrences are not necessarily indicative of future events, we anticipate that current and prospective fund investors could use this information as one factor to compare the risks and potential costs of investing in different money market funds. The DERA Study analyzed the distribution of weekly liquid assets and found that 83 prime funds per year, corresponding to 2.7% of the prime funds' weekly liquid asset observations, saw the percentage of their total assets that were invested in weekly liquid assets fall below 30%. The DERA Study further showed that less than one (0.6) fund per year, corresponding to 0.01% of the prime funds' weekly liquid asset observations, experienced a decline of total assets that were invested in weekly liquid assets to below 10%.[967] We believe that funds will, in general, try to avoid the need to disclose decreasing percentages of weekly liquid assets and/or the imposition of a liquidity fee or gate, as required under the new amendments to Form N-1A,[968] by keeping the percentage of their total assets invested in weekly liquid assets at or above 30%. Of those 83 funds that reported a percentage of total assets invested in weekly liquid assets below 30%, it is unclear how many, if any, would have attempted to keep the percentage of their total assets invested in weekly liquid assets at or above 30% to avoid having to report this information on their SAI (assuming they were to impose, at their board's discretion, a liquidity fee or gate).

The required disclosure will permit current and prospective shareholders to assess, among other things, patterns of stress experienced by the fund, as well as whether the fund's board has previously imposed fees and/or redemption gates in light of declines in portfolio liquidity. This disclosure also provides investors with historical information about the board's past analytical process in determining how to handle liquidity issues when the fund experiences stress, which could influence an investor's decision to purchase shares of, or remain invested in, the fund. In addition, the required disclosure may impose market discipline on portfolio managers to monitor and manage portfolio liquidity in a manner that lessens the likelihood that the fund would need to implement a liquidity fee or gate.[969] One commenter explicitly supported the utility of these disclosure requirements in providing investors with useful information regarding the frequency of the money market fund's breaching of certain liquidity thresholds, whether a fee or gate was applied, and the level of fee imposed, stating that “[t]his will allow investors to make informed decisions when determining whether to invest in [money market funds] and when comparing different [money market funds].” [970] No commenter argued that disclosure about the historical fact of occurrence of fees and gates would not be useful to investors. However, some commenters raised concerns about the potential redundancy of the proposed registration statement, Web site, and Form N-CR disclosure requirements.[971]

As discussed above, we also have determined not to adopt the proposed requirement for a fund to disclose “a short discussion of the board's analysis supporting its decision to impose a liquidity fee (or not to impose a liquidity fee) and/or temporarily suspend the fund's redemptions” in its SAI (or as discussed below, on its Web site).[972] We note that Form N-CR, as proposed, also would have required a fund imposing a fee or gate to disclose a “discussion of the board's analysis” supporting its decision, and a number of commenters objected to this proposed requirement.[973] In particular, commenters raised concerns that the disclosures proposed to be required in Form N-CR and Form N-1A would not be material to investors, would be burdensome to disclose, would chill deliberations among board members and hinder board confidentiality, and would encourage opportunistic litigation.[974] Commenters also argued that disclosure of the board's analysis is not necessary to disclose patterns of stress in a fund and that this disclosure is not likely to be a meaningful indication of the board's analytical process going forward.[975]

We discuss these commenters' concerns in detail in section III.F below and also provide our analysis supporting our attempt to balance these concerns with our interest in permitting the Commission and shareholders to understand why a board imposed (or did not impose) a liquidity fee or gate. As a result of these considerations and the analysis discussed in section III.F below, we have adopted a Form N-CR requirement to require disclosure of the primary considerations or factors taken into account by the fund's board in its decision to impose a liquidity fee or gate. However, in order to avoid unnecessary duplication in the disclosure that will appear in a fund's SAI and on Form N-CR, we have determined not to require parallel disclosure of these considerations or factors in the fund's SAI. Instead, a fund will only be required to present certain summary information about the imposition of fees and/or gates in its SAI (as well as on the fund's Web site [976] ), and will be required to present more detailed discussion solely on Form N-CR.[977] To inform investors about the inclusion of this more detailed information on Form N-CR, funds will be instructed to include the following statement as part of their SAI disclosure about the historical occasions in which the fund has considered or imposed liquidity fees or gates: “The Fund was required to disclose additional information about this event [or “these events,” as appropriate] on Form N-CR and to file this form with the Securities and Exchange Commission. Any Form Start Printed Page 47822N-CR filing submitted by the Fund is available on the EDGAR Database on the Securities and Exchange Commission's Internet site at http://www.sec.gov.” [978] In adopting these modified SAI disclosure requirements, we have attempted to balance concerns about potentially duplicative disclosure [979] with our interest in presenting the primary information about the fund's historical imposition of fees or gates that we believe shareholders may find useful in assessing fund risks.

6. Prospectus Fee Table

As proposed, we are clarifying in the instructions to Item 3 of Form N-1A (“Risk/Return Summary: Fee Table”) that the term “redemption fee,” for purposes of the prospectus fee table, does not include a liquidity fee that may be imposed in accordance with rule 2a-7.[980] Commenters on this aspect of our proposal agreed that the liquidity fee should not be included in the prospectus fee table.[981] For example, one commenter stated that the fees and expenses table is intended to show a typical investor the range of anticipated costs that will be borne by the investor directly or indirectly as a shareholder, but is not an ideal presentation for the kind of highly contingent cost that would be represented by a liquidity fee.[982]

As discussed in the Proposing Release and as adopted today, a liquidity fee will only be imposed when a fund experiences stress, and because we anticipate that a particular fund would impose this fee rarely, if at all,[983] we continue to believe that the prospectus fee table, which is intended to help shareholders compare the costs of investing in different mutual funds, should not include the liquidity fee.[984] We also note, as discussed above, that shareholders will be adequately informed about liquidity fees through other disclosures in funds' SAI and summary section of the statutory prospectus (and, accordingly, in any summary prospectus, if used).[985] If a fund imposes a liquidity fee, shareholders will also be informed about the imposition of this fee on the fund's Web site [986] and possibly by means of a prospectus supplement.[987] A fund could also provide complementary shareholder communications, such as a press release or social media update.[988] Accordingly, we are adopting the clarifying instruction to Item 3 as proposed.

7. Historical Disclosure of Affiliate Financial Support

As discussed above in section II.B.4, voluntary support provided by money market fund sponsors and affiliates has played a role in helping some money market funds maintain a stable share price, and, as a result, may have lessened investors' perception of the level of risk in money market funds. Such discretionary sponsor support was, in fact, not unusual during the financial crisis.[989] Today we are adopting, with certain modifications from the proposal to address commenter concerns, amendments that require that money market funds disclose current and historical instances of affiliate “financial support.” The final amendments define “financial support” in the same way it is defined in Form N-CR,[990] and specify that funds should incorporate certain information that the fund is required to report on Form N-CR in their SAI disclosure.[991] We discuss this definition in detail, including the modifications we have made to address commenter concerns, in section III.F.[992] This represents a slight change from the proposal, in that the required disclosure is now identical to what would be disclosed in the initial filings of Form N-CR. We have made this change to reduce the burdens associated with such disclosure so that funds need only prepare this information once in a single manner.[993]

In the Proposing Release, we requested comment on amending rule 17a-9 (which allows for the discretionary support of money market funds by their sponsors and other affiliates) to potentially restrict the practice of sponsor support, but did not propose any specific changes to the rule. While a few commenters suggested, in response to this request for comment, that we prohibit affiliates from providing discretionary support to maintain a money market fund's share value,[994] other commenters opposed making any changes to rule 17a-9, arguing that transactions facilitated by the rule are in the best interests of shareholders.[995] We continue to believe, as discussed in the Proposing Release, that permitting financial support (with adequate disclosure) will provide fund affiliates with the flexibility to protect shareholder interests, and we are not amending rule 17a-9 at this time.[996] Many commenters supported the various financial support disclosures we are adopting today.[997] We believe that these disclosure requirements will provide transparency to shareholders and the Commission about the frequency, nature, and amount of affiliate financial support.

a. General Requirements

We are adopting, with some changes from the proposal, amendments to Form N-1A to require a money market fund Start Printed Page 47823to disclose in its SAI historical instances in which the fund has received financial support from a sponsor or fund affiliate.[998] Specifically, each money market fund will be required to disclose any occasion during the last 10 years (but not for occasions that occurred before the compliance date of these amended rules) on which an affiliated person, promoter, or principal underwriter of the fund, or an affiliated person of such person,[999] provided any form of financial support to the fund. For the reasons discussed in the Proposing Release, we believe that the disclosure of historical instances of sponsor support will allow investors, regulators, academics, market observers and market participants, and other interested members of the public to understand better whether a particular fund has required financial support in the past and the extent of sponsor support across the fund industry.[1000] As proposed, with respect to each such occasion, funds would have been required to describe the nature of support, the person providing support, the relationship between the person providing support and the fund, the date the support provided, the amount of support,[1001] the security supported and its value on the date support was initiated (if applicable), the reason for support, the term of support, and any contractual restrictions relating to support.[1002] We are adopting the proposed disclosure requirements, with the exception of the requirements for a fund to describe the reason for support, the term of support, and any contractual restrictions relating to support.

While multiple commenters supported the proposed requirement for money market funds to disclose historical instances of financial support in the fund's SAI,[1003] other commenters expressed a number of concerns about this proposed requirement.[1004] For example, one commenter opposed this disclosure, stating that “many investors would extrapolate such disclosure as an implied guarantee of future support by the sponsor of the fund.” [1005] Another commenter rejected the notion that past sponsor support is indicative of a sponsor's management style and further observed that disclosure of historical support contradicts the proposed disclosure that a fund's sponsor has no legal obligation to provide support.[1006] While we acknowledge these concerns, we believe it is important for investors to understand the nature and extent that a fund's sponsor has discretionarily supported the fund in order to allow them to fully appreciate the risks of investing in the fund.[1007] Although we recognize that historical occurrences are not necessarily indicative of future events and that support does not equate to poor fund management, we continue to expect that these disclosures will permit investors to assess the sponsor's past ability and willingness to provide financial support to the fund. This disclosure also should help investors gain a better context for, and understanding of, the fund's risks, historical performance, and principal volatility.

A number of commenters stated that any disclosure of financial support, including the historical disclosures, should only apply to stable NAV funds.[1008] We disagree. Transparency of financial support is important for stable NAV funds, given the potential for a “breaking the buck” event absent the receipt of affiliate financial support. It is equally important, for both floating and stable NAV money market funds, that investors have transparency about the extent to which the fund's principal stability or liquidity profile is achieved through financial support as opposed to portfolio management. This is particularly the case when financial support for a floating NAV fund could obviate the need for it to impose a liquidity fee or redemption gate.[1009] We therefore believe that transparency of such support will help investors better evaluate the risks with respect to both stable and floating NAV funds.[1010]

Some commenters also suggested we shorten the look-back period. For example, one commenter proposed a look-back period of 3 to 5 years (rather than 10 years, as proposed).[1011] We believe, however, that a look-back period of less than 10 years would be too short to achieve our goals. As we noted in the Proposing Release,[1012] the 10-year look-back period will provide shareholders and the Commission with a historical perspective that is long enough to provide a useful understanding of past events, and to analyze patterns with respect to financial support received by the fund, but not so long as to include circumstances that may no longer be a relevant reflection of the fund's management or operations. We also note that, historically, episodes of financial support have occurred on average every 5 to 10 years.[1013] Accordingly, a shorter look-back period would result in disclosure that not does reflect the typical historical frequency of instances of financial support.

We proposed to limit historical disclosure of events of affiliate financial support to instances that occur after the compliance date of the amendments to Form N-1A.[1014] Several commenters Start Printed Page 47824generally supported this approach, suggesting that this disclosure requirement should only apply to events that occur after the compliance date of the disclosure reforms.[1015] We continue to believe that these disclosures should only apply to affiliate financial support events that occur after the compliance date of the disclosure reforms, in large part because to do otherwise would require funds and their affiliates to incur significant costs as they reexamine a variety of past transactions to determine whether such events fit our new definition of affiliate financial support.

Finally, a few commenters suggested disclosing historical financial support in Form N-MFP, N-CR, or N-CSR, rather than in the SAI (as proposed).[1016] One commenter noted that to the extent this disclosure will serve as a reporting function for analysis by regulators, other forms such as Form N-MFP have been developed for that particular purpose.[1017] Commenters also raised concerns about the potential redundancy of the proposed registration statement, Web site, and Form N-CR disclosure requirements.[1018] Because these historical sponsor support disclosures are intended to benefit investors, as well as regulators, we believe that the SAI is the most accessible and efficient format for such disclosure. As discussed in section III.F.3, we note that the contemplated SAI disclosure would consolidate historical instances of sponsor support that have occurred in the past 10 years, which would permit investors to view this information in a user-friendly manner, without the need to review prior form filings to piece together a fund's history of sponsor support. We also believe that, to the extent investors may not be familiar with researching filings on EDGAR, including this disclosure in a fund's SAI, which investors may receive in hard copy through the U.S. Postal Service or may access on a fund's Web site, as well as on EDGAR, may make this information more readily available to these investors than disclosure on other SEC forms that are solely accessible on EDGAR.

As discussed above, we are not adopting the proposed requirements that a fund include the reason for support, the term of support, and any contractual restrictions relating to support in its required SAI disclosure.[1019] Instead, a fund will only be required to present certain summary information about the receipt of financial support in its SAI (as well as on the fund's Web site [1020] ), and will be required to present more detailed discussion solely on Form N-CR.[1021] To inform investors about the inclusion of this more detailed information on Form N-CR, funds will be instructed to include the following statement as part of the historical disclosure of affiliate financial support appearing in the fund's SAI: “The Fund was required to disclose additional information about this event [or “these events,” as appropriate] on Form N-CR and to file this form with the Securities and Exchange Commission. Any Form N-CR filing submitted by the Fund is available on the EDGAR Database on the Securities and Exchange Commission's Internet site at http://www.sec.gov.” [1022] In adopting these modified SAI disclosure requirements, we have attempted to appropriately consider concerns about potentially duplicative disclosure [1023] as well as our belief, as discussed above, that the SAI is the most accessible and efficient format for investors to receive historical disclosures about affiliate financial support, and our interest in presenting the primary information about such financial support that we believe shareholders may find useful in assessing fund risks.

b. Historical Support of Predecessor Funds

We also are amending, generally as we proposed, the instructions to Form N-1A to clarify that funds must disclose any financial support provided to a predecessor fund (in the case of a merger or other reorganization) within the 10-year look-back period. As discussed in the Proposing Release, this amendment will provide additional transparency by providing investors the full extent of historical support provided to a fund or its predecessor. Specifically, except as noted below, the amended instructions state that if the fund has participated in a merger or other reorganization with another investment company during the last 10 years, the fund must additionally provide the required disclosure with respect to the other investment company.[1024]

Rather than require that funds disclose financial support provided to a predecessor fund in all cases (as proposed), we are revising the instruction to permit a fund to exclude such disclosure where the person or entity that previously provided financial support to the predecessor fund is not currently an affiliated person (including the adviser), promoter, or principal underwriter of the disclosing fund.[1025] A few commenters expressed concern about historical disclosures with respect to third-party reorganizations, asserting that past financial support would be irrelevant to shareholders where the surviving fund had a new manager unaffiliated with the prior manager.[1026] These commenters noted that this disclosure requirement could adversely affect potential merger transactions with funds that have received sponsor support.[1027]

We agree with these commenters that historical sponsor support information about a predecessor fund may be less relevant when the fund is not advised by, or otherwise affiliated with, the entity that had previously provided financial support to the predecessor fund. Accordingly, we are adopting an exclusion to this disclosure requirement based on whether the current fund continues to have any affiliation with the predecessor fund's affiliated persons (including the predecessor fund's adviser), promoter, or principal underwriter.[1028] We expect this approach should mitigate commenter concerns of adverse effects on fund mergers.

8. Economic Analysis

As discussed above, we are adopting a number of amendments to requirements for disclosure documents that are related to both our fees and Start Printed Page 47825gates and floating NAV requirements, as well as other disclosure enhancements discussed in the proposal. We believe that these amendments improve transparency and will better inform shareholders about the risks of investing in money market funds, which should result in shareholders making investment decisions that better match their investment preferences. We believe that many of these amendments will have effects on efficiency, competition, and capital formation that are similar to those that are outlined in the Macroeconomic Consequences section below,[1029] but some of the amendments introduce additional effects.

Many of the new disclosure requirements are designed to make investors aware of the more substantive amendments discussed earlier in the Release, i.e., the ability of certain funds to impose redemption fees and gates and the requirement that certain funds float their NAV. Increasing investor awareness via enhanced disclosure may lead to more efficient capital allocations because investors will possess greater knowledge of risks and thus will be able to make better informed investment decisions when deciding how to allocate their assets. Increased investor awareness also may promote capital formation if investors find a floating NAV and/or redemption fees and gates attractive and are more willing to invest in this market. For instance, investors may find fees and gates attractive insofar as imposing fees and gates during a time of market stress could help protect the interests of shareholders, or could permit a fund manager to invest the proceeds of maturing assets in short-term securities while the gate is down, thereby helping to protect the short-term financing markets.[1030] Moreover, enhanced investor awareness of fund risks may incentivize fund managers to hold less risky portfolio securities, which could also increase capital formation. Capital formation could be negatively impacted if investors find a floating NAV and/or redemption fees and gates unattractive or too complicated to understand. For instance, an investor could find it unattractive that imposing a fee or gate would prevent them from moving their investment into other investment alternatives or using their assets to satisfy liquidity needs.[1031] Additionally, disclosing a general risk of investment loss may negatively impact capital formation if this disclosure leads investors to decide that money market funds pose too great of an investment risk, and investors consequently decide not to invest in money market funds or to move their invested assets from money market funds. As such, capital formation could be negatively impacted if investors move their money from these types of funds to a different style of fund, for example, from an institutional prime fund to a government fund and thus affecting the short-term funding market. However, if investors move from a money market fund to a money market fund alternative that invests in similar types of assets, then there should not be an impact on capital formation with respect to the overall economy, but only within the money market fund industry.

To the extent that the disclosure amendments increase investor awareness of the more substantive reforms, there may be an effect on competition because some of the disclosure requirements are specific to the structure of the funds. As such, these funds will be competing with each other based on, among other things, what is stated in their advertisements, sales materials, and the summary section of their statutory prospectus. Disclosure providing that funds with a stable NAV seek to preserve the value of their investment at $1.00 per share, that share prices of floating NAV funds will fluctuate, that taxable investors in institutional prime money market funds may experience taxable gains or losses, or that non-government funds may impose a fee or gate may make investors more aware of different investment options, which could increase competition between funds.

The amendments that require money market funds to disclose current and historical information about affiliate financial support and historical information about the implementation of redemption fees and gates may also affect efficiency, competition, and capital formation. As discussed in the Proposing Release, these amendments may increase informational efficiency by providing additional information to investors and the Commission about the frequency, nature, and amount of financial support provided by money market fund sponsors,[1032] as well as the frequency and duration of redemption fees and gates. This in turn could assist investors in analyzing the risks associated with particular funds, which could increase allocative efficiency and could positively affect competition by permitting investors to choose whether to invest in certain funds based on this information. However, the disclosure of sponsor support could advantage larger funds and fund groups, if a fund sponsor's ability to provide financial support to a fund is perceived to be a competitive benefit. The disclosure of fees and gates also could advantage larger funds and fund groups if the ability to provide financial support reduces or eliminates the need to impose fees and/or gates (the imposition of which presumably would be perceived to be a competitive detriment). Additionally, if investors move their assets among money market funds or decide to invest in investment products other than money market funds as a result of the proposed disclosure requirements, the competitive stance of certain money market funds, or the money market fund industry generally, could be adversely affected.

The disclosure of affiliate financial support could have additional effects on capital formation, depending on whether investors interpret financial support as a sign of money market fund strength or weakness. If sponsor support (or the lack of need for sponsor support) were understood to be a sign of fund strength, the requirements could enhance capital formation by promoting stability within the money market fund industry. On the other hand, the disclosure requirements could detract from capital formation if sponsor support were understood to indicate fund weakness and make money market funds more susceptible to heavy redemptions during times of stress, or if money market fund investors decide to move their money out of money market funds entirely and not put it into an alternative with similar types of assets as a result. We did not receive comments on this aspect of our economic analysis. Similarly, the requirement to disclose historical redemption fees and gates could either promote or hinder capital formation. Disclosing the prior imposition of fees or gates may negatively impact capital formation if investors view the imposition of fees and gates unfavorably. Conversely, the requirement to disclose will allow investors to differentiate funds based on the extent to which funds have imposed fees and gates in the past, which could increase capital formation if investors perceive the absence of past fees and gates as a sign of greater stability within the money market fund industry. Furthermore, these required disclosures could assist the Commission in overseeing money market funds and Start Printed Page 47826developing regulatory policy affecting the money market fund industry, which might affect capital formation positively if the resulting more efficient or more effective regulatory framework encouraged investors to invest in money market funds. The Commission cannot estimate the quantitative benefits of the amendments to the disclosure forms because of uncertainty about how increased transparency may affect different investors' or groups of investors' understanding of the risks associated with money market funds. Uncertainty regarding how the proposed disclosure may affect different investors' behavior likewise makes it difficult for the Commission to measure the quantitative benefits of the proposed requirements.

As a possible alternative, we could have chosen to require disclosure, as suggested by commenters, of the historical information on Form N-MFP, Form N-CR, or Form N-CSR instead of through the SAI. Because the historical disclosures are intended to benefit both investors and regulators, we believe that the SAI is the most suitable format for such disclosure. As discussed above, we believe that including historical information about affiliate financial support and the imposition of fees and gates in the fund's SAI may make this information more readily available to investors than disclosure on other SEC forms that are solely accessible on EDGAR. We therefore believe that requiring this disclosure to appear in a fund's SAI could increase informational efficiency by facilitating the provision of this information to investors.

We believe that all money market funds will incur one-time and ongoing annual costs to update their registration statements, as well as their advertising and sales materials. The proposal estimated the costs that would be incurred under the fees and gates alterative separately from those that would be incurred under the floating NAV alternative. Under the fees and gates alternative, the proposal estimated that the average one-time costs for a money market fund (except government money market funds that are not subject to the fees and gates requirements pursuant to rule 2a-7(c)(2)(iii)) to amend its registration statement and to update its advertising and sales materials would be $3,092,[1033] and the average one-time costs for a government fund that is not subject to the fees and gates requirements pursuant to rule 2a-7(c)(2)(iii) would be $2,204.[1034] The proposal also estimated that the average annual costs for a money market fund (except government money market funds that are not subject to the fees and gates requirements pursuant to rule 2a-7(c)(2)(iii)) to amend its registration statement would be $296,[1035] and the average annual costs for a government fund that is not subject to the fees and gates requirements pursuant to rule 2a-7(c)(2)(iii) would be $148.[1036]

Under the floating NAV alternative, the proposal estimated that the average one-time costs that would be incurred for a floating NAV money market fund to amend its registration statement and update its advertising and sales materials would be $3,092,[1037] and the average one-time costs for a government or retail money market fund would be $2,204.[1038] The proposal also estimated that the average annual costs for a money market fund to amend its registration statement would be $148.[1039]

We requested comment on the estimates of the operational costs associated with the amended disclosure requirements. Certain commenters generally noted that complying with all of the new disclosure requirements, including the disclosure requirements involving the fund's advertisements and sales materials and its registration statement, would involve some additional costs.[1040] Several commenters provided dollar estimates Start Printed Page 47827of the initial costs to implement a fees and gates or floating NAV regime and noted that these estimates would include the costs of related disclosure, but these commenters did not specifically break out the disclosure-related costs in their estimates.[1041] One commenter stated that the costs to update a fund's registration statement to reflect the new fees and gates and floating NAV requirements would be “minimal when compared to other costs.” [1042] Another commenter stated that it did not consider the disclosure requirements burdensome and noted that it did not believe the disclosure requirements would impose unnecessary costs.[1043] We have considered the comments we received on the new disclosure requirements, and we have determined not to change the assumptions we used in our cost estimates in response to these comments, as the comments provided no specific suggestions or critiques regarding our methods for estimating these costs. However, our current estimates reflect the fact that the amendments we are adopting today combine the floating NAV and fees and gates proposal alternatives into one unified approach, and also incorporate updated industry data.

We anticipate that money market funds will incur costs to (i) amend the fund's advertising and sales materials (including the fund's Web site) to include the required risk disclosure statement; (ii) amend the fund's registration statement to include the required risk disclosure statement, disclosure of the tax consequences and effects on fund operations of a floating NAV (as applicable), and the effects of fees and gates on redemptions (as applicable); (iii) amend the fund's registration statement to disclose post-compliance-period historical occasions on which the fund has considered or imposed liquidity fees or gates; and (iv) amend the fund's registration statement to disclose post-compliance-period historical instances in which the fund has received financial support from a sponsor or fund affiliate. These costs will include initial, one-time costs, as well as ongoing costs. Each money market fund in a fund complex might not incur these costs individually.

We estimate that the average one-time costs for a money market fund (except government money market funds that are not subject to the fees and gates requirements pursuant to rule 2a-7(c)(2)(iii), and floating NAV money market funds) to comply with these disclosure requirements would be $3,059 (plus printing costs).[1044] We estimate that the average one-time costs for a government money market fund that is not subject to the fees and gates requirements pursuant to rule 2a-7(c)(2)(iii) to comply with these disclosure requirements would be $2,102 (plus printing costs).[1045] Finally, we estimate that the average one-time costs for floating NAV money market funds to comply with these disclosure requirements would be $4,016 (plus printing costs).[1046]

Ongoing compliance costs include the costs for money market funds periodically to: (i) Review and update the fund's registration statement disclosure regarding historical occasions on which the fund has considered or imposed liquidity fees or gates (as applicable); (ii) review and update the fund's registration statement disclosure regarding historical instances in which the fund has received financial support from a sponsor or fund affiliate; and (iii) inform investors of any fees or gates currently in place (as applicable) or the transition to a floating NAV (as applicable) by means of a prospectus supplement. Because the required registration statement disclosure overlaps with the information that a fund must disclose on Parts C, E, F, and G of Form N-CR, we anticipate that the costs a fund will incur to draft and finalize the disclosure that will appear in its registration statement and on its Web site will largely be incurred when the fund files Form N-CR, as discussed below in section III.F. We estimate that a fund (besides a government money market fund that is not subject to the fees and gates requirements pursuant to rule 2a-7(c)(2)(iii)) will incur average annual costs of $319 to comply with these disclosure requirements.[1047] We also estimate that a government money market fund that is not subject to the fees and gates requirements pursuant to rule 2a-7(c)(2)(iii) will incur average annual costs of $160 to comply with these disclosure requirements.[1048]

9. Web site Disclosure

a. Daily Disclosure of Daily and Weekly Liquid Assets

We are adopting, as proposed, amendments to rule 2a-7 that require money market funds to disclose prominently on their Web sites the percentage of the fund's total assets that are invested in daily and weekly liquid assets, as of the end of each business day during the preceding six months.[1049] The amendments we are adopting would require, as proposed, a fund to maintain a schedule, chart, graph, or other depiction on its Web site showing historical information about its investments in daily liquid assets and weekly liquid assets for the previous six Start Printed Page 47828months,[1050] and would require the fund to update this historical information each business day, as of the end of the preceding business day. Several commenters supported the disclosure on a fund's Web site of the fund's daily liquid assets and weekly liquid assets.[1051] Commenters supporting such disclosure noted that daily disclosure of this information would promote transparency and help investors better understand money market fund risks.[1052] A few commenters stated that providing this information could help investors evaluate whether a fund is positioned to meet redemptions or could approach a threshold where a fee or gate could be imposed.[1053] A number of commenters suggested that daily disclosure likely would impose external market discipline on portfolio managers and encourage careful management of daily and weekly assets.[1054] Finally, several commenters indicated that many money market funds are already disclosing such information on either a daily or a weekly basis, a fact we noted in the Proposing Release.[1055]

Other commenters, however, opposed certain aspects of the proposed amendment. Two commenters opposed daily disclosure of this information and thought the information could be provided on a weekly basis.[1056] We disagree. In times of market stress, money market funds may face rapid, heavy redemptions, which could quickly affect their liquidity.[1057] Having daily information in times of market stress can reduce uncertainty, providing investors assurance that a money market fund has sufficient liquidity to withstand the potential for heavy redemptions. One commenter opposed the six-month look-back because it would require a restructuring of fund Web sites that are already disclosing this data.[1058] We recognize, as discussed below, that the amendments will impose costs on funds. We believe, however, that it is important for funds to provide historical information for the prior six months, and updating such information daily will help investors place current information in context and thus have a more complete picture of current events.

One commenter argued that daily disclosure of this information would not be meaningful to investors,[1059] while another commenter expressed concern that daily disclosure, in combination with discretionary fees and gates, could cause reactionary redemptions.[1060] We recognize and have considered the risk that daily disclosure of weekly liquid assets and daily liquid assets could trigger heavy redemptions in some situations, particularly the risk of pre-emptive redemptions in anticipation of a potential fee or gate. However, as discussed in detail above, the board's discretion to impose a fee or a gate, among other things, mitigates the concern that investors will be able to accurately predict such an event which in turn would lead them to pre-emptively withdraw their assets from the fund.[1061] In addition, as discussed above, other aspects of today's amendments further mitigate the risks of pre-emptive runs. We believe that daily disclosure of weekly liquid assets and daily liquid assets ultimately benefits investors and could both increase stability and decrease risk in the financial markets.[1062] As mentioned above, while there is a potential for heavy redemptions in response to a decrease in liquidity, the increased transparency could reduce run risk in cases where it shows investors that a fund has sufficient liquidity to withstand market stress events. We also agree with commenters and believe that daily disclosure will increase market discipline, which could ultimately deter situations that could lead to heavy redemptions.[1063] Also, as noted elsewhere in this Release, we believe that the reforms we are adopting concerning fees and gates are a tool for handling heavy redemptions once they occur. Finally, we note that several funds have already voluntarily begun disclosing liquidity information on their Web sites.[1064]

A few commenters also believed that the proposed disclosures should apply only to stable NAV funds.[1065] We disagree with these commenters. We believe that the benefits we discuss throughout this section regarding disclosure apply regardless of whether a fund has a stable or floating NAV. As we have noted in several instances, a floating NAV may reduce but does not eliminate the risk of heavy redemptions if the fund comes under stress. Liquidity information can help investors understand a fund's ability to withstand heavy redemptions. Additionally, this information is relevant to investors to understand the potential for either a floating NAV fund or a stable NAV fund to impose a fee or a gate. We also believe that it is important for all money market funds, both floating NAV funds and stable NAV funds, to disclose liquidity information so that investors will easily be able to compare this data point, which could be seen as a risk metric, across funds when making investment decisions among types of money market funds (e.g., comparing an institutional prime money market fund to a government money market fund), as well as between money market funds of the same type (e.g., comparing two government money market funds).

We continue to believe that daily Web site disclosure of a fund's daily liquid assets and weekly liquid assets will increase transparency and enhance investors' understanding of money market fund risks. This disclosure will help investors understand how funds are managed, as well as help them monitor, in near real-time, a fund's ability to satisfy redemptions in various market conditions, including episodes of market turbulence. We also agree with commenters and believe that this disclosure will encourage market discipline on fund managers.[1066] In particular, we believe that this disclosure will encourage fund managers to manage the fund's liquidity in a manner that makes it less likely that the fund crosses a threshold where a fee or gate could be imposed, and also discourage month-end “window dressing” (in this context, the practice Start Printed Page 47829of periodically increasing the daily liquid assets and/or weekly liquid assets in a fund's portfolio, such that the fund's month-end reporting will reflect certain liquidity levels, and then decreasing the fund's investment in such assets shortly after the fund's month-end reporting calculations have been made).

b. Daily Disclosure of Net Shareholder Flows

We are also adopting, as proposed, amendments to rule 2a-7 that require money market funds to disclose prominently on their Web sites the fund's daily net inflows or outflows, as of the end of the previous business day, during the preceding six months.[1067] As proposed, the amendments we are adopting would require a fund to maintain a schedule, chart, graph, or other depiction on its Web site showing historical information about its net inflows or outflows for the previous six months,[1068] and would require the fund to update this historical information each business day, as of the end of the preceding business day. One commenter expressed support for daily disclosure of a fund's net inflows and outflows, though it opposed the requirement to report and continually update historical information.[1069] Several commenters objected to Web site disclosure of net shareholder flows, noting that money market funds often have large inflows and outflows as a normal course of business, and these flows are often anticipated.[1070] A number of commenters suggested that shareholders could misinterpret large inflows and outflows as a sign of stress even if the flows are anticipated and the fund's liquidity is adequate to handle them.[1071] Two commenters also expressed concern that a large net inflow or outflow could signal to the market that the money market fund would need to buy or sell securities in the market, potentially facilitating front running.[1072]

We continue to believe that daily disclosure of net inflows or outflows will provide beneficial information to shareholders, and thus we are adopting this requirement as proposed. In our view, information on shareholder redemptions can help provide important context to data regarding the funds' liquidity, as a fund that is experiencing increased outflow volatility will require greater liquidity. We understand, as commenters pointed out, that many funds can experience periodic and expected large net inflows or outflows on a regular basis. We believe that disclosure of this information over a rolling six-month period, however, will mitigate the risk that investors will misinterpret this information. Information about the historical context of fund inflows and outflows, which funds can include on their Web sites, should help investors distinguish between periodic large outflows that can occur in the normal course from periods of increased volatility in shareholder flow. Finally, we are not persuaded by commenters who suggested that information regarding net shareholder flows will promote front-running because we believe that front-running concerns are not especially significant for money market funds on account of the specific characteristics of these funds and their holdings.[1073]

c. Daily Disclosure of Current NAV

We are adopting, as proposed, amendments to rule 2a-7 that would require each money market fund to disclose daily, prominently on its Web site, the fund's current NAV per share (calculated based on current market factors), rounded to the fourth decimal place in the case of a fund with a $1.0000 share price or an equivalent level of accuracy for funds with a different share price [1074] (the fund's “current NAV”) as of the end of the previous business day during the preceding six months.[1075] The amendments require a fund to maintain a schedule, chart, graph, or other depiction on its Web site showing historical information about its daily current NAV per share for the previous six months,[1076] and would require the fund to update this historical information each business day as of the end of the preceding business day.[1077] These amendments complement the current requirement for a money market fund to disclose its shadow price monthly on Form N-MFP (broken out weekly).[1078] Disclosing the NAV per share to the fourth decimal would conform to the precision of NAV reporting that funds will be required to report on Form N-MFP and to what many funds are currently voluntarily disclosing.[1079]

Several commenters supported the proposed disclosure requirement of funds' current NAV per share. These commenters suggested that daily disclosure of the current NAV per share would increase transparency and investor understanding of money market funds.[1080] One commenter noted that the disclosure could impose discipline on portfolio managers, preventing, for example, month-end “window dressing.” [1081] Finally, as we noted in the Proposing Release, several commenters indicated that many money market funds are already disclosing such information on either a daily or a weekly basis.[1082]

Some commenters opposed certain aspects or questioned the usefulness of the proposed disclosure requirement. One commenter believed that frequent publication of a fund's current NAV per share would increase the risk of heavy redemptions for stable NAV funds during a period of market stress, noting the incentive for investors to redeem if they see the shadow price fall.[1083] We recognize and have considered the risk that daily disclosure of the current NAV per share could encourage heavy redemptions when it declines. We believe, however, that daily disclosure will not lead to significant redemptions and could, as we describe below, both Start Printed Page 47830increase stability and decrease risk in the financial markets.[1084] In particular, we believe that greater transparency regarding the current and historical NAV per share could help investors better assess the effects of market events on a fund's NAV and understand the context of a fund's principal stability during particular market stresses. For example, if an investor believes the values of one or more securities held by a fund are impaired, but does not see that impairment reflected in the NAV because it is only required to be disclosed once a month, they may sell their shares in the funds even though there is no actual impairment. Lack of transparency was one of the reasons cited in the DERA Study as a possible explanation for the large redemption activity during the financial crisis.[1085] As one commenter noted, such disclosure could allay concerns about how a money market fund might be affected by the occurrence of negative market events.[1086] We also believe that daily disclosure will increase market discipline, which could ultimately deter heavy redemptions. Also, as noted elsewhere in this Release, we believe that the reforms we are adopting concerning fees and gates are a tool for handling heavy redemptions when they occur. Finally, we note that many funds have voluntarily begun disclosing information about their current market-based NAV per share on their Web sites, and such disclosures have not led to significant redemptions.[1087]

As with the proposed requirement regarding daily disclosure of liquidity levels, several commenters supported daily disclosure of a fund's current NAV per share only for stable NAV funds.[1088] We disagree with commenters who suggested that daily Web site disclosure of the current NAV per share would only be useful for shareholders of stable NAV funds. We believe that the benefits we discuss above regarding disclosure apply regardless of whether a fund has a stable or floating NAV. For example, we believe that it is important for all money market funds, both floating NAV funds and stable NAV funds, to disclose NAV information so that investors will easily be able to compare this data point, which could be seen as a risk metric, across funds when making investment decisions among types of money market funds (e.g., comparing an institutional prime money market fund to a government money market fund), as well as between money market funds of the same type (e.g., comparing two institutional prime money market funds). The disclosure of the current NAV per share will enhance investors' understanding of money market funds and their inherent risks and allow investors to invest according to their risk preferences. This information will make changes in a money market fund's market-based NAV a regularly observable occurrence, which could promote investor confidence and generally provide investors with a greater understanding of the money market funds in which they invest.[1089] We note that this disclosure could make floating NAV money market funds appear to be volatile compared to alternatives like ultra-short bond funds, which are registered mutual funds that transact at three decimal places (and disclosure of these alternative funds' NAV per share, consequently, would likewise show three and not four decimal places).[1090] It is possible that investors might be incentivized to move their money to these alternatives because they appear more stable than money market funds.[1091]

The Commission continues to believe that requiring each fund to disclose daily its current NAV per share and also to provide six months of historical information about its current NAV per share will increase money market funds' transparency and permit investors to better understand money market funds' risks. This information will permit shareholders to reference funds' current NAV per share in near real time to assess the effect of market events on funds' portfolios, and will also provide investors the ability to discern trends through the provision of the six months of historical data.[1092] While some historical data regarding the current NAV per share will be available through monthly N-MFP filings,[1093] we believe that requiring funds to place this data on the fund's Web site will allow investors to consider this information in a more convenient and accessible format. In addition to increasing investors' understanding of money market funds' risks, we believe that this disclosure will encourage market discipline on fund managers, and particularly discourage month-end “window dressing.”

d. Daily Calculation of Current NAV per Share for Stable Value Money Market Funds

We are adopting, generally as proposed, amendments to rule 2a-7 that would require stable value money market funds to calculate the fund's current NAV per share (which the fund must calculate based on current market factors before applying the amortized cost or penny-rounding method, if used), rounded to the fourth decimal place in the case of funds with a $1.0000 share price or an equivalent level of accuracy for funds with a different share price (e.g., $10.000 per share) as of the end of each business day.[1094] Rule 2a-7 currently requires Start Printed Page 47831money market funds to calculate the fund's NAV per share, using available market quotations (or an appropriate substitute that reflects current market conditions), at such intervals as the board of directors determines appropriate and reasonable in light of current market conditions.[1095] We believe that daily disclosure of money market funds' current NAV per share would increase money market funds' transparency and permit investors to better understand money market funds' risks, and thus we are adopting amendments to rule 2a-7 that would require this disclosure.[1096] Because we are requiring money market funds to disclose their current NAV daily on the fund Web site, we correspondingly are amending rule 2a-7 to require funds to make this calculation as of the end of each business day, rather than at the board's discretion. We received no comments on this calculation requirement separate from comments on the related current NAV disclosure requirement. As discussed above, many money market funds already calculate and disclose their current NAV on a daily basis, and thus we do not expect that requiring all money market funds to perform a daily calculation should entail significant additional costs.[1097]

e. Harmonization of Rule 2a-7 and Form N-MFP Portfolio Holdings Disclosure Requirements

Money market funds are currently required to file information about the fund's portfolio holdings on Form N-MFP within five business days after the end of each month, and to disclose much of the portfolio holdings information that Form N-MFP requires on the fund's Web site each month with 60-day delay. We are adopting amendments to rule 2a-7 in order to harmonize the specific portfolio holdings information that rule 2a-7 currently requires funds to disclose on the fund's Web site with the corresponding portfolio holdings information required to be reported on Form N-MFP pursuant to amendments to Form N-MFP, with changes to conform to modifications we are making to Form N-MFP from the proposal. We believe that these amendments will benefit money market fund investors by providing additional, and more precise, information about portfolio holdings, which should allow investors to better evaluate the current risks of the fund's portfolio investments.

Specifically, in a change from the proposal, we are adopting amendments to the categories of portfolio investments reported on Form N-MFP, and are therefore also adopting conforming amendments to the categories of portfolio investments currently required to be reported on a money market fund's Web site.[1098] We are adopting, as proposed, an amendment to Form N-MFP that would require funds to report the maturity date for each portfolio security using the maturity date used to calculate the dollar-weighted average life maturity, and therefore we are also adopting, as proposed, conforming amendments to the current Web site disclosure requirements regarding portfolio securities' maturity dates.[1099] Currently, we do not require funds to disclose the market-based value of portfolio securities on the fund's Web site, because doing so would disclose this information prior to the time the information becomes public on Form N-MFP (because of the current 60-day delay before Form N-MFP information becomes publicly available). Because we are removing this 60-day delay, we are also requiring funds to make the market-based value of their portfolio securities available on the fund Web site at the same time that this information becomes public on Form N-MFP.[1100] One commenter supported the proposed amendments to harmonize portfolio information on Form N-MFP and information that funds disclose on their Web sites.[1101]

The information that money market funds currently are required to disclose about the fund's portfolio holdings on the fund's Web site includes, with respect to each security held by the money market fund, the security's amortized cost value.[1102] As part of the reforms to rule 2a-7, we proposed to eliminate the use of the amortized cost valuation method for stable value money market funds, and to correspond with that elimination, we also proposed to remove references to amortized cost from Form N-MFP.[1103] To harmonize the Web site disclosure of funds' portfolio holdings with these changes to Form N-MFP, we additionally proposed amendments to the current requirement for funds to disclose the amortized cost value of each portfolio security; instead, funds would be required to disclose the “value” of each portfolio security.[1104] As discussed previously in section III.B.5, the final amendments will permit the continued use of the amortized cost valuation method for stable value money market funds, and therefore to conform the changes to Form N-MFP to the final amendments to rule 2a-7, we are not adopting certain proposed Form N-MFP amendments that would have removed references to the amortized cost of securities in certain existing items.[1105] However, as proposed, we are amending Items 13 and 41 of Form N-MFP by replacing amortized cost with “value” as defined in section 2(a)(41) of the Act (generally the market-based value but can also be the amortized cost value, as appropriate),[1106] and therefore we are also adopting, as proposed, the requirement for funds to disclose the “value” (and not specifically the amortized cost value) of each portfolio security on the fund's Web site. Because the new information that a fund will be required to present on its Web site overlaps with the information that a fund will be required to disclose on Form N-MFP, we anticipate that the costs a fund will incur to draft and finalize the disclosure that will appear on its Web site will largely be incurred Start Printed Page 47832when the fund files Form N-MFP, as discussed below in section III.G.[1107]

f. Disclosure of the Imposition of Liquidity Fees and Gates

We are adopting, largely as proposed, an amendment to rule 2a-7 that requires a fund to post prominently on its Web site certain information that the fund is required to report to the Commission on Form N-CR [1108] regarding the imposition of liquidity fees, temporary suspension of fund redemptions, and the removal of liquidity fees and/or resumption of fund redemptions.[1109] The amendment requires a fund to include this Web site disclosure on the same business day as the fund files an initial report with the Commission in response to any of the events specified in Parts E, F, and G of Form N-CR,[1110] and, with respect to any such event, to maintain this disclosure on its Web site for a period of not less than one year following the date on which the fund filed Form N-CR concerning the event.[1111] This amendment requires a fund only to present certain summary information about the imposition of fees and gates on its Web site,[1112] whereas the fund will be required to present more detailed discussion solely on Form N-CR.[1113] The Web site disclosure requirements we are adopting regarding the imposition of fees and gates are similar to the proposed requirements in that they, like the proposed requirements, require a fund to post on its Web site only that information about the imposition of fees and gates that the fund is required to disclose in an initial report on Form N-CR.[1114] In addition, the amendments to rule 2a-7 that we are adopting also require a fund to include the following statement as part of its Web site disclosure: “The Fund was required to disclose additional information about this event [or “these events,” as appropriate] on Form N-CR and to file this form with the Securities and Exchange Commission. Any Form N-CR filing submitted by the Fund is available on the EDGAR Database on the Securities and Exchange Commission's Internet site at http://www.sec.gov.” [1115]

One commenter stated that it supported the proposed requirement that money market funds should post on their Web sites certain of the information required by Form N-CR, noting that although Form N-CR is publicly available upon filing with the SEC, investors will more readily find and make use of this information if posted on a particular funds' Web site.[1116] Another commenter, however, argued that the proposed Web site disclosure (and proposed Form N-CR) filings are redundant and that it would be challenging to comply with a one-day time frame, and also argued that the registration statement and Web site disclosure to investors should take priority over the Form N-CR filing.[1117] One commenter also supported a requirement for a money market fund to notify shareholders individually in order to allow a money market fund to apply a fee or gate.[1118]

As discussed below, we continue to believe that certain information required to be disclosed on Form N-CR must be filed with the Commission within one business day and that this information should also be posted on the fund's Web site within the same time-frame to help ensure that the Commission, investors generally, shareholders in each particular fund, and other market observers are all provided with these critical alerts as quickly as possible.[1119] Because we believe that these different parties all have a significant interest in receiving this information very quickly, we do not agree with the commenter who argued that Web site and registration disclosure should take priority over the Form N-CR filing.[1120] We believe that it is important for a money market fund that may impose fees and gates to inform existing and prospective shareholders on its Web site when: (i) The fund's weekly liquid assets fall below 10% of its total assets; (ii) the fund's weekly liquid assets fall below 30% of its total assets and the board of directors imposes a liquidity fee pursuant to rule 2a-7; (iii) the fund's board of directors temporarily suspends the fund's redemptions pursuant to rule 2a-7; or (iv) a liquidity fee has been removed or fund redemptions have been resumed. This information is particularly meaningful for shareholders to receive, as it could influence prospective shareholders' decision to purchase shares of the fund, as well as current shareholders' decision or ability to sell fund shares. We also note, as discussed in more detail in the Paperwork Reduction Act analysis section below,[1121] that we believe the burdens a fund would incur to draft and finalize the disclosure that would appear on its Web site would largely be incurred when the fund files Form N-CR, and therefore we do not believe that the one-day time-frame for updating the disclosure on the fund's Web site should be overly burdensome.

We maintain our belief that Web site disclosure provides important Start Printed Page 47833transparency to shareholders regarding occasions on which a particular fund's weekly liquid assets have dropped below certain thresholds, or a fund has imposed or removed a liquidity fee or gate, because many investors currently obtain important fund information on the fund's Web site.[1122] We understand that investors have become accustomed to obtaining money market fund information on funds' Web sites, and therefore we believe that Web site disclosure provides significant informational accessibility to shareholders and the format and timing of this disclosure serves a different purpose than the Form N-CR filing requirement.[1123] While we believe that it is important to have a uniform, central place for investors to access the required disclosure, we note that nothing in these amendments would prevent a fund from supplementing its Form N-CR filing and Web site posting with complementary shareholder communications, such as a press release or social media update disclosing a fee or gate imposed by the fund.

We believe that the one-year minimum time frame for Web site disclosure is appropriate because this time frame would effectively oblige a fund to post the required information in the interim period until the fund files an annual post-effective amendment updating its registration statement, which would incorporate the same information.[1124] Although a fund may inform prospective investors of any redemption fee or gate currently in place by means of a prospectus supplement,[1125] the prospectus supplement would not inform prospective and current shareholders of any fees or gates that were imposed, and then were removed, during the previous 12 months.

In addition, a fund currently must update its registration statement to reflect any material changes by means of a post-effective amendment or a prospectus supplement (or “sticker”) pursuant to rule 497 under the Securities Act. In order to meet this requirement, and as discussed in the Proposing Release,[1126] a money market fund that imposes a redemption fee or gate should consider informing prospective investors of any fees or gates currently in place by means of a prospectus supplement.[1127]

g. Disclosure of Sponsor Support

We are also amending rule 2a-7 to require that a fund post prominently on its Web site substantially the same information that the fund is required to report to the Commission on Form N-CR regarding the provision of financial support to the fund.[1128] The amendments that we are adopting reflect certain modifications from the proposal to address commenter concerns. Specifically, the proposal would have required a fund to post on its Web site substantially the same information that the fund is required to report to the Commission on Form N-CR regarding the provision of financial support to the fund. As discussed in more detail below, we are adopting amendments to rule 2a-7 that would require a fund to post on its Web site only a subset of this information.[1129] In addition, the amendments would require a fund to include the following statement as part of its Web site disclosure: “The Fund was required to disclose additional information about this event [or “these events,” as appropriate] on Form N-CR and to file this form with the Securities and Exchange Commission. Any Form N-CR filing submitted by the Fund is available on the EDGAR Database on the Securities and Exchange Commission's Internet site at http://www.sec.gov.” [1130] A fund would be required to maintain this disclosure on its Web site for a period of not less than one year following the date on which the fund filed Form N-CR.[1131]

For the reasons discussed in the Proposing Release and below, we believe it is important for money market funds to inform existing and prospective shareholders of any present occasion on which the fund receives financial support from a sponsor or other fund affiliate.[1132] In particular, we believe this disclosure could influence prospective shareholders' decision to purchase shares of the fund and could inform shareholders' assessment of the ongoing risks associated with an investment in the fund. While commenters also raised concerns about the potential redundancy of the proposed registration statement, Web site, and Form N-CR disclosure requirements,[1133] we believe that Web site disclosure provides significant informational accessibility to shareholders and that format and timing of this disclosure serves a different purpose than the Form N-CR filing requirement.[1134]

However, in response to commenter concerns about potentially duplicative disclosure requirements, we have modified the proposed disclosure requirements and are adopting amendments to rule 2a-7 that would require a fund to post on its Web site only a subset of the information that the fund is required to file on Form N-CR. A fund will only be required to present certain summary information about the receipt of financial support on its Web site (as well as in the fund's SAI [1135] ), and will be required to present more detailed discussion solely on Form N-CR.[1136] Specifically, a fund will be required to disclose on its Web site only that information that the fund is required to file on Form N-CR within one business day after the occurrence of any one or more of the events specified in Part C of Form N-CR (“Provision of Financial Support to Fund”).[1137] A fund thus will not be required, as proposed, to disclose the reason for support, term of support, and any contractual restrictions relating to support on its Web site, although a fund will be required to disclose this information on Start Printed Page 47834Form N-CR.[1138] We believe that the disclosure requirements we are adopting appropriately consider commenters' concerns about duplicative disclosure as well as our interest in requiring funds to disclose the primary information about affiliate financial support that we believe shareholders may find useful in assessing fund risks and determining whether to purchase fund shares. We also address general commenter concerns [1139] about the possible duplicative effects of the concurrent Web site and Form N-CR disclosures in section III.F.3 below, where we discuss how Form N-CR and Web site disclosure serve different purposes.[1140]

As proposed, we are requiring the Web site disclosure to be posted for a period of not less than one year following the date on which the fund filed Form N-CR concerning the event.[1141] As we stated in the Proposing Release, we believe that the one-year minimum time frame for Web site disclosure is appropriate because this time frame would effectively oblige a fund to post the required information in the interim period until the fund files an annual post-effective amendment updating its registration statement, which would incorporate the same information.[1142] We received no comments on this requirement, and we are adopting it as proposed.

h. Economic Analysis

As discussed above, and in our proposal, we are adopting a number of amendments to rule 2a-7 to amend a number of requirements that money market funds post certain information to funds' Web sites. These amendments require disclosure of information about money market funds' liquidity levels, shareholder flows, market-based NAV per share (rounded to four decimal places), and the use of affiliate financial support.[1143] The qualitative benefits and costs of these requirements are discussed above. These amendments should improve transparency and better inform shareholders about the risks of investing in money market funds, which should result in shareholders making investment decisions that better match their investment preferences. We believe that this will have effects on efficiency, competition, and capital formation that are similar to those that are outlined in the Macroeconomic Consequences section below.[1144]

We believe that the requirements could increase informational efficiency by providing additional information about money market funds' liquidity, shareholder flows, market-based NAV per share, imposition of fees and/or gates, and use of affiliate financial support, to investors and the Commission. This in turn could assist investors in analyzing the risks associated with certain funds. In particular, the daily disclosure of daily and weekly liquid assets, along with the daily disclosure of NAV to four decimal places, should better enable investors to understand the risks of a specific fund, which could increase allocative efficiency and could positively affect competition by permitting investors to choose whether to invest in certain funds based on this information. However, if investors were to move their assets among money market funds or decide to invest in investment products other than money market funds as a result of the disclosure requirements, this could adversely affect the competitive stance of certain money market funds, or the money market fund industry generally.

Certain parts of the disclosure amendments may have other specific effects on competition. To the extent some money market funds do not currently and voluntarily calculate and disclose daily market-based NAV per share data (rounded to the fourth decimal place), our amended disclosure requirements may promote competition by helping to level the associated costs incurred by all money market funds and neutralize any competitive advantage associated with determining not to calculate and disclose daily current per-share NAV. We also note that our amendment to require disclosure of affiliate sponsor support may adversely affect competition if investors move their assets to larger fund complexes on the theory that they may be more likely than smaller entities to provide financial support to their funds.

The requirements to disclose certain information about money market funds' liquidity, shareholder flows, market-based NAV per share, imposition of fees and/or gates, and use of affiliate financial support also could have effects on capital formation. The required disclosures may impose external market discipline on portfolio managers, which in turn could create market stability and enhance capital formation, if the resulting market stability encouraged more investors to invest in money market funds. However, the requirements could detract from capital formation by decreasing market stability if investors redeem more quickly during times of stress as a result of the disclosure requirements, and one commenter noted this increased risk as a potential cost to the fund.[1145] The required disclosure could assist the Commission in overseeing money market funds and developing regulatory policy affecting the money market fund industry, which might affect capital formation positively if the resulting regulatory framework more efficiently or more effectively encouraged investors to invest in money market funds.

The requirement to disclose the fund's current NAV to four decimal places should not have any effect on capital flows because funds will also transact at four decimal places. When compared to alternatives like ultra-short bond funds, which disclose and transact at three decimal places, money market prices may appear more volatile on a day-to-day basis if the greater precision in NAV disclosure leads to a greater frequency of fluctuations in NAV.[1146] This could incentivize investors to switch to these alternatives. However, over longer horizons like a month or a year these alternatives are likely to have more volatile NAVs than money market funds. The disclosure of daily and weekly liquid assets may increase the volatility of capital flows for money market funds, as it may create an incentive for investors to redeem shares when liquid assets fall or reach the threshold at which the board may impose a redemption fee or gate. Disclosing levels of liquid assets could lead to pre-emptive redemptions if daily Start Printed Page 47835or weekly liquid assets drop to a level at which investors anticipate that there is a greater likelihood of the fund imposing a redemption fee or gate. However, as discussed in detail above, the board's discretion to impose a fee or a gate mitigates the concern that investors will be able to accurately forecast such an event, leading them to pre-emptively withdraw their assets from the fund. We discuss this concern in more detail in section III.A.

A possible alternative suggested by commenters was to only have Web site disclosure apply to stable NAV funds.[1147] Allowing floating NAV funds not to disclose information on their Web site would lower the costs for these funds. Nevertheless, we rejected this alternative because we believe that the benefits we discuss above regarding disclosure apply regardless of whether a fund has a stable or floating NAV. Both types of funds, for example, could impose a fee or a gate so this information is valuable to both types of investors and, if only offered to one, could affect competition. For example, if a stable NAV investor has more information than a floating NAV investor about a possible fee or gate, then it is reasonable to assume that a stable NAV investor would have more confidence in his or her investment. The added disclosure for stable NAV funds could also increase market discipline in these funds, leading to investors' increased willingness to participate in this market and increase capital formation in these funds.

Another alternative would have been to require weekly instead of daily Web site disclosure of the daily and weekly liquid assets and net shareholder flow.[1148] Being required to disclose this information weekly instead of daily would lower the costs on funds because they would not have to report daily. However, we rejected this alternative because, as discussed above, in times of market stress, money market funds may face rapid, heavy redemptions, which could quickly affect their liquidity. These stresses could happen over a period of a day. As such, if investors have confidence that they will have the necessary information to make an informed decision quickly in a time of stress, then this may lead to additional capital for funds. Likewise, we also believe that daily disclosure instead of weekly could lead to more market discipline among funds, resulting in investors' increased willingness to participate in this market, which could also lead to additional capital for funds.

i. Costs of Disclosure of Daily and Weekly Liquid Assets and Net Shareholder Flows

Costs associated with the requirement for a fund to disclose information about its daily liquid assets, weekly liquid assets, and net shareholder flows on the fund's Web site include initial, one-time costs, as well as ongoing costs. Initial costs include the costs to design the schedule, chart, graph, or other depiction showing historical liquidity and flow information in a manner that clearly communicates the required information and to make the necessary software programming changes to the fund's Web site to present the depiction in a manner that can be updated each business day. Funds also would incur ongoing costs to update the depiction of daily liquid assets and weekly liquid assets and net shareholder flows each business day.[1149] The Proposing Release estimated that the average one-time costs for each money market fund to design and present the historical depiction of daily liquid assets and weekly liquid assets, as well as the fund's net inflows or outflows, would be $20,150.[1150] The Proposing Release also estimated that the average ongoing annual costs that each fund would incur to update the required disclosure would be $9,184.[1151]

In the Proposing Release, we stated that we believed funds should incur no additional costs in obtaining the percentage of daily liquid assets and weekly liquid assets, as funds are currently required to make such calculation under rule 2a-7. One commenter disagreed, noting that there would be costs because of additional controls associated with public disclosure, but did not provide a quantitative estimate of such costs.[1152] Two commenters generally believed that weekly disclosure of the data, as opposed to daily disclosure, would substantially reduce costs to funds, but they did not provide a quantitative estimate of the difference between the cost of daily and weekly disclosure.[1153] Additionally, one commenter objected to including historical information regarding weekly and daily liquid assets and net shareholder flows on a fund's Web site because of the expense involved in restructuring fund Web sites and maintaining such information, but did not provide a quantitative estimate of such expenses.[1154] One commenter also noted the potential cost of the risk of shareholders making redemption decisions in reliance on the disclosed information.[1155] The commenter, however, did not provide a quantitative estimate for this risk.[1156]

We agree that the costs for certain money market funds to upgrade internal systems and software, and/or engage third-party service providers if a money market fund does not have existing relevant systems, could be higher than those average one-time costs estimated in the Proposing Release. However, because the estimated one-time costs were based on the mid-point of a range of estimated costs, the higher costs that may be incurred by certain industry participants have already been factored into our estimates.[1157] While requiring weekly disclosure instead of daily disclosure could reduce costs for funds, we continue to believe that daily disclosure would convey important information to shareholders that weekly disclosure may not.[1158] We also believe that the benefits of increased transparency that would result from the disclosure requirements at hand outweigh the potential costs of reactionary redemptions resulting from the disclosure.[1159] The Commission agrees that money market funds may incur additional costs associated with the enhanced controls required to publicly disseminate daily and weekly liquid asset data, which costs were not estimated in the Proposing Release. The Commission has incorporated these additional costs into its new estimates of ongoing annual costs.

Based on these considerations, as well as updated industry data, we now estimate that the average one-time costs for each money market fund to design and present the historical depiction of daily liquid assets and weekly liquid assets, as well as the fund's net inflows or outflows, would be $20,280.[1160] We Start Printed Page 47836also estimate that the average ongoing annual costs that each fund would incur to update the required disclosure would be $10,274.[1161] Our estimate of average ongoing annual costs incorporates the costs associated with the enhanced controls required to publicly disseminate daily and weekly liquid asset data.[1162]

ii. Costs of Disclosure of Fund's Current NAV Per Share

Costs associated with the requirement for a fund to disclose information about its daily current NAV on the fund's Web site include initial, one-time costs, as well as ongoing costs. Initial costs include the costs to design the schedule, chart, graph, or other depiction showing historical NAV information in a manner that clearly communicates the required information and to make the necessary software programming changes to the fund's Web site to present the depiction in a manner that will be able to be updated each business day. Funds also would incur ongoing costs to update the depiction of the fund's current NAV each business day. Because floating NAV money market funds will be required to calculate their sale and redemption price each day, these funds should incur no additional costs in obtaining this data for purposes of the disclosure requirements. Stable price money market funds, which will be required to calculate their current NAV per share daily pursuant to amendments to rule 2a-7, likewise should incur no additional costs in obtaining this data for purposes of the disclosure requirements. The Proposing Release estimated that the average one-time costs for each money market fund to design and present the fund's current NAV each business day would be $20,150.[1163] The Commission also estimated that the average ongoing annual costs that each fund would incur to update the required disclosure would be $9,184.[1164]

Certain commenters generally noted that complying with the new Web site disclosure requirements would add costs for funds, including costs to upgrade internal systems and software relevant to the Web site disclosure requirements, as well as costs to engage third-party service providers for those money market fund managers that do not have existing relevant systems.[1165] One commenter noted that these costs could potentially be “significant to [a money market fund] and higher than those estimated in the Proposal.” [1166] However, another commenter stated that it agrees that those money market funds that presently publicize their current NAV per share daily on the fund's Web site will incur few additional costs to comply with the proposed disclosure requirements, and also that it agrees with the Commission's estimates for the ongoing costs of providing a depiction of the fund's current NAV each business day.[1167]

We agree that the costs for certain money market funds to upgrade internal systems and software, and/or engage third-party service providers if a money market fund does not have existing relevant systems, could be higher than those average one-time costs estimated in the Proposing Release. However, because the estimated one-time costs were based on the mid-point of a range of estimated costs, the higher costs that may be incurred by certain industry participants have already been factored into our estimates.[1168] Based on these considerations, as well as updated industry data, we now estimate that the average one-time costs for each money market fund to design and present the fund's daily current NAV would be $20,280.[1169] We also estimate that the average ongoing annual costs that each fund would incur to update the required disclosure would be $9,024.[1170]

iii. Costs of Daily Calculation of Current NAV per Share

The primary costs associated with the requirement for a fund to calculate its current NAV per share each day are the costs for funds to determine the current values of their portfolio securities each day.[1171] We estimate that 25% of active money market funds, or 140 funds, will incur new costs to comply with this requirement,[1172] because the requirement will result in no additional costs for those money market funds that presently determine their current NAV per share daily on a voluntary basis.[1173] The Proposing Release estimated that the average additional annual costs that a fund would incur associated with calculating its current NAV daily would range from $6,111 to $24,444.[1174] One commenter stated that it agrees with the Commission's estimates for the ongoing costs of providing a depiction of the fund's current NAV each business day.[1175] However, most comments on the proposed current NAV disclosure requirement did not discuss the Commission's estimates of the costs a fund would incur to calculate its current NAV per share daily, separate from their discussion of the general costs Start Printed Page 47837associated with the proposed NAV Web site disclosure requirement.[1176] After considering these comments, our current methods of estimating the costs associated with the NAV calculation requirement, described in more detail below, are the same estimation methods we used in the Proposing Release.

All money market funds are presently required to disclose their market-based NAV per share monthly on Form N-MFP, and the frequency of this disclosure will increase to weekly.[1177] As discussed below, some money market funds license a software solution from a third party that is used to assist the funds to prepare and file the information that Form N-MFP requires, and some funds retain the services of a third party to provide data aggregation and validation services as part of preparing and filing of reports on Form N-MFP on behalf of the fund.[1178] We expect, based on conversations with industry representatives, that money market funds that do not presently calculate the current values of their portfolio securities each day generally would use the same software or service providers to calculate the fund's current NAV per share daily that they presently use to prepare and file Form N-MFP.[1179] For these funds, the associated base costs of using this software or these service providers should not be considered new costs. However, the third-party software suppliers or service providers may charge more to funds to calculate a fund's current NAV per share daily, which costs would be passed on to the fund. While we do not have the information necessary to provide a point estimate (as such estimate would depend on a variety of factors, including discounts relating to volume and economies of scale, which pricing services may provide to certain funds), we estimate that the average additional annual costs that a fund would incur associated with calculating its current NAV daily would range from $6,111 to $24,444.[1180] Assuming, as discussed above, that 140 money market funds do not presently determine and publish their current NAV per share daily, the average additional annual cost that these 140 funds will collectively incur would range from $855,540 to $3,422,160.[1181] These costs could be less than our estimates if funds were to receive significant discounts based on economies of scale or the volume of securities being priced.

iv. Costs of Harmonization of Rule 2a-7 and Form N-MFP Portfolio Holdings Disclosure Requirements

Because the new portfolio holdings information that a fund is required to present on its Web site overlaps with the information that a fund would be required to disclose on Form N-MFP, we believe that the costs a fund will incur to draft and finalize the disclosure that will appear on its Web site will largely be incurred when the fund files Form N-MFP, as discussed below in section III.G. The Proposing Release estimated that, in addition, a fund would incur annual costs of $2,484 associated with updating its Web site to include the required monthly disclosure.[1182]

As discussed above, certain commenters generally noted that complying with the new Web site disclosure requirements would add costs for funds, including costs to upgrade internal systems and software relevant to the Web site disclosure requirements, as well as costs to engage third-party service providers for those money market fund managers that do not have existing relevant systems.[1183] One commenter, however, noted that the portfolio holdings disclosure requirements “should not cause a significant cost increase . . . as long as the information is made available from relevant accounting systems,”[1184] and another commenter stated that the proposed disclosure requirements generally should not produce any meaningful costs.[1185] Another commenter urged the Commission to harmonize new disclosure requirements so that funds would face lower administrative burdens, and investors would bear correspondingly fewer costs.[1186] As described above, the portfolio holdings disclosure requirements we are adopting have changed slightly from those that we proposed, in order to conform to modifications we are making to the proposed Form N-MFP disclosure requirements. However, we believe that these revisions do not produce additional burdens for funds and thus do not affect previous cost estimates. Because the 2010 money market fund reforms already require money market funds to post monthly portfolio information on their Web sites,[1187] funds should not need to upgrade their systems and software to comply with the new portfolio holdings information disclosure requirements. The Commission therefore does not believe that comments about the costs required to upgrade relevant systems and software should affect its estimates of the costs associated with the portfolio holdings disclosure requirements. Based on these considerations, as well as updated industry data, we now estimate that each fund would incur annual costs of $2,724 in updating its Web site to include the required monthly disclosure.[1188]

v. Costs of Disclosure Regarding Financial Support Received by the Fund, the Imposition and Removal of Liquidity Fees, and the Suspension and Resumption of Fund Redemptions

Because the required Web site disclosure overlaps with the information that a fund must disclose on Form N-CR when the fund receives financial support from a sponsor or fund affiliate, or when the fund imposes or removes liquidity fees or suspends or resumes fund redemptions, we anticipate that the costs a fund will incur to draft and finalize the disclosure that will appear on its Web site will largely be incurred when the fund files Form N-CR, as discussed below in section III.F. The Proposing Release estimated that, in addition, a fund Start Printed Page 47838would incur costs of $207 each time that it updates its Web site to include the required disclosure.[1189]

While certain commenters generally noted, as discussed above, that complying with the new Web site disclosure requirements would add costs for funds,[1190] one commenter stated that the costs of disclosing liquidity fees and gates and instances of financial support on the fund's Web site would be minimal when compared to other costs,[1191] and another commenter stated that the proposed disclosure requirements should not produce any meaningful costs.[1192] As described above, we have modified the required time frame for disclosing information about financial support received by a fund on the fund's Web site. However, this modification does not produce additional burdens for funds and thus does not affect previous cost estimates. Taking this into consideration, as well as the fact that we received no comments providing specific suggestions or critiques about our methods of estimating the burdens associated with the Form N-CR-linked Web site disclosure requirements, the Commission has not modified the estimated costs associated with these requirements, although it has modified its cost estimates based on updated industry data. We now estimate that a fund would incur costs of $227 each time that it updates its Web site to include the required disclosure.[1193]

F. Form N-CR

1. Introduction

Today we are adopting, largely as we proposed, a new requirement that money market funds file a current report with us when certain significant events occur.[1194] New Form N-CR will require disclosure of certain specified events. Generally, a money market fund will be required to file Form N-CR if a portfolio security defaults, an affiliate provides financial support to the fund, the fund experiences a significant decline in its shadow price, or when liquidity fees or redemption gates are imposed and when they are lifted.[1195] In most cases, a money market fund will be required to submit a brief summary filing on Form N-CR within one business day of the occurrence of the event, and a follow-up filing within four business days that includes a more complete description and information.[1196]

We proposed requiring reporting on Form N-CR under both the floating NAV and fees and gates reform alternatives, but the Form differed in certain respects depending on the alternative.[1197] Today we are adopting a combination of the alternatives, and therefore final Form N-CR is a combined single form.[1198]

As we stated in the Proposing Release,[1199] the information provided on Form N-CR will enable the Commission to enhance its oversight of money market funds and its ability to respond to market events. The Commission will be able to use the information provided on Form N-CR in its regulatory, disclosure review, inspection, and policymaking roles. Requiring funds to report these events on Form N-CR will provide important transparency to fund shareholders, and also will provide information more uniformly and efficiently to the Commission. It will also provide investors and other market observers with better and more timely disclosure of potentially important events.

Commenters generally supported new Form N-CR.[1200] For example, one commenter noted that Form N-CR would generally “[alert] the SEC to issues the funds may be having” and “[provide] the public with current information that investors need.”[1201] On the other hand, some commenters also voiced objections, suggesting that the form may be burdensome or redundant, and also offered specific improvements.[1202] As discussed in more detail below, we are making various changes to Form N-CR to address some of these concerns. However, while we appreciate commenters' concerns about possible redundancies of Form N-CR in light of the concurrent Web site or SAI disclosures, we believe each of these different disclosures to be appropriate because they serve distinct purposes.[1203]

2. Part B: Defaults and Events of Insolvency

Part B of Form N-CR is being adopted largely as proposed.[1204] We are Start Printed Page 47839adopting, as proposed, the requirement that a money market fund report to us if the issuer or guarantor of a security that makes up more than one half of one percent of a fund's total assets defaults or becomes insolvent.[1205] Such a report will, also as proposed, include the nature and financial effect of the default or event of insolvency, as well as the security or securities affected.[1206] As we noted in the Proposing Release, the Commission believes that the factors specified in the required disclosure are necessary to understand the nature and extent of a default, as well as the potential effect of a default on the fund's operations and its portfolio as a whole.[1207]

As stated above, we proposed to require disclosure of the security or securities affected by the default.[1208] In a change from the proposal, to help us better identify defaulted portfolio securities, the final form now requires funds to report the name of the issuer, the title of the issue and at least two identifiers, if available (e.g., CUSIP, ISIN, CIK, Legal Entity Identifier (“LEI”)) when they file a report under part B of the form.[1209] This requirement is similar to what we proposed and are adopting with respect to Items C.1 to C.5 of Form N-MFP.[1210] In particular, better identification of the particular fund portfolio security or securities subject to a default or event of insolvency at the time of notice to the Commission will facilitate the staff's monitoring and analysis efforts, as well as inform any action that may be required in response to the risks posed by such an event. Fund shareholders and potential investors will similarly benefit from the clear identification of defaulted fund portfolio securities when evaluating their investments.[1211]

One commenter expressed concern that publicly identifying a single security that has defaulted could be problematic if other contextual information about the quality of the fund's other holding is not immediately available.[1212] We note that the Form N-CR report will provide the value as well as the relative size of any defaulted security compared to the rest of a fund's portfolio, providing some context for the default. In addition, as further described in section III.F.6 below, we are also adopting a new Part H of Form N-CR that will permit money market funds, in their discretion, to discuss any other events or information that they may consider material or relevant, which should allow for additional context if necessary.

3. Part C: Financial Support

We are also adopting a requirement that money market funds report instances of financial support by sponsors or other affiliates on Part C of Form N-CR [1213] with several changes from the proposal.[1214] We have modified the definition of financial support from the proposal in response to comments, as discussed below. This revised definition will affect when Part C needs to be filed. When filed, the Part C report will, as proposed, require disclosure of the nature, amount, and terms of the support, as well as the relationship between the person providing the support and the fund [1215] Start Printed Page 47840except that, in a change from the proposal, the report will also require certain identifying information about securities that are the subject of any financial support.[1216]

As we noted in the Proposing Release, we believe that requiring disclosure of financial support from a fund sponsor or affiliate will provide important, near real-time transparency to shareholders and the Commission, and will therefore help shareholders better understand the ongoing risks associated with an investment in the fund.[1217] The information provided in the required disclosure is necessary for investors to understand the nature and extent of the sponsor's discretionary support of the fund and will also assist Commission staff in analyzing the economic effects of such financial support.[1218]

a. Definition of Financial Support

Although a number of commenters generally supported the proposed financial support disclosure,[1219] many of these supporters and other commenters also argued that the proposed definition of “financial support” was ambiguous and could trigger unnecessary filings.[1220] Many commenters suggested that the catchall provision of the proposed definition, which would require reporting of “any other similar action to increase the value of the Fund's portfolio or otherwise support the Fund during times of stress,” was too broad.[1221] Some commenters stated that the proposed definition would trigger reports on Form N-CR of routine transactions that occur in the ordinary course of business, which do not indicate stress on the fund.[1222] For example, a few commenters suggested that the proposed definition would result in Form N-CR filings with respect to ordinary fee waivers and expense reimbursements, inter-fund lending, purchases of fund shares, reimbursements made by the sponsor in error, and certain other routine fund transactions.[1223] Because many of the above actions likely would not indicate stress on a fund, commenters noted that reporting these actions would not enhance investors' ability to fully appreciate the risks of investing in a fund, potentially lead to further investor confusion and possibly even cause “disclosure fatigue” among investors.[1224] We also were asked to clarify what constitutes financial support in order to standardize disclosures by different funds.[1225]

We appreciate these commenters' concerns, and are today amending the final definition of “financial support” to minimize unnecessary filings of Form N-CR and reduce inconsistencies among different filers. In response to these comments, we are, among other things, modifying the rule text to specify that certain routine actions, and actions not reasonably intended to increase or stabilize the value or liquidity of the fund's portfolio, do not need to be reported as financial support on Form N-CR, as discussed below.[1226] The revised definition should help avoid Form N-CR filings that do not represent actions that the Commission, shareholders, and other market observers would consider significant enough in evaluating or monitoring for financial support. Each item of financial support in the definition is the same as was proposed, except we have deleted “purchase of fund shares” from the definition, we have refined the “catch-all provision,” and we have added several exclusions, all discussed below.

As we are adopting it today, the term “financial support” is defined to include (i) any capital contribution, (ii) purchase of a security from the fund in reliance on rule 17a-9, (iii) purchase of any defaulted or devalued security at par, (iv) execution of letter of credit or Start Printed Page 47841letter of indemnity, (v) capital support agreement (whether or not the fund ultimately received support), (vi) performance guarantee, (vii) or any other similar action reasonably intended to increase or stabilize the value or liquidity of the fund's portfolio; excluding, however, any (i) routine waiver of fees or reimbursement of fund expenses, (ii) routine inter-fund lending, (iii) routine inter-fund purchases of fund shares, or (iv) any action that would qualify as financial support as defined above, that the board of directors has otherwise determined not to be reasonably intended to increase or stabilize the value or liquidity of the fund's portfolio.[1227]

As some commenters suggested,[1228] we are refining the “catch-all” provision of the financial support definition.[1229] In the Proposing Release, we had proposed to require disclosure of “any other similar action to increase the value of the fund's portfolio or otherwise support the fund during times of stress.” [1230] Under the final definition, we are changing this provision to read: “any other similar action reasonably intended to increase or stabilize the value or liquidity of the Fund's portfolio.” [1231] In particular, we have eliminated the phrases “otherwise support” and “during times of stress” contained in the proposed definition to address more general concerns that the “catch-all” provision was too vague and could be subject to different interpretations by different funds.[1232] We also eliminated the phrase “during times of stress” because sponsors may also provide support pre-emptively, before a fund is experiencing any actual stress. Instead, we believe this new intentionality standard [1233] should serve to reduce the chance that a fund would need to report an action on Form N-CR that does not represent true financial support that the Commission or investors would likely be concerned with. By focusing on the primary intended effects of sponsor support—increasing or stabilizing the value or liquidity of a fund's portfolio [1234] —we believe the revised “catch-all” provision will better capture actions that the Commission, shareholders, and other market observers would consider significant in evaluating or monitoring for financial support.[1235] Actions that would likely fall within this “catch-all” provision include, for example, the purchase of a defaulted or devalued security at a price above fair value, or exchanges of securities with longer maturities for ones with shorter maturities.

We have also added exclusions to the definition in a change from the proposal. The revised definition of financial support explicitly excludes routine waivers of fees or reimbursement of fund expenses, routine inter-fund lending, and routine inter-fund purchases of fund shares.[1236] We agree with commenters that the actions we are excluding from the final definition are not generally indicative of stress at a fund.[1237] Correspondingly, we have also deleted purchases of fund shares as one of the items that had been explicitly included in the proposed definition.[1238] We note that these actions must be “routine” meaning that any such actions are excluded only to the extent they are not reasonably intended to increase or stabilize the value or liquidity of the fund's portfolio.[1239]

The final definition of financial support also includes a new intentionality exclusion that may be invoked by boards.[1240] Under this new exclusion, a particular action need not be reported as financial support under Part C of Form N-CR if the board of directors of the fund finds that the action was not “reasonably intended to increase or stabilize the value or liquidity of the Fund's portfolio.” We are adding this exclusion as a way to address certain remaining concerns by commenters about the reporting of actions that might otherwise still technically fall within the definition of financial support, but are not intended as such.[1241] During times of fund or market stress, however, we believe that boards likely would find it difficult to determine that a particular action that is otherwise captured by the definition of financial support should be excluded under this intentionality exception. We recognize that an action may be made for a number of reasons, but note that if an intent of the action is to increase or stabilize the value or liquidity of the Fund's portfolio, even if that is not the primary or sole purpose of the action, then it must be reported on the Start Printed Page 47842Form.[1242] As is the case with any board determination, boards would typically record in the board minutes the bases of any such determinations by the board.[1243]

b. Amount of Support

In the Proposing Release, we proposed that filers disclose, among other things, the “amount of support” in Part C of Form N-CR.[1244] One commenter asked the Commission to clarify the “amount” of financial support that they must report under Part C of the form to avoid misleading disclosures and to facilitate comparability in disclosures across the industry.[1245] For example, in the case of a purchase of a security from the fund, this commenter believed that it may be misleading to report the size of the position purchased as the “amount” supported and rather thought the amount of support should be the increase in the fund's NAV that results from the purchase. This commenter also asked that the Commission clarify that SEC staff interpretations relating to reporting the valuation of capital support agreements on Form N-MFP would be applicable for these purposes.[1246]

Below we are providing guidance to clarify what amounts should be reported specifically with respect to share purchases on Part C of Form N-CR. With respect to share purchases in particular, we disagree with the commenter that when financial support is provided through the purchase of a fund portfolio security, the size of the security position purchased is not relevant in considering the amount of support. When a distressed or potentially distressed security is purchased out of a fund's portfolio, support can be provided in two ways. First, if it is purchased at amortized cost and the security's market-based value is below amortized cost, one measure of the amount of support is the amount of the security's impairment below amortized cost. However, the purchase of the security position from the fund also removes this entire risk exposure from the fund and protects the fund from subsequent further price declines in the security. Accordingly, we believe that the size of the position purchased from the fund is also relevant when considering the “amount” of financial support. Therefore, in such a case filers should report under Part C of Form N-CR the following two separate items with respect to the “amount” of financial support: (i) The amount of the impairment below amortized cost in the security purchased and (ii) the amortized cost value of the securities purchased.

In the case of a capital support agreement, historically such agreements have supported a particular security position while others, as noted by a commenter, may support the market-based NAV per share of the fund as a whole.[1247] Where a capital support agreement is supporting a particular security position, we would consider the amount of reportable financial support on Form N-CR similar to that described above relating to purchases of portfolio securities. That is, the “amount” of financial support is the amount of security impairment effectively removed through the capital support agreement as well as the amortized cost value of the overall position supported (assuming the entire position is subject to the capital support agreement). For a capital support agreement that supports the fund as a whole, the amount of reportable financial support is the amount of impairment to the fund's NAV per share effectively removed through the capital support agreement with a notation describing that the capital support agreement supports the value of the fund as a whole (or the extent of the fund's value that is supported, if less than the full amortized cost value).

This guidance differs somewhat from the staff guidance relating to capital support agreement disclosures on Form N-MFP because the context differs. Form N-MFP already requires reporting on the overall size of the security position reported (and information about the size of the fund), so the additional capital support agreement reporting focuses on valuing the impairment effectively removed through the capital support agreement. Our guidance regarding “amount” of financial support reportable on Form N-CR for capital support agreements thus provides similar information to that which could be collectively determined by reviewing various Form N-MFP line items.

c. Concerns Over Potential Redundancy

One commenter argued that the financial support disclosure in Form N-CR is redundant in light of the corresponding financial support disclosures in the SAI, raising concerns about the additional preparation costs and burdens on fund personnel.[1248] More generally, commenters were also concerned about the redundancy of various other Parts of Form N-CR, Form N-CR as a whole, and even the various proposed disclosures in the aggregate.[1249] While we appreciate these concerns and have considered the costs and burdens of Form N-CR,[1250] we note that each of the Form N-CR and the corresponding Web site and SAI disclosure requirements serves a distinct purpose.[1251] Therefore, although we acknowledge there will be some textual overlap between these different formats, we believe there are strong public policy reasons for requiring the various different disclosures. We also note that we have required other such parallel reporting for similar reasons.[1252]

Most significantly, Form N-CR will alert Commission staff, shareholders and other market observers about any reportable events on Form N-CR Start Printed Page 47843(including any financial support) on a near real-time basis.[1253] In particular, Form N-CR will enable the Commission and other market observers to better monitor the entire fund industry, as they will be able to locate on EDGAR all Form N-CR reports specific to any particular time frame without having to search through the SAIs of all the funds in the industry. We expect financial news services to be among the market observers who will benefit from Form N-CR, which in turn could then also alert investors about these important developments more expeditiously.[1254] Although any corresponding SAI disclosures will also be available on EDGAR, because SAI filings contain many other disclosures (including those unrelated to financial support or the other reportable events on Form N-CR), it could take significant amounts of time for the Commission and other market observers (such as the aforementioned financial news services) to continually review all SAI filings for any relevant alerts.[1255] Similarly, we believe it would be significantly more time-consuming, if not impractical, if the Commission and other market observers had to continually check each fund's Web site for any relevant updates.[1256] We therefore believe that the corresponding Web site and SAI disclosures alone would not accomplish the primary goal of Form N-CR in alerting the Commission, investors and other market observers about important events in a timely and meaningful manner. Moreover, we note that certain Parts of Form N-CR as amended today will require more extensive disclosures than either the corresponding Web site or SAI disclosures,[1257] which further minimizes the degree to which there would have been any functionally overlapping disclosures. Finally, Form N-CR filings will also provide a permanent historical record of any financial support provided to the entire money market fund industry, which will be accessible on EDGAR.

On the other hand, we believe that the consolidated discussion in the SAI will be the most accessible format for disclosing historical instances of sponsor support in the past 10 years, as it would be a significant burden on the Commission, investors and other market observers if they had to review various prior Form N-CR filings to piece together a specific fund's history of sponsor support,[1258] even in light of the additional costs and burdens faced by funds in providing these SAI disclosures.[1259] We also believe that, to the extent investors may not be familiar with researching filings on EDGAR, including these disclosures in a fund's SAI (which investors may receive in hard copy through the U.S. Postal Service or may access on a fund's Web site, as well as accessing on EDGAR) may make this information more readily available to these investors than disclosure on other SEC forms that are solely accessible on EDGAR.

Similarly, the Web site disclosures are intended to be more accessible than Form N-CR for individual investors interested in information about particular funds, in particular to the extent such investors may not be familiar with researching filings on EDGAR.[1260] Given that individual investors are typically most interested in information about their own (or potential) investments and do not necessarily monitor the entire fund industry, visiting the Web sites of a few particular funds would likely not become overly time-consuming or burdensome for these investors.[1261]

4. Part D: Declines in Shadow Price

Part D of Form N-CR will, as proposed, require funds that transact at a stable price to file a report when the fund's current NAV per share deviates downward from its intended stable price (generally, $1.00) by more than 1/4 of 1 percent (i.e., generally below $0.9975).[1262] Today we are adopting Part D of Form N-CR largely as proposed.[1263] As we discussed in the Start Printed Page 47844Proposing Release,[1264] this requirement will not only permit the Commission and others to better monitor indicators of stress in specific funds or fund groups and in the industry, but also will help increase money market funds' transparency and permit investors to better understand money market funds' risks.[1265] To better understand the cause of such a decline in the fund's shadow price, we are also requiring, largely as proposed, funds to provide the principal reason or reasons[1266] for the reduction, which would involve identifying the particular securities or events that prompted the decline.[1267] In a change from the proposal, we are also requiring the disclosure of the same identifying information included in other parts of the Form.[1268] In particular, the final amendments to Item D.3 also now require funds to report the name of the issuer, the title of the issue and at least two identifiers, if available.[1269] In particular, better identification of the particular fund portfolio security or securities that may have prompted a shadow price decline will facilitate the staff's monitoring and analysis efforts, which we expect to help us better understand the nature and extent of the shadow price decline, the potential effect on the fund, potential contagion risk across funds more broadly, as well as inform any action that may be required in response to the risks posed by such an event. Fund shareholders and potential investors will similarly benefit from the clear identification of a fund portfolio security or securities that may have prompted a shadow price decline when evaluating their investments.[1270]

Some commenters expressed concerns about the reporting of shadow price declines on Form N-CR. For example, commenters argued that it would be redundant and unduly burdensome in light of funds' concurrent Web site disclosure of the shadow price.[1271] However, as already discussed with respect to the various concurrent disclosures of financial support in section III.F.3 above, while we are sensitive to commenters' concerns about duplication, we believe it appropriate given the different audiences and uses for such information.[1272]

With respect to the particular deviation threshold of 1/4 of 1 percent that we are adopting today as proposed, one commenter considered this level of deviation to be arbitrary, “as there are no other implications under Rule 2a-7 for the money market fund if it has a 25 basis point deviation.”[1273] However, as noted in the Proposing Release,[1274] we continue to believe that a deviation of 1/4 of 1 percent is sufficiently significant that it could signal future, further deviations in the fund's NAV that could require a stable price fund's board to consider re-pricing the fund's shares (among other actions). We note that we previously have similarly determined that a 1/4 of one percent decline in the shadow price from its intended stable price is an appropriate threshold requiring money market funds to report to us.[1275] Moreover, if a Form N-CR filing were not triggered until a higher threshold such as after a fall in the NAV that would require the re-pricing of fund shares (such as 0.5%),[1276] the disclosures would come too late to meaningfully allow the Commission and others to effectively monitor and respond to indicators of stress. We also believe a threshold of 1/4 of 1 percent strikes an appropriate balance with respect to the frequency of filings, because during periods of normal market activity we would expect relatively few Form N-CR filings for this part of the form.[1277] In fact, our staff has analyzed Form N-MFP data from November 2010 to February 2014 and found that only one fund had a 1/4 of 1 percent deviation from the stable $1.00 per share NAV, suggesting the burden to funds would be minimal during normal market activity. We note that funds may also provide additional context about the circumstances leading to the shadow price decline in Part H of Form N-CR, discussed below.

Another commenter suggested that disclosure of a deviation in the NAV might result in an increase in pre-emptive run risk, as shareholders could come to use these filings as a trigger for redemptions.[1278] Although we cannot predict individual shareholder actions with certainty, as discussed previously, we believe that the transparency provided by this information is important to the ability of money market fund shareholders to understand and assess the risks of their investments. Furthermore, while we acknowledge the possibility of pre-emptive redemptions, some of the other reforms we are adopting today (such as liquidity fees and redemption gates) will provide some fund managers additional tools for managing such redemptions, if they were to occur. We also note that some of our responses in section III.A.1.c.i to concerns over pre-emptive run risk related to the liquidity fees and gates requirement would similarly apply to run risk concerns over the disclosure of a deviation in the NAV in Part D of Form N-CR.[1279] More generally, we Start Printed Page 47845expect that Form N-CR could decrease, rather than increase, redemption risk by heightening self-discipline at funds.[1280]

5. Parts E, F, and G: Imposition and Lifting of Liquidity Fees and Gates

Today we are adopting a requirement that a money market fund file a report on Form N-CR when a fund imposes or lifts a liquidity fee or redemption gate, or if a fund does not impose a liquidity fee despite passing certain liquidity thresholds.[1281] As discussed in more detail below, we are making some changes from what we proposed.[1282] This report, as adopted, will require a description of the primary considerations the board took into account in taking the action (modified from the proposal and discussed below), as well as certain additional basic information, such as the date when the fee or gate was imposed or lifted, the fund's liquidity levels, and the size of the fee.[1283] Except for the change to the requirement to describe the primary considerations the board took into account in taking the action, the other changes to Parts E, F and G generally derive from the amendments to the liquidity fees and gates requirements that are being adopted today and are designed to conform these Parts of Form N-CR to those operative requirements. These changes are discussed below.[1284]

As we noted in the Proposing Release, we believe that the items required to be disclosed are necessary for investors and us better to understand the circumstances leading to the imposition or removal of a liquidity fee or redemption gate, or the decision not to impose one despite a reduction in liquidity.[1285] We believe such a better understanding will in turn enhance the Commission's oversight of the fund and regulation of money market funds generally,[1286] and could inform investors' decisions to purchase shares of the fund or remain invested in the fund.[1287]

a. Board Disclosures

A number of commenters objected to the proposed requirement that funds provide a “short discussion of the board of director's analysis supporting its decision” [1288] whether or not to impose liquidity fees or when imposing redemption gates.[1289] Many of these commenters raised concerns that the disclosures might chill deliberations among board members, hinder board confidentiality and encourage opportunistic litigation.[1290] More generally, commenters also challenged the materiality or usefulness of the board disclosures to investors.[1291] For example, one commenter stated that although “whether the fund is imposing a liquidity fee or suspending redemptions” would be material, the board's underlying analysis would not be.[1292] Some commenters also expressed concern that such disclosure would set a precedent for board disclosures in other contexts.[1293]

Start Printed Page 47846

We appreciate these concerns, but we believe that the imposition of a fee or gate is likely to be a very significant event for a money market fund [1294] and information about why it was imposed may prove pivotal to shareholders, many of whom may be evaluating their investment decision in the money market fund at that time.[1295] Accordingly, as discussed in the Proposing Release, we continue to believe that shareholders have a strong interest in understanding why a board determined to impose (or not to impose) a liquidity fee or gate.[1296] For example, this information may enable investors to better understand the events that are affecting and potentially causing stress to the fund.[1297] This information may also permit investors to confirm that the board is, as our rule requires, acting in the best interests of the fund.[1298] And given that under our final rules a board can impose a fee or gate as soon as the fund's weekly liquid assets fall below the 30% regulatory minimum (and thus different boards may impose fees or gates at different times), investors' interest in understanding the board's reasoning is likely to be even more important.[1299] For these reasons, we believe this disclosure will convey material information to those investors who are considering whether to redeem their shares in response to a fee or gate.

With respect to concerns that the board disclosures set a precedent implying that the reasoning underlying every other important decision taken by the board should be similarly disclosed,[1300] we disagree. As discussed in section II.A, ready access to liquidity is one of the hallmarks that has made money market funds popular cash management vehicles for both retail and institutional investors. Because liquidity fees and redemption gates could affect this core feature by potentially limiting the redeemability of money market fund shares under certain conditions,[1301] we believe the decision whether to impose those measures is sufficiently different in kind from most other significant decisions a board could make that the disclosures required by the rule would not be a precedent for broadly requiring the disclosure of boards' rationales in other contexts.

In addition, we have amended this disclosure requirement to address some of the commenters' concerns, while still eliciting useful information for the Commission and investors. More specifically, we are revising Form N-CR to require disclosure of a brief discussion of the “primary considerations or factors taken in account by the board of directors in its decision” to impose or not impose a liquidity fee or gate.[1302] One commenter suggested we make a similar change, requiring disclosure of “a list of material factors considered by the board in making its determination.” [1303] Rather than just a list of material factors, however, we believe it important that funds provide a more substantive, but brief, discussion of the primary considerations or factors taken in account by the board, so that our staff and investors better understand why the board determined they were important. This report would not need to include every factor considered by the board, only the most important or primary ones that shaped the determination of the board's action. This should help alleviate commenters' concerns that funds would need to provide lists of all possible factors or dissect a board's internal deliberations. Instead, we would expect only a description of the primary considerations or factors leading to the action taken by the board, and a brief discussion of each.

That said, we caution that in preparing these board disclosures, funds should avoid “boilerplate” summaries of all possible factors in addition to or in lieu of a more substantive narrative.[1304] Instead, filers generally should provide information that is tailored to their fund's particular situation and the context in which their board's decision was made. In preparing these filings, funds should consider discussing present circumstances as well as any potential future risks and contingencies to the extent the board took them into account. We also note that we provided a non-exhaustive list of possible factors that a board may have considered in imposing a liquidity fee or gate in section III.A.2.b above.[1305]

Another commenter argued that the board disclosures themselves might incite widespread redemptions, particularly where the board considered but chose not to impose a liquidity fee.[1306] As discussed in section III.A.1.c above, we acknowledge the possibility that the prospect of a liquidity fee or gate may cause pre-emptive redemptions, but we believe that several aspects of our final reforms both make pre-emptive runs less likely and substantially mitigate their broader effects if they occur. In addition, we believe disclosure of a board's reasoning is particularly important in times of stress in order to mitigate against investor flight to transparency that might otherwise occur.[1307]

Finally, we received comments discussing concerns about potentially Start Printed Page 47847duplicative disclosures, in particular the possible redundancy of the board disclosures on a fund's Web site as well as Form N-CR.[1308] However, as already discussed with respect to the various concurrent disclosures of financial support in section III.F.3 above, while we are sensitive to commenters' concerns about duplication, we believe it appropriate given the different audiences and uses for such information.[1309]

b. Conforming and Related Changes

As discussed earlier, the final amendments lower the weekly liquid asset threshold for triggering the default liquidity fee from 15% to 10% of total assets, and accordingly, we are making corresponding changes that would require reporting under Form N-CR at the lower weekly liquid asset threshold.[1310] In addition, in a change from the proposal, the final amendments permit money market fund boards to institute a liquidity fee or impose a gate at any time once weekly liquid assets fall below 30% if they find that doing so is in the best interests of the fund.[1311] We are therefore amending Form N-CR to reflect these changes.[1312] We are making certain additional changes to Form N-CR for clarity and to be consistent with our final amendments to the liquidity fees and gates requirement.[1313] Accordingly, under the revised reporting standard, Parts E and/or F of Form N-CR must be filed: (i) When a fund, at the end of a business day, has invested less than 10% of its portfolio in weekly liquid assets and is required to impose a liquidity fee (unless the board determines otherwise), or (ii) when a fund voluntarily imposes a liquidity fee or redemption gate any time it has invested less than 30% of its portfolio in weekly liquid assets.[1314]

In addition, revised Form N-CR includes a new requirement that funds report their level of weekly liquid assets at the time of the imposition of fees or gates.[1315] We believe this new requirement will allow the Commission and investors to better track and understand funds' liquidity levels when boards impose a fee or gate using their discretion, which we expect will enhance the Commission's and investors' ability to evaluate the extent to which a fund is experiencing stress as well as the context in which the board made its decision. Similarly, because we are revising the default liquidity fee from the proposed 2% to 1%, and thus we expect that there may be instances where liquidity fees are above or below the default fee (rather than just lower as permitted under the proposal), we are requiring that funds disclose the size of the liquidity fee, if one is imposed.[1316] In particular, we expect the particular size of the liquidity fee to be highly relevant to an investor determining whether to redeem fund shares, as it has a direct impact on the particular costs that such a shareholder would have to bear for redeeming fund shares. These changes are closely tailored to our final amendments to the liquidity fees and gate requirement, which we expect will enhance the quality and usefulness of Form N-CR to the Commission and investors.

6. Part H: Optional Disclosure

We are also adopting a new Part H in Form N-CR which allows money market funds the option to discuss any other events or information that they may wish to disclose. We intend new Part H to clarify and expand the scope and range of formats of any additional information that a fund may wish to provide. In particular, we are adopting Part H to address commenter concerns that the information provided in the other parts of Form N-CR may become outdated or lack context.[1317] We believe that this new optional disclosure could address some of these concerns.

This optional disclosure is intended to provide money market funds with additional flexibility to discuss any other information not required by Form N-CR, or to supplement and clarify other required disclosures.[1318] This optional disclosure does not impose on money market funds any affirmative obligation. Rather, this is solely intended as a discretionary forum where funds, if they so choose, can disclose any other information they deem helpful or relevant. In addition, although we expect that funds would typically file Part H along with a filing under another part of Form N-CR, we are not imposing any particular deadline for these filings, and thus a fund may file an optional disclosure on Part H of Form N-CR at any time.

7. Timing of Form N-CR

We are requiring initial filings of Form N-CR to be submitted within one business day of the triggering event, and in some cases, requiring a follow-up Start Printed Page 47848amendment with additional detail to be submitted four days after the event with some modifications from the proposal. A number of commenters requested additional time for Form N-CR filings, expressing concern over the timing requirements for specific items of Form N-CR,[1319] as well as objecting to the timing requirements more generally.[1320] For example, one commenter recommended that the filing deadline for the initial filing be extended from one to three business days and the follow-up filing from four to seven business days.[1321] Commenters argued that providing additional time would permit funds to ensure that filings are prepared accurately and thoughtfully [1322] while also better enabling fund personnel to prioritize other exigent matters during times of crisis.[1323] They also argued that it may not be feasible or may be extremely costly for a fund in times of crisis to formulate within one business day the actions it may take in response to an event of default and prepare a corresponding description, as required under the proposal.[1324] We are not changing the filing deadlines of Form N-CR. The Commission and shareholders have a significant interest in knowing about the events reported on Form N-CR as soon as possible, to be able to effectively monitor events and to respond as necessary. We believe the longer reporting periods or entirely alternative reporting format (such as periodic reports, which might not be filed until significantly later) as proposed by commenters would frustrate the intent of Form N-CR in alerting the Commission, investors and other market observers about such important events in a timely and meaningful manner.

We appreciate commenters' concerns, however, and to help ease the filing burden we are revising Form N-CR to move certain disclosures in Items B, C and D that may take longer to prepare from the initial filing due within a single day to the follow-up filing due in four business days.[1325] In particular, the items moved to the follow-up filing are the description of actions the fund plans to take, or has taken, in response to a default (Item B.5), the explanation for the reasons and terms of any financial support provided (Item C.8), the term of any financial support provided (Item C.9), the brief description of any contractual restrictions relating to any financial support (Item C.10), and the principal reason or reasons for a decline in a fund's shadow price (Item D.3).[1326] We appreciate commenters' concerns that disclosures such as these may take additional time to prepare.[1327] We believe these specific disclosure items may be more labor intensive and take longer to prepare because they generally solicit qualitative and analytical information, whereas the other items in Parts B through D generally focus more on initially alerting the Commission and shareholders about a particular event and other key quantitative data.[1328]

Reducing the number of items included in the initial filing and moving the more time consuming and complicated disclosures to a second filing is designed to help address commenters' concerns about the one-day deadline of the initial filing,[1329] while still ensuring that the Commission, shareholders and other market observers are provided with these critical alerts as quickly as possible. We expect the information filed on the initial report will be sufficient to alert the Commission, investors and other interested parties about certain significant events. While important, we also believe that the Items we are moving to the follow-up filing of Form N-CR may be of less immediate concern to the Commission and shareholders.

We are not, however, generally changing the one-day deadline of the initial filing,[1330] nor are we extending the four-day deadline for the follow-up filing of Form N-CR.[1331] We are concerned that extending the initial filing deadline beyond one business day could substantially diminish the informational utility of Form N-CR. The Commission and shareholders have a significant interest in knowing about the events reported on Form N-CR as soon as possible, to effectively monitor events and respond as necessary. We need this information to be reported promptly to effectively monitor money market funds that have come under stress and respond as necessary. A longer reporting period would frustrate the intent of Form N-CR in alerting the Commission, investors and other market observe