The Staff (the “Staff”) of the SEC’s Division of Investment Management recently wrote to the Investment Company Institute (the “ICI”) announcing that it would not recommend enforcement action if a money market fund board did not designate at least four nationally recognized statistical rating organizations (“NRSROs”) whose ratings would be used by the fund to determine the eligibility of portfolio securities for the purposes of Rule 2a-7 under the Investment Company Act of 1940.  The Staff also provided relief from related disclosure requirements for the designated NRSROs.  The compliance timeline for the February 2010 amendments to Rule 2a 7 and other rules affecting money market funds would have required a money market fund to comply with both provisions by December 31, 2010.

In its letter to the ICI, the Staff said that its no-action relief would remain in effect until the SEC determines whether to modify Rule 2a 7 and remove all references in the rule to NRSROs, as required by Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act (discussed in the July 28, 2010 Alert).  Until such modifications to Rule 2a 7, the Staff said that a money market fund must continue to comply with its obligations for determining and monitoring whether its securities, other than unrated asset backed securities, are or continue to be eligible securities for purposes of Rule 2a-7 as in effect before the February 2010 amendments to Rule 2a 7 took effect on May 5, 2010.  The Staff said that a money market fund may continue to acquire unrated asset-backed securities as permitted by the February 2010 amendments.  (Prior to the February 2010 amendments, a money market fund could acquire an asset-backed security only if the security was a rated security for purposes of Rule 2a-7.)

The Federal Reserve Bank of New York (the “FRB-NY”) expanded the number of counterparties eligible to participate with the FRB-NY in reverse repurchase agreements.  The new eligible participants are 26 money market funds (managed by a total of 14 investment managers, including, e.g., Bank of America, BlackRock, Fidelity, Goldman Sachs, Legg Mason, Vanguard and Wells Fargo).  The 26 new money market fund participants will join the existing 18 primary dealers currently eligible to participate in reverse repurchase transactions with the FRB-NY.  The addition of the 26 new potential counterparties is a matter of “prudent advance planning,” said the FRB-NY, and is intended to enable the FRB-NY, when it deems it appropriate, to lower bank reserves and tighten monetary policy.

The Staff of the SEC’s Division of Investment Management recently wrote to the Investment Company Institute (the “ICI”) and stated that a money market fund may treat a short-term floating rate security (“STFRS”) that is subject to an unconditional demand feature as a short term variable rate security (“STVRS”) for the purpose of calculating the fund’s dollar weighted average life to maturity (“WAL”).  Rule 2a-7 under the 1940 Act, which regulates all registered investment companies that hold themselves out as money market funds or which use the term “money market” or a similar term in their names, requires among other things that each money market fund maintain a WAL of 120 days or less.  Rule 2a-7(c)(2)(iii) provides that WAL is calculated without reference to the maturity shortening provisions in Rule 2a 7(d) regarding interest rate readjustments. [Read more →]

The Dodd-Frank Act, includes a change to the definition of an individual “accredited investor” in Regulation D under the Securities Act of 1933.  This provision would have an apparently immediate effect on companies of all types, including those outside the financial services industry, and on private funds.  Specifically, Section 413 of the Dodd Frank Act provides that the SEC must adjust the definition of “accredited investor” under Regulation D to exclude the value of a natural person’s primary residence when calculating that person’s net worth.  However, because Section 413 contemplates both that the SEC must act to give it effect and that the new standard takes effect on the date of enactment of the law (as show below, with emphasis added), there may be some ambiguity as to when this change actually takes effect.

“The Commission shall adjust any net worth standard for an accredited investor, as set forth in the rules of the Commission under the Securities Act of 1933, so that the individual net worth of any natural person, or joint net worth with the spouse of that person, at the time of purchase, is more than $1,000,000 (as such amount is adjusted periodically by rule of the Commission), excluding the value of the primary residence of such natural person, except that during the 4-year period that begins on the date of enactment of this Act, any net worth standard shall be $1,000,000, excluding the value of the primary residence of such natural person.”

Also, it is not clear when or how the SEC will act on this provision (and whether it might address the potential problem resulting from this uncertainty regarding timing).  Issuers in the process of preparing, distributing and accepting subscriptions in connection with a pending private placement relying on Regulation D may wish to consider obtaining appropriate representations from individual investors addressing the Dodd-Frank Act’s accredited investor standard even before the legislation is formally enacted.

The Staff of the SEC’s Division of Investment Management published responses to various questions relating to Rule 30b1-7 under the Investment Company Act of 1940, as amended (the “1940 Act”), and new Form N-MFP.  Rule 30b1-7 generally requires a money market fund to file a report of its portfolio holdings on Form N-MFP each month, with the portfolio holdings information becoming publicly available sixty days after the end of the month to which the report relates.  Rule 30b1-7 and Form N-MFP were adopted by the SEC in conjunction with the recent amendments to Rule 2a-7 under the 1940 Act and other rules relating to money market funds, which were discussed in the March 5, 2010 and June 1, 2010 Alerts.  Below is a summary of the Staff’s responses (with references to the relevant Items of Form N MFP, as applicable).  The compliance date for the requirements relating to Form N MFP is December 7, 2010.

SCOPE OF RULE 30b1-7

Any fund subject to Rule 2a-7 (that is, a registered investment company that holds itself out as a money market fund) must file a Form N-MFP each month, even if the fund does not maintain a stable share price using the amortized cost method or penny rounding method. [Read more →]

The Committee of European Securities Regulators (“CESR”) recently issued guidelines (the “Guidelines”) relating to any European fund that calls itself or markets itself as a “money market fund.”  The Guidelines cover both a UCITS fund (a fund that complies with the requirements of the European directives relating to “Undertakings for Collective Investment in Transferrable Securities”) and a non-UCITS fund regulated under a national law of a European Union member state.  Currently, there is no commonly accepted definition in Europe of what constitutes a money market fund.  Commission Directive 2006/73/EC (commonly known as the “MiFID Level 2 Directive”) provides for a “qualifying money market fund.” Under that directive an investment firm may deposit client funds in a qualifying money market fund for the purpose of safeguarding those funds.  The Guidelines on the other hand are intended to ensure that money market funds meet investor expectations.  As a result, the adoption by CESR of the Guidelines is roughly equivalent to the SEC’s adoption in 1983 of Rule 2a-7 under the Investment Company Act of 1940.  Although CESR guidance does not have legal status, as a practical matter, all European securities regulators apply CESR guidance.

The Guidelines describe a two-tiered approach consisting of a “Short-Term Money Market Fund” and a “Money Market Fund.”  The critical distinction between a Short Term Money Market Fund and a Money Market Fund is that a Short-Term Money Market Fund may purchase and sell its shares using a stable share price, but a Money Market Fund may not. This two-tier approach was recommended to the SEC by the Committee on Federal Regulation of Securities, Section of Business Law, American Bar Association (the “ABA”) in its September 8, 2009 letter commenting on amendments to Rule 2a-7 proposed by the SEC in June 2009. (John Hunt of Goodwin Procter participated in drafting that comment letter.)

CRITERIA APPLICABLE TO SHORT-TERM MONEY MARKET FUNDS AND MONEY MARKET FUNDS

The Guidelines specify the following criteria for both types of money market funds:

• A fund must have as its primary investment objective maintaining the fund’s principal, and must aim to provide a return in line with money market rates.

[Read more →]

The staff of the SEC’s Division of Investment Management (the “Staff”) recently responded to a number of questions concerning the recent amendments to Rule 2a-7 under the Investment Company Act of 1940, as amended (the “1940 Act”), and other rules relating to money market funds.  Those amendments were discussed in the March 5, 2010 Alert.  Below is a summary of the Staff’s responses. (Capitalized terms not otherwise defined have the meaning given them in Rule 2a-7.)

Board Designation of NRSROs - Rule 2a-7(a)(11)(i)

• The board of directors of a money market fund that invests only in U.S. government securities or repurchase agreement fully collateralized with U.S. government securities does not need to designate nationally recognized statistical ratings organizations (“NRSROs”), as required by Rule 2a-7(a)(11)(i).

[Read more →]

The SEC issued an order (the “SEC Order”) commencing administrative proceedings against a registered investment adviser (the “Adviser”), a registered broker-dealer affiliate of the Adviser (the “Distributor”), the Adviser’s portfolio manager (the “Portfolio Manager”) for seven affiliated bond funds sponsored by the Adviser (the “Funds”), and the Distributor’s Controller and Head of Fund Accounting (the “Controller”).  The SEC Order alleges that during the period between January 2007 and July 2007 (the “Relevant Period”) the daily net asset value (“NAV”) of each of the Funds, which consist of three open-end funds and four closed-end funds, was materially inflated as a result of fraudulent conduct relating to the pricing of securities backed by subprime mortgages (“Asset Backed Securities”) on the part of the Adviser, the Distributor, the Portfolio Manager and the Controller (collectively, the “SEC Respondents”).  This article summarizes the SEC’s allegations as included in the SEC Order.  The SEC Respondents have not yet filed an answer to the SEC Order nor has there yet been any finding with respect to the SEC’s allegations.  [Read more →]

The U.S. District Court for the District of Massachusetts (the “Court”) denied a motion to dismiss for failure to state a claim as to all but one of the claims in the complaint for a class action lawsuit filed by mutual fund investors against the fund, the fund’s investment adviser, the adviser’s parent, the adviser affiliate serving as the fund’s distributor, certain executives of the adviser and the fund’s trustees.  The complaint asserted violations of the federal securities laws under Section 11 and 12(a)(2) of the Securities Act of 1933, as amended (the “Act”), and control person liability under Section 15 of the Act.  Plaintiffs alleged that defendants misrepresented the nature of the fund’s investment objective and strategy in the fund’s offering documents as a safe, liquid and stable investment offering when the fund was comprised of illiquid, risky and volatile securities.

Background.  The plaintiffs alleged that during the period between October 28, 2005 and June 23, 2008, the fund’s net asset value (“NAV”) ranged from $9 to $10 per share, due at least partly to defendants’ artificial inflation of the fund’s NAV.  Eventually, according to the plaintiffs, the fund’s assets were re-priced and the fund was ultimately liquidated with significant losses to the fund’s investors.  Plaintiffs alleged that they lost approximately 25% of the value of their fund investments because of defendants’ misrepresentations in the fund’s offering documents that included: (i) misleading statements about the fund’s objectives, (ii) misrepresentations about the fund’s holdings of illiquid assets and (iii) misleading statements comparing the fund to certain securities indices. 

Fund Objective. The fund’s investment objective as set forth in its offering materials was to “seek to provide income consistent with preservation of capital and low principal fluctuation” and included the statement that “the fund seeks to provide investors with a high level of current income while reducing price volatility.”  The offering documents stated that the fund’s investment strategy was “to seek the highest total return by maximizing income and minimizing price fluctuations.”  Defendants argued that these statements were simply “general and indefinite” statements of objective which are not actionable under securities laws.  The Court, however, found that the statements in the fund’s prospectus were more than “mere aspirations” and instead were properly viewed as “key guidelines that established the [f]und’s investment strategy and laid down the basic ground rules it would follow.”  The Court also found that, although the fund’s prospectus contained general statements of the fund’s goals, these statements were nevertheless surrounded by more detailed specific statements about the fund which clarified the context in which the more general statements appeared and which, when read together, “made distinct claims about the posture of the [f]und, its investment strategies and the rules under which it would operate.”  For example, the fund’s prospectus stated that the fund intended to maintain an average portfolio duration of one year or less, that it would not invest more than 15% of its net assets in illiquid securities and that its returns would be comparable to those in certain specific indices. [Read more →]

The SEC staff is conducting a review of the use of derivatives by mutual funds, exchange traded funds (“ETFs”) and other investment companies, which may result in changes to SEC rules and guidance in this area.  Among the issues the staff has indicated it will explore are:

• how current market practices square with the leverage, concentration and diversification provisions of the Investment Company Act of 1940
• the risk management and other procedures followed by funds that rely substantially upon derivatives
• oversight of derivatives use by fund boards
• valuation and liquidity determinations for derivatives holdings
• prospectus risk disclosures regarding the risks of derivatives
• whether a fund’s derivative activities should be subject to special reporting requirements

The staff is deferring consideration of requests from ETFs for exemptive relief that would allow them to make significant investments in derivatives until the review is complete. This decision affects new and pending requests from certain actively-managed and leveraged ETFs that particularly rely on swaps and other derivative instruments to achieve their investment objectives.  The deferral does not affect any existing ETFs or other types of fund applications.

The Federal Reserve Bank of New York (the “FRBNY”) announced that money market funds that meet certain criteria may be eligible counterparties in a possible Federal Reserve Bank-sponsored reverse repurchase program intended to drain reserves from the U.S. financial system.  Previously, only the eighteen primary government securities dealers reporting to the Government Securities Dealers Statistics Unit of the FRBNY had been considered as eligible counterparties for the proposed program.  To be eligible, a money market fund must, among other things: (a) be registered with the SEC as an open-end management investment company, (b) be in compliance with Rule 2a-7 under the Investment Company Act of 1940, the SEC rule that sets forth certain risk-limiting conditions on a money market fund’s portfolio, as well as certain other conditions designed to allow the fund to maintain a stable share price, (c) have been in existence for at least one year, and (d) have net assets of at least $20 billion for the previous six consecutive months. [Read more →]

The March 5, 2010 Alert, which discussed the recent amendments to the SEC’s rules governing money market funds, stated that money market funds had until May 5, 2010 to comply with the new requirement to adopt stress testing procedures. The Alert noted, however, that the discussion of compliance dates in the SEC’s formal release adopting the amendments was not entirely clear on this issue. The SEC staff has subsequently indicated that the compliance date for money market fund stress testing procedures is May 28, 2010.

The SEC recently published its formal release (the “Adopting Release”) adopting significant amendments (the “Amendments”) to Rule 2a-7 and other rules under the Investment Company Act of 1940 (the “1940 Act”) that affect money market funds.  The SEC approved the Amendments at its January 27, 2010 open meeting.  This special edition of the Alert discusses the Amendments in detail.  It reviews the principal changes to the 1940 Act’s money market fund rules, and discusses the new obligations the Amendments impose on money market fund boards of directors as well as the new policies the Amendments require funds to adopt.  It also reviews the various compliance dates for the Amendments.

Summary of the Amendments

The Amendments reflect three categories of changes to the rules governing money market funds: (a) changes to Rule 2a-7’s risk limiting conditions governing a fund portfolio’s: (i) maturity, (ii) credit quality, (iii) diversification and (iv) liquidity, (b) changes relating to operational aspects of money market funds, and (c) new disclosure requirements. [Read more →]

As it makes its way through the legislative process, the EU’s Alternative Investment Fund Managers Directive continues to include elements that would significantly affect non-EU funds and managers that want to market to investors in the EU. For commentary and analysis from our colleagues at SJ Berwin LLP on amendments to the Directive recently proposed in the European Parliament and proposals put forward by the new Spanish Presidency of the EU, click here.

The agenda for the SEC’s open meeting on Wednesday, January 27, 2010 includes action on new rules, rule amendments, and a new form under the Investment Company Act of 1940 governing money market funds.