[Federal Register Volume 62, Number 236 (Tuesday, December 9, 1997)]
[Rules and Regulations]
[Pages 64968-64990]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-32026]
[[Page 64967]]
_______________________________________________________________________
Part IV
Securities and Exchange Commission
_______________________________________________________________________
17 CFR Parts 230, 239, 270, and 274
Technical Revisions to the Rules and Forms Regulating Money Market
Funds; Final Rule
Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 /
Rules and Regulations
[[Page 64968]]
SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 230, 239, 270 and 274
[Release Nos. 33-7479; IC-22921; S7-29-96]
RIN 3235-AE17
Technical Revisions to the Rules and Forms Regulating Money
Market Funds
AGENCY: Securities and Exchange Commission.
ACTION: Final rules.
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SUMMARY: The Commission is adopting amendments to rules and forms under
the Securities Act of 1933 and the Investment Company Act of 1940 that
govern money market funds. Technical amendments to rule 2a-7 under the
Investment Company Act of 1940, the rule regulating money market funds,
among other things, revise terminology used in the rule to reflect
common market usage and resolve certain interpretive issues under the
rule. Amendments to the advertising rules applicable to money market
funds, among other things, clarify the formula used by money market
funds to calculate yield.
DATES: Effective Date: The rule and form amendments adopted in this
Release will become effective February 10, 1998. Compliance Date: See
Section III of this Release.
FOR FURTHER INFORMATION CONTACT: David P. Mathews, Senior Counsel,
Office of Regulatory Policy, (202) 942-0690, Division of Investment
Management, Securities and Exchange Commission, 450 Fifth Street, N.W.,
Mail Stop 10-2, Washington, D.C. 20549.
SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission
(``Commission'') is adopting technical amendments to rule 2a-7 [17 CFR
270.2a-7] (``rule 2a-7'' or the ``rule'') under the Investment Company
Act of 1940 [15 USC 80a-1, et seq.] (``1940 Act''), the rule governing
the operations of money market funds (``funds'').1 The
Commission is adopting conforming amendments to rules 2a41-1, 12d3-1,
17a-9 and 31a-1 under the 1940 Act [17 CFR 270.2a41-1, 270.12d3-1,
270.17a-9 and 270.31a-1] to reflect the amendments to rule 2a-7. The
Commission also is adopting amendments to rule 482 [17 CFR 230.482]
under the Securities Act of 1933 [15 USC 77a, et seq.] (``1933 Act'')
and rule 34b-1 under the 1940 Act [17 CFR 270.34b-1]; and to Forms N-1A
[17 CFR 239.15A and 274.11A], N-3 [17 CFR 239.17a and 274.11b] and N-4
[17 CFR 239.17b and 274.11c].
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\1\ Unless otherwise noted, all references to ``rule 2a-7, as
amended,'' or any paragraph of the rule, will be to 17 CFR 270.2a-7
as amended by this Release.
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I. Technical Amendments to Rule 2a-7
A. Background
On March 21, 1996, the Commission adopted amendments to rule 2a-7
under the 1940 Act (``1996 Amendments'') to tighten the rule's risk-
limiting conditions imposed on tax exempt money market funds and to
address the treatment under the rule of certain instruments, such as
asset backed securities.2 These risk-limiting conditions
include requirements that a fund limit itself to investing in high
quality securities 3 and that the fund's portfolio be
diversified.4 After the adoption of the 1996 Amendments,
industry participants raised numerous questions concerning the
application of the amendments in different contexts. The Commission
thereafter suspended the compliance date of certain of the 1996
Amendments pending the proposal and adoption of technical amendments to
address these concerns.5
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\2\ Revisions to Rules Regulating Money Market Funds, Investment
Company Act Release No. 21837 (Mar. 21, 1996) [61 FR 13956 (Mar. 28,
1996)] (``Release 21837''). Unless otherwise noted, all references
to the ``1996 Amendments'' in this Release are to rule 2a-7 as
adopted in Release 21837. The compliance date for the 1996
Amendments to rule 2a-7 was suspended pending the adoption of
technical amendments. See infra note 5 and accompanying text.
\3\ The portfolio or credit quality provisions of the rule
generally limit funds to investments in U.S. dollar-denominated
securities that present minimal credit risks and that are, at the
time of acquisition, ``eligible securities'' as defined by the rule.
See paragraph (c)(3) of rule 2a-7, as amended (``portfolio quality
standards'' or ``credit quality standards''). ``Eligible security''
is defined in paragraph (a)(10) of rule 2a-7, as amended.
\4\ The diversification provisions of the rule generally limit
the amount of assets that a fund may invest in a single issuer of
securities, and the amount of assets that may be subject to credit
enhancements, such as letters of credit or puts, provided by the
same credit enhancement provider. See paragraph (c)(4) of rule 2a-7,
as amended (``diversification standards'').
\5\ Revisions to Rules Regulating Money Market Funds, Investment
Company Act Release No. 22135 (Aug. 13, 1996) [61 FR 42786 (Aug. 19,
1996)]. The Commission suspended the 1996 Amendments' compliance
date for rules 2a-7, 2a41-1, 12d3-1 and 31a-1 under the 1940 Act.
[17 CFR 270.2a-7, 2a41-1, 12d3-1 and 31a-1]. The compliance date was
not suspended with respect to the adoption of rule 17a-9 under the
1940 Act [17 CFR 270.17a-9] and the 1996 Amendments' revisions of
the rules and forms relating to money market fund disclosure,
advertising and reporting.
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On December 10, 1996, the Commission issued a release proposing
technical amendments to rule 2a-7 (``Proposing Release'').6
The proposed amendments would: (1) codify certain interpretive views
expressed by the Division of Investment Management;7 (2)
revise terminology used in the rule to reflect common market usage; (3)
modify certain of the 1996 Amendments so that the rule's treatment of
certain instruments (e.g., guarantees) more closely reflects the
treatment of those instruments by the financial markets; and (4) make
certain other technical corrections. The Commission also proposed
amendments to clarify the Commission's advertising rules regarding how
money market funds calculate current yield and represent short-term
total return in conjunction with current yield quotations.
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\6\ Technical Revisions to the Rules and Forms Regulating Money
Market Funds, Investment Company Act Release No. 22383 (Dec. 10,
1996) [61 FR 66621 (Dec. 18, 1996)] (``Proposing Release'').
\7\ See Investment Company Institute (pub. avail. May 9, 1996).
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The Commission received comments on the proposed amendments from
seventeen commenters, including nine mutual fund complexes.8
Commenters supported the proposed technical amendments to rule 2a-7,
and suggested further amendments to certain provisions of the rule
primarily relating to the treatment of asset backed securities. Most
commenters that addressed the proposed amendments to the Commission's
advertising rules relating to money market fund yield and total return
generally supported them. The Commission is adopting the technical
amendments substantially as proposed, with certain modifications that
reflect, in part, many of the commenters' suggestions. The Commission
also is establishing a new compliance date for the 1996 Amendments, as
further amended by the technical amendments adopted in this
Release.9
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\8\ The comment letters and a summary of the comments prepared
by the Commission staff are available to the public and are included
in File No. S7-29-96.
\9\ The new compliance date is discussed infra in Section III.B.
of this Release.
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B. Discussion
1. Guarantees
a. Definition of ``Guarantee''. Rule 2a-7 currently characterizes
certain features that enhance the credit or liquidity of portfolio
securities as ``puts'' and ``unconditional puts.''10 To
clarify
[[Page 64969]]
terminology used in rule 2a-7, the Commission proposed to replace these
terms with a new term--``guarantee''--that would include a wide-range
of arrangements designed to unconditionally support the credit of the
issuer of a security.11 Commenters generally supported the
proposed amendments, which the Commission is adopting substantially as
proposed.12
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\10\ The 1996 Amendments defined a ``put'' as the right to sell
a specified underlying security within a specified period of time at
a specified exercise price that may be sold, transferred or assigned
only with the underlying security. An ``unconditional put'' was
defined as a put (including any guarantee, financial guarantee
(bond) insurance, letter of credit or similar unconditional credit
enhancement) that by its terms would be readily exercisable in the
event of default in payment of principal or interest on the
underlying security. See paragraphs (a)(16) and (a)(27) of rule 2a-
7, as adopted by the 1996 Amendments.
\11\ See Proposing Release, supra note , at n.7 and accompanying
text.
\12\ Under the new definition, a guarantee is any unconditional
obligation of a person other than the issuer of the security to
undertake to pay, upon presentment by the holder of the guarantee
(if required), principal plus accrued interest when due upon
default. Paragraph (a)(15) of rule 2a-7, as amended. In order to
permit guarantees that are payable at any time, the Commission has
eliminated a requirement in the proposed definition that the issuer
of the guarantee be obligated to pay upon default ``at a specified
time.'' The Commission also is adopting amendments to the credit
quality and diversification provisions of the rule to incorporate
the new term ``guarantee,'' as discussed infra in Sections I.B.1.b.
and c. of this Release. The definition of ``guarantee'' is for
purposes of rule 2a-7 only, and is not intended to have any effect
on the status of these investments under other provisions of the
1940 Act or under other federal securities laws.
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b. Credit Substitution. Since 1986, rule 2a-7 has permitted a fund
to rely exclusively on the credit quality of the issuer of an
``unconditional demand feature'' in determining whether a security
meets the rule's credit quality standards.13 The 1996
Amendments also permitted a fund to exclude from the rule's issuer
diversification standards a security subject to an unconditional demand
feature provided by a person that does not control, or is not
controlled by or under common control with, the issuer of the security
(``non-controlled person'').14 Reflected in this approach is
the recognition that the holder of a security typically relies
exclusively on the credit quality of the issuer of the unconditional
demand feature in deciding to invest in the security.
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\13\ See Acquisition and Valuation of Certain Portfolio
Instruments by Registered Investment Companies, Investment Company
Act Release No. 14983 (Mar. 12, 1986) [51 FR 9773 (Mar. 21, 1986)].
A ``demand feature'' means (i) a feature exercisable either: (A) at
any time on no more than 30 calendar days' notice, or (B) at
specified intervals not exceeding 397 calendar days and upon no more
than 30 calendar days' notice; or (ii) a feature permitting the
holder of an asset backed security unconditionally to receive
principal and interest within 397 calendar days of making demand. An
``unconditional demand feature'' is a demand feature that by its
terms would be readily exercisable in the event of a default in
payment of principal or interest on the underlying security or
securities. See paragraphs (a)(8) and (a)(26) of rule 2a-7, as
amended.
\14\ Under the 1996 Amendments, a security subject to an
unconditional demand feature from a person in a control relationship
with the issuer of the security (i.e., one that controls, is
controlled by or under common control with the issuer) remains
subject to the issuer diversification standards in order to reduce a
fund's exposure to credit risks presented by a single economic
enterprise. See Release 21837, supra note 2, at nn.42-47 and
accompanying text.
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In addition to enhancing credit quality, money market funds also
rely on demand features to shorten the maturities of adjustable rate
securities or provide a source of liquidity.15 Because of
the significance of demand features to a money market fund's ability to
maintain a stable net asset value, the 1996 Amendments further provided
that a demand feature is not eligible for fund investment unless (i)
The demand feature (or the issuer of the demand feature) is rated by an
NRSRO (``Rating Requirement'');16 and (ii) arrangements are
in place for a fund holding a security subject to a demand feature to
be given notice in the event of a change in the identity of the issuer
of the demand feature (``Notification Requirement'').
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\15\ Tax exempt funds, for example, typically invest in long-
term adjustable rate securities subject to demand features. The
interest rates on these securities periodically adjust to reflect
short-term rates. The demand features permit funds to demand payment
of the security at relatively short intervals, and if unconditional,
also serve to enhance credit quality--thus providing the basis for
making the securities eligible for money market fund investment.
\16\ ``NRSRO'' is the acronym used in rule 2a-7 to stand for a
``nationally recognized statistical rating organization.'' See
paragraph (a)(17) of rule 2a-7, as amended. NRSROs are designated as
such by the Commission's Division of Market Regulation through the
no-action letter process for purposes of the Commission's net
capital rule [17 CFR 240.15c3-1].
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The Commission proposed to extend these provisions to other types
of guarantees commonly held by funds, such as bond insurance, letters
of credit and similar unconditional guarantees.17 Like
securities subject to unconditional demand features, securities subject
to guarantees typically trade on the basis of the credit of the
guarantor, rather than the issuer. Commenters strongly supported the
proposed amendments, which the Commission is adopting as
proposed.18
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\17\ Proposing Release, supra note 6, at nn. 8-16 and
accompanying text.
\18\ See paragraphs (c)(3)(iii) (determination of whether a
security meets the rule's credit quality standards may be based
exclusively on the credit quality of the security's guarantee);
(c)(4)(i) (excluding securities subject to guarantees from non-
controlled persons from the rule's issuer diversification
standards); (a)(10)(iii)(A) (extending the Rating Requirement to
guarantees); (a)(10)(iii)(B) (extending the Notification Requirement
to guarantees); and (a)(16) (definition of ``guarantee issued by a
non-controlled person'') of rule 2a-7, as amended. The amended rule
also permits a fund that holds a security subject to a guarantee and
a conditional demand feature to substitute the rating of the
guarantee for the rating of the underlying security. Paragraph
(c)(3)(iv)(C) of rule 2a-7, as amended. Consistent with the amended
rule, however, a fund must also consider the rating of the
conditional demand feature in evaluating the credit quality of the
entire instrument. Paragraph (c)(3)(iv)(A) of rule 2a-7, as amended.
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Under the rule as amended, a fund holding a security subject to a
guarantee (as defined in the rule) may rely exclusively on the credit
quality of the issuer of the guarantee in determining whether the
security meets the rule's credit quality standards.19 In
addition, securities subject to guarantees issued by non-controlled
persons are not subject to the rule's issuer diversification
standards.20
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\19\ Paragraph (c)(3)(iii) of rule 2a-7, as amended.
\20\ Paragraph (c)(4)(i) of rule 2a-7, as amended. Guarantees,
however, are subject to the guarantee and demand feature
diversification standards of paragraphs (c)(4)(iii), (c)(4)(iv) and
(c)(5) of rule 2a-7, as amended. A security subject to a guarantee
that is provided by a person in a control relationship with the
issuer of the security remains subject to the rule's issuer
diversification standards. See paragraphs (a)(16) (definition of
``guarantee issued by a non-controlled person'') and (c)(4)(i) of
rule 2a-7, as amended.
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c. Rating Requirement for Guarantees. The 1996 Amendments precluded
funds from investing in securities subject to demand features (whether
unconditional or conditional) that have not received a short-term
rating from an NRSRO. The Commission proposed, in light of its proposal
to extend the rule's treatment of unconditional demand features to all
guarantees, to extend the Rating Requirement to guarantees, subject to
certain exceptions.21 Commenters generally supported the
proposal, which the Commission is adopting substantially as proposed.
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\21\ Proposing Release, supra note 6, at nn. 17-24 and
accompanying text.
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Under rule 2a-7, as amended, all guarantees must be rated by an
NRSRO,22 except (i) a guarantee issued by a person that,
directly or indirectly, controls, is controlled by or is under common
control with the issuer of the security subject to the
guarantee,23 (ii) a guarantee with respect to a repurchase
agreement (``repo'') that is collateralized fully,24 (iii) a
guarantee issued by the
[[Page 64970]]
U.S. Government,25 or (iv) a guarantee not relied upon for
quality, maturity or liquidity purposes.26 Conditional
demand features, which are not within the definition of a ``guarantee''
under the amended rule, are not subject to the Rating
Requirement.27
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\22\ Paragraph (a)(10)(iii)(A) of rule 2a-7, as amended. Unlike
the 1996 Amendments, which required a short-term rating, the amended
rule allows any rating from an NRSRO to satisfy the Rating
Requirement.
\23\ Paragraph (a)(10)(iii)(A)(1) of rule 2a-7, as amended. The
Commission proposed to exclude this type of guarantee from the
Rating Requirement because a guarantor that guarantees securities
issued by a person in a control relationship with the guarantor may
not be in the business of lending its credit, and such a requirement
may be burdensome and result in a diminished supply of high quality,
eligible securities available for money market fund investment.
\24\ Paragraph (a)(10)(iii)(A)(2) of rule 2a-7, as amended. The
Commission has relaxed the Rating Requirement with respect to
guarantees of repos that are ``collateralized fully.'' One commenter
noted that funds often rely on unconditional puts (i.e.,
``guarantees'' under the amended rule's terminology) with respect to
``term repos''--which are repos for periods longer than one day. The
puts could be exercised if a repo counterparty's credit quality
deteriorated or to cover short-term cash outflows. The issuers of
unconditional puts with respect to term repos are typically
government securities dealers that are not rated by NRSROs. Since a
repo that is ``collateralized fully'' already has significant
protection from the risk of a counterparty's default or insolvency,
requiring puts (or guarantees) of such repos to be rated would add
little additional protection, and could cause funds to forgo a
beneficial method of liquidity enhancement. See infra Section
I.B.2.b. of this Release (treatment of repos that are
``collateralized fully'').
\25\ Paragraph (a)(10)(iii)(A)(3) of rule 2a-7, as amended; see
infra Section I.B.2.e. of this Release (discussing guarantees issued
by the U.S. Government).
\26\ Paragraph (c)(5) of rule 2a-7, as amended; see also infra
Section I.B.1.d. of this Release (demand features and guarantees not
relied upon).
\27\ A conditional demand feature is any demand feature that is
not an unconditional demand feature. Paragraph (a)(6) of rule 2a-7,
as amended.
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d. Demand Features and Guarantees Not Relied Upon. The 1996
Amendments permitted a fund that is not relying on a particular put to
disregard that put for purposes of meeting rule 2a-7's put and demand
feature diversification standards. The Commission is revising the rule
to extend this provision to guarantees, and to expand the provision to
permit funds to disregard a demand feature or a guarantee that is not
relied upon to satisfy the rule's credit quality or maturity standards,
or for liquidity, for all purposes under the rule.28
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\28\ Paragraph (c)(5) of rule 2a-7, as amended. A fund holding
securities subject to demand features or guarantees that are not
being relied upon for credit quality, maturity or liquidity must
establish written procedures requiring periodic re-evaluations of
this determination. Paragraph (c)(9)(ii) of rule 2a-7, as amended.
Funds are not required to establish procedures concerning demand
features and guarantees not relied upon if they do not hold such
instruments. Id.
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2. Diversification and Credit Quality Standards Applicable to Issuers
a. Second Tier Securities. Rule 2a-7 provides that a taxable fund
may not invest more than one percent of its total assets in second tier
securities issued by a single issuer.29 In the case of tax
exempt funds, this one percent limitation on investments in second tier
securities applies only to second tier ``conduit securities'' that are
issued by municipalities, but whose ultimate obligors are not
government or municipal entities.30 The Commission is
adopting the proposed amendments to the rule that clarify that these
limitations are not applicable to a security that is guaranteed by a
non-controlled person.31 Securities subject to guarantees
from non-controlled persons are subject only to the rule's guarantee
and demand feature diversification standards.32
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\29\ A ``second tier security'' is an eligible security that is
not a first tier security. Paragraph (a)(22) of rule 2a-7, as
amended. ``First tier securities'' are (i) securities that have
received short-term debt ratings in the highest category from the
requisite NRSROs; (ii) comparable unrated securities; (iii)
securities issued by money market funds; and (iv) Government
securities. Paragraph (a)(12) of rule 2a-7, as amended. ``Requisite
NRSROs'' means (i) any two NRSROs that have issued a rating with
respect to a security or class of debt obligations of an issuer; or
(ii) if only one NRSRO has issued a rating with respect to a
security or class of debt obligations of an issuer, that NRSRO.
Paragraph (a)(21) of rule 2a-7, as amended.
\30\ ``Conduit securities'' are issued to finance non-government
projects, such as private hospitals, housing projects, or industrial
development projects. See paragraph (a)(7) of rule 2a-7, as amended
(definition of ``conduit security'').
\31\ Paragraphs (c)(4)(i)(C) (1) and (2) of rule 2a-7, as
amended. Rule 2a-7 also limits a taxable fund and a tax exempt fund
to investing no more than five percent of total assets in second
tier securities and second tier conduit securities respectively
(``five percent quality test''). Paragraph (c)(3)(ii) of rule 2a-7,
as amended (portfolio quality standards--second tier securities).
The amendments do not make substantive changes to the five percent
quality test. Thus, a taxable fund, for example, could not invest
more than five percent of its total assets in second tier securities
subject to a second tier demand feature. The amendments, however,
reorganize the rule text to include the five percent quality test in
paragraph (c)(3) of the rule, which addresses portfolio quality
standards, rather than paragraph (c)(4), which addresses
diversification standards.
\32\ Paragraphs (c)(4)(iii) and (c)(4)(iv) of rule 2a-7, as
amended.
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b. Repurchase Agreements. Rule 2a-7 permits a fund to ``look-
through'' a repo to the underlying collateral and disregard the
counterparty in determining compliance with the rule's diversification
standards if the obligation of the counterparty is ``collateralized
fully.'' The 1996 Amendments sought to define ``collateralized fully''
to limit the collateral to that which could be liquidated promptly even
in the event of bankruptcy of the counterparty.
Because of questions concerning the treatment of cash and other
types of collateral not specifically addressed in the 1996 Amendments,
the Commission proposed to revise the ``look-through'' provisions of
the rule to focus on the treatment of the repo under applicable
insolvency law rather than exclusively on the type of collateral. Under
the proposed amendments, a repo would be ``collateralized fully'' if
(i) the collateral consists entirely of cash, Government securities, or
other securities that are rated in the highest rating category by the
requisite NRSROs, and (ii) upon an event of insolvency with respect to
the seller, the repo qualifies under a provision of applicable
insolvency law providing an exclusion from any ``general stay'' of
creditors rights against the seller.33
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\33\ Proposing Release, supra note 6, at nn. 30-36 and
accompanying text.
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Commenters supported the proposed revisions, but three commenters
urged that the rule's language be modified to refer to an ``automatic
stay'' rather than a ``general stay.'' These commenters pointed out
that even repos protected from automatic stays under federal insolvency
law may be subject to a court-ordered general stay obtained by the
Securities Investor Protection Corporation (``SIPC'') or the Federal
Deposit Insurance Corporation (``FDIC''). Because no provision of
insolvency law protects a purchaser of a repo from such orders, the
proposed amendments might have precluded money market funds from
relying on the rule's ``look-through'' provision for most repos, even
though it is the policy of both SIPC (as to broker-dealer
counterparties) and FDIC (as to bank counterparties) generally to allow
the prompt liquidation of repos in insolvency proceedings.34
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\34\ The United States Bankruptcy Code [11 U.S.C. 559] protects
certain repos from the automatic stay provision, but provides that
SIPC may obtain a court order barring the closeout of repo
transactions with member broker-dealer firms. As a matter of policy,
however, SIPC honors repos and allows their liquidation under most
circumstances. See Letter dated February 4, 1986, from Michael E.
Don, Deputy General Counsel of SIPC, to Robert A. Portnoy, Deputy
Executive Director and General Counsel of the Public Securities
Association. FDIC, as conservator or receiver for insolvent
depository institutions, similarly has the ability to avoid
contracts entered into by such institutions, but may not avoid
transfers of property in connection with repos under most
circumstances. See 12 U.S.C. 1821(e)(8)(A), (C) and (D); FDIC
Statement of Policy on Qualified Financial Contracts (Dec. 12,
1989).
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The Commission is adopting the proposed amendments, revised in part
to reflect the commenters' suggestions.35 The Commission
notes that, under the revised rule, a fund entering into a repo
collateralized by Government securities (which most are) should be able
to conclude that the repo qualifies for ``look-through'' treatment
(assuming the
[[Page 64971]]
other requirements of the rule are met), while funds wishing to enter
into repos using less traditional forms of collateral may rely on
opinions of bankruptcy counsel.36
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\35\ Paragraph (a)(5)(iv) of rule 2a-7, as amended. Commenters
also suggested that the text of this provision refer only to
applicable ``federal'' insolvency law. Although repos entered into
by funds typically involve domestic counterparties subject to
federal insolvency law, funds may enter into repos with non-U.S.
counterparties that are not subject to federal insolvency laws.
Therefore, the amended rule continues to apply to any applicable
insolvency law.
\36\ In addition, a money market fund must evaluate the repo
counterparty's creditworthiness in order to minimize the risk that
money market funds will enter into repos with parties that present a
serious risk of becoming involved in bankruptcy proceedings. The
Commission previously published a release setting forth the
conditions under which the Division of Investment Management would
not recommend enforcement action under section 12(d)(3) of the 1940
Act [15 U.S.C. 80a-12(d)(3)] (limiting fund investments in certain
securities-related businesses) if an investment company entered into
a repo with persons engaged in securities-related businesses.
Securities Trading Practices of Registered Investment Companies,
Investment Company Act Release No. 13005 (Feb. 2, 1983) [48 FR 5824
(Feb. 9, 1983)] (``Repo Release''). Among other things, the Repo
Release requires that the repo be ``fully collateralized.'' The
definition of ``fully collateralized'' in the Repo Release does not
include all of the conditions in rule 2a-7. A money market fund
entering into a repo that is ``collateralized fully'' within the
meaning of paragraph (a)(5) of rule 2a-7, as amended, will be deemed
to meet the ``fully collateralized'' requirement of the Repo
Release. Investment companies other than money market funds are not
required to comply with this provision of rule 2a-7 to be deemed to
hold repos that are ``fully collateralized'' for purposes of the
Repo Release.
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c. Refunded Securities. Money market funds often invest in
``refunded securities,'' which are securities the payment for which is
funded and secured by Government securities placed in an escrow
account. Rule 2a-7 permits a fund to ``look-through'' refunded
securities to the escrowed Government securities in determining its
compliance with the rule's issuer diversification standards under
certain conditions.37 One condition contained in the 1996
Amendments required certification by an independent public accountant
that the escrowed Government securities, or any subsequent substitution
of the escrowed securities, would satisfy all payments of principal,
interest and applicable premiums on the refunded securities
(collectively, the ``accountant's certification''). The Proposing
Release noted that NRSROs, in rating refunded securities, typically
require an independent third party to make the same
determination.38 Therefore, the Commission proposed, and is
now adopting, an amendment to the rule eliminating the accountant's
certification requirement if a refunded security has received a rating
from an NRSRO in the highest category for debt
obligations.39
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\37\ Paragraph (c)(4)(ii)(B) of rule 2a-7, as amended. This
``look-through'' treatment would not be available to refunded
securities subject to a swap agreement (i.e., the payments from the
escrowed Government securities are exchanged for payments made by a
swap counterparty) because the swap counterparty, rather than the
escrowed Government securities, acts as the ultimate source of
payment for the refunded securities. See J.P. Morgan Structured
Obligations Corp. (pub. avail. July 27, 1994); see generally infra
Section I.B.3.d. of this Release (swap arrangements).
\38\ See, e.g., Standard & Poor's Municipal Finance Criteria,
176-77 (1996).
\39\ Paragraph (a)(20)(iii) of rule 2a-7, as amended (definition
of ``refunded security'').
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d. Three-Day Safe Harbor. Rule 2a-7 permits a taxable or national
fund to invest up to twenty-five percent of its total assets in the
first tier securities of a single issuer for up to three business days
(``three-day safe harbor''). The Commission proposed, and is adopting,
amendments that restore unintentionally omitted language from the rule
text stating that a fund relying on the three-day safe harbor may not
make more than one investment in reliance on the safe harbor at any
time during the three day period.40
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\40\ Paragraph (c)(4)(i)(A) of rule 2a-7, as amended. The three-
day safe harbor is not available for single state funds. Single
state funds, however, are required to be diversified only as to
seventy-five percent of their assets, and so have available a
twenty-five percent basket to accommodate purchases in excess of
five percent of fund assets. Paragraph (c)(4)(i)(B) of rule 2a-7, as
amended.
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e. Government Guarantees. Two commenters suggested that the
Commission exclude guarantees issued by the U.S. Government from the
rule's guarantee and demand feature diversification standards as
finally amended, and thus treat government guarantees in the same
manner as securities issued directly by the U.S.
Government.41 The Commission is amending the demand feature
and guarantee diversification standards accordingly.42
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\41\ A security guaranteed as to principal and interest by a
U.S. Government agency is a ``Government security'' as defined in
section 2(a)(16) of the 1940 Act [15 U.S.C. 80a-2(a)(16)] and
paragraph (a)(14) of rule 2a-7, as amended. Investments in
Government securities are excluded from the rule's issuer
diversification standards because they are presumed to present
little, if any, credit risks. The same rationale applies to a
security guaranteed by a U.S. Government agency, which by definition
also is a ``Government security.''
\42\ Paragraph (c)(4)(iii) of rule 2a-7, as amended. Guarantees
issued by the U.S. Government are deemed to be first tier
securities. Paragraph (a)(12)(iv) of rule 2a-7, as amended
(definition of ``first tier security'').
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f. Definition of ``Rated Security''. Two commenters recommended
that the Commission adopt a new defined term, ``rated security,'' which
would permit rule 2a-7's definitions of ``unrated security,''
``eligible security'' and ``first tier security'' to be shortened and
clarified. The Commission is adopting the new term ``rated security''
and amending other provisions in the rule to incorporate the new
term.43
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\43\ A ``rated security'' is defined generally as (i) a security
(or the issuer with respect to a comparable security) that has
received a short-term rating from an NRSRO; or (ii) a security
subject to a guarantee if the guarantee (or the guarantor with
respect to a comparable guarantee) has received a short-term rating
from an NRSRO. A security is not a rated security, however, if it is
subject to an external credit support agreement that was not in
effect when the security was assigned its rating, unless the
security has received a short-term rating reflecting the existence
of the credit support agreement, or the credit support agreement has
received a short-term rating. Paragraph (a)(19) of rule 2a-7, as
amended. The Commission is making conforming amendments to
paragraphs (a)(10) (definition of ``eligible security'') and (a)(12)
(definition of ``first tier security'') of rule 2a-7, as amended,
and amending the definition of ``unrated security.'' Under the
amended definition, an ``unrated security'' is a security that is
not a ``rated security.'' Paragraph (a)(28) of rule 2a-7, as
amended.
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3. Asset Backed Securities and Synthetic Securities
The 1996 Amendments revised rule 2a-7 to accommodate asset backed
securities and synthetic securities (collectively ``ABS''). Rule 2a-7
defines an ABS as a fixed income security 44 issued by a
``special purpose entity'' substantially all of the assets of which
consist of ``qualifying assets.'' 45 Rule 2a-7 provides
separate credit quality,46 diversification 47 and
maturity 48 standards for ABSs. The ABSs covered by the rule
include interests in pools of receivables, such as credit card debt, as
well as short-term synthetic tax exempt securities.49
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\44\ For purposes of rule 2a-7's definition of ``asset backed
security,'' the term ``fixed income security'' has the same meaning
as that term is defined in rule 3a-7(b)(2) under the 1940 Act [17
CFR 270.3a-7(b)(2)]. Rule 3a-7 excludes structured financings, such
as ABSs, from the definition of ``investment company.''
\45\ Paragraph (a)(3) of rule 2a-7, as amended. Paragraph (a)(3)
defines ``special purpose entity'' as a trust, corporation,
partnership or other entity organized for the sole purpose of
issuing securities that entitle holders to receive payments from the
cash flows of the ``qualifying assets.'' Paragraph (a)(3) defines
``qualifying assets'' as either fixed or revolving financial assets
that by their terms convert into cash within a finite time period.
\46\ Paragraph (a)(10)(ii)(B) of rule 2a-7, as amended.
\47\ Paragraph (c)(4)(ii)(D) of rule 2a-7, as amended.
\48\ Paragraph (d) of rule 2a-7, as amended.
\49\ A synthetic security is created typically by placing a
long-term fixed rate municipal bond into a trust that issues short-
term variable or floating rate securities subject to a conditional
demand feature. This process effectively converts long-term fixed
rate bonds into short-term variable or floating rate demand
instruments that meet the rule's maturity requirements. Synthetic
securities were developed to address a shortage in the supply of
short-term tax exempt securities eligible for money market fund
investment. See Revisions to Rules Regulating Money Market Funds,
Investment Company Act Release No. 19959 (Dec. 17, 1993) [58 FR
68585 (Dec. 28, 1993)] at nn.100-05 and accompanying text (``Release
19959'') (discussing the development and characteristics of
synthetic securities).
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a. Rating Requirement. In recognition of the independent legal,
structural and credit analysis conducted by NRSROs before assigning a
rating to an ABS, the
[[Page 64972]]
1996 Amendments required that all ABSs purchased by money market funds
receive a rating from an NRSRO.\50\ In light of the role that NRSROs
have played in the development of structured finance, the Commission
believed that this ABS rating requirement was appropriate and would not
be burdensome.
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\50\ The 1996 Amendments excluded unrated ABSs from the
definition of an ``eligible security.''
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The Commission proposed to further amend the rule to exclude from
this rating requirement ABSs substantially all of the qualifying assets
of which consist of municipal securities.51 The Commission
was persuaded by the assertions of industry participants that, as
applied to these ABSs, the rating requirement was burdensome and
unnecessary.52 Commenters generally supported the amendment,
which the Commission is adopting as proposed.53
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\51\ Proposing Release, supra note, at nn.41-43 and accompanying
text.
\52\ Industry participants noted that when ABSs consist of a
large pool of financial assets, such as credit card receivables,
they may not be susceptible to conventional means of credit risk
analysis because credit quality is based on an actuarial analysis of
a pool of financial assets, rather than a single issuer. The credit
analysis for synthetic structures and municipal pools whose
qualifying assets consist of one or a few municipal issuers,
however, is typically no different than that required for a security
directly issued by a municipality. Since many synthetic securities
are not rated, applying the ABS rating requirement to them would
have restricted the available supply of ABSs suitable for money
market fund investment. ABSs involving large pools of financial
assets, on the other hand, are typically rated.
\53\ Paragraph (a)(10)(ii)(B) of rule 2a-7, as amended. An ABS
subject to a guarantee is not itself required to be rated. Under
rule 2a-7, as amended, an ABS subject to a guarantee that has
received a short-term rating is considered a ``rated security.''
Paragraph (a)(19) of rule 2a-7, as amended. Moreover, an ABS subject
to a guarantee may be determined to be an eligible security based
solely on whether the guarantee is an eligible security. Paragraph
(c)(3)(iii) of rule 2a-7, as amended.
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b. Diversification Standards. i. Look-Through to Secondary ABSs.
Rule 2a-7 treats the special purpose entity as the issuer of the ABS
and requires the rule's issuer diversification standards to be met with
respect to the special purpose entity. The rule contains an exception
to this treatment, which requires a fund to ``look-through'' the
special purpose entity to any issuer of qualifying assets whose
obligations constitute ten percent or more of the principal amount of
the qualifying assets of the special purpose entity (``ten percent
obligor''). For diversification purposes, a fund must treat these ten
percent obligors as if they issued a proportionate amount of the
special purpose entity.54 The ``look-through'' to ten
percent obligors is designed to ensure that a fund does not invest
indirectly more than five percent of its assets in a particular issuer.
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\54\ Paragraph (c)(4)(ii)(D)(1)(i) of rule 2a-7, as amended.
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Some or all of the qualifying assets of certain ABSs (``primary
ABSs'') also consist of other ABSs (``secondary ABSs''). The Commission
proposed amendments to clarify that a ten percent obligor of a primary
ABS that is also the issuer of secondary ABSs would be deemed to have
issued a portion of the assets of the primary ABS that such secondary
ABSs represent. For purposes of identifying ten percent obligors, the
proposed amendments provided that a fund should ``continue down the
chain'' of ten percent obligors until a special purpose entity with no
ten percent obligors is reached.55 Commenters supported this
general approach, which the Commission is adopting, but raised several
concerns that have led the Commission to further revise and clarify the
rule.
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\55\ Proposing Release, supra note, at nn. 48-50 and
accompanying text. The approach set forth in the Proposing Release
was illustrated in materials prepared by the staff of the Division
of Investment Management and made available at the 1996 ICI
Conference on Money Market Fund Regulation. See Materials for 1996
ICI Conference on Money Market Fund Regulation: Asset Backed
Securities and Synthetic Securities--Application of Paragraph
(c)(4)(vi)(A)(4) of Rule 2a-7 (May 9, 1996).
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One commenter observed that the benefits and materiality of the
required ``look-through'' to secondary ABSs diminish rapidly. This
commenter asserted that the risks posed by remote special purpose
entities are likely to be outweighed by the costs incurred by funds to
create compliance systems that identify, and treat as proportionate
issuers, ten percent obligors beyond those comprising the qualifying
assets of secondary ABSs. The Commission agrees and has amended the ABS
``look-through'' provision so that, instead of ``continuing down the
chain'' indefinitely, funds are required to identify and treat as
proportionate issuers of a primary ABS only ten percent obligors of the
primary ABS and ten percent obligors of any secondary
ABSs.56
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\56\ Paragraphs (c)(4)(ii)(D)(1)(i) and (ii) of rule 2a-7, as
amended. Under this provision, funds must ``look through'' to any
ten percent obligor of a primary ABS, and to any ten percent obligor
of a secondary ABS, and treat each such obligor as an issuer of a
portion of the primary ABS. Funds need not, however, ``look-
through'' to the qualifying assets of any ten percent obligor of a
``tertiary ABS'' (i.e., a ten percent obligor of a secondary ABS
that is itself a special purpose entity issuing ABSs) for purposes
of compliance with the rule's diversification standards. Although
the rule does not specifically prohibit a multi-layered ABS designed
to avoid the ``look-through'' to secondary ABSs, the Commission
would collapse the multiple layers of such an ABS and view remote
ten percent obligors as proportionate issuers for purposes of
determining compliance with the rule's issuer diversification
standards. The Appendix to this Release illustrates the operation of
the ``look-through'' to secondary ABSs under the amended rule.
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Another commenter urged that a particular type of ABS issuer, a
``restricted special purpose entity,'' be excluded from treatment as a
ten percent obligor under the rule, and thus not be counted for
diversification purposes. A ``restricted special purpose entity'' is
one that does not issue its ABSs to anyone other than another specific
ABS issuer. For example, a company that provides financing for
automobile purchasers may establish a restricted special purpose entity
to securitize its automobile loans. The restricted special purpose
entity will only sell ABSs to another special purpose entity that
issues ABSs to money market funds or other investors. No
diversification risk would appear to be posed to funds in this instance
because funds cannot directly or indirectly invest in the restricted
special purpose entity (i.e., a secondary ABS) other than through the
purchase of ABSs from a particular primary ABS issuer.57 The
Commission has decided to further amend the rule to exclude restricted
special purpose entities from treatment as ten percent
obligors.58
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\57\ This commenter further noted that compliance costs of
tracking ten percent obligors may cause funds to avoid any ABS whose
issuer discloses the existence of ten percent obligors. Since a
large number of ABSs may be structured such that all or a
significant portion of ten percent obligors are restricted special
purpose entities, allowing funds to disregard these ten percent
obligors would further increase the supply of desirable ABSs for
money market fund investment, avert the imposition of unnecessary
constraints on the asset backed commercial paper market, and expose
funds to little, if any, additional risks.
\58\ Paragraph (c)(4)(ii)(D)(2) of rule 2a-7, as amended. The
amended rule provides that a restricted special purpose entity may
issue its securities to other persons that control, are controlled
by or are under common control with, the restricted special purpose
entity if such persons are not ABS issuers.
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ii. Demand Features and Guarantees Securing Obligations of Ten
Percent Obligors. The Commission is adopting a proposed amendment to
clarify that in the case of any ten percent obligors deemed to be
issuers for purposes of the rule's diversification standards, any
demand features or guarantees supporting the obligations of the ten
percent obligors are treated as being held by the fund and are subject
to the rule's demand feature and guarantee diversification
standards.59
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\59\ Paragraph (c)(4)(ii)(D)(3) of rule 2a-7, as amended. If the
fund is not relying on a demand feature or guarantee of a ten
percent obligor for purposes of credit quality or maturity, or for
liquidity, the fund may disregard the demand feature or guarantee
for all purposes. See paragraph (c)(5) of rule 2a-7, as amended.
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[[Page 64973]]
iii. Special Purpose Entity Cap. In the Proposing Release, the
Commission explained that it was possible under the rule for a large
portion of a fund to be exposed to a single ABS, as a result of a fund
investing in a special purpose entity with one or more ten percent
obligors.60 The Commission noted that this could expose the
fund to an undue amount of structural risk (e.g., the risk that the
special purpose entity might be affected by the bankruptcy of its
sponsor), and requested comment whether the rule should restrict fund
investment in the obligations of a single special purpose entity.
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\60\ Proposing Release, supra note 6, at n.52 and accompanying
text.
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Although the three industry participants that responded to the
request for comment urged adoption of such a cap, the Commission has
decided not to amend the rule in this manner. The Commission is
concerned that such a cap would add complexity to the rule without
meaningfully limiting structural risks. While a cap would limit a
fund's investment in a particular special purpose entity, it would not
prevent a fund from investing large amounts of its assets in multiple
identically-structured special purpose entities established by the same
sponsor. A structural flaw in an ABS that exposes investors in one
special purpose entity to the bankruptcy of the sponsor would likely
affect all of the special purpose entities similarly structured.
Therefore, the Commission is not persuaded that a cap would effectively
contain a fund's exposure to structural risk, and in any event, rule
2a-7 looks to the ratings of the NRSROs to provide an independent
review of ABS structures.61 Fund advisers, however, should
consider the fund's exposure to structural risk when evaluating whether
an investment in a particular ABS is consistent with the fund's
objective of maintaining a stable net asset value.
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\61\ NRSROs, prior to assigning a rating, not only analyze the
quality of the assets underlying an ABS, but also conduct an
independent analysis of the structural integrity of the ABS. See
Release 19959, supra note 49, at nn.108-12 and accompanying text.
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iv. Sponsor-Provided Demand Features and Guarantees. Rule 2a-7
provides that a fund may not invest, with respect to seventy-five
percent of its total assets, more than ten percent of its total assets
in securities issued by or subject to puts from the same institution
(or under the amended rule's terminology, ``guarantee'' or ``demand
feature'').62 A fund is not subject to the ten percent
limitation with respect to the remaining twenty-five percent of its
total assets (``twenty-five percent basket'') if the securities held in
the basket are first tier securities and the puts are issued by non-
controlled persons.63 As a result, a fund holding an ABS
subject to a put from its sponsor is not able to include this
investment in its twenty-five percent basket if the sponsor is in a
control relationship with the special purpose entity.64
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\62\ Paragraph (c)(4)(iii) of rule 2a-7, as amended.
\63\ Id. The amended rule refers to such instruments as
guarantees or demand features from ``non-controlled persons.'' See
paragraphs (a)(9) and (a)(16) of rule 2a-7, as amended. The Appendix
to this Release illustrates the operation of the twenty-five percent
basket under the amended rule when securities are subject to
guarantees or demand features from multiple providers.
\64\ This may occur, for example, if an ABS sponsor owns a
residual equity interest in the special purpose entity. In this
case, the ABS sponsor might ``control'' the special purpose entity
within the meaning of section 2(a)(9) of the 1940 Act [15 U.S.C.
80a-2(a)(9)]. See Proposing Release, supra note 6, at n.54 and
accompanying text. An ABS sponsor may not, however, be deemed to
``control'' the special purpose entity under other federal
securities laws or for other purposes.
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The twenty-five percent basket is restricted to securities subject
to puts from non-controlled persons in order to minimize a fund's
exposure to the credit risk of a single economic enterprise and limit
the aggregate exposure to the risks of related, active
businesses.65 Permitting a fund to invest more than ten
percent of its total assets in an ABS subject to a demand feature or
guarantee issued by a sponsor, however, would not have this effect,
because the special purpose entity, unlike an active enterprise, is a
limited purpose vehicle created solely for the purpose of issuing fixed
income securities based on the cash flow of the qualifying assets.
Therefore, the Commission proposed to amend rule 2a-7 to allow funds to
treat a demand feature or guarantee from an ABS sponsor as a demand
feature or guarantee from a non-controlled person. Commenters supported
the proposed amendment, which the Commission is adopting as
proposed.66
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\65\ Release 21837, supra note 2, at n.73 and accompanying text.
\66\ Paragraphs (a)(9) (``demand feature issued by a non-
controlled person'') and (a)(16) (``guarantee issued by a non-
controlled person'') of rule 2a-7, as amended. Although a guarantee
provided by a person in a control relationship with the issuer of
the underlying security is excluded from the Rating Requirement for
guarantees, the exclusion does not apply to a sponsor-provided
guarantee of an ABS under the amended rule. Thus, sponsor-provided
guarantees of ABSs must be rated. Paragraph (a)(10)(iii)(A) of rule
2a-7, as amended; see also supra Section I.B.1.c. of this Release.
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v. First Loss Guarantees. Some ABSs are supported by a guarantee
that covers all losses up to an amount of expected losses likely to be
experienced by the ABS. Because a fund's exposure to such a ``first
loss guarantee'' is similar to its exposure to a guarantee of the
entire security,67 the 1996 Amendments required a fund to
treat a first loss guarantor as a guarantor of the entire ABS.
Commenters urged that first loss guarantees be treated similar to other
fractional guarantees under the rule and raised numerous questions
about the application of the provision to certain ABS structures.
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\67\ The failure of a first loss guarantor covering the first
ten percent of all losses likely to be incurred by an ABS is likely
to have a more significant effect on the value of the ABS than the
failure of a fractional guarantor supporting only a portion of any
losses incurred.
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The Commission continues to believe that investment in an ABS
subject to a first loss guarantee can potentially result in a fund
being overexposed to the credit risk of the first loss guarantor. The
number and nature of questions raised by the 1996 Amendments, however,
have convinced the Commission that these risks are better managed by
the fund's investment adviser. The Commission, therefore, is revising
the rule to permit funds to treat a first loss guarantee as any other
fractional guarantee when calculating compliance with the rule's
guarantee and demand feature diversification standards.68
Advisers should, however, carefully consider potential exposure to the
credit risks of a first loss guarantor when evaluating whether
investment in an ABS is consistent with the fund's objective of
maintaining a stable net asset value.
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\68\ Paragraph (c)(4)(iv)(A) of rule 2a-7, as amended. ABSs also
may be subject to ``second loss guarantees'' that guarantee a
specific amount of losses in excess of losses covered by a first
loss guarantee. Funds should treat second loss guarantees of ABSs in
the same manner as any other fractional guarantees or demand
features under the amended rule. Sponsors of ABSs may provide
additional credit risk protection by structuring an offering such
that the value of qualifying assets in the pool exceeds the amount
of the ABS offering. For example, a $1 billion ABSs offering might
be collateralized by an asset pool of $1.1 billion. The $100 million
of ``overcollateralization'' may be applied to cover any first
losses incurred before drawing upon third party guarantees or other
credit enhancements. Although overcollateralization would be
relevant in determining whether the ABS presents minimal credit
risks, this type of seller-provided credit enhancement does not fall
within the rule's definition of a guarantee or demand feature and
may be disregarded for purposes of the rule's diversification
standards. See paragraphs (a)(8) (definition of ``demand feature'')
and (a)(15) (definition of ``guarantee'') of rule 2a-7, as amended.
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c. Periodic Determinations Regarding Ten Percent Obligors. The 1996
Amendments required a fund to adopt written procedures requiring
periodic determinations of the number of ten percent obligors deemed to
be issuers of all or a portion of an ABS. The Commission is amending
this requirement so that periodic determinations are not required with
[[Page 64974]]
respect to any ABS that a fund's board of directors initially has
determined will never have, or is unlikely to have, any ten percent
obligors.69 This determination may be based upon a
structural analysis of the ABS or upon representations in the offering
materials or governing documents of an ABS that it will never have ten
percent obligors. Funds also must maintain a record of this
determination.70
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\69\ Paragraph (c)(9)(iv) of rule 2a-7, as amended. The board of
directors may delegate this determination, and most other
determinations required by the rule, to the fund's adviser or to the
officers of the fund. The board, however, may not delegate certain
specific determinations required under rule 2a-7. See paragraph (e)
of rule 2a-7, as amended.
\70\ Paragraph (c)(10)(v) of rule 2a-7, as amended.
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d. Swap Arrangements. The Proposing Release noted that certain ABSs
may consist of qualifying assets whose cash flow has been ``swapped''
to a financial institution (the ``swap counterparty'') that ultimately
acts as the primary source of payment to funds holding the ABSs (i.e.,
a ``total return swap''). The Commission requested comment whether the
swap counterparty in this instance should be treated as the issuer of
the ABSs for diversification purposes and on the appropriate treatment
of swaps and similar arrangements under the rule.
Commenters suggested various approaches to the treatment of swaps
under the rule.71 All acknowledged, however, the difficulty
of addressing swaps and similar arrangements by rule due to the
constantly evolving nature of swap transactions and the wide variations
in the types of swaps used to structure ABSs offerings. The Commission
has determined not to amend the rule at this time to specifically
address the treatment of swaps or similar arrangements. Swaps and
similar arrangements that fall within the rule's definition of a
guarantee or demand feature, however, should be treated as such for
purposes of guarantee and demand feature diversification.72
A fund's adviser, however, should seek to ensure that investments by
the fund in securities subject to swap arrangements are consistent with
rule 2a-7's overriding policy of limiting funds to investments that are
consistent with maintaining a stable net asset value and do not expose
the fund excessively to credit risks posed by swap counterparties.
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\71\ Six commenters addressed this issue and generally suggested
that a swap counterparty acting as the primary source of payment to
a fund be treated as an issuer and subject to the issuer
diversification standards. Most of these commenters suggested that
counterparties in swaps that support or guarantee the obligations of
an ABS issuer or other party to pay (but are not the sole source of
payment on the ABS) be treated as guarantees subject to the
guarantee and demand feature diversification standards.
\72\ See paragraphs (a)(8), (a)(15), (c)(4)(iii) and (c)(4)(iv)
of rule 2a-7, as amended.
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4. Other Amendments to Rule 2a-7
a. Investments in Other Money Market Funds. The 1996 Amendments
permitted a fund (``acquiring fund'') to treat an investment in another
money market fund (``acquired fund'') as a first tier security, but
limited investment in any single money market fund to no more than five
percent of fund assets. The 1996 Amendments created an exception,
however, for a fund investing substantially all of its assets in shares
of another money market fund in reliance on section 12(d)(1)(E) of the
1940 Act (e.g., a master-feeder arrangement).73 The 1996
Amendments deemed this type of a fund to be in compliance with rule 2a-
7's diversification standards if the acquiring fund's board of
directors reasonably believed that the acquired fund is in compliance
with rule 2a-7.
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\73\ 15 USC 80a-12(d)(1)(E).
---------------------------------------------------------------------------
Several commenters pointed out that, as a result of Commission
exemptive orders 74 and amendments to the 1940 Act's
limitations on ``funds of funds'' arrangements,75 some money
market funds may now invest more than five percent but less than
substantially all of their assets in shares of another money market
fund. The Commission is amending the rule to expand the exception to
cover all investments by a fund in the shares of another money market
fund in excess of the otherwise applicable issuer diversification
standards.76
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\74\ See, e.g., Daily Money Fund, et al., Investment Company Act
Release Nos. 22285 (Oct. 16, 1996) (Order) and 22236 (Sept. 20,
1996) (Notice).
\75\ In 1996, the 1940 Act's restrictions on fund investments in
other funds were relaxed by, among other things, adding new section
12(d)(1)(G) [15 USC 80a-12(d)(1)(G)] that excepts ``affiliated''
funds of funds from the restrictions of section 12(d)(1)(A) under
certain conditions. See The National Securities Markets Improvement
Act of 1996, Pub. L. No. 104-290, 110 Stat. 3416 (1996).
\76\ Paragraph (c)(4)(ii)(E) of rule 2a-7, as amended.
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Under the amended rule, shares of money market funds are considered
to be first tier securities,77 and are thus subject to the
rule's issuer diversification standards with respect to first tier
securities.78 A fund may, however, within the limitations of
section 12(d)(1) of the 1940 Act, invest in shares of another money
market fund in excess of the rule's issuer diversification standards,
but only if the acquiring fund's board of directors reasonably believes
that the acquired fund is in compliance with rule 2a-7.79
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\77\ Paragraph (a)(12) of rule 2a-7, as amended.
\78\ See paragraph (c)(4)(i) of rule 2a-7, as amended.
\79\ Paragraph (c)(4)(ii)(E) of rule 2a-7, as amended. A taxable
or national fund could take advantage of the three day safe harbor
of paragraph (c)(4)(i)(A) and a single state fund could use its
``twenty-five percent basket'' under paragraph (c)(4)(i)(B) to
invest up to twenty-five percent of fund assets in the securities of
a single money market fund without the board making a ``reasonable
belief'' finding, even though, in both cases, the investment would
be in excess of five percent of fund assets. Under the rule, an
acquiring fund that holds securities of a particular issuer
(``Issuer A''), and invests in shares of an acquired fund that also
holds securities of Issuer A, would not aggregate those positions to
determine its compliance with the rule's diversification standards
with respect to Issuer A.
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b. Definition of Eligible Security--Certain Unrated Securities.
Under the 1996 Amendments, an unrated security that was a long-term
security when issued, but had a remaining maturity of less than 397
calendar days when purchased by the fund, was an eligible security
based on whether the security is comparable in quality to a rated
security (i.e., one with a short-term rating), unless the unrated
security had received a long-term rating from any NRSRO that was not
within the three highest categories of long-term ratings. The
Commission is adopting a proposed amendment to the rule permitting a
fund to treat such a security as an eligible security if that security
has a long-term rating from the ``requisite NRSROs'' 80
within the three highest rating categories.81
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\80\ Paragraph (a)(21) of rule 2a-7, as amended (definition of
``requisite NRSROs'').
\81\ Paragraph (a)(10)(ii)(A) of rule 2a-7, as amended. For
example, an unrated ``stub'' security may have long-term ratings
from three NRSROs. One of these NRSROs may give the security a long-
term rating in the NRSRO's fourth highest category, which would have
precluded the fund from purchasing the security before the adoption
of these amendments. Under the revised rule, however, the fund may
look to the other ratings and treat the security as an eligible
security if the two other NRSROs have given the security long-term
ratings within one of their three highest long-term rating
categories. If any NRSRO has given the security (or the issuer of
the security with respect to a class of debt obligations that is
comparable in priority and security) a short-term rating, however,
the short-term rating would override the long-term ratings and
reference to long-term ratings would be unnecessary to determine
whether the security was an eligible security. Long-term ratings may
be relevant, however, to an evaluation of whether the issuer
presents minimal credit risks under paragraph (c)(3)(i) of rule 2a-
7, as amended.
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c. Additional Amendments. The Commission proposed additional
amendments designed to further clarify and make technical corrections
to the rule. Commenters supported the amendments, and the Commission is
adopting them as follows:
(i) Acquisition of Portfolio Securities. The Commission is adding
the new defined term ``acquisition'' to make the rule more uniform in
its application to
[[Page 64975]]
fund investments and to clarify that the failure of a fund to exercise
a demand feature does not have similar consequences under the rule as a
decision to ``rollover'' commercial paper.82
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\82\ Paragraph (a)(1) of rule 2a-7, as amended.
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(ii) Single State Funds. The Commission is amending the definition
of a ``single state fund'' to include a fund seeking to ``maximize''
the amount of income exempt from income taxes of a particular
state.83
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\83\ Paragraph (a)(23) of rule 2a-7, as amended. The effect of
the amendment would be to permit this type of a fund to take
advantage of the twenty-five percent basket in determining
compliance with the rule's diversification standards, even if it did
not primarily distribute income exempt from state income taxes. See
paragraph (c)(4)(i)(B) of rule 2a-7, as amended; see also Proposing
Release, supra note 6, at nn.66-68 and accompanying text.
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(iii) Standby Commitments. As proposed, the Commission has deleted
the term ``standby commitment'' and all references to that term from
the rule.84
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\84\ See Proposing Release, supra note 6, at nn.69-71 and
accompanying text. Under the amended rule, a standby commitment that
meets the definition of a demand feature must be treated as such.
See paragraph (a)(8) of rule 2a-7, as amended (definition of
``demand feature''). A standby commitment that is not a demand
feature is not subject to the rule's credit quality or
diversification standards.
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(iv) Downgrades, Defaults, and Other Events. The Commission is
amending the rule to require a fund's board of directors to reassess
whether an unrated or second tier security continues to present minimal
credit risks only when the fund's adviser (or other person delegated
portfolio management responsibilities) becomes aware that the security
has been downgraded by any NRSRO below that NRSRO's two highest short-
term rating categories.85
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\85\ Paragraph (c)(6)(i)(A)(2) of rule 2a-7, as amended; see
Proposing Release, supra note 6, at n.72 and accompanying text.
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(v) Recordkeeping Requirements. The Commission is adding rule text
inadvertently omitted from the 1996 Amendments that requires the board
of directors to document minimal credit risk determinations of
portfolio securities.86
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\86\ Paragraph (c)(10)(iii) of rule 2a-7, as amended; see
Proposing Release, supra note 6, at nn.74-75 and accompanying text.
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(vi) Holding Out. Using new rulemaking authority, the Commission is
restating the rule's prohibition on a fund's use of names suggesting
that it is a money market fund, unless it complies with rule 2a-
7.87
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\87\ Paragraph (b) of rule 2a-7, as amended. The National
Securities Markets Improvement Act of 1996 [Pub. L. 104-290, 110
Stat. 3416 (1996)] amended Section 35(d) of the 1940 Act [15 USC
80a-34(d)] to make it unlawful to adopt as a fund name or title, or
as a title of fund securities, words that the Commission finds are
materially deceptive or misleading, and to authorize the Commission
to define names and titles deemed to be ``materially deceptive and
misleading.''
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II. Amendments to the Advertising Rules Applicable to Money Market
Funds
The Commission is adopting amendments to the Commission's money
market fund advertising rules and forms to clarify the formula used by
money market funds to calculate yield and to reduce the potential for
investors being misled or confused by the presentation of a money
market fund's short-term total return.
A. Calculation of Yield
The Commission proposed to amend its money market fund yield
formula to clarify that only investment income may be included in the
yield of a money market fund. Three commenters supported the amendment;
one opposed it and urged the Commission to specifically permit
inclusion of non-investment income. The Commission is concerned that
inclusion of non-investment income will distort yield and diminish the
utility of money market fund yield to investors. The Commission,
therefore, has decided to adopt the proposed amendment to the money
market fund yield formula.88
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\88\ See Item 22 of Form N-1A [17 CFR 239.15A and 274.11A], Item
25 of Form N-3 [17 CFR 239.17a and 274.11b], and Item 21 of Form N-4
[17 CFR 239.17b and 274.11c], as amended.
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B. Use of Total Return
The Proposing Release noted that some money market fund
advertisements have used short-term total return instead of yield and
expressed concern that many investors may not understand the
difference.89 The Commission proposed to amend its rules to
require that total return quotations in advertisements and sales
literature cover a period of at least one year, and that such
quotations be accompanied by a quotation of current yield, computed in
accordance with Commission rules and set forth with equal prominence.
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\89\ Proposing Release, supra note 6, at n.81 and accompanying
text. As a result, investors may assume incorrectly that a fund
quoting the higher total return figure is a better performing fund
than other money market funds quoting yield. For example, during a
period of declining interest rates, the fund's total return will be
higher than its current yield because it will include periods of
time during which the fund held higher yielding securities. In
addition, investors may incorrectly assume that the higher ``total
return'' is the yield they can expect to receive upon an investment
in the fund.
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All commenters that addressed this proposal objected to the
proposed requirement that total return quotations cover at least one
year. They argued that the proposal would preclude total return
quotations during a fund's first year and in other circumstances in
which the purpose of the advertisement was other than to circumvent the
Commission's yield formula. The Commission has decided not to require
all money market fund total return quotations to cover a period of one
year. Instead, the Commission is revising its rules to require that (i)
quotations of total return be accompanied by quotations of current
yield and that both quotations be placed next to each other and shown
in the same size print, 90 and (ii) if there is a material
difference between the quoted total return and the quoted yield, a
statement that the yield quotation more closely reflects the current
earnings of the fund than the total return quotation.91
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\90\ Quotations of total return and current yield in an
advertisement delivered electronically must be presented together
and in a manner that presents each quotation with identical
prominence in light of the particular electronic medium used to
transmit the advertisement.
\91\ See paragraph (d)(2) of rule 482 under the 1933 Act, as
amended [17 CFR 230.482(d)(2)]; paragraph (b)(1)(ii)(C) of rule 34b-
1 under the 1940 Act, as amended [17 CFR 270.34b-1(b)(1)(ii)(C)].
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III. Effective Date/Compliance Date
A. Effective Date
The rule amendments adopted in this Release will become effective
February 10, 1998. The Office of Management and Budget has determined
that the technical amendments to rule 2a-7 are ``major rules'' and the
amendments to the Commission's money market fund advertising rules and
forms are ``minor rules'' under Chapter 8 of the Administrative
Procedure Act, 92 which was added by the Small Business
Regulatory Enforcement Fairness Act of 1996 (``SBREFA'').93
SBREFA requires all final agency rules to be submitted to Congress for
review and requires generally that the effective date of a major rule
be delayed for sixty days pending Congressional review. A major rule
may become effective at the end of the sixty-day review period, unless
Congress passes a joint resolution disapproving the rule.94
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\92\ 5 USC 801.
\93\ Pub. L. No. 104-121, Title II, 110 Stat. 857 (1996). Under
SBREFA, a rule is ``major'' if it is likely to result in (i) an
annual effect on the economy of $100 million or more, (ii) a major
increase in costs or prices for consumers or individual industries,
or (iii) significant adverse effects on competition, investment, or
innovation. 5 USC 804(2).
\94\ 5 USC 801(a)(3).
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B. Compliance Dates
The Proposing Release requested comment whether the Commission
should provide for a six-month
[[Page 64976]]
transition period for compliance.95 Commenters supported a
six-month period to give fund boards of directors sufficient time to
review and approve fund procedures. Several commenters also suggested
that the ``grandfathering'' of certain securities provided for by the
release adopting the 1996 Amendments be extended, 96 whereas
one commenter opposed such extension. The Commission has decided to
delay the date for compliance with the amended rule for six months and
to extend the ``grandfathering'' of fund investments in certain
securities, as described below.
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\95\ See Proposing Release, supra note 6, at nn.84-85 and
accompanying text.
\96\ The 1996 Amendments ``grandfathered'' fund investments in
certain securities issued on or before June 3, 1996.
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1. General Compliance Date
All money market funds must be in compliance with rule 2a-7, as
amended, (and with conforming amendments reflecting the revisions to
rule 2a-7) by July 1, 1998, except with respect to ``grandfathered
securities'' as provided below.97 Funds must comply with the
amendments to the advertising rules and forms applicable to money
market funds by February 10, 1998.
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\97\ Rule 2a-7 requires a fund to meet the rule's
diversification standards with respect to a particular issuer on the
date the fund acquires a security of that issuer. Paragraphs
(c)(4)(i) and (ii) (with respect to issuer diversification) and
(c)(4)(iii) and (iv) (with respect to diversification of demand
features and guarantees) of rule 2a-7, as amended. A tax exempt fund
holding a greater percentage of its total assets in the securities
of an issuer than the applicable diversification standard permits as
of July 1, 1998 may not purchase additional securities or ``roll
over'' current holdings until the purchase or roll over of such
securities will not cause the fund to exceed the applicable
diversification standards immediately after the purchase or roll
over. Funds are not required to exercise puts or otherwise dispose
of portfolio holdings to meet the new diversification standards.
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2. ``Grandfathered'' Securities
To minimize disruption to funds and markets as a result of the
adoption of these amendments, the Commission is ``grandfathering''
certain securities first issued on or before February 10, 1998 that do
not meet the following requirements of the amended rule:
(i) The Rating Requirement for guarantees; 98
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\98\ Paragraph (a)(10)(iii)(A) of rule 2a-7, as amended.
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(ii) The Notification Requirement, which provides that, in order
for a security subject to a guarantee or demand feature to be an
eligible security, the fund must receive notice from the demand feature
or guarantee provider (or another institution) if there is a
substitution of the provider of the demand feature or guarantee;
99
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\99\ Paragraph (a)(10)(iii)(B) of rule 2a-7, as amended.
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(iii) The requirements for ABSs regarding maturity determinations
and ratings; 100
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\100\ Paragraphs (a)(8)(ii) (definition of demand feature for
ABSs) and (a)(10)(ii)(B) (rating requirement for ABSs) of rule 2a-7,
as amended. Funds are required, however, to apply the issuer
diversification standards for ABSs in accordance with Section
I.B.3.b. of this Release, supra. See paragraph (c)(4)(ii)(D) of rule
2a-7, as amended.
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(iv) The requirement that a demand feature and a guarantee include
the ability to recover principal and any accrued interest;
101 and
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\101\ Paragraphs (a)(8) and (a)(15) of rule 2a-7, as amended.
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(v) The requirement that a security subject to a conditional demand
feature is an eligible security only if the fund's board of directors
makes certain determinations regarding the conditional demand feature's
exercisability.102
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\102\ Paragraph (c)(3)(iv)(B) of rule 2a-7, as amended.
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A fund may continue to hold these ``grandfathered'' securities or
acquire these securities provided that they satisfy the other
provisions of the rule, as amended, and are issued on or before
February 10, 1998.
IV. Cost/Benefit Analysis and Effects on Competition, Efficiency
and Capital Formation
A. Technical Amendments to Rule 2a-7
The technical amendments to rule 2a-7 make refinements and
corrections to the 1996 Amendments. They are intended to permit money
market funds the maximum amount of flexibility in selecting their
investments consistent with the objective of maintaining a stable net
asset value. This additional flexibility will promote market efficiency
by allowing funds to invest in a wider variety of instruments that
present risks consistent with that objective. For example, the
technical amendments expand the investment opportunities of funds,
without increasing risks, by allowing funds to substitute the credit
quality of guarantee providers for the issuers of securities subject to
guarantees (instead of only those subject to unconditional demand
features) for purposes of compliance with the rule's credit quality
standards. By resolving interpretive issues, the technical amendments
also address competitive inequities that might arise among funds if,
for example, funds draw different conclusions as to the permissibility
of a particular investment that may increase fund yield.
As discussed above,103 the 1996 Amendments tighten the
risk-limiting conditions of rule 2a-7 applicable to tax exempt money
market funds and clarify the rule's treatment of certain instruments,
such as ABSs. The technical amendments potentially will benefit
investors to the extent that rule 2a-7, as finally amended, operates to
decrease the likelihood that a fund will not maintain a stable net
asset value and provides investors greater opportunities to obtain
higher yields without exposure to risks inconsistent with their
investment expectations.
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\103\ See supra Section I.A. of this Release.
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The costs of the technical amendments to funds and fund advisers
(and ultimately fund shareholders) are likely to be minimal, since the
amendments do not impose additional procedural requirements or
reporting burdens on funds. The Commission believes that the direct or
indirect benefits derived from the technical amendments cannot be
quantified because it is impossible to predict with certainty how funds
will structure their portfolio holdings in response to these
amendments.104 In addition, any costs or benefits are likely
to affect not only funds, but also a wide variety of market
participants.105
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\104\ For example, many money market funds currently do not
invest in ABSs, or invest only in those ABSs that do not raise the
diversification issues addressed in this Release. The Commission
expects that more funds will invest in ABSs, although there is no
empirical basis for predicting the size of that expected effect.
\105\ Many of the complex money market fund instruments affected
by the technical amendments are specifically designed to comply with
rule 2a-7. The primary effect of the amendments will be to change
how those instruments are structured, rather than to prohibit funds
from investing in currently-available money market instruments.
Thus, to the extent the amendments impose costs or provide benefits,
these costs and benefits may be shared by funds, investors, issuers,
and the investment banks or other entities that structure money
market instruments.
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In the Proposing Release, the Commission requested specific comment
on the costs and benefits associated with the proposals. No commenters
provided specific estimates of any costs or benefits. One noted
generally the increase in time and costs incurred to document
compliance with rule 2a-7 since 1991, and suggested that procedural
requirements focus less on periodic reviews of existing information and
more on actions required by a board or fund managers in response to new
information.106 In response to these
[[Page 64977]]
concerns, the technical amendments create exceptions to the rule's
periodic review requirements when those requirements are not necessary
to prevent the fund from inadvertently holding ineligible
securities.107
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\106\ The technical amendments do not require additional
periodic reviews. The rule's procedural requirements, including
periodic reviews of certain determinations, were adopted before the
proposal of the technical amendments. The costs and benefits of
these procedures were analyzed previously in connection with the
adoption of rule 2a-7 in 1983, and in connection with amendments to
rule 2a-7 in 1986, 1991 and 1996.
\107\ For example, the amended rule does not require periodic
determinations of the number of ten percent obligors of an ABS that
the board determines will never have, or is unlikely to have, ten
percent obligors. See paragraphs (c)(9)(iv) and (c)(10)(v) of rule
2a-7, as amended.
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Section 2(c) of the 1940 Act provides that whenever the Commission
is engaged in rulemaking and is required to consider whether an action
is necessary or appropriate in the public interest, the Commission also
must consider, in addition to the protection of investors, whether the
action will promote efficiency, competition, and capital
formation.108 For the reasons stated in the cost/benefit
analysis above, the Commission has concluded that the technical
amendments will promote efficiency, competition and capital formation.
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\108\ 15 USC 80a-2(c).
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B. Amendments to Advertising Rules Applicable to Money Market Funds
The amendments to the Commission's advertising rules and forms
applicable to money market funds are designed to clarify the formula
used by money market funds to calculate yield and reduce the potential
for investors being misled or confused by the presentation of a money
market fund's short-term total return. They benefit funds and fund
investors by clarifying the yield formula and codifying accepted
practices under the current rules. The amendments are intended to
preserve the consistency of advertised yield and to maintain the
ability of investors to compare yields quoted by various funds.
The Commission anticipates that the costs of these amendments to
funds and investors are likely to be minimal. No commenters responded
to the Commission's request for specific estimates of costs or benefits
associated with the proposed rule amendments. One commenter stated that
the proposal to clarify that only investment income may be included in
a fund's yield would benefit neither funds nor investors, because it
would discourage funds from identifying sources of safe, non-investment
income, encourage funds to increase yield through riskier investments,
and deprive investors of information regarding consistent sources of
non-investment income.109 The Commission believes, however,
that the rule will benefit investors by ensuring that a money market
fund's yield is consistently advertised and represents only income that
reflects the performance of the fund's investment
portfolio.110
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\109\ According to this commenter, the inability to advertise
non-investment income also would have an adverse effect on
competition in the industry.
\110\ The Commission believes that it is not relevant to
consider the costs to funds identified by the commenter in
connection with these amendments. The amendments are intended to
clarify the existing money market fund yield formula, and as noted
in the Proposing Release, the existing yield formula does not permit
the inclusion of non-investment income in yield. See Proposing
Release, supra note 6, at n.83 and accompanying text. In addition,
the Commission believes that any such costs are in fact quite
limited, since it is aware of only one fund that has sought to
include non-investment income in its calculation of yield.
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V. Paperwork Reduction Act
As set forth in the Proposing Release, certain provisions of the
amendments adopted in this Release contain ``collection of
information'' requirements within the meaning of the Paperwork
Reduction Act of 1995 (``PRA'').111 The collection of
information requirements contained in these amendments were submitted
to the Office of Management and Budget (``OMB'') for review in
accordance with section 3507(d) of the PRA. The title for the
collection of information is ``Rules Regulating Money Market Funds.''
The collection of information requirements are in accordance with
section 3507 of the PRA. An agency may not conduct or sponsor, and a
person is not required to respond to, a collection of information
unless the agency displays a valid OMB control number. OMB approved the
PRA submission with respect to these amendments and assigned OMB
control numbers with respect to the rules amended by this
Release.112
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\111\ 44 U.S.C 3501--3520.
\112\ OMB control numbers are as follows: rule 2a-7 (3235-0268,
expires Mar. 31, 2000); rule 34b-1 (3235-0346, expires Mar. 31,
2000); rule 482 (3235-0074, expires Mar, 31, 2000); Form N-1A (3235-
0307, expires May 31, 2000); Form N-3 (3235-0316, expires Mar. 31,
2000); and Form N-4 (3235-0318, expires Apr. 30, 2000).
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Responses to the collection of information requirements for the
rules and forms amended by this Release are mandatory. The collection
of information requirements under rule 2a-7 are designed to enable the
Commission staff to ascertain a money market funds' compliance with the
rule and ensure that funds have in place procedures for collecting
information necessary to make the required determinations regarding
portfolio securities. Most responses required by rule 2a-7 and
requested by or submitted to the Commission will be kept confidential
to the extent permitted by relevant statutory and regulatory
provisions.113 The collection of information required by
rule 34b-1, rule 482, Form N-1A, Form N-3 and Form N-4, and which is
disclosed in fund prospectuses, registration statements and
advertisements, is public and is not kept confidential by the
Commission.
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\113\ If the board of directors takes action with respect to
defaulted securities, events of insolvency or deviations in share
price, however, funds must file an exhibit to Form N-SAR describing
the action. This collection of information under rule 2a-7 is public
and is not kept confidential by the Commission. See paragraph
(c)(10)(vii) of rule 2a-7, as amended.
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The Supporting Statement to this Paperwork Reduction Act submission
notes that, because the technical amendments to rule 2a-7 clarify
existing reporting and recordkeeping obligations, it is estimated that
they will have no effect on the annual reporting burden of money market
funds. The amendments to the advertising rules and forms applicable to
money market funds are estimated to impose no substantive additional
paperwork burdens on funds. The Commission is aware of only one money
market fund that has sought to include income other than investment
income in its yield calculation, and very few money market funds that
quote any type of total return in their advertisements. If total return
is quoted, however, an insignificant additional burden is required only
if the quoted yield differs materially from quoted total return, which
the Commission believes occurs infrequently.
VI. Summary of Regulatory Flexibility Analysis
A summary of the Initial Regulatory Flexibility Analysis (``IRFA'')
regarding the proposed amendments, which was prepared in accordance
with 5 U.S.C 603, was published in the Proposing Release. No comments
were received on the IRFA. The Commission has prepared a Final
Regulatory Flexibility Analysis (``FRFA'') in accordance with 5 U.S.C
604 regarding the adoption of technical amendments to rule 2a-7 and the
adoption of amendments to the Commission's advertising rules applicable
to money market funds.
The FRFA discusses the need for, and objectives of, the rule
amendments. The FRFA explains that the technical amendments to rule 2a-
7 address many of the questions and issues raised by industry
participants after the adoption of the 1996 Amendments. The objective
of the technical amendments is to refine
[[Page 64978]]
and correct the 1996 Amendments, and thereby permit money market funds
the maximum amount of flexibility in selecting their investments
consistent with the objective of maintaining a stable net asset value.
The FRFA explains that the amendments to the advertising rules
applicable to money market funds clarify that only investment income
may be included in the yield of a money market fund and reduce the
potential for investors being misled or confused by the presentation of
a money market fund's short-term total return.
The FRFA estimates that out of the approximately 650 investment
companies registered with the Commission that have one or more
portfolios that are money market funds, a total of 130 would be
considered small entities. The FRFA indicates that the technical
amendments to rule 2a-7 and the amendments to the advertising rules and
forms applicable to money market funds would effect small entities in
the same manner as other funds subject to these rules.
The FRFA explains that neither the technical amendments to rule 2a-
7 nor the amendments to the advertising rules applicable to money
market funds impose any substantive additional reporting, recordkeeping
or other compliance burdens. Finally, the FRFA states that in adopting
the amendments the Commission considered (a) the establishment of
differing compliance requirements that take into account the resources
available to small entities; (b) simplification of the requirements for
small entities; (c) the use of performance rather than design
standards; and (d) an exemption from the rules for small entities. The
FRFA states that the Commission concluded that different requirements
for small entities with respect to either the technical amendments to
rule 2a-7 or the amendments to the advertising rules applicable to
money market funds are unnecessary and would be inconsistent with
investor protection, and that the adopted amendments are not design
standards.
Cost/benefit information reflected in the ``Cost/Benefit Analysis''
section of this Release also is reflected in the FRFA. A copy of the
FRFA may be obtained by contacting David P. Mathews, Senior Counsel,
Mail Stop 10-2, Securities and Exchange Commission, 450 Fifth Street,
N.W., Washington, D.C. 20549.
VII. Statutory Authority
The Commission is amending rule 2a-7 and the advertising rules and
forms applicable to money market funds under the exemptive and
rulemaking authority set forth in sections 6(c) [15 USC 80a-6(c)], 8(b)
[15 USC 80a-8(b)], 22(c) [15 USC 80a-22(c)], 34(b) [15 USC 80a-33(b)],
35(d) [15 USC 80a-34(d)] and 38(a) [15 USC 80a-37(a)] of the Investment
Company Act of 1940. The authority citations for the amendments to the
rules and forms precede the text of the amendments.
VIII. Text of Rule and Form Amendments
List of Subjects in 17 CFR Parts 230, 239, 270 and 274
Investment companies, Reporting and recordkeeping requirements,
Securities.
For the reasons set out in the preamble, the Commission is amending
chapter II, title 17 of the Code of Federal Regulations as follows:
PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933
1. The authority citation for Part 230 continues to read, in part,
as follows:
Authority: 15 U.S.C. 77b, 77f, 77g, 77h, 77j, 77s, 77sss, 78c,
78d, 78l, 78m, 78n, 78o, 78w, 79ll(d), 79t, 80a-8, 80a-29, 80a-30,
and 80a-37, unless otherwise noted.
* * * * *
2. Section 230.482 is amended by revising paragraph (d) to read as
follows:
Sec. 230.482 Advertising by an investment company as satisfying
requirements of section 10.
* * * * *
(d) In the case of a money market fund:
(1) Any quotation of the money market fund's yield in an
advertisement shall be based on the methods of computation prescribed
in Form N-1A (Secs. 239.15A and 274.11A of this chapter), Form N-3
(Secs. 239.17a and 274.11b of this chapter), or Form N-4 (Secs. 239.17b
and 274.11c of this chapter) and may include:
(i) A quotation of current yield that identifies the length of and
the date of the last day in the base period used in computing that
quotation; or
(ii) A quotation of effective yield if it appears in the same
advertisement as a quotation of current yield and each quotation
relates to an identical base period and is presented with equal
prominence.
(2) Accompany any quotation of the money market fund's total return
in an advertisement with a quotation of the money market fund's current
yield under paragraph (d)(1)(i) of this section. Place the quotations
of total return and current yield next to each other, in the same size
print, and if there is a material difference between the quoted total
return and the quoted current yield, include a statement that the yield
quotation more closely reflects the current earnings of the money
market fund than the total return quotation.
* * * * *
PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940
3. The general authority citation for Part 270 is revised to read
as follows:
Authority: 15 U.S.C. 80a-1 et seq., 80a-34(b), 80a-37, 80a-39
unless otherwise noted;
* * * * *
4. Section 270.2a-7 is revised to read as follows:
Sec. 270.2a-7 Money market funds.
(a) Definitions.
(1) Acquisition (or Acquire) means any purchase or subsequent
rollover (but does not include the failure to exercise a Demand
Feature).
(2) Amortized Cost Method of valuation means the method of
calculating an investment company's net asset value whereby portfolio
securities are valued at the fund's Acquisition cost as adjusted for
amortization of premium or accretion of discount rather than at their
value based on current market factors.
(3) Asset Backed Security means a fixed income security (other than
a Government security) issued by a Special Purpose Entity (as defined
in this paragraph), substantially all of the assets which consist of
Qualifying Assets (as defined in this paragraph). Special Purpose
Entity means a trust, corporation, partnership or other entity
organized for the sole purpose of issuing securities that entitle their
holders to receive payments that depend primarily on the cash flow from
Qualifying Assets, but does not include a registered investment
company. Qualifying Assets means financial assets, either fixed or
revolving, that by their terms convert into cash within a finite time
period, plus any rights or other assets designed to assure the
servicing or timely distribution of proceeds to security holders.
(4) Business Day means any day, other than Saturday, Sunday, or any
customary business holiday.
(5) Collateralized Fully in the case of a repurchase agreement
means that:
(i) The value of the securities collateralizing the repurchase
agreement (reduced by the transaction costs (including loss of
interest) that the money market fund reasonably could
[[Page 64979]]
expect to incur if the seller defaults) is, and during the entire term
of the repurchase agreement remains, at least equal to the Resale Price
(as defined in paragraph (a)(5)(v) of this section) provided in the
agreement;
(ii) The money market fund or its custodian either has actual
physical possession of the collateral or, in the case of a security
registered on a book entry system, the book entry is maintained in the
name of the money market fund or its custodian;
(iii) The collateral consists entirely of cash items, Government
Securities or other securities that at the time the repurchase
agreement is entered into are rated in the highest rating category by
the Requisite NRSROs; and
(iv) Upon an Event of Insolvency with respect to the seller, the
repurchase agreement would qualify under a provision of applicable
insolvency law providing an exclusion from any automatic stay of
creditors' rights against the seller.
(v) Resale Price means the Acquisition price paid to the seller of
the securities plus the accrued resale premium on such Acquisition
price. The accrued resale premium shall be the amount specified in the
repurchase agreement or the daily amortization of the difference
between the Acquisition price and the resale price specified in the
repurchase agreement.
(6) Conditional Demand Feature means a Demand Feature that is not
an Unconditional Demand Feature. A Conditional Demand Feature is not a
Guarantee.
(7) Conduit Security means a security issued by a Municipal Issuer
(as defined in this paragraph) involving an arrangement or agreement
entered into, directly or indirectly, with a person other than a
Municipal Issuer, which arrangement or agreement provides for or
secures repayment of the security. Municipal Issuer means a state or
territory of the United States (including the District of Columbia), or
any political subdivision or public instrumentality of a state or
territory of the United States. A Conduit Security does not include a
security that is:
(i) Fully and unconditionally guaranteed by a Municipal Issuer; or
(ii) Payable from the general revenues of the Municipal Issuer or
other Municipal Issuers (other than those revenues derived from an
agreement or arrangement with a person who is not a Municipal Issuer
that provides for or secures repayment of the security issued by the
Municipal Issuer); or
(iii) Related to a project owned and operated by a Municipal
Issuer; or
(iv) Related to a facility leased to and under the control of an
industrial or commercial enterprise that is part of a public project
which, as a whole, is owned and under the control of a Municipal
Issuer.
(8) Demand Feature means:
(i) A feature permitting the holder of a security to sell the
security at an exercise price equal to the approximate amortized cost
of the security plus accrued interest, if any, at the time of exercise.
A Demand Feature must be exercisable either:
(A) At any time on no more than 30 calendar days' notice; or
(B) At specified intervals not exceeding 397 calendar days and upon
no more than 30 calendar days' notice; or
(ii) A feature permitting the holder of an Asset Backed Security
unconditionally to receive principal and interest within 397 calendar
days of making demand.
(9) Demand Feature Issued By A Non-Controlled Person means a Demand
Feature issued by:
(i) A person that, directly or indirectly, does not control, and is
not controlled by or under common control with the issuer of the
security subject to the Demand Feature (control means ``control'' as
defined in section 2(a)(9) of the Act (15 U.S.C. 80a-2(a)(9)); or
(ii) A sponsor of a Special Purpose Entity with respect to an Asset
Backed Security.
(10) Eligible Security means:
(i) A Rated Security with a remaining maturity of 397 calendar days
or less that has received a rating from the Requisite NRSROs in one of
the two highest short-term rating categories (within which there may be
sub-categories or gradations indicating relative standing); or
(ii) An Unrated Security that is of comparable quality to a
security meeting the requirements for a Rated Security in paragraph
(a)(10)(i) of this section, as determined by the money market fund's
board of directors; Provided, however, that:
(A) A security that at the time of issuance had a remaining
maturity of more than 397 calendar days but that has a remaining
maturity of 397 calendar days or less and that is an Unrated Security
is not an Eligible Security if the security has received a long-term
rating from any NRSRO that is not within the NRSRO's three highest
long-term ratings categories (within which there may be sub-categories
or gradations indicating relative standing), unless the security has
received a long-term rating from the Requisite NRSROs in one of the
three highest rating categories;
(B) An Asset Backed Security (other than an Asset Backed Security
substantially all of whose Qualifying Assets consist of obligations of
one or more Municipal Issuers, as that term is defined in paragraph
(a)(7) of this section) shall not be an Eligible Security unless it has
received a rating from an NRSRO.
(iii) In addition, in the case of a security that is subject to a
Demand Feature or Guarantee:
(A) The Guarantee has received a rating from an NRSRO or the
Guarantee is issued by a guarantor that has received a rating from an
NRSRO with respect to a class of debt obligations (or any debt
obligation within that class) that is comparable in priority and
security to the Guarantee, unless:
(1) The Guarantee is issued by a person that, directly or
indirectly, controls, is controlled by or is under common control with
the issuer of the security subject to the Guarantee (other than a
sponsor of a Special Purpose Entity with respect to an Asset Backed
Security);
(2) The security subject to the Guarantee is a repurchase agreement
that is Collateralized Fully; or
(3) The Guarantee is itself a Government Security; and
(B) The issuer of the Demand Feature or Guarantee, or another
institution, has undertaken promptly to notify the holder of the
security in the event the Demand Feature or Guarantee is substituted
with another Demand Feature or Guarantee (if such substitution is
permissible under the terms of the Demand Feature or Guarantee).
(11) Event of Insolvency means, with respect to a person:
(i) An admission of insolvency, the application by the person for
the appointment of a trustee, receiver, rehabilitator, or similar
officer for all or substantially all of its assets, a general
assignment for the benefit of creditors, the filing by the person of a
voluntary petition in bankruptcy or application for reorganization or
an arrangement with creditors; or
(ii) The institution of similar proceedings by another person which
proceedings are not contested by the person; or
(iii) The institution of similar proceedings by a government agency
responsible for regulating the activities of the person, whether or not
contested by the person.
(12) First Tier Security means any Eligible Security that:
[[Page 64980]]
(i) Is a Rated Security that has received a short-term rating from
the Requisite NRSROs in the highest short-term rating category for debt
obligations (within which there may be sub-categories or gradations
indicating relative standing); or
(ii) Is an Unrated Security that is of comparable quality to a
security meeting the requirements for a Rated Security in paragraph
(a)(12)(i) of this section, as determined by the fund's board of
directors; or
(iii) Is a security issued by a registered investment company that
is a money market fund; or
(iv) Is a Government Security.
(13) Floating Rate Security means a security the terms of which
provide for the adjustment of its interest rate whenever a specified
interest rate changes and that, at any time until the final maturity of
the instrument or the period remaining until the principal amount can
be recovered through demand, can reasonably be expected to have a
market value that approximates its amortized cost.
(14) Government Security means any ``Government security'' as
defined in section 2(a)(16) of the Act (15 U.S.C. 80a-2(a)(16)).
(15) Guarantee means an unconditional obligation of a person other
than the issuer of the security to undertake to pay, upon presentment
by the holder of the Guarantee (if required), the principal amount of
the underlying security plus accrued interest when due or upon default,
or, in the case of an Unconditional Demand Feature, an obligation that
entitles the holder to receive upon exercise the approximate amortized
cost of the underlying security or securities, plus accrued interest,
if any. A Guarantee includes a letter of credit, financial guaranty
(bond) insurance, and an Unconditional Demand Feature (other than an
Unconditional Demand Feature provided by the issuer of the security).
(16) Guarantee Issued By A Non-Controlled Person means a Guarantee
issued by:
(i) A person that, directly or indirectly, does not control, and is
not controlled by or under common control with the issuer of the
security subject to the Guarantee (control means ``control'' as defined
in section 2(a)(9) of the Act (15 U.S.C. 80a-2(a)(9)); or
(ii) A sponsor of a Special Purpose Entity with respect to an Asset
Backed Security.
(17) NRSRO means any nationally recognized statistical rating
organization, as that term is used in paragraphs (c)(2)(vi)(E), (F) and
(H) of Sec. 240.15c3-1 of this Chapter, that is not an ``affiliated
person,'' as defined in section 2(a)(3)(C) of the Act (15 U.S.C. 80a-
2(a)(3)(C)), of the issuer of, or any insurer or provider of credit
support for, the security.
(18) Penny-Rounding Method of pricing means the method of computing
an investment company's price per share for purposes of distribution,
redemption and repurchase whereby the current net asset value per share
is rounded to the nearest one percent.
(19) Rated Security means a security that meets the requirements of
paragraphs (a)(19)(i) or (ii) of this section, in each case subject to
paragraph (a)(19)(iii) of this section:
(i) The security has received a short-term rating from an NRSRO, or
has been issued by an issuer that has received a short-term rating from
an NRSRO with respect to a class of debt obligations (or any debt
obligation within that class) that is comparable in priority and
security with the security; or
(ii) The security is subject to a Guarantee that has received a
short-term rating from an NRSRO, or a Guarantee issued by a guarantor
that has received a short-term rating from an NRSRO with respect to a
class of debt obligations (or any debt obligation within that class)
that is comparable in priority and security with the Guarantee; but
(iii) A security is not a Rated Security if it is subject to an
external credit support agreement (including an arrangement by which
the security has become a Refunded Security) that was not in effect
when the security was assigned its rating, unless the security has
received a short-term rating reflecting the existence of the credit
support agreement as provided in paragraph (a)(19)(i) of this section,
or the credit support agreement with respect to the security has
received a short-term rating as provided in paragraph (a)(19)(ii) of
this section.
(20) Refunded Security means a debt security the principal and
interest payments of which are to be paid by Government Securities
(``deposited securities'') that have been irrevocably placed in an
escrow account pursuant to agreement between the issuer of the debt
security and an escrow agent that is not an ``affiliated person,'' as
defined in section 2(a)(3)(C) of the Act (15 U.S.C. 80a-2(a)(3)(C)), of
the issuer of the debt security, and, in accordance with such escrow
agreement, are pledged only to the payment of the debt security and, to
the extent that excess proceeds are available after all payments of
principal, interest, and applicable premiums on the Refunded
Securities, the expenses of the escrow agent and, thereafter, to the
issuer or another party; provided that:
(i) The deposited securities shall not be redeemable prior to their
final maturity;
(ii) The escrow agreement shall prohibit the substitution of the
deposited securities unless the substituted securities are Government
Securities; and
(iii) At the time the deposited securities are placed in the escrow
account, or at the time a substitution of the deposited securities is
made, an independent certified public accountant shall have certified
to the escrow agent that the deposited securities will satisfy all
scheduled payments of principal, interest and applicable premiums on
the Refunded Securities; Provided, however, an independent public
accountant need not have provided the certification described in this
paragraph (a)(20)(iii) if the security, as a Refunded Security, has
received a rating from an NRSRO in the highest category for debt
obligations (within which there may be sub-categories or gradations
including relative standing).
(21) Requisite NRSROs means:
(i) Any two NRSROs that have issued a rating with respect to a
security or class of debt obligations of an issuer; or
(ii) If only one NRSRO has issued a rating with respect to such
security or class of debt obligations of an issuer at the time the fund
acquires the security, that NRSRO.
(22) Second Tier Security means any Eligible Security that is not a
First Tier Security. Second Tier Conduit Security means any Conduit
Security that is an Eligible Security that is not a First Tier
Security.
(23) Single State Fund means a Tax Exempt Fund that holds itself
out as seeking to maximize the amount of its distributed income that is
exempt from the income taxes or other taxes on investments of a
particular state and, where applicable, subdivisions thereof.
(24) Tax Exempt Fund means any money market fund that holds itself
out as distributing income exempt from regular federal income tax.
(25) Total Assets means, with respect to a money market fund using
the Amortized Cost Method, the total amortized cost of its assets and,
with respect to any other money market fund, the total market-based
value of its assets.
(26) Unconditional Demand Feature means a Demand Feature that by
its terms would be readily exercisable in the event of a default in
payment of principal or interest on the underlying security or
securities.
[[Page 64981]]
(27) United States Dollar-Denominated means, with reference to a
security, that all principal and interest payments on such security are
payable to security holders in United States dollars under all
circumstances and that the interest rate of, the principal amount to be
repaid, and the timing of payments related to such security do not vary
or float with the value of a foreign currency, the rate of interest
payable on foreign currency borrowings, or with any other interest rate
or index expressed in a currency other than United States dollars.
(28) Unrated Security means a security that is not a Rated
Security.
(29) Variable Rate Security means a security the terms of which
provide for the adjustment of its interest rate on set dates (such as
the last day of a month or calendar quarter) and that, upon each
adjustment until the final maturity of the instrument or the period
remaining until the principal amount can be recovered through demand,
can reasonably be expected to have a market value that approximates its
amortized cost.
(b) Holding Out and Use of Names and Titles. (1) It shall be an
untrue statement of material fact within the meaning of section 34(b)
of the Act (15 U.S.C. 80a-33(b)) for a registered investment company,
in any registration statement, application, report, account, record, or
other document filed or transmitted pursuant to the Act, including any
advertisement, pamphlet, circular, form letter, or other sales
literature addressed to or intended for distribution to prospective
investors that is required to be filed with the Commission by section
24(b) of the Act (15 U.S.C. 80a-24(b)), to hold itself out to investors
as a money market fund or the equivalent of a money market fund, unless
such registered investment company meets the conditions of paragraphs
(c)(2), (c)(3) and (c)(4) of this section.
(2) It shall constitute the use of a materially deceptive or
misleading name or title within the meaning of section 35(d) of the Act
(15 U.S.C. 80a-34(d)) for a registered investment company to adopt the
term ``money market'' as part of its name or title or the name or title
of any redeemable securities of which it is the issuer, or to adopt a
name that suggests that it is a money market fund or the equivalent of
a money market fund, unless such registered investment company meets
the conditions of paragraphs (c)(2), (c)(3), and (c)(4) of this
section.
(3) For purposes of this paragraph, a name that suggests that a
registered investment company is a money market fund or the equivalent
thereof shall include one that uses such terms as ``cash,'' ``liquid,''
``money,'' ``ready assets'' or similar terms.
(c) Share Price Calculations. The current price per share, for
purposes of distribution, redemption and repurchase, of any redeemable
security issued by any registered investment company (``money market
fund'' or ``fund''), notwithstanding the requirements of section
2(a)(41) of the Act (15 U.S.C. 80a-2(a)(41)) and of Secs. 270.2a-4 and
270.22c-1 thereunder, may be computed by use of the Amortized Cost
Method or the Penny-Rounding Method; Provided, however, that:
(1) Board Findings. The board of directors of the money market fund
shall determine, in good faith, that it is in the best interests of the
fund and its shareholders to maintain a stable net asset value per
share or stable price per share, by virtue of either the Amortized Cost
Method or the Penny-Rounding Method, and that the money market fund
will continue to use such method only so long as the board of directors
believes that it fairly reflects the market-based net asset value per
share.
(2) Portfolio Maturity. The money market fund shall maintain a
dollar-weighted average portfolio maturity appropriate to its objective
of maintaining a stable net asset value per share or price per share;
Provided, however, that the money market fund will not:
(i) Except as provided in paragraph (c)(2)(ii) of this section,
Acquire any instrument with a remaining maturity of greater than 397
calendar days; or
(ii) In the case of a money market fund not using the Amortized
Cost Method, Acquire a Government Security with a remaining maturity of
greater than 762 calendar days; or
(iii) Maintain a dollar-weighted average portfolio maturity that
exceeds ninety days.
(3) Portfolio Quality--(i) General. The money market fund shall
limit its portfolio investments to those United States Dollar-
Denominated securities that the fund's board of directors determines
present minimal credit risks (which determination must be based on
factors pertaining to credit quality in addition to any rating assigned
to such securities by an NRSRO) and that are at the time of Acquisition
Eligible Securities.
(ii) Second Tier Securities. Immediately after the Acquisition of
any Second Tier Security:
(A) Taxable Funds. A money market fund that is not a Tax Exempt
Fund shall not have invested more than five percent of its Total Assets
in securities that are Second Tier Securities; and
(B) Tax Exempt Funds. A money market fund that is a Tax Exempt Fund
shall not have invested more than five percent of its Total Assets in
Conduit Securities that are Second Tier Conduit Securities.
(iii) Securities Subject to Guarantees. A security that is subject
to a Guarantee may be determined to be an Eligible Security or a First
Tier Security based solely on whether the Guarantee is an Eligible
Security or First Tier Security, as the case may be.
(iv) Securities Subject to Conditional Demand Features. A security
that is subject to a Conditional Demand Feature (``Underlying
Security'') may be determined to be an Eligible Security or a First
Tier Security only if:
(A) The Conditional Demand Feature is an Eligible Security or First
Tier Security, as the case may be;
(B) At the time of the Acquisition of the Underlying Security, the
money market fund's board of directors has determined that there is
minimal risk that the circumstances that would result in the
Conditional Demand Feature not being exercisable will occur; and
(1) The conditions limiting exercise either can be monitored
readily by the fund, or relate to the taxability, under federal, state
or local law, of the interest payments on the security; or
(2) The terms of the Conditional Demand Feature require that the
fund will receive notice of the occurrence of the condition and the
opportunity to exercise the Demand Feature in accordance with its
terms; and
(C) The Underlying Security or any Guarantee of such security (or
the debt securities of the issuer of the Underlying Security or
Guarantee that are comparable in priority and security with the
Underlying Security or Guarantee) has received either a short-term
rating or a long-term rating, as the case may be, from the Requisite
NRSROs within the NRSROs' two highest short-term or long-term rating
categories (within which there may be sub-categories or gradations
indicating relative standing) or, if unrated, is determined to be of
comparable quality by the money market fund's board of directors to a
security that has received a rating from the Requisite NRSROs within
the NRSROs' two highest short-term or long-term rating categories, as
the case may be.
(4) Portfolio Diversification--(i) Issuer Diversification. The
money market fund shall be diversified with respect to issuers of
securities Acquired by the fund as provided in paragraphs (c)(4)(i) and
(c)(4)(ii) of this section, other than
[[Page 64982]]
with respect to Government Securities and securities subject to a
Guarantee Issued By A Non-Controlled Person.
(A) Taxable and National Funds. Immediately after the Acquisition
of any security, a money market fund other than a Single State Fund
shall not have invested more than five percent of its Total Assets in
securities issued by the issuer of the security; Provided, however,
that such a fund may invest up to twenty-five percent of its Total
Assets in the First Tier Securities of a single issuer for a period of
up to three Business Days after the Acquisition thereof; Provided,
further, that the fund may not invest in the securities of more than
one issuer in accordance with the foregoing proviso in this paragraph
at any time.
(B) Single State Funds. With respect to seventy-five percent of its
Total Assets, immediately after the Acquisition of any security, a
Single State Fund shall not have invested more than five percent of its
Total Assets in securities issued by the issuer of the security;
Provided, however, that a Single State Fund shall not invest more than
five percent of its Total Assets in securities issued by the issuer of
the security unless the securities are First Tier Securities.
(C) Second Tier Securities--(1) Taxable Funds. Immediately after
the Acquisition of any Second Tier Security, a money market fund that
is not a Tax Exempt Fund shall not have invested more than the greater
of one percent of its Total Assets or one million dollars in securities
issued by that issuer that are Second Tier Securities.
(2) Tax Exempt Funds. Immediately after the Acquisition of any
Second Tier Conduit Security, a money market fund that is a Tax Exempt
Fund shall not have invested more than the greater of one percent of
its Total Assets or one million dollars in securities issued by that
issuer that are Second Tier Conduit Securities.
(ii) Issuer Diversification Calculations. For purposes of making
calculations under paragraph (c)(4)(i) of this section:
(A) Repurchase Agreements. The Acquisition of a repurchase
agreement may be deemed to be an Acquisition of the underlying
securities, provided the obligation of the seller to repurchase the
securities from the money market fund is Collateralized Fully.
(B) Refunded Securities. The Acquisition of a Refunded Security
shall be deemed to be an Acquisition of the escrowed Government
Securities.
(C) Conduit Securities. A Conduit Security shall be deemed to be
issued by the person (other than the Municipal Issuer) ultimately
responsible for payments of interest and principal on the security.
(D) Asset Backed Securities--(1) General. An Asset Backed Security
Acquired by a fund (``Primary ABS'') shall be deemed to be issued by
the Special Purpose Entity that issued the Asset Backed Security,
Provided, however:
(i) Holdings of Primary ABS. Any person whose obligations
constitute ten percent or more of the principal amount of the
Qualifying Assets of the Primary ABS (``Ten Percent Obligor'') shall be
deemed to be an issuer of the portion of the Primary ABS such
obligations represent; and
(ii) Holdings of Secondary ABS. If a Ten Percent Obligor of a
Primary ABS is itself a Special Purpose Entity issuing Asset Backed
Securities (``Secondary ABS''), any Ten Percent Obligor of such
Secondary ABS also shall be deemed to be an issuer of the portion of
the Primary ABS that such Ten Percent Obligor represents.
(2) Restricted Special Purpose Entities. A Ten Percent Obligor with
respect to a Primary or Secondary ABS shall not be deemed to have
issued any portion of the assets of a Primary ABS as provided in
paragraph (c)(4)(ii)(D)(1) of this section if that Ten Percent Obligor
is itself a Special Purpose Entity issuing Asset Backed Securities
(``Restricted Special Purpose Entity''), and the securities that it
issues (other than securities issued to a company that controls, or is
controlled by or under common control with, the Restricted Special
Purpose Entity and which is not itself a Special Purpose Entity issuing
Asset Backed Securities) are held by only one other Special Purpose
Entity.
(3) Demand Features and Guarantees. In the case of a Ten Percent
Obligor deemed to be an issuer, the fund shall satisfy the
diversification requirements of paragraph (c)(4)(iii) of this section
with respect to any Demand Feature or Guarantee to which the Ten
Percent Obligor's obligations are subject.
(E) Shares of Other Money Market Funds. A money market fund that
Acquires shares issued by another money market fund in an amount that
would otherwise be prohibited by paragraph (c)(4)(i) of this section
shall nonetheless be deemed in compliance with this section if the
board of directors of the Acquiring money market fund reasonably
believes that the fund in which it has invested is in compliance with
this section.
(iii) Diversification Rules for Demand Features and Guarantees. The
money market fund shall be diversified with respect to Demand Features
and Guarantees Acquired by the fund as provided in paragraphs
(c)(4)(iii) and (c)(4)(iv) of this section, other than with respect to
a Demand Feature issued by the same institution that issued the
underlying security, or with respect to a Guarantee or Demand Feature
that is itself a Government Security.
(A) General. Immediately after the Acquisition of any Demand
Feature or Guarantee or security subject to a Demand Feature or
Guarantee, a money market fund, with respect to seventy-five percent of
its Total Assets, shall not have invested more than ten percent of its
Total Assets in securities issued by or subject to Demand Features or
Guarantees from the institution that issued the Demand Feature or
Guarantee, subject to paragraphs (c)(4)(iii) (B) and (C) of this
section.
(B) Second Tier Demand Features or Guarantees. Immediately after
the Acquisition of any Demand Feature or Guarantee (or a security after
giving effect to the Demand Feature or Guarantee) that is a Second Tier
Security, a money market fund shall not have invested more than five
percent of its Total Assets in securities issued by or subject to
Demand Features or Guarantees from the institution that issued the
Demand Feature or Guarantee.
(C) Demand Features or Guarantees Issued by Non-Controlled Persons.
Immediately after the Acquisition of any security subject to a Demand
Feature or Guarantee, a money market fund shall not have invested more
than ten percent of its Total Assets in securities issued by, or
subject to Demand Features or Guarantees from the institution that
issued the Demand Feature or Guarantee, unless, with respect to any
security subject to Demand Features or Guarantees from that institution
(other than securities issued by such institution), the Demand Feature
or Guarantee is a Demand Feature or Guarantee Issued By A Non-
Controlled Person.
(iv) Demand Feature and Guarantee Diversification Calculations--(A)
Fractional Demand Features or Guarantees. In the case of a security
subject to a Demand Feature or Guarantee from an institution by which
the institution guarantees a specified portion of the value of the
security, the institution shall be deemed to guarantee the specified
portion thereof.
(B) Layered Demand Features or Guarantees. In the case of a
security subject to Demand Features or Guarantees from multiple
institutions that have not limited the extent of their obligations as
described in paragraph (c)(4)(iv)(A) of this section, each
[[Page 64983]]
institution shall be deemed to have provided the Demand Feature or
Guarantee with respect to the entire principal amount of the security.
(v) Diversification Safe Harbor. A money market fund that satisfies
the applicable diversification requirements of paragraphs (c)(4) and
(c)(5) of this section shall be deemed to have satisfied the
diversification requirements of section 5(b)(1) of the Act (15 U.S.C.
80a-5(b)(1)) and the rules adopted thereunder.
(5) Demand Features and Guarantees Not Relied Upon. If the fund's
board of directors has determined that the fund is not relying on a
Demand Feature or Guarantee to determine the quality (pursuant to
paragraph (c)(3) of this section), or maturity (pursuant to paragraph
(d) of this section), or liquidity of a portfolio security, and
maintains a record of this determination (pursuant to paragraphs
(c)(9)(ii) and (c)(10)(vi) of this section), then the fund may
disregard such Demand Feature or Guarantee for all purposes of this
section.
(6) Downgrades, Defaults and Other Events--(i) Downgrades--(A)
General. Upon the occurrence of either of the events specified in
paragraphs (c)(6)(i)(A) (1) and (2) of this section with respect to a
portfolio security, the board of directors of the money market fund
shall reassess promptly whether such security continues to present
minimal credit risks and shall cause the fund to take such action as
the board of directors determines is in the best interests of the money
market fund and its shareholders:
(1) A portfolio security of a money market fund ceases to be a
First Tier Security (either because it no longer has the highest rating
from the Requisite NRSROs or, in the case of an Unrated Security, the
board of directors of the money market fund determines that it is no
longer of comparable quality to a First Tier Security); and
(2) The money market fund's investment adviser (or any person to
whom the fund's board of directors has delegated portfolio management
responsibilities) becomes aware that any Unrated Security or Second
Tier Security held by the money market fund has, since the security was
Acquired by the fund, been given a rating by any NRSRO below the
NRSRO's second highest short-term rating category.
(B) Securities to Be Disposed Of. The reassessments required by
paragraph (c)(6)(i)(A) of this section shall not be required if, in
accordance with the procedures adopted by the board of directors, the
security is disposed of (or matures) within five Business Days of the
specified event and, in the case of events specified in paragraph
(c)(6)(i)(A)(2) of this section, the board is subsequently notified of
the adviser's actions.
(C) Special Rule for Certain Securities Subject to Demand Features.
In the event that after giving effect to a rating downgrade, more than
five percent of the fund's Total Assets are invested in securities
issued by or subject to Demand Features from a single institution that
are Second Tier Securities, the fund shall reduce its investment in
securities issued by or subject to Demand Features from that
institution to no more than five percent of its Total Assets by
exercising the Demand Features at the next succeeding exercise date(s),
absent a finding by the board of directors that disposal of the
portfolio security would not be in the best interests of the money
market fund.
(ii) Defaults and Other Events. Upon the occurrence of any of the
events specified in paragraphs (c)(6)(ii)(A) through (D) of this
section with respect to a portfolio security, the money market fund
shall dispose of such security as soon as practicable consistent with
achieving an orderly disposition of the security, by sale, exercise of
any Demand Feature or otherwise, absent a finding by the board of
directors that disposal of the portfolio security would not be in the
best interests of the money market fund (which determination may take
into account, among other factors, market conditions that could affect
the orderly disposition of the portfolio security):
(A) The default with respect to a portfolio security (other than an
immaterial default unrelated to the financial condition of the issuer);
(B) A portfolio security ceases to be an Eligible Security;
(C) A portfolio security has been determined to no longer present
minimal credit risks; or
(D) An Event of Insolvency occurs with respect to the issuer of a
portfolio security or the provider of any Demand Feature or Guarantee.
(iii) Notice to the Commission. In the event of a default with
respect to one or more portfolio securities (other than an immaterial
default unrelated to the financial condition of the issuer) or an Event
of Insolvency with respect to the issuer of the security or any Demand
Feature or Guarantee to which it is subject, where immediately before
default the securities (or the securities subject to the Demand Feature
or Guarantee) accounted for \1/2\ of 1 percent or more of a money
market fund's Total Assets, the money market fund shall promptly notify
the Commission of such fact and the actions the money market fund
intends to take in response to such situation. Notification under this
paragraph shall be made telephonically, or by means of a facsimile
transmission or electronic mail, followed by letter sent by first class
mail, directed to the attention of the Director of the Division of
Investment Management.
(iv) Defaults for Purposes of Paragraphs (c)(6) (ii) and (iii). For
purposes of paragraphs (c)(6) (ii) and (iii) of this section, an
instrument subject to a Demand Feature or Guarantee shall not be deemed
to be in default (and an Event of Insolvency with respect to the
security shall not be deemed to have occurred) if:
(A) In the case of an instrument subject to a Demand Feature, the
Demand Feature has been exercised and the fund has recovered either the
principal amount or the amortized cost of the instrument, plus accrued
interest; or
(B) The provider of the Guarantee is continuing, without protest,
to make payments as due on the instrument.
(7) Required Procedures: Amortized Cost Method. In the case of a
money market fund using the Amortized Cost Method:
(i) General. In supervising the money market fund's operations and
delegating special responsibilities involving portfolio management to
the money market fund's investment adviser, the money market fund's
board of directors, as a particular responsibility within the overall
duty of care owed to its shareholders, shall establish written
procedures reasonably designed, taking into account current market
conditions and the money market fund's investment objectives, to
stabilize the money market fund's net asset value per share, as
computed for the purpose of distribution, redemption and repurchase, at
a single value.
(ii) Specific Procedures. Included within the procedures adopted by
the board of directors shall be the following:
(A) Shadow Pricing. Written procedures shall provide:
(1) That the extent of deviation, if any, of the current net asset
value per share calculated using available market quotations (or an
appropriate substitute that reflects current market conditions) from
the money market fund's amortized cost price per share, shall be
calculated at such intervals as the board of directors determines
appropriate and reasonable in light of current market conditions;
(2) For the periodic review by the board of directors of the amount
of the deviation as well as the methods used to calculate the
deviation; and
[[Page 64984]]
(3) For the maintenance of records of the determination of
deviation and the board's review thereof.
(B) Prompt Consideration of Deviation. In the event such deviation
from the money market fund's amortized cost price per share exceeds \1/
2\ of 1 percent, the board of directors shall promptly consider what
action, if any, should be initiated by the board of directors.
(C) Material Dilution or Unfair Results. Where the board of
directors believes the extent of any deviation from the money market
fund's amortized cost price per share may result in material dilution
or other unfair results to investors or existing shareholders, it shall
cause the fund to take such action as it deems appropriate to eliminate
or reduce to the extent reasonably practicable such dilution or unfair
results.
(8) Required Procedures: Penny-Rounding Method. In the case of a
money market fund using the Penny-Rounding Method, in supervising the
money market fund's operations and delegating special responsibilities
involving portfolio management to the money market fund's investment
adviser, the money market fund's board of directors undertakes, as a
particular responsibility within the overall duty of care owed to its
shareholders, to assure to the extent reasonably practicable, taking
into account current market conditions affecting the money market
fund's investment objectives, that the money market fund's price per
share as computed for the purpose of distribution, redemption and
repurchase, rounded to the nearest one percent, will not deviate from
the single price established by the board of directors.
(9) Specific Procedures: Amortized Cost and Penny-Rounding Methods.
Included within the procedures adopted by the board of directors for
money market funds using either the Amortized Cost or Penny-Rounding
Methods shall be the following:
(i) Securities for Which Maturity is Determined by Reference to
Demand Features. In the case of a security for which maturity is
determined by reference to a Demand Feature, written procedures shall
require ongoing review of the security's continued minimal credit
risks, and that review must be based on, among other things, financial
data for the most recent fiscal year of the issuer of the Demand
Feature and, in the case of a security subject to a Conditional Demand
Feature, the issuer of the security whose financial condition must be
monitored under paragraph (c)(3)(iv) of this section, whether such data
is publicly available or provided under the terms of the security's
governing documentation.
(ii) Securities Subject to Demand Features or Guarantees. In the
case of a security subject to one or more Demand Features or Guarantees
that the fund's board of directors has determined that the fund is not
relying on to determine the quality (pursuant to paragraph (c)(3) of
this section), maturity (pursuant to paragraph (d) of this section) or
liquidity of the security subject to the Demand Feature or Guarantee,
written procedures shall require periodic evaluation of such
determination.
(iii) Adjustable Rate Securities Without Demand Features. In the
case of a Variable Rate or Floating Rate Security that is not subject
to a Demand Feature and for which maturity is determined pursuant to
paragraphs (d)(1), (d)(2) or (d)(4) of this section, written procedures
shall require periodic review of whether the interest rate formula,
upon readjustment of its interest rate, can reasonably be expected to
cause the security to have a market value that approximates its
amortized cost value.
(iv) Asset Backed Securities. In the case of an Asset Backed
Security, written procedures shall require the fund to periodically
determine the number of Ten Percent Obligors (as that term is used in
paragraph (c)(4)(ii)(D) of this section) deemed to be the issuers of
all or a portion of the Asset Backed Security for purposes of paragraph
(c)(4)(ii)(D) of this section; Provided, however, written procedures
need not require periodic determinations with respect to any Asset
Backed Security that a fund's board of directors has determined, at the
time of Acquisition, will not have, or is unlikely to have, Ten Percent
Obligors that are deemed to be issuers of all or a portion of that
Asset Backed Security for purposes of paragraph (c)(4)(ii)(D) of this
section, and maintains a record of this determination.
(10) Record Keeping and Reporting--(i) Written Procedures. For a
period of not less than six years following the replacement of such
procedures with new procedures (the first two years in an easily
accessible place), a written copy of the procedures (and any
modifications thereto) described in paragraphs (c)(6) through (c)(9)
and (e) of this section shall be maintained and preserved.
(ii) Board Considerations and Actions. For a period of not less
than six years (the first two years in an easily accessible place) a
written record shall be maintained and preserved of the board of
directors' considerations and actions taken in connection with the
discharge of its responsibilities, as set forth in this section, to be
included in the minutes of the board of directors' meetings.
(iii) Credit Risk Analysis. For a period of not less than three
years from the date that the credit risks of a portfolio security were
most recently reviewed, a written record of the determination that a
portfolio security presents minimal credit risks and the NRSRO ratings
(if any) used to determine the status of the security as an Eligible
Security, First Tier Security or Second Tier Security shall be
maintained and preserved in an easily accessible place.
(iv) Determinations With Respect to Adjustable Rate Securities. For
a period of not less than three years from the date when the
determination was most recently made, a written record shall be
preserved and maintained, in an easily accessible place, of the
determination required by paragraph (c)(9)(iii) of this section (that a
Variable Rate or Floating Rate Security that is not subject to a Demand
Feature and for which maturity is determined pursuant to paragraphs
(d)(1), (d)(2) or (d)(4) of this section can reasonably be expected,
upon readjustment of its interest rate at all times during the life of
the instrument, to have a market value that approximates its amortized
cost).
(v) Determinations with Respect to Asset Backed Securities. For a
period of not less than three years from the date when the
determination was most recently made, a written record shall be
preserved and maintained, in an easily accessible place, of the
determinations required by paragraph (c)(9)(iv) of this section (the
number of Ten Percent Obligors (as that term is used in paragraph
(c)(4)(ii)(D) of this section) deemed to be the issuers of all or a
portion of the Asset Backed Security for purposes of paragraph
(c)(4)(ii)(D) of this section). The written record shall include:
(A) The identities of the Ten Percent Obligors (as that term is
used in paragraph (c)(4)(ii)(D) of this section), the percentage of the
Qualifying Assets constituted by the securities of each Ten Percent
Obligor and the percentage of the fund's Total Assets that are invested
in securities of each Ten Percent Obligor; and
(B) Any determination that an Asset Backed Security will not have,
or is unlikely to have, Ten Percent Obligors deemed to be issuers of
all or a portion of that Asset Backed Security for purposes of
paragraph (c)(4)(ii)(D) of this section.
(vi) Evaluations with Respect to Securities Subject to Demand
Features or Guarantees. For a period of not less
[[Page 64985]]
than three years from the date when the evaluation was most recently
made, a written record shall be preserved and maintained, in an easily
accessible place, of the evaluation required by paragraph (c)(9)(ii)
(regarding securities subject to one or more Demand Features or
Guarantees) of this section.
(vii) Inspection of Records. The documents preserved pursuant to
this paragraph (c)(10) shall be subject to inspection by the Commission
in accordance with section 31(b) of the Act (15 U.S.C. 80a-30(b)) as if
such documents were records required to be maintained pursuant to rules
adopted under section 31(a) of the Act (15 U.S.C. 80a-30(a)). If any
action was taken under paragraphs (c)(6)(ii) (with respect to defaulted
securities and events of insolvency) or (c)(7)(ii) (with respect to a
deviation from the fund's share price of more than 1/2 of 1 percent) of
this section, the money market fund will file an exhibit to the Form N-
SAR (17 CFR 274.101) filed for the period in which the action was taken
describing with specificity the nature and circumstances of such
action. The money market fund will report in an exhibit to such Form
any securities it holds on the final day of the reporting period that
are not Eligible Securities.
(d) Maturity of Portfolio Securities. For purposes of this section,
the maturity of a portfolio security shall be deemed to be the period
remaining (calculated from the trade date or such other date on which
the fund's interest in the security is subject to market action) until
the date on which, in accordance with the terms of the security, the
principal amount must unconditionally be paid, or in the case of a
security called for redemption, the date on which the redemption
payment must be made, except as provided in paragraphs (d)(1) through
(d)(8) of this section:
(1) Adjustable Rate Government Securities. A Government Security
that is a Variable Rate Security where the variable rate of interest is
readjusted no less frequently than every 762 calendar days shall be
deemed to have a maturity equal to the period remaining until the next
readjustment of the interest rate. A Government Security that is a
Floating Rate Security shall be deemed to have a remaining maturity of
one day.
(2) Short-Term Variable Rate Securities. A Variable Rate Security,
the principal amount of which, in accordance with the terms of the
security, must unconditionally be paid in 397 calendar days or less
shall be deemed to have a maturity equal to the earlier of the period
remaining until the next readjustment of the interest rate or the
period remaining until the principal amount can be recovered through
demand.
(3) Long-Term Variable Rate Securities. A Variable Rate Security,
the principal amount of which is scheduled to be paid in more than 397
calendar days, that is subject to a Demand Feature, shall be deemed to
have a maturity equal to the longer of the period remaining until the
next readjustment of the interest rate or the period remaining until
the principal amount can be recovered through demand.
(4) Short-Term Floating Rate Securities. A Floating Rate Security,
the principal amount of which, in accordance with the terms of the
security, must unconditionally be paid in 397 calendar days or less
shall be deemed to have a maturity of one day.
(5) Long-Term Floating Rate Securities. A Floating Rate Security,
the principal amount of which is scheduled to be paid in more than 397
calendar days, that is subject to a Demand Feature, shall be deemed to
have a maturity equal to the period remaining until the principal
amount can be recovered through demand.
(6) Repurchase Agreements. A repurchase agreement shall be deemed
to have a maturity equal to the period remaining until the date on
which the repurchase of the underlying securities is scheduled to
occur, or, where the agreement is subject to demand, the notice period
applicable to a demand for the repurchase of the securities.
(7) Portfolio Lending Agreements. A portfolio lending agreement
shall be treated as having a maturity equal to the period remaining
until the date on which the loaned securities are scheduled to be
returned, or where the agreement is subject to demand, the notice
period applicable to a demand for the return of the loaned securities.
(8) Money Market Fund Securities. An investment in a money market
fund shall be treated as having a maturity equal to the period of time
within which the Acquired money market fund is required to make payment
upon redemption, unless the Acquired money market fund has agreed in
writing to provide redemption proceeds to the investing money market
fund within a shorter time period, in which case the maturity of such
investment shall be deemed to be the shorter period.
(e) Delegation. The money market fund's board of directors may
delegate to the fund's investment adviser or officers the
responsibility to make any determination required to be made by the
board of directors under this section (other than the determinations
required by paragraphs (c)(1) (board findings); (c)(6)(i)(C) (rule for
certain securities subject to second tier Demand Features); (c)(6)(ii)
(defaults and other events); (c)(7)(i) (general required procedures:
Amortized Cost Method); (c)(7)(ii)(A) (shadow pricing), (B) (prompt
consideration of deviation), and (C) (material dilution or unfair
results); and (c)(8) (required procedures: Penny Rounding Method) of
this section) provided:
(1) Written Guidelines. The Board shall establish and periodically
review written guidelines (including guidelines for determining whether
securities present minimal credit risks as required in paragraph (c)(3)
of this section) and procedures under which the delegate makes such
determinations:
(2) Oversight. The Board shall take any measures reasonably
necessary (through periodic reviews of fund investments and the
delegate's procedures in connection with investment decisions and
prompt review of the adviser's actions in the event of the default of a
security or Event of Insolvency with respect to the issuer of the
security or any Guarantee to which it is subject that requires
notification of the Commission under paragraph (c)(6)(iii) of this
section) to assure that the guidelines and procedures are being
followed.
5. Section 270.2a41-1 is amended by revising the introductory text
of paragraph (a) to read as follows:
Sec. 270.2a41-1 Valuation of standby commitments by registered
investment companies.
(a) A standby commitment means a right to sell a specified
underlying security or securities within a specified period of time and
at an exercise price equal to the amortized cost of the underlying
security or securities plus accrued interest, if any, at the time of
exercise, that may be sold, transferred or assigned only with the
underlying security or securities. A standby commitment entitles the
holder to receive same day settlement, and will be considered to be
from the party to whom the investment company will look for payment of
the exercise price. A standby commitment may be assigned a fair value
of zero, Provided, That:
* * * * *
6. Section 270.12d3-1 is amended by revising paragraph (d)(7)(v) to
read as follows:
Sec. 270.12d3-1 Exemption of acquisitions of securities issued by
persons engaged in securities related businesses.
* * * * *
(d) * * *
[[Page 64986]]
(7) * * *
(v) Acquisition of Demand Features or Guarantees, as these terms
are defined in Secs. 270.2a-7(a)(8) and 270.2a-7(a)(15) respectively,
provided that, immediately after the acquisition of any Demand Feature
or Guarantee, the company will not, with respect to 75 percent of the
total value of its assets, have invested more than ten percent of the
total value of its assets in securities underlying Demand Features or
Guarantees from the same institution. For the purposes of this section,
a Demand Feature or Guarantee will be considered to be from the party
to whom the company will look for payment of the exercise price.
* * * * *
7. Section 270.17a-9 is amended by revising the cite to ``paragraph
(a)(9)'' in the introductory paragraph to read ``paragraph (a)(10)''.
8. Section 270.31a-1 is amended by revising the last sentence of
paragraph (b)(1) to read as follows:
Sec. 270.31a-1 Records to be maintained by registered investment
companies, certain majority-owned subsidiaries thereof, and other
persons having transactions with registered investment companies.
* * * * *
(b) * * *
(1) * * * In the case of a money market fund, also identify the
provider of any Demand Feature or Guarantee (as defined in Sec. 270.2a-
7(a)(8) or Sec. 270.2a-7(a)(15) respectively) and give a brief
description of the nature of the Demand Feature or Guarantee (e.g.,
unconditional demand feature, conditional demand feature, letter of
credit, or bond insurance) and, in a subsidiary portfolio investment
record, provide the complete legal name and accounting and other
information (including sufficient information to calculate coupons,
accruals, maturities, puts, and calls) necessary to identify, value,
and account for each investment.
* * * * *
9. Section 270.34b-1 is amended by revising paragraph (b) (the Note
remains unchanged) to read as follows:
Sec. 270.34b-1 Sales literature deemed to be misleading.
* * * * *
(b)(1) Except as provided in paragraph (b)(3) of this section:
(i) In any sales literature that contains performance data for an
investment company, include the disclosure required by paragraph (a)(6)
of Sec. 230.482 of this chapter.
(ii) In any sales literature for a money market fund:
(A) Accompany any quotation of yield or similar quotation
purporting to demonstrate the income earned or distributions made by
the money market fund with a quotation of current yield specified by
paragraph (d)(1)(i) of Sec. 230.482 of this chapter;
(B) Accompany any quotation of tax equivalent yield or other
similar quotation purporting to demonstrate the tax equivalent yield
earned or distributions made by the money market fund with a quotation
of current yield specified in paragraph (d)(1)(i) of Sec. 230.482 of
this chapter; and
(C) Accompany any quotation of the money market fund's total return
with a quotation of the money market fund's current yield specified in
paragraph (d)(1)(i) of Sec. 230.482 of this chapter. Place the
quotations of total return and current yield next to each other, in the
same size print, and if there is a material difference between the
quoted total return and the quoted current yield, include a statement
that the yield quotation more closely reflects the current earnings of
the money market fund than the total return quotation.
(iii) In any sales literature for an investment company other than
a money market fund that contains performance data:
(A) Include the total return information required by paragraph
(e)(3) of Sec. 230.482 of this chapter;
(B) Accompany any quotation of yield or similar quotation
purporting to demonstrate the income earned or distributions made by
the company with a quotation of current yield specified by paragraph
(e)(1) of Sec. 230.482 of this chapter; and
(C) Accompany any quotation of tax equivalent yield or other
similar quotation purporting to demonstrate the tax equivalent yield
earned or distributions made by the company with a quotation of tax
equivalent yield specified in paragraph (e)(2) and current yield
specified by paragraph (e)(1) of Sec. 230.482 of this chapter.
(2) Any performance data included in sales literature under
paragraphs (b)(1)(ii) or (iii) of this section must meet the
currentness requirements of paragraph (f) of Sec. 230.482 of this
chapter.
(3) The requirements specified in paragraph (b)(1) of this section
shall not apply to any quarterly, semi-annual, or annual report to
shareholders under Section 30 of the Act (15 U.S.C. 80a-29), containing
performance data for a period commencing no earlier than the first day
of the period covered by the report; nor shall the requirements of
paragraphs (e)(3)(ii) and (f) of Sec. 230.482 of this chapter apply to
any such periodic report containing any other performance data.
* * * * *
PART 239--FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933
PART 274--FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY ACT OF 1940
10. The authority citation for part 239 continues to read, in part,
as follows:
Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77sss, 78c,
78l, 78m, 78n, 78o(d), 78u-5, 78w(a), 78ll(d), 79e, 79f, 79g, 79j,
79l, 79m, 79n, 79q, 79t, 80a-8, 80a-29, 80a-30 and 80a-37, unless
otherwise noted.
* * * * *
11. The authority citation for part 274 continues to read as
follows:
Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 78c(b), 78l, 78m,
78n, 78o(d), 80a-8, 80a-24, and 80a-29, unless otherwise noted.
12. Part B, Item 22(a) of Form N-1A (referenced in Secs. 239.15A
and 274.11A) is amended by:
(a) Adding in paragraphs (i) and (ii) the phrase ``and income other
than investment income'' after the phrase ``exclusive of capital
changes'' in each paragraph.
(b) Adding at the end of Instruction 2 the following: ``Exclude
income other than investment income.''
Note: Form N-1A does not and the amendments will not appear in
the Code of Federal Regulations.
13. Item 25(a) of Form N-3 (referenced in Secs. 239.17a and
274.11b) is amended by:
(a) Adding in paragraphs (i) and (ii) the phrase ``and income other
than investment income'' after the phrase ``exclusive of capital
changes'' in each paragraph.
(b) Adding at the end of Instruction 3 the following: ``Exclude
income other than investment income.''
Note: Form N-3 does not and the amendments will not appear in
the Code of Federal Regulations.
14. Guide 38 to Form N-3 (Money Market Fund Investments in Other
Money Market Funds) (referenced in Secs. 239.17a and 274.11b) is
amended by revising the last sentence to read as follows:
* * * Paragraph (c)(4)(ii)(E) of rule 2a-7 describes the
obligations of a fund that invests its assets in another money market
fund.
Note: Guide 38 to Form N-3 does not and the amendments will not
appear in the Code of Federal Regulations.
15. Part B, Item 21(a) of Form N-4 (referenced in Secs. 239.17b and
274.11c) is amended by:
[[Page 64987]]
(a) Adding in paragraphs (i) and (ii) the phrase ``and income other
than investment income'' after the phrase ``exclusive of capital
changes'' in each paragraph.
(b) Adding at the end of Instruction 3 the following: ``Exclude
income other than investment income.''
Note: Form N-4 does not and the amendments will not appear in
the Code of Federal Regulations.
By the Commission.
Dated: December 2, 1997.
Margaret H. McFarland,
Deputy Secretary.
Note: The following Appendix will not appear in the Code of
Federal Regulations.
BILLING CODE 8010-01-P
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[FR Doc. 97-32026 Filed 12-8-97; 8:45 am]
BILLING CODE 8010-01-C
