[Federal Register Volume 76, Number 46 (Wednesday, March 9, 2011)]
[Proposed Rules]
[Pages 12896-12916]
[FR Doc No: 2011-5184]

-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 239, 270, and 274

[Release Nos. 33-9193; IC-29592; File No. S7-07-11]
RIN 3235-AL02

References to Credit Ratings in Certain Investment Company Act
Rules and Forms

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

-----------------------------------------------------------------------

SUMMARY: This is one of several releases that the Securities and
Exchange Commission (``Commission'') will be considering relating to
the use of credit ratings in our rules and forms. In this release, we
are proposing a new rule as well as rule and form amendments under the
Securities Act of 1933 and the Investment Company Act of 1940 to
implement provisions of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (``Dodd-Frank Act''). The Commission is proposing
amendments to two rules and four forms under the Investment Company Act
and the Securities Act that contain references to credit ratings. The
proposed amendments would give effect to provisions of the Dodd-Frank
Act that call for the amendment of Commission regulations that contain
credit rating references. In addition, the Commission is proposing a
new rule under the Investment Company Act to establish a standard of
credit-worthiness in place of a statutory reference to credit ratings
in that Act that the Dodd-Frank Act removes.

DATES: Comments should be received on or before April 25, 2011.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml); or
     Send an e-mail to<EMAIL_ADDRESS>Please include
File Number S7-07-11 on the subject line; or
     Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090.

All submissions should refer to File Number S7-07-11. This file number
should be included on the subject line if e-mail is used. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's Web
site (http://www.sec.gov/rules/proposed.shtml). Comments are also
available for Web site viewing and printing in the Commission's Public
Reference Room, 100 F Street, NE., Washington, DC 20549, on official
business days between the hours of 10 a.m. and 3 p.m. All comments
received will be posted without change; we do not edit personal
identifying information from submissions. You should submit only
information that you wish to make publicly available.

FOR FURTHER INFORMATION CONTACT: With respect to the proposed rule,
rule amendments or Form N-MFP, Anu Dubey, Attorney, or Penelope
Saltzman, Assistant Director<PHONE_NUMBER>, Office of Regulatory
Policy, or with respect to Forms N-1A, N-2 and N-3, Jane H. Kim,
Attorney, or Mark T. Uyeda, Assistant Director,<PHONE_NUMBER>, Office
of Disclosure Regulation, Division of Investment Management, Securities
and Exchange Commission, 100 F Street, NE., Washington, DC 20549-8549.

SUPPLEMENTARY INFORMATION: The Commission is proposing for public
comment amendments to rules 2a-7 [17 CFR 270.2a-7] and 5b-3 [17 CFR
270.5b-3] and new rule 6a-5 [17 CFR 270.6a-5] under the Investment
Company Act of 1940 (``Investment Company Act'').\1\ The Commission is
also proposing for comment amendments to Forms N-1A [17 CFR 239.15A and
17 CFR 274.11A], N-2 [17 CFR 239.14 and 17 CFR 274.11a-1] and N-3 [17
CFR 239.17a and 17 CFR 274.11b] under the Investment Company Act and
the Securities Act of 1933 (``Securities Act'')\2\ and Form N-MFP [17
CFR 274.201] under the Investment Company Act.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 80a-1. Unless otherwise noted, all references to
statutory sections are to the Investment Company Act, and all
references to rules under the Investment Company Act are to Title
17, Part 270 of the Code of Federal Regulations [17 CFR 270].
    \2\ 15 U.S.C. 77a.
---------------------------------------------------------------------------

Table of Contents

I. Background
II. Discussion
    A. Rule 2a-7
    1. Eligible Securities
    2. Securities With a Conditional Demand Feature
    3. Monitoring Minimal Credit Risks
    4. Stress Testing
    B. Form N-MFP
    C. Rule 5b-3
    D. Proposed Rule 6a-5
    E. Forms N-1A, N-2 and N-3
III. Request for Comment
IV. Paperwork Reduction Act
V. Cost-Benefit Analysis
VI. Consideration of Promotion of Efficiency, Competition and
Capital Formation
VII. Regulatory Flexibility Act Certification
VIII. Initial Regulatory Flexibility Analysis
Statutory Authority
Text of Proposed Rule and Form Amendments

I. Background

    The Dodd-Frank Act was enacted on July 21, 2010.\3\ Section 939A of
the Act requires the Commission to review its regulations for any
references to or requirements regarding credit ratings that require the
use of an assessment of the credit-worthiness of a security or money
market instrument, remove these references or requirements and
substitute in those regulations other standards of credit-worthiness in
place of the credit ratings that we determine to be appropriate.\4\
Section 939 of the Dodd-Frank Act removes a reference to credit ratings
from section 6(a)(5) of the Investment Company Act and replaces it with
a reference to ``such standards of credit-worthiness as the Commission
shall adopt.''\5\
---------------------------------------------------------------------------

    \3\ Public Law 111-203, 124 Stat. 1376 (2010).
    \4\ Section 939A(a)-(b) of the Dodd-Frank Act.
    \5\ Section 939(c) of the Dodd-Frank Act (amending section
6(a)(5)(A)(iv)(I) of the Investment Company Act). The Dodd-Frank Act
also requires the Commission to adopt a number of rules concerning
the integrity and transparency of the credit rating process and the
accountability of credit rating agencies. See sections 931 to 939H
of the Dodd-Frank Act.
---------------------------------------------------------------------------

    In 2008, we undertook a review similar to that required under
section 939A for references to credit ratings in our rules. As a result
of that review, we proposed to eliminate references to ratings issued
by nationally recognized statistical rating organizations (``NRSROs'')
in four rules under the Investment Company Act.\6\ Specifically,

we proposed to remove references to credit ratings in rules 2a-7, 3a-7,
5b-3 and 10f-3 under the Investment Company Act. In 2009, we adopted
certain of the proposed amendments to rules 5b-3 and 10f-3 and reopened
the comment period for the other proposed amendments to rules 3a-7 and
5b-3.\7\ In 2010, when we adopted amendments to rule 2a-7 (which
governs the operation of money market funds), we retained the use of
credit ratings in rule 2a-7 as an initial threshold requirement for
whether a money market fund may invest in the security, but eliminated
a requirement that all asset-backed securities in which a money market
fund invests have received a rating.\8\
---------------------------------------------------------------------------

    \6\ See References to Ratings of Nationally Recognized
Statistical Rating Organizations, Investment Company Act Release No.
28327 (July 1, 2008) [73 FR 40124 (July 11, 2008)] (``2008 Ratings
Removal Proposing Release''). The Commission also proposed to
eliminate references to credit ratings in rules under the Securities
Act and the Securities Exchange Act of 1934 (15 U.S.C. 78a)
(``Exchange Act''). See Security Ratings, Securities Act Release No.
8940 (July 1, 2008) [73 FR 40106 (July 11, 2008)]; References to
Ratings of Nationally Recognized Statistical Rating Organizations,
Securities Exchange Act Release No. 58070 (July 1, 2008) [73 FR
40088 (July 11, 2008)]. Prior to this initiative, in 2003, the
Commission published a concept release in which we sought comment on
the use of NRSRO ratings in our rules. See Rating Agencies and the
Use of Credit Ratings under the Federal Securities Laws, Investment
Company Act Release No. 26066 (June 4, 2003) [68 FR 35258 (June 12,
2003)].
    \7\ See References to Ratings of Nationally Recognized
Statistical Rating Organizations, Investment Company Act Release No.
28939 (Oct. 5, 2009) [74 FR 52358 (Oct. 9, 2009)] (``2009 Ratings
Removal Adopting Release'') (adopting amendments to rule 5b-3, with
respect to the treatment of refunded securities, and rule 10f-3);
References to Ratings of Nationally Recognized Statistical Rating
Organizations, Investment Company Act Release No. 28940 (Oct. 5,
2009) [74 FR 52374 (Oct. 9, 2009)] at Section IV (reopening the
comment period for the proposed amendments to rules 3a-7 and 5b-3,
with respect only to repurchase agreements). We also sought comment
on removing references to credit ratings in rule 2a-7 in our 2009
proposal for certain reforms for money market funds. See Money
Market Fund Reform Proposing Release, infra note 8. We received over
70 comments in response to the 2008 proposed amendments. Most
commenters opposed the proposals. These comment letters are
available on the Commission's Internet Web site (http://www.sec.gov/comments/s7-19-08/s71908.shtml; http://www.sec.gov/comments/s7-17-08/s71708.shtml). In light of today's proposal to amend rule 5b-3,
we are withdrawing the 2008 proposed amendments to rule 5b-3 from
further consideration.
    \8\ See Money Market Fund Reform, Investment Company Act Release
No. 29132 (Feb. 23, 2010) [75 FR 10060 (Mar. 4, 2010)] (``Money
Market Fund Reform Adopting Release''). See also Money Market Fund
Reform, Investment Company Act Release No. 28807 (June 30, 2009) [74
FR 32688 (July 8, 2009)] (``Money Market Fund Reform Proposing
Release''). Most commenters that responded to our request for
additional comment on the 2008 proposed amendments to rule 2a-7 in
the Money Market Fund Reform Proposing Release opposed that
approach.
---------------------------------------------------------------------------

    As directed by section 939A of the Dodd-Frank Act, we have reviewed
our regulations for any references to or requirements regarding credit
ratings in regulations that require the use of an assessment of the
credit-worthiness of a security or money market instrument. In light of
our review, and as further directed by the Dodd-Frank Act, we are
proposing in this release to amend two rules and four forms under the
Investment Company Act and the Securities Act.\9\ In addition, in order
to implement section 939(c) of the Dodd-Frank Act, we are proposing a
new rule to establish a standard of credit-worthiness for purposes of
section 6(a)(5) of the Investment Company Act.
---------------------------------------------------------------------------

    \9\ We have already proposed to remove references to credit
ratings in certain rules and forms under the Securities Act and the
Exchange Act. See Security Ratings, Securities Act Release No. 9186
(Feb. 9, 2011) [76 FR 8946 (Feb. 16, 2011)].
---------------------------------------------------------------------------

II. Discussion

    Three rules--rules 2a-7, 3a-7 and 5b-3 and four forms--Forms N-1A,
N-2, N-3 and N-MFP under the Investment Company Act currently contain
references to credit ratings issued by NRSROs.\10\ We propose to remove
the references to credit ratings in rules 2a-7 and 5b-3 and replace
them with alternative standards of credit-worthiness that are designed
to appropriately achieve the same purposes as the ratings requirements.
In addition to the amendments to rules 2a-7 and 5b-3, we are proposing
a new rule--rule 6a-5 under the Investment Company Act--to establish a
credit-worthiness standard to replace the credit rating reference in
section 6(a)(5) of that Act that the Dodd-Frank Act eliminates.\11\
Finally, we propose to eliminate required disclosures of credit ratings
in Form N-MFP and remove from Forms N-1A, N-2 and N-3 the requirement
that NRSRO credit ratings be used when portraying credit quality in
shareholder reports. We discuss our proposed amendments and new rule in
greater detail below.
---------------------------------------------------------------------------

    \10\ Rule 2a-7 defines the term NRSRO to have the same meaning
as in section 3(a)(62) of the Exchange Act [15 U.S.C. 78c(a)(62)].
Rule 5b-3 defines NRSRO with reference to Exchange Act rule 15c3-
1(c)(2)(vi)(E), (F), and (H) [17 CFR 240.15c3-1(c)(2)(vi)(E), (F),
(H)].
    \11\ We intend to propose amendments to rule 3a-7 in a separate
release.
---------------------------------------------------------------------------

A. Rule 2a-7

    Rule 2a-7 under the Investment Company Act governs the operation of
money market funds. Unlike other investment companies (``funds''),
money market funds seek to maintain a stable share price, typically at
$1.00 per share. To do so, most money market funds use the amortized
cost method of valuation (``amortized cost method'') and the penny-
rounding method of pricing (``penny-rounding method'') permitted by
rule 2a-7.\12\ The Investment Company Act and applicable rules
generally require funds to calculate current net asset value per share
by valuing their portfolio instruments at market value or, if market
quotations are not readily available, at fair value as determined in
good faith by the board of directors.\13\ These valuation requirements
are designed to prevent unfair share pricing from diluting or otherwise
adversely affecting the interests of investors.\14\
---------------------------------------------------------------------------

    \12\ Under the amortized cost method, portfolio instruments are
valued by reference to their acquisition cost as adjusted for
amortization of premium or accretion of discount. See rule 2a-
7(a)(2). Share price is determined under the penny-rounding method
by valuing securities at market value, fair value or amortized cost
and rounding the per share net asset value to the nearest cent on a
share value of a dollar, as opposed to the nearest one tenth of one
cent as otherwise would be required. See Valuation of Debt
Instruments and Computation of Current Price Per Share by Certain
Open-End Investment Companies (Money Market Funds), Investment
Company Act Release No. 13380 (July 11, 1983) [48 FR 32555 (July 18,
1983)] (``1983 Money Market Fund Adopting Release'') at n.6
(``Release 9786 sets the amount of less than \1/10\ of one cent on a
share value of one dollar as the benchmark for materiality.'');
Valuation of Debt Instruments by Money Market Funds and Certain
Other Open-End Investment Companies, Investment Company Act Release
No. 9786 (May 31, 1977) [42 FR 28999 (June 7, 1977)] at text
accompanying n.11; rule 2a-7(a)(20) (defining penny-rounding
method).
    \13\ See section 2(a)(41) of the Investment Company Act
(defining value) and rules 2a-4 (defining current net asset value)
and 22c-1 (generally requiring open-end funds to sell and redeem
their shares at a price based on the funds' current net asset value
as next computed after receipt of a redemption, purchase or sale
order).
    \14\ If shares are sold or redeemed based on a net asset value
that turns out to have been either understated or overstated
compared to the amount at which portfolio instruments could have
been sold, then the interests of either existing shareholders or new
investors will have been diluted. See Investment Trusts and
Investment Companies: Hearings on S. 3580 Before a Subcomm. of the
Sen. Comm. on Banking and Currency, 76th Cong., 3d Sess. 136-138,
288-289 (1940).
---------------------------------------------------------------------------

    Rule 2a-7 exempts money market funds from these provisions but
contains conditions designed to minimize the amount of risk a money
market fund may assume and thus reduce the deviation between a money
market fund's stabilized share price and the market value of its
portfolio.\15\ Among these conditions, rule 2a-7 limits a money market
fund's portfolio investments to securities that have received credit
ratings from the ``requisite NRSROs'' in one of the two highest short-
term rating categories or comparable unrated securities (i.e.,
``eligible securities'').\16\ A requisite NRSRO must be one of the
NRSROs that a money market fund's board of directors has designated
(``designated NRSRO'') for use, and determines at least annually issues
credit ratings that

are sufficiently reliable for the fund to use, in determining the
eligibility of portfolio securities.\17\ Rule 2a-7 further restricts
money market funds to securities that the fund's board of directors (or
its delegate\18\) determines present minimal credit risks, and
specifically requires that determination ``be based on factors
pertaining to credit quality in addition to any ratings assigned to
such securities by an NRSRO.''\19\
---------------------------------------------------------------------------

    \15\ Rule 2a-7 contains conditions that apply to each investment
a money market fund proposes to make, as well as conditions that
apply to a money market fund's entire portfolio.
    \16\ The term ``eligible security'' is currently defined in rule
2a-7(a)(12).
    \17\ See rule 2a-7(a)(11) (defining ``designated NRSRO''); 2a-
7(a)(23) (defining ``requisite NRSRO'').
    \18\ See rule 2a-7(e).
    \19\ Rule 2a-7(c)(3)(i). Thus, under the current rule, where the
security is rated, having the requisite NRSRO rating is a necessary
but not sufficient condition for investing in the security and
cannot be the sole factor considered in determining whether a
security presents minimal credit risks. See Revisions to Rules
Regulating Money Market Funds, Investment Company Act Release No.
18005 (Feb. 20, 1991) [56 FR 8113 (Feb. 27, 1991)] (``1991 Money
Market Fund Adopting Release'') at text preceding n.18.
---------------------------------------------------------------------------

    We are proposing to remove references to credit ratings in rule 2a-
7, which would affect five elements of the rule: Determination of
whether a security is an eligible security; determination of whether a
security is a first tier security; credit quality standards for
securities with a conditional demand feature; requirements for
monitoring securities for ratings downgrades and other credit events;
and stress testing.\20\ The proposed amendments to rule 2a-7, which are
similar to those we proposed in 2008, are designed to offer protections
comparable to those provided by the NRSRO ratings.\21\
---------------------------------------------------------------------------

    \20\ The proposed rule also would make conforming amendments to
rule 2a-7's recordkeeping and reporting requirements. See proposed
rule 2a-7(c)(11)(iii).
    \21\ We previously adopted certain of the amendments that we
proposed in 2008 as part of the 2010 money market fund reforms. See
Money Market Fund Reform Adopting Release, supra note 8, at Sections
II.C.2, II.G.2. Specifically, we expressly limited money market
funds' investments in illiquid securities. See rule 2a-7(c)(5)(i).
We also required money market funds to notify the Commission
promptly when an affiliate has purchased certain securities,
including a security that is no longer an eligible security, from
the fund in reliance on rule 17a-9, which permits certain affiliated
persons to purchase certain portfolio securities from a money market
fund under certain conditions. See rule 2a-7(c)(7)(iii)(B). See also
2008 Ratings Removal Proposing Release, supra note 6, at Sections
III.A.2, III.A.4.
---------------------------------------------------------------------------

1. Eligible Securities
    Under the proposed amendments, a money market fund would continue
to be limited to investing in securities that money market fund boards
of directors (or their delegates) determine present minimal credit
risks,\22\ and each of which is either a ``first tier security'' or a
``second tier security'' under the rule.\23\ Fund boards of directors
(which typically rely on the fund's adviser) would still be able to
consider quality determinations prepared by outside sources, including
NRSRO ratings, that fund advisers conclude are credible and reliable,
in making credit risk determinations. We would expect the fund advisers
to understand the method for determining the rating and make an
independent judgment of credit risks, and to consider an outside
source's record with respect to evaluating the types of securities in
which the fund invests.
---------------------------------------------------------------------------

    \22\ See proposed rule 2a-7(a)(11).
    \23\ The proposal would not change current rule 2a-7 limitations
on money market fund investments in second tier securities, under
which a money market fund cannot acquire second tier securities with
remaining maturities greater than 45 days, generally must limit its
investments in second tier securities to no more than three percent
of fund assets, and limit investments in the second tier securities
of any one issuer to one half of one percent of fund assets. Rule
2a-7(c)(3)(ii); 2a-7(c)(4)(i)(C).
---------------------------------------------------------------------------

    We propose to eliminate the requirement that an eligible security
be rated by an NRSRO or be of comparable quality while maintaining the
two-step analysis currently required by rule 2a-7. Under the proposed
amendments, a security would be a first tier security (regardless of
the ratings it has received from any credit rating agency) if the
fund's board (or its delegate) determines that the issuer (or in the
case of a security subject to a guarantee, the guarantor) \24\ has the
``highest capacity to meet its short-term financial obligations.'' \25\
A security would be a second tier security if it is an eligible
security but is not a first tier security.\26\ In addition, a security
would be an eligible security only if the board of directors (or its
delegate) determines that it presents minimal credit risks, which
determination must be based on factors pertaining to credit quality and
the issuer's ability to meet its short-term financial obligations.\27\
---------------------------------------------------------------------------

    \24\ See rule 2a-7(c)(3)(iii) (allowing the credit quality of a
guarantee to substitute for the credit quality of the security
subject to the guarantee); 2a-7(a)(17) (defining ``guarantee'' to
mean ``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.'').
    \25\ Proposed rule 2a-7(a)(13). As under the current rule,
government securities and securities issued by a money market fund
also would be first tier securities. Proposed rule 2a-7(a)(13); see
rule 2a-7(a)(14).
     Our proposed amendments would eliminate the defined terms
``designated NRSRO,'' ``rated security,'' ``requisite NRSRO,'' and
``unrated security'' from the rule. As a result, under the proposal,
fund boards would no longer be required to designate NRSROs and
funds would not have to disclose designated NRSROs in their
statements of additional information (``SAI''). See rule 2a-7(a)(11)
(defining ``designated NRSRO'' as one of at least four NRSROs that,
among other things, the fund's board has designated as an NRSRO
whose credit ratings will be used by the fund to determine the
eligibility of portfolio securities, the board determines at least
annually issues credit ratings sufficiently reliable for such use,
and the fund discloses in its SAI is a designated NRSRO, including
any limitations on the fund's use of the designation). We note that
after enactment of the Dodd-Frank Act, money market funds received
Commission staff assurances that the staff would not recommend
enforcement action if a money market fund board did not designate
NRSROs and did not make related disclosures in its SAI before the
Commission had completed its review of rule 2a-7 required by the
Dodd-Frank Act and made any modifications to the rule. See
Investment Company Institute, SEC No-Action Letter (Aug. 19, 2010).
    \26\ See proposed rule 2a-7(a)(21). The specific language of
this provision would not change (compare current rule 2a-7(a)(24)),
but the definitions of ``eligible security'' and ``first tier
security'' would change under the proposal.
    \27\ Proposed rule 2a-7(a)(11). Currently, the requirement that
the fund board (or its delegate) determine that a security presents
minimal credit risks is contained in paragraph (c)(3)(i) of the
rule. In connection with the amendments discussed above, we propose
to restructure the rule to incorporate the minimal credit risk
determination into the definition of ``eligible security,''
currently in paragraph (a)(12) of the rule, but which would be
renumbered as paragraph (a)(11).
---------------------------------------------------------------------------

    We have designed these amendments to retain a degree of risk
limitation on money market funds similar to the current rule. The
proposed amendments would continue to require that funds invest at
least 97 percent of their total assets in the highest quality short-
term debt securities.\28\ Money market fund holdings of these first
tier securities would have to satisfy a standard similar to the credit
quality standards that have been articulated by the credit ratings
agencies.\29\ An issuer of a first tier

security that would satisfy our proposed standard should have an
exceptionally strong ability to repay its short-term debt obligations
and the lowest expectation of default.\30\ The credit risk associated
with a second tier security, which would continue to be limited to
three percent of total fund assets,\31\ would differ from that
associated with first tier securities only to a small degree. Thus, the
issuer of a second tier security that would satisfy our proposed
standard should have a very strong ability to repay its short-term debt
obligations, and a very low vulnerability to default.\32\ Finally, we
propose to eliminate the requirement that guarantors or guarantees of
securities held by a money market fund be rated by an NRSRO.\33\
---------------------------------------------------------------------------

    \28\ See proposed rule 2a-7(a)(13) (defining first tier
security); rule 2a-7(c)(3)(ii) (prohibiting money market funds from
acquiring second tier securities if, as a result of the acquisition,
second tier securities would comprise more than three percent of the
fund's total assets).
    \29\ See, e.g., Standard & Poor's Ratings Definitions, Short-
Term Issue Credit Ratings, http://www.standardandpoors.com/ratings/articles/en/us/?assetID=1245219848760 (``S&P Ratings Definitions'')
(a short-term obligation rated ``A-1'' is rated in the highest
category, and the obligor's capacity to meet its financial
commitment on the obligation is strong; obligations within the
category designated with a plus sign (+) indicates that the
obligor's capacity to meet its financial commitment on these
obligations is extremely strong); Moody's Investors Service Rating
Symbols and Definitions, http://v3.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004 (``Moody's Ratings
Definitions'') at 5-6 (issuers rated Prime-1 ``have a superior
ability to repay short-term debt obligations.''); FitchRatings,
International Issuer and Credit Rating Scales, http://www.fitchratings.com/creditdesk/public/ratings_definitions/index.cfm?rd_file=ltr (``Fitch Ratings Definitions'') (stating that
a rating of F1 is the highest short-term rating, indicating the
``strongest intrinsic capacity for timely payment of financial
commitments; may have an added `+' to denote any exceptionally
strong credit feature.'').
    \30\ We note that all money market fund portfolio securities
also must be eligible securities (i.e., present minimal credit risks
under the proposed amendments). See proposed rule 2a-7(a)(13). Thus,
even if the issuer had the highest capacity to meet its short-term
financial obligations, a security, such as a subordinated short-term
security secured by assets that are not of high credit quality,
likely would not present minimal credit risks to a money market
fund's portfolio and therefore likely would not be an eligible
security.
    \31\ Rule 2a-7(c)(3)(ii).
    \32\ Nothing in the proposed rule would prohibit a money market
fund from relying on policies and procedures it has adopted to
comply with the current rule as long as the board (or its delegate)
concluded that the ratings specified in the policies and procedures
establish similar standards to those proposed, and are credible and
reliable for that use. A fund also would be able to revise its
policies and procedures to change or eliminate the use of specific
NRSRO ratings or to incorporate other third party evaluations of
credit quality.
    \33\ See rule 2a-7(a)(12)(iii)(A). We also propose to move the
provision that conditions the eligibility of a demand feature or
guarantee of the issuer, or another institution, on an undertaking
promptly to notify the fund in the event of a substitution of a
demand feature or guarantee, which is currently in paragraph
(a)(12)(iii)(B), to paragraphs (c)(3)(iii) (permitting money market
funds to substitute the credit quality of a guarantee for the credit
quality of the security subject to the guarantee in determining
whether a security is an eligible or first tier security) and
(c)(3)(iv)(D) (conditions under which a security subject to a
conditional demand feature may be determined to be an eligible
security or first tier security).
---------------------------------------------------------------------------

    Our proposal would eliminate the objective standard provided by
credit ratings in the definitions of eligible security and first tier
security and instead require a subjective determination of both
eligible securities and first tier securities. We request comment on
this proposed approach.
     Would our proposed approach achieve the goal of retaining
a degree of risk limitation on money market funds similar to the
current rule?
     Are there alternatives to our proposed approach that would
provide a more robust or objective evaluation of credit quality?
     Is there a better way to describe the characteristics of a
first tier security?
     Should we instead simply limit money market funds to
investing in securities solely based on a minimal credit risk
determination, i.e., establish a single test for determining whether a
fund could invest in a security?
     Would such an approach allow money market funds to invest
a large portion of their portfolios in what are currently second tier
securities?
2. Securities With a Conditional Demand Feature
    Under rule 2a-7, a security subject to a conditional demand feature
\34\ may be determined to be an eligible security or a first tier
security if, among other conditions, (i) the conditional demand feature
is an eligible security or a first tier security, and (ii) the
underlying security (or its guarantee) has received either a short-term
rating or a long-term rating, as the case may be, within the highest
two categories from the requisite NRSROs or is a comparable unrated
security.\35\ We propose to remove the credit rating requirement from
this provision of the rule and amend the provision to require that the
fund's board (or its delegate) determine that the underlying security
be of high quality and subject to very low credit risk.\36\ The
proposed standard is designed to retain a similar degree of risk
limitation to that in the current rule. An issuer that is determined to
have a very strong capacity to meet its financial commitments, a very
low risk of default, and a capacity for payment of its financial
commitments that is not significantly vulnerable to reasonably
foreseeable events would satisfy the proposed definition.\37\ In making
the credit quality determinations required under the proposed
amendment, a fund board (or its delegate) would continue to be able to
consider analyses provided by third parties, including ratings provided
by ratings agencies, that it concludes are credible and reliable for
such purposes.\38\
---------------------------------------------------------------------------

    \34\ A conditional demand feature is a demand feature that a
fund may be precluded from exercising because of the occurrence of a
condition. See rule 2a-7(a)(6) (defining ``conditional demand
feature'' as a demand feature that is not an unconditional demand
feature); 2a-7(a)(28) (defining ``unconditional demand feature'' as
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). For purposes of rule 2a-7, a demand feature
allows the security holder to receive, upon exercise, the
approximate amortized cost of the security, plus accrued interest,
if any. In addition, a demand feature must be exercisable either:
(i) At any time on no more than 30 calendar days' notice; or (ii) at
specified intervals not exceeding 397 calendar days and upon no more
than 30 calendar days' notice. Rule 2a-7(a)(9)(i). If an asset-
backed security is subject to a demand feature, the feature must
permit the security holder unconditionally to receive principal and
interest within 397 calendar days of making demand. Rule 2a-
7(a)(9)(ii).
    \35\ Rule 2a-7(c)(3)(iv).
    \36\ Proposed rule 2a-7(c)(3)(iv)(C). The rule references both
short-term and long-term ratings because most money market fund
portfolio securities with demand features are long-term securities
(that would not meet the portfolio maturity requirements of rule 2a-
7 without the demand feature). Under current rule 2a-7, a money
market fund must limit its investments in securities subject to a
demand feature or guarantee of the same issuer that are second tier
securities to 2.5% of the fund's total assets. Rule 2a-7(c)(4)(iii).
If, as a result of a downgrade, a fund exceeds this limitation on
such securities, the fund must reduce its investment in the
securities to no more than 2.5% of total assets by exercising the
demand feature at the next succeeding exercise date(s). Rule 2a-
7(c)(7)(i)(C). In a conforming change, we propose to amend this
provision to require the fund to reduce its investment in securities
subject to a demand feature or guarantee of a single issuer that are
second tier securities, if, as a result of a portfolio security that
ceases to be a first tier security, the fund exceeds the 2.5%
investment limit on such securities. Proposed rule 2a-7(c)(7)(i)(B).
    \37\ These credit quality characteristics are similar to credit
quality standards that have been articulated by credit rating
agencies. See, e.g., S&P Ratings Definitions, supra note 29
(describing the capacity of an issuer of long-term obligations rated
``AA'' as ``very strong''); Moody's Ratings Definitions, supra note
29 (describing Aa-rated long-term obligations as ``judged to be of
high quality and are subject to very low credit risk.''); Fitch
Ratings Definitions, supra note 29 (describing AA-rated long-term
obligations as denoting expectations of very low default risk and
indicating that the issuer's capacity for payment of financial
commitments is very strong and ``not significantly vulnerable to
foreseeable events'').
    \38\ The proposed amendment would not prohibit a money market
fund from relying on policies and procedures it has adopted to
comply with the current rule regarding the credit quality of
securities with conditional demand features as long as the board (or
its delegate) concluded that the ratings specified in the policies
and procedures establish similar standards to those proposed, and
that the agencies providing ratings used in the policies and
procedures are credible and reliable for that use. A fund also could
revise its policies and procedures to change or eliminate the
consideration of specific NRSRO ratings or to incorporate other
third party evaluations of credit quality.
---------------------------------------------------------------------------

    We request comment on the proposed credit quality standard for
securities with a conditional demand feature.
     Does our proposed standard retain the same or similar
degree of risk limitation as that under the current rule?
     Are there alternative standards that would provide a more
robust or objective evaluation of credit quality?
3. Monitoring Minimal Credit Risks
    Rule 2a-7 currently requires a money market fund board (or its
delegate) promptly to reassess whether a security that has been
downgraded by an NRSRO continues to present minimal credit risks, and
take such action as it

determines is in the best interests of the fund and its
shareholders.\39\ We propose to amend the rule to require that, in the
event the money market fund's adviser (or any person to whom the board
has delegated portfolio management responsibilities) becomes aware of
any credible information about a portfolio security or an issuer of a
portfolio security that suggests that the security is no longer a first
tier security or a second tier security, as the case may be, the board
or its delegate would have to reassess promptly whether the portfolio
security continues to present minimal credit risks.\40\ To satisfy the
proposed standard, an investment adviser would be required to exercise
reasonable diligence in keeping abreast of new information about a
portfolio security that the adviser believes to be credible. We
understand that most money market fund advisers currently exercise a
similar degree of diligence in monitoring their portfolios in order to
meet the rule 2a-7 requirement that portfolio investments be limited to
securities that the board determines present minimal credit risks.
---------------------------------------------------------------------------

    \39\ Rule 2a-7(c)(7)(i)(A). This current reassessment is not
required, however, if the downgraded security is disposed of or
matures within five business days of the specified event and in the
case of events specified in rule 2a-7(c)(7)(i)(A)(2), the board is
subsequently notified of the adviser's actions. Rule 2a-
7(c)(7)(i)(B).
    \40\ Proposed rule 2a-7(c)(7)(i)(A). As under the current rule,
the proposal would not require reassessment in certain
circumstances. See supra note 39. Our proposed standard differs
slightly from our proposal in 2008, which would have required the
board's reassessment if the money market fund's investment adviser
became aware of any information about a portfolio security or an
issuer of a portfolio security that suggested that the security
might not have continued to present minimal credit risks. See 2008
Ratings Removal Proposing Release, supra note 6, at Section III.A.3.
We believe that requiring the relevant information to relate to
whether the portfolio security may no longer be first or second tier
(as compared with the standard proposed in 2008) is more similar to
the current standard. In addition, as noted by several commenters on
the standard proposed in 2008, without limiting the information to
be monitored in any way, the standard could be interpreted to
require monitoring of all information regarding portfolio
securities, including unreliable sources or unsubstantiated market
rumors. See, e.g., Comment Letter of CFA Institute Centre for
Financial Market Integrity (Mar. 26, 2009); Comment Letter of
Charles Schwab & Co., Inc. (Sept. 5, 2008); Comment Letter of
Federated Investors, Inc. (Sept. 5, 2008).
---------------------------------------------------------------------------

    We request comment on the proposed amendments for monitoring
minimal credit risks.
     Would our proposed approach to describing when
reassessment of whether a portfolio security presents minimal credit
risks is required achieve the objective of retaining a degree of risk
limitation on money market funds similar to the current rule?
     Is there an alternative or more objective standard for
determining when the board must reassess the credit risk of a security
that would provide adequate investor protections?
     Are we correct in our understanding of current monitoring
practices?
4. Stress Testing
    Rule 2a-7 currently requires money market funds to adopt written
procedures for stress testing their portfolios. Specifically they must
test the fund's ability to maintain a stable net asset value per share
based on certain hypothetical events, including a downgrade of
portfolio securities.\41\ We propose to replace this reference to
ratings downgrades with a hypothetical event that is designed to have a
similar impact on a money market fund's portfolio. Our proposal would
require that money market funds stress test for an adverse change in
the ability of a portfolio security issuer to meet its short-term
financial obligations.\42\ Under the proposed rule, funds could
continue to test their portfolios by treating a downgrade as a credit
event that might adversely affect the value or liquidity of the
portfolio security (and affect the fund's ability to maintain a stable
net asset value per share).
---------------------------------------------------------------------------

    \41\ Rule 2a-7(c)(10)(v)(A).
    \42\ Proposed rule 2a-7(c)(10)(v)(A).
---------------------------------------------------------------------------

    We request comment on our proposed amendment to the stress testing
requirements.
     Does the standard we propose adequately address the same
concerns that arise when a security is downgraded?
     Is the proposed standard too broad?
     Would the proposed standard provide adequate guidance to
funds?
     Is there a narrower standard that we should specify?

B. Form N-MFP

    As part of the money market fund reforms we adopted in 2010, money
market funds must provide to the Commission a monthly electronic filing
of portfolio holdings information on Form N-MFP.\43\ The information
money market funds must disclose with respect to each portfolio
security (and any guarantee, demand feature or other enhancement
associated with the portfolio security) includes the name of each
designated NRSRO for the portfolio security and the rating assigned to
the security.\44\ We propose to eliminate the items requiring
disclosure of ratings information from the form. We also propose to
amend Item 33 of Form N-MFP to remove the reference to a rating in this
item so that funds would only disclose whether a portfolio security is
first or second tier or no longer an eligible security.\45\
---------------------------------------------------------------------------

    \43\ See rule 30b1-7. See also Money Market Fund Reform Adopting
Release, supra note 8, at n.301 and accompanying and preceding text.
    \44\ See Items 34 (requiring disclosure of each designated NRSRO
for a portfolio security and the credit rating given by the
designated NRSRO for each portfolio security); 37b-c (requiring
disclosure of each designated NRSRO and the credit rating given by
the designated NRSRO for each portfolio security demand feature);
38b-c (requiring disclosure of each designated NRSRO and the credit
rating given by the designated NRSRO for each portfolio security
guarantee); 39c-d (requiring disclosure of each designated NRSRO and
the credit rating given by the designated NRSRO for each portfolio
security enhancement) of Form N-MFP.
    \45\ See Item 33 of Form N-MFP (requiring money market funds to
disclose whether a security is a ``rated'' first or second tier
security, an unrated security, or no longer an eligible security).
---------------------------------------------------------------------------

    We request comment on the proposed form amendments.

C. Rule 5b-3

    Rule 5b-3 under the Investment Company Act permits a fund, subject
to certain conditions, to treat a repurchase agreement as an
acquisition of the securities collateralizing the repurchase agreement
in determining whether the fund is in compliance with two provisions of
the Investment Company Act that may affect a fund's ability to invest
in repurchase agreements. In a typical investment company repurchase
agreement, a fund enters into a contract with a broker, dealer or bank
(the ``counterparty'' to the transaction) for the purchase of
securities. The counterparty agrees to repurchase the securities at a
specified future date, or on demand, for a price that is sufficient to
return to the fund its original purchase price, plus an additional
amount representing the return on the fund's investment.\46\
---------------------------------------------------------------------------

    \46\ Repurchase agreements provide funds with a convenient means
to invest excess cash on a secured basis, generally for short
periods of time. Economically, a repurchase agreement functions as a
loan from the fund to the counterparty, in which the securities
purchased by the fund serve as collateral for the loan and are
placed in the possession or under the control of the fund's
custodian during the term of the agreement. See Treatment of
Repurchase Agreements and Refunded Securities as an Acquisition of
the Underlying Securities, Investment Company Act Release No. 25058
(July 5, 2001) [66 FR 36156 (July 11, 2001)] (``Rule 5b-3 Adopting
Release''). Various issues arose during the market events of 2007 to
2009 that affected the market for repurchase agreements. In
response, a task force of participants in the market for tri-party
repurchase agreements was formed and issued a report setting forth
its findings and recommendations for improvements. See Report of
Task Force on Tri-Party Repo Infrastructure, (May 17, 2010) at
http://www.ny.frb.org/prc/report_100517.pdf.
---------------------------------------------------------------------------

    Section 12(d)(3) of the Investment Company Act generally prohibits
a fund from acquiring an interest in a broker, dealer, or underwriter.
Because a repurchase agreement may be considered to be the acquisition
of an

interest in the counterparty, section 12(d)(3) may limit a fund's
ability to enter into repurchase agreements with many of the firms that
act as repurchase agreement counterparties. Section 5(b)(1) of the
Investment Company Act limits the amount that a fund that holds itself
out as being a diversified investment company may invest in the
securities of any one issuer (other than the U.S. Government). This
provision may limit the number and principal amounts of repurchase
agreements a diversified fund may enter into with any one counterparty.
    Rule 5b-3 allows funds to treat the acquisition of a repurchase
agreement as an acquisition of securities collateralizing the
repurchase agreement for purposes of sections 5(b)(1) and 12(d)(3) of
the Investment Company Act if the obligation of the seller to
repurchase the securities from the fund is ``collateralized fully.''
\47\ A repurchase agreement is collateralized fully if, among other
things, the collateral for the repurchase agreement consists entirely
of (i) cash items, (ii) government securities, (iii) securities that at
the time the repurchase agreement is entered into are rated in the
highest rating category by the ``requisite NRSROs'' \48\ or (iv)
unrated securities that are of a comparable quality to securities that
are rated in the highest rating category by the requisite NRSROs, as
determined by the fund's board of directors or its delegate.\49\ In
proposing rule 5b-3, the Commission explained that the highest rating
category requirement in the definition of collateralized fully was
designed to help ensure that the market value of the collateral would
remain stable and that the fund could more readily liquidate the
collateral quickly in the event of a default.\50\
---------------------------------------------------------------------------

    \47\ Rule 5b-3(a). The term ``collateralized fully'' is defined
in rule 5b-3(c)(1). In general, a fund investing in a repurchase
agreement looks to the value and liquidity of the securities
collateralizing the repurchase agreement rather than the credit
quality of the counterparty for satisfaction of the repurchase
agreement. See Rule 5b-3 Adopting Release, supra note 46, at Section
II.A.3. But see rule 2a-7(c)(4)(ii)(A) (requiring money market funds
to evaluate the counterparty's credit-worthiness).
    \48\ The term ``requisite NRSROs'' means any two NRSROs that
have issued a rating with respect to a security or class of debt
obligations of an issuer or, 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 investment company acquires the security,
that NRSRO. Rule 5b-3(c)(6).
    \49\ Rule 5b-3(c)(1)(iv). The term ``unrated securities'' means
securities that have not received a rating from the requisite
NRSROs. Rule 5b-3(c)(8). We note, however, that as a result of our
recent money market fund reforms, money market funds seeking similar
treatment with respect to the diversification requirements under
rule 2a-7 are subject to stricter limitations. In order to qualify
for such special treatment, a repurchase agreement is collateralized
fully only if the collateral for the repurchase agreement consists
entirely of cash or government securities. Rule 2a-7(a)(5). See
Money Market Fund Reform Adopting Release, supra note 8, at Section
II.D.
    \50\ See Treatment of Repurchase Agreements and Refunded
Securities as an Acquisition of the Underlying Securities,
Investment Company Act Release No. 24050 (Sept. 23, 1999) [64 FR
52476 (Sept. 29, 1999)] (``Rule 5b-3 Proposing Release'') at n.43
and accompanying text (noting that the high quality requirement is
designed to limit a fund's exposure to the ability of the
counterparty to maintain sufficient collateral, and that securities
of lower quality may be subject to greater price fluctuation).
---------------------------------------------------------------------------

    We propose to eliminate the requirement that collateral other than
cash or government securities be rated in the highest category by the
requisite NRSROs or be of comparable quality. In place of this
requirement, we propose to require that collateral other than cash or
government securities consist of securities that the fund's board of
directors (or its delegate) determines at the time the repurchase
agreement is entered into are: (i) Issued by an issuer that has the
highest capacity to meet its financial obligations; and (ii)
sufficiently liquid that they can be sold at approximately their
carrying value in the ordinary course of business within seven calendar
days.\51\ For purposes of rule 5b-3, an issuer would be defined to
include an issuer of an unconditional guarantee of the security.\52\
Thus, a collateral security with an unconditional guarantee, the issuer
of which meets the proposed credit quality test, would satisfy that
element of the proposed standard.
---------------------------------------------------------------------------

    \51\ Proposed rule 5b-3(c)(1)(iv)(C). Under the proposal, the
board would make credit quality determinations for all collateral
securities that are not government securities, rather than just
unrated securities. As in the current rule, the proposed rule would
permit the board to delegate the credit quality and liquidity
determination. The proposed amendment to rule 5b-3 would not affect
a money market fund that seeks special treatment under the
diversification provisions of rule 2a-7 because in order to obtain
such treatment, a money market fund is limited to investing in
repurchase agreements collateralized by cash items or government
securities. See supra note 49. We are proposing to amend rule 2a-
7(a)(5), which defines ``collateralized fully,'' to conform the
references in that provision to the proposed amendments to rule 5b-
3.
     The first element of this proposed standard reflects the same
standard as that proposed for the definition of first tier security
under rule 2a-7. See proposed rule 2a-7(a)(13).
    \52\ Proposed rule 5b-3(c)(4) (defining ``issuer'' to mean ``the
issuer of a collateral security or the issuer of an unconditional
obligation of a person other than the issuer of the collateral
security to undertake to pay, upon presentment by the holder of the
obligation (if required), the principal amount of the underlying
collateral security plus accrued interest when due or upon
default.'').
---------------------------------------------------------------------------

    We have designed the proposed amendments to retain a degree of
credit quality similar to that under the current rule. An issuer of
collateral securities that the board (or its delegate) determined has
an exceptionally strong capacity to repay its short or long-term debt
obligations, as appropriate, the lowest expectation of default, and a
capacity for repayment of its financial commitments that is the least
susceptible to adverse effects of changes in circumstances would
satisfy the proposed standard.\53\
---------------------------------------------------------------------------

    \53\ See supra text accompanying note 30.
---------------------------------------------------------------------------

    Our proposal also would require that at the time the repurchase
agreement is entered into, collateral could be sold at approximately
its carrying value in the ordinary course of business within seven
calendar days.\54\ We expect that securities that trade in a secondary
market at the time of the acquisition of the repurchase agreement would
satisfy this liquidity standard. We also understand that most
securities that are currently used to collateralize repurchase
agreements \55\ generally trade in a secondary market.
---------------------------------------------------------------------------

    \54\ The proposed liquidity standard is the same as that we use
for rule 2a-7. See, e.g., rule 2a-7(a)(19) (defining illiquid
security to mean a security that cannot be sold or disposed of in
the ordinary course of business within seven calendar days at
approximately the value ascribed to it by the fund).
    \55\ See Tri-Party Repo Infrastructure, Reform Task Force, Tri-
Party Repo Margin Data, Summary Statistics for the U.S. Tri-Party
Repo Market (as of Jan. 11, 2011), http://www.newyorkfed.org/tripartyrepo/margin_data.html (describing 98.7% of tri-party
repurchase agreement collateral as composed of asset-backed
securities, agency collateralized mortgage backed obligations
(``CMOs''), agency debentures and strips, agency mortgage-backed
securities, private label CMOs, corporate debt, equity securities,
money market instruments and U.S. Treasury securities).
---------------------------------------------------------------------------

    We have designed the proposed amendments to be clear enough to
permit a fund board or fund investment adviser to make a determination
regarding credit quality and liquidity that would achieve the same
objectives that the credit rating requirement was designed to achieve,
i.e., to limit collateral securities to those that are likely to retain
a fairly stable market value and that, under ordinary circumstances,
the fund would be able to liquidate quickly in the event of a
counterparty default.\56\ We believe that fund advisers have experience
with or knowledge of the evaluation of securities and would be
qualified to make the credit and liquidity

determinations proposed under the rule.\57\
---------------------------------------------------------------------------

    \56\ See supra note 50. A fund that acquires repurchase
agreements would, under rule 38a-1, have to adopt and implement a
written policy reasonably designed to comply with the conditions of
rule 5b-3, including any credit quality and liquidity requirements
we might adopt under the rule. See rule 38a-1(a) (requiring
registered funds to adopt and implement written policies and
procedures reasonably designed to prevent the fund's violation of
Federal securities laws).
    \57\ We note that under the current rule, if collateral
securities are unrated, fund boards of directors (or their
delegates) must determine that the securities are of comparable
quality to securities rated in the highest category by an NRSRO.
Rule 5b-3(c)(iv)(D).
---------------------------------------------------------------------------

    Under the proposal, the board could delegate day-to-day
determinations regarding the quality and liquidity of collateral if it
chooses, provided that the board retained sufficient oversight. In
addition, although the rule would no longer require the collateral to
be rated by an NRSRO, fund boards (or their delegates) would still be
able to consider analysis provided by outside sources, including credit
agency ratings, that they conclude are credible and reliable, for
purposes of making these credit quality evaluations.\58\
---------------------------------------------------------------------------

    \58\ We understand that credit quality standards for securities
collateralizing repurchase agreements are typically contained in the
agreements between funds and counterparties. We expect that those
standards include a rating (for rated collateral securities) and any
additional criteria a fund manager considers necessary to ensure
that the credit quality of collateral securities meets the fund's
requirements, or for unrated securities, a comparable credit quality
standard. The proposed amendment would not prohibit fund boards (or
their delegates) from relying on the credit quality standards in
current repurchase agreements and policies and procedures adopted to
comply with the current rule regarding the credit quality of
collateral securities as long as they conclude that the ratings
specified in the repurchase agreements and policies and procedures
establish similar standards to those proposed, and that the agencies
providing the ratings used in the policies and procedures are
credible and reliable for that use. A fund could also revise its
repurchase agreements and policies and procedures to change or
eliminate the consideration of specific NRSRO ratings or to
incorporate other third party evaluations of credit quality.
---------------------------------------------------------------------------

    We request comment on our proposed amendment to rule 5b-3.
     Would the proposed determinations sufficiently address our
concerns that collateral securities be of high quality in order to
limit a fund's exposure to counterparties' credit risks? If not, are
there additional or alternative standards that do not use credit
ratings that would better address our concerns?
     Should a fund board (or its delegate) be permitted to
consider assessments issued by third parties, as we anticipate? What,
if any, criteria or standards should be imposed on the use of such
assessments? Would the use of third party assessments help fund boards
(or their delegates) arrive at consistent determinations regarding the
credit quality of collateral under the rule?
     We propose to allow the credit quality of an issuer of an
unconditional guarantee to substitute for the credit quality of the
issuer of a collateral security subject to the guarantee.\59\ This is
designed to preserve a fund's ability to use the same types of
collateral securities as it currently uses to satisfy the conditions of
rule 5b-3. Should we instead limit collateral to securities that alone
satisfy the proposed credit quality standard regardless of whether the
security is subject to an unconditional guarantee?
---------------------------------------------------------------------------

    \59\ See proposed rule 5b-3(c)(1)(iv)(C)(4).
---------------------------------------------------------------------------

     Would the proposed standard adequately address our concern
that a fund be able to readily liquidate collateral securities in the
event of a counterparty default?
     As noted above, we expect that, in general, securities
that trade in secondary markets and most securities that are used as
collateral for repurchase agreements would meet the proposed liquidity
requirement. Are there securities typically used for collateral that
would not meet the proposed liquidity standard?
     We have noted before that high quality securities
generally are more liquid than lower quality securities.\60\ Would the
proposed credit quality requirement alone be sufficient to address
concerns regarding liquidity of the collateral?
---------------------------------------------------------------------------

    \60\ See Rule 5b-3 Proposing Release, supra note 50, at n.43.
---------------------------------------------------------------------------

     We acknowledge that securities that may be liquid at the
time of acquisition of the repurchase agreement may be less liquid when
the counterparty defaults.\61\ Would a different standard of liquidity
provide any greater protection? For example, if we required that
collateral could be sold at carrying value almost immediately, would it
be more likely to remain liquid if many holders of the security are
trying to sell at the same time? Would such a standard limit collateral
securities to U.S. Treasury securities as a practical matter?
---------------------------------------------------------------------------

    \61\ We have noted before the difficulties of liquidating
collateral in the case of a default by a large counterparty when
many investors in repurchase agreements seek to liquidate similar
collateral at the same time. See Money Market Fund Reform Proposing
Release, supra note 8, at n.229 and accompanying and preceding text.
---------------------------------------------------------------------------

     In light of the potential for decreased liquidity of
collateral securities at the time of a counterparty default, should we
limit the exemption to repurchase agreements that are collateralized
only by cash or government securities?
     Would we better achieve the goals of rule 5b-3 if the rule
provided that a fund could no longer rely on rule 5b-3 if, at any point
after the time a fund enters into a repurchase agreement, the
collateral no longer met the proposed liquidity standard?

D. Proposed Rule 6a-5

    Business and industrial development companies (``BIDCOs'') are
companies that operate under state statute that provide direct
investment and loan financing, as well as managerial assistance, to
state and local enterprises.\62\ Because they invest in securities,
BIDCOs frequently meet the definition of ``investment company'' under
the Investment Company Act.\63\ In 1996, the Investment Company Act was
amended to add section 6(a)(5) to exempt these companies from most
provisions of the Act subject to certain conditions.\64\ The statutory
exemption was premised on states having a strong interest in overseeing
the structure and operations of these companies, thus rendering
regulation under the Investment Company Act largely duplicative and
unnecessary.\65\
---------------------------------------------------------------------------

    \62\ See S. Rep. No. 103-166, at 11 (1993) (``1993 Senate
Report'').
    \63\ For purposes of the Investment Company Act, an ``investment
company'' means any issuer that (A) is or holds itself out as being
engaged primarily, or proposes to engage primarily, in the business
of investing, reinvesting, or trading in securities; (B) is engaged
or proposes to engage in the business of issuing face-amount
certificates of the installment type, or has been engaged in such
business and has any such certificate outstanding; or (C) is engaged
or proposes to engage in the business of investing, reinvesting,
owning, holding, or trading in securities, and owns or proposes to
acquire investment securities having a value exceeding 40 per centum
of the value of such issuer's total assets (exclusive of government
securities and cash items) on an unconsolidated basis. 15 U.S.C.
80a-3(a)(1).
    \64\ 15 U.S.C. 80a-6(a)(5); Pub. L. 104-290 Sec.  501, 110 Stat.
3416, 3444 (1996). Section 6(a)(5)(B) provides that section 9 and,
to the extent necessary to enforce section 9, sections 38 through
51, apply to a BIDCO as though the company were a registered
investment company. Among other conditions to reliance on the
exemption in section 6(a)(5), a BIDCO may not issue redeemable
securities.
    \65\ See 1993 Senate Report, supra note 62, at 19 (further
stating that states are well positioned to monitor these companies
and address the needs of resident investors). Prior to the addition
of section 6(a)(5), the Commission had granted orders to exempt
BIDCOs from regulation under the Act. See, e.g., The Idaho Company,
Investment Company Release Nos. 18926 (Sept. 3, 1992) (notice) and
18985 (Sept. 30, 1992) (order).
---------------------------------------------------------------------------

    BIDCOs that seek to rely on the exemption in section 6(a)(5) are
limited with respect to the types of securities issued by investment
companies and companies exempt from the definition of investment
company under section 3(c)(1) or 3(c)(7) of the Act (``private funds'')
that they may purchase. Specifically, section 6(a)(5)(A)(iv) limits
these BIDCOs from purchasing securities issued by investment companies
and private funds other than debt securities that are rated investment
grade by at least one NRSRO and securities issued by registered open-
end investment companies that invest at

least 65 percent of their assets in investment grade securities or
securities that the fund determines are comparable in quality.\66\ This
provision was intended to provide limited flexibility to invest capital
not immediately needed for the company's long-term commitments.\67\
Although the legislative history of the provision does not specifically
explain why Congress restricted BIDCOs to acquiring ``investment
grade'' debt of investment companies and private funds, it may have
been designed to limit BIDCOs to investing in debt securities of
sufficiently high credit quality that they are likely to maintain a
fairly stable market value and that could be liquidated easily, as
appropriate, for the BIDCO to support its investment and financing
activities.
---------------------------------------------------------------------------

    \66\ 15 U.S.C. 80a-6(a)(5)(A), as in effect prior to July 21,
2012 (exempting any company that is not engaged in the business of
issuing redeemable securities, the operations of which are subject
to regulation by the State in which the company is organized under a
statute governing entities that provide financial or managerial
assistance to enterprises doing business, or proposing to do
business in that state if, among other things, the company does not
purchase any security issued by an investment company or by any
company that would be an investment company except for the
exclusions from the definition of the term ``investment company''
under sections 3(c)(1) or 3(c)(7), other than (I) any debt security
that is rated investment grade by not less than 1 nationally
recognized statistical rating organization; or (II) any security
issued by a registered open-end fund that is required by its
investment policies to invest not less than 65% of its total assets
in securities described in subclause (I) or securities that are
determined by such registered open-end fund to be comparable in
quality to securities described in subclause (I)).
    \67\ See 1993 Senate Report, supra note 62, at 20.
---------------------------------------------------------------------------

    As described above, section 939(c) of the Dodd-Frank Act eliminates
the credit rating reference in section 6(a)(5)(A)(iv) of the Investment
Company Act. Instead of limiting BIDCOs to purchasing debt securities
issued by investment companies and private funds that are rated
``investment grade,'' the amendment requires such debt securities to
meet ``such standards of credit-worthiness as the Commission shall
adopt.''
    We are proposing new rule 6a-5 to establish this standard of
credit-worthiness. Proposed rule 6a-5 would deem a BIDCO to have met
the requirements for credit-worthiness of certain debt securities under
section 6(a)(5)(A)(iv)(I) if the board of directors or members of the
company (or its delegate) determines that the debt security is (i)
subject to no greater than moderate credit risk and (ii) sufficiently
liquid that the security can be sold at or near its carrying value
within a reasonably short period of time.\68\ The proposed standard is
designed to limit BIDCOs to purchasing debt securities issued by
investment companies or private funds of sufficiently high credit
quality that they are likely to maintain a fairly stable market value
and may be liquidated easily, as appropriate, for the BIDCO to support
its investment and financing activities. The board of directors or
members of a BIDCO (or its delegate) would have to make the
determination at the time of acquisition.\69\ As a result of the
proposed rule, section 6(a)(5) of the Act would also limit a BIDCO's
investments in registered open-end funds to those funds that invest at
least 65 percent of their assets in debt securities that meet our
proposed standard.\70\
---------------------------------------------------------------------------

    \68\ Proposed rule 6a-5. The standard for credit-worthiness that
we are proposing in rule 6a-5 is similar to the standard that we
adopted in rule 10f-3 under the Investment Company Act. See 2009
Ratings Removal Adopting Release, supra note 7, at Section II.B.2;
rule 10f-3(a)(3). This credit quality standard differs from those we
propose for rules 2a-7 and 5b-3 because it reflects the different
standard of credit quality associated with the ratings referenced in
rule 10f-3 and section 6(a)(5)(A)(iv)(I) of the Act before the
amendment of each provision. Compare supra notes 16, 48, and
accompanying text with supra note 66 and accompanying text and rule
10f-3(a)(3), as in effect before November 12, 2009 (conditioning an
exemption to permit an investment company that is affiliated with
members of an underwriting syndicate to purchase securities from the
syndicate if certain conditions are met, including if the securities
are municipal securities, that have received an investment grade
rating, or if the securities are less seasoned, one of the three
highest ratings, from an NRSRO).
    \69\ Proposed rule 6a-5. From our review of the state statutes
under which BIDCOs are formed and operate, we understand that BIDCOs
must be organized as corporations with boards of directors or
limited liability companies that are managed by members or managers.
See, e.g., Mich. comp. Laws Sec.  301 (2010) (stating that a company
other than a Michigan corporation or a limited liability company
cannot apply for a license to be a BIDCO); Mont. Code Ann. Sec.  102
(2010) (defining a BIDCO as a corporation that is licensed under the
act to provide financial and management assistance to businesses);
Alaska Stat. Sec.  20 (2010) (stating that a license to operate a
BIDCO will be issued to a corporation if certain conditions are
met); Tenn. Code Ann. Sec.  208 (2010) (stating that a person other
than a Tennessee corporation cannot apply for a license to be a
BIDCO).
    \70\ Section 6(a)(5)(A)(iv)(II) (permitting a BIDCO to purchase
any security issued by a registered open-end fund that is required
by its investment policies to invest not less than 65% of its total
assets in securities described in subclause (I) (i.e., securities
that meet the standards of credit-worthiness that the Commission
adopts) or securities that are determined by such registered open-
end fund to be comparable in quality to securities described in
subclause (I)).
---------------------------------------------------------------------------

    Moderate credit risk would denote current low expectations of
default risk, with an adequate capacity for payment of principal and
interest.\71\ Debt securities (or their issuers) subject to a moderate
level of credit risk would demonstrate at least average credit-
worthiness relative to other similar debt issues (or issuers of similar
debt).\72\ In making these determinations, a BIDCO's board of
directors, members or managers would be able to consider credit quality
reports prepared by outside sources, including NRSRO ratings, that they
conclude are credible and reliable for this purpose.
---------------------------------------------------------------------------

    \71\ See 2009 Ratings Removal Adopting Release, supra note 7, at
n.86.
    \72\ Id.
---------------------------------------------------------------------------

    We request comment on proposed rule 6a-5.
     Does the standard we have proposed provide BIDCOs with
flexibility to invest in certain debt securities that are likely to
retain their value and that a BIDCO could sell quickly if necessary to
support its investment and financing activities? If not, are there
additional or alternative standards that do not use credit ratings that
would be more appropriate to the statutory intent of section 6(a)(5)?
     Is our understanding that BIDCOs are organized as
corporations with a board of directors or limited liability companies
with members or managers correct? Are there BIDCOs that are formed as
partnerships or other structures?
     Do BIDCO directors or members have sufficient experience
with or knowledge of evaluating securities to allow them to make the
determinations called for by proposed rule 6a-5 or to oversee decisions
made by a delegate?

E. Forms N-1A, N-2 and N-3

    We are proposing to amend Forms N-1A, N-2 and N-3 to remove the
required use of credit ratings assigned by an NRSRO. Forms N-1A, N-2
and N-3, among other things, contain the requirements for shareholder
reports of mutual funds, closed-end funds, and certain insurance
company separate accounts that offer variable annuities.\73\
---------------------------------------------------------------------------

    \73\ Form N-1A is used by open-end management investment
companies, commonly known as mutual funds. Form N-2 is used by
closed-end management investment companies. Form N-3 is used by
separate accounts, organized as management investment companies,
that offer variable annuity contracts.
---------------------------------------------------------------------------

    Currently, Forms N-1A, N-2 and N-3 each require shareholder reports
to include a table, chart, or graph depicting portfolio holdings by
reasonably identifiable categories (e.g., type of security, industry
sector, geographic region, credit quality or maturity).\74\ The forms
require the categories to be selected in a manner reasonably designed
to depict clearly the types of investments made by the fund, given its
investment objectives. If credit quality is

used to present portfolio holdings, the forms require that credit
quality be depicted using the credit ratings assigned by a single
NRSRO.
---------------------------------------------------------------------------

    \74\ Item 27(d)(2) of Form N-1A; Instruction 6(a) to Item 24 of
Form N-2; Instruction 6(i) to Item 28(a) of Form N-3.
---------------------------------------------------------------------------

    We are proposing to amend Forms N-1A, N-2 and N-3 to eliminate the
required use of NRSRO credit ratings by funds that choose to use credit
quality categorizations in the required table, chart or graph of
portfolio holdings. If a fund chooses to use NRSRO credit ratings to
depict credit quality of portfolio holdings, the proposal, like the
current forms, generally would require the fund to use the credit
ratings of a single NRSRO. This requirement is intended to eliminate
the possibility that a fund could choose to use NRSRO credit ratings
and then select the most favorable ratings among credit ratings
assigned by multiple NRSROs. The proposal would clarify that, if credit
ratings of the NRSRO selected by a fund are not available for certain
holdings, the fund must briefly discuss the methodology for determining
credit quality for those holdings, including, if applicable, the use of
credit ratings assigned by another NRSRO.\75\ Funds typically provide
this discussion in their shareholder reports today.\76\
---------------------------------------------------------------------------

    \75\ Proposed Item 27(d)(2) of Form N-1A; proposed Instruction
6(a) to Item 24 of Form N-2; proposed Instruction 6(i) to Item 28(a)
of Form N-3. In these items, we are also proposing to define NRSRO
by reference to the Exchange Act definition, rather than by
reference to Exchange Act rule 15c3-1 as is currently the case, and
to replace the use of the term ``rating'' with ``credit rating'' as
defined under the Exchange Act. See sections 3(a)(60) [15 U.S.C.
78c(a)(60)] and 3(a)(62) [15 U.S.C. 78c(a)(62)] of the Exchange Act,
which define ``credit rating'' and ``nationally recognized
statistical rating organization,'' respectively.
    \76\ This statement is based on a staff review of a sample of
fund shareholder reports filed with the Commission.
---------------------------------------------------------------------------

    We request comment on the proposal to eliminate the required use of
NRSRO credit ratings by funds that choose to use credit quality
categorizations in shareholder reports.
     Are there better methods than the proposal by which funds
could portray credit quality for purposes of the required table, chart
or graph that presents portfolio holdings?
     Does the proposal adequately address situations where a
fund would choose to portray credit quality using NRSRO ratings and
there is no single NRSRO that has rated all of the fund's portfolio
holdings?

III. Request for Comment

    We request comment on the rule and form amendments and new rule
proposed in this release. We also request suggestions for additional
changes to existing rules, and comments on other matters that might
have an effect on the proposals contained in this release. Commenters
are requested to provide empirical data to support their views.

IV. Paperwork Reduction Act

    Certain provisions of our proposal contain ``collections of
information'' within the meaning of the Paperwork Reduction Act of 1995
(``PRA'').\77\ The titles for the existing collections of information
are: (1) ``Rule 2a-7 under the Investment Company Act of 1940, Money
market funds''; (2) ``Rule 30e-1 under the Investment Company Act of
1940, Reports to Stockholders of Management Companies'';\78\ (3) ``Rule
38a-1 under the Investment Company Act of 1940, Compliance procedures
and practices of registered investment companies''; and (4) ``Form N-
MFP under the Investment Company Act of 1940, Portfolio Holdings of
Money Market Funds.'' We adopted the rules and form pursuant to the
Investment Company Act. The Commission is submitting these collections
of information to the Office of Management and Budget (``OMB'') for
review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11.
---------------------------------------------------------------------------

    \77\ 44 U.S.C. 3501-3520.
    \78\ The proposed amendments to Forms N-1A, N-2 and N-3 relate
solely to the contents of fund shareholder reports. The PRA burden
associated with fund shareholder reports is included in the burden
associated with the collection of information for rule 30e-1 under
the Investment Company Act rather than Forms N-1A, N-2 and N-3.
---------------------------------------------------------------------------

    There is currently no approved collection of information for rule
5b-3 and the proposed amendments would not create any new collections
under that rule. The proposed amendments to rule 5b-3 would, however,
affect the collection of information burden for rule 38a-1. Proposed
rule 6a-5 also would not create any new collections of information.
    An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a
currently valid control number. The approved collection of information
associated with rule 2a-7 displays control number 3235-0268. The
approved collection of information associated with rule 30e-1 displays
control number 3235-0025. The approved collection of information
associated with rule 38a-1, which would be revised by the proposed
amendments to rule 5b-3, displays control number 3235-0586. The
approved collection of information associated with Form N-MFP displays
control number 3235-0657.

A. Money Market Funds

1. Rule 2a-7
    As discussed above, we are proposing to remove references to credit
ratings in rule 2a-7, which would affect five elements of the rule.
First, we propose to eliminate the requirement that an eligible
security be rated by an NRSRO or be of comparable quality, while
maintaining the two-step analysis currently required by rule 2a-7. A
security would be an eligible security only if the board of directors
(or its delegate) determines that it presents minimal credit risks,
which determination must be based on factors pertaining to credit
quality and the issuer's ability to meet its short-term financial
obligations.\79\ Second, we propose to define first tier security as a
security whose issuer the fund's board (or its delegate) determines has
the ``highest capacity to meet its short-term financial obligations.''
\80\ Third, we propose to require that with respect to a security (or
its guarantee) subject to a conditional demand feature, in addition to
other conditions, the underlying security (or its guarantee) must
itself be of high quality and subject to very low credit risk as
determined by the fund's board (or its delegate).\81\ Fourth, we
propose to eliminate the use of credit ratings in the rule's downgrade
and default provisions. The proposed amendment would require that in
the event 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 of any credible information about a
portfolio security or an issuer of a portfolio security that suggests
that the security is no longer a first tier security or a second tier
security, as the case may be, the money market fund's board of
directors would have to reassess promptly whether the portfolio
security continues to present minimal credit risks.\82\ Finally, we
propose to eliminate the reference to portfolio securities' downgrades
in the stress testing provisions. Under the proposal, a money market
fund's stress testing procedures would be required to include as a
hypothetical event, ``an adverse change in the ability of the issuer of
a portfolio security to meet its

short-term financial obligations.'' \83\ The respondents to these
collections of information are money market funds. A fund must comply
with the requirements of rule 2a-7, including the collections of
information, in order to obtain the exemptive relief provided under the
rule and to operate as a money market fund.
---------------------------------------------------------------------------

    \79\ Proposed rule 2a-7(a)(11). See supra Section II.A.1.
    \80\ Proposed rule 2a-7(a)(13). See supra Section II.A.1.
    \81\ Proposed rule 2a-7(c)(3)(iv)(C). See supra Section II.A.2.
    \82\ Proposed rule 2a-7(c)(7)(i)(A). See supra Section II.A.3.
    \83\ Proposed rule 2a-7(c)(10)(v)(A). See supra Section II.A.4.
As a result of eliminating the term ``designated NRSRO,'' the
proposal would eliminate the requirement that boards of directors
designate NRSROs and disclose such designated NRSROs in their SAIs.
See supra note 25. We believe that the deletion of the disclosure
requirement would not affect the collection of information
requirements in the SAI, however, and therefore would not change
current paperwork burden estimates. When we adopted the requirement
to disclose designated NRSROs in the SAI, we stated that we
anticipated that making this disclosure would not result in
additional hourly burdens or printing costs beyond those currently
approved in the existing collection of information for Form N-1A.
See Money Market Fund Reform Adopting Release, supra note 8, at 106.
The proposed amendments also would make conforming amendments to
rule 2a-7's recordkeeping and reporting requirements. See proposed
rule 2a-7(c)(11)(iii). These conforming changes would not result in
changes in the estimated hourly burden associated with the
recordkeeping and reporting requirements.
---------------------------------------------------------------------------

    We do not anticipate that the proposed amendments would
significantly change collection of information requirements under rule
2a-7 because we believe funds would likely rely on their current
policies and procedures to comply with the proposed amendments. Under
current rule 2a-7, money market fund boards, or their delegates, are
required to perform a minimal credit risk evaluation with respect to
each of the fund's portfolio securities. Funds also must adopt policies
and procedures regarding those determinations.\84\ Eligible securities
and first tier securities currently are defined with reference to
credit ratings, and securities subject to a conditional demand feature
must meet a minimum credit rating threshold or if unrated, be of
comparable quality. With respect to monitoring for downgrades and
defaults, Commission staff understands that money market funds
generally monitor for information regarding credit events that may
affect the portfolio in addition to those specified in the rule. In
addition, a fund could treat a downgrade as a credit event that might
adversely affect a portfolio security. Finally, staff also understands
that money market funds stress test for credit events other than
downgrades that might affect the fund's portfolio. As we have noted
above, with respect to each of the amendments we propose today, money
market funds could continue to consider evaluations of outside sources,
including credit ratings, in making credit quality determinations,
monitoring and stress testing. Moreover, we anticipate that funds would
likely continue to rely on their current policies and procedures with
respect to credit quality determinations, monitoring for credit events
and stress testing because that is likely to be less costly than
revising policies. Accordingly, we do not expect the proposed
amendments would significantly change current collection of information
burden estimates for rule 2a-7.\85\ Nevertheless, money market funds
may make technical changes to their policies and procedures in response
to the proposed amendments, if adopted. Staff estimates that it would
take, on average, 1.5 hours of a senior business analyst's time to make
any technical changes for an individual money market fund, for an
estimated one-time burden of 978 hours for all money market funds at a
total cost of $226,896.\86\ Amortized over three years, we estimate
that the total annual burden would be 326 hours at a cost of $75,632.
---------------------------------------------------------------------------

    \84\ See rules 2a-7(c)(3); 2a-7(c)(11)(ii); 2a-7(e); 38a-1.
    \85\ The current approved annual burden for rule 2a-7 under the
PRA is 395,779 hours. The estimated number of respondents is 652
money market funds as of December 31, 2010. The estimated number of
money market funds is based on the Investment Company Institute,
Trends in Mutual Fund Investing, December 2010 (Jan. 27, 2011),
http://www.ici.org/research/stats/trends/trends_12_10.
    \86\These estimates are based on the following calculation: (652
money market funds x 1.5 hours = 978 hours); (978 hours x $232 per
hour = $226,896). The staff estimates that the internal cost of a
senior business analyst is $232 per hour. This estimate, as well as
other internal time cost estimates made in this analysis, is derived
from SIFMA's Management and Professional Earnings in the Securities
Industry 2010, modified by Commission staff to account for an 1800-
hour work week and multiplied by 5.35 to account for bonuses, firm
size, employee benefits and overhead.
---------------------------------------------------------------------------

     We request comment on these assumptions. If commenters
believe these assumptions are not accurate, we request they provide
specific data that would allow us to make more accurate estimates.
2. Form N-MFP
    Rule 30b1-7 requires money market funds to file electronically a
monthly report on Form N-MFP within five business days after the end of
each month. The information required by the form must be data-tagged in
XML format and filed through EDGAR. Preparing Form N-MFP is a
collection of information under the PRA.\87\ The respondents to the
requirement to prepare Form N-MFP are investment companies that are
regulated as money market funds under rule 2a-7. Compliance with the
requirement to prepare Form N-MFP is mandatory for any fund that holds
itself out as a money market fund in reliance on rule 2a-7. Responses
to the disclosure requirement of Form N-MFP are not kept confidential.
---------------------------------------------------------------------------

    \87\ For purposes of the PRA analysis, the current burden
associated with the requirements of rule 30b1-7 is included in the
collection of information requirements of Form N-MFP. The current
approved annual burden for Form N-MFP under the PRA is 94,189 hours.
---------------------------------------------------------------------------

    As discussed previously, the proposed amendments would eliminate
the items requiring disclosure for each portfolio security (and any
guarantee, demand feature or enhancement associated with the portfolio
security) of the designated NRSROs for the security and the rating
assigned to the security in Items 34, 37, 38 and 39 of the Form. The
proposed amendments would also eliminate the requirement in Item 33
that a money market fund disclose whether a security is a rated
security or an unrated security.
    The staff estimates that, as of December 31, 2010, there are
approximately 652 money market funds that are required to file Form N-
MFP.\88\ The staff estimates that our proposed amendments would reduce
the time it takes money market funds to complete Form N-MFP by 0.5
hours. Because Form N-MFP is completed 12 times a year, the staff
estimates that each respondent would save approximately 6 hours
annually (at an internal cost of $301 per hour).\89\ The staff
therefore estimates that our proposed amendments to Form N-MFP would
result in total incremental time savings of approximately 3912 hours
(and $1,177,512) annually.\90\
---------------------------------------------------------------------------

    \88\ See supra note 85.
    \89\ The staff estimates that the internal cost of a senior
database administrator is $301 per hour.
    \90\ These estimates are based on the following calculation:
(652 x 6 hours = 3912 hours); (3912 hours x $301 per hour =
$1,177,512). We understand that some money market funds may
outsource all or a portion of their responsibilities regarding Form
N-MFP to a filing agent, software consultant, or other third-party
service provider. We believe that a fund would engage third-party
service providers at an external cost similar to or less than the
estimated internal costs so the amount of the savings would be
comparable.
---------------------------------------------------------------------------

     We request comment on these estimates. If commenters
believe these estimates are not accurate, we request they provide
specific data that would allow us to make more accurate estimates.

B. Rule 5b-3

    Rule 5b-3 under the Investment Company Act allows funds to treat
the acquisition of a repurchase agreement as an acquisition of
securities collateralizing the repurchase agreement for purposes of
sections 5(b)(1) and

12(d)(3) of the Act under certain conditions. We propose to amend rule
5b-3 to require that the securities collateralizing a repurchase
agreement consist of securities that the fund's board of directors, or
its delegate, determines are issued (or have unconditional guarantees
that are issued) by an issuer that has the highest capacity to meet its
financial obligations and are highly liquid.\91\ To that end, the
fund's board of directors, pursuant to rule 38a-1 under the Act, would
have to develop procedures to ensure that at the time the repurchase
agreement is entered into, the securities meet the requirements for
collateral outlined in the proposed amendments to the rule.\92\ As
discussed above, these procedures are designed to limit collateral
securities to those that are likely to retain a stable market value and
that, in ordinary circumstances, the fund would be able to liquidate
quickly in the event of a default. This collection of information would
be mandatory for funds that rely on rule 5b-3. Records of information
made in connection with this requirement would be required to be
maintained for inspection by Commission staff, but the collection would
not otherwise be submitted to the Commission. The information, when
provided to the Commission in connection with staff examinations or
investigations, would be kept confidential to the extent permitted by
law.
---------------------------------------------------------------------------

    \91\ Proposed rule 5b-3(c)(1)(iv)(C). See supra Section II.C.
    \92\ Under rule 38a-1, funds must have written policies and
procedures reasonably designed to prevent violation of the Federal
securities laws. Rule 38a-1(a)(1). Funds thus would have policies
and procedures for complying with rule 5b-3, which would include
policies and procedures relating to credit quality determinations of
unrated collateral securities, if appropriate.
---------------------------------------------------------------------------

    We do not anticipate that the proposed amendments would
significantly change collection of information burdens under rule 38a-1
because we believe funds would likely rely on their current policies
and procedures to determine the credit quality of collateral securities
to comply with rule 5b-3, as we propose to amend it. We understand that
credit quality standards for securities collateralizing repurchase
agreements are contained in the repurchase agreements between funds and
counterparties. We expect that those standards currently include a
rating and any additional criteria a fund manager considers necessary
to ensure that the credit quality of the collateral securities meets
the fund's requirements, or, for unrated securities, a comparable
credit quality standard. Counterparties provide collateral securities
to conform to these standards and funds confirm that the securities are
conforming. As we have noted above, funds could continue to consider
evaluations of outside sources, including credit ratings, that the
board determines are credible and reliable in making their credit
quality determinations under the proposed rule. We expect that funds
would likely continue to rely on their current policies and procedures
(i.e., using credit quality standards that include ratings currently
set forth in their repurchase agreements with counterparties). Thus, we
do not expect that the proposed amendments would significantly change
the current collection of information burden estimates for rule 38a-
1.\93\ Nevertheless, funds may review their repurchase agreements and
policies and procedures that address rule 5b-3 compliance and make
technical changes to those documents in response to the proposed
amendments, if adopted. Staff estimates that it will take, on average,
1.5 hours of a senior business analyst's time to perform this review
and make any technical changes for an individual fund portfolio, for an
estimated burden of 12,690 hours for all fund portfolios (other than
money market fund portfolios) \94\ at a total cost of $2,944,080.\95\
Amortized over three years, we estimate that the total burden would be
4230 hours at a cost of $981,360. We anticipate that the fund's board
would review the fund manager's recommendation, but that the cost of
this review would be incorporated in the fund's overall annual board
costs and would not result in any particular additional cost.
---------------------------------------------------------------------------

    \93\ The current approved annual burden for rule 38a-1 under the
PRA is 254,703 hours.
    \94\ For purposes of this PRA analysis, we assume that all funds
enter into repurchase agreements and rely on rule 5b-3. We have not
included money market funds in our estimates, however, because they
are subject to different requirements under rule 2a-7, as noted
above. See supra note 49. The staff's estimate of the number of fund
portfolios is based on staff examination of industry data as of
December 31, 2010.
    \95\ These estimates are based on the following calculation:
(8,460 fund portfolios x 1.5 hours = 12,690 hours); (12,690 hours
$232 per hour = $2,944,080). The staff estimates that the internal
cost for time spent by a senior business analyst is $232 per hour.
---------------------------------------------------------------------------

     We request comment on these estimates. If commenters
believe these estimates are not accurate, we request they provide
specific data that would allow us to make more accurate estimates.
     Is our expectation that funds would continue to consider
ratings in their credit quality standards to evaluate rated collateral
securities for repurchase agreements correct? If funds choose not to
continue this consideration of ratings, we request comment on how long
it would take a fund to confirm that collateral securities satisfy the
credit quality standards in a repurchase agreement under our proposed
standard.

C. Rule 30e-1

    The proposed amendments to Forms N-1A, N-2 and N-3 eliminate the
required use of NRSRO credit ratings by funds that choose to use credit
quality categorizations in the required table, chart, or graph of
portfolio holdings. If a fund chooses to use NRSRO credit ratings to
depict credit quality of portfolio holdings, the proposed amendments,
like the current forms, generally would require the fund to use the
credit ratings of a single NRSRO. The proposed amendments would clarify
that, if credit ratings of the NRSRO selected by a fund are not
available for certain holdings, the fund must briefly discuss the
methodology for determining credit quality for those holdings,
including, if applicable, the use of credit ratings assigned by another
NRSRO.
    The Commission believes that the proposed amendments to Forms N-1A,
N-2 and N-3 would not affect the current PRA burden under rule 30e-1,
because funds would remain obligated to provide a table, chart, or
graph of portfolio holdings by reasonably identifiable categories. The
proposed amendments only eliminate the required use of NRSRO credit
ratings by funds that choose to use credit quality categorizations. The
Commission further believes that the proposed clarification for cases
when credit ratings of the NRSRO selected by a fund are not available
for certain holdings would not impose any additional PRA burden because
funds typically provide this disclosure in their shareholder reports
today.\96\
---------------------------------------------------------------------------

    \96\ This assessment is based on a staff review of a sample of
fund shareholder reports filed with the Commission.
---------------------------------------------------------------------------

     We request comment on this analysis. If commenters believe
this analysis is not accurate, we request that they provide specific
data that would allow us to make a more accurate analysis.

D. Request for Comments

    We request comment on whether the estimates provided in this PRA
analysis are accurate. Pursuant to 44 U.S.C. 3506(c)(2)(B), the
Commission solicits comments in order to: (i) Evaluate whether the
proposed collections of information are necessary for the proper

performance of the functions of the Commission, including whether the
information will have practical utility; (ii) evaluate the accuracy of
the Commission's estimate of the burden of the proposed collections of
information; (iii) determine whether there are ways to enhance the
quality, utility, and clarity of the information to be collected; and
(iv) minimize the burden of the collections of information on those who
are to respond, including through the use of automated collection
techniques or other forms of information technology.
    Persons wishing to submit comments on the collection of information
requirements of the proposed amendments should direct them to the
Office of Management and Budget, Attention Desk Officer for the
Securities and Exchange Commission, Office of Information and
Regulatory Affairs, Room 10102, New Executive Office Building,
Washington DC 20503, and should send a copy to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090, with reference to File No. S7-7-11. OMB is
required to make a decision concerning the collections of information
between 30 and 60 days after publication of this Release; therefore a
comment to OMB is best assured of having its full effect if OMB
receives it within 30 days after publication of this Release. Requests
for materials submitted to OMB by the Commission with regard to these
collections of information should be in writing, refer to File No. S7-
7-11, and be submitted to the Securities and Exchange Commission,
Office of Investor Education and Advocacy, 100 F Street, NE.,
Washington, DC 20549-0213.

V. Cost-Benefit Analysis

    The Commission is sensitive to the costs and benefits imposed by
its rules. We have identified certain costs and benefits of the
proposed rule and form amendments and proposed rule, and we request
comment on all aspects of this cost-benefit analysis, including
identification and assessment of any costs and benefits not discussed
in this analysis. We seek comment and data on the value of the benefits
identified. We also welcome comments on the accuracy of the cost
estimates in each section of this analysis, and request that commenters
provide data that may be relevant to these cost estimates. In addition,
we seek estimates and views regarding these costs and benefits for
particular funds, including funds that are small entities, as well as
any other costs or benefits that may result from the adoption of the
proposed rule and rule and form amendments. Where possible, we request
commenters provide empirical data to support any positions advanced.
    As discussed above, to implement provisions of the Dodd-Frank Act,
we propose to (i) remove the references to credit ratings in rules 2a-7
and 5b-3 and replace them with alternative standards of credit-
worthiness that are designed to appropriately achieve the same purposes
as the ratings, (ii) eliminate references to credit ratings in Form N-
MFP, and (iii) remove from Forms N-1A, N-2 and N-3 the requirement that
NRSRO credit ratings be used when portraying credit quality in
shareholder reports. We are also proposing rule 6a-5 to replace a
statutory reference to credit ratings that the Dodd-Frank Act removes
from the Investment Company Act and for which the Dodd-Frank Act
anticipates the Commission will adopt a replacement standard. Thus, the
benefits and costs associated with the replacement of credit rating
references with alternative standards of credit-worthiness are
attributable to the Dodd-Frank Act. The Commission has discretion,
however, in adopting the alternative standards of credit-worthiness,
and we undertake below to discuss the costs and benefits of the rule
and form amendments and new rule that we are proposing.

A. Money Market Funds

1. Rule 2a-7
    As discussed above, we are proposing to remove references to credit
ratings in rule 2a-7, which would affect five elements of the rule.
First, we propose to eliminate the requirement that an eligible
security be rated by an NRSRO or be of comparable quality, while
maintaining the two-step analysis currently required by rule 2a-7. A
security would be an eligible security only if the board of directors
(or its delegate) determines that it presents minimal credit risks,
which determination must be based on factors pertaining to credit
quality and the issuer's ability to meet its short-term financial
obligations.\97\ Second, we propose to define first tier security as a
security whose issuer the fund's board (or its delegate) determines has
the ``highest capacity to meet its short-term financial obligations.''
\98\ Third, we propose to require that with respect to a security (or
its guarantee) subject to a conditional demand feature, in addition to
other conditions, the underlying security (or its guarantee) must
itself be of high quality and subject to very low credit risk as
determined by the fund's board (or its delegate).\99\ Fourth, we
propose to remove the reference to credit ratings in the rule's
downgrade and default provisions. The proposed amendment would require
that, in the event 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 of any credible information
about a portfolio security or an issuer of a portfolio security that
suggests that the security is no longer a first tier security or a
second tier security, as the case may be, the money market fund's board
of directors would have to reassess promptly whether the portfolio
security continues to present minimal credit risks.\100\ Finally, we
propose to eliminate the reference to portfolio securities' downgrades
in the stress testing provisions. Under the proposal, a money market
fund's stress testing procedures would be required to include as a
hypothetical event, ``an adverse change in the ability of the issuer of
a portfolio security to meet its short-term financial obligations.''
\101\
---------------------------------------------------------------------------

    \97\ Proposed rule 2a-7(a)(11). See supra Section II.A.1.
    \98\ Proposed rule 2a-7(a)(13). See supra Section II.A.1.
    \99\ Proposed rule 2a-7(c)(3)(iv)(C). See supra Section II.A.2.
    \100\ Proposed rule 2a-7(c)(7)(i)(A). See supra Section II.A.3.
    \101\ Proposed rule 2a-7(c)(10)(v)(A). See supra Section II.A.4.
As noted above, see supra note 20, the proposed amendments would
make conforming changes to rule 2a-7's recordkeeping and reporting
requirements. We do not believe that these amendments would affect
costs.
---------------------------------------------------------------------------

a. Benefits
    We believe that the proposed amendments to rule 2a-7 may provide
certain benefits to money market funds. As discussed above, in
connection with the PRA analysis, money market funds have adopted
policies and procedures that with respect to portfolio securities
(including securities subject to a conditional demand feature) address
credit quality, minimal credit risk determinations, monitoring for
downgrades and defaults and stress testing. Under the proposed rules,
money market funds could revise their policies and procedures with
respect to each of these requirements to change or eliminate the
consideration of credit ratings or consider other sources of credit
quality evaluations as funds determine would be appropriate.
Nevertheless, because the proposed amendments are designed to retain
the same degree of credit risk limitation and similar standards for
monitoring credit

events and stress testing as under current rule 2a-7, the proposed
amendments would not prohibit a money market fund from using its
current policies and procedures to comply with the proposed amendments.
In particular, as discussed above, fund boards (or their delegates)
could still consider credit quality evaluations prepared by outside
sources, including NRSRO ratings, that they conclude are credible and
reliable for purposes of making credit quality determinations with
respect to portfolio securities (including securities subject to a
conditional demand feature), monitoring minimal credit risks of the
portfolio and stress testing. We expect that each money market fund
would undertake its own analysis of the costs or benefits of revising
policies and procedures and would only change them to the extent the
fund believed the benefits justified the costs of doing so.
    Although some money market funds may eliminate the specific use of
ratings in their credit risk determinations, we anticipate that many of
those funds are likely to consider some outside analyses in evaluating
the credit quality of, and minimal credit risks presented by, portfolio
securities (including securities subject to a conditional demand
feature). Fund boards' (or their delegates') consideration of external
analyses by third party sources determined to be credible and reliable
to the extent the fund board (or its delegate) considers appropriate
may contribute to the accuracy of funds' determinations and thus help
money market funds arrive at consistent credit risk determinations.
b. Costs
    We recognize that there may be minor costs associated with the
proposed amendments to rule 2a-7. Money market funds may incur some
costs internally or to consult outside legal counsel to evaluate any
need to change their policies and procedures relating to determinations
of credit quality, monitoring for credit events and stress testing if
the proposed amendments were adopted. We do not believe, however, that
these costs are attributable to the proposed rule and form amendments
because the requirement in the Dodd-Frank Act that we replace the use
of credit ratings in rules with alternative standards of credit-
worthiness would result in similar costs of evaluating compliance with
a new credit quality standard.
    As discussed above, because the proposed amendments are designed to
retain the same degree of credit risk limitation and similar standards
for monitoring credit events and stress testing as under current rule
2a-7, a money market fund also could use its current policies and
procedures to comply with the proposed amendments. In particular, as
discussed above, a fund could still incorporate credit quality
evaluations prepared by outside sources, including NRSRO ratings, that
the fund's board or adviser concludes are credible and reliable for
purposes of making credit quality determinations with respect to
portfolio securities (including securities subject to a conditional
demand feature), monitoring minimal credit risks of the portfolio, and
stress testing. We expect that each money market fund would undertake
its own analysis of the costs or benefits of revising policies and
procedures and would only change its policies to the extent the fund
believed the benefits justified the costs of doing so. Nevertheless,
money market funds may make technical changes to their policies and
procedures in response to the proposed amendments, if adopted. We
estimate that money market funds would incur a one-time aggregate cost
of $226,896 to make any technical changes.\102\
---------------------------------------------------------------------------

    \102\ See supra note 86 and accompanying text.
---------------------------------------------------------------------------

    In addition to the costs that funds may incur, the removal of
credit ratings pursuant to the Dodd-Frank Act may result in increased
risks to money market funds and their shareholders. As discussed above,
rule 2a-7 limits money market funds to investing in securities that,
among other things, have received a rating in one of the highest two
short-term rating categories from the requisite NRSROs or are unrated
securities of comparable quality.\103\ The rule further limits money
market funds' investments in second tier securities to no more than
three percent of the fund's portfolio.\104\ The minimum credit rating
requirement in the current rule provides the Commission with an
objective standard to use in examining and enforcing money market fund
compliance with rule 2a-7's credit quality conditions, including the
limitation on investments in second tier securities. As discussed
above, the proposed rule would eliminate the requirement that eligible
securities meet minimum rating requirements, while maintaining the two-
step analysis provided in the current rule and the limitation on
investments in second tier securities.\105\ Although we anticipate that
funds would continue to manage risk in the same manner as under the
current rule, under the proposed subjective standard, a money market
fund board (or its delegate) could disregard a second tier rating in
order to invest a larger portion of the fund's portfolio in lower
quality securities that it classifies as first tier securities. In
addition, it could be difficult for the Commission to challenge the
determination of a money market fund board (or its delegate) in those
circumstances.\106\
---------------------------------------------------------------------------

    \103\ See rule 2a-7(a)(12)(i)-(ii); supra notes 15-17 and
accompanying text.
    \104\ Rule 2a-7(c)(3)(ii).
    \105\ See supra note 23, notes 24-25 and accompanying and
preceding text.
    \106\ The increased risks to money market funds associated with
investments in short-term securities rated second tier are discussed
in detail in the Money Market Fund Reform Adopting Release, supra
note 8, at Section II.A.1. and Money Market Fund Reform Proposing
Release, supra note 8, at Section II.A.1.
---------------------------------------------------------------------------

2. Form N-MFP
    We propose to amend Form N-MFP to eliminate the items requiring
disclosure for each portfolio security (and any guarantee, demand
feature or enhancement associated with the portfolio security) of the
designated NRSROs for the security and the rating assigned to the
security. We also propose to eliminate the requirement that a money
market fund disclose whether a security is a rated security or an
unrated security.
a. Benefits
    The proposed amendments to Form N-MFP would conform the disclosure
in Form N-MFP to the proposed amendments to rule 2a-7. The proposed
amendments to Form N-MFP should reduce costs for money market funds by
eliminating from the form certain disclosure items relating to
designated NRSROs and ratings, which would no longer be elements of
rule 2a-7. For purposes of the PRA analysis, we estimate that money
market funds would realize, in the aggregate, a cost savings of
$1,177,512 in completing Form N-MFP as a result of the proposed
amendments.\107\
---------------------------------------------------------------------------

    \107\ See supra note 90 and accompanying text. As noted above,
however, money market funds have not had to make these disclosures
so actual savings may be less.
---------------------------------------------------------------------------

b. Costs
    We do not believe there would be any costs associated with the
proposed amendments to Form N-MFP.

B. Rule 5b-3

    We propose to amend rule 5b-3 to allow a fund to treat the
acquisition of a repurchase agreement as an acquisition of securities
collateralizing the repurchase agreement for purposes of sections
5(b)(1) and 12(d)(3) of the Investment Company Act if the

collateral other than cash or government securities consists of
securities that the fund's board of directors, or its delegate,
determines at the time the repurchase agreement is entered into are:
(i) Issued by an issuer that has the highest capacity to meet its
financial obligations; and (ii) sufficiently liquid that they can be
sold at approximately their carrying value in the ordinary course of
business within seven days.
1. Benefits
    We believe that the proposed amendments to rule 5b-3 may yield
certain benefits. First, our proposed standard is designed to achieve
the same purpose as the credit rating reference in the existing rule.
i.e., limit collateral securities to those that are likely to retain a
stable market value and that, under ordinary circumstances, the fund
would be able to liquidate quickly in the event of a counterparty
default. Second, we believe that the proposed standards would not
result in significant changes in fund evaluations of the quality of
collateral securities. A fund's board of directors or its delegate is
already required under the rule to assess the credit quality of unrated
securities.\108\ As noted above, funds typically establish standards
for the credit quality of collateral securities (that include credit
ratings and additional credit quality criteria required by the fund) in
repurchase agreements with counterparties.\109\ In addition, although
the rule would no longer require the collateral to be rated by an
NRSRO, the evaluation of credit risk could incorporate ratings,
reports, analyses and other assessments issued by third parties,
including NRSRO ratings, that the board concludes are credible and
reliable for purposes of making the evaluation. We expect that the
ability to consider outside assessments would help minimize any burdens
on the fund's board or its delegate under the proposed amendments. In
addition, the use of external analyses by third party sources that fund
boards (or their delegates) believe are credible and reliable to the
extent the fund board (or its delegate) considers appropriate may
contribute to the accuracy of funds' determinations and thus help funds
arrive at consistent minimal credit risk determinations.
---------------------------------------------------------------------------

    \108\ Rule 5b-3(c)(1)(iv)(D).
    \109\ See supra text preceding note 93.
---------------------------------------------------------------------------

2. Costs
    The proposed credit quality standard for rule 5b-3 may impose costs
on funds that rely on the rule. A fund's board of directors, or its
delegate, pursuant to rule 38a-1 of the Act, would be required to
develop written policies or procedures to ensure that at the time the
repurchase agreement is entered into, the collateral meets the
requirements outlined in the proposed amendments.\110\ Consistent with
the requirements of rule 38a-1 under the Act, we expect that boards of
funds relying on rule 5b-3 have established procedures regarding
compliance with the rule. We recognize that these funds may incur minor
costs associated with the proposed amendments to rule 5b-3 including
some internal costs or costs of consulting outside legal counsel to
determine whether they must change their policies and procedures for
evaluating collateral securities if the proposed amendments are
adopted. We do not believe, however, that those costs are attributable
to the proposed amendments because the requirement in the Dodd-Frank
Act that we replace the use of credit ratings in rules with alternative
standards of credit-worthiness would result in similar costs of
evaluating compliance with a new standard of credit quality.
---------------------------------------------------------------------------

    \110\ Rule 38a-1(a).
---------------------------------------------------------------------------

    As noted above, funds typically set forth credit quality standards
for securities collateralizing a repurchase agreement in the agreement
with the counterparty. We expect that those standards include a rating
and any additional criteria a fund manager considers necessary to
ensure that the credit quality of the collateral meets the fund's
requirements. As we have noted above, fund boards (or their delegates)
could continue to consider evaluations of outside sources, including
credit rating agencies, in making their credit quality determinations
under rule 5b-3, as we propose to amend it. We anticipate that funds
would likely continue to rely on the credit quality standards in their
current repurchase agreements and their existing policies and
procedures that address compliance with rule 5b-3 if the proposed
amendments were adopted. We expect that each fund would undertake its
own analysis of the costs or benefits of revising repurchase agreements
and policies and procedures that address compliance with rule 5b-3 and
would only change these documents to the extent the fund believed the
benefits justified the costs of doing so. Nevertheless, funds may
consider whether to amend their repurchase agreements and policies and
procedures that address compliance with rule 5b-3, including making
technical changes to these documents in response to the proposed
amendments, if adopted. As noted above, we estimate that funds would
incur a one-time aggregate cost of $2,944,080 to make any of these
changes.\111\
---------------------------------------------------------------------------

    \111\ See supra note 95 and accompanying text.
---------------------------------------------------------------------------

     We request comment on these cost estimates. Do commenters
foresee additional or alternative costs if the proposed amendments to
rule 5b-3 are adopted? Have we accurately estimated costs of amending
repurchase agreements and policies and procedures for the evaluation of
the credit quality and liquidity of collateral securities?

C. Proposed Rule 6a-5

    We are proposing new rule 6a-5, which would establish a credit-
worthiness standard under section 6(a)(5)(A)(iv)(I) of the Investment
Company Act. BIDCOs that seek to rely on the exemption in section
6(a)(5) of the Act would be limited to investing in debt securities
issued by investment companies and private funds if, at the time of
purchase, the board of directors or members of the BIDCO (or their
delegate) determines that the debt security is (i) subject to no
greater than moderate credit risk and (ii) sufficiently liquid that the
security can be sold at or near its carrying value within a reasonably
short period of time.
1. Benefits
    We anticipate that proposed rule 6a-5 would result in certain
benefits. Our proposed standard is intended to achieve the same purpose
as the credit rating it would replace. In particular, the proposed
standard is designed to limit BIDCOs to purchasing debt securities
issued by investment companies or private funds of sufficiently high
credit quality that they are likely to maintain a fairly stable market
value and may be liquidated easily, as appropriate, for the BIDCO to
support its investment and financing activities.
    Furthermore, to comply with the proposed standard, we do not
believe that BIDCOs would be required to change any policies and
procedures they may have with respect to the evaluation of these debt
securities. As noted above, under proposed rule 6a-5, in evaluating
whether debt securities issued by investment companies and private
funds present moderate credit risk, boards of directors and members of
BIDCOs (or their delegates) would be able to consider credit quality
determinations prepared by outside sources, including NRSRO ratings,
that they conclude are credible and reliable for purposes of making
these determinations. We expect that the

ability to consider outside assessments in making these determinations
would help minimize the burden on BIDCOs and contribute to a BIDCO's
ability to make consistent credit quality determinations.
2. Costs
    We recognize that BIDCOs may incur some costs if we adopted
proposed rule 6a-5. These may be internal costs or costs to consult
outside legal counsel to evaluate whether changes to any policies and
procedures the BIDCOs may have currently for acquiring debt securities
issued by investment companies or private funds may be appropriate in
light of the proposed rule. We do not believe, however, that these
costs are attributable to the proposed rule because the Dodd-Frank
Act's replacement of the credit rating standard in the Investment
Company Act with a standard to be adopted by the Commission would
result in similar costs of evaluating compliance with a new credit
quality standard.
    We expect that, although not required by the Investment Company
Act, as a matter of good business practice, directors or members of
most BIDCOs that do not currently have them may prepare policies and
procedures to make the credit quality and liquidity determinations
required by the proposed rule. Commission staff estimates that the
costs of preparing the procedures for making determinations of credit
quality and liquidity under the rule would be borne upfront. Once
generated, reviewed and implemented by directors or members of BIDCOs
(or their delegates), directors and members (or their delegates) would
be able to follow them for purposes of making future determinations
under the rule. Our staff has estimated that each BIDCO would incur, on
average, an initial one-time cost of $928 to prepare policies and
procedures and an average of $928 in annual costs for making credit
determinations with respect to the acquisition of debt securities.\112\
---------------------------------------------------------------------------

    \112\ We estimate that each BIDCO would incur on average a one-