and floating NAV reforms.
---------------------------------------------------------------------------

    \769\ See supra note 759 and accompanying text.
    \770\ See DERA memo ``Municipal Money Market Funds Exposure to
Parents of Guarantors'' http://www.sec.gov/comments/s7-03-13/s70313-323.pdf.
    \771\ See supra note 744 and accompanying text.
    \772\ Based on a review of Form N-MFP data as of February 28,
2014, over 10% of the amortized cost value of VRDNs are guaranteed
by a single bank, and approximately 54% of the amortized cost value
is guaranteed by 10 banks.
---------------------------------------------------------------------------

    A number of commenters cited the resilient portfolio construction
of municipal money market funds and

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

    \773\ See, e.g., Fidelity Comment Letter (weekly liquid assets
of tax-exempt funds is typically more than double the current 30%
requirement under rule 2a-7). See also, e.g., ICI Comment Letter;
SIFMA Comment Letter; Invesco Comment Letter; Legg Mason & Western
Asset Comment Letter. Interest rate risk, as measured by weighted
average maturity, is consistently lower for tax-exempt funds
(averaging 35 days, well below the 60-day requirement in rule 2a-7)
than prime and government funds. See Fidelity Comment Letter (citing
iMoneyNet). Commenters also argued that the credit risk of tax-
exempt funds is more similar to government funds than prime funds.
See, e.g., ICI Comment Letter (tax-exempt securities have low credit
risk because municipalities are not generally interconnected and
deterioration occurs over a protracted time); Dreyfus Comment Letter
(many distressed issues (e.g., City of Detroit) become ineligible
under rule 2a-7s risk-limiting conditions and therefore bankruptcy
does not affect direct holdings of tax-exempt funds).
    \774\ See supra note 766.
    \775\ See, e.g., Notice of the City of Detroit, Michigan's
bankruptcy filing with the United States Bankruptcy Court, Eastern
District of Michigan, available at http://www.mieb.uscourts.gov/sites/default/files/detroit/Chp%209%20Detroit.pdf.
---------------------------------------------------------------------------

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

    \776\ See supra note 744 and accompanying text.
    \777\ See supra notes 744-748 and accompanying text.
    \778\ See DERA Study, supra note 24, at Table 1 (discussing how
money market funds were adversely affected because of credit events
that resulted in large numbers of securities being ``put'' back to
demand feature providers, which resulted in bankruptcy, including
Mutual Benefit Life Insurance Company and General American Life
Insurance Co.).
---------------------------------------------------------------------------

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

    \779\ See 2010 Adopting Release, supra note 17, at nn.240-243
and accompanying text.
    \780\ See Fidelity Comment Letter; but see Wells Fargo Comment
Letter. We note also that new regulations also may affect the
issuance of the dominant types of securities that now provide the
stability of tax-exempt funds. For example, because TOB programs are
not exempt from the Volcker rule, banks and their affiliates will no
longer be able to sponsor or provide support to a TOB program. See
Volcker Rule, infra note 782. As a result, the portfolio composition
of some tax-exempt funds may change and present different risks in
the future.
    \781\ See rule 2a-7(d)(4)(ii).
---------------------------------------------------------------------------

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

do not agree with commenters that, as noted above, suggest that the
credit risk of tax-exempt funds is more similar to government funds
than prime funds.
---------------------------------------------------------------------------

    \782\ Participation by banks and their affiliates in TOB
programs are subject to the prohibitions and restrictions applicable
to covered funds under the recently adopted Volcker Rule
(implemented by Title VI of the Dodd-Frank Act, named for former
Federal Reserve Chairman Paul Volcker, Section 619 of the Dodd-Frank
Wall Street Reform and Consumer Protection Act (12 U.S.C. 1851)
(``Volcker Rule'')).
    \783\ See, e.g., Fidelity Comment Letter; ICI Comment Letter;
SIFMA Comment Letter.
    \784\ Based on Form N-MFP data as of February 28, 2014, only 57%
of VRDNs, which make up a majority of the assets in municipal money
market funds, have a guarantee that protects a fund in case of
default. In comparison, the federal government guarantees all
government securities held by government funds.
    \785\ Credit risk may result from the financial health of the
issuer itself, such as when the city of Detroit recently filed for
bankruptcy, becoming the largest municipal issuer default in U.S.
history, leading to significant outflows from municipal bond funds.
See Jeff Benjamin, Detroit bankruptcy has surprising long-term
implications for muni bond market, Crain's Detroit Business (Dec. 3,
2013) http://www.crainsdetroit.com/article/20131203/NEWS/131209950/detroit-bankruptcy-has-surprising-long-term-implications-for-muni#.
Although Detroit's credit deteriorated over a long period of time
and thus the bankruptcy did not cause tax-exempt money market funds,
which had largely anticipated the event, to experience significant
losses, in the past there have not have not been significant lead
times before a municipality evidenced a credit deterioration. See,
e.g., ICI Comment Letter. For example, Orange County, California,
had high-quality bond credit ratings just before filing one of the
largest municipal bankruptcies in U.S. history on December 6, 1994.
See Handbook of Fixed Income Securities, supra note 745, at 239.
Orange County caused one money market fund to break the buck and
several sponsors to inject millions of dollars of additional cash to
rescue their funds. See, e.g., Viral V. Acharya et al, Regulating
Wall Street: The Dodd-Frank Act and the New Architecture of Global
Finance 308 (2011); see also Suzanne Barlyn, Investing Strategy What
the Orange County Fiasco Means to the Muni Bond Market, Fortune
(Jan. 16, 1995), http://archive.fortune.com/magazines/fortune/fortune_archive/1995/01/16/201819/index.htm. Another type of credit
risk arises when financial institutions provide credit enhancement
to municipal securities. For example, in 1992, Mutual Benefit Life
Insurance Company (``Mutual Benefit'') went into conservatorship
with the New Jersey Insurance Commissioner. The company had
guaranteed forty-three municipal bond issues totaling $600 million,
which financed money-losing real estate projects. Mutual Benefit's
insolvency resulted in the termination of its guarantee on the bonds
and halted interest payments resulting in losses for investors. See
C. Richard Lehmann, Municipal Bond Defaults, in The Handbook of
Municipal Bonds 509 (Susan C. Heide et al. eds., 1994).
---------------------------------------------------------------------------

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

    \786\ Our rationale is consistent with our finding, discussed
above, that we no longer believe that exempting institutional prime
money market funds under section 6(c) of the Act is appropriate. See
supra note 446 and accompanying text .
---------------------------------------------------------------------------

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

    \787\ We believe that the economic analysis that follows would
apply equally in the context of the fees and gates reform. For a
discussion of the economic implications that may arise for
investors, including retail investors who may be unable or unwilling
to invest in a fund that can impose fees and gates, including
potential implications on state and local funding, see infra section
III.K.
---------------------------------------------------------------------------

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

    \788\ A number of commenters argued that applying our floating
NAV reform to tax-exempt funds would reduce demand for municipal
securities and raise the costs of financing. See, e.g., Fidelity
Comment Letter (noting that tax-exempt funds purchase approximately
65% of short-term municipal securities and that fewer institutional
investors in tax-exempt funds will lead to less purchasing of short-
term municipal securities by tax-exempt funds and a corresponding
higher yield paid by municipal issuers to attract new investors);
BlackRock II Comment Letter; Federated VII Comment Letter; ICI
Comment Letter; Comment Letter of Mayors, City of Irving, TX, et al
(Sept. 12, 2013) (``U.S. Mayors Comment Letter'').
    \789\ Other published data is consistent with this estimate.
See, for example, the Federal Reserve Board ``Flow of Funds Accounts
of the United States'' (Z.1), which details the flows and levels of
municipal securities and loans, to estimate outstanding municipal
debt (March 6, 2014), available at http://www.federalreserve.gov/releases/z1/current/. These estimates are consistent with previous
estimates presented in U.S. Securities and Exchange Commission. 2012
Report on the Municipal Securities Market. The estimates in the 2012
report were based on data from Mergent's Municipal Bond Securities
Database.
    \790\ See supra note 742 and accompanying text.
    \791\ This estimate is calculated as follows: tax-exempt funds
hold 7% of municipal debt outstanding x 30% of tax-exempt assets
held by institutional investors = 2.1% of total tax-exempt debt held
by institutions.
    \792\ The statistics in this paragraph are based on the Federal
Reserve Board's Flow of Funds data.
    \793\ See Proposing Release, supra note 25, at 309.
---------------------------------------------------------------------------

    Although institutional municipal funds represent a relatively small
portion of the municipal debt market, we recognize that these funds
represent a significant portion of the short-term municipal debt
market.\794\ According to Form N-MFP data, municipal money market funds
held $256 billion in VRDNs and short-term municipal debt as of the last
quarter of 2013.\795\ Effectively, municipal money market funds
absorbed nearly 100% of the outstanding VRDNs and short-term municipal
debt. Considering that institutional tax-exempt funds represented
approximately 30% of the municipal money market fund market, it follows
that institutional tax-exempt funds likely held about $77 billion in
VRDNs and short-term municipal debt. Any reduction in municipal funds
therefore could have an appreciable impact on the ability of
municipalities to obtain short-term lending. That said, this impact
could be substantially mitigated because, as discussed above, other
market participants may buy these securities or municipalities will
adapt to a changing market by, for example, altering their debt
structure. As discussed in the Proposing Release, ``[t]o make their
issues attractive to alternative lenders, municipalities lengthened the
terms of some of their debt securities,'' \796\ in the face of changing
market conditions in recent years. To the extent that other market
participants step in and fill the potential gap in demand, competition
may increase. To the extent other market participants do not step in
and fill the gap, capital formation may be adversely affected. Finally,
if municipalities are required to alter their debt structure to foster
demand for their securities (e.g.,

because demand declined as a result of our amendments), there may be an
adverse effect on efficiency. Although we discuss above ways in which
the short-term municipal debt market may adapt to continue to raise
capital as it does today, we acknowledge that our floating NAV reform
will impact institutional investors in tax-exempt funds and therefore
likely impact the short-term municipal markets. On balance, however, we
believe that realizing the goals of this rulemaking, including
recognizing the concerns discussed above with respect to the risks
presented by tax-exempt funds, justifies the potential adverse effects
on efficiency, competition, and capital formation.
---------------------------------------------------------------------------

    \794\ See, e.g., BlackRock II Comment Letter; Dreyfus Comment
Letter.
    \795\ Based on data from N-MFP and iMoneyNet.
    \796\ See Proposing Release, supra note 25, at 309.
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4. Implications for Local Government Investment Pools
    As we discussed in the Proposing Release, we recognize that many
states have established local government investment pools (``LGIPs''),
money market fund-like investment pools that invest in short-term
securities,\797\ which are required by law or investment policies to
maintain a stable NAV per share.\798\ Accordingly, as we discussed in
the Proposing Release, the floating NAV reform may have implications
for LGIPs, including the possibility that state statutes and policies
may need to be amended to permit the operation of investment pools that
adhere to amended rule 2a-7.\799\ In addition, some commenters
suggested that our floating NAV reform, as well as the liquidity fees
and gates requirement, may result in outflows of LGIP assets into
alternative investments that provide a stable NAV and/or do not
restrict liquidity.\800\
---------------------------------------------------------------------------

    \797\ LGIPs tend to emulate typical money market funds by
maintaining a stable NAV per share through investments in short-term
securities. See infra III.K.1, Table 1, note N.
    \798\ See, e.g., Comment Letter of U.S. Chamber of Commerce to
the Hon. Elisse Walter (Feb. 13, 2013) (``Chamber III Comment
Letter''), available at  http://www.centerforcapitalmarkets.com/wp-content/uploads/2010/04/2013-2.13-Floating-NAV-Qs-Letter.pdf. See
also, e.g., Virginia's Local Government Investment Pool Act, which
sets certain prudential investment standards but leaves it to the
state treasury board to formulate specific investment policies for
Virginia's LGIP. See Va. Code Ann. Sec.  2.2-4605(A)(3).
Accordingly, the treasury board instituted a policy of managing
Virginia's LGIP in accordance with ``certain risk-limiting
provisions to maintain a stable net asset value at $1.00 per share''
and ``GASB `2a-7 like' requirements.'' Virginia LGIP's Investment
Circular, June 30, 2012, available at http://www.trs.virginia.gov/cash/lgip.aspx. Not all LGIPs are currently managed to maintain a
stable NAV, however, see infra section III.K.1, Table 1, note N.
    \799\ GASB states that LGIPs that are operated in a manner
consistent with rule 2a-7 (i.e., a ``2a-7-like pool'') may use
amortized cost to value securities (and presumably, facilitate
maintaining a stable NAV per share). See GASB, Statement No. 31,
Accounting and Financial Reporting for Certain Investments and for
External Investment Pools (Mar. 1997).
    \800\ See, e.g., Comment Letter of TRACS Financial/Institute of
Public Investment Management (Sept. 17, 2013) (``TRACS Financial
Comment Letter''); Comment Letter of Treasurer, State of Georgia
(Sept. 16, 2013) (``Ga. Treasurer Comment Letter''); Comment Letter
of County of San Diego Treasurer-Tax Collector (Sept. 17, 2013)
(``San Diego Treasurer Comment Letter''). Because we are unable to
predict how GASB will respond to our final amendments to rule 2a-7,
we cannot quantify the extent to which LGIP assets may migrate into
alternative investments.
---------------------------------------------------------------------------

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

    \801\ See, e.g., TRACS Financial Comment Letter; Federated IX
Comment Letter.
    \802\ See, e.g., Federated II Comment Letter; Ga. Treasurer
Comment Letter; Va. Treasury Comment Letter.
    \803\ See, e.g., Federated II, Comment Letter; Federated IV
Comment Letter; TRACS Financial Comment Letter.
    \804\ See, e.g., Ga. Treasurer Comment Letter; Va. Treasury
Comment Letter.
    \805\ See Ga. Comment Letter; Comment Letter of West Virginia
Board of Treasury Investments (Sept. 17, 2013) (``WV Bd. of Treas.
Invs. Comment Letter'').
---------------------------------------------------------------------------

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

    \806\ GASB has currently included as a potential project in 2014
an agenda item to identify potential alternative pool structures
that could be suitable in the event that the Commission amends the
way in which money market funds operate under rule 2a-7, including a
move to a floating NAV. See Government Accounting Standards Board,
Technical Plan for the First Third of 2014: Technical Projects (2a7-
Like External Investment Pools), available at http://gasb.org/cs/ContentServer?c=Document_C&pagename=GASB%2FDocument_C%2FGASBDocumentPage&cid=1176163713461.
    \807\ See infra section III.N.
    \808\ As noted above, we do not have authority over the actions
of GASB and/or its decision to facilitate the operation of LGIPs as
stable value investment vehicles through linkage to rule 2a-7
(including, as amended today).
---------------------------------------------------------------------------

5. Unregistered Money Market Funds Operating Under Rule 12d1-1
    Several commenters expressed concern regarding amended rule 2a-7's
effect on unregistered money market funds that choose to operate under
certain provisions of rule 12d1-1 under the Investment Company
Act.\809\ Rule 12d1-1 permits investment companies (``acquiring
investment companies'') to acquire shares of registered money market
funds in the same or in a different fund group in excess of the
limitations set forth in section 12(d)(1) of the Investment Company
Act.\810\ In

addition to providing an exemption from section 12(d)(1) of the
Investment Company Act, rule 12d1-1 also provides exemptions from
section 17(a) and rule 17d-1, which restrict a fund's ability to enter
into transactions and joint arrangements with affiliated persons.\811\
A fund's investments in unregistered money market funds is not
restricted by section 12(d)(1).\812\ Nonetheless, these investments are
subject to the affiliate transaction restrictions in section 17(a) and
rule 17d-1 and therefore require exemptive relief from such
restrictions.\813\ Rule 12d1-1 thus permits a fund to invest in an
unregistered money market fund without having to comply with the
affiliate transaction restrictions in section 17(a) and rule 17d-1,
provided that the unregistered money market fund satisfies certain
conditions in rule 12d1-1.
---------------------------------------------------------------------------

    \809\ Dechert Comment Letter; Comment Letter of Russell
Investments (Sept. 17, 2013) (``Russell Comment Letter'');
Oppenheimer Comment Letter; UBS Comment Letter. See also Wells Fargo
Comment Letter (arguing that proposed amendments to Form PF should
not apply to unregistered liquidity vehicles owned exclusively by
registered funds and complying with rule 12d1-1 under the Investment
Company Act). We address the Form PF requirements for unregistered
money market funds below. See infra section III.H.
    \810\ Under section 12(d)(1)(A), an investment company (and
companies or funds it controls) is generally prohibited from
acquiring more than three percent of another investment company's
outstanding voting securities, investing more than five percent of
its total assets in any given investment company, and investing more
than 10 percent of its total assets in investment companies in the
aggregate. See also section 12(d)(1)(B) (limiting the sale of
registered open-end fund shares to other funds).
    \811\ Section 17(a) generally prohibits affiliated persons of a
registered fund (``first-tier affiliates'') or affiliated persons of
the fund's affiliated persons (``second-tier affiliates'') from
selling securities or other property to the fund (or any company the
fund controls). Section 17(d) of the Investment Company Act makes it
unlawful for first- and second-tier affiliates, the fund's principal
underwriters, and affiliated persons of the fund's principal
underwriters, acting as principal, to effect any transaction in
which the fund, or a company it controls, is a joint or a joint and
several participant in contravention of Commission rules. Rule 17d-
1(a) prohibits first- and second-tier affiliates of a registered
fund, the fund's principal underwriters, and affiliated persons of
the fund's principal underwriter, acting as principal, from
participating in or effecting any transaction in connection with any
joint enterprise or other joint arrangement or profit-sharing plan
in which the fund (or any company it controls) is a participant
unless an application regarding the enterprise, arrangement or plan
has been filed with the Commission and has been granted.
    \812\ Private funds are generally excluded from the definition
of an ``investment company'' for purposes of the Investment Company
Act. However, private funds that fall under section 3(c)(1) or
3(c)(7) are deemed to be an investment company for purposes of the
limitations set forth in section 12(d)(1)(A)(i) and 12(d)(1)(B)(i)
governing the purchase or other acquisition by such private fund of
any security issued by any registered investment company and the
sale of any securities issued by any registered investment company
to any such private fund. Although a private fund is subject to the
limitations set forth in section 12(d) with respect to its
investment in a registered investment company, a registered
investment company is not subject to the limitations set forth in
section 12(d) with respect to its investment in any such private
fund.
    \813\ See Funds of Funds Investments, Investment Company Act
Release No. 27399 (June 20, 2006) [71 FR 36640 (June 27, 2006)].
---------------------------------------------------------------------------

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

    \814\ Id.
    \815\ Rule 12d1-1(d)(2)(ii). In addition, the unregistered money
market fund's adviser must be registered as an investment adviser
with the Commission. See rule 12d1-1(b)(2)(ii). In order for a
registered fund to invest in reliance on rule 12d1-1 in an
unregistered money market fund that does not have a board of
directors, the unregistered money market fund's investment adviser
must perform the duties required of a money market fund's board of
directors under rule 2a-7. See rule 12d1-1(d)(2)(ii)(B). Lastly, the
investment company is also required to reasonably believe that the
unregistered money market fund operates like a registered money
market fund and that it complies with certain provisions of the
Investment Company Act. See rule 12d1-1(b)(2)(i).
---------------------------------------------------------------------------

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

    \816\ Dechert Comment Letter; Russell Comment Letter;
Oppenheimer Comment Letter; UBS Comment Letter.
    \817\ See, e.g., Dechert Comment Letter; Russell Comment Letter;
UBS Comment Letter.
    \818\ See, e.g., Dechert Comment Letter; Russell Comment Letter.
---------------------------------------------------------------------------

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

    \819\ Id.
    \820\ Id.
---------------------------------------------------------------------------

    We disagree, and we believe that if registered funds invest in
unregistered money market funds in a different fund complex, these
unregistered funds are equally susceptible to the concerns that our
amendments are designed to address, including concerns about the risks
of investors' incentives to redeem ahead of other investors in times of
market stress and the resulting potential dilution of investor shares.
For example, if multiple registered funds are investing in an
unregistered money market fund in a different fund complex, a
registered fund in one fund complex may have an incentive to redeem
shares in times of market stress prior to the redemption of shares by
funds in other fund complexes. This redemption could have a potentially
negative impact on the remaining registered funds that are investing in
the unregistered money market and could increase the risk of dilution
of shares for the remaining registered funds.
    We also believe that unregistered money market funds that are being
used solely as investments by investment companies in the same fund
complex remain susceptible to redemptions in times of fund and market
stress. For example, if multiple registered funds are invested in an
unregistered money market fund in the same fund complex, a portfolio
manager of one registered fund may have an incentive to redeem shares
in times of market stress, which could have a potentially negative
impact on the other registered funds that may also be invested in the
unregistered fund. After further consideration regarding the
comparability of risk in these funds, we believe that it is appropriate
that our floating NAV

amendments apply to unregistered money market funds that conform their
operations to the requirements of rule 12d1-1.\821\
---------------------------------------------------------------------------

    \821\ We note that unregistered money market funds that
otherwise meet the definition of a government money market fund as
defined in rule 2a-7(c)(2)(iii) would not be subject to the floating
NAV requirement. See rule 2a-7(a)(16).
---------------------------------------------------------------------------

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

    \822\ See Dechert Comment Letter; Russell Comment Letter; UBS
Comment Letter.
    \823\ Id.
    \824\ Id.
---------------------------------------------------------------------------

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

    \825\ See supra note 815.
    \826\ See Funds of Funds Release, supra note 813, at n.42. See
also supra note 815.
    \827\ SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180,
194 (1963).
    \828\ See rule 206(4)-7 of the Advisers Act (making it unlawful
for an investment adviser registered with the Commission to provide
investment advice unless the adviser has adopted and implemented
written policies and procedures reasonably designed to prevent
violation of the Advisers Act by the adviser or any of its
supervised persons).
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6. Master/Feeder Funds--Fees and Gates Requirements
    We are adopting, as suggested by a commenter, a provision
specifying the treatment of feeder funds in a master/feeder fund
structure under the fees and gates requirements.\829\ This provision
will not allow a feeder fund to independently impose a fee or gate in
reliance on today's amendments.\830\ However, under the amended rule, a
feeder fund will be required to pass through to its investors a fee or
gate imposed by the master fund in which it invests.\831\ In response
to our request for comment on whether particular funds or redemptions
should not be subject to fees and gates, a commenter recommended that
we permit a master fund and its board, but not a feeder fund and its
board, to impose and set the terms of a fee or gate.\832\ The feeder
fund would then have to ``institute'' the fee or gate on its
redemptions ``at the times and in the amounts instituted by the master
fund.'' \833\ Another commenter suggested, however, that fund boards
should be given discretion to impose fees and/or gates on either or
both a master or feeder fund(s).\834\
---------------------------------------------------------------------------

    \829\ See rule 2a-7(c)(2)(v) (defining ``feeder fund'' as any
money market fund that owns, pursuant to section 12(d)(1)(E), shares
of another money market fund).
    \830\ See id.
    \831\ Id.
    \832\ See Stradley Ronon Comment Letter.
    \833\ Id.
    \834\ See UBS Comment Letter.
---------------------------------------------------------------------------

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

    \835\ For example, if a master fund's board determines that the
master fund should impose a liquidity fee, a feeder fund must pass
through that liquidity fee to its investors and we would expect it
would subsequently remit such fee to the master fund.
    \836\ See Stradley Ronon Comment Letter. We note that only the
master fund has an investment adviser because a master fund's shares
are the only investment securities that may be held by the feeder
fund. See section 12(d)(1)(E).
    \837\ See rule 22e-3(b).
---------------------------------------------------------------------------

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

    \838\ See, e.g., supra sections III.C.2 and III.C.3 (discussing
commenter support for excluding retail and municipal money market
funds); but see, HSBC Comment Letter (``[W]e believe all MMFs should
be required to have the power to apply a liquidity fee or gate so
that the MMF provider can manage a low probability but high impact
event.''); U.S. Bancorp Comment Letter.
    \839\ See PFM Asset Mgmt. Comment Letter.
    \840\ See State Street Comment Letter.
---------------------------------------------------------------------------

    Because of the board flexibility and discretion included in the
fees and gates amendments we are adopting today, as well as for the
reasons discussed

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

    \841\ See also supra sections III.C.2-III.C.5 for a discussion
of reasons specific to certain types of funds.
    \842\ See supra sections III.C.1 and III.C.6. As discussed above
with respect to feeder funds, we believe feeder funds in a master/
feeder structure are distinguishable from other funds in that their
liquidity is dictated by the liquidity of the master fund. Thus, we
believe the flexibility and discretion afforded to boards in today's
amendments should be limited to a master fund's board. We note that
although feeder funds may not individually impose fees and gates in
reliance on today's amendments, master funds are subject to today's
amendments and their imposition of fees and gates will be passed
through to feeder funds' investors.
---------------------------------------------------------------------------

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

    \843\ We noted in the Proposing Release that retail money market
funds experienced fewer redemptions than institutional money market
funds during the financial crisis and thus may be less likely to
suffer heavy redemptions in the future. Nonetheless, we cannot
predict if this will be the case if there is a future financial
crisis.
---------------------------------------------------------------------------

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

    \844\ See, e.g., Fin. Info. Forum Comment Letter.
    \845\ See Proposing Release, supra note 25, at 200-201.
    \846\ See supra note 315 and accompanying text. Commenters
suggested that concerns over gaming could be addressed by putting
additional policies in place, such as placing limits on the number
of redemptions in any given period. See, e.g., Fin. Info. Forum
Comment Letter. We believe that such a solution to gaming, much like
an exception to the fees and gates requirements, would create
additional cost and complexity to the amendments without substantial
benefit.
    \847\ See supra note 315 and accompanying text.
---------------------------------------------------------------------------

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

    \848\ See, e.g., Schwab Comment Letter; Fin. Svcs. Inst. Comment
Letter; Oppenheimer Comment Letter; TIAA-CREF Comment Letter.
    \849\ See, e.g., Fin. Svcs. Roundtable Comment Letter; Schwab
Comment Letter; Comment Letter of American Benefits Council (Sept.
16, 2013) (``American Benefits Council Comment Letter'').
    \850\ See, e.g., Schwab Comment Letter; American Benefits
Council Comment Letter; SPARK Comment Letter.
    \851\ See, e.g., id.
    \852\ See, e.g., American Benefits Council Comment Letter (``In
some circumstances, retirement assets must be moved because of
mandatory rollover requirements or because a plan has been
abandoned. Certain safe harbor regulations and prohibited
transaction class exemptions effectively require that funds be
placed in an investment that seeks to maintain the dollar value that
is equal to the amount invested, generally is liquid and does not
impose `substantial restrictions' on redemptions.'') (citations
omitted); Schwab Comment Letter.
    \853\ See, e.g., Schwab Comment Letter; American Benefits
Council Comment Letter.
    \854\ See, e.g., American Bankers Ass'n Comment Letter; American
Benefits Council Comment Letter.
---------------------------------------------------------------------------

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

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

    \855\ See Department of Labor, Employee Benefits Security
Administration Field Assistance Bulletin 2008-03, Q11 (Apr. 29,
2008).
    \856\ See Prohibited Transaction Exemption 80-26, [45 FR 28545
(Apr. 29, 1980)], as amended at, [65 FR 17540 (Apr. 3, 2000)], [67
FR 9485 (Mar. 1, 2002)] and [71 FR 17917 (Apr. 7, 2006)].
---------------------------------------------------------------------------

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

    \857\ [69 FR 57964 (Sept. 28, 2004)].
    \858\ [71 FR 20856 (Apr. 21, 2006)], as amended, [73 FR 58629
(Oct. 7, 2008)].
    \859\ See section IV(e) of PTE 2004-16 and section V(c) of PTE
2006-06.
    \860\ See section II(i) of PTE 2004-16 and section III(h) of PTE
2006-06.
---------------------------------------------------------------------------

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

    \861\ In addition, with respect to the minimum distribution
requirement, we note that participants could be encouraged to take
required distributions before the deadline to avoid the possibility
that a gate could prevent them from meeting the requirements.
    \862\ See section 4974(d) of the Tax Code. We understand that to
request a waiver, a taxpayer would file Form 5329 with the IRS.
Whether to grant a waiver request is within the IRS's discretion.
    \863\ See Rev. Proc. 2013-12. We understand that, pursuant to
the EPCRS, if a minimum required distribution or refund timing
failure is insignificant or is corrected within a limited time
period, and certain other requirements are satisfied, then the
failure can be voluntarily corrected without filing with the IRS.
Otherwise, we understand that a filing is required to correct
qualification failures.
---------------------------------------------------------------------------

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

    \864\ See, .e.g., Dechert Comment Letter; Comment Letter of
American Council of Life Insurers (Sept. 17, 2013) (``ACLI Comment
Letter''); TIAA-CREF Comment Letter.
    \865\ See ACLI Comment Letter; Comment Letter of Committee of
Annuity Insurers (Sept. 17, 2013) (``CAI Comment Letter'').
    \866\ See Comment Letter of John Sklar (July 9, 2013) (``Sklar
Comment Letter'').
    \867\ See id.
---------------------------------------------------------------------------

    We have determined not to provide special treatment for money
market funds underlying variable annuity contracts or other insurance
products for the fees and gates requirements. We recognize money market
funds underlying variable annuity contracts or other insurance products
may be indirectly subject to certain restrictions or requirements that
do not apply to other money market funds. We note, however, that these
same funds currently are permitted to suspend redemptions pursuant to
rule 22e-3 and their ability to do so has not prevented them from being
offered in connection with variable annuity and other insurance
products. In addition, to the extent today's fees and gates amendments
are incompatible with contractual or state law, or with free look
provisions, we note that an insurance company can instead offer a
government money market fund as an investment option under its
contract(s).\868\ Moreover, fees and gates will not affect the everyday
activities of money market funds. They are instead

designed to be used during times of potential stress.\869\ If the
market or a money market fund is experiencing stress, an insurance
company could choose not to place contract holders' investments into a
money market fund during free look periods, subject to contractual
provisions and prospectus disclosures.
---------------------------------------------------------------------------

    \868\ To the extent an insurance company determines to offer a
government money market fund as a new investment option under a
contract, we recognize that there may be costs associated with this
process, including costs associated with disclosing a new investment
option to contract-holders, negotiating arrangements with new
government money market funds, and filing with the Commission a
substitution application under section 26(c).
    \869\ We note that if, as suggested by commenters, money market
funds underlying variable annuity or other insurance contracts are
less prone to runs, then under the terms of our final rule
amendments, such funds may be less likely to reach the liquidity
thresholds that would trigger board consideration of fees or gates
and, thus, may be less likely to be affected by today's amendments.
See supra text accompanying note 865.
---------------------------------------------------------------------------

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

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

    \870\ See supra section III.B.5.
    \871\ See ASR 219, Financial Reporting Codification (CCH)
section 404.05.a and .b (May 31, 1977), supra note 5. In this
regard, the Commission has stated that the ``fair value of
securities with remaining maturities of 60 days or less may not
always be accurately reflected through the use of amortized cost
valuation, due to an impairment of the creditworthiness of an
issuer, or other factors. In such situations, it would appear to be
incumbent on the directors of a fund to recognize such factors and
take them into account in determining `fair value.' ''
    \872\ For a mutual fund not regulated under rule 2a-7, the
Investment Company Act and applicable rules generally require that
it price its shares at the current NAV by valuing portfolio
securities for which market quotations are readily available at
market value, or if market quotations are not readily available, at
fair value as determined in good faith by the fund's board of
directors. See section 2(a)(41)(B) and rules 2a-4 and 22c-1.
Notwithstanding these provisions, rule 2a-7 currently permits money
market funds to use the amortized cost method of valuation and/or
the penny rounding method of pricing. See current rule 2a-7(c).
---------------------------------------------------------------------------

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

    \873\ Although discussed here primarily in the context of money
market funds, except as noted below, this guidance is applicable to
all registered investment companies and business development
companies. For ease of reference, throughout this section we refer
to all of these entities as ``funds.'' We note that stable NAV money
market funds that qualify as retail or government money market funds
may use the amortized cost method of valuation to compute the
current share price provided, among other things, the board of
directors believes that the amortized cost method of valuation
fairly reflects the market-based NAV and does not believe that such
valuation may result in material dilution or other unfair results to
investors or existing shareholders. See generally rule 2a-7(c)(1)(i)
and rule 2a-7(g)(1)(i)(A)-(C). We also note that stable NAV money
market funds that qualify as retail or government money market funds
may not rely on this guidance to use amortized cost valuation in
shadow pricing because rule 2a-7 specifically requires shadow prices
to reflect ``the current net asset value per share calculated using
available market quotations (or an appropriate substitute that
reflects current market conditions),'' and we would not consider
amortized cost valuation to be an appropriate substitute that
reflects current market conditions. See also 1983 Adopting Release,
supra note 3, at n.44 and accompanying text (``In determining the
market-based value of the portfolio for purposes of computing the
amount of deviation, all portfolio instruments, regardless of the
time to maturity, should be valued based upon market factors and not
their amortized cost value.'').
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1. Use of Amortized Cost Valuation
    We consider it important, for a number of reasons, that funds and
their investment advisers and boards of directors have clear guidance
regarding amortized cost valuation. Typically, money market funds hold
a significant portion of portfolio securities with remaining maturities
of 60 days or less,\874\ and therefore, a floating NAV money market
fund may use the amortized cost method to value these portfolio
securities if the fund's board determines that the amortized cost value
of the security is fair value. In addition, managers of floating NAV
money market funds may have an incentive to use amortized cost
valuation whenever possible in order to help stabilize the funds' NAV
per share.
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    \874\ For example, we estimate that approximately 56% of prime
money market funds' portfolio securities had remaining maturities of
60 days or less (not including interest-rate resets) as of February
28, 2014. This estimate is based on Form N-MFP data.
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    As noted above, under existing Commission guidance, funds would not
be able to use amortized cost valuation to value certain debt
securities when circumstances dictate that the amortized cost value of
the security is not fair value.\875\ The Commission's guidance in the
Proposing Release construed the statute to effectively limit the use of
amortized cost valuation to circumstances where it is the same as
valuation using market-based factors.\876\ Some commenters objected to
this interpretation and suggested that the Commission more generally
clarify this guidance.\877\
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    \875\ See ASR 219, Financial Reporting Codification (CCH)
section 404.05.a and .b (May 31, 1977), supra note 5 (``Although
debt securities with remaining maturities in excess of 60 days
should not be valued at amortized cost, the Commission will not
object if the board of directors of a money market fund, in good
faith, determines that the fair value of debt securities originally
purchased with remaining maturities of 60 days or less shall be
their amortized cost value, unless the particular circumstances
dictate otherwise. Nor will the Commission object if, under similar
circumstances, the fair value of debt securities originally
purchased with maturities of in excess of 60 days, but which
currently have maturities of 60 days or less, is determined by using
amortized cost valuation for the 60 days prior to maturity, such
amortization being based upon the market or fair value of the
securities on the 61st day prior to maturity'' (footnotes omitted)).
    \876\ See Proposing Release, supra note 25, n.136.
    \877\ See, e.g., Invesco Comment Letter (``one of the footnotes
to the Proposed Rule . . . refers to amortized cost pricing being
available when it is the same as valuation based on market factors,
implying that MMF could be barred from using amortized cost pricing
if it differs even minutely from the market value of the securities.
While we believe this implication to have been unintentional, we
nevertheless request the Commission to reaffirm clearly that MMFs,
as all other mutual funds, can continue to use amortized cost
pricing for securities with maturities of 60 days and less.''
(internal citations omitted)); ICI Comment Letter (also referring to
this footnote and stating ``It is unclear whether this means that
amortized cost must at all times be identical to market-based price,
or whether it is just another way of saying funds must use market-
based pricing and not amortized cost. We urge the SEC to clarify
that ASR 219 and its interpretations remain unchanged.'').
---------------------------------------------------------------------------

    We recognize that existing valuation guidance may not be clear on
how frequently funds should compare a debt security's amortized cost
value to its fair value determined using market-based factors and what
extent of deviation between the two values is permissible. We generally
believe that a fund may only use the amortized cost method to value a
portfolio security with a remaining maturity of 60 days or less when it
can reasonably conclude, at each time it makes a valuation
determination,\878\ that the amortized

cost value of the portfolio security is approximately the same as the
fair value of the security as determined without the use of amortized
cost valuation. Existing credit, liquidity, or interest rate conditions
in the relevant markets and issuer specific circumstances at each such
time should be taken into account in making such an evaluation.
---------------------------------------------------------------------------

    \878\ As discussed below, we believe that, in some circumstances
(e.g., intraday), a fund may rely on the last obtained market-based
data to assist it when valuing its portfolio securities using
amortized cost.
---------------------------------------------------------------------------

    Accordingly, it would not be appropriate for a fund to use
amortized cost to value a debt security with a remaining maturity of 60
days or less and thereafter not continue to review whether amortized
cost continues to be approximately fair value until, for example, there
is a significant change in interest rates or credit deterioration. We
generally believe that a fund should, at each time it makes a valuation
determination, evaluate the use of amortized cost for portfolio
securities, not only quarterly or each time the fund produces financial
statements. We note that, under the final rules, each money market fund
will be required to value, on a daily basis, the fund's portfolio
securities using market-based factors and disclose the fund's share
price (or shadow price) rounded to four decimal places on the fund's
Web site. As a result, we believe that each money market fund should
have readily available market-based data to assist it in monitoring any
potential deviation between a security's amortized cost and fair value
determined using market-based factors. We believe that, in certain
circumstances, such as intraday, a fund may rely on the last obtained
market-based data to assist it when valuing its portfolio securities
using amortized cost. To address this, a fund's policies and procedures
could be designed to ensure that the fund's adviser is actively
monitoring both market and issuer-specific developments that may
indicate that the market-based fair value of a portfolio security has
changed during the day, and therefore indicate that the use of
amortized cost valuation for that security may no longer be
appropriate.
2. Other Valuation Matters
    Rule 2a-4 under the Investment Company Act provides that
``[p]ortfolio securities with respect to which market quotations are
readily available shall be valued at current market value, and other
securities and assets shall be valued at fair value as determined in
good faith by the board of directors of the registered company.'' As we
discussed in the Proposing Release, the vast majority of money market
fund portfolio securities do not have readily available market
quotations because most portfolio securities such as commercial paper,
repos, and certificates of deposit are not actively traded in the
secondary markets.\879\ Accordingly, most money market fund portfolio
securities are valued largely based upon ``mark-to-model'' or ``matrix
pricing'' estimates.\880\ In matrix pricing, portfolio asset values are
derived from a range of different inputs, with varying weights attached
to each input, such as pricing of new issues, yield curve information,
spread information, and yields or prices of securities of comparable
quality, coupon, maturity, and type.\881\ Money market funds also may
consider evaluated prices from third-party pricing services, which may
take into account these inputs as well as prices quoted from dealers
that make markets in these instruments and financial models.\882\
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    \879\ See Proposing Release, supra note 25, at section II.B.1.
    \880\ See, e.g., Harvard Business School FSOC Comment Letter
(``secondary markets for commercial paper and other private money
market assets such as CDs are highly illiquid. Therefore, the asset
prices used to calculate the floating NAV would largely be
accounting or model-based estimates, rather than prices based on
secondary market transactions with sizable volumes.'');
Institutional Money Market Funds Association, The Use of Amortised
Cost Accounting by Money Market Funds, available at http://www.immfa.org/assets/files/IMMFA%20The%20use%20of%20amortised%20cost%20accounting%20by%20MMF.pdf
 (noting that investors typically hold money market instruments to
maturity and therefore there are relatively few prices from the
secondary market or broker quotes).
    \881\ See, e.g., Federated VI Comment Letter; Hai Jin, et al.,
Liquidity Risk and Expected Corporate Bond Returns, 99 J. of Fin.
Econ. 628, at n.4 (2011) (``Matrix prices are set according to some
algorithm based on prices of bonds with similar characteristics'').
    \882\ See, e.g., Federated VI Comment Letter; Angel Comment
Letter.
---------------------------------------------------------------------------

    We received a number of comments regarding the utility of market-
based valuation for money market securities and other securities that
do not frequently trade in secondary markets. We also received comments
discussing certain other valuation matters more generally, such as the
use of pricing services in valuing such securities. Together, these
comments indicated to us the need for further guidance in this area,
which we provide below.
a. Fair Value for Thinly Traded Securities
    First, some commenters suggested that market-based valuations of
money market fund portfolio securities are not particularly meaningful,
given the infrequent trading in money market fund portfolio securities
and the use of matrix or model-based pricing or evaluated prices from
third-party pricing services.\883\ One commenter stated that ``it does
not follow that the normal arguments for using actual market prices for
calculating mutual fund NAVs apply to using noisy guesstimates of true
value of non-traded assets.'' \884\ Another commenter stated that, with
regard to matrix-priced money market fund portfolio securities,
``[m]arket-based valuations are not more accurate valuations than
amortized cost.'' \885\
---------------------------------------------------------------------------

    \883\ See, e.g., Federated IV Comment Letter; Legg Mason &
Western Asset Comment Letter; Chamber II Comment Letter.
    \884\ See Angel Comment Letter.
    \885\ See Federated VI Comment Letter (``Pricing experts have
confirmed to us that only a small percentage of money market
instruments actually trade daily in secondary markets. While the
amortized cost method of valuing MMF portfolios is a simple and
accurate means of valuing these types of high-quality, short-term
instruments that generally are held to maturity, the effort to
arrive at market-based valuations for these types of instruments is
time-consuming, complicated and less exact.'').
---------------------------------------------------------------------------

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

companies, relative to the value of the portfolios determined with
reference to current market-based factors.'' \888\ Such guidance is
based on a preference embodied in the Investment Company Act that funds
value portfolio securities taking into account current market
information.\889\
---------------------------------------------------------------------------

    \886\ Many money market funds promise in fund disclosures to
satisfy redemption requests on the same day as the request, except
in extraordinary conditions. In addition, funds that are sold
through broker-dealers seek to satisfy redemption requests within
three business days because broker-dealers are subject to Securities
Exchange Act rule 15c6-1, which establishes three business days as
the standard settlement period for securities trades effected by a
broker or a dealer.
    \887\ See ASR 219, Financial Reporting Codification (CCH)
section 404.05.a and .b (May 31, 1977), supra note 5. We have said
that it is inconsistent with rule 2a-4 to use the amortized cost
method of valuation to determine the fair value of debt securities
that mature at a date more than 60 days after the valuation date.
    \888\ Id.
    \889\ Section 22(c) and rules 2a-4 and 22c-1(a).
---------------------------------------------------------------------------

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

    \890\ As discussed further below, although a fund's directors
cannot delegate their statutory duty to determine the fair value of
fund portfolio securities, the board may appoint others, such as the
fund's investment adviser or a valuation committee, to assist them
in determining fair value. See infra note 898 and accompanying text.
    \891\ See Securities and Exchange Commission Codification of
Financial Reporting Policies, Statement Regarding ``Restricted
Securities,'' Investment Company Act Release No. 5847 (Oct. 21,
1969) [35 FR 19989 (Dec. 31, 1970)] (``ASR 113''); Investment
Companies, Investment Company Act Release No. 6295 (Dec. 23, 1970)
[35 FR 19986 (Dec. 31, 1970)], Financial Reporting Codification
(CCH) section 404.03 (Apr. 15, 1982) (``ASR 118''). We generally
believe that the current sale standard appropriately reflects the
fair value of securities and other assets for which market
quotations are not readily available within the meaning of section
2(a)(41)(B). The price that an unrelated willing buyer would pay for
a security or other asset under current market conditions is
indicative of the value of the security or asset. See also FASB ASC
paragraph 820-10-35-3 and FASB ASC paragraph 820-10-20 (``A fair
value measurement assumes that the asset or liability is exchanged
in an orderly transaction between market participants to sell the
asset or transfer the liability at the measurement date under
current market conditions.''; Fair Value means ``the price that
would be received to sell an asset or paid to transfer a liability
in an orderly transaction between market participants at the
measurement date'').
    \892\ As we have previously stated: ``Fair value cannot be based
on what a buyer might pay at some later time, such as when the
market ultimately recognizes the security's true value as currently
perceived by the portfolio manager. Funds also may not fair value
portfolio securities at prices not achievable on a current basis on
the belief that the fund would not currently need to sell those
securities.'' See, e.g., In the Matter of Jon D. Hammes, et al.,
Investment Company Act Release No. 26290 (Dec. 11, 2003) at n.5
(settlement). See also FASB ASC 820, at paragraph 820-10-35-54H (``A
reporting entity's intention to hold the asset or to settle or
otherwise fulfill the liability is not relevant when measuring fair
value because fair value is a market-based measurement, not an
entity-specific measurement.'').
---------------------------------------------------------------------------

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

    \893\ See, e.g., Federated VI Comment Letter; SIFMA Comment
Letter; Angel Comment Letter.
    \894\ See, e.g., Federated VI Comment Letter; Chamber II Comment
Letter.
---------------------------------------------------------------------------

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

    \895\ See section 2(a)(41)(B) and rule 2a-4.
---------------------------------------------------------------------------

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

    \896\ See ASR 118, supra note 891 (``[i]t is incumbent upon the
Board of Directors to satisfy themselves that all appropriate
factors relevant to the fair value of securities for which market
quotations are not readily available have been considered and to
determine the method of arriving at the fair value of each such
security.'' A fund's directors cannot delegate this responsibility
to anyone else). See, e.g., In the Matter of Seaboard Associates,
Inc. (Report of Investigation Pursuant to Section 21(a) of the
Exchange Act), Investment Company Act Release No. 13890 (Apr. 16,
1984) (``The Commission wishes to emphasize that the directors of a
registered investment company may not delegate to others the
ultimate responsibility of determining the fair value of any asset
not having a readily ascertainable market value. . . .'').
    \897\ See ASR 118, supra note 891.
    \898\ See id.
---------------------------------------------------------------------------

    Before deciding to use evaluated prices from a pricing service to
assist it in determining the fair values of a fund's portfolio
securities, the fund's board of directors may want to consider the
inputs, methods, models, and assumptions used by the pricing service to
determine its evaluated prices, and how those inputs, methods, models,
and assumptions are affected (if at all) as market conditions change.
In choosing a particular pricing service, a fund's board may want to
assess, among other things, the quality of the evaluated prices
provided by the service and the extent to which the service determines
its evaluated prices as close as possible to the time as of which the
fund calculates its net asset value. In addition, the

fund's board should generally consider the appropriateness of using
evaluated prices provided by pricing services as the fair values of the
fund's portfolio securities where, for example, the fund's board of
directors does not have a good faith basis for believing that the
pricing service's pricing methodologies produce evaluated prices that
reflect what the fund could reasonably expect to obtain for the
securities in a current sale under current market conditions.\899\
---------------------------------------------------------------------------

    \899\ See ASR 113 and ASR 118, supra note 891; see also 1983
Adopting Release supra note 3 (``If the [money market] fund uses an
outside service to provide this type of pricing for its portfolio
instruments, it may not delegate to the provider of the service the
ultimate responsibility to check the accuracy of the system.'').
---------------------------------------------------------------------------

E. Amendments to Disclosure Requirements

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

    \900\ In keeping with the enhanced disclosure framework we
adopted in 2009, the amendments are intended to provide a layered
approach to disclosure in which key information about the new
features of money market funds would be provided in the summary
section of the statutory prospectus (and, accordingly, in any
summary prospectus, if used) with more detailed information provided
elsewhere in the statutory prospectus and in the SAI. See Enhanced
Disclosure and New Prospectus Delivery Option for Registered Open-
End Management Investment Companies, Investment Company Act Release
No. 28584 (Jan. 13, 2009) [74 FR 4546 (Jan. 26, 2009)] (``Summary
Prospectus Adopting Release'') at paragraph preceding section III
(adopting rules permitting the use of a summary prospectus, which is
designed to provide key information that is important to an informed
investment decision).
---------------------------------------------------------------------------

1. Required Disclosure Statement
a. Overview of Disclosure Statement Requirements
    As discussed in the Proposing Release, and as modified to reflect
commenters' concerns, we are adopting amendments to rule 482 under the
Securities Act and Item 4 of Form N-1A to revise the disclosure
statement requirements concerning the risks of investing in a money
market fund in its advertisements or other sales materials that it
disseminates (including on the fund Web site) and in the summary
section of its prospectus (and, accordingly, in any summary prospectus,
if used).
    Money market funds are currently required to include a specific
statement concerning the risks of investing in their advertisements or
other sales materials and in the summary section of the fund's
prospectus (and, accordingly, in any summary prospectus, if used).\901\
In the Proposing Release, we proposed to modify the format and content
of this required disclosure. Specifically, we proposed to require money
market funds to present certain disclosure statements in a bulleted
format. The content of the proposed disclosure statements would have
differed under each of the proposed reform alternatives. Under each
reform alternative, the proposed statement would have included
identical wording changes designed to clarify, and inform investors
about, the primary risks of investing in money market funds generally,
including new disclosure emphasizing that money market fund sponsors
are not obligated to provide financial support. Additionally, the
proposed statement under the fees and gates alternative would have
included disclosure that would call attention to the risks of investing
in a money market fund that could impose liquidity fees or gates, and
the proposed statement under the floating NAV alternative would have
included disclosure to emphasize the particular risks of investing in a
floating NAV money market fund.
---------------------------------------------------------------------------

    \901\ Rule 482(b)(4); Item 4(b)(1)(ii) of Form N-1A. Money
market funds are currently required to include the following
statement: An investment in the Fund is not insured or guaranteed by
the Federal Deposit Insurance Corporation or any other government
agency. Although the Fund seeks to preserve the value of your
investment at $1.00 per share, it is possible to lose money by
investing in the Fund.
---------------------------------------------------------------------------

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

    \902\ See CFA Institute Comment Letter (noting that the proposed
disclosures would put investors on notice that money market funds
are not riskless and would provide the information in a clear and
succinct manner); HSBC Comment Letter (generally supporting both
statements but suggesting additions to cross-reference the
prospectus's risk warnings and to make clear fees and gates would be
used to protect investors); Federated II Comment Letter; Comment
Letter of Federated Investors (Disclosure Requirements for Money
Market Funds and Current Requirements of Rule 2a-7) (Sept. 17, 2013)
(``Federated VIII Comment Letter'') (concurring with the risk
disclosure under the fees and gates alternative).
    \903\ See ABA Business Law Section Comment Letter; NYC Bar
Committee Comment Letter.
    \904\ See, e.g., Dreyfus Comment Letter; NYC Bar Committee
Comment Letter.
---------------------------------------------------------------------------

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

these reforms, increase and decrease as a result of the changes in the
value of the underlying securities.\906\
---------------------------------------------------------------------------

    \905\ See Proposing Release, supra note 25, at sections III.A.8
and III.B.8.
    \906\ Id.
---------------------------------------------------------------------------

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

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

    \907\ Government funds that are not subject to the fees and
gates requirements pursuant to rule 2a-7(c)(2)(iii) may omit the
following sentence: ``The Fund may impose a fee upon the sale of
your shares or may temporarily suspend your ability to sell shares
if the fund's liquidity falls below required minimums because of
market conditions or other factors.'' See rule 482(b)(4)(iii); Form
N-1A Item 4(b)(1)(ii)(C).
    \908\ See Rule 482(b)(4)(ii); Form N-1A Item 4(b)(1)(ii)(B).
Besides the amendments to the disclosure statement requirements set
forth in Rule 482(b)(4)(ii) and Form N-1A Item 4(b)(1)(ii)(B), we
also are adopting non-substantive changes to the text of these rule
and form provisions. If an affiliated person, promoter, or principal
underwriter of the fund, or an affiliated person of such person, has
contractually committed to provide financial support to the fund,
the fund would be permitted to omit the last sentence from the
disclosure statement in advertisements and sales materials for the
term of the agreement. See Note to paragraph (b)(4), rule 482(b)(4).
Likewise, if an affiliated person, promoter, or principal
underwriter of the fund, or an affiliated person of such person, has
contractually committed to provide financial support to the fund,
and the term of the agreement will extend for at least one year
following the effective date of the fund's registration statement,
the fund would be permitted to omit the last sentence from the
disclosure statement that appears in the fund's registration
statement. See Instruction to Item 4(b)(1)(ii) of Form N-1A.
    The proposal likewise would have permitted a similar omission
from the proposed disclosure statement. See Proposing Release, supra
note 25, at nn.429 and 431. As proposed, such omission would have
been permitted if ``an affiliated person, promoter, or principal
underwriter of the fund, or an affiliated person of such person, has
entered into an agreement to provide financial support to the
fund.'' We have modified the language of the Note to paragraph
(b)(4), rule 482(b)(4) and the Instruction to Item 4(b)(1)(ii) of
Form N-1A to clarify that the omission would be permitted only in
the case of contractual commitments to provide financial support,
and not in the case of informal agreements that may not be
enforceable.
    As discussed in more detail below, we are adopting amendments
that would require money market funds to disclose current and
historical instances of affiliate financial support on Form N-CR and
Form N-1A, respectively. See infra sections III.F.3, III.E.7.

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

    You could lose money by investing in the Fund. Because the share
price of the Fund will fluctuate, when you sell your shares they may
be worth more or less than what you originally paid for them. The
Fund may impose a fee upon the sale of your shares or may
temporarily suspend your ability to sell shares if the Fund's
liquidity falls below required minimums because of market conditions
or other factors. An investment in the Fund is not insured or
guaranteed by the Federal Deposit Insurance Corporation or any other
government agency. The Fund's sponsor has no legal obligation to
provide financial support to the Fund, and you should not expect
that the sponsor will provide financial support to the Fund at any
time.\909\
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    \909\ See Rule 482(b)(4)(i); Form N-1A Item 4(b)(1)(ii)(A).
Besides the amendments to the disclosure statement requirements set
forth in Rule 482(b)(4)(i) and Form N-1A Item 4(b)(1)(ii)(A), we
also are adopting non-substantive changes to the text of these rule
and form provisions. Funds may omit the last sentence regarding
sponsor support under certain circumstances, such as when a fund's
sponsor has contractually committed to provide support to the fund.
See supra note 908; Instructions to Item 4(b)(1)(ii) of Form N-1A;
Note to paragraph (b)(4), rule 482(b)(4). The proposal likewise
would have permitted this omission from the proposed disclosure
statement. See Proposing Release, supra note 25, at nn.307 and 313.
As discussed in more detail below, we are adopting amendments that
would require money market funds to disclose current and historical
instances of affiliate financial support on Form N-CR and Form N-1A,
respectively. See infra sections III.F.3, III.E.7.

    Below we describe in detail the ways in which the format and
content of the required disclosure statement that we are adopting today
differ from that which we proposed, as well as the reasons for these
differences.
b. Format of the Statement
    We have decided not to adopt the proposed requirement that funds
provide the statement in a bulleted format. One commenter argued that
prescribing a specific graphical format is not necessary and might be
difficult to execute in certain forms of advertising, such as social
media.\910\ We agree. We also believe that refraining from requiring
funds to provide the disclosure statement in a bulleted format, in
combination with other modifications discussed below that shorten the
disclosure statement, addresses concerns raised by commenters that the
length of the proposed disclosure statement could draw attention away
from other important information in an advertisement or sales
materials.\911\
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    \910\ See ABA Business Law Section Comment Letter.
    \911\ See NYC Bar Committee Comment Letter (noting that,
particularly in inherently brief formats like advertisements, there
is a risk that mandated legends may crowd out material informational
content); ABA Business Law Section Comment Letter (arguing that the
proposed disclosure statement could take up so much of the space
available in an advertisement that it will discourage investors from
viewing other important information in the communication).
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c. Disclosure Concerning General Risk of Investment Loss
    As proposed, the required disclosure statement would have included
a bulleted statement providing: ``You could lose money by investing in
the Fund.'' We are adopting identical content in the required
disclosure statement. As discussed in the proposal, we have taken into
consideration investor preferences for clear, concise, and
understandable language in adopting the required disclosure and also
have considered whether strongly-worded disclaimer language would more
effectively convey the particular risks associated with money market
funds than more moderately-worded language would.\912\ We received one
comment on this language arguing that it is duplicative with other
language in the required disclosure statement.\913\ We have responded
to this comment by shortening and modifying the required disclosure
statement.\914\
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    \912\ See Proposing Release, supra note 25, at nn.316-317.
    \913\ See Federated VIII Comment Letter.
    \914\ As proposed, the required disclosure statement included
the statements ``You could lose money by investing in the Fund'' and
``Your investment in the Fund therefore may experience losses.'' As
adopted, the required disclosure statement no longer includes the
second statement, which could be construed to be repetitive with the
first.
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d. Disclosure Concerning Fees and Gates
    As proposed, the required disclosure statement would have included
bulleted statements providing: ``The Fund may impose a fee upon sale of
your shares when the Fund is under considerable stress'' and ``The Fund
may temporarily suspend your ability to sell shares of the Fund when
the Fund is under considerable stress.'' Instead of including these
bullet points in the required disclosure, we are adopting similar
content in the required disclosure statement providing: ``The Fund may
impose a fee upon the sale of your shares or may temporarily suspend
your ability to sell shares if the Fund's liquidity falls below
required

minimums because of market conditions or other factors.'' One
commenter, while generally supporting the proposed statement, suggested
that the statement be amended to say that the fund could impose a fee
or a gate ``in order to protect shareholders of the Fund.'' \915\ One
commenter expressed concerns about requiring the inclusion of
statements about fees and gates in advertisements or other sales
materials, arguing that the description of circumstances and conditions
under which fees and gates might be imposed is difficult to reduce to a
brief statement.\916\ No commenters explicitly supported the inclusion
of the term ``considerable stress,'' and several commenters argued that
this term was not clear, and may cause investors to believe that funds
could impose fees and gates arbitrarily or, conversely, only during
extreme market events.\917\ To address this concern, one commenter
suggested requiring a different term than ``considerable stress,''
arguing that this term overstates the prospect for imposing fees or
gates.\918\ Other commenters suggested that the disclosure state
explicitly that a fee or gate could be imposed as a result of a
reduction in the fund's liquidity.\919\ Commenters also suggested that
any disclosure regarding fees and gates could be combined into a single
statement.
---------------------------------------------------------------------------

    \915\ See HSBC Comment Letter.
    \916\ See NYC Bar Committee Comment Letter.
    \917\ See NYC Bar Committee Comment Letter; ABA Business Law
Section Comment Letter; Dreyfus Comment Letter.
    \918\ See Dreyfus Comment Letter.
    \919\ See NYC Bar Committee Comment Letter; ABA Business Law
Section Comment Letter.
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    After considering the comments, we continue to believe that
disclosure about fees or gates should be included in advertisements,
sales materials, and the summary section of the prospectus. Even some
commenters that expressed concerns about including the disclosure in
advertisements acknowledged that the possible imposition of fees and
gates is information that is likely to be important to investors.\920\
As we stated in the Proposing Release, we are concerned that investors
will not be fully aware of potential restrictions on fund redemptions.
To address commenters' concerns regarding the ambiguity of the term
``considerable stress,'' we have revised the statement, as suggested by
commenters, to make clear that funds could impose a fee or gate in
response to a reduction in the fund's liquidity. The statement does not
include a reference that a fee or gate could be imposed ``to protect
investors of the fund,'' as suggested by one commenter. We believe that
including the additional suggested language could detract from the
statement's emphasis that a fee or gate could be imposed, which could
in turn diminish shareholders' awareness of potential restrictions on
fund redemptions. The language we have adopted reflects commenter
suggestions that any disclosure regarding fees or gates be combined
into a single statement. We believe that the adopted language also
responds to commenter concerns about the difficulty of briefly
describing the conditions under which fees and gates might be imposed
by providing that fees and gates could be imposed if ``the Fund's
liquidity falls below required minimums because of market conditions or
other factors.''
---------------------------------------------------------------------------

    \920\ See ABA Business Law Section Comment Letter; NYC Bar
Committee Comment Letter.
---------------------------------------------------------------------------

e. Disclosure Concerning Sponsor Support
    As proposed, the required disclosure statement would have included
a bulleted statement providing: ``The Fund's sponsor has no legal
obligation to provide financial support to the Fund, and you should not
expect that the sponsor will provide financial support to the Fund at
any time.'' We are adopting identical content in the required
disclosure statement. Several commenters opposed the inclusion of a
reference to sponsor support in the required disclosure statement.\921\
Some commenters argued that the disclosure would raise sponsor support
to an unwarranted level of prominence, noting that there have not been
any studies to determine whether investors actually rely on the
potential for sponsor support as a factor when determining whether to
invest in a money market fund.\922\ Commenters also were concerned that
investors will not understand the disclosure in fund advertisements,
since advertisements will not afford space or opportunity to explain to
investors who the fund's ``sponsor'' is and what ``financial support''
means.\923\
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    \921\ See Dreyfus Comment Letter; NYC Bar Committee Comment
Letter; ABA Business Law Section Comment Letter. But see CFA
Institute Comment Letter; HSBC Comment Letter (both generally
supporting the proposed disclosure statement, including the language
discussing sponsor support).
    \922\ See, e.g., ABA Business Law Section Comment Letter; NYC
Bar Committee Comment Letter.
    \923\ Id.
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    We continue to believe that the disclosure statement should include
a statement that the fund's sponsor has no obligation to provide
financial support. In the Proposing Release, we recognized that
particular instances of sponsor support were not particularly
transparent to investors in past years because sponsor support
generally was not immediately disclosed, and was not required to be
disclosed by the Commission.\924\ But although investors might not have
known of particular instances of sponsor support, we believe that many
investors, particularly institutional investors, have historically
understood that there was a possibility of financial support from the
money market fund's sponsor and that this possibility has affected
investors' perceptions about the level of risk in investing in money
market funds.\925\ We therefore disagree with the commenter who
suggested that investors were generally unaware of this practice
preceding and during the financial crisis.\926\ For this reason, we
believe that it is important to emphasize to investors that they should
not expect a fund sponsor to provide financial support to the fund.
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    \924\ Proposing Release, supra note 25, at section II.B.3.
    \925\ See, e.g., Roundtable Transcript, supra note 63 (Lance
Pan, Capital Advisors Group) (``over the last 30 or 40 years,
[investors] have relied on the perception that even though there is
risk in money market funds, that risk is owned somehow implicitly by
fund sponsors. So once they perceive that they are not able to get
that additional assurance, I believe that was one probably cause of
the run.'').
    \926\ See NYC Bar Committee Comment Letter (arguing that the
Commission's discussion of the lack of transparency regarding
instances of sponsor support shows that the proposed risk statement
addresses a practice that investors were not aware of during the
financial crisis).
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    For similar reasons, we disagree with one commenter who argued that
requiring this disclosure is at odds with the requirement that funds
publicly disclose instances of sponsor support.\927\ As discussed
below, we are requiring funds to disclose current and historical
instances of sponsor support because we believe that such disclosure
will help investors better understand the risks of investing in the
funds.\928\ This reporting, which should help investors understand
instances when the fund has come under stress, provides historical
information about the fund. The required disclosure statement, on the
other hand, is a forward-looking risk statement that reminds current
and prospective investors that sponsors do not have an obligation to
provide sponsor support and that investors should not expect that
sponsors will provide support in the future.
---------------------------------------------------------------------------

    \927\ See Dreyfus Comment Letter.
    \928\ See infra notes 1007-1010, 1132 and accompanying text.

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

    \929\ See ABA Business Law Section Comment Letter; NYC Bar
Committee Comment Letter.
---------------------------------------------------------------------------

f. Disclosure for Floating NAV Funds
    As proposed, the required disclosure statement for floating NAV
funds would have included bulleted statements providing: ``You should
not invest in the Fund if you require your investment to maintain a
stable value'' and ``The value of the Fund will increase and decrease
as a result of changes in the value of the securities in which the Fund
invests. The value of the securities in which the Fund invests may in
turn be affected by many factors, including interest rate changes and
defaults or changes in the credit quality of a security's issuer.''
Instead of including these bullet points in the required disclosure, we
are adopting similar content in the required disclosure statement
providing: ``Because the share price of the Fund will fluctuate, when
you sell your shares they may be worth more or less than what you
originally paid for them.'' While one commenter questioned whether the
proposed disclosure was necessary for investors in institutional prime
funds,\930\ we believe it is important to emphasize to investors the
potential impact of a floating NAV.\931\ In response to suggestions by
commenters,\932\ we have decided not to require that the disclosure
statement include the proposed statement that investors that require a
stable value not invest in the fund. We were persuaded by commenters
that the term ``stable value'' is often used by financial advisers when
referring to certain investment products, at least some of which do
have a variable NAV.\933\ We are also not including in the disclosure
requirements the proposed statements about the relationship between the
fund share price and the value of the fund's underlying securities and
the risk factors that can affect the value of the fund's underlying
securities. We were persuaded by one commenter who noted that
discussion of specific risk factors will be addressed in other areas of
the prospectus, including the summary prospectus.\934\ We also believe
that not including these statements addresses more general concerns
expressed by commenters regarding the length and efficacy of the
proposed disclosure statement.\935\
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    \930\ See Dreyfus Comment Letter (``[W]e also question the
Commission's concern that investors will fail to understand that the
value of the [floating NAV] MMF will fluctuate. We question at what
point investors will be given the benefit of the doubt for
understanding the product in which they are invested and when such
concerns will cease to drive additional regulatory action.'')
    \931\ Cf. ABA Business Law Section Comment Letter (suggesting
that ``floating NAV money market funds include in their
advertisements a statement that their principal value will fluctuate
so that an investor's shares, when redeemed may be worth more or
less than their original cost''); CFA Institute Comment Letter
(stating that ``[d]isclosures are needed to alert investors to the
potential for loss of principal and interest'').
    \932\ See NYC Bar Committee Comment Letter; ABA Business Law
Section Comment Letter.
    \933\ See NYC Bar Committee Comment Letter (noting that ``stable
value'' commonly refers to a ``retirement product that will use a
combination of government bonds, guaranteed return insurance
wrappers and potentially other synthetic instruments to deliver a
minimum rate of return'').
    \934\ See Dreyfus Comment Letter.
    \935\ See ABA Business Law Section Comment Letter; NYC Bar
Committee Comment Letter. The required disclosure statement that we
are adopting today (see supra text accompanying note 909) is about
30% shorter than the proposed bulleted disclosure statement. (We
have modified the proposed bulleted disclosure statement to
encompass the proposed language referencing fluctuating share price
as well as the ability of a fund to impose fees or gates. The
Proposing Release conceived of two separate reform approaches, each
with its own disclosure statement, while this Release combines the
approaches into a single reform package, and the disclosure
statement we are adopting therefore references both reform elements,
as appropriate.)
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2. Disclosure of Tax Consequences and Effect on Fund Operations--
Floating NAV
    As discussed in the Proposing Release, the requirement that
institutional prime money market funds transition to a floating NAV
will entail certain additional tax- and operations-related disclosure,
but these disclosure requirements do not necessitate rule and form