[Federal Register: July 8, 2009 (Volume 74, Number 129)]
[Proposed Rules]
[Page 32687-32741]
[DOCID:fr08jy09-36]

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Part II

Securities and Exchange Commission

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17 CFR Parts 270 and 274

Money Market Fund Reform; Proposed Rule

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 270 and 274

[Release No. IC-28807; File No. S7-11-09]
RIN 3235-AK33

Money Market Fund Reform

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'' or
``SEC'') is proposing amendments to certain rules that govern money
market funds under the Investment Company Act. The amendments would:
Tighten the risk-limiting conditions of rule 2a-7 by, among other
things, requiring funds to maintain a portion of their portfolios in
instruments that can be readily converted to cash, reducing the
weighted average maturity of portfolio holdings, and limiting funds to
investing in the highest quality portfolio securities; require money
market funds to report their portfolio holdings monthly to the
Commission; and permit a money market fund that has ``broken the buck''
(i.e., re-priced its securities below $1.00 per share) to suspend
redemptions to allow for the orderly liquidation of fund assets. In
addition, the Commission is seeking comment on other potential changes
in our regulation of money market funds, including whether money market
funds should, like other types of mutual funds, effect shareholder
transactions at the market-based net asset value, i.e., whether they
should have ``floating'' rather than stabilized net asset values. The
proposed amendments are designed to make money market funds more
resilient to certain short-term market risks, and to provide greater
protections for investors in a money market fund that is unable to
maintain a stable net asset value per share.

DATES: Comments should be received on or before September 8, 2009.

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

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/proposed.shtml); or
     Send an e-mail to<EMAIL_ADDRESS>Please include
File Number S7-11-09 on the subject line; or
     Use the Federal eRulemaking Portal (http://
www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

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

All submissions should refer to File Number S7-11-09. This file number
should be included on the subject line if e-mail is used. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments
are also available for public inspection and copying in the
Commission's Public Reference Room, 100 F Street, NE., Washington, DC
20549, on official business days between the hours of 10 a.m. and 3
p.m. All comments received will be posted without change; we do not
edit personal identifying information from submissions. You should
submit only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT: Office of Regulatory Policy, at (202)
551-6792, Division of Investment Management, Securities and Exchange
Commission, 100 F Street, NE., Washington, DC 20549-8549.

SUPPLEMENTARY INFORMATION: The Commission is proposing for public
comment amendments to rules 2a-7 [17 CFR 270.2a-7], 17a-9 [17 CFR
270.17a-9], and 30b1-5 [17 CFR 270.30b1-5], new rules 22e-3 [17 CFR
270.22e-3] and 30b1-6 [17 CFR 270.30b1-6], and new Form N-MFP under the
Investment Company Act of 1940 (``Investment Company Act'' or
``Act'').\1\
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    \1\ 15 U.S.C. 80a. Unless otherwise noted, all references to
statutory sections are to the Investment Company Act, and all
references to rules under the Investment Company Act, including rule
2a-7, will be to Title 17, Part 270 of the Code of Federal
Regulations [17 CFR part 270].
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Table of Contents

I. Background
    A. Money Market Funds
    B. Market Significance
    C. Regulation of Money Market Funds
    D. Recent Developments
II. Discussion
    A. Portfolio Quality
    1. Second Tier Securities
    2. Eligible Securities
    3. Credit Reassessments
    4. Asset Backed Securities
    B. Portfolio Maturity
    1. Weighted Average Maturity
    2. Weighted Average Life
    3. Maturity Limit for Government Securities
    4. Maturity Limit for Other Portfolio Securities
    C. Portfolio Liquidity
    1. Limitation on Acquisition of Illiquid Securities
    2. Cash and Securities That Can Be Readily Converted to Cash
    3. Stress Testing
    D. Diversification
    E. Repurchase Agreements
    F. Disclosure of Portfolio Information
    1. Public Web site Posting
    2. Reporting to The Commission
    3. Amendment to Rule 30b1-5
    G. Processing of Transactions
    H. Exemption for Affiliate Purchases
    1. Expanded Exemptive Relief
    2. New Reporting Requirement
    I. Fund Liquidation
    1. Proposed Rule 22e-3
    2. Request for Comment on Other Regulatory Changes
III. Request for Comment
    A. Floating Net Asset Value
    B. In-Kind Redemptions
    IV. Paperwork Reduction Act Analysis
    V. Cost Benefit Analysis
    VI. Competition, Efficiency And Capital Formation
    VII. Regulatory Flexibility Act Certification
    VIII. Statutory Authority
Text of Proposed Rules and Form

I. Background

A. Money Market Funds

    Money market funds are open-end management investment companies
that are registered under the Investment Company Act and regulated
under rule 2a-7 under the Act. They invest in high-quality, short-term
debt instruments such as commercial paper, Treasury bills and
repurchase agreements.\2\ Money market funds pay dividends that reflect
prevailing short-term interest rates and, unlike other investment
companies, seek to maintain a stable net asset value per share,
typically $1.00 per share.\3\
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    \2\ Money market funds are also sometimes called ``money market
mutual funds'' or ``money funds.''
    \3\ See generally Valuation of Debt Instruments and Computation
of Current Price Per Share by Certain Open-End Investment Companies
(Money Market Funds), Investment Company Act Release No. 13380 (July
11, 1983) [48 FR 32555 (July 18, 1983)] (``1983 Adopting Release'').
Most money market funds seek to maintain a stable net asset value
per share of $1.00, but a few seek to maintain a stable net asset
value per share of a different amount, e.g., $10.00. For
convenience, throughout this release, the discussion will simply
refer to the stable net asset value of $1.00 per share.
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    This combination of stability of principal and payment of short-
term yields has made money market funds one of the most popular
investment vehicles for many different types of investors. Commonly
offered features, such as check-writing privileges, exchange
privileges, and near-immediate liquidity, have contributed to the
popularity of money market funds. More than 750 money market funds are
registered with the Commission, and collectively they hold
approximately

$3.8 trillion of assets.\4\ Money market funds account for
approximately 39 percent of all investment company assets.\5\
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    \4\ See Investment Company Institute, Trends in Mutual Fund
Investing, Apr. 2009, available at http://www.ici.org/highlights/
trends_04_09 (``ICI Trends'').
    \5\ See id.
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    Individual (or ``retail'') investors use money market funds for a
variety of reasons. For example, they may invest in money market funds
to hold cash temporarily or to take a temporary ``defensive position''
in anticipation of declining equity markets. Money market funds also
play an important role in cash management accounts for banks, broker-
dealers, variable insurance products, and retirement accounts. As of
December 2008, about one-fifth of U.S. households' cash balances were
held in money market funds.\6\
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    \6\ See Investment Company Institute, Report of the Money Market
Working Group, at 21 (Mar. 17, 2009), available at http://
www.ici.org/pdf/ppr_09_mmwg.pdf (``ICI Report'').
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    Different types of money market funds have been introduced to meet
the differing needs of retail money market fund investors.
Historically, most retail investors have invested in ``prime money
market funds,'' which hold a variety of taxable short-term obligations
issued by corporations and banks, as well as repurchase agreements and
asset backed commercial paper secured by pools of assets.\7\ Prime
money market funds typically have paid higher yields than other types
of money market funds available to retail investors.\8\ ``Government
money market funds'' principally hold obligations of the U.S.
Government, including obligations of the U.S. Treasury and federal
agencies and instrumentalities, as well as repurchase agreements
collateralized by Government securities. Some government money market
funds limit themselves to holding only Treasury obligations. Compared
to prime funds, government funds generally offer greater safety of
principal but historically have paid lower yields. ``Tax exempt money
market funds'' primarily hold obligations of state and local
governments and their instrumentalities, and pay interest that is
generally exempt from federal income taxes.
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    \7\ See Investment Company Institute, 2009 Investment Company
Fact Book, at 147, Table 38 (May 2009), available at http://
www.ici.org/pdf/2009_factbook.pdf (``2009 Fact Book'').
    \8\ See, e.g., iMoneyNet Money Fund Report (Mar. 20, 2009),
available at http://www.imoneynet.com/files/Publication_News/
mfr.pdf.
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    Institutional investors account for a growing portion of
investments in money market funds. These investors include
corporations, bank trust departments, securities lending operations of
brokerage firms, state and local governments, hedge funds and other
private funds. Many corporate treasurers of large businesses have
essentially ``outsourced'' cash management operations to money market
funds, which may be able to manage cash more efficiently due both to
the scale of their operations and their expertise. As of January 2008,
approximately 80 percent of U.S. companies used money market funds to
manage at least a portion of their cash balances.\9\ At year-end 2008,
U.S. non-financial businesses held approximately 32 percent of their
cash balances in money market funds.\10\ According to the Investment
Company Institute, about 66 percent of money market fund assets are
held in money market funds or share classes intended to be sold to
institutional investors (``institutional money market funds'').\11\
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    \9\ See ICI Report, supra note 6, at 28-29, Figure 3.7.
    \10\ See id. at 28-29, Figure 3.6.
    \11\ See Investment Company Institute, Money Market Mutual Fund
Assets, June 11, 2009, available at http://www.ici.org/highlights/
mm_06_11_09.
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    Institutional money market funds hold securities similar to those
held by prime funds and government funds. They typically have large
minimum investment amounts (e.g., $1 million), and offer lower expenses
and higher yields due to the large account balances, large transaction
values, and smaller number of accounts associated with these funds. As
we will discuss in more detail below, institutional money market funds
also tend to have greater investment inflows and outflows than retail
money market funds.

B. Market Significance

    Due in large part to the growth of institutional funds, money
market funds have grown substantially over the last decade, from
approximately $1.4 trillion in assets under management at the end of
1998 to approximately $3.8 trillion in assets under management at the
end of 2008.\12\ During this same period, retail taxable money market
fund assets grew from approximately $835 billion to $1.36 trillion, or
63 percent, while institutional taxable money market fund assets grew
from approximately $516 billion to $2.48 trillion, or 380 percent.\13\
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    \12\ See Investment Company Institute, 1999 Mutual Fund Fact
Book, at 4 (May 1999), available at http://www.ici.org/pdf/1999_
factbook.pdf; Investment Company Institute, Trends in Mutual Fund
Investing, May 28, 2009, available at http://www.ici.org/highlights/
trends_04_2009.
    \13\ See Investment Company Institute, 2008 Investment Company
Fact Book, at 144, Table 35 (May 2008) (``2008 Fact Book''); 2009
Fact Book, supra note 7, at 147, Table 38.
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    One implication of the growth of money market funds is the
increased role they play in the capital markets. They are by far the
largest holders of commercial paper, owning almost 40 percent of the
outstanding paper.\14\ The growth of the commercial paper market has
generally followed the growth of money market funds over the last three
decades.\15\ Today, money market funds provide a substantial portion of
short-term credit extended to U.S. businesses.
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    \14\ Federal Reserve Board, Statistical Release Z.1: Flow of
Funds Accounts of the United States: Flows and Outstandings Fourth
Quarter 2008, at 86, Table L.208 (Mar. 12, 2009), available at
http://www.federalreserve.gov/releases/z1/Current/z1.pdf (``Fed.
Flow of Funds Report'').
    \15\ See Instruments of the Money Market, at 121, Table 2
(Timothy Q. Cook & Robert K. Laroche eds., 1993), available at
http://www.richmondfed.org/publications/research/special_reports/
instruments_of_the_money_market/pdf/full_publication.pdf; Fed.
Flow of Funds Report, supra note 14, at Tables L.206 and L.208. One
commenter has called the growth of these two markets ``inextricably
linked.'' See Leland Crabbe & Mitchell A. Post, The Effect of SEC
Amendments to Rule 2a-7 on the Commercial Paper Market, at 4
(Federal Reserve Board, Finance and Economics Discussion Series
199, May 1992) (``Crabbe & Post'').
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    Money market funds also play a large role in other parts of the
short-term market. They hold approximately 23 percent of all repurchase
agreements, 65 percent of state and local government short-term debt,
24 percent of short-term Treasury securities, and 44 percent of short-
term agency securities.\16\ They serve as a substantial source of
financing in the broader capital markets, holding approximately 22
percent of all state and local government debt, approximately nine
percent of U.S. Treasury securities and 15 percent of agency
securities.\17\
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    \16\ These securities include securities issued or guaranteed by
the Federal National Mortgage Association (``Fannie Mae''), the
Federal Home Loan Mortgage Corporation (``Freddie Mac'') and the
Federal Home Loan Banks. See ICI Report, supra note 6, at 19, Figure
2.3. See generally U.S. Treasury Department, FAQs on Fixed Income
Agency Securities, available at http://www.treas.gov/education/faq/
markets/fixedfederal.shtml.
    \17\ See Fed. Flow of Funds Report, supra note 14 (percentages
derived from flow of funds data). Foreign banks also have relied
substantially on U.S. money market funds for dollar-denominated
funding. See Naohiko Baba, Robert N. McCauley, & Srichander
Ramaswamy, U.S. Dollar Money Market Funds and non-U.S. Banks, BIS
Quarterly Review, Mar. 2009, available at http://www.bis.org/publ/
qtrpdf/r_qt0903g.htm (``U.S. Dollar Money Market Funds'').
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    As a consequence, the health of money market funds is important not
only to their investors, but also to a

large number of businesses and state and local governments that finance
current operations through the issuance of short-term debt. A ``break
in the link [between borrowers and money market funds] can lead to
reduced business activity and pose risks to economic growth.'' \18\ The
regulation of money market funds, therefore, is important not only to
fund investors, but to a wide variety of operating companies as well as
state and local governments that rely on these funds to purchase their
short-term securities.
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    \18\ See Mike Hammill & Andrew Flowers, MMMF, and AMLF, and
MMIFF, Macroblog (Federal Reserve Bank of Atlanta), Oct. 30, 2008,
available at http://www.macroblog.typepad.com/macroblog/2008/10/
index.html.
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C. Regulation of Money Market Funds

    The Commission regulates money market funds under the Investment
Company Act and pursuant to rule 2a-7 under the Act. We adopted rule
2a-7 as an exemptive rule in 1983 and amended it in 1986 to facilitate
the development of tax-exempt money market funds.\19\ We also amended
it substantially in 1991 (taxable funds) and 1996 (tax-exempt funds) to
provide for a more robust set of regulatory conditions and to expand
the rule to apply it to any investment company holding itself out as a
money market fund.\20\
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    \19\ See 1983 Adopting Release, supra note 3; Acquisition and
Valuation of Certain Portfolio Instruments by Registered Investment
Companies, Investment Company Act Release No. 14983 (Mar. 12, 1986)
[51 FR 9773 (Mar. 21, 1986)] (``1986 Adopting Release'').
    \20\ See Revisions to Rules Regulating Money Market Funds,
Investment Company Act Release No. 18005 (Feb. 20, 1991) [56 FR 8113
(Feb. 27, 1991)] (``1991 Adopting Release''); Revisions to Rules
Regulating Money Market Funds, Investment Company Act Release No.
21837 (Mar. 21, 1996) [61 FR 13956 (Mar. 28, 1996)] (``1996 Adopting
Release'').
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    The Investment Company Act and applicable rules generally require
that mutual funds price their securities at the current net asset value
per share by valuing portfolio instruments at market value or, if
market quotations are not readily available, at fair value determined
in good faith by the board of directors.\21\ As a consequence, the
price at which funds will sell and redeem shares ordinarily fluctuates
daily with changes in the value of the fund's portfolio securities.
These valuation and pricing requirements are designed to prevent
investors' interests from being diluted or otherwise adversely affected
if fund shares are not priced fairly.\22\
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    \21\ See section 2(a)(41) of the Act (defining ``value'' of fund
assets); rule 2a-4 (defining ``current net asset value'' for use in
computing the current price of a redeemable security); and rule 22c-
1 (generally requiring open-end funds to sell and redeem their
shares at a price based on the funds' current net asset value as
next computed after receipt of a redemption, purchase, or sale
order).
    \22\ See Revisions to Rules Regulating Money Market Funds,
Investment Company Act Release No. 17589 at n.7 and accompanying
text (July 17, 1990) [55 FR 30239 (July 25, 1990)] (``1990 Proposing
Release'').
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    Rule 2a-7, however, permits money market funds to use the amortized
cost method of valuation and penny-rounding method of pricing instead,
which facilitate money market funds' ability to maintain a stable net
asset value.\23\ Under the amortized cost method, portfolio securities
generally are valued at cost plus any amortization of premium or
accumulation of discount (``amortized cost'').\24\ The basic premise
underlying money market funds' use of the amortized cost method of
valuation is that high-quality, short-term debt securities held until
maturity will eventually return to the amortized cost value, regardless
of any current disparity between the amortized cost value and market
value, and would not ordinarily be expected to fluctuate significantly
in value.\25\ Therefore, the rule permits money market funds to value
portfolio securities at their amortized cost so long as the deviation
between the amortized cost and current market value remains minimal and
results in the computation of a share price that represents fairly the
current net asset value per share of the fund.\26\
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    \23\ The penny-rounding method of pricing means the method of
computing a fund's price per share for purposes of distribution,
redemption and repurchase whereby the current net asset value per
share is rounded to the nearest one percent. See rule 2a-7(a)(18).
    \24\ See rule 2a-7(a)(2) (defining the amortized cost method as
calculating an investment company's net asset value whereby
portfolio securities are valued at the fund's acquisition cost as
adjusted for amortization of premium or accretion of discount rather
than at their value based on current market factors).
    \25\ See 1983 Adopting Release, supra note 3, at nn. 3-7 and
accompanying text; Valuation of Debt Instruments and Computation of
Current Price Per Share by Certain Open-End Investment Companies,
Investment Company Act Release No. 12206, at nn. 3-4 and
accompanying text (Feb. 1, 1982) [47 FR 5428 (Feb. 5, 1982)] (``1982
Proposing Release'').
    \26\ See rule 2a-7(c)(1), (c)(7)(ii)(C).
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    To reduce the likelihood of a material deviation occurring between
the amortized cost value of a portfolio and its market-based value, the
rule contains several conditions (which we refer to as ``risk-limiting
conditions'') that limit the fund's exposure to certain risks, such as
credit, currency, and interest rate risks.\27\ In addition, the rule
includes certain procedural requirements overseen by the fund's board
of directors. One of the most important is the requirement that the
fund periodically ``shadow price'' the amortized cost net asset value
of the fund's portfolio against the mark-to-market net asset value of
the portfolio.\28\ If there is a difference of more than \1/2\ of 1
percent (or $0.005 per share), the fund's board of directors must
consider promptly what action, if any, should be taken, including
whether the fund should discontinue the use of the amortized cost
method of valuation and re-price the securities of the fund below (or
above) $1.00 per share, an event colloquially known as ``breaking the
buck.'' \29\
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    \27\ For example, the rule requires, among other things, that a
money market fund's portfolio securities meet certain credit quality
requirements, such as being rated in the top one or two rating
categories by nationally recognized statistical rating organizations
(``NRSROs''), and by limiting the portion of the fund's portfolio
that may be invested in securities rated in the second highest
rating category. See rule 2a-7(c)(3). The rule also places limits on
the remaining maturity of securities in the fund's portfolio. A fund
generally may not acquire, for example, any securities with a
remaining maturity greater than 397 days, and the dollar-weighted
average maturity of the securities owned by the fund may not exceed
90 days. See rule 2a-7(c)(2).
    \28\ See rule 2a-7(c)(7); see also supra note 21 and
accompanying text.
    \29\ See rule 2a-7(c)(7)(ii)(B). Regardless of the extent of the
deviation, rule 2a-7 imposes on the board of a money market fund a
duty to take appropriate action whenever the board believes the
extent of any deviation may result in material dilution or other
unfair results to investors or current shareholders. Rule 2a-
7(c)(7)(ii)(C). See 1983 Adopting Release, supra note 3, at nn. 51-
52 and accompanying text.
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D. Recent Developments

    Money market funds have had a record of stability during their more
than 30 years of operation. Before last fall, only one money market
fund had ever broken the buck.\30\ This record appears to be due
primarily to three factors. First, the short-term debt markets
generally were relatively stable during this period. Second, many fund
advisers (and their portfolio managers and credit analysts) were
skillful in analyzing the risks of portfolio securities and thereby
largely avoiding significant losses that could force a fund to break
the buck.\31\ Finally, fund managers and their affiliated persons have
had significant sources of private capital that they were willing to
make available to support the stable net asset

value of a money market fund when it experienced losses in one or more
of its portfolio securities.
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    \30\ In September 1994, a series of a small institutional money
market fund re-priced its shares below $1.00 as a result of loss in
value of certain floating rate securities. The fund promptly
announced that it would liquidate and distribute its assets to its
shareholders. See 1996 Adopting Release, supra note 20, at n.162.
    \31\ We made similar observations last year. See Temporary
Exemption for Liquidation of Certain Money Market Funds, Investment
Company Act Release No. 28487, at text accompanying nn. 6-7 (Nov.
20, 2008) [73 FR 71919 (Nov. 26, 2008)] (``Rule 22e-3T Adopting
Release'').
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    Since the late 1980s, fund managers from time to time have sought
to prevent a money market fund from breaking the buck by voluntarily
purchasing distressed portfolio securities from the fund, directly or
through an affiliated person, at the higher of market price or
amortized cost.\32\ These events occurred irregularly and involved a
limited number of funds.\33\ In response to these events, the
Commission tightened the risk-limiting conditions of the rule for
taxable funds in 1991 and for tax exempt funds in 1996.\34\ Among other
things, we added diversification requirements to the rule, which
limited the exposure of a fund to any one issuer of securities, thus
reducing the consequences of a credit event affecting the value of a
portfolio holding.\35\ We repeatedly emphasized the responsibility of
fund managers to manage, and fund boards to oversee that the fund is
managed, in a manner consistent with the investment objective of
maintaining a stable net asset value.\36\
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    \32\ These transactions implicate section 17(a) of the
Investment Company Act, which prohibits an affiliated person of a
fund or an affiliated person of such a person from knowingly
purchasing a security from the fund, except in limited
circumstances. Under section 17(b) of the Act, such persons can
apply to the Commission for an exemption from these prohibitions. In
1996, the Commission adopted rule 17a-9, which permits affiliated
persons of funds and affiliated persons of such persons to purchase
distressed securities in funds' portfolios subject to certain
conditions, without the need to first obtain an individual
exemption. We are proposing certain amendments to rule 17a-9 in this
release, as well as an amendment to rule 2a-7 that would require
money market funds to notify us of any transactions under rule 17a-
9. See infra Section II.H.
    \33\ See 1990 Proposing Release, supra note 22, at nn.16-18 and
accompanying text; 1996 Adopting Release, supra note 20, at nn. 22-
23 and accompanying text.
    \34\ See 1991 Adopting Release, supra note 20; 1996 Adopting
Release, supra note 20.
    \35\ See rule 2a-7(c)(4).
    \36\ See 1983 Adopting Release, supra note 3, at nn. 41-42 and
accompanying text; 1996 Adopting Release, supra note 20, at nn. 22-
29 and accompanying text.
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    In 2007, however, losses in the subprime mortgage markets adversely
affected a significant number of money market funds. These money market
funds had invested in asset backed commercial paper issued by
structured investment vehicles (``SIVs''), which were off-balance sheet
conduits sponsored mostly by certain large banks and money
managers.\37\ Although we understand that most SIVs had little exposure
to sub-prime mortgages, they suffered severe liquidity problems and
significant losses when risk-averse short-term investors (including
money market funds), fearing increased exposure to liquidity risk and
residential mortgages, began to avoid the commercial paper the SIVs
issued.\38\ Unable to roll over their short-term debt, SIVs were forced
to liquidate assets to pay off maturing obligations and began to wind
down operations.\39\ In addition, NRSROs rapidly downgraded SIV
securities, increasing downward price pressures already generated by
these securities' lack of liquidity. The value of the commercial paper
fell, which threatened to force several money market funds to break the
buck.
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    \37\ See Neil Shah, Money Market Funds Cut Exposure to Risky SIV
Debt--S&P, Reuters, Nov. 21, 2007, available at http://
www.reuters.com/article/bondsNews/idUSN2146813220071121.
    \38\ We know of at least 44 money market funds that were
supported by affiliates because of SIV investments. In many of these
cases the affiliate support was provided in reliance on no-action
assurances provided by Commission staff. Many of these no-action
letters are available on our Web site. See http://www.sec.gov/
divisions/investment/im-noaction.shtml#money. Unlike other asset
backed commercial paper, SIV debt was not backed by an external
liquidity provider.
    \39\ See, e.g., Alistair Barr, HSBC's Bailout Puts Pressure on
Citi, ``Superfund,'' MarketWatch, Nov. 26, 2007, available at http:/
/www.marketwatch.com/story/hsbcs-35-bln-siv-bailout-puts-pressure-
on-citi-superfund.
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    Money market funds weathered this storm. In some cases, bank
sponsors of SIVs provided support for the SIVs.\40\ In other cases,
money market fund affiliates voluntarily provided support to the funds
by purchasing the SIV investments at their amortized cost or providing
some form of credit support.\41\ Money market funds also benefited from
strong cash flows into money market funds, as investors fled from
riskier markets. During the period from July 2007 to August 2008, more
than $800 billion in new cash was invested in money market funds,
increasing aggregate fund assets by one-third.\42\ Eighty percent of
these investments came from institutional investors.\43\
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    \40\ See, e.g., id.
    \41\ See, e.g., Shannon D. Harrington & Christopher Condon, Bank
of America, Legg Mason Prop Up Their Money Funds, Bloomberg, Nov.
13, 2007, available at http://www.bloomberg.com/apps/
news?pid=20601087&sid=aWWjLp8m3J1I&refer=home. Under rule 17a-9,
funds are not required to report to us all such transactions. See
infra Section II.H.
    \42\ See ICI Report, supra note 6, at 49.
    \43\ Id.
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    As financial markets continued to deteriorate in 2008, however,
money market funds came under renewed stress. This pressure culminated
the week of September 15, 2008 when the bankruptcy of Lehman Brothers
Holdings Inc. (``Lehman Brothers'') led to heavy redemptions from about
a dozen money market funds that held Lehman Brothers debt securities.
On September 15, 2008, The Reserve Fund, whose Primary Fund series held
a $785 million position in commercial paper issued by Lehman Brothers,
began experiencing a run on its Primary Fund, which spread to the other
Reserve funds. The Reserve funds rapidly depleted their cash to satisfy
redemptions, and began offering to sell the funds' portfolio securities
into the market, further depressing their valuations. Unlike the other
money market funds that held Lehman Brothers debt securities (and SIV
commercial paper), The Reserve Primary Fund ultimately had no affiliate
with sufficient resources to support the $1.00 net asset value. On
September 16, 2008, The Reserve Fund announced that as of that
afternoon, its Primary Fund would break the buck and price its
securities at $0.97 per share.\44\ On September 22, 2008, in response
to a request by The Reserve Fund, the Commission issued an order
permitting the suspension of redemptions in certain Reserve funds, to
permit their orderly liquidation.\45\
---------------------------------------------------------------------------

    \44\ See Press Release, The Reserve Fund, A Statement Regarding
The Primary Fund (Sept. 16, 2008). The Reserve Fund subsequently
stated that the fund had broken the buck earlier in the day on
September 16. See Press Release, The Reserve Fund, Important Notice
Regarding Reserve Primary Fund's Net Asset Value (Nov. 26, 2008)
(``The Fund is announcing today that, contrary to previous
statements to the public and to investors, the Fund's net asset
value per share was $0.99 from 11 a.m. Eastern time to 4 p.m.
Eastern time on September 16, 2008 and not $1.00.'').
    \45\ See In the Matter of The Reserve Fund, Investment Company
Act Release No. 28386 (Sept. 22, 2008) [73 FR 55572 (Sept. 25,
2008)] (order). Several other Reserve funds also obtained an order
from the Commission on October 24, 2008 permitting them to suspend
redemptions to allow for their orderly liquidation. See Reserve
Municipal Money-Market Trust, et al., Investment Company Act Release
No. 28466 (Oct. 24, 2008) [73 FR 64993 (Oct. 31, 2008)] (order).
---------------------------------------------------------------------------

    These events led many investors, especially institutional
investors, to redeem their holdings in other prime money market funds
and move assets to Treasury or government money market funds.\46\ This
trend was intensified by turbulence in the market for financial sector
securities as a result of the bankruptcy of Lehman Brothers and the
near failure of American International Group, whose commercial paper
was

held by many prime money market funds.
---------------------------------------------------------------------------

    \46\ See U.S. Dollar Money Market Funds, supra note 17, at 72;
BlackRock, The Credit Crisis: U.S. Government Actions and
Implications for Cash Investors (Nov. 2008), available at https://
www2.blackrock.com/webcore/litService/search/
getDocument.seam?venue=PUB_
INS&ServiceName=PublicServiceView&ContentID=50824 (``The Credit
Crisis''); Standard & Poor's, Money Market Funds Tackle `Exuberant
Irrationality,' Ratings Direct, Sept. 30, 2008, available at http://
www2.standardandpoors.com/spf/pdf/media/MoneyMarketFunds_
Irrationality.pdf.
---------------------------------------------------------------------------

    During the week of September 15, 2008, investors withdrew
approximately $300 billion from prime (taxable) money market funds, or
14 percent of the assets held in those funds.\47\ Most of the heaviest
redemptions were from institutional funds, which depleted cash
positions and threatened to force a fire sale of portfolio securities
that would have placed widespread pressure on fund share prices.\48\
Fearing further redemptions, money market fund (and other cash)
managers began to retain cash rather than invest in commercial paper,
certificates of deposit or other short-term instruments.\49\ In the
final two weeks of September 2008, money market funds reduced their
holdings of top-rated commercial paper by $200.3 billion, or 29
percent.\50\
---------------------------------------------------------------------------

    \47\ See ICI Report, supra note 6, at 62 (analyzing data from
iMoneyNet); see also Investment Company Institute, Money Market
Mutual Fund Assets Historical Data, Apr. 30, 2009, available at
http://www.ici.org/pdf/mm_data_2009.pdf (``ICI Mutual Fund
Historical Data'').
    \48\ See ICI Mutual Fund Historical Data, supra note 47.
    \49\ See Philip Swagel, ``The Financial Crisis: An Inside
View,'' Brookings Papers on Economic Activity, at 31 (Spring 2009)
(conference draft), available at http://www.brookings.edu/economics/
bpea/~/media/Files/Programs/ES/BPEA/2009_spring_bpea_papers/
2009_spring_bpea_swagel.pdf.
    \50\ See Christopher Condon & Bryan Keogh, Funds' Flight from
Commercial Paper Forced Fed Move, Bloomberg, Oct. 7, 2008, available
at http://www.bloomberg.com/apps/
news?pid=newsarchive&sid=a5hvnKFCC_pQ.
---------------------------------------------------------------------------

    As a consequence, short-term markets seized up, impairing access to
credit in short-term private debt markets.\51\ Some commercial paper
issuers were only able to issue debt with overnight maturities.\52\ The
interest rate premium (spread) over three-month Treasury bills paid by
issuers of three-month commercial paper widened significantly from
approximately 25-100 basis points before the September 2008 market
events to approximately 200-350 basis points, and issuers were exposed
to the costs and risks of having to roll over increasingly large
amounts of commercial paper each day.\53\ Many money market fund
sponsors took extraordinary steps to protect funds' net assets and
preserve shareholder liquidity by purchasing large amounts of
securities at the higher of market value or amortized cost and by
providing capital support to the funds.\54\
---------------------------------------------------------------------------

    \51\ See Minutes of the Federal Open Market Committee, Federal
Reserve Board, Oct. 28-29, 2008, at 5, available at http://
www.federalreserve.gov/monetarypolicy/files/fomcminutes20081029.pdf
(``FRB Open Market Committee Oct. 28-29 Minutes'') (stating that
following The Reserve Fund's announcement that the Primary Fund
would break the buck, ``risk spreads on commercial paper rose
considerably and were very volatile'' and ``[c]onditions in short-
term funding markets improved somewhat following the announcement of
* * * a number of mutual initiatives by the Federal Reserve and the
Treasury to address the pressures on money market funds and the
commercial paper market''). See also Press Release, Federal Reserve
Board Announces Creation of the Commercial Paper Funding Facility
(CPFF) to Help Provide Liquidity to Term Funding Markets (Oct. 7,
2008), available at http://www.federalreserve.gov/newsevents/press/
monetary/20081007c.htm (``The commercial paper market has been under
considerable strain in recent weeks as money market mutual funds and
other investors, themselves often facing liquidity pressures, have
become increasingly reluctant to purchase commercial paper,
especially at longer-dated maturities. As a result, the volume of
outstanding commercial paper has shrunk, interest rates on longer
term commercial paper have increased significantly, and an
increasingly high percentage of outstanding paper must now be
refinanced each day. A large share of outstanding commercial paper
is issued or sponsored by financial intermediaries, and their
difficulties placing commercial paper have made it more difficult
for those intermediaries to play their vital role in meeting the
credit needs of businesses and households.'').
    \52\ See Matthew Cowley, Burnt Money Market Funds Stymie Short-
Term Debt, Dow Jones International News, Oct. 1, 2008; Anusha
Shrivastava, Commercial-Paper Market Seizes Up, The Wall Street
Journal, Sept. 19, 2008, at C2.
    \53\ See Federal Reserve Board data, available at http://
www.frbatlanta.org/econ_rd/macroblog/102808b.jpg (charting three-
month commercial paper spreads over three-month Treasury bill); see
also Federal Reserve Board Chairman Ben S. Bernanke, Testimony
before the Committee on Financial Services, U.S. House of
Representatives (Nov. 18, 2008), available at http://
www.federalreserve.gov/newsevents/testimony/bernanke20081118a.htm.
    \54\ Commission staff provided no-action assurances allowing 100
money market funds in 18 different fund complexes to enter into such
arrangements during the period from September 16, 2008 to October 1,
2008. See, e.g., http://www.sec.gov/divisions/investment/im-
noaction.shtml#money.
---------------------------------------------------------------------------

    On September 19, 2008, the U.S. Department of the Treasury and the
Board of Governors of the Federal Reserve System (``Federal Reserve
Board'') announced an unprecedented market intervention by the federal
government in order to stabilize and provide liquidity to the short-
term markets. The Department of the Treasury announced its Temporary
Guarantee Program for Money Market Funds (``Guarantee Program''), which
temporarily guaranteed certain investments in money market funds that
decided to participate in the program.\55\ The Federal Reserve Board
announced the creation of its Asset-Backed Commercial Paper Money
Market Mutual Fund Liquidity Facility (``AMLF''), through which it
extended credit to U.S. banks and bank holding companies to finance
their purchases of high-quality asset backed commercial paper from
money market funds.\56\ In addition, the Federal Reserve Board's
Commercial Paper Funding Facility (``CPFF'') provided support to
issuers of commercial paper through a conduit that purchased commercial
paper from eligible issuers, although the CPFF did not purchase
commercial paper from money market funds.\57\ The Commission and its
staff worked closely with the Treasury Department and the Federal
Reserve Board to help design these programs, most of which relied in
part on rule 2a-7 to tailor the program and/or condition the terms of a
fund's participation in the program, and we also assisted in
administering the Guarantee Program.\58\ Our staff also

worked with sponsors of money market funds to provide regulatory relief
they requested to participate fully in these programs.\59\
---------------------------------------------------------------------------

    \55\ See Press Release, U.S. Department of the Treasury,
Treasury Announces Guaranty Program for Money Market Funds (Sept.
19, 2008), available at http://www.treas.gov/press/releases/
hp1147.htm. The Program insures investments in money market funds,
to the extent of their shareholdings as of September 19, 2008, if
the fund has chosen to participate in the Program. The Guarantee
Program is due to expire on September 18, 2009. We adopted, on an
interim final basis, a temporary rule, rule 22e-3T, to facilitate
the ability of money market funds to participate in the Guarantee
Program. The rule permits a participating fund to suspend
redemptions if it breaks a buck and liquidates under the terms of
the Program. See Rule 22e-3T Adopting Release, supra note 31. The
temporary rule will expire on October 18, 2009. We discuss this rule
in more detail in infra Section II.I.
    \56\ See Press Release, Federal Reserve Board, Federal Reserve
Board Announces Two Enhancements to Its Programs to Provide
Liquidity to Markets (Sept. 19, 2008), available at http://
www.federalreserve.gov/newsevents/press/monetary/20080919a.htm. The
AMLF will expire on February 1, 2010, unless extended. See Press
Release, Federal Reserve Board, Federal Reserve Announces Extensions
of and Modifications to a Number of Its Liquidity Programs (June 25,
2009), available at http://www.federalreserve.gov/newsevents/press/
monetary/20090625a.htm (``2009 Federal Reserve Extension and
Modification Announcement'').
    \57\ See Press Release, Federal Reserve Board, Board Announces
Creation of the Commercial Paper Funding Facility (CPFF) to Help
Provide Liquidity to Term Funding Markets (Oct. 7, 2008), available
at http://www.federalreserve.gov/newsevents/press/monetary/
20081007c.htm. At one point the Federal Reserve had purchased about
one-fifth of all commercial paper outstanding in the U.S. market.
See Bryan Keogh, GE Leads Commercial Paper ``Test'' as Fed's Buying
Ebbs, Bloomberg, Jan. 27, 2009, available at http://
www.bloomberg.com/apps/news?pid=newsarchive&sid=aHWA87Aa2aQQ. The
CPFF will expire on February 1, 2010, unless extended. See 2009
Federal Reserve Extension and Modification Announcement, supra note
56. Although the CPFF did not directly benefit money market funds,
it did indirectly benefit them by stabilizing the commercial paper
market. See, e.g., Richard G. Anderson, The Success of the CPFF?
(Economic Synopses No. 18, Federal Reserve Bank of St. Louis, 2009),
at 2, available at http://www.research.stlouisfed.org/publications/
es/09/ES0918.pdf.
    \58\ See, e.g., Guarantee Agreement that money market funds
participating in the Treasury's Guarantee Program were required to
sign, at 2, 10, available at http://www.treas.gov/offices/domestic-
finance/key-initiatives/money-market-docs/Guarantee-Agreement_
form.pdf (under which money market funds were required to state that
they operated in compliance with rule 2a-7 to be eligible to
initially participate in the program and must continue to comply
with rule 2a-7 to continue to participate in the program); see also
http://www.sec.gov/divisions/investment/mmtempguarantee.htm.
    \59\ See Investment Company Institute, SEC Staff No-Action
Letter (Sept. 25, 2008) (relating to the AMLF); Investment Company
Institute, SEC Staff No-Action Letter (Oct. 8, 2008) (relating to
the Guarantee Program). These no-action letters are available on our
Web site at http://www.sec.gov/divisions/investment/im-
noaction.shtml#money.
---------------------------------------------------------------------------

    These steps helped to stanch the tide of redemptions from
institutional prime money market funds,\60\ and provided liquidity to
money market funds that held asset backed commercial paper. Commercial
paper markets remained illiquid, however, and, as a result, money
market funds experienced significant problems pricing portfolio
securities. Institutional as well as retail money market funds with
little redemption activity and no distressed securities reported to our
staff that they nevertheless faced the prospect of breaking the buck as
a consequence of their reliance on independent pricing services that
reported prices based on models with few reliable inputs. The
Commission's Office of Chief Accountant and the Financial Accounting
Standards Board provided funds and others guidance on determining fair
value of securities in turbulent markets,\61\ but it appeared that fund
boards remained reluctant to deviate from the prices received from
their vendors. On October 10, 2008, our Division of Investment
Management issued a letter agreeing not to recommend enforcement action
if money market funds met the ``shadow pricing'' obligations of rule
2a-7 by pricing certain of their portfolio securities with a remaining
final maturity of less than 60 days by reference to their amortized
cost.\62\
---------------------------------------------------------------------------

    \60\ During the week ending September 18, 2008, taxable
institutional money market funds experienced net outflows of $165
billion. See Money Fund Assets Fell to $3.4T in Latest Week,
Associated Press, Sept. 18, 2008. Almost $80 billion was withdrawn
from prime money market funds even after the announcement of the
Guarantee Program on September 19, 2008. See Diana B. Henriques, As
Cash Leaves Money Funds, Financial Firms Sign Up for U.S.
Protection, N.Y. Times, Oct. 2, 2008, at C10. However, by the end of
the week following the announcement, net outflows from taxable
institutional money market funds had ceased. See Money Fund Assets
Fell to $3.398T in Latest Week, Associated Press, Sept. 25, 2008.
    \61\ See Press Release No. 2008-234, Securities and Exchange
Commission, Office of the Chief Accountant and FASB Staff
Clarifications on Fair Value Accounting (Sept. 30, 2008), available
at http://www.sec.gov/news/press/2008/2008-234.htm.
    \62\ Investment Company Institute, SEC Staff No-Action Letter
(Oct. 10, 2008). This letter is available on our Web site at http://
www.sec.gov/divisions/investment/noaction/2008/ICI101008.htm. The
letter by its terms did not apply, however, to shadow pricing if
particular circumstances (such as the impairment of the
creditworthiness of the issuer) suggested that amortized cost was
not appropriate. The staff position also was limited to portfolio
securities that were ``first tier securities'' under rule 2a-7 and
that the fund reasonably expected to hold to maturity. The letter
applied to shadow pricing procedures through January 12, 2009.
---------------------------------------------------------------------------

    Over the four weeks after The Reserve Fund's announcement, assets
in institutional prime money market funds shrank by 30 percent, or
approximately $418 billion (from $1.38 trillion to $962 billion).\63\
No money market fund other than The Reserve Primary Fund broke the
buck, although money market fund sponsors or their affiliated persons
in many cases committed extraordinary amounts of capital to support the
$1.00 net asset value per share. Our staff estimates that during the
period from August 2007 to December 31, 2008, almost 20 percent of all
money market funds received some support from their money managers or
their affiliates.\64\
---------------------------------------------------------------------------

    \63\ On September 10, 2008, six days prior to The Reserve Fund's
announcement, approximately $1.38 trillion was invested in
institutional prime (taxable) money market funds. See ICI Mutual
Fund Historical Data, supra note 47. On October 8, 2008,
approximately $962 billion was invested in those funds. See id. In
addition, between September 10 and September 17, the assets of these
funds fell by approximately $193 billion. See id.
    \64\ This estimate is based on no-action requests and other
conversations with our staff during this time period.
---------------------------------------------------------------------------

    During this time period, short-term credit markets became virtually
frozen as market participants hoarded cash and generally refused to
lend on more than an overnight basis.\65\ Interest rate spreads
increased dramatically.\66\ After shrinking to historically low levels
as credit markets boomed in the mid-2000s, interest rate spreads surged
upward in the summer of 2007 and peaked after the bankruptcy of Lehman
Brothers in September 2008.\67\ Money market funds shortened the
weighted average maturity of their portfolios to be better positioned
in light of increased liquidity risk to the funds.\68\
---------------------------------------------------------------------------

    \65\ The Credit Crisis, supra note 46, at 1 (``After
experiencing more than $400 billion in outflows over a short period
of time, money funds had little appetite for commercial paper; even
quality issuers discovered they could not access the commercial
paper market * * *.'').
    \66\ An interest rate spread measures the difference in interest
rates of debt instruments with different risk. See Markus K.
Brunnermeier, Deciphering the Liquidity and Credit Crunch 2007-2008,
23 J. Econ. Perspectives 77, 85, Winter 2009 (``Brunnermeier'').
    \67\ See id.; David Oakley, LIBOR Hits Record Low as Credit
Fears Ease, Fin. Times, May 5, 2009. For example, the ``TED'' spread
(the difference between the risk-free U.S. Treasury Bill rate and
the riskier London Interbank Offering Rate (``LIBOR'')), normally
around 50 basis points, reached a high of 463 basis points on
October 10, 2008. See David Serchuk, Banks Led by the TED, Forbes,
Jan. 12, 2009.
    \68\ Taxable money market fund average weighted average
maturities shortened to 40-42 days during October 2008 from 45-46
days shortly prior to this period based on analysis of data from the
iMoneyNet Money Fund Analyzer database.
---------------------------------------------------------------------------

    Although the crisis money markets faced last fall has abated, the
problems have not disappeared. Today, while interest rate spreads have
recently declined considerably, they remain above levels prior to the
crisis,\69\ and short-term debt markets remain fragile.\70\ Although
the average weighted average maturity of taxable money market funds (as
a group) had risen to 53 days as of the week ended June 16, 2009,\71\
we understand that the long-term securities that account for the longer
weighted average maturity are not commercial paper and corporate medium
term notes (as they were before the crisis), but instead are
predominantly government securities, which suggests that money market
funds may still be concerned about credit risk.
---------------------------------------------------------------------------

    \69\ The TED spread was 52 basis points on May 29, 2009. The
LIBOR-OIS spread (the difference between three-month dollar London
Interbank Offered Rate and the overnight index swap rate) was 45
basis points. See Lukanyo Mnyanda, Libor Declines for Second Day on
Signs Economic Slump is Easing, Bloomberg, May 29, 2009, available
at http://www.bloomberg.com/apps/news?pid=20670001&sid=agpZArg2paJE.
Prior to the start of the financial turbulence in the summer of
2007, the TED spread averaged approximately 25-50 basis points and
the three-month LIBOR-OIS spread averaged 7-9 basis points. See
historical chart of TED spread available at http://
www.bloomberg.com/apps/cbuilder?ticker1=.TEDSP%3AIND; Simon Kwan,
Behavior of LIBOR in the Current Financial Crisis, FRBSF Economic
Letter (Federal Reserve Bank of San Francisco), Jan. 23, 2009, at 2-
3, available at http://www.frbsf.org/publications/economics/letter/
2009/el2009-04.pdf.
    \70\ See Bryan Keogh, John Detrixhe & Gabrielle Coppola, Coca-
Cola Flees Commercial Paper for Safety in Bonds, Bloomberg, Mar. 17,
2009, available at http://www.bloomberg.com/apps/
news?pid=newsarchive&sid=atxKQSJUp6RE (noting that certain companies
are issuing long-term debt to replace commercial paper to avoid the
risk of not being able to roll over their commercial paper, given
the instability in short-term credit markets); Michael McKee, Fed
Credit Has Stabilized Markets, Not Fixed Them, Study Says,
Bloomberg, Mar. 6, 2008, available at http://www.bloomberg.com/apps/
news?pid=newsarchive&sid=aRGBZuGYE78Y.
    \71\ This information is based on analysis of data from the
iMoneyNet Money Fund Analyzer database.
---------------------------------------------------------------------------

    The Treasury Guarantee Program has been extended twice, but is set
to expire on September 18, 2009.\72\ Programs

established by the Federal Reserve Board to support liquidity in the
short-term market are set to expire early next year.\73\ Total money
market fund assets have continued to grow and now amount to
approximately $3.8 trillion.\74\ However, the composition of those
assets has changed dramatically. Between September 10 and October 8,
2008, government money market fund assets increased by about 47 percent
compared to a decrease of about 21 percent in taxable prime money
market fund assets.\75\ Since that time, prime money market fund assets
have begun to grow again, although they remain below pre-September 2008
levels and government money market fund assets remain elevated.\76\
---------------------------------------------------------------------------

    \72\ See Press Release, U.S. Department of the Treasury,
Treasury Announces Extension of Temporary Guarantee Program for
Money Market Funds (Nov. 24, 2008), available at http://
www.treas.gov/press/releases/hp1290.htm; Press Release, U.S.
Department of the Treasury, Treasury Announces Extension of
Temporary Guarantee Program for Money Market Funds (Mar. 31, 2009),
available at http://www.treas.gov/press/releases/tg76.htm.
    \73\ The AMLF and the CPFF will expire on February 1, 2010. See
Press Release, Federal Reserve (June 25, 2009), available at http://
www.federalreserve.gov/newsevents/press/monetary/20090625a.htm. The
use of the AMLF peaked on October 1, 2008, with holdings of $152.1
billion. See Federal Reserve Board, Statistical Release H.4.1:
Factors Affecting Reserve Balances (Oct. 2, 2008), available at
http://www.federalreserve.gov/releases/h41/20081002. AMLF holdings
as of April 29, 2009 stood at $3.699 billion. See Federal Reserve
Board, Statistical Release H.4.1: Factors Affecting Reserve Balances
(Apr. 30, 2009), available at http://www.federalreserve.gov/
releases/h41/20090430.
    \74\ See ICI Trends, supra note 4.
    \75\ See ICI Mutual Fund Historical Data, supra note 47.
    \76\ See id.
---------------------------------------------------------------------------

    Finally, The Reserve Primary Fund has yet to distribute all of its
remaining assets to shareholders, many of whom were placed in financial
hardship as a result of losing access to their investments.\77\ The
dissolution of the fund has been affected by several factors, including
operational difficulties and lack of liquidity in the secondary
markets, and by legal uncertainties over the disposition of the
remaining assets. We recently instituted an action in federal court
seeking to ensure that the liquidation is effected on a fair and
equitable basis,\78\ and propose in this release regulatory changes
designed to protect investors in a fund that breaks a dollar in the
future.\79\
---------------------------------------------------------------------------

    \77\ The Reserve Primary Fund did not make an initial partial
pro rata distribution of assets until October 30, 2008. See Press
Release, The Reserve Fund, Reserve Primary Fund Makes Initial
Distribution of $26 Billion to Primary Fund Shareholders (Oct. 30,
2008). The fund has distributed approximately 90 percent of its
assets. See Press Release, The Reserve Fund, Court Issues Order
Setting Objection and Hearing Dates on Securities and Exchange
Commission's Proposed Plan for Distribution of Reserve Primary
Fund's Assets (June 15, 2009).
    \78\ See SEC v. Reserve Management Co., Inc., et al., Litigation
Release No. 21025 (May 5, 2009), available at http://www.sec.gov/
litigation/litreleases/2009/lr21025.htm. We note that we also have
filed fraud charges against several entities and individuals who
operate The Reserve Primary Fund alleging that they failed to
provide key material facts to investors and trustees about the
fund's vulnerability as Lehman Brothers sought bankruptcy
protection. See id.
    \79\ See infra Section II.I.
---------------------------------------------------------------------------

II. Discussion

    The severe problems experienced by money market funds since the
fall of 2007 and culminating in the fall of 2008 have prompted us to
review our regulation of money market funds. Based on that review,
including our experience with The Reserve Fund, we today are proposing
for public comment a number of significant amendments to rule 2a-7
under the Investment Company Act.
    In formulating these proposals, Commission staff has consulted
extensively with other members of the President's Working Group on
Financial Markets, and in particular the Department of Treasury and the
Federal Reserve Board, which provided support to money market funds and
the short-term debt markets last fall, and which continue to administer
programs from which money market funds and their shareholders benefit.
We have consulted with managers of money market funds and other experts
to develop a deeper understanding of the stresses experienced by funds
and the impact of our regulations on the readiness of money market
funds to cope with market turbulence and satisfy heavy demand for
redemptions. In March, we received an extensive report from a ``Money
Market Working Group'' assembled by the Investment Company Institute
(``ICI Report''), which recommended a number of changes to our rule 2a-
7 that it believes could improve the safety and oversight of money
market funds.\80\ We have also drawn from our experience as a regulator
of money market funds under rule 2a-7 for more than 25 years and
particularly since autumn 2007.
---------------------------------------------------------------------------

    \80\ ICI Report, supra note 6.
---------------------------------------------------------------------------

    Our proposals, which we discuss in more detail below, are designed
to increase the resilience of money market funds to market disruptions
such as those that occurred last fall. The proposed rules would reduce
the vulnerability of money market funds to breaking the buck by, among
other things, improving money market funds' ability to satisfy
significant demands for redemptions. If a particular fund does break
the buck and determines to liquidate, the proposed rules would
facilitate the orderly liquidation of the fund in order to protect the
interests of all fund shareholders. These changes together should make
money market funds (collectively) less susceptible to a run by
diminishing the chance that a money market fund will break a dollar
and, if one does, provide a means for the fund to orderly liquidate its
assets. Finally, our proposals would improve our ability to oversee
money market funds by requiring funds to submit to us current portfolio
information.
    Our proposals represent the first step in addressing issues we
believe merit immediate attention.\81\ Throughout this release, we ask
comment on other possible regulatory changes aimed at further
strengthening the stability of money market funds. In addition, we ask
comment on some more far-reaching changes that could transform the
business and regulatory model on which money market funds have operated
for more than 30 years, including whether money market funds should
move to a floating net asset value.\82\ We expect to benefit from the
comments we receive before deciding whether to propose further changes.
---------------------------------------------------------------------------

    \81\ We note that we accomplished the reforms of money market
fund regulation we initiated in 1990 in two steps. See 1990
Proposing Release, supra note 22 (taxable money market funds);
Revisions to Rules Regulating Money Market Funds, Investment Company
Act Release No. 19959 (Dec. 17, 1993) [58 FR 68585 (Dec. 28, 1993)]
(tax exempt money market funds) (``1993 Proposing Release'').
    \82\ See infra Section III.A.
---------------------------------------------------------------------------

A. Portfolio Quality

    To limit the amount of credit risk to which money market funds can
be exposed, rule 2a-7 limits them to investing in securities that a
fund's board of directors (or its delegate pursuant to written
guidelines) determines present minimal credit risks.\83\ In addition,
securities must at the time of acquisition be ``eligible securities,''
which means in part that they must have received the highest or second
highest short-term debt ratings from the ``requisite NRSROs.'' \84\

Because of the additional credit risk that generally is represented by
securities rated in the second highest, rather than the highest, NRSRO
rating category, a taxable money market fund may not invest more than
five percent of its total assets in ``second tier securities.'' \85\
Tax exempt money market funds are limited in the same manner only with
respect to second tier ``conduit securities,'' i.e., municipal
securities backed by a private issuer.\86\
---------------------------------------------------------------------------

    \83\ Rule 2a-7(c)(3)(i). Although rule 2a-7 refers to
determinations to be made by a fund or its board, many of these
determinations under the rule may be delegated to the investment
adviser or fund officers pursuant to written guidelines that the
board establishes and oversees to assure that the applicable
procedures are being followed. Rule 2a-7(e).
    \84\ Rule 2a-7(a)(10)(i) (defining ``eligible security''). If
the securities are unrated, they must be of comparable quality. Rule
2a-7(a)(10)(ii). The term ``requisite NRSROs'' is defined in
paragraph (a)(21) of the rule to mean ``(i) Any two NRSROs that have
issued a rating with respect to a security or class of debt
obligations of an issuer; or (ii) If only one NRSRO has issued a
rating with respect to such security or class of debt obligations of
an issuer at the time the fund Acquires the security, that NRSRO.''
Thus, a security can satisfy the ratings requirement in one of four
ways: (1) It is rated in the same (top two) category by any two
NRSROs; (2) if it is rated by at least two NRSROs in either of the
top two categories, but no two NRSROs assign the same rating, the
lower rating is assigned; (3) it is rated by only one NRSRO, in one
of the top two categories; or (4) it is an unrated security that the
board or its delegate determines to be of comparable quality to
securities satisfying the rating criteria. The terms ``rated
security'' and ``unrated security'' are defined in paragraphs
(a)(19) and (a)(28) of rule 2a-7, respectively.
    \85\ Rule 2a-7(c)(3)(ii)(A). See also rule 2a-7(a)(10) (defining
``eligible security''), (a)(22) (defining ``second tier security''
as any eligible security that is not a first tier security), and
(a)(12) (defining ``first tier security'' as, among other things,
any eligible security that, if rated, has received the highest
short-term term debt rating from the requisite NRSROs or, if
unrated, has been determined by the fund's board of directors to be
of comparable quality). See also 1990 Proposing Release, supra note
22, at Section II.1.b.
    \86\ Rule 2a-7(c)(3)(ii)(B). See also rule 2a-7(a)(7) (defining
``conduit security'').
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    We are also proposing a change to the provisions of rule 2a-7 that
limit money market funds to investing in high quality securities. We
propose to generally limit money market fund investments to securities
rated in the highest NRSRO ratings category. In addition, we are
seeking comment on whether to modify provisions of the rule that
incorporate minimum ratings by NRSROs to reflect changes made to the
federal securities laws by the Credit Rating Agency Reform Act of 2006
(``Rating Agency Reform Act'').\87\
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    \87\ Credit Rating Agency Reform Act of 2006, Pub. L. 109-291,
120 Stat. 1327.
---------------------------------------------------------------------------

1. Second Tier Securities
    We propose to amend rule 2a-7 to allow money market funds to invest
only in first tier securities. Under the proposed amendments, money
market funds could ``acquire'' only ``eligible securities,'' which
would be re-defined to include securities receiving only the highest
(rather than the highest two) short-term debt ratings from the
``requisite NRSROs.'' \88\ Funds would not have to immediately dispose
of a security that was downgraded by the requisite NRSROs but, under
existing provisions of rule 2a-7, the fund would have to dispose of the
security ``as soon as practicable consistent with achieving an orderly
disposition of the security'' unless the fund's board of directors
finds that such disposal would not be in the best interest of the
fund.\89\
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    \88\ See rule 2a-7(a)(1) (defining acquisition (or acquire) as
any purchase or subsequent rollover, but not including the failure
to exercise a demand feature); proposed rule 2a-7(a)(11)(iii)
(defining eligible security); proposed rule 2a-7(c)(3) (portfolio
quality). Because eligible securities would no longer be divided
into first tier and second tier securities, both of those terms
would be deleted from the rule, as would provisions relating
specifically to second tier securities. See rule 2a-7(a)(12),
(a)(22), (c)(3)(ii), (c)(4)(i)(C), (c)(4)(iii)(B), (c)(6)(i)(A), and
(c)(6)(i)(C). We would therefore amend the definition of eligible
security to require that securities receive ``the highest,'' as
opposed to ``one of the two highest'' short-term rating categories,
as the current definition provides, and delete other references in
the rule to the second highest rating category. See proposed rule
2a-7(a)(11)(iii). The definition of eligible security also would be
expanded to include two types of securities, securities issued by a
money market fund and ``Government securities,'' that were formerly
part of the definition of first tier securities. See proposed rule
2a-7(a)(11)(i) and (ii); see also rule 2a-7(a)(14) (defining
Government security). Unrated securities determined by the board of
directors of the fund or its delegate to be of comparable quality
also would still be eligible securities. See proposed rule 2a-
7(a)(11)(iv).
    \89\ See rule 2a-7(c)(6)(ii); proposed rule 2a-7(c)(7)(ii).
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    We have considered previously the extent to which money market
funds should be permitted to invest in second tier securities. In 1991,
following distress at several money market funds that held defaulted
commercial paper, the Commission, among other things, limited a taxable
money market fund's total investment in second tier securities to five
percent of the fund's portfolio assets and limited the investment in
any particular issuer of second tier securities to no more than the
greater of one percent of the fund's portfolio assets or $1
million.\90\ At that time, commenters in favor of eliminating money
market funds' investment in second tier securities argued that such
securities may undergo a rapid deterioration and thus may pose risks to
the fund holding such securities as well as to investor confidence in
money market funds in general.\91\ On the other hand, issuers of second
tier securities urged the Commission not to limit money market funds'
holdings of second tier securities, arguing that the Commission's
concerns regarding the creditworthiness of second tier securities were
misplaced and that restrictions would raise issuers' borrowing costs
and discourage money market funds from holding any second tier
securities.\92\ Based principally on the potential risk to money market
funds of holding second tier securities, we adopted the five percent
and one percent limitations to limit (but not eliminate) exposure of
money market funds to second tier securities and any one issuer of
second tier securities.\93\
---------------------------------------------------------------------------

    \90\ See rule 2a-7(c)(3)(ii)(A), (c)(4)(i)(C)(1). See also 1991
Adopting Release, supra note 20.
    \91\ See 1991 Adopting Release, supra note 20, at n.36 and
accompanying text. Most commenters representing the mutual fund
industry supported or did not oppose the limitations we proposed.
Id. at n.35 and accompanying text.
    \92\ See id. at text following n.35.
    \93\ See id. at n.35-37 and accompanying text; 1990 Proposing
Release, supra note 22, at n.33 and accompanying text.
---------------------------------------------------------------------------

    Second tier securities were not directly implicated in the recent
strains on money market funds. The ICI's Money Market Working Group
expressed concern to us, however, that these securities may present an
``imprudent'' risk to the stable value of money market funds because
they present ``weaker credit profiles, smaller overall market share,
and smaller issuer program sizes * * *'' \94\ Our examination of the
data discussed below suggests support for their recommendation that
money market funds no longer be permitted to invest in these
securities.\95\
---------------------------------------------------------------------------

    \94\ ICI Report, supra note 6, at 101.
    \95\ Id. at 100.
---------------------------------------------------------------------------

    Compared to the market for first tier securities, the market for
second tier securities is relatively small. As of June 24, 2009, there
was $1082.5 billion in rule 2a-7-eligible commercial paper outstanding,
consisting of $1035.8 billion (95.7 percent) of first tier and $46.7
billion (4.3 percent) of second tier.\96\ The size of the second tier
market has remained consistently small over time.\97\
---------------------------------------------------------------------------

    \96\ See Federal Reserve Board Commercial Paper Outstanding
Chart, available at http://www.federalreserve.gov/releases/cp/
outstandings.htm (showing weekly levels of rule 2a-7-eligible
commercial paper outstanding).
    \97\ See Federal Reserve Board Commercial Paper Data Download
Program, available at http://www.federalreserve.gov/DataDownload/
Choose.aspx?rel=CP (select year-end outstandings from the
preformatted data package menu and follow the instructions for
download). Over the last eight years, the market for second tier
securities on average has represented only 4.6 percent of the rule
2a-7-eligible commercial paper market.
---------------------------------------------------------------------------

    In addition, second tier securities present potentially
substantially more risk than first tier securities. As the following
chart shows, during the market disruptions of last fall, second tier
securities experienced significantly wider credit spreads than first
tier securities.\98\
---------------------------------------------------------------------------

    \98\ See Federal Reserve Board Commercial Paper Rates Chart,
available at http://www.federalreserve.gov/releases/cp/default.htm.
See also Frank J. Fabozzi, The Handbook of Fixed Income Securities,
at 4 (7th ed. 2005) (``Default risk or credit risk refers to the
risk that the issuer of a bond may be unable to make timely payment
of principal or interest payments * * *. The spread between Treasury
securities and non-Treasury securities that are identical in all
respects except for quality is referred to as a credit spread or
quality spread.'').

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[GRAPHIC] [TIFF OMITTED] TP08JY09.000

Second tier securities as an asset class also are of weaker credit
quality in terms of interest coverage ratios, debt coverage ratios, and
debt to equity ratios.\99\ These data strongly suggest that second tier
securities generally present additional risks to a money market fund.
This is a conclusion that may have been reached by money market fund
managers, most of which (as described below) do not invest in second
tier securities. In light of the risks that second tier securities
generally present to money market funds, and the consequences to funds
and fund investors of breaking a dollar, we are proposing to limit
funds to investing in first tier securities. We believe such a
limitation would make it less likely that a money market fund would
hold a problematic security, or a security that would lose significant
value as a result of market disruptions.
---------------------------------------------------------------------------

    \99\ See Standard & Poor's, CreditStats: 2007 Adjusted Key U.S.
Industrial and Utility Financial Ratios, at 6, Table 3 (Sept. 10,
2008), available at http://www2.standardandpoors.com/spf/pdf/
fixedincome/CreditStats_2007_Adjusted_Key_Financial_Ratios.pdf
(showing A-2 rated commercial paper had EBIT interest coverage of
7.2x, free operating cash flow to debt of 16.7%, and debt to debt
plus equity of 45.1%, compared to A-1 averages of 11.5x, 31.3%, and
37.1%, respectively, represented as three-year (2005-2007)
averages).
---------------------------------------------------------------------------

    It does not appear that amending rule 2a-7 to eliminate money
market funds' ability to acquire second tier securities would be
materially disruptive to funds. Prior to our amendments to rule 2a-7 in
1991, non-government money market funds held more than eight percent of
their assets in second tier securities.\100\ After we restricted the
amount of second tier securities money market funds could buy, the
funds soon reduced their holdings to almost zero.\101\ Our staff's
review of money market fund portfolios in September 2008 found that
second tier securities represented only 0.4 percent of the $3.6
trillion held by the funds (approximately $14.6 billion).
---------------------------------------------------------------------------

    \100\ See Crabbe & Post, supra note 15, at 11, Table 2.
    \101\ See id. at 11-12.
---------------------------------------------------------------------------

    We request comment on our proposal to eliminate the ability of
money market funds to invest in second tier securities. What would be
the impact on funds? Would the benefit of reducing credit risk by
eliminating the ability of money market funds to invest in second tier
securities outweigh any potential diversification benefits that second
tier securities may otherwise provide to money market funds? What, if
any, diversification benefits do money market funds currently receive
from investing in second tier securities? Would this change have a
significant effect on yields?
    Would there be a proportionately greater impact of eliminating
second tier securities on smaller or less established money market
funds or on particular types of funds (e.g., single-state tax exempt
funds)? If the proposal to eliminate funds' ability to hold second tier
securities is adopted, what transition period should we provide money
market funds to dispose of their existing second tier holdings in an
orderly manner? Should we allow funds that hold second tier securities
after the amended rule becomes effective to continue to hold such
securities until maturity?
    Are there alternatives to eliminating entirely the ability of a
money market fund to invest in second tier securities? For example,
should money market funds instead be limited to investing in second
tier securities (i) with a maximum maturity of, for example, 45 days,
or (ii) as a smaller portion of fund assets, such as two percent of the
total assets, or (iii) a combination of both? A security with a shorter
maturity presents less credit risk to a fund (because the exposure is
shorter) and less liquidity risk (because cash will be available
sooner). Would such an approach address, or at least partly address,
the concerns raised by the ICI Report and in this Release? \102\ Could
additional credit risk analysis or other procedures be imposed with
respect to second tier securities to address these concerns?
---------------------------------------------------------------------------

    \102\ See ICI Report, supra note 6, at 100-101.

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

2. Eligible Securities
a. Use of NRSROs
    As discussed above, rule 2a-7 currently requires a money market
fund to limit its portfolio investments to eligible securities, i.e.,
short-term securities that at the time of acquisition have received
ratings from the ``requisite NRSROs'' in one of the two highest short-
term debt rating categories and securities that are comparable to rated
securities.\103\
---------------------------------------------------------------------------

    \103\ See supra note 84 and accompanying text. A ``rated
security'' generally means a security that (i) has received a short-
term rating from an NRSRO, or whose issuer has received a short-term
rating from an NRSRO with respect to a class of debt obligations
that is comparable in priority and security with the security; or
(ii) is subject to a guarantee that has received a short-term rating
from an NRSRO, or a guarantee whose issuer has received a short-term
rating from an NRSRO with respect to a class of debt obligations
that is comparable in priority and security with the guarantee. Rule
2a-7(a)(19).
---------------------------------------------------------------------------

    A determination that a security is an eligible security as a result
of its NRSRO ratings is a necessary but not sufficient finding in order
for a fund to acquire the security.\104\ References to NRSRO ratings in
rule 2a-7 and other regulations were designed to provide a clear
reference point to regulators and market participants. The reliability
of credit ratings, however, has been questioned, in particular in light
of developments during the recent financial crisis. As a result, there
have been calls to produce higher quality ratings. Last year, we
proposed to eliminate the use of NRSRO ratings in rules under the
Investment Company Act, including rule 2a-7, and instead to rely solely
on the fund manager's credit risk determination.\105\ In 2003, in a
concept release seeking comment on various issues relating to credit
rating agencies, we also asked whether credit ratings should be used as
a minimum objective standard in rule 2a-7. Most commenters who
addressed the specific question in 2003 supported retaining the ratings
requirement in rule 2a-7.\106\ One commenter asserted that ``[t]he
combination of this objective test with the `subjective test' (credit
analysis performed by the adviser to the money market fund) provides an
important complementary rating structure under Rule 2a-7.'' \107\
Similarly, in our proposal last year, a substantial majority of
commenters disagreed with the proposed elimination of the ratings
requirement.\108\ The ICI Report summed up the views of many of these
commenters, asserting that elimination of the NRSRO ratings' ``floor *
* * would remove an important investor protection from Rule 2a-7,
introduce new uncertainties and risks, and abandon a regulatory
framework that has proven to be highly successful.'' \109\ A few
commenters supported removing the ratings requirement in 2003 and as
proposed in 2008, however. One of these commenters noted that ``one of
the core causes of the sub-prime crisis was dependence on inaccurate
and unsupportable credit ratings.'' \110\
---------------------------------------------------------------------------

    \104\ The rule also requires fund boards (which typically rely
on the fund's adviser) to determine that the security presents
minimal credit risks, and specifically requires that determination
``be based on factors pertaining to credit quality in addition to
any ratings assigned to such securities by an NRSRO.'' Rule 2a-
7(c)(3)(i).
    \105\ See, e.g., References to Ratings of Nationally Recognized
Statistical Rating Organizations, Investment Company Act Release No.
28327 (July 1, 2008) [73 FR 40124 (July 11, 2008)] (``NRSRO
References Proposal'').
    \106\ See, e.g., Comment Letter of Fidelity Investments (July
25, 2003) (File No. S7-12-03). Comment letters on File No. S7-12-03
are available at http://www.sec.gov/rules/concept/s71203.shtml.
    \107\ Comment Letter of Denise Voigt Crawford, Securities
Commissioner, Texas State Securities Board (July 28, 2003) (File No.
S7-12-03).
    \108\ See, e.g., Comment Letter of T. Rowe Price Family of Funds
(Sept. 5, 2008) (File No. S7-19-08). Comment letters on File No. S7-
19-08 are available at http://www.sec.gov/comments/s7-19-08/
s71908.shtml.
    \109\ See ICI Report, supra note 6, at 81.
    \110\ See Comment Letter of Professor Frank Partnoy (received
Sept. 5, 2008) (File No. S7-19-08).
---------------------------------------------------------------------------

    In light of recent market developments, we request that commenters
again address whether or not the approach we proposed last year would
provide safeguards with respect to credit risk that are comparable to
the continued inclusion of NRSRO references in the rule. What other
alternatives could we adopt to encourage more independent credit risk
analysis and meet the regulatory objectives of rule 2a-7's requirement
of NRSRO ratings? Are there additional factors that we should consider
with respect to last year's proposal? Should we consider establishing a
roadmap for phasing in the eventual removal of NRSRO references from
the rule? We are also considering an approach under which a money
market fund's board would designate three (or more) NRSROs that the
fund would look to for all purposes under rule 2a-7 in determining
whether a security is an eligible security.\111\ In addition, the board
would be required to determine at least annually that the NRSROs it has
designated issue credit ratings that are sufficiently reliable for that
use.\112\ We request comment on an approach in which the fund board
designates NRSROs. Would the inclusion of a number of ``designated
NRSROs'' improve rule 2a-7's use of NRSRO ratings as a threshold
investment criterion and be consistent with the goals of Congress in
passing the Rating Agency Reform Act? \113\ What are the advantages and
disadvantages of such an approach? Should funds be required to
designate a minimum number of NRSROs to use in determining thresholds
for Eligible Securities or in monitoring ratings? If so, would at least
three be the appropriate number, as some have suggested? \114\ Would
more be appropriate to address these purposes (e.g., four, five or
six)? Should we permit fund boards to designate different NRSROs with
respect to different types of issuers of securities in which the fund
invests? Should the funds be required to disclose these designated
NRSROs in their statements of additional information? \115\
---------------------------------------------------------------------------

    \111\ Commenters on our NRSRO References Proposal and the ICI
Report recommended similar approaches. See Comment Letter of
Federated Investors, Inc. (Sept. 5, 2008) (File No. S7-19-08)
(suggesting that rule 2a-7 require the board or its delegate to
select by security type at least three NRSROs on which the fund
would rely under the rule); Comment Letter of OppenheimerFunds, Inc.
(Sept. 4, 2008) (File No. S7-19-08) (suggesting the rule allow fund
boards to designate (presumably after considering any
recommendations of the investment manager) the identity and number
of NRSROs whose ratings will be used to determine eligible portfolio
securities); ICI Report, supra note 6, at 82 (recommending the fund
designate three or more NRSROs that the fund would use in
determining the eligibility of portfolio securities). See also
Comment Letter of Stephen A. Keen on behalf of Federated Investors,
Inc. (Mar. 12, 2007) (File No. S7-04-07) (in response to our 2007
proposal on oversight of NRSROs, asserting that investment advisers
should be free to choose which NRSROs they will rely upon and
monitor only their ratings).
    \112\ The only time that funds would be required to look to all
NRSROs under this approach would be, as under the current rule, in
determining whether a long-term security with a remaining maturity
of 397 calendar days or less that does not, and whose issuer does
not, have a short-term rating is an eligible security. See infra
section II.A.2.b.
    \113\ See Senate Committee on Banking, Housing, and Urban
Affairs, Credit Rating Agency Reform Act of 2006, S. Rep. No. 109-
326, at 2 (2006) (``Senate Report 109-326'') (purposes of the Act
include improving the quality of NRSRO credit ratings by fostering
accountability, transparency, and competition in the credit rating
industry).
    \114\ See supra note 111.
    \115\ See Part B of Form N-1A.
---------------------------------------------------------------------------

    What impact would a requirement that the fund board designate
NRSROs have on competition among NRSROs? Would NRSROs compete through
ratings to achieve designation by money market funds? Given that the
staff believes it is reasonable to assume that the three NRSROs that
issued almost 99 percent of all outstanding ratings across all
categories that were issued by the 10 registered NRSROs as of June
2008,\116\

also issued well over 90 percent of all outstanding ratings of short
term debt, and in light of concerns about enhancing competition among
NRSROs, should the minimum number of designated NRSROs be greater than
three, such as four, five, or six? \117\ What are the advantages and
disadvantages of requiring boards to monitor the ratings issued by all
NRSROs? Should rule 2a-7 specify certain minimum policies and
procedures for monitoring NRSROs? Should money market fund boards be
permitted to designate credit rating agencies or credit evaluation
providers that are not registered as NRSROs with the Commission under
the Securities Exchange Act of 1934 and the rules we have adopted under
those provisions? \118\ Should a board be solely responsible for
designating and annually reviewing a designated NRSRO or should we
permit delegation of this responsibility? How many NRSROs would money
market fund boards be likely to evaluate before making their
designations? After a fund board had designated NRSROs, what incentives
would the board have to change the designated NRSROs?
---------------------------------------------------------------------------

    \116\ The staff's belief is based on its report that three
NRSROs issued almost 99 percent of all the outstanding ratings
across all categories that were issued by the 10 registered NRSROs
as of June 2008. See SEC, Annual Report on Nationally Recognized
Statistical Rating Organizations at 35 (June 2008) (``2008 NRSRO
Report'').
    \117\ According to the ICI Report, requiring money market funds
to designate at least three NRSROs whose ratings the fund would use
in determining eligible portfolio securities could encourage
competition among NRSROs to achieve designation by money market
funds. See ICI Report, supra note 6, at 82.
    \118\ See 15 U.S.C. 78o-7; 17 CFR 240.17g-1 (rules governing the
registration of NRSROs).
---------------------------------------------------------------------------

    We request comment on the impact of any of these approaches on
funds and their ability to maintain a stable net asset value. Would any
particular requirement help funds to better determine whether a
security is an eligible security? We also request comment on the
potential impact on competition among NRSROs.
b. Long-Term Unrated Securities
    Rule 2a-7 permits money market funds to invest in a long-term
security with a remaining maturity of 397 calendar days or less (``stub
security'') that is an unrated security (i.e., neither the security nor
its issuer or guarantor has a short-term rating) unless the security
has received a long-term rating from any NRSRO that is not within the
NRSRO's three highest categories of long-term ratings.\119\ Under rule
2a-7, the measure of quality is the rating given to the issuer's short-
term debt. In the absence of a short-term rating, the minimum long-term
rating is designed to provide an independent check on a fund's quality
determination.\120\ In light of the changes we are proposing above to
increase the portfolio quality standards of the rule, we propose to
permit money market funds to acquire such securities only if they have
received long-term ratings in the highest two ratings categories to
more narrowly limit the credit risk to which a money market fund may be
exposed.\121\ As under the current rule, fund boards would continue to
be required to determine that such a security is ``of comparable
quality'' to a rated security if it met these proposed conditions.\122\
---------------------------------------------------------------------------

    \119\ Rule 2a-7(a)(10)(ii)(A). Nonetheless, the security may be
an eligible security if it has received a long-term rating from the
requisite NRSROs in one of the three highest long-term rating
categories and (as with any unrated security that is an eligible
security) is of comparable quality to a rated security. Id.
    \120\ See 1991 Adopting Release, supra note 20, at text
accompanying nn.65-68.
    \121\ Proposed rule 2a-7(a)(11)(iv)(A). Similar to the provision
in the current rule, the security might be an eligible security even
if it received a long-term rating below the two highest long-term
rating categories if the requisite NRSROs rate the security in one
of the two highest long-term rating categories. Id.
    \122\ Proposed rule 2a-7(a)(11)(iv).
---------------------------------------------------------------------------

    We request comment on this proposed change. Given our proposal to
increase the quality standards of the rule, is the proposed change
appropriate? Should we consider permitting funds to acquire these stub
securities only if they have received long-term ratings in the highest
rating category? What impact would the proposed amendment have on money
market funds' current portfolio holdings? We request commenters
expressing views on this change to provide us with data identifying the
relationship between the long-term ratings on these stub securities and
short-term ratings.
3. Credit Reassessments
    Rule 2a-7 currently requires a money market fund's board of
directors to promptly reassess whether a portfolio security continues
to present minimal credit risks if, subsequent to its acquisition by
the fund, (i) the security has ceased to be a first tier security
(e.g., the security is downgraded to second tier by one of the
requisite NRSROs), or (ii) the fund's adviser becomes aware that an
unrated or second tier security has received a rating from any NRSRO
below the second highest short-term rating category.\123\ In light of
the proposed elimination of second tier securities from the definition
of eligible security, we propose to amend rule 2a-7 so the only
circumstance in which the fund's board of directors would be required
to reassess whether a security continues to present minimal credit
risks would be if, subsequent to its acquisition by the fund, the
fund's money market fund adviser becomes aware that an unrated security
has received a rating from any NRSRO below the highest short-term
rating category.\124\
---------------------------------------------------------------------------

    \123\ Rule 2a-7(c)(6)(i)(A)(1) and (2).
    \124\ Proposed rule 2a-7(c)(7)(i)(A). As under the current rule,
the proposed rule amendment would not require, and we would not
expect, investment advisers to subscribe to every rating service
publication in order to comply with the requirement that the board
reassess when the fund's adviser becomes aware that any NRSRO has
rated an unrated security below its highest rating. We would expect
an investment adviser to become aware of a subsequent rating if it
is reported in the national financial press or in publications to
which the adviser subscribes. See 1991 Adopting Release, supra note
20, at n.71.
---------------------------------------------------------------------------

    We request comment on whether these are appropriate circumstances
under which to require a reassessment in light of our proposal to
eliminate the ability of money market funds to invest in second tier
securities.
4. Asset Backed Securities
    Rule 2a-7 contains provisions that specifically address asset
backed securities (``ABSs''),\125\ including the circumstances under
which an ABS is an eligible security,\126\ the maturity of an ABS,\127\
and how a fund must treat such an investment under the diversification
provisions.\128\ The rule, however, does not specifically address how a
fund board (or its delegate) should determine that an investment in an
ABS (or other potential portfolio investment) presents minimal credit
risks, nor does it specifically address liquidity issues presented by a
money market fund's investment in an ABS.
---------------------------------------------------------------------------

    \125\ An asset backed security is defined very generally to mean
a fixed income security that entitles its holders to receive
payments that depend primarily on the cash flow from financial
assets underlying the asset backed security. See rule 2a-7(a)(3).
    \126\ See rule 2a-7(a)(10)(ii)(B).
    \127\ See rules 2a-7(a)(8)(ii) and 2a-7(d).
    \128\ See rule 2a-7(c)(4)(ii)(D).
---------------------------------------------------------------------------

    Both such matters were raised in 2007 by money market funds'
investment in SIVs, which we discussed briefly above. SIVs issued
commercial paper to finance a portfolio of longer term, higher yielding
investments, including residential mortgages. Unlike other commercial
paper programs, SIVs typically did not have access to liquidity
facilities to protect commercial paper investors (including money
market funds) against the risk of the issuer's inability to reissue (or
``rollover'') commercial paper caused by either a credit event of the
issuer or a disruption in the commercial paper

market.\129\ When they could no longer rollover their debt beginning in
2007, those SIVs, unable to secure liquidity support from sponsoring
banks, were forced to begin selling the vehicles' assets into depressed
markets to pay maturing debt and to begin winding down their
operations. SIV credit ratings deteriorated rapidly as they
deleveraged, placing pressure on valuations of SIV securities held by
money market funds. We understand that eventually most funds holding
SIV securities not supported by a large bank entered into agreements
with affiliates of the fund to support the fund's stable net asset
value per share.
---------------------------------------------------------------------------

    \129\ For a discussion of the evolution of the asset backed
commercial paper market and SIV securities during this period, see
generally Jim Croke, New Developments in Asset-Backed Commercial
Paper (2008), at 2-4, available at http://www.orrick.com/fileupload/
1485.pdf.
---------------------------------------------------------------------------

    We request comment on whether, and if so how, we should amend rule
2a-7 to address risks presented by SIVs or similar ABSs. As discussed
above, rule 2a-7 requires that money market funds only invest in
securities that the board of directors or its delegate determines
present minimal credit risks.\130\ The Commission has stated that
``[d]etermining that an ABS presents minimal credit risks requires an
examination of the criteria used to select the underlying assets, the
credit quality of the put providers, and the conditions of the
contractual relationships among the parties to the arrangement. When an
ABS consists of a large pool of financial assets, such as credit card
receivables or mortgages, it may not be susceptible to conventional
means of credit risk analysis because credit quality is based not on a
single issuer but on an actuarial analysis of a pool of financial
assets.'' \131\ We also said, however, that we were concerned that
``fund credit analysts may be unable to perform the thorough legal,
structural and credit analyses required to determine whether a
particular ABS involves inappropriate risks for money market funds''
and, as a result, required that any ABS in which a money market fund
invested be rated by an NRSRO because of NRSROs' role in assuring that
the underlying ABS assets are properly valued and provide adequate
asset coverage for the cash flows required to fund ABSs.\132\
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    \130\ Rule 2a-7(c)(3)(i).
    \131\ 1993 Proposing Release, supra note 81, at text
accompanying nn.108-109.
    \132\ Id. at nn.110-112 and accompanying text.
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    As discussed above, beginning in 2007, SIV securities were rapidly
downgraded by NRSROs revealing money market funds' varying minimal
credit risk determinations with respect to these securities. In light
of this experience, should we provide additional guidance to money
market funds on the required minimal credit risk evaluation with
respect to ABSs? We believe that part of this analysis, when evaluating
any security, should include an evaluation of the issuer's ability to
maintain its promised cash flows which, in the case of an asset backed
security, would entail an analysis of the underlying assets, their
behavior in various market conditions, and the terms of any liquidity
or other support provided by the sponsor of the security.\133\ Should
we amend rule 2a-7 to remove the requirement that any ABS be rated by
an NRSRO in order to be an eligible security for money market funds in
light of the NRSROs' recent rapid downgrading of these securities?
Under our proposed liquidity requirements (discussed below), the
liquidity features of an ABS would have to be considered in determining
whether the fund holds sufficiently liquid assets to meet shareholder
redemptions.\134\
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    \133\ The ICI Report recommended that we amend rule 2a-7 to
require money market fund advisers to adopt a ``new products
committee.'' See ICI Report, supra note 6, at 79-80. Although such
committees may be useful, their usefulness would turn on what might
be a ``new product'' as well as the judgment of its members, whose
judgment is today required to be brought to bear on whether the
security presents minimal credit risks.
    \134\ See infra Section II.C.
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    We request comment on whether rule 2a-7 should explicitly require
fund boards of directors (or their delegates) to evaluate whether the
security includes any committed line of credit or other liquidity
support. Are there other factors that we should require money market
fund boards to evaluate when determining whether SIV investments or
other new financial products pose minimal credit risks? We note that
some money market funds invested more significantly in SIV securities
while other money market funds avoided such investments entirely. Are
there facets of the credit analysis that led certain money market funds
to avoid such investments that should be incorporated explicitly into
rule 2a-7? \135\ Should we limit money market funds to investing in
ABSs that the manager concludes can be paid upon maturity with existing
cash flow, i.e., the payment upon maturity is not dependent on the
ability of the special purpose entity to rollover debt? Alternatively,
should the rule itself require ABSs to be subject to unconditional
demand features to be eligible securities? \136\
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    \135\ The staff's recent examinations of money market funds
indicate that credit analysts for money market funds that invested
in SIVs that subsequently defaulted appear to have had access to the
same basic set of information on SIVs as did analysts at money
market funds that did not and that the judgment of these credit
analysts regarding minimal creditworthiness of the SIVs that
subsequently defaulted appeared to have been different. The staff's
exams also appear to indicate that credit analysts for money market
funds that invested in SIVs that subsequently defaulted placed less
emphasis on the length of time that payment experience was available
on assets in the collateral pool and they were willing to accept
sub-prime mortgage credits as a seasoned asset class. In addition,
their decision, in part, may have been influenced by the greater
amount of over-collateralization of the collateral pools and the
high yields paid by notes supported by sub-prime credits.
    \136\ Rule 2a-7(a)(26) defines an ``unconditional demand
feature'' as a ``demand feature'' that by its terms would be readily
exercisable in the event of a default in payment of principal or
interest on the underlying security or securities.
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B. Portfolio Maturity

    Rule 2a-7 restricts the maximum remaining maturity of a security
that a money market fund may acquire, and the weighted average maturity
of the fund's portfolio, in order to limit the exposure of money market
fund investors to certain risks, including interest rate risk. The
Commission is proposing changes to the rule's maturity limits to
further reduce such risks, as discussed below. First, we propose to
reduce the maximum weighted average portfolio maturity permitted by the
rule. Second, we propose a new maturity test that would limit the
portion of a fund's portfolio that could be held in longer term
variable- or floating-rate securities. Third, we propose to delete a
provision in the rule that permits certain money market funds to
acquire Government securities with extended maturities of up to 762
calendar days. We are also requesting comment on other ways of
adjusting the rule's maturity provisions in order to accomplish our
goal of decreasing the risks associated with a money market fund
holding longer term investments.
1. Weighted Average Maturity
    Rule 2a-7 requires a money market fund to maintain a dollar-
weighted average portfolio maturity appropriate to its objective of
maintaining a stable net asset value or price per share, but in no case
greater than 90 days.\137\ We adopted this provision because securities
that have shorter periods remaining until maturity (and are of higher
quality) generally exhibit a low level of volatility and thus provide a
greater assurance that the money market fund will continue to be able
to maintain a stable share price.\138\
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    \137\ See rule 2a-7(c)(2)(iii).
    \138\ See 1983 Adopting Release, supra note 3, at n.7 and
accompanying text.

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    Having a portfolio weighted towards securities with longer
maturities poses several risks to a money market fund. First, as we
have noted in the past, a longer weighted average maturity increases a
fund's exposure to interest rate risk.\139\ Second, and as we discuss
in more detail below, longer maturities also amplify the effect of
widening credit and interest rate spreads on a fund.\140\ Finally, a
fund holding securities with longer maturities generally is exposed to
greater liquidity risk, because fewer securities mature on a daily or
weekly basis. Perhaps in recognition of these risks, few fund managers
maintain weighted average maturity at or near the maximum permissible
90 days.\141\
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    \139\ See 1990 Proposing Release, supra note 22, at text
accompanying n.60. See also Standard & Poor's, Money Market Fund
Ratings Criteria, at 21 (2007) available at http://
www2.standardandpoors.com/spf/pdf/events/MMX709.pdf (``S&P 2007
Ratings Criteria'') (``The portfolio's weighted average maturity
(WAM) is a key determinant of the tolerance of a fund's investments
to rising interest rates. In general, the longer the WAM, the more
susceptible the fund is to rising interest rates. A fund comprised
entirely of Treasury securities with a WAM of 45 days could
withstand approximately twice the interest rate increase than could
a fund with a 90-day WAM, leaving all other factors aside.'');
Fabozzi, supra note 98, at 4 (``[T]he volatility of a bond's price
is closely associated with maturity: Changes in the market level of
[interest] rates will wrest much larger changes in price from bonds
of long maturity than from otherwise similar debt of shorter
life.'').
    \140\ See also supra notes 65-71 and accompanying text.
    \141\ According to monthly statistics kept by the Investment
Company Institute, during the past 10 years, the weighted average
maturities of funds in the longest maturity categories (the 90th
percentile of all taxable prime money market funds) seldom have
exceeded 75 days. As of April 30, 2009, these funds maintained an
average weighted maturity of 67 days. These statistics are available
in File No. S7-11-09.
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    In view of the extraordinary market conditions we have witnessed
recently, the Commission is concerned that the 90-day maximum weighted
average maturity under the rule may be too long. Particularly during
the market events of last fall, funds with shorter portfolio maturities
were much better positioned to withstand heavy redemptions, because a
greater portion of their portfolios matured each week and provided cash
to pay to redeeming investors. They also were better able to withstand
increased credit spreads in certain financial sector notes because of
the shorter period of exposure to such distressed securities. Finally,
interest rate spreads on longer maturity securities widened to a much
greater degree than interest rate spreads on shorter maturity
securities.\142\
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    \142\ See, e.g., U.S. Department of the Treasury, Daily Treasury
Yield Curve Rates, available at http://www.treasury.gov/offices/
domestic-finance/debt-management/interest-rate/yield_historical_
main.shtml.
---------------------------------------------------------------------------

    The ICI Report recommended reducing the maximum weighted average
maturity to 75 days.\143\ Historically, however, most funds have
maintained shorter maturities. During the last 20 years, the average
weighted average maturity of taxable money market funds (as a group)
has never exceeded 58 days.\144\ As of June 16, 2009, it was 53
days.\145\ Some money market funds have, from time to time, extended
their maturities substantially longer than the average to gain a yield
advantage, anticipating declining or stable interest rates. By doing
so, these funds assumed greater risk and would be more likely to
experience losses that could result in their breaking the buck if
interest rates rise, credit markets do not behave as they expect, or
they receive substantial redemption requests.
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    \143\ See ICI Report, supra note 6, at 77.
    \144\ 2008 Fact Book, supra note 13, at Table 38. In 2009, the
ICI Fact Book began presenting this information separately for
taxable government and taxable non-government money market funds,
which had average maturities of 49 days and 47 days, respectively,
in 2008. 2009 Fact Book, supra note 7, at 150-51, Tables 41 & 42.
    \145\ See Money Fund Report, iMoneyNet, May 7, 2008. Average
maturity for tax exempt money market funds (as a group) is even
lower--24 days as of June 16, 2009. Id.
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    Most European money market funds with stable share prices (many of
which are domiciled in Ireland) are limited to 60-day weighted average
maturities.\146\ So are money market funds rated highly by the
NRSROs.\147\ In light of these considerations, we believe that a
shorter period may be appropriate. Accordingly, we propose that rule
2a-7 be amended to impose a 60-day weighted average maturity
limit.\148\
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    \146\ See Irish Financial Services Regulatory Authority,
Valuation of Assets of Money Market Funds, 2008 Guidance Note 1/08
(Aug. 2008), available at http://www.financialregulator.ie/industry-
sectors/funds/Documents/
Guidance%20Note%20108%20Valuation%20of%20Assets%20of%20Money%20Market
%20Funds.pdf (``Financial Regulator Guidance Note 1/08''). As of
April 2009, money market funds registered in Ireland managed
approximately [euro]317 billion ($419 billion) in assets. See Irish
Financial Regulator statistics available at http://
www.irishfunds.ie/money_marketfunds.htm. In addition, the
Institutional Money Market Funds Association (``IMMFA'') requires
the triple-A rated institutional money market funds sponsored by its
members to comply with a Code of Practice that generally limits
portfolio maturity to 60 days. See IMMFA, Code of Practice, Part
IV., ] 22 (2005), available at http://www.immfa.org/about/
Codefinal.pdf. As of February 13, 2009, IMMFA-member constant net
asset value money market funds managed approximately $493 billion in
assets. See IMMFA statistics, available at http://www.immfa.org/
stats/IMFR130209.pdf. See also ICI Report, supra note 6, at 184,
Appendix H.
    \147\ See S&P 2007 Ratings Criteria, supra note 139, at 21;
Moody's Investors Service, Frequently Asked Questions about Moody's
Ratings of Managed Funds, at 4 (July 20, 2005), available at http://
www.moodys.com/moodys/cust/research/MDCdocs/20/
2003600000425726.pdf?search=5&searchQuery=Frequently+Asked+Questions+
about+Moody; Fitch Ratings, U.S. Money Market Fund Ratings, at 4
(Mar. 3, 2006), available at http://www.fitchresearch.com/
creditdesk/reports/report_frame.cfm?rpt_id=266376.
    \148\ See proposed rule 2a-7(c)(2)(ii).
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    We request comment on the proposed 60-day weighted average maturity
limit. Would it decrease portfolio volatility and increase fund
liquidity, as we suggest? What would be the anticipated effect on money
market fund yields? Would a negative effect on yields make money market
funds less attractive to investors? Should a different weighted average
maturity limit apply, such as 45 days or 75 days? We request that
commenters provide us with data demonstrating the effect that
alternative weighted average maturity limits would have had on
portfolios of money market funds during the recent economic turmoil.
2. Weighted Average Life
    We propose to add to rule 2a-7 a new maturity test, which would
limit the weighted average life maturity of portfolio securities to 120
days.\149\ As explained further below, the weighted average life of a
portfolio would be measured without regard to a security's interest
rate reset dates, and thus would limit the extent to which a fund could
invest in longer term securities that may expose a fund to interest
rate spread risk and credit spread risk.\150\
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    \149\ See proposed rule 2a-7(c)(2)(iii).
    \150\ While the proposed rule would ignore interest rate resets
for purposes of calculating the fund's weighted average life to
maturity, a security's demand features could continue to be used in
this calculation. See, e.g., rule 2a-7(d)(3) and (d)(5).
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    Generally, under rule 2a-7 the maturity of a portfolio security is
the period remaining until the date on which the principal must
unconditionally be repaid according to its terms (its final ``legal''
maturity) or, in the case of a security called for redemption, the date
on which the redemption payment must be made.\151\ The rule contains
exceptions from this general approach for specific types of securities,
which are referred to as the ``maturity shortening'' provisions.\152\
Among these exceptions are three provisions that allow a fund to treat
a variable- or floating-rate security as having a maturity equal to the
time remaining to the next interest rate reset

date.\153\ First, a fund may treat a short-term variable-rate security
(i.e., one with a remaining maturity of 397 days or less), as having a
maturity equal to the earlier of the interest rate reset date or the
time it would take the fund to recover the principal by exercising a
demand feature.\154\ Second, a fund may treat a short-term floating-
rate security (i.e., one with a remaining maturity of 397 days or less)
as having a maturity of one day.\155\ Third, a variable- or floating-
rate Government security generally may be deemed to have a maturity
equal to the next reset date even if it is a long-term security.\156\
For purposes of calculating weighted average maturity, the rule
effectively treats short-term variable- and floating-rate securities
and all adjustable-rate Government securities as if they were a series
of short-term obligations that are continually ``rolled over'' on the
reset dates at the current short-term interest rates.
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    \151\ See rule 2a-7(d).
    \152\ Id. We added maturity shortening provisions to the rule in
1986; they are particularly important for tax exempt funds, which
invest in municipal obligations, most of which are issued with
longer maturities. See 1986 Adopting Release, supra note 19, at
nn.9-10 and accompanying text.
    \153\ See rule 2a-7(a)(13) (defining ``floating rate security'')
and (a)(29) (defining ``variable rate security''). The interest rate
for a variable-rate security is established on set dates, whereas
the interest rate for a floating-rate security adjusts whenever a
specified interest rate changes. We also may refer to variable- and
floating-rate securities collectively in this Release as
``adjustable-rate'' securities.
    \154\ See rule 2a-7(d)(2). See also rule 2a-7(a)(8) (definition
of ``demand feature'').
    \155\ See rule 2a-7(d)(4).
    \156\ See rule 2a-7(d)(1) (allowing a variable-rate Government
security where the variable rate is readjusted no less frequently
than every 762 days to be deemed to have a maturity equal to the
period remaining until the next readjustment of the interest rate,
and a floating-rate Government security to be deemed to have a
remaining maturity of one day).
---------------------------------------------------------------------------

    As the ICI Report explains, however, longer term adjustable-rate
securities are more sensitive to credit spreads (the amount of
additional yield demanded by purchasers above a risk-free rate of
return to compensate for the credit risk of the issuer) than short-term
securities with final maturities equal to the reset date of the longer
term security.\157\ Longer term adjustable-rate securities also are
subject for a longer period of time to risk from widening interest rate
spreads.\158\ As a result, prices of longer term adjustable-rate
securities could fall more than prices of comparable short-term
securities in times of market turbulence. The ICI Report also notes
that while adjustable-rate securities do protect a fund against changes
in interest rates, permitting maturity shortening based on interest
rate resets does not protect against liquidity risk to the
portfolio.\159\
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    \157\ See ICI Report, supra note 6, at 77.
    \158\ Interest rate spreads can widen because a variable-rate
note has a fixed period of time to the next interest reset date and
during that time the benchmark interest rate will likely change.
Interest rate spreads can also widen because market conditions
change after the security is issued such that investors may demand a
greater margin to hold the security. See Fabozzi, supra note 98, at
196.
    \159\ See ICI Report, supra note 6, at text accompanying n.140.
---------------------------------------------------------------------------

    We are concerned that the traditional weighted average maturity
measurement of rule 2a-7 does not require that a manager of a money
market fund limit these risks. We understand that some money market
fund portfolio managers, to protect the fund, have already begun using
a weighted average maturity measurement that ignores interest rate
resets.
    The ICI Report confirms our observations of the behavior of prices
for certain securities last fall, when money market funds found it
difficult to sell at amortized cost longer term adjustable-rate
securities, including securities issued by agencies of the federal
government. We believe that the use of the measurement the ICI
recommends, which we will call the ``weighted average life'' to
maturity of a money market fund portfolio, appears to be a prudent
limitation on the structure of a money market fund portfolio and would
limit credit and interest rate spread risks not encompassed by the
weighted average maturity restriction of rule 2a-7. As suggested by the
ICI Report, we are proposing that money market funds maintain a
weighted average life of no more than 120 days.\160\ The Commission
believes that a 120-day weighted average life requirement would provide
a reasonable balance between strengthening the resilience of money
market funds to market stress (e.g., interest rate increases, widening
spreads, and large redemptions) while not unduly restricting the funds'
ability to offer a diversified portfolio of short-term, high quality
debt securities.
---------------------------------------------------------------------------

    \160\ The proposed rule would require a money market fund to
maintain a weighted average maturity not to exceed 120 days,
determined without reference to the exceptions in paragraph (d) of
the rule regarding interest rate resets. See proposed rule 2a-
7(c)(2)(iii).
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    One of the effects of a limit on the weighted average life of a
portfolio would appear to be on funds that hold longer term floating-
rate Government securities, which are issued by federal agencies.
Consider a money market fund with a portfolio consisting 50 percent of
overnight repurchase agreements and 50 percent of two-year Government
agency floating-rate obligations that reset daily based on the federal
funds rate. Using the reset dates as permitted by the rule's maturity
shortening provisions, the portfolio would have a weighted average
maturity of one day. In contrast, by applying a measurement that does
not recognize resets, the portfolio would have a weighted average life
of 365.5 days (i.e., half of the portfolio has a one day maturity and
half has a two-year maturity), which would be considerably longer than
the 120-day limit we are proposing. The weighted average life
limitation would provide an extra layer of protection for funds and
their shareholders against spread risk, particularly in volatile
markets.
    We request comment on all aspects of the proposed weighted average
life limitation. Is this new maturity test appropriate? Is 120 days an
appropriate limit? What would be the effect on yield? Does it place too
much of a constraint on the ability of money market fund advisers to
effectively manage fund portfolios? Does it permit funds to assume too
much risk? Would a different limit be more appropriate, such as 90 days
or 150 days? Would the proposed weighted average life limitation have a
material impact on the issuers of short-term debt and, if so, what
would it be?
    We request comment on whether there are alternative approaches to
measuring these risks. We understand that some fund managers use an
alternative maturity test that focuses solely on credit spread risk.
Such a test not only disregards interest rate resets, but also excludes
Government securities from the weighted average maturity calculation.
Would this test provide a clearer indication of the overall credit
spread risk of the portfolio? Are there other advantages to such an
approach? If so, what would be an appropriate limit? Should it be the
same as proposed weighted average life limitation of 120 days, or
should it be different, such as 90 days or 150 days? We request that
commenters provide us with data demonstrating the effect of such
alternative credit limitations and/or weighted average life limitations
on their portfolios during the recent economic turmoil.
    When the Commission first adopted rule 2a-7, we explained that we
were allowing Government securities to use resets for purposes of the
maturity limitations under the rule because we understood that the
volatility of such instruments would be no greater than the volatility
of fixed interest rate instruments having a maturity equal to the
period before the security's interest rate reset.\161\ The Commission
noted, however, that this position was based entirely upon experience
with Small Business Administration guaranteed debentures--at the time
the only

adjustable-rate Government securities of which the Commission was
aware.\162\ The Commission stated that it would consider amending this
provision if market experience indicates that such treatment is
inappropriate.\163\
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    \161\ See 1983 Adopting Release, supra note 3, at n.16.
    \162\ See id.
    \163\ See id.
---------------------------------------------------------------------------

    Since 1983, the number and variety of adjustable-rate Government
securities have grown and, in particular, the issuance of such