[Federal Register: March 4, 2010 (Volume 75, Number 42)]
[Rules and Regulations]
[Page 10059-10120]
[DOCID:fr04mr10-13]

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Part III

Securities and Exchange Commission

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17 CFR Parts 270 and 274

Money Market Fund Reform; Final Rule

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 270 and 274

[Release No. IC-29132; File Nos. S7-11-09, S7-20-09]
RIN 3235-AK33

Money Market Fund Reform

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'' or
``SEC'') is adopting amendments to certain rules that govern money
market funds under the Investment Company Act of 1940. The amendments
will 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 maximum
weighted average maturity of portfolio holdings, and improving the
quality of 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), or is at imminent risk of breaking
the buck, to suspend redemptions to allow for the orderly liquidation
of fund assets. The 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: The rules, rule amendments, and form are effective May 5, 2010.
The expiration date for 17 CFR 270.30b1-6T is extended from September
17, 2010 to December 1, 2010. Compliance dates are discussed in Section
III of the SUPPLEMENTARY INFORMATION.

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 adopting amendments to
rules 2a-7 [17 CFR 270.2a-7], 17a-9 [17 CFR 270.17a-9] and 30b1-6T [17
CFR 270.30b1-6T], new rules 22e-3 [17 CFR 270.22e-3] and 30b1-7 [17 CFR
270.30b1-7], and new Form N-MFP [17 CFR 274.201] 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, are to Title 17, Part 270 of the Code of Federal Regulations
[17 CFR 270]. References to ``current'' rules relate to rules in
their current form [17 CFR Part 270 (2009 version)], and references
to ``amended'' rules relate to rules as they will be amended by this
Release.
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Table of Contents

I. Background
II. Discussion
    A. Portfolio Quality
    1. Second Tier Securities
    2. Eligible Securities
    3. Asset Backed Securities
    B. Portfolio Maturity
    1. Weighted Average Maturity
    2. Weighted Average Life
    3. Maturity Limit for Government Securities
    C. Portfolio Liquidity
    1. General Liquidity Requirement
    2. Limitation on Acquisition of Illiquid Securities
    3. Minimum Daily and Weekly Liquidity Requirements
    4. Stress Testing
    D. Repurchase Agreements
    E. Disclosure of Portfolio Information
    1. Public Web site Posting
    2. Reporting to the Commission
    3. Phase-Out of Weekly Reporting by Certain Funds
    F. Processing of Transactions
    G. Exemption for Affiliate Purchases
    1. Expanded Exemptive Relief
    2. New Reporting Requirement
    H. Fund Liquidation
III. Compliance Dates
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 Rules, Rule Amendments, and Form

I. Background

    On June 30, 2009, the Commission issued a release proposing new
rules and rule amendments governing the operation of money market
funds.\2\ Money market funds are open-end management investment
companies that are registered under the Investment Company Act. They
invest in high-quality, short-term debt instruments such as commercial
paper, Treasury bills and repurchase agreements. Money market funds pay
dividends that reflect prevailing short-term interest rates and, unlike
other investment companies, maintain a stable net asset value per share
(or ``NAV''), typically $1.00 per share. Money market funds have over
$3.3 trillion dollars in assets under management, and comprise over 30
percent of the assets of registered investment companies.\3\
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    \2\ Money Market Fund Reform, Investment Company Act Release No.
28807 (June 30, 2009) [74 FR 32688 (July 8, 2009)] (``Proposing
Release''). All references to ``proposed'' rules relate to rules as
proposed in the Proposing Release.
    \3\ See Investment Company Institute, Trends in Mutual Fund
Investing, Nov. 2009, available at http://www.ici.org/research/
stats/trends/trends_11_09.
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    All money market funds are subject to rule 2a-7 under the
Investment Company Act. Rule 2a-7, among other things, facilitates
money market funds' ability to maintain a stable net asset value per
share by permitting them to use the amortized cost method of valuation
and the penny-rounding method of pricing.\4\ But for rule 2a-7, the
Investment Company Act and our rules would require a money market fund
to calculate its current net asset value per share by valuing portfolio
securities at their current value (``mark-to-market'').\5\
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    \4\ Current rule 2a-7(a)(2) defines the amortized cost method as
the method of calculating an investment company's net asset value
per share (or ``NAV'') 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. 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
current rule 2a-7(a)(18).
    \5\ 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).
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    Under the amortized cost method, portfolio securities generally are
valued at cost plus any amortization of premium or accumulation of
discount. 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 their
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.\6\ Therefore, the rule
permits money market funds to value portfolio securities at their
amortized cost so long as the deviation between the portfolio's
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.\7\
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    \6\ See Valuation of Debt Instruments and Computation of Current
Price Per Share by Certain Open-End Investment Companies (Money
Market Funds), Investment Company Act Release No. 13380 (July 11,
1983) [48 FR 32555 (July 18, 1983)] (``1983 Adopting Release'') at
nn.3-7 and accompanying text; 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. 12206 (Feb. 1, 1982) [47 FR 5428 (Feb. 5, 1982)] at
nn.3-4 and accompanying text.
    \7\ See amended rule 2a-7(c)(1), (c)(8)(ii)(B)-(C) (requiring,
among other things, that the fund's board of directors promptly
consider what action, if any, should be taken if the deviation
between the money market fund's current market value and the fund's
amortized cost price per share exceeds \1/2\ of 1%).
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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.\8\ 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.\9\ If there is a difference of more than one-half of one
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.'' \10\
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    \8\ For example, the current 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''). A fund, moreover, may only invest a
limited portion of its portfolio in securities rated in the second
highest rating category. See current rule 2a-7(c)(3). The current
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 current rule 2a-7(c)(2).
    \9\ See current rule 2a-7(c)(7) (requiring that such shadow
pricing be calculated at such intervals as the board of directors
determines appropriate and reasonable in light of current market
conditions).
    \10\ See current 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.
Current rule 2a-7(c)(7)(ii)(C). See 1983 Adopting Release, supra
note 6, at nn.51-52 and accompanying text.
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    As discussed in significant detail in the Proposing Release, during
2007-2008 money market funds were exposed to substantial losses, first
as a result of exposure to debt securities issued by structured
investment vehicles (``SIVs''), and then as a result of the default of
debt securities issued by Lehman Brothers Holdings Inc. (``Lehman
Brothers''). All but one of the funds that were exposed to losses from
SIV and Lehman Brothers securities obtained support of some type from
their advisers or other affiliated persons, which absorbed the losses
or provided a guarantee covering a sufficient amount of losses to
prevent the fund from breaking the buck. The Reserve Primary Fund,
which held a $785 million position in Lehman Brothers debt, ultimately
did not have a sponsor with sufficient resources to support it, and on
September 16, 2008 the fund announced that it would re-price its
securities at $0.97 per share.\11\ It subsequently suspended
redemptions as of September 17, 2008.\12\
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    \11\ See Proposing Release, supra note 2, at n.44 and
accompanying text. The Reserve Primary Fund distributed the bulk of
its assets, and investors have received more than $0.98 on the
dollar. See Press Release, SEC, Reserve Primary Fund Distributes
Assets to Investors (Jan. 29, 2010) available at http://www.sec.gov/
news/press/2010/2010-16.htm.
    \12\ 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. 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).
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    The cumulative effect of these events, when combined with general
turbulence in the financial markets, led to a run primarily on
institutional taxable prime money market funds, which contributed to
severe dislocations in short-term credit markets and strains on the
businesses and institutions that obtain funding in those markets.\13\
During the week of September 15, 2008, investors withdrew approximately
$300 billion from taxable prime money market funds, or 14 percent of
the assets held in those funds.\14\ 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.\15\
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    \13\ 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''). See also 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.
    \14\ See Investment Company Institute, Report of the Money
Market Working Group, at 62 (Mar. 17, 2009), available at http://
www.ici.org/pdf/ppr_09_mmwg.pdf (``ICI Report'') (analyzing data
from iMoneyNet); see also Investment Company Institute, Money Market
Mutual Fund Assets Historical Data, available at http://www.ici.org/
pdf/mm_data_2010.pdf (``ICI Mutual Fund Historical Data'').
    \15\ 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.
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    On September 19, 2008, the U.S. Department of the Treasury
(``Treasury Department'') and the Board of Governors of the Federal
Reserve System (``Federal Reserve Board'') announced an unprecedented
intervention in the short-term markets. The Treasury Department
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.\16\ This program has now expired.\17\ 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.\18\ These programs were effective in containing the
run on institutional prime money market funds and providing additional
liquidity to money market funds.\19\
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    \16\ See Press Release, Treasury Department, Treasury Announces
Guaranty Program for Money Market Funds (Sept. 19, 2008), available
at http://www.treas.gov/press/releases/hp1147.htm. The Program
insured investments in money market funds, to the extent of their
shareholdings as of September 19, 2008, if the fund chose to
participate in the Program. 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
permitted a participating fund to suspend redemptions if it broke
the buck and liquidated under the terms of the Program. See
Temporary Exemption for Liquidation of Certain Money Market Funds,
Investment Company Act Release No. 28487 (Nov. 20, 2008) [73 FR
71919 (Nov. 26, 2008)].
    \17\ See Press Release, U.S. Department of the Treasury,
Treasury Announces Expiration of Guarantee Program for Money Market
Funds (Sept. 18, 2009), available at http://www.treas.gov/press/
releases/tg293.htm. The Program expired on September 19, 2009, and
rule 22e-3T expired on October 18, 2009.
    \18\ 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 expired on February 1, 2010. See Press Release, Federal Reserve
Board, FOMC Statement (Jan. 27, 2010), available at http://
www.federalreserve.gov/newsevents/press/monetary/20100127a.htm.
    \19\ 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. By the end of the week
after the announcement, however, 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.

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    The severity of the problems experienced by money market funds
during 2007 and 2008 prompted us to review our regulation of money
market funds. We sought to better understand how we might revise rule
2a-7 to reduce the susceptibility of money market funds to runs and
reduce the consequences of a run on fund shareholders. Our staff
consulted extensively with staff from other members of the President's
Working Group on Financial Markets. We talked to many market
participants, and reviewed a report from a ``Money Market Fund Working
Group'' assembled by the Investment Company Institute (``ICI Report''),
which recommended a number of changes.\20\
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    \20\ ICI Report, supra note 14.
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    Our June 2009 proposals were the product of that review and were,
we explained, a first step to addressing regulatory concerns we
identified. They were designed to make money market funds more
resilient and less likely to break a buck as a result of disruptions
such as those that occurred in the fall of 2008. They would give us
better tools to oversee money market funds. If a money market fund did
break a buck, they would facilitate an orderly liquidation in order to
protect fund shareholders and help contain adverse effects on the
capital markets and other money market funds. In addition, throughout
the Proposing Release we requested comment on additional regulatory
changes aimed at further strengthening the stability of money market
funds.
    We received approximately 120 comments on the rule, including
approximately 45 comments from investment companies and their
representatives, 22 from debt security issuers, and 30 from
individuals, including investors and academics. The comment letters
reflected a wide variety of views on most of the topics discussed in
the Proposing Release. The investment companies generally supported
those aspects of the proposal that were similar to those recommended in
the ICI Report.\21\ Most of them strongly objected to changes that
would affect the stable net asset value that today is the principal
characteristic of a money market fund.\22\ Most debt security issuers
who wrote to us objected to changes designed to increase the credit
quality of money market fund portfolios by precluding funds from
investing in second tier securities (as defined by the rule).\23\ Many
fund commenters pointed to the historical stability of funds and urged
us to be modest in our changes to rule 2a-7.\24\ Some others, however,
pointed to the near-cataclysmic events of September 2008 in supporting
more substantial changes.\25\
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    \21\ See, e.g., Comment Letter of T. Rowe Price Associates, Inc.
(Sept. 8, 2009) (``T. Rowe Price Comment Letter''); Comment Letter
of UBS Global Asset Management (Americas) Inc. (Sept. 8, 2009);
Comment Letter of The Vanguard Group, Inc. (Aug. 19, 2009)
(``Vanguard Comment Letter'').
    \22\ See, e.g., Comment Letter of BlackRock Inc. (Sept. 4, 2009)
(``BlackRock Comment Letter''); Comment Letter of the Dreyfus
Corporation (Sept. 8, 2009) (``Dreyfus Comment Letter''); Comment
Letter of Goldman Sachs Asset Management, L.P. (Sept. 8, 2009)
(``Goldman Sachs Comment Letter'').
    \23\ See, e.g., Comment Letter of American Electric Power
Company, Inc. (Sept. 8, 2009) (``Am. Elec. P. Comment Letter'');
Comment Letters of the U.S. Chamber of Commerce and Joint Treasurer
Signatories (Sept. 3 & Sept. 24, 2009) (``Chamber/Tier 2 Issuers
Comment Letter''); Comment Letter of Dominion Resources Services,
Inc. (Sept. 8, 2009) (``Dominion Res. Comment Letter'').
    \24\ See, e.g., Comment Letter of Fidelity Investments (Aug. 24,
2009) (``Fidelity Comment Letter''); T. Rowe Price Comment Letter;
Comment Letter of USAA Investment Management Company (Sept. 8, 2009)
(``USAA Comment Letter'').
    \25\ See, e.g., Comment Letter of Deutsche Investment Management
Americas Inc. (Aug. 31, 2009) (``Deutsche Comment Letter''); Comment
Letter of Jeffrey N. Gordon, Professor of Law, Columbia Law School
(Sept. 9, 2009); Comment Letter of John R. Jay, CFA (Sept. 8, 2009).
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    As we stated in the Proposing Release, we recognize that the events
of 2007-2008 raise the question of whether further changes to the
regulatory structure governing money market funds may be warranted.
Accordingly, in the Proposing Release we requested comment on
additional, more fundamental regulatory changes, some of which we
recognized could transform the business and regulatory model on which
money market funds have been operating for more than 30 years.\26\ For
example, we requested comment on whether money market funds should move
to the ``floating net asset value'' used by other open-end investment
companies.\27\ We received over 75 comment letters addressing this
issue. We have continued to explore possible more significant changes
to the regulation of money market funds in light of these comments and
through the staff's work with members of the President's Working Group.
We expect to issue a release addressing these issues and proposing
further reform to money market fund regulation.
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    \26\ See Proposing Release, supra note 2, at Section III.
    \27\ See id. at Section III.A.
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II. Discussion

    Today we are adopting the amendments we proposed last June to the
rules governing money market funds, with several changes made in
response to the comments we received. As described below in more
detail, we believe these amendments will make money market funds more
resilient and less likely to break the buck. They will further limit
the risks money market funds may assume by, among other things,
requiring them to increase the credit quality of fund portfolios and to
reduce the maximum weighted average maturity of their portfolios, and
by requiring for the first time that all money market funds maintain
liquidity buffers that will help them withstand sudden demands for
redemptions. The rule amendments require fund managers to stress test
their portfolios against potential economic shocks such as sudden
increases in interest rates, heavy redemptions, and potential defaults.
They provide investors with more timely, relevant information about
fund portfolios to hold fund managers more accountable for the risks
they take. They will improve our ability to oversee money market funds.
And finally, they provide a means to wind down the operations of a fund
that does break the buck or suffers a run, in an orderly way that is
fair to the fund's investors and reduces the risk of market losses that
could spread to other funds. We believe that these reforms collectively
will better protect money market fund investors in times of financial
market turmoil and lessen the possibility that the money market fund
industry will not be able to withstand stresses similar to those
experienced in 2007-08. Thus, we believe that each of the rules and
rule amendments we are adopting is necessary or appropriate in the
public interest and consistent with the protection of investors and the
policies and purposes of the Investment Company Act.\28\
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    \28\ See section 6(c) of the Investment Company Act (under which
rule 22e-3 and amendments to rules 2a-7 and 17a-9 are adopted).
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A. Portfolio Quality

    Rule 2a-7 limits a money market fund to investing in securities
that are, at the time of their acquisition, ``eligible securities,''
which means that securities must have been rated in either of the two
highest short-term debt ratings categories from the relevant NRSROs or
are comparable to securities that have

been so rated in these categories.\29\ Before a fund may invest in an
``eligible security,'' a fund's board of directors (or its delegate)
must also determine that the security presents minimal credit risks,
which must be based on factors pertaining to credit quality in addition
to any rating assigned to a security.\30\
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    \29\ Amended rule 2a-7(a)(12) (eligible security).
    \30\ Amended rule 2a-7(c)(3)(i) (portfolio quality).
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    We are amending rule 2a-7 to reduce the amount of credit risk a
money market fund may assume by limiting the securities in which money
market funds may invest. We are also amending provisions of rule 2a-7
that address how NRSRO ratings are used in the rule.
1. Second Tier Securities
    We are amending rule 2a-7 to further limit money market funds'
investments in ``second tier securities.'' \31\ Under the amendments,
we are reducing permissible money market fund investments in second
tier securities by (i) lowering the permitted percentage of a fund's
``total assets'' that may be invested in second tier securities from
five percent to three percent and (ii) lowering the permitted
concentration of its total assets in second tier securities of a single
issuer from the greater of one percent or $1 million to one-half of one
percent.\32\ In addition, money market funds will not be permitted to
acquire any second tier security with a remaining maturity in excess of
45 days.\33\
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    \31\ Second tier securities are eligible securities that, if
rated, have received other than the highest short-term term debt
rating from the requisite NRSROs or, if unrated, have been
determined by the fund's board of directors to be of comparable
quality. See amended rule 2a-7(a)(24) (defining ``second tier
security''); amended rule 2a-7(a)(23) (defining ``requisite
NRSROs'').
    \32\ See amended rule 2a-7(c)(3)(ii) (portfolio quality--second
tier securities); amended rule 2a-7(c)(4)(i)(C) (portfolio
diversification--second tier securities); amended rule 2a-7(a)(27)
(defining ``total assets'').
    \33\ See amended rule 2a-7(c)(3)(ii) (portfolio quality--second
tier securities).
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    Last June, we proposed to prohibit money market funds from
acquiring second tier securities, based on our analysis of the risks
that these securities can pose to money market funds. We noted that
second tier securities trade in thinner markets, generally have a
weaker credit quality profile, and exhibited credit spreads that
widened more dramatically than those of first tier securities during
the 2008 financial turmoil.\34\ During times of financial market
stress, we understand that these securities tend to become illiquid and
sell in the secondary market, if at all, only at prices substantially
discounted from their amortized cost value.\35\ This additional risk
created by the credit and liquidity profile of second tier securities
increases the possibility that a fund holding these securities could
break the buck in times of financial market turmoil, with a detrimental
impact on fund investors.
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    \34\ See Proposing Release, supra note 2, at Section II.A.1. See
also Thomas K. Hahn, Commercial Paper (Federal Reserve Bank of
Richmond, Economic Quarterly Vol. 79/2, Spring 1993), at Fig. 4
(showing historical spreads between A-1/P-1 commercial paper and A-
2/P-2 commercial paper between 1974 and 1992, including the tendency
of such spreads to spike shortly before and during recessions);
Comment Letter of the Investment Company Institute (Sept. 8, 2009)
(``ICI Comment Letter'') (noting that the market for Tier 2
commercial paper is less deep with fewer issuers than the Tier 1
market).
    \35\ See, e.g., Comment Letter of Invesco AIM Advisors, Inc.
(Sept. 4, 2009) (``Invesco Aim Comment Letter'') (noting that it has
historically avoided the second tier market due to, among other
factors, the less overall market liquidity of second tier
securities); ICI Comment Letter. See also Proposing Release, supra
note 2, at Section II.A.1 for a discussion of the wider credit
spreads of second tier securities during the fall of 2008,
indicating the extent to which such securities traded at a
discounted price.
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    Commenters were evenly divided between those supporting our
proposed elimination of money market funds' ability to acquire second
tier securities and those against our proposal. In general, most money
market fund sponsors who commented supported elimination,\36\ while
most issuers of second tier securities who commented opposed
elimination.\37\ Those supporting elimination argued that it would be
an effective way to increase the safety of money market funds and would
reduce the likelihood that a fund would break the buck. Some commenters
noted that the money market funds they manage have not acquired second
tier securities historically \38\ because of second tier issuers'
weaker credit profiles, smaller issuer program sizes, and lower market
liquidity.\39\ A few commenters noted that eliminating money market
funds' ability to acquire second tier securities should result in
minimal market disruption because money market funds currently hold
small amounts of such securities.\40\
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    \36\ See, e.g., Comment Letter of Bankers Trust Company, N.A.
(Aug. 28, 2009) (``Bankers Trust Comment Letter''); BlackRock
Comment Letter; Comment Letter of Charles Schwab Investment
Management, Inc. (Sept. 4, 2009) (``Charles Schwab Comment
Letter''); Dreyfus Comment Letter; Vanguard Comment Letter. But see
Comment Letter of Federated Investors, Inc. (Sept. 8, 2009)
(``Federated Comment Letter''); Fidelity Comment Letter (opposing
elimination).
    \37\ See, e.g., Comment Letter of the American Securitization
Forum (Sept. 8, 2009) (``Am. Securit. Forum Comment Letter'');
Comment Letter of the U.S. Chamber of Commerce, Center for Capital
Markets Competitiveness (Sept. 8, 2009) (``Chamber Comment
Letter''); Dominion Res. Comment Letter; Comment Letter of XTO
Energy Inc. (Sept. 3, 2009) (``XTO Energy Comment Letter'').
    \38\ See, e.g., Dreyfus Comment Letter; Invesco Aim Comment
Letter.
    \39\ See, e.g., Invesco Aim Comment Letter.
    \40\ See, e.g., ICI Comment Letter; Comment Letter of TD Asset
Management (Sept. 8, 2009) (``TDAM Comment Letter'').
---------------------------------------------------------------------------

    Commenters that opposed the proposal disagreed that second tier
securities significantly increase risk at money market funds,\41\
argued that a complete ban would not be justified on a cost-benefit
basis,\42\ and stated that a ban would have a material adverse impact
on second tier security issuers.\43\ Some commenters noted that in a
report of default rates through 2006, second tier securities have
default rates substantially similar to those of first tier
securities.\44\ These commenters also noted that rating agencies
require that second tier security issuers establish backup liquidity
lines of credit providing 100 percent coverage for any issuance.\45\
Several commenters agreed

with our statement in the Proposing Release that second tier securities
were not the direct cause of strains on money market funds during the
2007-2008 period.\46\ A few stated that banning the acquisition of
second tier securities would reduce diversification of money market
fund portfolio holdings and thus increase risk, noting in particular
that a greater percentage of second tier security issuers are not
financial institutions, compared to first tier security issuers.\47\
---------------------------------------------------------------------------

    \41\ See, e.g., Comment Letter of the Association for Financial
Professionals (Sept. 8, 2009) (``Assoc. Fin. Professionals Comment
Letter''); Chamber/Tier 2 Issuers Comment Letter; Dominion Res.
Comment Letter.
    \42\ See, e.g., Comment Letter of Fund Democracy and the
Consumer Federation of America (Sept. 8, 2009) (``CFA/Fund Democracy
Comment Letter''); Chamber Comment Letter; Dominion Res. Comment
Letter. But see TDAM Comment Letter (stating that the benefits of
eliminating second tier securities will far outweigh any
disadvantages).
    \43\ See, e.g., Chamber Comment Letter; Dominion Res. Comment
Letter; Comment Letter of Treasury Strategies, Inc. (Sept. 8, 2009)
(``Treasury Strategies Comment Letter'').
    \44\ Chamber Comment Letter; Chamber/Tier 2 Issuers Comment
Letter. These commenters were citing the following study: Moody's
Investors Service, Short-Term Corporate and Structured Finance
Rating Transition Rates, 1972-2006 (June 2007), available at http://
www.moodys.com/cust/content/content.ashx?source=staticcontent/
free%20pages/regulatory%20affairs/documents/st_corp_and_struc_
transition_rates_06_07.pdf (showing, for example, a default rate
for P-1 rated commercial paper over a 365 day time horizon of 0.02%
versus a default rate for P-2 rated commercial paper of 0.10% over
the same time horizon).
    \45\ We note, however, that commenters did not discuss
conditions under which those issuers would not be permitted to draw
on those backup liquidity facilities. It is our understanding that
such backup liquidity facilities typically do not provide a full
backstop of liquidity support because they contain conditions
limiting an issuer's ability to draw on the facility if the issuer
has experienced a ``material adverse change,'' which would often
occur if the financial situation of the issuer had declined due to
financial market or other economic turmoil. See also Hahn, supra
note 34 (stating that backup lines of credit generally will not be
useful for a firm whose operating and financial condition has
deteriorated to the point where it is about to default on its short-
term liabilities because credit agreements often contain ``material
adverse change'' clauses that allow banks to cancel credit lines if
the financial condition of the firm changes significantly); Pu Shen,
Why Has the Nonfinancial Commercial Paper Market Shrunk Recently?,
Federal Reserve Bank of Kansas City Economic Review, at 69 (First
Quarter 2003) (stating that commercial paper backup facilities are
only meant to provide emergency assistance for short-term liquidity
difficulties and not to enhance the credit quality of issues);
Standard & Poor's, 2008 Corporate Criteria: Commercial Paper, at 3
(Apr. 15, 2008) (``Given the size of the CP market, backup
facilities could not be relied on with a high degree of confidence
in the event of widespread disruption.'').
    \46\ See, e.g., Chamber/Tier 2 Issuers Comment Letter; Federated
Comment Letter; Fidelity Comment Letter.
    \47\ See, e.g., Treasury Strategies Comment Letter; USAA Comment
Letter; XTO Energy Comment Letter. We note that while a greater
percentage of second tier security issuers do appear to be non-
financial companies, there are a much greater number of non-
financial first tier issuers and thus it is not clear that money
market funds would not be able to achieve sufficient diversification
in their portfolio holdings even if limited to acquiring first tier
securities. The Chamber/Tier 2 Issuers Comment Letter also states
that prohibiting money market funds from acquiring second tier
securities would ``cut the pool of potential issuers by 43%''
(emphasis added). Any diversification is not driven only by the
number of potential issuers, however. It is also determined by the
amount of money market fund assets that can be actually allocated to
different issuers. For example, while there are over 200 P-2 rated
commercial paper programs, only approximately half of these programs
are active in issuing any commercial paper and only 16 programs have
an average quarterly outstanding issuance in excess of $500 million.
See American Securit. Forum Comment Letter. In addition, during the
market turmoil of 2007 and 2008, second tier securities did not
exhibit less risky or countervailing economic metrics relevant to
money market funds maintaining a stable net asset value compared to
first tier securities. See Proposing Release, supra note 2, at
Section II.A.1, at n.98 and accompanying text and chart. In fact,
AA-rated non-financial commercial paper did exhibit significantly
greater price stability than A2/P2-rated non-financial commercial
paper during the fall of 2008. See Federal Reserve Board, Commercial
Paper Data, available at http://www.federalreserve.gov/DataDownload/
Choose.aspx?rel=CP (``Federal Reserve Commercial Paper Data''). See
also V.V. Chari, L. Christiano & P. Kehoe, Facts and Myths about the
Financial Crisis of 2008, Federal Reserve Bank of Minneapolis
Working Paper 666, at Fig. 7B (Oct. 2008).
---------------------------------------------------------------------------

    Commenters also asserted that prohibiting the acquisition of second
tier securities would have unintended consequences for the capital
markets. They stated that it might discourage investors other than
money market funds from investing in second tier securities, causing a
more substantial reduction in the issuance of second tier
securities.\48\ Some argued that if second tier issuers are not able to
issue sufficient commercial paper, they will be forced to borrow more
from banks, which is a less flexible and more costly alternative that
will increase borrowing costs.\49\ Finally, two commenters stated that
a complete ban on the acquisition of second tier securities by money
market funds might have a negative effect on those issuers of first
tier securities that are viewed as presenting a higher risk of being
downgraded, because money market funds may elect not to invest in those
securities out of concern that the securities might soon become second
tier securities.\50\
---------------------------------------------------------------------------

    \48\ See, e.g., Chamber Comment Letter; Dominion Res. Comment
Letter; Treasury Strategies Comment Letter. Commenters asserted that
eliminating money market funds' ability to acquire second tier
securities might have a substantially greater adverse impact on
second tier issuers, and thus potentially on capital formation
because other investors in second tier securities or lesser quality
first tier securities might avoid investment in those securities as
a result of our rule amendments. Investor behavior in this regard is
difficult to predict. It is equally likely that investors in second
tier paper would demand higher yields, increasing issuers' financing
costs. As discussed below, however, we are not precluding money
market funds from investing in second tier securities. Accordingly,
we do not need to reach a conclusion on this matter.
    \49\ See, e.g., Am. Elec. P. Comment Letter; Chamber/Tier 2
Issuers Comment Letter; Dominion Res. Comment Letter; XTO Energy
Comment Letter. We note that money market funds hold a relatively
low percentage of outstanding second tier commercial paper. See Bank
of America Merrill Lynch, Tier-2 US Commercial Paper Market Update
(Oct. 15, 2009) (attached to the Am. Securit. Forum Comment Letter)
(indicating that over 75% of Tier-2 commercial paper is held by
insurance firms, corporations and banks, and that only 11% is held
by the asset management industry, which would include money market
funds as well as other mutual funds and asset managers).
    \50\ Fidelity Comment Letter; USAA Comment Letter. Two other
commenters suggested that the Commission should consider the effect
of banning the acquisition of second tier securities on tax-exempt
money market funds, and in particular single-State funds. See
Dreyfus Comment Letter; Federated Comment Letter. As discussed
further in the cost benefit analysis section of this Release, based
on our review of money market fund portfolios in September 2008,
very few money market funds, including tax-exempt funds, will be
impacted by our amendments relating to second tier securities. The
greatest potential impact on tax-exempt funds will be the 45-day
maturity limitation for acquisition of second tier securities. Given
the prevalence of variable rate demand notes among municipal
securities, however, we believe that tax-exempt funds should be able
to effectively manage the 45-day maturity limit without a
substantial impact. Accordingly, we do not believe that a special
accommodation for tax-exempt money market funds is required with
respect to second tier securities.
---------------------------------------------------------------------------

    The focus of our concerns is and must be on the risk to money
market funds and their shareholders from their investments in second
tier securities. While, as commenters noted,\51\ second tier securities
do not appear to be subject to substantially greater default risk than
first tier securities they present greater credit spread risk and trade
in thinner markets,\52\ all of which can lead to greater price
volatility and illiquidity in times of market stress.\53\ While these
characteristics may not pose the same degree of risk to money market
funds as the likelihood that a security could default and become
worthless, they can adversely affect money market funds' ability to
maintain a stable net asset value. This is particularly the case given
money market funds' narrow margin for deviation between the mark-to-
market value of their assets and the amortized cost value of those
assets, and the significant negative impact on money market funds and
their investors if a fund breaks the buck.
---------------------------------------------------------------------------

    \51\ See supra note 44 and accompanying text.
    \52\ A few commenters argued that the increase in spreads of
Tier 2 commercial paper over Tier 1 commercial paper during the fall
of 2008 was due to the Federal Reserve Board's announcement of its
creation of the Commercial Paper Funding Facility (CPFF) on October
7, 2008, which only supported issuance of 90-day Tier 1 commercial
paper. See Chamber Comment Letter; Chamber/Tier 2 Issuers Comment
Letter; Dominion Res. Comment Letter. We note, however, that spreads
between Tier 1 and Tier 2 commercial paper widened significantly (by
well over 300 basis points) immediately after the bankruptcy of
Lehman Brothers was announced on September 14, 2008--well before the
CPFF was announced on October 7. See Federal Reserve Commercial
Paper Data, supra note 47 (comparing AA and A2/P2 rated 30-day and
60-day nonfinancial commercial paper rates).
    \53\ We note that second tier securities are also more likely to
be downgraded than first tier securities. See Moody's Investors
Service, Short-Term Corporate and Structured Finance Rating
Transition Rates, supra note 44, cited in Chamber/Tier 2 Issuers
Comment Letter (showing that for each time period, commercial paper
with a P-2 rating had a greater percentage chance of being
downgraded than commercial paper with a P-1 rating, and that this
gap widened over time--for example, P-2 rated commercial paper had a
1.09% chance of being downgraded over a 60-day period compared to a
0.72% chance of P-1 commercial paper being downgraded (a 0.37%
difference); P-2 rated commercial paper had a 2.07% chance of being
downgraded over a 120-day period compared to a 1.46% chance of P-1
commercial paper being downgraded (a 0.61% difference); and P-2
rated commercial paper had a 4% chance of being downgraded over a
270-day period compared to a 3.18% chance of P-1 commercial paper
being downgraded (a 0.82% difference)).
---------------------------------------------------------------------------

    Several commenters asserted that there are high-quality second tier
securities available and that money market funds conducting a thorough
credit risk analysis may conclude that certain second tier securities
provide a higher yield than first tier securities while still
maintaining a risk profile consistent with investment objectives for
money market fund investment.\54\ In these circumstances, investment in
higher yielding second tier securities may benefit fund investors.
These commenters suggested that, given these benefits, it may be more
appropriate for

us to preserve money market funds' ability to invest in second tier
securities, but to a reduced degree.\55\
---------------------------------------------------------------------------

    \54\ See, e.g., Fidelity Comment Letter; Comment Letter of
Thrivent Mutual Funds (Sept. 8, 2009) (``Thrivent Comment Letter'').
    \55\ See, e.g., Federated Comment Letter (suggesting, as an
alternative to eliminating money market funds' ability to acquire
second tier securities, further limitations including reducing the
percentage of fund assets permitted to be invested in second tier
securities and limiting the final maturity of permissible second
tier securities). See also, e.g., Am. Elec. P. Comment Letter;
Fidelity Comment Letter; USAA Comment Letter (each suggesting, as an
alternative to eliminating money market funds' ability to acquire
second tier securities, limiting the final maturity of permissible
second tier securities to 90 days).
---------------------------------------------------------------------------

    In light of these considerations, we believe that it is not
necessary to prohibit money market funds from acquiring second tier
securities. Instead, we believe that a better approach is to further
limit money market funds' exposure to the risks presented by second
tier securities. We expect that this treatment will both satisfy our
policy objectives, as further discussed below, while mitigating some of
the possible negative consequences noted by commenters that could
result from eliminating money market funds' ability to acquire second
tier securities. This approach is reflected in three amendments we are
adopting to rule 2a-7.
    First, as suggested by some commenters,\56\ we are reducing the
amount of second tier securities that money market funds can acquire
from five to three percent of their total assets, in order to reduce
money market funds' aggregate exposure to the risks posed by second
tier securities.\57\ We are concerned that a limit of less than three
percent could be equivalent to eliminating money market funds' ability
to acquire second tier securities because we understand that investing
in second tier securities requires an additional amount of credit
analysis.\58\ Accordingly, money market funds may not be willing to
incur the costs of this additional credit analysis if they could only
acquire second tier securities in amounts unlikely to make a meaningful
contribution to fund yields.
---------------------------------------------------------------------------

    \56\ See Federated Comment Letter; Comment Letter of the Sargent
Shriver National Center on Poverty Law (Jul. 13, 2009) (``Shriver
Poverty Law Ctr. Comment Letter''). These commenters did not suggest
a particular percentage level to which the permissible aggregate
amount of second tier securities that could be acquired should be
reduced.
    \57\ The amendments apply the new limit on second tier
securities holdings to all money market funds, including tax-exempt
funds. See amended rule 2a-7(c)(3). Current rule 2a-7 limits tax-
exempt funds' holdings of second tier securities only with respect
to conduit securities (i.e., securities issued by a municipal issuer
involving an arrangement or agreement entered into with a person
other than the issuer that provides for or secures repayment of the
security). See current rule 2a-7(c)(3)(ii)(B).
    \58\ In light of our decision not to prohibit the acquisition of
second tier securities and after review of comments we received, we
are persuaded that the current requirements regarding the rating
standards in rule 2a-7 for certain long-term securities with
remaining maturities of less than 397 days (``stub securities'') are
sufficient. We proposed to permit money market funds to acquire only
those stub securities that had received a long-term rating in the
highest two categories rather than the highest three categories, as
permitted under the current rule. See current rule 2a-7(a)(10(ii)A).
Commenters largely opposed our proposal asserting that standards
associated with long-term ratings referenced in the current rule
generally are correlated with the standards associated with the
highest categories of short-term ratings. See BlackRock Comment
Letter; Charles Schwab Comment Letter; ICI Comment Letter.
---------------------------------------------------------------------------

    Second, we are reducing the amount of second tier securities of any
one issuer that a money market fund can acquire from one percent of the
fund's total assets or $1 million (whichever is greater), to one-half
of one percent of the fund's total assets.\59\ We requested comment in
the Proposing Release on whether the issuer diversification limitations
under rule 2a-7 should be further reduced and, if so, to what
level.\60\ Most commenters focused their response on whether there
should be a general increase in the diversification limits under rule
2a-7 for all eligible securities. Many argued against an increase
because it would require funds to invest in securities of lower credit
quality in order to increase the number of issuers of portfolio
securities and satisfy the greater diversification requirement.\61\ One
commenter, however, recommended that funds not be able to acquire more
than one-half of one percent of their assets in second tier securities
of any particular issuer as a method of limiting money market funds'
exposure to the risks of second tier securities.\62\
---------------------------------------------------------------------------

    \59\ Amended rule 2a-7(c)(4)(i)(C). The limitation also applies
to tax-exempt funds, which under the current rule are only subject
to the issuer diversification requirement with respect to conduit
securities that are second tier. We also are amending rule 2a-
7(c)(4)(i)(B) to prohibit each ``single State fund'' from acquiring
more than \1/2\ of 1% of its total assets in second tier securities.
We also discussed modification to the guarantor and demand feature
diversification provisions under rule 2a-7 in Section II.D of the
Proposing Release. In addition to the reduction in the ability of
money market funds to acquire second tier securities of any
particular issuer, we are proportionately reducing by half the
ability of a money market fund to acquire ``demand features'' or
``guarantees'' of a single issuer that are second tier securities
from 5% to 2.5% of the money market fund's total assets. See amended
rule 2a-7(c)(4)(iii)(B). We believe that this reduction will provide
appropriate protection to money market funds against exposure to any
particular guarantor or demand feature provider. We do not believe
that we need to reduce this limitation to \1/2\ of 1%, as we are
doing with other individual second tier issuer exposures, because in
these cases a security holder has recourse to both the security
issuer and the issuer of the demand feature or guarantee, and thus
there is a lesser chance that an individual company's default or
distress will adversely impact the security. We received no comments
on this aspect of the Proposing Release.
    \60\ See Proposing Release, supra note 2, at Section II.D.
    \61\ See, e.g., Charles Schwab Comment Letter; Invesco Aim
Comment Letter.
    \62\ See Comment Letter of James J. Angel, Professor of Finance,
Georgetown University (Sept. 8, 2009). Two other commenters also
generally supported greater restrictions on money market funds'
ability to acquire securities of any particular issuer. See Shriver
Poverty Law Ctr. Comment Letter; Comment Letter of C. Stephen
Wesselkamper (Sept. 3, 2009) (``C. Wesselkamper Comment Letter'').
---------------------------------------------------------------------------

    We are adopting this commenter's suggestion because we believe the
limitation will enhance the resilience of money market funds. It should
decrease the likelihood that the default of, or significant distress
experienced by, any particular second tier issuer alone will cause a
money market fund to break the buck. While a money market fund can
break the buck due to simultaneous stresses across its portfolio, it
also can break the buck due to a sudden decline in the market-based
price of a particular security in its portfolio, as was the case with
respect to securities of Lehman Brothers during September 2008.\63\ In
addition, unlike in the case of imposing a one-half of one percent
diversification limitation on all issuers held in a money market fund's
portfolio, given the other limitations on holdings of second tier
securities that we are adopting today, a diversification limitation of
one-half of one percent that applies only to second tier securities
should not require money market funds to invest in a substantially
greater number of issuers, and thus should not expose the fund to
investing in securities of lower credit quality.\64\ In sum, we believe
this tightened limitation on exposure to any particular second tier
security issuer will provide additional protection to the stability of
money market funds.
---------------------------------------------------------------------------

    \63\ See supra text accompanying note 11.
    \64\ Under the current rule, a taxable money market fund could
invest the greater of 1% or $1 million of its assets in second tier
securities of a single issuer. Under the amendments we are adopting
today, a money market fund maximizing its investment ability in
second tier securities and trying to concentrate its holdings in as
few issuers as possible would hold securities of six different
second tier security issuers, rather than five second tier issuers
under the current rule.
---------------------------------------------------------------------------

    Third, we are limiting money market funds to acquiring second tier
securities with remaining maturities of 45 days or less.\65\ Several
commenters urged us to adopt this approach to limiting money market
funds' exposure to risk from second tier securities.\66\ The risks of

second tier securities discussed above can be substantially limited by
restricting the length of time that a money market fund is exposed to
the risks of that particular security. Securities of shorter maturity
will pose less credit spread risk and liquidity risk to the fund
because there is a shorter period of credit exposure and a shorter
period until the security will mature and pay cash. Moreover, second
tier securities with shorter maturities are less likely to be
downgraded.\67\ In recognition of the role that a shorter maturity can
play in reducing second tier securities' risk, the market typically has
demanded that such securities be issued at shorter maturities than
first tier securities.\68\ We believe that limiting the risk arising
out of second tier securities through limiting their permissible
maturity is appropriate and that a 45-day maturity limit will provide
additional protection to investors without causing undue market
disruption.\69\
---------------------------------------------------------------------------

    \65\ Amended rule 2a-7(c)(3)(ii). We requested comment on this
approach in the Proposing Release. See Proposing Release, supra note
2, at Section II.A.1.
    \66\ See, e.g., Am. Elec. P. Comment Letter; Fidelity Comment
Letter; USAA Comment Letter (all suggesting that permissible second
tier security maturities be limited to a 90-day maximum); Thrivent
Comment Letter (suggesting that permissible second tier security
maturities be limited to a 45-day maximum). Given the need for money
market funds to adjust quickly to changes in market risk to avoid
breaking the buck (and given that based on historical experience
second tier securities are unlikely to be issued with a 90-day
maturity limit), we believe that a 45-day maturity limit is more
prudent than a 90-day maturity limit.
    \67\ See Moody's Investors Service, Short-Term Corporate and
Structured Finance Rating Transition Rates, supra note 44 (showing
that P-2 rated commercial paper had a 98.79% chance of being rated
P-2 or higher over a 30-day period, but a 96.31% chance of being
rated P-2 or higher over a 90-day period, and a 92.75% chance of
maintaining this rating level over a 180-day period).
    \68\ For example, the average maturity of outstanding non-asset
backed second tier commercial paper as of November 20, 2009 was 25.6
days compared to 52.2 days for non-asset backed first tier
commercial paper. See Federal Reserve Board, Average Maturity by
Category for Outstanding Commercial Paper, available at http://
www.federalreserve.gov/releases/cp/maturity.htm (last visited Dec.
2009). The Federal Reserve Board also has reported that during each
of 2007, 2008, and 2009, on average over 96% of non-financial A2/P2
commercial paper had a maturity of 40 days or less at issuance. See
Federal Reserve Board, Volume Statistics for Commercial Paper, A2/P2
Nonfinancial, available at http://www.federalreserve.gov/releases/
cp/volumestats.htm (last visited Dec. 2009).
    \69\ One commenter asserted that because so little of second
tier commercial paper currently is issued with a maturity of greater
than 45 days, imposing a maturity limitation of 45 days on second
tier securities eligible for money market fund investment would have
little effect on a fund's overall exposure to credit risk. See ICI
Comment Letter. We disagree. It is true that in recent years, second
tier commercial paper has been issued largely at maturities of less
than 45 days. See supra note 68. This fact may mean that there will
be less cost impact from our amendments limiting money market funds
to acquiring second tier securities with maturities of 45 days or
less. It does not mean, however, that this historical maturity
distribution will hold true in the future, and that money market
funds will not seek in the future to invest in longer term second
tier securities to achieve a higher yield, which would expose money
market funds to the higher risks associated with longer term second
tier securities.
---------------------------------------------------------------------------

    We believe that the above combination of limitations on money
market funds' ability to acquire second tier securities will achieve an
appropriate balance between reducing the risk that money market funds
will not be able to maintain a stable price per share and allowing fund
investors to benefit from the higher returns that limited exposure to
second tier securities can provide.
2. Eligible Securities
    We are amending rule 2a-7 to require that the board of directors of
each money market fund (i) designate four or more NRSROs, any one or
more of whose short-term credit ratings the fund would look to under
the rule in determining whether a security is an eligible security, and
(ii) determine at least once each calendar year that the designated
NRSROs issue credit ratings that are sufficiently reliable for that
use.\70\ In addition, funds must identify the designated NRSROs in the
fund's statement of additional information (``SAI'').\71\ Under the
amendments, funds may, but are not required to, consider (or monitor)
the ratings of other NRSROs under other provisions of the rule.\72\
---------------------------------------------------------------------------

    \70\ Amended rule 2a-7(a)(11)(i). As under the definition of
``NRSRO'' in current rule 2a-7, a designated NRSRO may not be an
affiliated person of the issuer of, or any insurer or provider of
credit support for, the security. Amended rule 2a-7(a)(11)(ii). The
definition of ``designated NRSRO'' incorporates the definition of
NRSRO in section 3(a)(62) of the Securities Exchange Act of 1934
(``Exchange Act'') [15 U.S.C. 78c(a)(62)]. Amended rule 2a-7(a)(11).
    \71\ Amended rule 2a-7(a)(11)(iii) (requiring the fund to
disclose in its SAI its designated NRSROs and any limitations with
respect to the fund's use of such designation). See Part B of Form
N-1A. In addition, funds must identify designated NRSROs in Form N-
MFP with respect to each of the fund's portfolio securities. See
infra Section II.E.2.
    \72\ See infra notes 116-118, 121 and accompanying text.
---------------------------------------------------------------------------

    As we have stated on several occasions, we are concerned with the
authority that references to NRSRO ratings in our rules have given
certain rating agencies, and whether such references have inadvertently
placed an ``official seal of approval'' on ratings that could adversely
affect the quality of due diligence and investment analysis.\73\ The
debt crisis of 2007-2008 also has given us concern about the
reliability of these ratings.\74\ Accordingly, we asked in the
Proposing Release and in 2008 in a separate release whether we should
eliminate or alter our use of ratings by NRSROs in rule 2a-7.\75\
---------------------------------------------------------------------------

    \73\ 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 Proposing Release''); References to Ratings of Nationally
Recognized Statistical Rating Organizations, Investment Company Act
Release No. 28939 (Oct. 5, 2009) [74 FR 52358 (Oct. 9, 2009)]
(``NRSRO References Adopting Release'').
    \74\ See NRSRO References Proposing Release, supra note 73, at
text following n.6.
    \75\ See Proposing Release, supra note 2, at text following
n.110; NRSRO References Proposing Release, supra note 73, at Section
III.A.
---------------------------------------------------------------------------

    The Proposing Release requested comment on alternative approaches.
One approach would have eliminated any references to ratings in rule
2a-7, the effect of which would be to eliminate the floor established
by the ``eligible security'' requirement and rely entirely on fund
boards (and their delegates) to determine whether investment in a
security involved minimal credit risks. An alternative approach would
have maintained references to credit ratings in the rule, but shifted
responsibility to fund boards to determine at least annually which
NRSROs were sufficiently reliable for the fund to use to determine
whether a security is an eligible security that could be considered for
investment. Among other things, we requested comment on the minimum
number of credit rating agencies we should require that a board
designate for this purpose.
    Each time we have solicited comments, a substantial majority of
commenters has strongly supported retaining the references to NRSRO
ratings in the rule.\76\ Among other reasons, commenters argued that
using credit ratings as a floor for credit quality limits money market
fund advisers from taking greater risks that could weaken the rule's
risk limiting conditions and thus the protection of investors.\77\ Many
urged us instead to address the ``root causes'' of ratings failures
rather than remove the safety net provided by the

credit ratings requirements of the rule.\78\ Some disputed suggestions
that inclusion of ratings in rule 2a-7 encourages fund managers to
over-rely on the ratings, pointing to provisions in the rule that
specifically require independent analysis by fund managers.\79\ One
commenter argued that NRSRO ratings provide ``an additional,
independent check on the investment manager's judgment.'' \80\ By
acting as a floor, the commenter argued, these ratings keep all money
market funds operating at or above the same level,\81\ and they
restrain any particular money market fund from taking (and exposing
investors to) greater risks than other competing money market funds in
order to gain a competitive advantage in a highly yield-sensitive
market.\82\
---------------------------------------------------------------------------

    \76\ See, e.g., Comment Letter of Calvert Group, Ltd. (Sept. 8,
2009) (``Calvert Comment Letter''); Federated Comment Letter; ICI
Comment Letter. See also Comment Letter of the American Bar
Association (Committee on Federal Regulation of Securities and
Committee on Securitization and Structured Finance) (Sept. 12, 2008)
(available in File No. S7-19-08); Comment Letter of the
Institutional Money Market Funds Association (Sept. 5, 2008)
(available in File No. S7-19-08); Comment Letter of the Securities
Industry and Financial Markets Association (Dec. 8, 2009) (available
in File No. S7-19-08). Comment letters submitted in File No. S7-19-
08 are available on the Commission's Web site at: http://
www.sec.gov/comments/s7-19-08/s71908.shtml.
    \77\ See, e.g., Dreyfus Comment Letter; ICI Comment Letter;
Comment Letter of J.P. Morgan Asset Management (Sept. 8, 2009)
(``J.P. Morgan Asset Mgt. Comment Letter''). See also Proposing
Release, supra note 2, at nn.108-110 and accompanying text.
    \78\ See, e.g., Comment Letter of the Northern Funds and
Northern Institutional Funds--Independent Trustees (Sept. 8, 2009)
(``Northern Funds Indep. Trustees Comment Letter''); Comment Letter
of the Tamarack Funds Trust (Sept. 8, 2009) (``Tamarack Funds
Comment Letter''). See also Comment Letter of Charles Schwab & Co.,
Inc. (Sept. 5, 2008) (available in File No. S7-19-08); Comment
Letter of Dechert LLP (Sept. 5, 2008) (available in File No. S7-19-
08); Comment Letter of Realpoint (Aug. 14, 2008) (available in File
No. S7-19-08). We have recently adopted rule amendments designed to
improve our regulation and oversight of NRSROs, which help address
the integrity of their rating procedures and methodologies. See
Amendments to Rules for Nationally Recognized Statistical Rating
Organizations, Exchange Act Release No. 61050 (Nov. 23, 2009) [74 FR
63832 (Dec. 4, 2009)]; Amendments to Rules for Nationally Recognized
Statistical Rating Organizations, Exchange Act Release No. 59342
(Feb. 2, 2009) [74 FR 6456 (Feb. 9, 2009)]; Oversight of Credit
Rating Agencies Registered as Nationally Recognized Statistical
Rating Organizations, Exchange Act Release No. 55857 (June 5, 2007)
[72 FR 33564 (June 18, 2007)].
    \79\ See ICI Comment Letter; TDAM Comment Letter.
    \80\ See ICI Comment Letter.
    \81\ See, e.g., Comment Letter of State Street Global Advisors
(Sept. 8, 2009) (``State Street Comment Letter''); Vanguard Comment
Letter.
    \82\ See ICI Comment Letter. See also J.P. Morgan Asset Mgt.
Comment Letter; Comment Letter of Stradley Ronon Stevens & Young,
LLP (Sept. 8, 2009) (``Stradley Ronon Comment Letter'').
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    Only a few commenters have supported removing references to NRSRO
ratings.\83\ These commenters principally asserted that removing credit
ratings references would prevent fund boards and advisers from
overreliance on NRSRO ratings and encourage advisers to make
independent decisions about whether a security presents a credit
risk.\84\ Other commenters, however, countered that eliminating NRSRO
ratings from the rule would do nothing to prevent a fund manager from
being highly dependent upon NRSRO ratings in making its minimal credit
risk determination.\85\
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    \83\ See Comment Letter of James B. Burnham, Business School
Professor, Duquesne University (Aug. 27, 2009) (``J. Burnham Comment
Letter''); Comment Letter of Moody's Investors Service (Sept. 8,
2009) (``Moody's Comment Letter''); Comment Letter of James L.
Nesfield (Jul. 4, 2009) (``J. Nesfield Comment Letter''); Comment
Letter of the Shadow Financial Regulatory Committee (Sept. 14, 2009)
(``Shadow FRC Comment Letter''); Comment Letter of John M. Winters,
CFA (Jul. 23, 2009). See also Comment Letter of Professor Lawrence
J. White (Sept. 5, 2008) (available in File No. S7-19-08); Comment
Letter of Professor Frank Partnoy (Sept. 5, 2008) (available in File
No. S7-19-08); Comment Letter of the Government Finance Officers
Association (Sept. 5, 2008) (available in File No. S7-19-08);
Comment Letter of the Financial Economists Roundtable (Dec. 1, 2008)
(available in File No. S7-19-08).
    \84\ See J. Burnham Comment Letter; Moody's Comment Letter; J.
Nesfield Comment Letter; Shadow FRC Comment Letter. One commenter
asserted that transparency of portfolio holdings was a better
approach than using references to NRSRO ratings. J. Nesfield Comment
Letter. We note that we are amending rule 2a-7 to require money
market funds to disclose information about their portfolio holdings
each month on their Web sites. See infra Section II.E.1.
    \85\ Stradley Ronon Comment Letter (removing the references
would not prevent advisers from relying too heavily on NRSRO ratings
under their own internal credit risk analysis).
---------------------------------------------------------------------------

    Commenters did, however, largely support the approach of allowing
funds to designate a minimum number of NRSROs that the fund would look
to under rule 2a-7 in determining whether a security is an eligible
security. They asserted that NRSRO designation would encourage
competition among NRSROs to achieve designation and reduce the cost of
subscribing to all NRSROs' ratings.\86\ They also noted that this
approach would permit funds to focus better on standards, methods, and
current ratings levels developed by designated NRSROs.\87\ Several
commenters expressed concern, however, that requiring designation of
only three NRSROs would result in funds designating the three largest
NRSROs, which could further entrench their market dominance.\88\ Other
commenters stated that designating NRSROs could disadvantage small
NRSROs with well-developed capabilities regarding certain investments
and suggested that the fund should have flexibility to rely on the
particular NRSROs it determines have the best expertise to evaluate a
particular security.\89\ Some commenters, while supporting designation
of NRSROs, asserted that fund boards are unprepared to make such
determinations and urged that fund advisers be given the
responsibility.\90\
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    \86\ See, e.g., Federated Comment Letter; Fidelity Comment
Letter; ICI Comment Letter.
    \87\ See Am. Securit. Forum Comment Letter.
    \88\ See, e.g., Comment Letter of DBRS Limited (Sept. 8, 2009)
(``DBRS Comment Letter''); Comment Letter of Wells Fargo Funds
Management, LLC (Sept. 8, 2009) (``Wells Fargo Comment Letter'').
Three of the 10 NRSROs registered with the Commission issued
approximately 97% of all outstanding ratings across all categories
reported to the Commission for 2008. See SEC, Annual Report on
Nationally Recognized Statistical Rating Organizations (Sept. 2008)
at 10.
    \89\ See Tamarack Funds Comment Letter; TDAM Comment Letter.
    \90\ See Comment Letter of the American Bar Association
(Committee on Federal Regulation of Securities) (Sept. 9, 2009)
(``ABA Comment Letter''); Comment Letter of the Mutual Fund
Directors Forum (Sept. 8, 2009) (``MFDF Comment Letter''); Comment
Letter of Northern Funds and Northern Institutional Funds (Sept. 8,
2009) (``Northern Funds Comment Letter'').
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    The Commission is committed to reevaluating the use of NRSRO
ratings in our rules. Recently we eliminated references to NRSRO
ratings in several rules where we concluded that they were no longer
warranted as serving their intended purposes and where the elimination
was consistent with the protection of investors.\91\ Today, as
discussed in more detail below, we are eliminating the only provision
in rule 2a-7 that limits money market funds to investing in a type of
security only if it is rated.\92\ We continue to work to further the
goals of the Credit Rating Agency Reform Act in order to improve the
quality and reliability of securities ratings.\93\
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    \91\ See NRSRO References Adopting Release, supra note 73.
    \92\ Compare amended rule 2a-7(a)(12) with current rule 2a-
7(a)(10)(i)(B).
    \93\ See, e.g., Proposed Rules for Nationally Recognized
Statistical Rating Organizations, Exchange Act Release No. 61051
(Nov. 23, 2009) [74 FR 63866 (Dec. 4, 2009)] (proposing rule
amendments and a new rule requiring each NRSRO to: (1) Furnish an
annual report describing the steps taken by the firm's designated
compliance officer during the fiscal year with respect to certain
compliance matters; (2) disclose additional information about
sources of revenues on Form NRSRO; and (3) make publicly available
information about revenues of the NRSRO attributable to persons
paying the NRSRO for the issuance or maintenance of a credit
rating).
---------------------------------------------------------------------------

    We have found no evidence that suggests that over-reliance on NRSRO
ratings contributed to the problems that money market funds faced
during the debt crisis. Our staff closely examined, for example, why
some money market funds held securities issued by certain SIVs that
became distressed in 2007. The staff exams appear to indicate that the
minimal creditworthiness evaluations of SIVs made by advisers to funds
that held those SIVs differed from the evaluations made by advisers to
funds that did not invest in those SIVs in the emphasis the advisers
gave to particular elements of the analysis.\94\ Had fund managers
relied too heavily on credit rating agencies, we would have expected to
see far more funds

holding Lehman Brothers commercial paper when it defaulted than we
did.\95\
---------------------------------------------------------------------------

    \94\ See Proposing Release, supra note 2, at note 135.
    \95\ See Fitch: Market Challenges Offer `Lessons' for Rated
Money Market Funds, Business Wire (Oct. 1, 2008) (``Most funds were
able to eliminate or minimize their exposure to securities issued by
SIVs and Lehman Brothers by limiting their absolute exposures and/or
taking measures to scale back their risk as the credit picture
deteriorated.''). See Bloomberg Terminal Database, LEH (Equity) CRPR
(historical short-term credit ratings for credit rating agencies,
including Moody's and Fitch, indicate that these agencies did not
downgrade their ratings of Lehman Brothers debt before the company
filed for bankruptcy); Bob Ivry, Mark Pittman & Christine Harper,
Sleep-At-Night-Money Lost in Lehman Lesson Missing $63 Billion,
Bloomberg (Sept. 8, 2009), available at http://www.bloomberg.com/
apps/news?pid=email_en&sid=aLhi.S5xkemY (historical short-term
credit ratings for Moody's and Fitch indicate that these credit
rating agencies did not downgrade their ratings of Lehman Brothers
debt before the company filed for bankruptcy); David Segal, The
Silence of the Oracle, New York Times (Mar. 18, 2009) (noting
Moody's rated Lehman Brothers' debt A2 before the firm's
bankruptcy).
---------------------------------------------------------------------------

    The current provisions of rule 2a-7 were designed to prevent excess
reliance on credit rating agencies.\96\ Under rule 2a-7, adequate
ratings alone do not provide a basis for eligibility. As we have noted
before, a determination that a security is an eligible security is a
necessary but not sufficient finding in order for a fund to acquire the
security.\97\ 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.'' \98\ Thus, credit ratings
provide an important but not exclusive input into the investment
decision-making process, \99\ and the unreliability or low quality of
ratings issued by one or more NRSROs can (and should) be addressed by
an investment adviser providing a thorough analysis of the security to
determine if it involves minimal credit risks. The use of these ratings
provides an independent perspective on the creditworthiness of short-
term securities that we have considered, in part, when determining
whether to exercise our exemptive authority to permit money market
funds to use the amortized cost method of valuation.\100\
---------------------------------------------------------------------------

    \96\ 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'') at Section II.A.
    \97\ See, e.g., id. at text accompanying n.18.
    \98\ Current rule 2a-7(c)(3)(i).
    \99\ See 1991 Adopting Release, supra note 96, at Section II.A.
    \100\ See 1983 Adopting Release, supra note 6, at paragraphs
following n.31.
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    This is not to say, however, that we are content with the current
approach of rule 2a-7. Any one of the growing number of NRSROs,
regardless of its expertise in rating short-term securities of the type
held by money market funds, could have deemed a security unfit for a
money market fund to acquire or, conversely, deemed a security to be
eligible for investment by a money market fund. To address this
concern, we are adopting amendments to rule 2a-7 that shift
responsibility to money market fund boards for deciding which NRSROs
they will use in determining whether a security is an eligible security
for purposes of the rule.
    The amendments are designed, among other things, to foster greater
competition among NRSROs to produce the most reliable ratings in order
to obtain designation by money market fund boards. Accordingly, we
believe this approach will improve the utility of the rule's use of
NRSRO ratings as threshold investment criteria, and is consistent with
the goals of Congress in passing the Credit Rating Agency Reform
Act.\101\
---------------------------------------------------------------------------

    \101\ See Senate Committee on Banking, Housing, and Urban
Affairs, Credit Rating Agency Reform Act of 2006, S. Rep. 109-326,
at 1 (2006) (``Senate Report No. 109-326'') (``The purpose of the
`Credit Rating Agency Reform Act' * * * is to improve ratings
quality for the protection of investors and in the public interest
by fostering accountability, transparency, and competition in the
credit rating industry.''). In 2007, pursuant to the Credit Rating
Agency Reform Act, we adopted rules to implement a program for
registration and Commission oversight of NRSROs (``NRSRO Rules'').
Oversight of Credit Rating Agencies Registered as Nationally
Recognized Statistical Rating Organizations, Exchange Act Release
No. 55857 (June 5, 2007) [72 FR 33564 (June 18, 2007)] (``NRSRO
Rules Adopting Release''). Our rule amendments regarding NRSROs have
been designed, among other things, to foster greater competition
among NRSROs and to encourage more of them to enter the market. See,
e.g., Amendments to Rules for Nationally Recognized Statistical
Rating Organizations, Exchange Act Release No. 61050 (Nov. 23, 2009)
[74 FR 63832 (Dec. 4, 2009)], at nn.1-3 and accompanying text
(citing Senate Report No. 109-326, at 1).
---------------------------------------------------------------------------

a. Number of Designated NRSROs
    Under amended rule 2a-7, each money market fund must designate in
its registration statement \102\ at least four NRSROs that the fund
will use to determine, among other things, whether a security is an
eligible security.\103\ Several commenters expressed concern that
permitting funds to designate only three NRSROs (which was recommended
by the ICI Report) would simply embrace the current market for ratings,
which is dominated by three rating agencies.\104\ We share these
commenters' concerns and thus are requiring funds to designate at least
four NRSROs, an approach recommended by commenters as a way to foster
competition among NRSROs to develop a specialized service of providing
short-term ratings to money market funds and improve independent credit
ratings for purposes of the rule.\105\ We also believe that the
designation of at least four NRSROs will allow funds to designate
smaller NRSROs that specialize in rating particular investments.
---------------------------------------------------------------------------

    \102\ The fund must disclose the designated NRSROs, including
any limitations with respect to the fund's use of such designation,
in the fund's SAI. Amended rule 2a-7(a)(11)(iii). In response to our
request for comment on whether to require disclosure of designated
NRSROs in money market funds' SAI, see Proposing Release, supra note
2, at text accompanying n.115, several commenters suggested we
require disclosure of designated NRSROs in the fund's registration
statement. See, e.g., Fidelity Comment Letter (recommending
disclosure in the fund's SAI); Invesco Aim Comment Letter (same);
ICI Comment Letter (recommending disclosure in the fund's prospectus
or Web site). In contrast, one commenter objected to disclosure of
designated NRSROs in the fund's registration statement on the
grounds that investors do not consider this information to be
material and stickering the fund's prospectus for each change in
designation would be too costly. See Federated Comment Letter. We
believe that the identity of each designated NRSRO is not essential
information for investors, but that some investors may find it
useful, and therefore are requiring it in the SAI. See generally
Form N-1A at General Instruction C.2(b) (noting that the purpose of
the SAI is to provide additional information about a fund that is
not necessary to be in the prospectus but that some investors may
find useful).
    \103\ Amended rule 2a-7(a)(11). A fund may designate only credit
rating agencies that are registered as NRSROs with the Commission
under the Exchange Act and the rules adopted under those provisions.
See section 15E of the Exchange Act [15 U.S.C. 78o-7]; 17 CFR
240.17g-1. In response to our request for comment, one commenter
recommended permitting designation of unregistered credit rating
agencies on the grounds that this could promote competition. See
Moody's Comment Letter. Two commenters opposed designation of an
unregistered credit rating agency, and one of these commenters
argued that the potential for introducing under-researched data into
the marketplace could disrupt the orderly functioning of markets.
See DBRS Comment Letter; Invesco Aim Comment Letter. In light of the
enhanced disclosure obligations and ongoing rulemaking initiatives
designed to improve the quality and reliability of ratings issued by
registered NRSROs, we are maintaining the requirement that only
credit rating agencies registered as NRSROs with the Commission may
be designated under the rule. See, e.g., supra note 93.
    \104\ See, e.g., DBRS Comment Letter; Wells Fargo Comment
Letter; C. Wesselkamper Comment Letter.
    \105\ See DBRS Comment Letter; Fidelity Comment Letter. In
response to our request for comment on the appropriate number of
NRSROs a board should designate, another commenter requested we
require funds to designate at least five NRSROs as a way to
encourage new entrants to the market. See Federated Comment Letter.
See also Proposing Release, supra note 2, at text following n.113
and at n.117 and accompanying text (requesting comment).
---------------------------------------------------------------------------

    Under the amendments, a fund could designate an NRSRO with respect
to short-term credit ratings for only certain types of issuers or
securities.\106\ This

would allow a fund, for example, to designate an NRSRO that specializes
in securities issued by insurance companies or banks.\107\ This
approach, which was supported by several of the commenters,\108\ may
further encourage new entrants among NRSROs that fund managers might
not otherwise consider designating due to lack of confidence in ratings
outside the NRSROs' areas of expertise.
---------------------------------------------------------------------------

    \106\ Amended rule 2a-7(a)(11)(i)(A) (providing that a money
market fund's board of directors may designate an NRSRO whose short-
term credit ratings with respect to any obligor or security or
particular obligors or securities will be used by the fund to
determine whether a security is an eligible security).
    \107\ A fund that has designated an NRSRO to use in determining
the eligibility of insurance company-issued securities need not
review or monitor any class of ratings that the NRSRO issued with
respect to other securities or their issuers in which the fund may
invest. A fund adviser (under delegated authority) would be free
(but not required) to consider these ratings in determining whether
the non-insurance company-issued security (or its issuer) presents
minimal credit risks. Amended rule 2a-7(c)(3)(i).
    \108\ See DBRS Comment Letter; Moody's Comment Letter; Wells
Fargo Comment Letter.
---------------------------------------------------------------------------

b. Board Designation and Annual Determination
    The amendments require each money market fund's board of directors
to designate the NRSROs on which the fund will rely for purposes of the
rule. In addition, the board must determine at least once each calendar
year that each designated NRSRO issues credit ratings that are
sufficiently reliable for such use.\109\ Before designating an NRSRO
and before making its annual determination, a board should have the
benefit of the adviser's evaluation regarding the quality of the
NRSRO's short-term ratings.\110\ We would anticipate that the board's
designations and annual determinations would be based on
recommendations of the fund adviser and its credit analysts, who would
have evaluated each NRSRO based on their experiences in addition to any
information provided by the NRSRO. We would expect the adviser's annual
evaluation to be based, among other things, on an examination of the
methodology an NRSRO uses to rate securities, including the risks they
measure, and the NRSRO's record with respect to the types of securities
in which the fund invests, including asset backed securities.\111\ The
reliability of a newly registered NRSRO could be evaluated based upon
the quality and relevant experience of the personnel conducting the
rating. Even with the recommendations of the fund adviser, we recognize
that ultimately, a board's determination whether an NRSRO's ratings are
``sufficiently reliable'' for use in determining whether a security is
an eligible security will be a matter of judgment.
---------------------------------------------------------------------------

    \109\ Amended rule 2a-7(a)(11)(i). We are requiring funds to
perform the annual determination once each calendar year to simplify
compliance so that a fund is not in violation of the rule if the
board's determination occurs soon after the year anniversary of the
previous determination.
    \110\ Fund boards may, however, also find an NRSRO's record with
respect to long-term securities to be helpful in evaluating the
overall quality of the organization.
    \111\ See Moody's Comment Letter (advocating that any board
designation be ``based on the board's assessment of ratings'
attributes, such as quality, comparability and historical
performance.''). We have recently adopted rule amendments relating
to NRSROs that should help fund advisers and their credit analysts
in performing their evaluations. Our amendments require NRSROs,
among other things, to disclose information about their ratings
methodology, experience and performance. For example, NRSROs must
disclose in their applications their ratings experience, performance
in assessing the creditworthiness of securities and obligors,
procedures and methodologies used in determining credit ratings, the
types of conflicts NRSROs face and how they manage those conflicts,
and the qualifications of the NRSRO's credit analysts. See Items 6,
7 and Exhibits 1, 2, 6, 7, 8 of Form NRSRO. In addition, NRSROs
currently are required to disclose on a public Web site a random
sample of 10% of the ratings histories of issuer paid ratings in
each class of credit ratings for which the NRSRO is registered and
has issued 500 or more issuer paid credit ratings. Rule 17g-2(a)(8)
and (d) [17 CFR 240.17g-2(a)(8) and (d)]. In June of this year,
these public disclosures will have to include ratings action
histories for all credit ratings initially determined on or after
June 26, 2007. See Amendments to Rules for Nationally Recognized
Statistical Ratings Organizations, Exchange Act Release No. 61050
(Nov. 23, 2009) [74 FR 63832 (Dec. 4, 2009)] at text following n.19
and compliance date.
---------------------------------------------------------------------------

    Many commenters expressed concern that a money market fund's board
of directors does not have the necessary expertise to designate NRSROs,
and urged that we delegate the authority to fund advisers to make the
designation.\112\ A number of these commenters seem to assume that we
would require fund boards to engage in the type of analysis that we
expect the adviser will provide the board for its consideration. We
believe that it will be useful for boards to consider the designation
of NRSROs, a role not unlike the role that many boards play in
approving other matters of substantial significance to the operation of
the fund.\113\ Board designation and determination (at least once a
calendar year) will serve as a check on fund managers that may have
conflicts of interest in selecting an NRSRO from which the manager
seeks a rating for the fund (in order to facilitate marketing the
fund),\114\ or an NRSRO that may accommodate the fund's investment in
higher yielding, riskier securities.\115\
---------------------------------------------------------------------------

    \112\ See, e.g., ABA Comment Letter; MFDF Comment Letter;
Northern Funds Comment Letter. These commenters responded to our
discussion of this approach in the Proposing Release. See Proposing
Release, supra note 2, at text following n. 118.
    \113\ See, e.g., amended rule 2a-7(c)(8) (requiring the fund's
board of directors to establish procedures to stabilize the fund's
NAV, including procedures providing for, among other things, the
board's periodic review of the fund's shadow price, the methods used
for calculating shadow price, and what action, if any, the board
should initiate if the fund's shadow price exceeds amortized cost by
more than \1/2\ of 1%).
    \114\ See Wells Fargo Comment Letter.
    \115\ See Moody's Comment Letter (noting that the more narrowly
defined the categories of ratings for which a designation can be
obtained, the ``easier it could be for mutual funds to game the
system, e.g., by dropping an NRSRO from its list of designated
NRSROs for a particular class of ratings because the NRSRO has
introduced a more conservative ratings methodology.'').
---------------------------------------------------------------------------

c. Operation of the Rule
    Once a board has designated the NRSROs, the fund could look to the
designated NRSROs whenever it has to consider credit ratings under rule
2a-7 unless and until the board changes the designation.\116\ A fund
must look to only the designated NRSROs to determine whether the
security is an eligible security, a rated security,\117\ and whether it
is a first tier or a second tier

security.\118\ Under the amendments, a security is an unrated security
if neither the security nor its issuer has received a short-term rating
from any of the designated NRSROs.\119\ Accordingly, before investing
in the security, the fund adviser must make a determination that the
security is of comparable quality to a rated security.\120\ After a
money market fund acquires a security, the fund manager must monitor
only the ratings of designated NRSROs to determine whether a change in
those ratings requires the board to reassess promptly whether the
security continues to present minimal credit risks or to dispose of a
portfolio security that is no longer an eligible security.\121\
---------------------------------------------------------------------------

    \116\ We have changed the term from ``NRSRO'' to ``designated
NRSRO'' throughout the rule each time it is used. As a consequence,
changes in the fund's designated NRSROs may affect the ability of
the fund to purchase a new security or roll over a current holding,
and may require the fund to reassess promptly whether the security
continues to present minimal creditworthiness and dispose of a
current holding. This is because a new designation of an NRSRO (or a
removal of a designated NRSRO) is now treated under the rule as the
equivalent of a credit event requiring the fund board or adviser to
consider the rating of the newly designated NRSRO (or preclude the
consideration of a formerly designated NRSRO). For example, if a
fund acquires an unrated security (i.e., a security (or its issuer)
that does not have a short-term rating from a designated NRSRO) that
the fund considered to be equivalent to a first tier security and
the fund thereafter designates a new NRSRO that has rated the
security as a second tier security, the fund must then treat the
security as a second tier security. The fund would not be required
to dispose of the security (although it would be required to perform
a credit assessment, which might prompt it to dispose of the
security) even if the position in the security exceeds the fund's
limits on second tier securities, because compliance with the limits
on second tier securities is determined immediately after the fund
acquires the security. See amended rule 2a-7(c)(3)(ii); 2a-
7(c)(4)(i)(C). The fund could only roll over the position to the
extent that immediately after the rollover the fund would meet the
rule's limits on second tier securities. See amended rule 2a-7(a)(1)
(defining ``acquisition'' to include a rollover of a position in
security).
    \117\ Amended rule 2a-7(a)(23) (defining the term ``requisite
NRSROs''). For purposes of determining whether a rated security is
an eligible security and a first tier security, rule 2a-7 requires
the fund to determine whether the security (or its issuer) has
received a short-term rating from the requisite NRSROs. Amended rule
2a-7(a)(12)(i). Under the amended rule, the requisite NRSROs must be
drawn from the designated NRSROs. Amended rule 2a-7(a)(23). Thus,
for example, a security that is rated as a first tier security by
two NRSROs, only one of which is a designated NRSRO, and as a second
tier security by another designated NRSRO, is a split-rated security
and thus a second tier security. Id.
    \118\ Amended rule 2a-7(a)(12) (defining ``eligible security'');
amended rule 2a-7(a)(14) (defining ``first tier security''); and
amended rule 2a-7(a)(24) (defining ``second tier security'').
    \119\ Amended rule 2a-7(a)(30) (defining ``unrated security'' by
reference to amended rule 2a-7(a)(21), which defines a ``rated
security'' as, among other things, a security that has received or
been issued by an issuer that has received a short-term rating by a
designated NRSRO).
    \120\ Amended rule 2a-7(a)(12) (defining ``eligible security'').
    \121\ Amended rule 2a-7(c)(7)(i)(A) (requiring a fund's board of
directors to reassess promptly whether the security continues to
present minimal credit risks and cause the fund to take action if:
(i) The security ceases to be a first tier security because it no
longer has the highest rating from the requisite NRSROs or, in the
case of an unrated security, the board determines it is no longer of
comparable quality to a first tier security, or (ii) the security is
an unrated security or second tier security and the fund's
investment adviser (or portfolio manager) becomes aware since
acquisition of the security that any designated NRSRO has given it a
rating below the designated NRSRO's second highest short-term
rating); amended rule 2a-7(c)(7)(ii)(B) (requiring a fund to dispose
of a security that ceases to be an eligible security as soon as
practicable consistent with achieving an orderly disposition of the
security, absent a finding by the board of directors that disposal
of the portfolio security would not be in the best interests of the
money market fund).
---------------------------------------------------------------------------

3. Asset Backed Securities
    We are amending rule 2a-7 to eliminate a requirement that an asset
backed security (``ABS'') be rated by at least one NRSRO in order to be
an eligible security that a money market fund may acquire.\122\ As a
consequence, funds may acquire an unrated asset backed security that
otherwise meets the requirements of rule 2a-7, including those
requirements that apply to unrated securities.\123\
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    \122\ We are thus amending current rule 2a-7(a)(10)(ii) to
eliminate paragraph (B) and renumber paragraph 2a-7(a)(10)(ii)(A) as
2a-7(a)(12)(ii).
    \123\ See, e.g., amended rule 2a-7(a)(12)(ii); (c)(3)(iv)(C);
(c)(7)(i)(A)(1). As under the current rule, if an asset backed
security is a rated security, it will be required to satisfy the
rule's ratings criteria. Amended rule 2a-7(a)(12)(i).
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    In 1996, we limited funds to investing in rated ABSs because we
thought that NRSROs played a beneficial role in assuring that assets
underlying an ABS were properly valued and would support the cash flows
required to fund the ABS, and we were concerned that fund advisers may
not be in as good a position to perform the legal, structural, and
credit analysis that the rating agencies performed.\124\ As discussed
in the Proposing Release, NRSROs rapidly downgraded ABSs from their
status as first tier securities over a short time period during 2007-
2008.\125\ The NRSROs thus did not seem to play a role in buttressing
the minimal credit risk analysis of fund management sufficient to
warrant a requirement that all ABSs be rated to be eligible for money
market fund investment. We would otherwise have expected a slower, more
orderly downgrading process for these ABSs, which would have permitted
money market funds to gradually roll off the paper.
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    \124\ Revisions to Rules Regulating Money Market Funds,
Investment Company Act Release No. 21837 (Mar. 21, 1996) [61 FR
13956 (Mar. 28, 1996)] at Section II.E.4; Revisions to Rules
Regulating Money Market Funds, Investment Company Act Release No.
19959 (Dec. 17, 1993) [58 FR 68585 (Dec. 28, 1993)] (``1993
Proposing Release'') at nn.110-112 and accompanying text.
    \125\ See Proposing Release, supra note 2, at Section II.A.4.
See also Standard & Poor's, Global Structured Finance Default and
Transition Study--1978-2008: Credit Quality of Global Structured
Securities Fell Sharply in 2008 Amid Capital Market Turmoil (Feb.
25, 2009), available at http://www2.standardandpoors.com/portal/
site/sp/en/ca/page.article/3,3,3,0,1204847668460.html (showing
greater default rate and significantly greater downgrades in
structured finance securities).
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    We received only a few comments on this approach.\126\ One NRSRO
commenter supported removing this requirement.\127\ Two urged us to
keep the ratings requirement for ABSs,\128\ and one of those asserted
that ratings ``under appropriate criteria'' enhance the liquidity of
ABSs and provide credit and structural expertise and research that
benefit investors.\129\ As noted above, we do not believe that NRSRO
ratings of ABSs served this function during the 2007-2008 turmoil in
the ABS marketplace, and we no longer believe that the provision of
rule 2a-7 that has required such ratings for all ABSs is warranted as
serving its intended purpose, and thus we are eliminating this
requirement.\130\
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    \126\ We also solicited comment generally on whether, and if so
how, we should amend rule 2a-7 to generally address the risks
presented by ABSs. We received a number of comments in response to
this request, and will consider them in developing further
amendments to rule 2a-7.
    \127\ See Moody's Comment Letter.
    \128\ See Am. Securit. Forum Comment Letter; Shriver Poverty Law
Ctr. Comment Letter.
    \129\ See Am. Securit. Forum Comment Letter.
    \130\ See Statement of Lawrence J. White, SEC Roundtable to
Examine Oversight of Credit Rating Agencies at 2 (Apr. 15, 2009)
(initial ratings on bonds securitized from subprime residential
mortgages ``proved to be excessively optimistic''--especially for
the bonds based on mortgages originated in 2005 and 2006).
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    We do note, however, that as part of the minimal credit risk
analysis that any money market fund must conduct before investing in an
ABS, the board of directors (or its delegate) should: (i) Analyze the
underlying ABS assets to ensure that they are properly valued and
provide adequate asset coverage for the cash flows required to fund the
ABS under various market conditions; (ii) analyze the terms of any
liquidity or other support provided by the sponsor of the ABS; and
(iii) otherwise perform the legal, structural, and credit analyses
required to determine that the particular ABS involves appropriate
risks for the money market fund.\131\
---------------------------------------------------------------------------

    \131\ See 1993 Proposing Release, supra note 124, at nn.108-111
and preceding and accompanying text.
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B. Portfolio Maturity

    We are adopting amendments to rule 2a-7 to further restrict the
maturity limitations on a money market fund's portfolio in order to
reduce the exposure of money market fund investors to certain risks,
including interest rate risk, spread risk, and liquidity risk. First,
we are reducing the maximum weighted average portfolio maturity
permitted by the rule from 90 days to 60 days. Second, we are adopting
a 120-day limit on the weighted average life of a money market fund's
portfolio, which will limit the portion of a fund's portfolio that
could be held in longer term adjustable-rate securities. Finally, we
are deleting a provision in the rule that permitted certain money
market funds to acquire Government securities with extended maturities
of up to 762 calendar days.
1. Weighted Average Maturity
    We are amending rule 2a-7 to require that each money market fund
maintain a dollar-weighted average portfolio maturity (WAM) appropriate
to its objective of maintaining a stable net asset value or price per
share, but in no case greater than 60 days.\132\ We believe that such a
limit on the maximum WAM will result in money market funds that are
more resilient to changes in interest rates that may be accompanied by
other market shocks, and thus reduce the likelihood of a run and better
protect money market fund investors. As we explained in the Proposing
Release, a portfolio weighted towards securities with longer maturities
increases the fund's exposure to interest rate risk, amplifies spread
risk, and decreases the

ability of a fund to pay redeeming shareholders.\133\
---------------------------------------------------------------------------

    \132\ See amended rule 2a-7(c)(2).
    \133\ See Proposing Release, supra note 2, at Section II.B.1.
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    Most commenters that addressed this proposal supported further
reducing the maximum WAM of fund portfolios in order to reduce the
funds' exposure to related risk. Those commenters were divided between
those supporting the 60-day maximum WAM that we proposed \134\ and
those supporting a reduction to 75 days.\135\ Other commenters argued
for no reduction at all (i.e., leaving the limit at 90 days).\136\
Commenters supporting a maximum WAM limitation of 60 days believed that
such a reduction would be appropriate to increase the stability and
liquidity of money market funds \137\ and would reduce funds' exposure
to interest rate risk.\138\ One asserted that a 60-day limitation is
appropriate as it prioritizes a money market fund's safety and
liquidity over yield.\139\
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    \134\ See, e.g., Goldman Sachs Comment Letter; Comment Letter of
the Institutional Money Market Funds Association (Sept. 8, 2009)
(``IMMFA Comment Letter''); Northern Funds Indep. Trustees Comment
Letter.
    \135\ See, e.g., Charles Schwab Comment Letter; Comment Letter
of GE Asset Management Incorporated (Sept. 8, 2009) (``GE Asset Mgt.
Comment Letter''); T. Rowe Price Comment Letter.
    \136\ See, e.g., State Street Comment Letter; Comment Letter of
Victory Capital Management (Sept. 8, 2009) (``Victory Cap. Mgt.
Comment Letter''); Wells Fargo Comment Letter.
    \137\ See Tamarack Funds Comment Letter.
    \138\ See TDAM Comment Letter.
    \139\ See Invesco Aim Comment Letter.
---------------------------------------------------------------------------

    Commenters supporting a maximum WAM of 75 days argued that such a
limitation would achieve the Commission's goal of reducing funds'
exposure to interest rate risk while providing funds with sufficient
flexibility to invest in high quality securities when shorter term
investments are scarce.\140\ Some expressed concern about whether a 60-
day WAM would reduce a money market fund's ability to generate
sufficient yield.\141\ Still others argued that a shorter WAM could
make some money market funds more risky because of the alternative
investment strategies they might employ as a result.\142\ Finally, two
commenters opposing any change in the maximum WAM permitted by rule 2a-
7 argued that liquidity risk to funds is more appropriately limited by
other aspects of our amendments to rule 2a-7, and that the resulting
reduction in yield would ``homogenize'' money market funds to such an
extent that investors may be driven to invest in unregulated funds,
thus increasing systemic risk.\143\
---------------------------------------------------------------------------

    \140\ See, e.g., Charles Schwab Comment Letter; GE Asset Mgt.
Comment Letter; ICI Comment Letter.
    \141\ See, e.g., Charles Schwab Comment Letter; Comment Letter
of Crane Data LLC and Money Fund Intelligence (Aug. 31, 2009)
(``Crane Data Comment Letter''); T. Rowe Price Comment Letter.
    \142\ One commenter noted that a WAM limitation longer than 60
days would allow a fund to improve the credit profile of its
portfolio by substituting longer term Government securities for
shorter term corporate securities. See BlackRock Comment Letter.
Another commenter argued that a reduction would lead to fund
portfolios with a ``barbelled'' maturity structure in which the fund
balanced the low yield offered by the large amount of very short-
term securities it would be required to hold with an offsetting
amount of riskier longer term securities, which could increase the
riskiness of fund portfolios. See Comment Letter of Waddell & Reed/
Ivy Fund Portfolio Managers (Sept. 8, 2009) (``Waddell & Reed
Comment Letter''). Another stated that higher risk issuers tend to
be limited to issuing shorter maturity securities, so a shorter WAM
limitation could increase a fund's credit risk profile. See Wells
Fargo Comment Letter.
    \143\ See Fidelity Comment Letter; State Street Comment Letter.
Several commenters also asserted that any reduction in WAM would
increase issuers' reliance on short-term funding, also increasing
systemic risk. See, e.g., Am. Securit. Forum Comment Letter; State
Street Comment Letter; Wells Fargo Comment Letter.
---------------------------------------------------------------------------

    We believe that the maximum WAM permissible for money market funds
should be reduced to 60 days in order to reduce the likelihood of funds
breaking the buck. The increased resilience to simultaneous stresses
from interest rate and other risks that a money market fund would
achieve through a maximum WAM of 60 days is significant. A fund with a
90-day WAM could withstand an instantaneous change in interest rates of
200 basis points before breaking the buck.\144\ In contrast, a fund
with a WAM of 60 days could withstand an interest rate change of 300
basis points without breaking the buck.\145\ Although an interest rate
change of such a magnitude may be unlikely to occur,\146\ funds must
also be able to withstand multiple shocks occurring simultaneously,
such as those that occurred in September 2008 when there was a
simultaneous increase in LIBOR rates and widening spreads due to credit
deterioration and liquidity pressures, together with extraordinary
redemptions.\147\
---------------------------------------------------------------------------

    \144\ See Fidelity Comment Letter.
    \145\ Our staff supplemented stress test analysis conducted by
commenters with more data points and stress scenarios to illustrate
the impact on a money market fund's net asset value per share from
multiple stresses on that fund's portfolio. A fund with a 75-day WAM
could withstand an interest rate change of less than 250 basis
points without breaking the buck. We note that these scenarios also
represent the most conservative scenarios because they assume that
the money market fund started with a market-based net asset value of
$1.00. It is our understanding that at any point in time, a large
number of money market funds will not start from a market-based net
asset value of $1.00--many will start with a market-based net asset
value of less than a dollar and thus a smaller interest rate change
will cause the funds to break the buck.
    \146\ Interest rate shocks of a 300 basis point magnitude over a
relatively short period of time have occurred, although not since
the late 1970s. See Federal Reserve Bank of New York, Historical
Changes of the Target Federal Funds and Discount Rates, 1971 to
present, available at http://www.newyorkfed.org/markets/statistics/
dlyrates/fedrate.html. In low interest rate environments (such as
today), a shock in interest rates could occur if the Federal Reserve
determines to raise interest rates quickly, for example, to stave
off inflation as the economy recovers or to strengthen the U.S.
dollar.
    \147\ See Proposing Release, supra note 2, at nn.47-48, 53, 63,
66-67 and accompanying text. See also infra note 178 (discussing the
increase in LIBOR during the financial crisis). Many money market
fund portfolio holdings at the time were tied to LIBOR.
---------------------------------------------------------------------------

    A fund with a lower WAM has significantly greater protection in the
circumstances described above. For example, a fund with a 90-day WAM
facing a change in credit spreads of 50 basis points and redemptions of
10 percent would break the buck with an interest rate change of a
little more than 100 basis points.\148\ Greater shocks from an even
larger increase in spreads or redemptions would only lessen that
interest rate cushion--last fall increases in spreads and redemptions
were considerably above this level.\149\ A fund with a 60-day WAM would
be in a better position to withstand multiple shocks without breaking
the buck than if it maintained a 90-day or 75-day WAM.\150\
---------------------------------------------------------------------------

    \148\ This assumes a weighted average life limitation of 120
days. A fund with a 75-day WAM could withstand a 50 basis point
increase in credit spreads across its portfolio, 10% redemptions,
and an increase in interest rates of 125 basis points before
breaking the buck, assuming a 120-day weighted average life.
    \149\ In addition, we note that spreads have widened to
significant degrees in the past. See, e.g., Benjamin N. Friedman &
Kenneth N. Kuttner, Why Does the Paper-Bill Spread Predict Real
Economic Activity?, NBER Working Paper No. 3879, at Fig.1 (Oct.
1991) (showing historical spreads for 6-month commercial paper over
6-month Treasury bill rates from 1959 to 1990).
    \150\ Based on staff review of various stress test scenarios, a
fund with a 60-day WAM could withstand a 50 basis point increase in
credit spreads across its portfolio, 10% redemptions, and an
increase in interest rates of over 150 basis points before breaking
the buck, again assuming a weighted average life limitation of 120
days. Others have recognized that exposure to multiple stresses may
call for a lower WAM. See, e.g., Standard & Poor's, Fund Ratings
Criteria: Market Price Exposure, at 3 (2007), available at http://
www2.standardandpoors.com/spf/pdf/events/MMX709.pdf (stating that
money market funds with a greater liquidity risk due to a smaller
asset size or shareholder composition may need to maintain a lower
WAM than 60 days).
---------------------------------------------------------------------------

    We disagree with those commenters that asserted that a reduction of
maximum permissible WAM would have a significant adverse effect on
money market funds' investment strategies or yield. We have not
observed such adverse effect in funds with WAMs below 60 days or a
greater tendency to invest in riskier short-term

securities or to follow riskier portfolio strategies to increase yield.
These funds do not appear to have had great difficulties in creating
portfolios that generated competitive yields and attracted
investors.\151\ Indeed, many domestic money market funds currently
limit their WAM to a maximum of 60 days voluntarily, a limit they
likely would have discontinued if they had experienced the management
or competitive difficulties suggested by commenters.\152\ No commenter
reported to us that any of these funds were doing so. We acknowledge
that one consequence of our amendments may be to further ``homogenize''
fund portfolios as managers have fewer avenues to acquire yield by
exposing the funds to risk, but we believe that the level of potential
homogenization is justified to reduce the risk to investors that a
money market fund will break the buck. In addition, we are not
persuaded by comments that a likely consequence of a shortened maximum
WAM will be riskier portfolios. Accordingly, we are adopting the 60-day
WAM limitation as proposed.
---------------------------------------------------------------------------

    \151\ Similarly, European stable value money market funds do not
appear to have had these difficulties. As the Institutional Money
Market Fund Association (IMMFA) notes in its comment letter, IMMFA
funds (which manage a significant amount of stable value money
market fund assets in Europe) have been required to maintain a
maximum WAM of 60 days since 2002. The recent proposals by the
European Union's Committee of European Securities Regulators to
create common requirements for European money market funds would
impose a maximum 60-day WAM for short-term money market funds. See
Committee of European Securities Regulators Consultation Paper, A
Common Definition of European Money Market Funds, CESR/09-850 (Oct.
20, 2009), available at http://www.cesr.eu/
index.php?page=consultation_details&id=151.
    \152\ For some time and through various interest rate and market
environments a large portion of domestic money market funds have
maintained a maximum WAM of less than 60 days. According to data
provided by the ICI, from January 1998 through April 2009, even the
75th percentile of prime money market funds has maintained an
average WAM of 53 days and the 90th percentile of prime money market
funds has maintained an average WAM of 65 days. Investment Company
Institute, Average Maturity of Taxable Prime Money Market Funds,
1998-2009, available at http://www.sec.gov/comments/s7-11-09/s71109-
14.htm. The 75th percentile of these funds only reported a WAM in
excess of 60 days on 8 monthly occasions out of the 136 monthly time
periods reported. We also note that to obtain a top rating from an
NRSRO, money market funds must maintain a WAM of no greater than 60
days. According to the iMoneyNet Money Market Fund Analyzer
Database, as of November 17, 2009, 61% of money market fund assets
were held in funds that were top rated by at least one NRSRO and 34%
of money market funds had a top rating from at least one NRSRO.
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2. Weighted Average Life
    We are adopting, as proposed, a requirement that limits the dollar-
weighted average life to maturity of a money market fund's portfolio to
120 calendar days.\153\ Unlike weighted average maturity, the weighted
average life (or ``WAL'') of a portfolio is measured without reference
to any rule 2a-7 provision that otherwise permits a fund to shorten the
maturity of an adjustable-rate security by reference to its interest
rate reset dates.\154\ The WAL limitation thus restricts the extent to
which a fund can invest in longer term securities that may expose a
fund to spread risk.\155\
---------------------------------------------------------------------------

    \153\ See amended rule 2a-7(c)(2)(iii). This limitation will
apply to all money market funds (including taxable and tax-exempt
funds).
    \154\ The Fidelity Comment Letter, the Comment Letter of
HighMark Capital Management, Inc. (Sept. 8, 2009) (``HighMark
Capital Comment Letter''), and the ICI Comment Letter requested that
the Commission amend rule 2a-7 to specify how cash balances held by
money market funds would be treated under the WAM and WAL
limitations. For purposes of the WAM and WAL limitations, cash
balances have a maturity of one day. The Tamarack Funds Comment
Letter also suggested that the Commission address extendible notes.
For purposes of the WAM and WAL limitations, in calculating the
final legal maturity of a security extendible at the option of the
issuer the security should be deemed fully extended. See amended
rule 2a-7(d) (final maturity is determined with reference to the
time at which a fund will unconditionally receive payment); see also
Revisions to Rules Regulating Money Market Funds, Investment Company
Act Release No. 21837 (Mar. 21, 1996) [61 FR 13956 (Mar. 28, 1996)]
at n. 151 and accompanying text (discussing the unconditional right
to receive payment with respect to demand features).
    \155\ See Morgan Stanley, Weighted Average Life: Enhancing Money
Market Fund Transparency (2009), available at http://
www.morganstanley.com/msamg/msimintl/docs/en_US/common/comm/
200907_mm_update.pdf (``[Morgan Stanley Investment Management is]
introducing WAL to supplement our WAM reporting. The WAL calculation
is based on a security's stated final maturity date or, when
relevant, the date of the next demand feature when the fund may
receive payment of principal and interest (such as a put feature).
Accordingly, WAL reflects how a portfolio would react to
deteriorating credit (widening spreads) or tightening liquidity
conditions. We believe that when viewed alongside WAM, the
supplemental WAL disclosure will provide investors with a further
degree of insight into our portfolios' structure.'').
---------------------------------------------------------------------------

    We proposed the WAL limitation because we were concerned that the
traditional WAM limitation of rule 2a-7 does not require that a manager
of a money market fund limit the spread risk associated with longer
term adjustable-rate securities.\156\ These securities are more
sensitive to credit spreads than short-term securities with final
maturities equal to the reset date of the longer term security.\157\
The WAL limitation will provide an extra layer of protection for funds
and their shareholders against spread risk, particularly in volatile
markets. We proposed a 120-day limit as a prudent limit recommended to
us in the ICI Report and one that we understand is currently used by
some money market fund managers.\158\ We requested comment on whether a
higher or lower WAL limitation would be more appropriate.
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    \156\ For example, if the market perceived an issuer's credit
risk as deteriorating, the spreads on that issuer's 30-day floating-
rate securities would likely widen to a lesser extent than the
spreads on that issuer's 397-day floating-rate securities because
the longer term securities have a much longer exposure to the
issuer's credit risk (assuming neither security had a Demand
Feature). Because the WAM limitation allows the use of interest rate
reset dates to shorten the maturity of a security, each of the 397-
day floating-rate securities and the 30-day floating-rate securities
would be considered to have a maturity of one day. In contrast,
under the WAL limitation we are today adopting each adjustable-rate
security without a Demand Feature would have a maturity equal to its
final legal maturity. As a result, if spreads on these securities
widen to different degrees due to changing market perceptions of
credit risk or liquidity, the WAL limitation will capture these
different risk exposures.
    \157\ See Proposing Release, supra note 2, at Section II.B.2.
    \158\ See, e.g., HighMark Capital Comment Letter (``We have been
calculating a WAL for years and believe it will more appropriately
reflect the total interest rate and spread risk of a portfolio.'').
See also JPMorgan Prime Money Market Fund Quarterly Fact Sheet (Dec.
31, 2009), available at https://www.jpmorganfunds.com/cm/BlobServer/
FS-PMM-
P.PDF?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=11585
72105887&blobheader=application%2FPDF&blobheadername1=Content-