On behalf of Federated Investors, David Freeman, partner at Arnold & Porter LLP law firm, issued yet another comment letter to the SEC on money fund reform. The letter, which may be setting the stage for a legal challenge to pending SEC rules, is addressed to Chair Mary Jo White and was posted to the SEC's web site on July 16. It was prompted by the news that the SEC will meet to discuss and potentially adopt new money fund rules on July 23. (See our July 17 News "SEC Posts Notice Confirming MMF Reform Vote on July 23".) Note that the SEC's "Comments on Proposed Rule: Money Market Fund Reform" page also now shows July 15 letters from Senator Mike Crapo and Senator Pat Toomey to Treasury Secretary Lew on the tax issues associated with a floating NAV. (See our "Link of the Day" from July 17, "Reuters writes "U.S. Senators Urge Treasury to Fix Money Fund Tax Concerns".)
Citing a recent piece in the Wall Street Journal, Freeman writes, "The Commission soon may adopt new MMF rules that would impose on MMF investors and MMFs an onerous regulatory alternative that would destroy the utility of MMFs for a large segment of investors, with further adverse consequences for issuers who rely upon MMFs as an important alternative to bank financing. This is particularly troubling when the Commission has before it less burdensome alternatives that would achieve its regulatory goals of reducing run risk and potential first movers, as well as enhancing the transparency of MMFs for investors." The missive supplements earlier letters posted on behalf of Federated on April 4, April 23, April 25, and May 14.
He writes, "In the current rulemaking, the Commission must address the overwhelming rejection by commenters of Alternative One (because a floating net asset value (NAV) will impose enormous costs on investors and affected issuers with no benefit in terms of curbing run risk) and further rejection of the combination of Alternatives One and Two (because the resulting product will not be viable for investors and the alternative of gates/fees can address potential run risk and potential first movers). The Commission must address, as well, comments on its current formulation of Alternative Two, which Federated and other commenters have suggested can and should be strengthened to give MMF boards additional authorities and flexibility to protect shareholders from potential first movers and enhance investor acceptance. The Commission must, under the APA (Administrative Procedure Act) and under the Investment Company Act of 1940, consider whether its rules 'promote efficiency, competition, and capital formation.' This requires more than simply checking the box on economic studies but mandates a real weighing of the economic impact of rules. In the current rulemaking, this requires the Commission to choose a regulatory alternative that best 'preserve[s] the ability of money market funds to function as an effective and efficient cash management tool for investors,' as the Release states, while furthering the Commission's goal of preventing or mitigating large-scale redemptions during market stress. As the Commission itself has acknowledged, the gates and fees alternative maintains the day-to-day utility of MMFs; the floating NAV alternative does not."
Freeman continues, "The Commission also must act consistent with its published Guidance on Economic Analysis in Commission Rulemakings, which requires, among other things, consideration of whether alternatives to a proposed rule are 'better or worse ... in terms of achieving the regulatory purpose in a cost-effective manner' when measured against the proposed rule. As the record demonstrates, an enhanced gates and fees proposal (modified as Federated and others have proposed), together with enhanced disclosures of MMF 'market-based' NAVs, best achieves the Commission's objectives of curbing run risk and enhancing transparency in the most cost-effective manner. The Commission must, under the Administrative Procedure Act, articulate a 'rational connection' between the facts found and the regulatory choice made. A final rule cannot rest merely on the Commission's 'predictive judgments,' but must be supported by the rulemaking record. In particular, speculation that a floating NAV for MMFs 'could alter investor expectations' and therefore investors 'should become more accustomed' to MMF NAV fluctuations and investors 'thus may be less likely to redeem shares in times of stress,' without credible support for this proposition in the record (of which there is none) cannot possibly support the Commission's floating NAV proposal."
He comments, "We reiterate, as we did in our May 14th letter, that there is no justification in the Commission's extensive rulemaking record for requiring a large segment of MMFs to convert to floating NAV, where the Commission has the alternative of fully informing investors of minute fluctuations in MMF valuations through enhanced disclosure, and where the Commission has a further alternative -- gates and fees -- that best addresses run risk." He adds, "Indeed, if the Commission were to choose a regulatory option that would destroy a product for a large segment of investors, when a far less disruptive alternative is available that better achieves its regulatory goals, better protects investors, and preserves the product, the Commission would violate its obligations under the Administrative Procedure Act and the Investment Company Act."
The letter goes on, "The Commission has described its own proposal in terms of alternatives: 'Alternative One,' a floating NAV for MMFs that are not 'retail' or 'government' MMFs; 'Alternative Two,' liquidity fees and gates applicable to all MMFs except government MMFs; and a third alternative, which would combine the first two alternatives. In weighing the costs and benefits of the Commission's rulemaking, these alternatives must be measured against each other as well as against various alternatives proposed by commenters. The Commission must consider that commenters, as well as the Commission itself, nearly uniformly state that a floating NAV would not prevent or mitigate large-scale redemptions in a crisis and that gates are the 'one regulatory reform discussed' that will."
Freeman continues, "Similarly, the Commission's statements in the Release that a floating NAV for MMFs 'could alter investor expectations' and therefore investors 'should become more accustomed' to MMF NAV fluctuations and investors 'thus may be less likely to redeem shares in times of stress' remain pure speculation, unsupported by the record or any other data. In any event, the Commission, if it chooses to impose a floating NAV on a large segment of MMFs, will need to explain why it believes investors, intermediaries, and issuers to affected funds should bear the enormous costs of a floating NAV (restructuring, retooling and accounting for a floating NAV in the case of investors and intermediaries; higher financing costs for affected issuers) when disclosure of underlying NAV fluctuations, particularly for institutional investors, could achieve the same informational result, and gates/fees could achieve a better result in terms of curbing run risk. If the Commission, as proposed, adopts a floating NAV for institutional, but not retail, prime MMFs, it also will need to explain why institutions need the informational benefit of a floating NAV, while retail investors do not -- which is a ridiculous proposition."
Freeman adds, "The Commission is obligated to consider whether the gates and fees proposal as compared to the floating NAV proposal (or any proposed modification thereto) is more effective in achieving the proposed rule's goal of deterring runs and protecting investors against first movers with lower costs than the floating NAV approach. The Commission itself acknowledged that 'gates are the one regulatory reform in this Release ... that definitely stops a run on a fund (by blocking all redemptions),' a position strongly supported by the record. The Commission also has acknowledged that gates and fees would be less detrimental to MMF investors because they would preserve the day to day utility of the product. Thus, the gates and fees proposal is better in achieving the Commission's regulatory purpose in a cost-effective manner, when measured against the floating NAV. Only a small number of commenters raised concerns about the effectiveness of the gates/fee proposal, suggesting that it could lead to preemptive runs by investors who closely monitored a MMF as it approached a gate or fee trigger. As the Commission is aware, this concern can be addressed through modifying the proposal, as Federated and other commenters have suggested, to give MMF boards greater flexibility to intervene to protect shareholders and avoid the potential adverse effects of a hard 'trigger' for gates and fees."
He further states, "The record does not justify the Commission's third alternative -- the imposition of both a floating NAV and gates and fees on a large segment of MMFs. There is substantial evidence in the record that a floating NAV MMF with gates and fees simply will not be viable -- creating 'a uniquely undesirable product that no rational investor would select.' This will completely deprive affected investors of the use of prime MMFs, and prime MMFs' shrinking capacity will, in tum, diminish the market for commercial paper issuers."
In conclusion, Freeman writes, "As we previously wrote the Commission, the data, studies, and commentary in the Commission's extensive comment file point to a clear answer: Give due consideration to the comments, follow the facts, and insist upon a data-driven, cost-effective rule that best provides the benefits the Commission seeks to achieve. There is no question that authorizing MMF boards in rare and limited circumstances to temporarily halt redemptions for periods of short duration will stop a run. The Commission's gates and fees proposal, modified as Federated and others have recommended and coupled with enhanced disclosure, will fully address the Commission's regulatory goals. Adding a floating NAV requirement for prime institutional funds serves no purpose, other than to destroy the utility of those fuds for affected investors."
