• Mutual Funds
  • Money Funds and the Regulators

    by Mike Krasner

    Money Funds And The Regulators Splash image

    It is highly likely that as a member of AAII you have savings or retirement money tucked away in a money market mutual fund (MMF), or indeed maybe more than one.

    The Investment Company Institute (ICI), the trade association that speaks for the mutual fund industry, cited in its 2013 “Fact Book,” year-end 2011 data attributed to The IRA Investor Database showing that traditional IRA investors allocated 13.9% of their portfolios to money market funds while in their 30s and 13.9% when in their 60s. Overall, ICI stated that retirement account assets in money market funds totaled $379 billion in 2012.

    Money fund investors are all given a fund prospectus that spells out the fund’s objective and what types of securities it is allowed to buy or specific security types it is not allowed to hold in its portfolio. The prospectus also covers the benchmark index used to measure investor returns, how the fund allocates its expenses, how to invest in the fund, and other pertinent information.

    The prospectus and each accompanying marketing piece issued by a fund provider include some bullet points in bold type intended to make it as clear as humanly possible that a money market fund is an investment product and is not a bank product. Fund providers note in bold letters that a money market fund is not covered by bank insurance. Such communications also include an unambiguous, strong warning that there is a risk that you can lose money by investing in a money market fund. In fact, each fund offering typically includes language that is similar to this: “While the fund’s portfolios seek to maintain a stable net asset value of $1.00 per share, it is possible to lose money investing in the fund.”

    Plus, money market funds are subject to regulation by the Securities and Exchange Commission under its Rule 2a-7 to the Investment Company Act of 1940.

    These very clear pronouncements and current oversight apparently are not clear enough for a cadre of regulators, mostly on the banking side, or money fund critics who are provided soapboxes by media outlets. They seemingly will not be satisfied until every penny of the $2.6 trillion recently held in U.S. money market fund portfolios is redirected into federally insured bank accounts or the funds themselves are radically restructured. The suggested restructuring would morph money market funds into products equivalent to extremely short-term bond funds. Such a change would likely drive investors into alternative products that, in many cases, are beyond the reach of regulators and provide much less transparency than do money market funds.

    Before we discuss the possible next steps affecting money funds and you as a money fund investor, let’s pause for a refresher about how and why they came into being.

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    A Brief History of Money Market Funds

    Bruce R. Bent and a partner launched the first-ever money fund, called The Reserve Fund, in October 1971 with the goal of permitting any investor, large or small, to earn money market rates on their cash holdings. Bent often described his fund as being a “sleep-at-night” stable-value product. The fund was conservatively invested in short-term instruments that were deemed to be extremely safe. It was billed simply: “a dollar in, a dollar out with some interest,” though no guarantees were issued.

    Over time, other companies introduced their own money funds, and checking privileges were added. In the super-inflationary period of the late 1970s and early 1980s, even banks created their own funds to stem deposit outflows to retail-oriented money funds, which resulted from mandated limits on allowed interest-rate payouts for banks’ savings products.

    Taxable money market funds, which consist of government funds and prime funds, came first. They were later joined by tax-exempt money market funds. Government funds principally invest in “U.S. Treasury obligations and other financial instruments issued or guaranteed by the U.S. government, its agencies or instrumentalities,” according to the ICI. Prime funds, the ICI noted, “invest in a wider variety of high-quality, short-term money market instruments, including Treasury and government obligations, certificates of deposit, repurchase agreements, commercial paper and other money market securities.”

    Tax-exempt or tax-free money market funds likewise seek to maintain a stable net asset value of $1 and invest in municipal money market securities. “The dividends of these funds are not taxed by the federal government, nor in some cases are they taxed by states and municipalities,” stated ICI.

    Total assets of U.S. money market funds reached $1 trillion in August 1997 and smashed through the $2 trillion barrier in November 2001, iMoneyNet data recorded. The funds’ virtually unblemished success, the simplicity of keeping track of $1-per-share pricing and higher returns than offered by competing bank products, continued to attract investors seeking safe havens during periods of market turbulence or to set aside cash intended for future purposes, first primarily retail then later predominately institutional investors.

    Tranquility in money-fund land was disturbed by the financial crisis of 2008 and the blowup of securities packaged with subprime mortgages issued in the U.S. This crisis led to European banks refusing to lend to one another, and the U.S. commercial paper and repurchase agreement (“repo”) markets seizing up. [Editor’s note: The International Capital Market Association defines a repo as an agreement where “one party sells an asset (usually fixed-income securities) to another party at one price at the start of the transaction and commits to repurchase the asset from the second party at a different price at a future date or (in the case of an open repo) on demand.”]

    Tranquility disappeared when the first-ever money fund, which by then had been renamed as the Reserve Primary Fund, ran aground in mid-September 2008. Bent’s fund was caught holding large amounts of top-rated but suddenly worthless securities issued by Lehman Brothers when that firm unexpectedly filed for bankruptcy and was not included in a government rescue plan. The Reserve Fund thus became the first retail fund to “break the buck,” meaning its price fell below $1 per share. The fund ceased operations immediately and its shareholders ultimately received about $0.98 on each dollar invested. The fund’s demise prompted a thorough review of money fund structures and operations by the industry itself and by the SEC, which in January 2010 announced changes to Rule 2a-7.

    “The SEC’s new rules are intended to increase the resilience of money market funds to economic stresses and reduce the risks of runs on the funds by tightening the maturity and credit quality standards and imposing new liquidity requirements,” the agency said.

    Post-Financial Crisis Changes

    Taxable funds since the phase-in of the SEC’s amended rules have been required to hold at least 10% of total assets in “daily liquid assets” and at least 30% of assets in “weekly liquid assets.” Liquidity provisions were added to meet reasonable requests by investors to cash in some or all shares. Basically, daily liquid assets are subject to a one-business-day demand feature and feature cash or U.S. Treasury securities, while the fund’s so-called weekly liquidity bucket consists of similar securities with remaining maturities of 60 days or fewer, or that mature or are subject to a demand feature within five business days.

    All money market funds are now subject to periodic stress testing. They are also allowed to suspend redemptions if maintaining the “amortized-cost” $1.00 share price is believed to be problematic. Other rule changes include limitation to a 60-day maximum weighted-average maturity for all securities being held in portfolios (it was previously set at 90 days); institution of a new metric, the 120-day weighted-average life based on final maturity dates; and fresh curbs on investments in repos.

    The SEC also required fund companies to supply the agency with detailed portfolio information and market-based value for each fund at the end of every month. Funds were additionally required to show investors, through monthly website postings, details about the securities in each fund’s portfolio. Such postings are supposed to appear within five business days after a month ends, enabling investors to better compare one fund’s makeup to another’s. Furthermore, the 2010 money market fund amendments also gave fund families until October 31, 2011, to be able to process transactions at a variable price other than $1 per share.

    Proposed Additional Changes

    The SEC chairman at the time, Mary Schapiro, made it known that while she was head of the regulatory body, she personally would continue to press for variable net asset values (NAVs) to supplant the long-established constant net asset value pricing for all funds. Her reasoning was that investors would be shown that pricing of the securities held in money fund portfolios fluctuates each day due to market forces. She feared that the share price of $1.00 was being misinterpreted by many as being a “bank-like” guarantee.

    In August 2012, the SEC held up a planned discussion of mandating a floating net asset value for money funds and other suggested further changes to Rule 2a-7. This occurred after three of the five members requested a staff study about the funds’ ability to withstand financial upsets in Europe, the downgrading of U.S. government debt by a major rating agency and other market developments since the 2010 amendments were adopted. That report was issued on November 30, 2012.

    In the meantime, Schapiro had taken her arguments for further money-fund regulation to the Financial Stability Oversight Council (FSOC), a body created by the Dodd-Frank Act on which she served due to her SEC position. Five of the 10 voting members of the FSOC regulate banks or depository-type institutions. Then-Treasury Secretary Timothy Geithner and Schapiro pushed through a package of several alternative structural reforms “to address the risks posed by money market funds” on November 13, 2012.

    The FSOC continues to study assigning the systemic-risk label to money market funds and other so-called nonbanks operating in the “shadow-banking system.” The council first called for replacing the stable net asset value, based on amortized-cost accounting and/or penny rounding (see the box below for explanation), with a floating net asset value, which would not always be at $1 based on market values of securities held in a portfolio, a concept that the SEC had rejected several times previously after study.


    Yield (%)*
    ($ Mil)
    Phone Number
    Government Retail Money Funds
    1. Selected Daily Govt Fund/Cl D
    (800) 243-1575
    2. Direxion US Govt MMF/Cl A
    (800) 851-0511
    3. First Amer Govt Oblig/Cl A
    (800) 677-3863
    3. Lord Abbett US Govt & Govt SE MMF/A
    (888) 522-2388
    Government Average
    Prime Retail Money Funds
    1. Invesco MMF/Investor Class
    (800) 659-1005
    2. Meeder MMF/Retail
    (800) 325-3539
    3. Schwab Cash Reserves
    (800) 435-4000
    4. Capital Assets Fund/Preferred MMP
    (800) 730-1313
    4. Delaware Cash Reserve/Class A
    (800) 362-7500
    4. PNC Money Market Fund/Cl A
    (800) 622-3863
    Prime Average
    Tax-Free National Retail Money Funds
    1. Invesco Tax-Exempt Cash Fund/Inv
    (800) 659-1005
    2. Alpine Municipal MMF/Inv
    (888) 785-5578
    3. Vanguard Tax-Exempt MMF
    (800) 662-7447
    4. PNC Tax-Exempt MMF/Cl A
    (800) 622-3863
    4. Western Asset T-F Reserves/Cl N
    (800) 331-1792
    Tax-Free National Average
    *Highest compounded (effective) rate of return to shareholders reported to Money Fund Report for the past seven days for period ended May 7, 2013.
    Source: iMoneyNet Inc., an Informa Financial company,Westborough, Mass. 01581; www.imoneynet.com.


    The issue facing the industry and investors who rely on money funds is: Will regulators harm or kill a product that is admittedly not risk-free, in the interest of attempting to eliminate all risk? As Commissioner Paredes asked, “What are we solving for?”

    Stable NAV Accounting Methods

    Current money market fund regulation, SEC Rule 2a-7(a)(2) of the Investment Company Act of 1940, defines the amortized-cost method as “the method of calculating an investment company’s net asset value [per share] 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.” Rule 2a-7(a)(20) defines the penny-rounding method of pricing as 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.”

    Mike Krasner is managing editor at iMoneyNet, which provides information on money market funds to institutions.


    Roger from Louisiana posted over 3 years ago:

    The Gov't should leave money market funds alone. Every time they mess with something they make it worse. They ruined our energy supplies - instead of making our energy supply more independent, they made us more dependent; they ruined our education system; they ruined our health system; they have made millions more dependent on gov't handouts; and much much more. We have been over-regulated to the breaking point. Once we were the free-est nation in the world. All to soon we have dropped to 10th place. At the rate we are going we will soon be a 3rd-world country.

    harryrich from Ohio posted over 3 years ago:

    Given the fact that the MMF manager's income and decision-making systems are a large part of MMF cost I'd think a manager could have a hard time being objective in a choice between reducing cost and increasing risk. So, regulation seems appropriate. The question as to whether it will work or not is beyond me.

    My fear if MMF share prices are allowed to float is that keeping track of or avoiding wash sales, particularly with multiple accounts, may become a nightmare.


    Charles Rotblut from IL posted over 3 years ago:

    Investment News has a recent update on what is happening with money market reform:

    John from Kentucky posted over 2 years ago:

    Banking and investment companies were and are highly regulated companies. It was the regulators that made the decision to save Bear Sterns and let Lehman Brothers collapse triggering the liquidity crisis.

    One money market fund broke the "buck" and now we need more rules from the same people who triggered the crisis?

    Charles Rotblut from IL posted over 2 years ago:

    An addendum: After this article was published, the SEC published new rules regarding money market funds. These rules were discussed in the Investor Update email.


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