On Friday night, the Securities & Exchange Commission issued a "no-action" letter allowing Eaton Vance Management to proceed with a plan to issue "liquidity protected preferred shares (LPP)," a "new type of preferred stock ... to be issued by closed-end investment companies" that would be eligible for purchase by money market mutual funds, said the SEC in its response letter. The new securities would "supplement or replace" auction-rate preferred shares (ARP), because "it is highly unlikely that the existing auction markets for ARP will resume normal functioning in the near term."

The SEC says they are not endorsing money funds investing in the new ARPs, that they do not believe this in any way compromises the integrity of Rule 2a-7, and that they would not have formed a different conclusion had there been no failures in the ARP market. Money funds will still "have to comply with all other provisions of rule 2a-7" and fund advisers will still have to "determine that investment in the ARPs presents minimal credit risks."

An SEC staffer adds, "Because the liquidity features would be unconditional puts, the funds could make this determination based on the issuer of the put." He adds that the Commission worked closely with the Department of Treasury, and that, "The result is a win-win for both the tax exempt money market funds (which need additional source of high quality tax exempt paper) and investors in ARP (who needed liquidity)."

Though the letter clears the way for some auction-rate debt to be repackaged into money fund eligible securities, it remains to be seen whether funds will buy. Some have expressed interest (see our Link of the Day "Federated Comments on ARPS"), but we're still skeptical (see our "Money Funds Keeping Distance From Auction Rate Securities Fiasco").

The letter says, "The LPP will pay a dividend that will be reset every seven days in a remarketing process administered by one or more financial institutions," and that "each Fund will enter into an agreement with a Liquidity Provider ... to purchase unconditionally all LPP". Though it's clear the investments will be permitted by 2a-7, we doubt that money funds will brave the headline risk associated with ARPS.

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