Another comment letter was posted Friday to the SEC's "President's Working Group Report on Money Market Fund Reform" web page. The latest comment was written by Jill Fisch of the University of Pennsylvania Law School and Eric Roiter of the Boston University School of Law. The letter says, "We are writing in response to the Commission's solicitation of public comments on the President's Working Group Report on Money Market Fund Reform (Oct. 2010). Although the Commission set January 10, 2011 as the original deadline for comments, we note that the Commission has continued to receive and post in the public file throughout this year comment letters and staff memoranda memorializing visits between interested persons and Commissioners on the issues raised in the PWG Report. We note further that SEC Chairman Schapiro in her speech on November 7 at SIFMA's annual meeting suggested that the Commission will be considering whether additional steps, beyond the 2010 revisions to Rule 2a-7, should be taken to address the risk of runs on market market funds."
The pair write, "We have recently written an article addressing whether money market funds should be forced to abandon their stable NAVs or other measures put in place to stem the potential for runs. A copy of the article (forthcoming in the University of Illinois Law Review), "A Floating NAV for Money Market Funds: Fix or Fantasy," is attached hereto, and we request that it be included in the public file."
The letter explains, "Our article concludes that the debate on whether to compel a floating NAV is misplaced and rests on erroneous assumptions. The $1 NAV is not, and has never been, fixed or divorced from market value. As is true for share prices of all mutual funds, the price of money market fund shares is, of necessity, a rounded price. Stock and bond funds round their NAVs to the nearest cent; money market funds round their shares to a $1 NAV if, and only if, the market value of their portfolio equals or exceeds 99.5 cents per share. As we point out in our article, upon adopting Rule 2a-7, the SEC approved the use of amortized cost accounting precisely because it reflects fairly the market-based net asset value of money market fund shares so long as the risk-limiting requirements of the rule are met."
Fisch and Roiter continue, "We conclude that the run on money market funds unleashed in 2008 was animated by investors' (more particularly, institutional investors') fear over the loss of liquidity, not the loss of principal. Indeed, the liquidation of the Reserve Primary Fund -- which substantially delayed investors' access to their money despite the fact that their eventual losses were less than 1% -- bears this out. The measures we propose, accordingly, address liquidity concerns once a fund has broken the buck. A fund's board must promptly decide whether to operate the fund with a fluctuating NAV or liquidate the fund. If the former course is chosen, investors should be free to redeem their shares, just as investors in ultra-short bond funds would be able to do. If the latter course is chosen, a fund board does not need, and should not have, the unfettered right to suspend redemptions indefinitely. We propose that the SEC amend its rules to permit full suspension of redemptions for only two days following the breaking of the buck; for three days thereafter, suspension of redemptions should be limited to no more than 50% of a shareholder's shares. By this time, a fund board, having decided to liquidate the fund, should have also created a reserve account based on a reasonable estimate of the costs of liquidation and any losses in the disposition of fund assets. Thereafter, shareholders in the fund should be free to redeem up to 90% of their shares, based upon a floating NAV reflecting the creation of the reserve account."
They add, "Our proposal would ameliorate concerns about runs because investors would know that a fund that has broken the buck would remain liquid, either because it will revert to a floating NAV or redemptions could be totally suspended for a maximum of two business days. The proposal would also create an additional incentive for investors who do not need immediately liquidity to stay in the fund because the reserve, once released, provides them with the prospect of greater recovery than those who redeem early."
Finally, the two state, "As for a "capital buffer," the Commission, in our view, should permit but not require it. Money market fund shareholders, of course, hold equity, not debt, and a requirement for capital that is subordinated to common shares obscures, rather than clarifies, their status. In effect, a capital buffer would convert money market fund investors into holders of preferred shares, senior to a new subordinated equity class. If the marketplace wants that feature, the Commission could certainly revise its rules to permit such a capital structure. We doubt, however, the efficacy of a subordinated capital cushion that is likely to be only a modest one. Once a fund's portfolio, on a fair value basis, drops below 99.5 cents per share, investors are put on notice that the fund might not be able to sustain its $1 NAV. Knowing that the capital buffer is limited (somewhere between, perhaps, 0.5% to 3% of NAV), investors might have an extra incentive to redeem before the cushion is exhausted, thereby aggravating rather than reducing problems of collective action. In any event, their concern has to do with loss of liquidity, and it is this concern that our proposal addresses."
