Yesterday, we excerpted from the main body of Federated Investors' most recent quarterly earnings call. Today, we quote the Q&A section, which features Federated's responses to various questions on possible regulatory options, acquisitions and contingency plans. Federated CEO Chris Donahue says in the Q&A, "`Mary Schapiro had said that she expected or wanted to release a proposal before the end of the first quarter." When asked, "If a [capital] proposal were something that required 40 basis points or so ... but there were seven years to get there. Is that a model that you can manage to as a non-bank money market sponsor?" Donahue answers, "Probably. It would be an unnecessary and unwise.... [But] the concept that Fidelity put out ... is something that could work, because that comes out as a fund and is simply taking yield from today or number of years. There's not much yield today, but taking yield from certain times and then putting it into the fund up to some number, 35 basis points or 40 basis points that does not cause the fund to trigger a (1.005) and thereby jump a penny. So stuff within that context is workable but unnecessary."
Donahue answers a question on the SEC Commissioners, "There are five votes as to whether to come up with a proposal and what would be in the proposal.... [W]e tell the story and hopefully we're able to ... convince three of the Commissioners that they've done enough.... [Also, the] Administrative Procedures Act has been a little bit of a stumbling block for some SEC rules, like the Proxy Access Rules and the Independent Chair Rules, because there has been no study yet of unintended consequences [or] cost-benefit analysis of what doing something really crazy to the money funds would do. So ... hopefully [we will] have at least some of them see the wisdom of hitting pause mode on this whole thing."
Asked about acquisitions, the Federated CEO comments, "We are continuing to look there. The Prime Rate [Capital] thing is a good thing to have happened and came out of that effort.... [T]hat effort continues. We think that we're going to be seeing more product come on to the market ... because of the effect of Basel III on some large banking institutions in terms of how they will handle their investment management operations from a capital standpoint.... As regards to our appetite, we have appetite to do good solid money fund deals for the long haul, and so we would continue to do that.... [T]here is, as we've talked about before, an oligopolization occurring in this business and this lower-for-longer theme will influence that more so. I think it was in the end of 2007 there are 300 people offering money funds, today there are less than 100. So that will continue. So, it's really hard to say how some of the other big people will look at it, but we would be happy to receive any big people's calls on that subject."
On contingency plans for drastic regulatory change, Donahue responds, "What you will see as a contingency plan is first to fight it initially, then to fight it regulatory-wise and legal-wise as much as can be done. There will be time if this actually occurs, wherein they don't want disruption in the marketplace as the money funds unwind, and so that will all be planned out and be organized in that way. Then, you get to the next level where you start shining up all your other products. You've got UCITS products, you've got separate accounts, and you've got a short and intermediate and ultrashort bond funds, that, if everything else becomes illegal for inappropriate reasons and inappropriate results, then you have to face that reality. So that's the area where the plans would go. There are number of clients who are large enough that they could sustain separate accounts. They don't want to go there and we don't want to go there. But if forced to, that's certainly an area that could be covered."
One analyst asked about legal actions to stop the SEC. Federated answers, "Well, what happens is when they come up with a rule that's, what I meant by the Proxy Access Rule comment and the Independent Chair comment, that the SEC for those rules had not done their homework in terms of studying the potential effects, i.e. the cost benefit. This went to court and the information that the SEC supplied was deemed inadequate under the Administrative Procedures Act and therefore the rule was overturned. So that is a path that we would go down.... It depends on whether or not you're able to get the injunction at the moment of impact and then you fight it out in court. So that would all be court type determination, and it could delay it indefinitely.... I think if they did any really thorough analysis of the cost-benefit of the kind of ideas they are talking about on money funds, they would discover it's a whopping negative. So, the study would probably end up delaying it forever."
Well I don't have a lot of evidence that they have done studies on the effects of taking money funds out. We're seriously diminishing their participation. I think that they are rather driven by higher goals that they have in mind and because the first round of changes in 2a-7 were basically designed around enhancing the resiliency of money funds and on this next round doesn't seem to do that, and therefore it must be oriented towards some other goal which has not exactly been articulated. So, I tried to take them into words and what we are after is enhancing resiliency and not killing. That should take off the table all the things that tend to kill or severely injure. So, I can't say what kinds of internal studies they have done. They haven't said them with us and I'm just not aware of them. They are all smart people though and are very knowledgeable and I think they should therefore have done the homework first before they come up with these ideas which don't help the funds, don't help us, don't help our stock and don't appear to have in the public domain anyway. A lot of evidence is to how they could do what they want to do and not end up breaking a lot of things, with a lot of unintended consequences.
When asked about a 3% redemption holdback for 30 days and a floating NAV, CFO Tom Donahue quips, "It's like the choice between you want to die by hanging or by bullet. So you can go one way or the other. You have guided exactly right because they each injure the basic concept of daily liquidly at par. At the next level, they each injure severely the operational things that have been set up for 40 years to use money funds. The variable NAV is obvious because people then have no anticipation of coming in, going out and all of their internal transactions to the dollar. On the holdback, a fiduciary has a heck of a time figuring out that the fiduciary is going to put himself or herself into an investment where 3% of it doesn't come back out for 30 days and then what happens then.... So, in each of those cases, it's just chose your different poison."
Finally, CEO Donahue comments, "If the deal is closed around the Fidelity buffer idea, that's probably something people could agree to. But if it goes beyond that, then it's going to have a lot of the same problems as the other one has. One of the other comments on capital that [one] SEC Commissioner made was that ... either the numbers are so big that it makes the industry uneconomic, or it isn't big enough to take care of a problem.... So in either case, it doesn't work. [R]emember, we're dealing here with an investment company under the Investment Company Act of 1940, which was passed in order to enhance disclosure. This is not a capital regime like the banking industry.... [T]oying with the fundamental rights like the right to redeem, it's just antithetical, as is adding capital into a fund where basically it's all capital already."
