The latest "Comments on Proposed Rule: Money Market Fund Reform" on the SEC's website comes from David F. Freeman, Jr., Arnold and Porter LLP, on behalf of Federated Investors, Inc., Washington, District of Columbia, who critiques a recent Fed paper on gates and fees. He writes, "We are writing on behalf of our client Federated Investors, Inc. and its subsidiaries ("Federated") to respond to a paper published last week by the Staff of the Federal Reserve Bank of New York ("FRBNY") on the FRBNY website, titled "Gates, Fees, and Preemptive Runs" ("FRBNY Staff Gates & Fees Paper”). The FRBNY Staff Gates & Fees Paper analyzes Alternative Two (the "Fees and Gates" proposal) of the rulemaking proposal regarding money market mutual funds ("MMFs") currently before the Securities and Exchange Commission (the "Commission"). The abstract accompanying the FRBNY Staff Gates & Fees Paper states: "We build a model of a financial intermediary, in the tradition of Diamond and Dybvig (1983), and show that allowing the intermediary to impose redemption fees or gates in a crisis -- a form of suspension of convertibility -- can lead to preemptive runs. In our model, a fraction of investors (depositors) can become informed in advance about a shock to the return on the intermediary's assets. Later, the informed investors learn the realization of the shock and choose their redemption behavior based on this information. We prove two results: First, there are situations in which informed investors would wait until the uncertainty is resolved before redeeming if redemption fees or gates cannot be imposed, but those same investors would redeem preemptively if fees or gates are possible. Second, we show that for the intermediary, which maximizes the expected utility only of its own investors, imposing gates or fees can be ex post optimal. These results have important policy implications for intermediaries that are vulnerable to runs, such as money market funds, because the preemptive runs that can be caused by the possibility of gates or fees may have damaging negative externalities." The Freeman letter explains, "The key assumption underlying the entire analysis, that banks are currently prohibited from imposing gates or fees on redemptions, is demonstrably false. Other than demand deposit accounts ("DDAs"), banks (1) are required by Federal Reserve Regulation D to reserve the right to require seven days' advance notice of a withdrawal from MMDAs, NOW accounts and other savings accounts; (2) are not required to allow early withdrawal from CDs and other time deposits; and (3) are allowed to impose early withdrawal fees on time deposits if they choose to permit an early withdrawal from a time deposit.... In Federated's view, only the Commission's proposed Alternative Two would achieve the Commission's stated reform goals while promoting efficiency, competition, and capital formation and satisfying the Commission's own internal guidelines for economic analysis (provided that the critical modifications suggested by Federated in other letters to the Commission are adopted). Implementing the Commission's Alternative One (the "floating NAV" proposal) either by itself or in conjunction with Alternative Two, would fail to achieve the Commission's reform goals while imposing costs on investors, funds, and the economy as a whole that far outweigh any benefits, thereby contravening the Commission's statutory obligations and the Commission's guidance."
