March 28, 1991
TO: BOARD OF GOVERNORS NO. 21-91
MONEY MARKET MEMBERS - ONE PER COMPLEX NO. 7-91
SEC RULES COMMITTEE NO. 18-91
MONEY MARKET FUNDS AD HOC COMMITTEE NO. 9-91
RE: INSTITUTE LETTER TO SEC STAFF ON TAX-EXEMPT MONEY MARKET
FUND PROPOSALS
__________________________________________________________
At the recent SEC meeting at which amendments to the rules
regulating money market funds were adopted, Commissioner Roberts
urged the staff of the Division of Investment Management to
consider changes to the quality and diversification requirements
applicable to tax-exempt money market funds, since the amendments
to those requirements were applicable only to taxable money
market funds. It is our understanding that the Division staff
has, in fact, started looking into issues relating to tax-exempt
funds.
The Institute's ad hoc committee on money market funds has
met a number of times over the past couple of months to consider
proposals to modify the regulation of tax-exempt funds. The
Institute recently submitted to the SEC staff the attached letter
recommending modifications to the rules affecting tax-exempt
money market funds, which reflects the proposals developed by the
committee.
Set forth below are the significant amendments proposed by
the Institute.
Diversification
The Institute recommended that the diversification
requirement applicable to taxable money market funds (i.e., no
more than 5% of a fund's assets may be invested in any one
issuer) be adopted for national tax-exempt funds.
However, because of the more limited supply of tax-exempt
securities in certain states and the dominance of only one or a
few municipal issuers within a given state, the Institute
recommended that single state tax-exempt funds not be required to
meet the 5% diversification requirement proposed for national
funds. Instead, the Institute recommended that additional
disclosure be required in the prospectuses of those funds that do
not meet the 5% diversification requirement. The Institute also
recommended that the name of single state funds accurately
reflect the fund's intention to concentrate its investment in
securities of issuers domiciled in a particular state and that
additional cover page disclosure be made as to the fund's intent
to concentrate in such securities and that there may be
additional risks of doing so.
Quality
The Institute recommended that the 5% limit on second tier
securities applicable to taxable funds be adopted for both
national and single state tax-exempt funds, provided that funds
be permitted to treat split-rated securities as being of the same
quality as the higher rating, so long as at least 50% of the
agencies rating that security have assigned it the highest
rating.
Under the SEC's amendments (which apply to taxable and tax-
exempt funds), a security that received different ratings from
the rating agencies could be considered a top tier security (and,
therefore, not subject to the 5% limit on second tier securities)
only if two rating agencies rated it in the highest category.
Thus, a split-rated security that was rated by only two agencies
(e.g., A-1/P-2) would have to go in the 5% basket of second tier
securities. As a result, tax-exempt funds could be precluded
from purchasing a large number of securities since, historically,
there have been only two rating agencies that have rated tax-
exempt securities. Moreover, the recently adopted amendments
could provide one rating agency with de facto veto power over
tax-exempt funds' purchases of securities. The Institute also
recommended that this change be made with respect to taxable
funds to further investor protection and to provide for
reasonable investment flexibility by avoiding a single NRSRO
"veto".
Miscellaneous
The Institute recommended that Rule 2a-7 be amended to
prohibit funds from purchasing conditional demand features used
to shorten maturity of tax-exempt securities, unless the
conditions are limited to those set forth in the letter. This
proposal is intended to reduce the risk of a tax-exempt security
losing its demand feature, which could result in the fund holding
a long-term security, the value of which may significantly
deviate from its amortized cost value.
In addition, given the complexity of some of the tax-exempt
securities that have recently come to market and the potential
tax issues that may affect the tax-exempt status of these
securities, the Institute recommended that the SEC caution funds
about the additional tax-related risks to a stable net asset
value that are present with respect to tax-exempt securities and
remind boards of directors of tax-exempt money market funds of
their obligations concerning the valuation of fund shares.
We will keep you informed of developments.
Amy B.R. Lancellotta
Assistant General Counsel
Attachment