June 27, 1991
TO: SEC RULES MEMBERS NO. 37-91
RE: SEC STAFF MODIFIES ITS POSITION ON LIQUIDITY OF MUNICIPAL
LEASE SECURITIES
__________________________________________________________
Last year, the SEC staff stated in its industry comment
letter that it considers municipal lease securities to be
illiquid because of the inefficiency of the market in which they
traded. (See Memorandum to SEC Rules Members No. 4-90, dated
January 19, 1990 and Memorandum to SEC Rules Committee No. 11-91,
dated February 6, 1991.) Therefore, mutual funds had to treat
these securities as illiquid for purposes of the ten percent
limitation on the purchase of illiquid securities.
The Institute requested the staff to reconsider its
position since many municipal lease obligations are in fact
liquid. In response, the staff issued the attached letter
modifying its position, which recognizes that "in certain
circumstances, it may be appropriate to view municipal lease
obligations as liquid securities."
In the letter, the staff states that a fund may make the
determination to treat such securities as liquid under guidelines
established by the board of directors. The staff suggests
several factors that a fund should consider in making this
determination such as: (1) the frequency of trades and quotes for
the obligation; (2) the number of dealers willing to purchase or
sell the security and the number of other potential buyers; (3)
the willingness of dealers to undertake to make a market in the
security; and (4) the nature of the marketplace trades.
In addition, the staff stated that factors unique to
municipal lease obligations should be considered in determining
liquidity such as whether the marketability of the security will
be maintained throughout the time the fund holds the security.
This determination depends on factors related to the credit
quality of the municipality and the essentiality to the
municipality of the property covered by the lease. In this
respect, the staff notes the factors that a rating agency
generally considers when evaluating the credit quality of a
municipal lease obligation. The staff warns that it may view as
imprudent the purchase of an unrated municipal lease obligation
unless the fund can perform an analysis of factors similar to
those performed by the rating agencies and reasonably conclude
that the obligation is liquid.
Finally, the letter requires a fund that invests, or
intends to invest, more than five percent of its net assets in
municipal lease obligations that the board (or its delegate)
determines to be liquid to disclose in the prospectus the factors
considered by the board in making that determination. This
disclosure may be added by a "sticker" to the prospectus under
Rule 497 of the Securities Act.
Amy B.R. Lancellotta
Assistant General Counsel
Attachment (in .pdf format)