December 9, 1991
TO: MONEY MARKET MEMBERS - ONE PER COMPLEX NO. 32-91
MONEY MARKET FUNDS AD HOC COMMITTEE NO. 31-91
SEC RULES MEMBERS NO. 59-91
RE: SEC STAFF POSITION ON MONEY MARKET FUNDS PURCHASING INVERSE
FLOATERS
__________________________________________________________
The Director of the Division of Investment Management
issued the attached letter expressing the staff's views on the
purchase of instruments known as "inverse floaters" by money
market funds. The staff views these instruments (which are
described as instruments with floating or variable interest rates
that move in the opposite direction of short-term interest rates
and at an accelerated rate) as being inappropriate investments
for funds seeking to maintain a stable net asset value. The
staff believes that it is likely that the market value of inverse
floaters will deviate from their amortized cost value as a result
of their high volatility. In addition, the staff notes that an
investment in these instruments amounts to leveraging the fund's
portfolio, which is an inappropriate portfolio management
technique for a fund seeking to maintain a stable net asset
value. The staff stated that an investment in these instruments
raises the following specific legal issues.
First, the staff concluded that an investment in inverse
floaters would "circumvent the provisions of rule 2a-7 governing
the maximum maturity of individual securities and the average
weighted portfolio maturity where a sufficient amount of a fund's
assets are invested in these instruments." Therefore, the staff
believes that an investment in these securities would constitute
doing indirectly what the fund cannot do directly in violation of
Section 48 of the Investment Company Act (which prohibits any
person from doing indirectly any act which it would be unlawful
to do directly under the provisions of the Act). In addition,
the staff stated in footnote 2 of the letter that it would
"arrive at the same conclusion regarding an instrument whose rate
of interest magnifies the effect of interest rate changes
directly with prevailing interest rates."
Second, the letter states that since the average weighted
maturity reported to investors would not accurately reflect the
exposure of a fund that owns inverse floaters to interest rate
changes, a fund owning these instruments may be materially
misleading investors as to the risks associated with an
investment in the fund when it reports its average weighted
maturity.
The staff concludes the letter by warning that if in the
course of inspections they continue to find these instruments in
fund portfolios, the Division will consider recommending to the
Commission that an enforcement action be instituted against fund
advisers and directors who have caused or permitted these
securities to be included in fund portfolios.
Amy B.R. Lancellotta
Associate General Counsel
Attachment