January 29, 1993
TO: BOARD OF GOVERNORS NO. 8-93
MONEY MARKET MEMBERS - ONE PER COMPLEX NO. 2-93
SEC RULES MEMBERS NO. 15-93
COMPLIANCE COMMITTEE NO. 2-93
RE: SEC SANCTIONS WITH RESPECT TO MONEY MARKET FUND PURCHASE OF
UNRATED SECURITIES
__________________________________________________________
The Securities and Exchange Commission recently sanctioned
an investment adviser and a former portfolio manager for
willfully violating Section 34(b) of the Investment Company Act
and aiding and abetting violations of Rule 22c-1 under the Act in
connection with the purchase of approximately $177 million of
unrated securities by a tax-exempt money market fund. The
alleged violations were discovered during a routine SEC
examination of the fund in November and December 1990.
The SEC found that from July 18, 1989 to November 28, 1990,
a series investment company used the amortized cost valuation
method to value the portfolio of its tax-exempt money market
fund, in reliance on Rule 2a-7 (as in effect at the time).
During that period, the portfolio manager purchased for the fund
(1) $81 million in unrated securities that were guaranteed by
letters of credit issued by financial institutions that had not
received ratings on their short-term debt, and (2) $96 million in
synthetic securities that were guaranteed by a conditional letter
of credit issued by a financial institution that had received a
"high quality" rating on its short-term debt. The conditions for
this letter of credit dictated that the guarantee would not be
operative if any pool security went into default before a ratings
downgrade or if certain tax events occurred, such as a denial of
tax exempt status for any pool security.
The SEC found that the investment company's board of
directors has not made a minimal credit risk or comparable
quality determination with respect to the unrated securities, nor
had the board delegated that responsibility to the adviser. The
SEC also found that neither the adviser nor the portfolio manager
had concluded thatthe credit enhancement facility supporting the
synthetic securities was conditional before determining that the
synthetic securities were eligible for purchase by the money
market fund.
The SEC thus found that the investment company could not
rely on Rule 2a-7 from July 18, 1989 to November 28, 1990 and
therefore violated Rule 22c-1 by selling, redeeming or
repurchasing securities issued by the money market fund without
calculating its net asset value in a manner prescribed by the
rule. The SEC found that the adviser and portfolio manager
willfully aided and abetted that violation of Rule 22c-1.
The SEC also found that the portfolio manager had made
entries on the order tickets for the unrated debt securities that
stated incorrectly that an NRSRO had rated the securities "high
quality." According to the SEC, the adviser and the investment
company's board used schedules and other documents that were
derived from these order tickets to monitor the money market
fund's portfolio. The adviser also relied on these documents to
compile the schedule of the money market fund's portfolio
investments that was incorporated in its periodic reports. The
reports for the period thus inaccurately stated that all
portfolio securities had either been rated "high quality" or had
been determined by the money market fund's board of directors to
be of comparable quality. The SEC thus found that the adviser
and portfolio manager willfully violated Section 34(b).
Finally, the SEC found that, during the period in question,
the adviser did not have in place a sufficient system to monitor
compliance with the quality requirements of Rule 2a-7, or to
sufficiently assure the accuracy of certain records and reports
required to be maintained or filed with the Commission. Further,
no operative instrument was in effect delegating to the adviser
the board's responsibility to make minimal credit risk and
comparable quality determinations for unrated securities. As a
result, the adviser did not have, in accordance with Section
203(e) of the Investment Advisers Act, adequate procedures
reasonably expected to prevent and deter the portfolio manager's
aiding and abetting violations of Rule 22c-1 or his principal
violations of Section 34(b).
Without admitting or denying the allegations, the adviser
consented to a censure and payment of a $50,000 civil penalty,
and the portfolio manager consented to a censure and payment of a
$5,000 civil penalty. The adviser agreed to certify that it had
undertaken (or caused the investment company's board to
undertake) to (1) engage an independent accounting firm to review
the adviser and company's Rule 2a-7 compliance procedures, (2)
adopt appropriate Rule 2a-7 compliance procedures, and (3)
appoint a compliance committee to review all acquisitions of
portfolio securities by the fund. The portfolio manager also
agreed to an order to cease and desist from committing or causing
any violation of Section 34(b) and Rule 22c-1.
A copy of the SEC's order is attached.
Craig S. Tyle
Vice President - Securities
Attachment