September 30, 1994
TO: ACCOUNTING/TREASURERS MEMBERS NO. 28-94
BOARD OF GOVERNORS NO. 101-94
FEDERAL LEGISLATION MEMBERS NO. 28-94
MEMBERS - ONE PER COMPLEX NO. 72-94
SEC RULES MEMBERS NO. 69-94
RE: SEC STAFF MEMORANDUM ON MUTUAL FUNDS AND DERIVATIVES
__________________________________________________________
On September 26th, the Securities and Exchange Commission
released a memorandum prepared by the Division of Investment
Management entitled "Mutual Funds and Derivative Instruments." A
copy of the memorandum is attached. The memorandum was drafted in
response to a June 15th letter from House Telecommunications and
Finance Subcommittee Chairman Edward Markey (D-MA) and Ranking
Minority Member Jack Fields (D-TX) requesting that the Commission
undertake a comprehensive study of the use of derivatives by mutual
funds and the adequacy of laws and regulations governing their
disclosure and use. The letter also posed a series of specific
questions.
The staff's memorandum includes responses to these questions,
which relate to: (1) Commission knowledge of mutual fund use of
derivatives; (2) disclosure of mutual fund use of derivatives; (3)
the effect of mutual fund competition on derivatives use; (4)
mutual fund pricing of derivatives; (5) liquidity of derivatives
held by mutual funds; (6) leverage available to mutual funds
through derivatives; (7) risks faced by investors in bank-advised
mutual funds, and (8) derivative use by money market funds. The
memorandum also reviews steps taken to date by the Commission and
the Division of Investment Management to address investor
protection issues raised by mutual fund use of derivatives, and
further actions recommended by the Division.
The Division's principal recommendations are as follows: (a)
the Commission should seek public comment on requiring some form of
quantitative risk measurement in fund prospectuses; (b) the
Commission should consider reducing the ceiling on fund illiquid
holdings to 10% of net assets; and should continue to evaluate
liquidity and pricing issues raised by derivatives through the fund
inspection process and determine on the basis of its findings
whether rulemaking is necessary in these areas; (c) the Commission
should reexamine the application of the leverage restrictions of
the Investment Company Act to derivatives and seek public comment
on whether regulatory or legislative action is needed to address
the leverage created by fund use of derivatives; and (d) the
Commission should recommend that Congress enact legislation to
enhance the Commission's ability to obtain information necessary to
monitor fund use of derivatives.
The memorandum further states that "responsibility for
managing a mutual fund's derivative investments falls, in the first
instance, on the fund's management and board of directors or
trustees." It indicates that the Division's inspection staff
examines fund management controls, and is giving particular
attention to controls relating to derivatives risk. Based upon the
staff's findings and discussions with industry participants, the
Division will determine whether to recommend that the Commission
consider rulemaking with respect to management controls of
derivatives risk.
Paul Schott Stevens
General Counsel
Attachment