[Federal Register Volume 62, Number 236 (Tuesday, December 9, 1997)]
[Rules and Regulations]
[Pages 64968-64990]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-32026]



[[Page 64967]]

_______________________________________________________________________

Part IV





Securities and Exchange Commission





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17 CFR Parts 230, 239, 270, and 274



Technical Revisions to the Rules and Forms Regulating Money Market 
Funds; Final Rule

Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / 
Rules and Regulations

[[Page 64968]]



SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 230, 239, 270 and 274

[Release Nos. 33-7479; IC-22921; S7-29-96]
RIN 3235-AE17


Technical Revisions to the Rules and Forms Regulating Money 
Market Funds

AGENCY: Securities and Exchange Commission.

ACTION: Final rules.

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SUMMARY: The Commission is adopting amendments to rules and forms under 
the Securities Act of 1933 and the Investment Company Act of 1940 that 
govern money market funds. Technical amendments to rule 2a-7 under the 
Investment Company Act of 1940, the rule regulating money market funds, 
among other things, revise terminology used in the rule to reflect 
common market usage and resolve certain interpretive issues under the 
rule. Amendments to the advertising rules applicable to money market 
funds, among other things, clarify the formula used by money market 
funds to calculate yield.

DATES: Effective Date: The rule and form amendments adopted in this 
Release will become effective February 10, 1998. Compliance Date: See 
Section III of this Release.

FOR FURTHER INFORMATION CONTACT: David P. Mathews, Senior Counsel, 
Office of Regulatory Policy, (202) 942-0690, Division of Investment 
Management, Securities and Exchange Commission, 450 Fifth Street, N.W., 
Mail Stop 10-2, Washington, D.C. 20549.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission 
(``Commission'') is adopting technical amendments to rule 2a-7 [17 CFR 
270.2a-7] (``rule 2a-7'' or the ``rule'') under the Investment Company 
Act of 1940 [15 USC 80a-1, et seq.] (``1940 Act''), the rule governing 
the operations of money market funds (``funds'').<SUP>1</SUP> The 
Commission is adopting conforming amendments to rules 2a41-1, 12d3-1, 
17a-9 and 31a-1 under the 1940 Act [17 CFR 270.2a41-1, 270.12d3-1, 
270.17a-9 and 270.31a-1] to reflect the amendments to rule 2a-7. The 
Commission also is adopting amendments to rule 482 [17 CFR 230.482] 
under the Securities Act of 1933 [15 USC 77a, et seq.] (``1933 Act'') 
and rule 34b-1 under the 1940 Act [17 CFR 270.34b-1]; and to Forms N-1A 
[17 CFR 239.15A and 274.11A], N-3 [17 CFR 239.17a and 274.11b] and N-4 
[17 CFR 239.17b and 274.11c].
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    \1\ Unless otherwise noted, all references to ``rule 2a-7, as 
amended,'' or any paragraph of the rule, will be to 17 CFR 270.2a-7 
as amended by this Release.
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I. Technical Amendments to Rule 2a-7

A. Background

    On March 21, 1996, the Commission adopted amendments to rule 2a-7 
under the 1940 Act (``1996 Amendments'') to tighten the rule's risk-
limiting conditions imposed on tax exempt money market funds and to 
address the treatment under the rule of certain instruments, such as 
asset backed securities.<SUP>2</SUP> These risk-limiting conditions 
include requirements that a fund limit itself to investing in high 
quality securities <SUP>3</SUP> and that the fund's portfolio be 
diversified.<SUP>4</SUP> After the adoption of the 1996 Amendments, 
industry participants raised numerous questions concerning the 
application of the amendments in different contexts. The Commission 
thereafter suspended the compliance date of certain of the 1996 
Amendments pending the proposal and adoption of technical amendments to 
address these concerns.<SUP>5</SUP>
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    \2\ Revisions to Rules Regulating Money Market Funds, Investment 
Company Act Release No. 21837 (Mar. 21, 1996) [61 FR 13956 (Mar. 28, 
1996)] (``Release 21837''). Unless otherwise noted, all references 
to the ``1996 Amendments'' in this Release are to rule 2a-7 as 
adopted in Release 21837. The compliance date for the 1996 
Amendments to rule 2a-7 was suspended pending the adoption of 
technical amendments. See infra note 5 and accompanying text.
    \3\ The portfolio or credit quality provisions of the rule 
generally limit funds to investments in U.S. dollar-denominated 
securities that present minimal credit risks and that are, at the 
time of acquisition, ``eligible securities'' as defined by the rule. 
See paragraph (c)(3) of rule 2a-7, as amended (``portfolio quality 
standards'' or ``credit quality standards''). ``Eligible security'' 
is defined in paragraph (a)(10) of rule 2a-7, as amended.
    \4\ The diversification provisions of the rule generally limit 
the amount of assets that a fund may invest in a single issuer of 
securities, and the amount of assets that may be subject to credit 
enhancements, such as letters of credit or puts, provided by the 
same credit enhancement provider. See paragraph (c)(4) of rule 2a-7, 
as amended (``diversification standards'').
    \5\ Revisions to Rules Regulating Money Market Funds, Investment 
Company Act Release No. 22135 (Aug. 13, 1996) [61 FR 42786 (Aug. 19, 
1996)]. The Commission suspended the 1996 Amendments' compliance 
date for rules 2a-7, 2a41-1, 12d3-1 and 31a-1 under the 1940 Act. 
[17 CFR 270.2a-7, 2a41-1, 12d3-1 and 31a-1]. The compliance date was 
not suspended with respect to the adoption of rule 17a-9 under the 
1940 Act [17 CFR 270.17a-9] and the 1996 Amendments' revisions of 
the rules and forms relating to money market fund disclosure, 
advertising and reporting.
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    On December 10, 1996, the Commission issued a release proposing 
technical amendments to rule 2a-7 (``Proposing Release'').<SUP>6</SUP> 
The proposed amendments would: (1) codify certain interpretive views 
expressed by the Division of Investment Management;<SUP>7</SUP> (2) 
revise terminology used in the rule to reflect common market usage; (3) 
modify certain of the 1996 Amendments so that the rule's treatment of 
certain instruments (e.g., guarantees) more closely reflects the 
treatment of those instruments by the financial markets; and (4) make 
certain other technical corrections. The Commission also proposed 
amendments to clarify the Commission's advertising rules regarding how 
money market funds calculate current yield and represent short-term 
total return in conjunction with current yield quotations.
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    \6\ Technical Revisions to the Rules and Forms Regulating Money 
Market Funds, Investment Company Act Release No. 22383 (Dec. 10, 
1996) [61 FR 66621 (Dec. 18, 1996)] (``Proposing Release'').
    \7\ See Investment Company Institute (pub. avail. May 9, 1996).
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    The Commission received comments on the proposed amendments from 
seventeen commenters, including nine mutual fund complexes.<SUP>8</SUP> 
Commenters supported the proposed technical amendments to rule 2a-7, 
and suggested further amendments to certain provisions of the rule 
primarily relating to the treatment of asset backed securities. Most 
commenters that addressed the proposed amendments to the Commission's 
advertising rules relating to money market fund yield and total return 
generally supported them. The Commission is adopting the technical 
amendments substantially as proposed, with certain modifications that 
reflect, in part, many of the commenters' suggestions. The Commission 
also is establishing a new compliance date for the 1996 Amendments, as 
further amended by the technical amendments adopted in this 
Release.<SUP>9</SUP>
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    \8\ The comment letters and a summary of the comments prepared 
by the Commission staff are available to the public and are included 
in File No. S7-29-96.
    \9\ The new compliance date is discussed infra in Section III.B. 
of this Release.
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B. Discussion

1. Guarantees
    a. Definition of ``Guarantee''. Rule 2a-7 currently characterizes 
certain features that enhance the credit or liquidity of portfolio 
securities as ``puts'' and ``unconditional puts.''<SUP>10</SUP> To 
clarify

[[Page 64969]]

terminology used in rule 2a-7, the Commission proposed to replace these 
terms with a new term--``guarantee''--that would include a wide-range 
of arrangements designed to unconditionally support the credit of the 
issuer of a security.<SUP>11</SUP> Commenters generally supported the 
proposed amendments, which the Commission is adopting substantially as 
proposed.<SUP>12</SUP>
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    \10\ The 1996 Amendments defined a ``put'' as the right to sell 
a specified underlying security within a specified period of time at 
a specified exercise price that may be sold, transferred or assigned 
only with the underlying security. An ``unconditional put'' was 
defined as a put (including any guarantee, financial guarantee 
(bond) insurance, letter of credit or similar unconditional credit 
enhancement) that by its terms would be readily exercisable in the 
event of default in payment of principal or interest on the 
underlying security. See paragraphs (a)(16) and (a)(27) of rule 2a-
7, as adopted by the 1996 Amendments.
    \11\ See Proposing Release, supra note , at n.7 and accompanying 
text.
    \12\ Under the new definition, a guarantee is any unconditional 
obligation of a person other than the issuer of the security to 
undertake to pay, upon presentment by the holder of the guarantee 
(if required), principal plus accrued interest when due upon 
default. Paragraph (a)(15) of rule 2a-7, as amended. In order to 
permit guarantees that are payable at any time, the Commission has 
eliminated a requirement in the proposed definition that the issuer 
of the guarantee be obligated to pay upon default ``at a specified 
time.'' The Commission also is adopting amendments to the credit 
quality and diversification provisions of the rule to incorporate 
the new term ``guarantee,'' as discussed infra in Sections I.B.1.b. 
and c. of this Release. The definition of ``guarantee'' is for 
purposes of rule 2a-7 only, and is not intended to have any effect 
on the status of these investments under other provisions of the 
1940 Act or under other federal securities laws.
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    b. Credit Substitution. Since 1986, rule 2a-7 has permitted a fund 
to rely exclusively on the credit quality of the issuer of an 
``unconditional demand feature'' in determining whether a security 
meets the rule's credit quality standards.<SUP>13</SUP> The 1996 
Amendments also permitted a fund to exclude from the rule's issuer 
diversification standards a security subject to an unconditional demand 
feature provided by a person that does not control, or is not 
controlled by or under common control with, the issuer of the security 
(``non-controlled person'').<SUP>14</SUP> Reflected in this approach is 
the recognition that the holder of a security typically relies 
exclusively on the credit quality of the issuer of the unconditional 
demand feature in deciding to invest in the security.
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    \13\ See Acquisition and Valuation of Certain Portfolio 
Instruments by Registered Investment Companies, Investment Company 
Act Release No. 14983 (Mar. 12, 1986) [51 FR 9773 (Mar. 21, 1986)]. 
A ``demand feature'' means (i) a feature exercisable either: (A) at 
any time on no more than 30 calendar days' notice, or (B) at 
specified intervals not exceeding 397 calendar days and upon no more 
than 30 calendar days' notice; or (ii) a feature permitting the 
holder of an asset backed security unconditionally to receive 
principal and interest within 397 calendar days of making demand. An 
``unconditional demand feature'' is a demand feature that by its 
terms would be readily exercisable in the event of a default in 
payment of principal or interest on the underlying security or 
securities. See paragraphs (a)(8) and (a)(26) of rule 2a-7, as 
amended.
    \14\ Under the 1996 Amendments, a security subject to an 
unconditional demand feature from a person in a control relationship 
with the issuer of the security (i.e., one that controls, is 
controlled by or under common control with the issuer) remains 
subject to the issuer diversification standards in order to reduce a 
fund's exposure to credit risks presented by a single economic 
enterprise. See Release 21837, supra note 2, at nn.42-47 and 
accompanying text.
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    In addition to enhancing credit quality, money market funds also 
rely on demand features to shorten the maturities of adjustable rate 
securities or provide a source of liquidity.<SUP>15</SUP> Because of 
the significance of demand features to a money market fund's ability to 
maintain a stable net asset value, the 1996 Amendments further provided 
that a demand feature is not eligible for fund investment unless (i) 
The demand feature (or the issuer of the demand feature) is rated by an 
NRSRO (``Rating Requirement'');<SUP>16</SUP> and (ii) arrangements are 
in place for a fund holding a security subject to a demand feature to 
be given notice in the event of a change in the identity of the issuer 
of the demand feature (``Notification Requirement'').
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    \15\ Tax exempt funds, for example, typically invest in long-
term adjustable rate securities subject to demand features. The 
interest rates on these securities periodically adjust to reflect 
short-term rates. The demand features permit funds to demand payment 
of the security at relatively short intervals, and if unconditional, 
also serve to enhance credit quality--thus providing the basis for 
making the securities eligible for money market fund investment.
    \16\ ``NRSRO'' is the acronym used in rule 2a-7 to stand for a 
``nationally recognized statistical rating organization.'' See 
paragraph (a)(17) of rule 2a-7, as amended. NRSROs are designated as 
such by the Commission's Division of Market Regulation through the 
no-action letter process for purposes of the Commission's net 
capital rule [17 CFR 240.15c3-1].
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    The Commission proposed to extend these provisions to other types 
of guarantees commonly held by funds, such as bond insurance, letters 
of credit and similar unconditional guarantees.<SUP>17</SUP> Like 
securities subject to unconditional demand features, securities subject 
to guarantees typically trade on the basis of the credit of the 
guarantor, rather than the issuer. Commenters strongly supported the 
proposed amendments, which the Commission is adopting as 
proposed.<SUP>18</SUP>
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    \17\ Proposing Release, supra note 6, at nn. 8-16 and 
accompanying text.
    \18\ See paragraphs (c)(3)(iii) (determination of whether a 
security meets the rule's credit quality standards may be based 
exclusively on the credit quality of the security's guarantee); 
(c)(4)(i) (excluding securities subject to guarantees from non-
controlled persons from the rule's issuer diversification 
standards); (a)(10)(iii)(A) (extending the Rating Requirement to 
guarantees); (a)(10)(iii)(B) (extending the Notification Requirement 
to guarantees); and (a)(16) (definition of ``guarantee issued by a 
non-controlled person'') of rule 2a-7, as amended. The amended rule 
also permits a fund that holds a security subject to a guarantee and 
a conditional demand feature to substitute the rating of the 
guarantee for the rating of the underlying security. Paragraph 
(c)(3)(iv)(C) of rule 2a-7, as amended. Consistent with the amended 
rule, however, a fund must also consider the rating of the 
conditional demand feature in evaluating the credit quality of the 
entire instrument. Paragraph (c)(3)(iv)(A) of rule 2a-7, as amended.
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    Under the rule as amended, a fund holding a security subject to a 
guarantee (as defined in the rule) may rely exclusively on the credit 
quality of the issuer of the guarantee in determining whether the 
security meets the rule's credit quality standards.<SUP>19</SUP> In 
addition, securities subject to guarantees issued by non-controlled 
persons are not subject to the rule's issuer diversification 
standards.<SUP>20</SUP>
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    \19\ Paragraph (c)(3)(iii) of rule 2a-7, as amended.
    \20\ Paragraph (c)(4)(i) of rule 2a-7, as amended. Guarantees, 
however, are subject to the guarantee and demand feature 
diversification standards of paragraphs (c)(4)(iii), (c)(4)(iv) and 
(c)(5) of rule 2a-7, as amended. A security subject to a guarantee 
that is provided by a person in a control relationship with the 
issuer of the security remains subject to the rule's issuer 
diversification standards. See paragraphs (a)(16) (definition of 
``guarantee issued by a non-controlled person'') and (c)(4)(i) of 
rule 2a-7, as amended.
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    c. Rating Requirement for Guarantees. The 1996 Amendments precluded 
funds from investing in securities subject to demand features (whether 
unconditional or conditional) that have not received a short-term 
rating from an NRSRO. The Commission proposed, in light of its proposal 
to extend the rule's treatment of unconditional demand features to all 
guarantees, to extend the Rating Requirement to guarantees, subject to 
certain exceptions.<SUP>21</SUP> Commenters generally supported the 
proposal, which the Commission is adopting substantially as proposed.
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    \21\ Proposing Release, supra note 6, at nn. 17-24 and 
accompanying text.
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    Under rule 2a-7, as amended, all guarantees must be rated by an 
NRSRO,<SUP>22</SUP> except (i) a guarantee issued by a person that, 
directly or indirectly, controls, is controlled by or is under common 
control with the issuer of the security subject to the 
guarantee,<SUP>23</SUP> (ii) a guarantee with respect to a repurchase 
agreement (``repo'') that is collateralized fully,<SUP>24</SUP> (iii) a 
guarantee issued by the

[[Page 64970]]

U.S. Government,<SUP>25</SUP> or (iv) a guarantee not relied upon for 
quality, maturity or liquidity purposes.<SUP>26</SUP> Conditional 
demand features, which are not within the definition of a ``guarantee'' 
under the amended rule, are not subject to the Rating 
Requirement.<SUP>27</SUP>
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    \22\ Paragraph (a)(10)(iii)(A) of rule 2a-7, as amended. Unlike 
the 1996 Amendments, which required a short-term rating, the amended 
rule allows any rating from an NRSRO to satisfy the Rating 
Requirement.
    \23\ Paragraph (a)(10)(iii)(A)(1) of rule 2a-7, as amended. The 
Commission proposed to exclude this type of guarantee from the 
Rating Requirement because a guarantor that guarantees securities 
issued by a person in a control relationship with the guarantor may 
not be in the business of lending its credit, and such a requirement 
may be burdensome and result in a diminished supply of high quality, 
eligible securities available for money market fund investment.
    \24\ Paragraph (a)(10)(iii)(A)(2) of rule 2a-7, as amended. The 
Commission has relaxed the Rating Requirement with respect to 
guarantees of repos that are ``collateralized fully.'' One commenter 
noted that funds often rely on unconditional puts (i.e., 
``guarantees'' under the amended rule's terminology) with respect to 
``term repos''--which are repos for periods longer than one day. The 
puts could be exercised if a repo counterparty's credit quality 
deteriorated or to cover short-term cash outflows. The issuers of 
unconditional puts with respect to term repos are typically 
government securities dealers that are not rated by NRSROs. Since a 
repo that is ``collateralized fully'' already has significant 
protection from the risk of a counterparty's default or insolvency, 
requiring puts (or guarantees) of such repos to be rated would add 
little additional protection, and could cause funds to forgo a 
beneficial method of liquidity enhancement. See infra Section 
I.B.2.b. of this Release (treatment of repos that are 
``collateralized fully'').
    \25\ Paragraph (a)(10)(iii)(A)(3) of rule 2a-7, as amended; see 
infra Section I.B.2.e. of this Release (discussing guarantees issued 
by the U.S. Government).
    \26\ Paragraph (c)(5) of rule 2a-7, as amended; see also infra 
Section I.B.1.d. of this Release (demand features and guarantees not 
relied upon).
    \27\ A conditional demand feature is any demand feature that is 
not an unconditional demand feature. Paragraph (a)(6) of rule 2a-7, 
as amended.
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    d. Demand Features and Guarantees Not Relied Upon. The 1996 
Amendments permitted a fund that is not relying on a particular put to 
disregard that put for purposes of meeting rule 2a-7's put and demand 
feature diversification standards. The Commission is revising the rule 
to extend this provision to guarantees, and to expand the provision to 
permit funds to disregard a demand feature or a guarantee that is not 
relied upon to satisfy the rule's credit quality or maturity standards, 
or for liquidity, for all purposes under the rule.<SUP>28</SUP>
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    \28\ Paragraph (c)(5) of rule 2a-7, as amended. A fund holding 
securities subject to demand features or guarantees that are not 
being relied upon for credit quality, maturity or liquidity must 
establish written procedures requiring periodic re-evaluations of 
this determination. Paragraph (c)(9)(ii) of rule 2a-7, as amended. 
Funds are not required to establish procedures concerning demand 
features and guarantees not relied upon if they do not hold such 
instruments. Id.
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2. Diversification and Credit Quality Standards Applicable to Issuers
    a. Second Tier Securities. Rule 2a-7 provides that a taxable fund 
may not invest more than one percent of its total assets in second tier 
securities issued by a single issuer.<SUP>29</SUP> In the case of tax 
exempt funds, this one percent limitation on investments in second tier 
securities applies only to second tier ``conduit securities'' that are 
issued by municipalities, but whose ultimate obligors are not 
government or municipal entities.<SUP>30</SUP> The Commission is 
adopting the proposed amendments to the rule that clarify that these 
limitations are not applicable to a security that is guaranteed by a 
non-controlled person.<SUP>31</SUP> Securities subject to guarantees 
from non-controlled persons are subject only to the rule's guarantee 
and demand feature diversification standards.<SUP>32</SUP>
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    \29\ A ``second tier security'' is an eligible security that is 
not a first tier security. Paragraph (a)(22) of rule 2a-7, as 
amended. ``First tier securities'' are (i) securities that have 
received short-term debt ratings in the highest category from the 
requisite NRSROs; (ii) comparable unrated securities; (iii) 
securities issued by money market funds; and (iv) Government 
securities. Paragraph (a)(12) of rule 2a-7, as amended. ``Requisite 
NRSROs'' means (i) any two NRSROs that have issued a rating with 
respect to a security or class of debt obligations of an issuer; or 
(ii) if only one NRSRO has issued a rating with respect to a 
security or class of debt obligations of an issuer, that NRSRO. 
Paragraph (a)(21) of rule 2a-7, as amended.
    \30\ ``Conduit securities'' are issued to finance non-government 
projects, such as private hospitals, housing projects, or industrial 
development projects. See paragraph (a)(7) of rule 2a-7, as amended 
(definition of ``conduit security'').
    \31\ Paragraphs (c)(4)(i)(C) (1) and (2) of rule 2a-7, as 
amended. Rule 2a-7 also limits a taxable fund and a tax exempt fund 
to investing no more than five percent of total assets in second 
tier securities and second tier conduit securities respectively 
(``five percent quality test''). Paragraph (c)(3)(ii) of rule 2a-7, 
as amended (portfolio quality standards--second tier securities). 
The amendments do not make substantive changes to the five percent 
quality test. Thus, a taxable fund, for example, could not invest 
more than five percent of its total assets in second tier securities 
subject to a second tier demand feature. The amendments, however, 
reorganize the rule text to include the five percent quality test in 
paragraph (c)(3) of the rule, which addresses portfolio quality 
standards, rather than paragraph (c)(4), which addresses 
diversification standards.
    \32\ Paragraphs (c)(4)(iii) and (c)(4)(iv) of rule 2a-7, as 
amended.
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    b. Repurchase Agreements. Rule 2a-7 permits a fund to ``look-
through'' a repo to the underlying collateral and disregard the 
counterparty in determining compliance with the rule's diversification 
standards if the obligation of the counterparty is ``collateralized 
fully.'' The 1996 Amendments sought to define ``collateralized fully'' 
to limit the collateral to that which could be liquidated promptly even 
in the event of bankruptcy of the counterparty.
    Because of questions concerning the treatment of cash and other 
types of collateral not specifically addressed in the 1996 Amendments, 
the Commission proposed to revise the ``look-through'' provisions of 
the rule to focus on the treatment of the repo under applicable 
insolvency law rather than exclusively on the type of collateral. Under 
the proposed amendments, a repo would be ``collateralized fully'' if 
(i) the collateral consists entirely of cash, Government securities, or 
other securities that are rated in the highest rating category by the 
requisite NRSROs, and (ii) upon an event of insolvency with respect to 
the seller, the repo qualifies under a provision of applicable 
insolvency law providing an exclusion from any ``general stay'' of 
creditors rights against the seller.<SUP>33</SUP>
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    \33\ Proposing Release, supra note 6, at nn. 30-36 and 
accompanying text.
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    Commenters supported the proposed revisions, but three commenters 
urged that the rule's language be modified to refer to an ``automatic 
stay'' rather than a ``general stay.'' These commenters pointed out 
that even repos protected from automatic stays under federal insolvency 
law may be subject to a court-ordered general stay obtained by the 
Securities Investor Protection Corporation (``SIPC'') or the Federal 
Deposit Insurance Corporation (``FDIC''). Because no provision of 
insolvency law protects a purchaser of a repo from such orders, the 
proposed amendments might have precluded money market funds from 
relying on the rule's ``look-through'' provision for most repos, even 
though it is the policy of both SIPC (as to broker-dealer 
counterparties) and FDIC (as to bank counterparties) generally to allow 
the prompt liquidation of repos in insolvency proceedings.<SUP>34</SUP>
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    \34\ The United States Bankruptcy Code [11 U.S.C. 559] protects 
certain repos from the automatic stay provision, but provides that 
SIPC may obtain a court order barring the closeout of repo 
transactions with member broker-dealer firms. As a matter of policy, 
however, SIPC honors repos and allows their liquidation under most 
circumstances. See Letter dated February 4, 1986, from Michael E. 
Don, Deputy General Counsel of SIPC, to Robert A. Portnoy, Deputy 
Executive Director and General Counsel of the Public Securities 
Association. FDIC, as conservator or receiver for insolvent 
depository institutions, similarly has the ability to avoid 
contracts entered into by such institutions, but may not avoid 
transfers of property in connection with repos under most 
circumstances. See 12 U.S.C. 1821(e)(8)(A), (C) and (D); FDIC 
Statement of Policy on Qualified Financial Contracts (Dec. 12, 
1989).
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    The Commission is adopting the proposed amendments, revised in part 
to reflect the commenters' suggestions.<SUP>35</SUP> The Commission 
notes that, under the revised rule, a fund entering into a repo 
collateralized by Government securities (which most are) should be able 
to conclude that the repo qualifies for ``look-through'' treatment 
(assuming the

[[Page 64971]]

other requirements of the rule are met), while funds wishing to enter 
into repos using less traditional forms of collateral may rely on 
opinions of bankruptcy counsel.<SUP>36</SUP>
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    \35\ Paragraph (a)(5)(iv) of rule 2a-7, as amended. Commenters 
also suggested that the text of this provision refer only to 
applicable ``federal'' insolvency law. Although repos entered into 
by funds typically involve domestic counterparties subject to 
federal insolvency law, funds may enter into repos with non-U.S. 
counterparties that are not subject to federal insolvency laws. 
Therefore, the amended rule continues to apply to any applicable 
insolvency law.
    \36\ In addition, a money market fund must evaluate the repo 
counterparty's creditworthiness in order to minimize the risk that 
money market funds will enter into repos with parties that present a 
serious risk of becoming involved in bankruptcy proceedings. The 
Commission previously published a release setting forth the 
conditions under which the Division of Investment Management would 
not recommend enforcement action under section 12(d)(3) of the 1940 
Act [15 U.S.C. 80a-12(d)(3)] (limiting fund investments in certain 
securities-related businesses) if an investment company entered into 
a repo with persons engaged in securities-related businesses. 
Securities Trading Practices of Registered Investment Companies, 
Investment Company Act Release No. 13005 (Feb. 2, 1983) [48 FR 5824 
(Feb. 9, 1983)] (``Repo Release''). Among other things, the Repo 
Release requires that the repo be ``fully collateralized.'' The 
definition of ``fully collateralized'' in the Repo Release does not 
include all of the conditions in rule 2a-7. A money market fund 
entering into a repo that is ``collateralized fully'' within the 
meaning of paragraph (a)(5) of rule 2a-7, as amended, will be deemed 
to meet the ``fully collateralized'' requirement of the Repo 
Release. Investment companies other than money market funds are not 
required to comply with this provision of rule 2a-7 to be deemed to 
hold repos that are ``fully collateralized'' for purposes of the 
Repo Release.
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    c. Refunded Securities. Money market funds often invest in 
``refunded securities,'' which are securities the payment for which is 
funded and secured by Government securities placed in an escrow 
account. Rule 2a-7 permits a fund to ``look-through'' refunded 
securities to the escrowed Government securities in determining its 
compliance with the rule's issuer diversification standards under 
certain conditions.<SUP>37</SUP> One condition contained in the 1996 
Amendments required certification by an independent public accountant 
that the escrowed Government securities, or any subsequent substitution 
of the escrowed securities, would satisfy all payments of principal, 
interest and applicable premiums on the refunded securities 
(collectively, the ``accountant's certification''). The Proposing 
Release noted that NRSROs, in rating refunded securities, typically 
require an independent third party to make the same 
determination.<SUP>38</SUP> Therefore, the Commission proposed, and is 
now adopting, an amendment to the rule eliminating the accountant's 
certification requirement if a refunded security has received a rating 
from an NRSRO in the highest category for debt 
obligations.<SUP>39</SUP>
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    \37\ Paragraph (c)(4)(ii)(B) of rule 2a-7, as amended. This 
``look-through'' treatment would not be available to refunded 
securities subject to a swap agreement (i.e., the payments from the 
escrowed Government securities are exchanged for payments made by a 
swap counterparty) because the swap counterparty, rather than the 
escrowed Government securities, acts as the ultimate source of 
payment for the refunded securities. See J.P. Morgan Structured 
Obligations Corp. (pub. avail. July 27, 1994); see generally infra 
Section I.B.3.d. of this Release (swap arrangements).
    \38\ See, e.g., Standard & Poor's Municipal Finance Criteria, 
176-77 (1996).
    \39\ Paragraph (a)(20)(iii) of rule 2a-7, as amended (definition 
of ``refunded security'').
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    d. Three-Day Safe Harbor. Rule 2a-7 permits a taxable or national 
fund to invest up to twenty-five percent of its total assets in the 
first tier securities of a single issuer for up to three business days 
(``three-day safe harbor''). The Commission proposed, and is adopting, 
amendments that restore unintentionally omitted language from the rule 
text stating that a fund relying on the three-day safe harbor may not 
make more than one investment in reliance on the safe harbor at any 
time during the three day period.<SUP>40</SUP>
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    \40\ Paragraph (c)(4)(i)(A) of rule 2a-7, as amended. The three-
day safe harbor is not available for single state funds. Single 
state funds, however, are required to be diversified only as to 
seventy-five percent of their assets, and so have available a 
twenty-five percent basket to accommodate purchases in excess of 
five percent of fund assets. Paragraph (c)(4)(i)(B) of rule 2a-7, as 
amended.
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    e. Government Guarantees. Two commenters suggested that the 
Commission exclude guarantees issued by the U.S. Government from the 
rule's guarantee and demand feature diversification standards as 
finally amended, and thus treat government guarantees in the same 
manner as securities issued directly by the U.S. 
Government.<SUP>41</SUP> The Commission is amending the demand feature 
and guarantee diversification standards accordingly.<SUP>42</SUP>
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    \41\ A security guaranteed as to principal and interest by a 
U.S. Government agency is a ``Government security'' as defined in 
section 2(a)(16) of the 1940 Act [15 U.S.C. 80a-2(a)(16)] and 
paragraph (a)(14) of rule 2a-7, as amended. Investments in 
Government securities are excluded from the rule's issuer 
diversification standards because they are presumed to present 
little, if any, credit risks. The same rationale applies to a 
security guaranteed by a U.S. Government agency, which by definition 
also is a ``Government security.''
    \42\ Paragraph (c)(4)(iii) of rule 2a-7, as amended. Guarantees 
issued by the U.S. Government are deemed to be first tier 
securities. Paragraph (a)(12)(iv) of rule 2a-7, as amended 
(definition of ``first tier security'').
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    f. Definition of ``Rated Security''. Two commenters recommended 
that the Commission adopt a new defined term, ``rated security,'' which 
would permit rule 2a-7's definitions of ``unrated security,'' 
``eligible security'' and ``first tier security'' to be shortened and 
clarified. The Commission is adopting the new term ``rated security'' 
and amending other provisions in the rule to incorporate the new 
term.<SUP>43</SUP>
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    \43\ A ``rated security'' is defined generally as (i) a security 
(or the issuer with respect to a comparable security) that has 
received a short-term rating from an NRSRO; or (ii) a security 
subject to a guarantee if the guarantee (or the guarantor with 
respect to a comparable guarantee) has received a short-term rating 
from an NRSRO. A security is not a rated security, however, if it is 
subject to an external credit support agreement that was not in 
effect when the security was assigned its rating, unless the 
security has received a short-term rating reflecting the existence 
of the credit support agreement, or the credit support agreement has 
received a short-term rating. Paragraph (a)(19) of rule 2a-7, as 
amended. The Commission is making conforming amendments to 
paragraphs (a)(10) (definition of ``eligible security'') and (a)(12) 
(definition of ``first tier security'') of rule 2a-7, as amended, 
and amending the definition of ``unrated security.'' Under the 
amended definition, an ``unrated security'' is a security that is 
not a ``rated security.'' Paragraph (a)(28) of rule 2a-7, as 
amended.
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3. Asset Backed Securities and Synthetic Securities
    The 1996 Amendments revised rule 2a-7 to accommodate asset backed 
securities and synthetic securities (collectively ``ABS''). Rule 2a-7 
defines an ABS as a fixed income security <SUP>44</SUP> issued by a 
``special purpose entity'' substantially all of the assets of which 
consist of ``qualifying assets.'' <SUP>45</SUP> Rule 2a-7 provides 
separate credit quality,<SUP>46</SUP> diversification <SUP>47</SUP> and 
maturity <SUP>48</SUP> standards for ABSs. The ABSs covered by the rule 
include interests in pools of receivables, such as credit card debt, as 
well as short-term synthetic tax exempt securities.<SUP>49</SUP>
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    \44\ For purposes of rule 2a-7's definition of ``asset backed 
security,'' the term ``fixed income security'' has the same meaning 
as that term is defined in rule 3a-7(b)(2) under the 1940 Act [17 
CFR 270.3a-7(b)(2)]. Rule 3a-7 excludes structured financings, such 
as ABSs, from the definition of ``investment company.''
    \45\ Paragraph (a)(3) of rule 2a-7, as amended. Paragraph (a)(3) 
defines ``special purpose entity'' as a trust, corporation, 
partnership or other entity organized for the sole purpose of 
issuing securities that entitle holders to receive payments from the 
cash flows of the ``qualifying assets.'' Paragraph (a)(3) defines 
``qualifying assets'' as either fixed or revolving financial assets 
that by their terms convert into cash within a finite time period.
    \46\ Paragraph (a)(10)(ii)(B) of rule 2a-7, as amended.
    \47\ Paragraph (c)(4)(ii)(D) of rule 2a-7, as amended.
    \48\ Paragraph (d) of rule 2a-7, as amended.
    \49\ A synthetic security is created typically by placing a 
long-term fixed rate municipal bond into a trust that issues short-
term variable or floating rate securities subject to a conditional 
demand feature. This process effectively converts long-term fixed 
rate bonds into short-term variable or floating rate demand 
instruments that meet the rule's maturity requirements. Synthetic 
securities were developed to address a shortage in the supply of 
short-term tax exempt securities eligible for money market fund 
investment. See Revisions to Rules Regulating Money Market Funds, 
Investment Company Act Release No. 19959 (Dec. 17, 1993) [58 FR 
68585 (Dec. 28, 1993)] at nn.100-05 and accompanying text (``Release 
19959'') (discussing the development and characteristics of 
synthetic securities).
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    a. Rating Requirement. In recognition of the independent legal, 
structural and credit analysis conducted by NRSROs before assigning a 
rating to an ABS, the

[[Page 64972]]

1996 Amendments required that all ABSs purchased by money market funds 
receive a rating from an NRSRO.\50\ In light of the role that NRSROs 
have played in the development of structured finance, the Commission 
believed that this ABS rating requirement was appropriate and would not 
be burdensome.
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    \50\ The 1996 Amendments excluded unrated ABSs from the 
definition of an ``eligible security.''
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    The Commission proposed to further amend the rule to exclude from 
this rating requirement ABSs substantially all of the qualifying assets 
of which consist of municipal securities.<SUP>51</SUP> The Commission 
was persuaded by the assertions of industry participants that, as 
applied to these ABSs, the rating requirement was burdensome and 
unnecessary.<SUP>52</SUP> Commenters generally supported the amendment, 
which the Commission is adopting as proposed.<SUP>53</SUP>
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    \51\ Proposing Release, supra note, at nn.41-43 and accompanying 
text.
    \52\ Industry participants noted that when ABSs consist of a 
large pool of financial assets, such as credit card receivables, 
they may not be susceptible to conventional means of credit risk 
analysis because credit quality is based on an actuarial analysis of 
a pool of financial assets, rather than a single issuer. The credit 
analysis for synthetic structures and municipal pools whose 
qualifying assets consist of one or a few municipal issuers, 
however, is typically no different than that required for a security 
directly issued by a municipality. Since many synthetic securities 
are not rated, applying the ABS rating requirement to them would 
have restricted the available supply of ABSs suitable for money 
market fund investment. ABSs involving large pools of financial 
assets, on the other hand, are typically rated.
    \53\ Paragraph (a)(10)(ii)(B) of rule 2a-7, as amended. An ABS 
subject to a guarantee is not itself required to be rated. Under 
rule 2a-7, as amended, an ABS subject to a guarantee that has 
received a short-term rating is considered a ``rated security.'' 
Paragraph (a)(19) of rule 2a-7, as amended. Moreover, an ABS subject 
to a guarantee may be determined to be an eligible security based 
solely on whether the guarantee is an eligible security. Paragraph 
(c)(3)(iii) of rule 2a-7, as amended.
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    b. Diversification Standards. i. Look-Through to Secondary ABSs. 
Rule 2a-7 treats the special purpose entity as the issuer of the ABS 
and requires the rule's issuer diversification standards to be met with 
respect to the special purpose entity. The rule contains an exception 
to this treatment, which requires a fund to ``look-through'' the 
special purpose entity to any issuer of qualifying assets whose 
obligations constitute ten percent or more of the principal amount of 
the qualifying assets of the special purpose entity (``ten percent 
obligor''). For diversification purposes, a fund must treat these ten 
percent obligors as if they issued a proportionate amount of the 
special purpose entity.<SUP>54</SUP> The ``look-through'' to ten 
percent obligors is designed to ensure that a fund does not invest 
indirectly more than five percent of its assets in a particular issuer.
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    \54\ Paragraph (c)(4)(ii)(D)(1)(i) of rule 2a-7, as amended.
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    Some or all of the qualifying assets of certain ABSs (``primary 
ABSs'') also consist of other ABSs (``secondary ABSs''). The Commission 
proposed amendments to clarify that a ten percent obligor of a primary 
ABS that is also the issuer of secondary ABSs would be deemed to have 
issued a portion of the assets of the primary ABS that such secondary 
ABSs represent. For purposes of identifying ten percent obligors, the 
proposed amendments provided that a fund should ``continue down the 
chain'' of ten percent obligors until a special purpose entity with no 
ten percent obligors is reached.<SUP>55</SUP> Commenters supported this 
general approach, which the Commission is adopting, but raised several 
concerns that have led the Commission to further revise and clarify the 
rule.
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    \55\ Proposing Release, supra note, at nn. 48-50 and 
accompanying text. The approach set forth in the Proposing Release 
was illustrated in materials prepared by the staff of the Division 
of Investment Management and made available at the 1996 ICI 
Conference on Money Market Fund Regulation. See Materials for 1996 
ICI Conference on Money Market Fund Regulation: Asset Backed 
Securities and Synthetic Securities--Application of Paragraph 
(c)(4)(vi)(A)(4) of Rule 2a-7 (May 9, 1996).
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    One commenter observed that the benefits and materiality of the 
required ``look-through'' to secondary ABSs diminish rapidly. This 
commenter asserted that the risks posed by remote special purpose 
entities are likely to be outweighed by the costs incurred by funds to 
create compliance systems that identify, and treat as proportionate 
issuers, ten percent obligors beyond those comprising the qualifying 
assets of secondary ABSs. The Commission agrees and has amended the ABS 
``look-through'' provision so that, instead of ``continuing down the 
chain'' indefinitely, funds are required to identify and treat as 
proportionate issuers of a primary ABS only ten percent obligors of the 
primary ABS and ten percent obligors of any secondary 
ABSs.<SUP>56</SUP>
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    \56\ Paragraphs (c)(4)(ii)(D)(1)(i) and (ii) of rule 2a-7, as 
amended. Under this provision, funds must ``look through'' to any 
ten percent obligor of a primary ABS, and to any ten percent obligor 
of a secondary ABS, and treat each such obligor as an issuer of a 
portion of the primary ABS. Funds need not, however, ``look-
through'' to the qualifying assets of any ten percent obligor of a 
``tertiary ABS'' (i.e., a ten percent obligor of a secondary ABS 
that is itself a special purpose entity issuing ABSs) for purposes 
of compliance with the rule's diversification standards. Although 
the rule does not specifically prohibit a multi-layered ABS designed 
to avoid the ``look-through'' to secondary ABSs, the Commission 
would collapse the multiple layers of such an ABS and view remote 
ten percent obligors as proportionate issuers for purposes of 
determining compliance with the rule's issuer diversification 
standards. The Appendix to this Release illustrates the operation of 
the ``look-through'' to secondary ABSs under the amended rule.
---------------------------------------------------------------------------

    Another commenter urged that a particular type of ABS issuer, a 
``restricted special purpose entity,'' be excluded from treatment as a 
ten percent obligor under the rule, and thus not be counted for 
diversification purposes. A ``restricted special purpose entity'' is 
one that does not issue its ABSs to anyone other than another specific 
ABS issuer. For example, a company that provides financing for 
automobile purchasers may establish a restricted special purpose entity 
to securitize its automobile loans. The restricted special purpose 
entity will only sell ABSs to another special purpose entity that 
issues ABSs to money market funds or other investors. No 
diversification risk would appear to be posed to funds in this instance 
because funds cannot directly or indirectly invest in the restricted 
special purpose entity (i.e., a secondary ABS) other than through the 
purchase of ABSs from a particular primary ABS issuer.<SUP>57</SUP> The 
Commission has decided to further amend the rule to exclude restricted 
special purpose entities from treatment as ten percent 
obligors.<SUP>58</SUP>
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    \57\ This commenter further noted that compliance costs of 
tracking ten percent obligors may cause funds to avoid any ABS whose 
issuer discloses the existence of ten percent obligors. Since a 
large number of ABSs may be structured such that all or a 
significant portion of ten percent obligors are restricted special 
purpose entities, allowing funds to disregard these ten percent 
obligors would further increase the supply of desirable ABSs for 
money market fund investment, avert the imposition of unnecessary 
constraints on the asset backed commercial paper market, and expose 
funds to little, if any, additional risks.
    \58\ Paragraph (c)(4)(ii)(D)(2) of rule 2a-7, as amended. The 
amended rule provides that a restricted special purpose entity may 
issue its securities to other persons that control, are controlled 
by or are under common control with, the restricted special purpose 
entity if such persons are not ABS issuers.
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    ii. Demand Features and Guarantees Securing Obligations of Ten 
Percent Obligors. The Commission is adopting a proposed amendment to 
clarify that in the case of any ten percent obligors deemed to be 
issuers for purposes of the rule's diversification standards, any 
demand features or guarantees supporting the obligations of the ten 
percent obligors are treated as being held by the fund and are subject 
to the rule's demand feature and guarantee diversification 
standards.<SUP>59</SUP>
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    \59\ Paragraph (c)(4)(ii)(D)(3) of rule 2a-7, as amended. If the 
fund is not relying on a demand feature or guarantee of a ten 
percent obligor for purposes of credit quality or maturity, or for 
liquidity, the fund may disregard the demand feature or guarantee 
for all purposes. See paragraph (c)(5) of rule 2a-7, as amended.

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[[Page 64973]]

    iii. Special Purpose Entity Cap. In the Proposing Release, the 
Commission explained that it was possible under the rule for a large 
portion of a fund to be exposed to a single ABS, as a result of a fund 
investing in a special purpose entity with one or more ten percent 
obligors.<SUP>60</SUP> The Commission noted that this could expose the 
fund to an undue amount of structural risk (e.g., the risk that the 
special purpose entity might be affected by the bankruptcy of its 
sponsor), and requested comment whether the rule should restrict fund 
investment in the obligations of a single special purpose entity.
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    \60\ Proposing Release, supra note 6, at n.52 and accompanying 
text.
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    Although the three industry participants that responded to the 
request for comment urged adoption of such a cap, the Commission has 
decided not to amend the rule in this manner. The Commission is 
concerned that such a cap would add complexity to the rule without 
meaningfully limiting structural risks. While a cap would limit a 
fund's investment in a particular special purpose entity, it would not 
prevent a fund from investing large amounts of its assets in multiple 
identically-structured special purpose entities established by the same 
sponsor. A structural flaw in an ABS that exposes investors in one 
special purpose entity to the bankruptcy of the sponsor would likely 
affect all of the special purpose entities similarly structured. 
Therefore, the Commission is not persuaded that a cap would effectively 
contain a fund's exposure to structural risk, and in any event, rule 
2a-7 looks to the ratings of the NRSROs to provide an independent 
review of ABS structures.<SUP>61</SUP> Fund advisers, however, should 
consider the fund's exposure to structural risk when evaluating whether 
an investment in a particular ABS is consistent with the fund's 
objective of maintaining a stable net asset value.
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    \61\ NRSROs, prior to assigning a rating, not only analyze the 
quality of the assets underlying an ABS, but also conduct an 
independent analysis of the structural integrity of the ABS. See 
Release 19959, supra note 49, at nn.108-12 and accompanying text.
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    iv. Sponsor-Provided Demand Features and Guarantees. Rule 2a-7 
provides that a fund may not invest, with respect to seventy-five 
percent of its total assets, more than ten percent of its total assets 
in securities issued by or subject to puts from the same institution 
(or under the amended rule's terminology, ``guarantee'' or ``demand 
feature'').<SUP>62</SUP> A fund is not subject to the ten percent 
limitation with respect to the remaining twenty-five percent of its 
total assets (``twenty-five percent basket'') if the securities held in 
the basket are first tier securities and the puts are issued by non-
controlled persons.<SUP>63</SUP> As a result, a fund holding an ABS 
subject to a put from its sponsor is not able to include this 
investment in its twenty-five percent basket if the sponsor is in a 
control relationship with the special purpose entity.<SUP>64</SUP>
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    \62\ Paragraph (c)(4)(iii) of rule 2a-7, as amended.
    \63\ Id. The amended rule refers to such instruments as 
guarantees or demand features from ``non-controlled persons.'' See 
paragraphs (a)(9) and (a)(16) of rule 2a-7, as amended. The Appendix 
to this Release illustrates the operation of the twenty-five percent 
basket under the amended rule when securities are subject to 
guarantees or demand features from multiple providers.
    \64\ This may occur, for example, if an ABS sponsor owns a 
residual equity interest in the special purpose entity. In this 
case, the ABS sponsor might ``control'' the special purpose entity 
within the meaning of section 2(a)(9) of the 1940 Act [15 U.S.C. 
80a-2(a)(9)]. See Proposing Release, supra note 6, at n.54 and 
accompanying text. An ABS sponsor may not, however, be deemed to 
``control'' the special purpose entity under other federal 
securities laws or for other purposes.
---------------------------------------------------------------------------

    The twenty-five percent basket is restricted to securities subject 
to puts from non-controlled persons in order to minimize a fund's 
exposure to the credit risk of a single economic enterprise and limit 
the aggregate exposure to the risks of related, active 
businesses.<SUP>65</SUP> Permitting a fund to invest more than ten 
percent of its total assets in an ABS subject to a demand feature or 
guarantee issued by a sponsor, however, would not have this effect, 
because the special purpose entity, unlike an active enterprise, is a 
limited purpose vehicle created solely for the purpose of issuing fixed 
income securities based on the cash flow of the qualifying assets. 
Therefore, the Commission proposed to amend rule 2a-7 to allow funds to 
treat a demand feature or guarantee from an ABS sponsor as a demand 
feature or guarantee from a non-controlled person. Commenters supported 
the proposed amendment, which the Commission is adopting as 
proposed.<SUP>66</SUP>
---------------------------------------------------------------------------

    \65\ Release 21837, supra note 2, at n.73 and accompanying text.
    \66\ Paragraphs (a)(9) (``demand feature issued by a non-
controlled person'') and (a)(16) (``guarantee issued by a non-
controlled person'') of rule 2a-7, as amended. Although a guarantee 
provided by a person in a control relationship with the issuer of 
the underlying security is excluded from the Rating Requirement for 
guarantees, the exclusion does not apply to a sponsor-provided 
guarantee of an ABS under the amended rule. Thus, sponsor-provided 
guarantees of ABSs must be rated. Paragraph (a)(10)(iii)(A) of rule 
2a-7, as amended; see also supra Section I.B.1.c. of this Release.
---------------------------------------------------------------------------

    v. First Loss Guarantees. Some ABSs are supported by a guarantee 
that covers all losses up to an amount of expected losses likely to be 
experienced by the ABS. Because a fund's exposure to such a ``first 
loss guarantee'' is similar to its exposure to a guarantee of the 
entire security,<SUP>67</SUP> the 1996 Amendments required a fund to 
treat a first loss guarantor as a guarantor of the entire ABS. 
Commenters urged that first loss guarantees be treated similar to other 
fractional guarantees under the rule and raised numerous questions 
about the application of the provision to certain ABS structures.
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    \67\ The failure of a first loss guarantor covering the first 
ten percent of all losses likely to be incurred by an ABS is likely 
to have a more significant effect on the value of the ABS than the 
failure of a fractional guarantor supporting only a portion of any 
losses incurred.
---------------------------------------------------------------------------

    The Commission continues to believe that investment in an ABS 
subject to a first loss guarantee can potentially result in a fund 
being overexposed to the credit risk of the first loss guarantor. The 
number and nature of questions raised by the 1996 Amendments, however, 
have convinced the Commission that these risks are better managed by 
the fund's investment adviser. The Commission, therefore, is revising 
the rule to permit funds to treat a first loss guarantee as any other 
fractional guarantee when calculating compliance with the rule's 
guarantee and demand feature diversification standards.<SUP>68</SUP> 
Advisers should, however, carefully consider potential exposure to the 
credit risks of a first loss guarantor when evaluating whether 
investment in an ABS is consistent with the fund's objective of 
maintaining a stable net asset value.
---------------------------------------------------------------------------

    \68\ Paragraph (c)(4)(iv)(A) of rule 2a-7, as amended. ABSs also 
may be subject to ``second loss guarantees'' that guarantee a 
specific amount of losses in excess of losses covered by a first 
loss guarantee. Funds should treat second loss guarantees of ABSs in 
the same manner as any other fractional guarantees or demand 
features under the amended rule. Sponsors of ABSs may provide 
additional credit risk protection by structuring an offering such 
that the value of qualifying assets in the pool exceeds the amount 
of the ABS offering. For example, a $1 billion ABSs offering might 
be collateralized by an asset pool of $1.1 billion. The $100 million 
of ``overcollateralization'' may be applied to cover any first 
losses incurred before drawing upon third party guarantees or other 
credit enhancements. Although overcollateralization would be 
relevant in determining whether the ABS presents minimal credit 
risks, this type of seller-provided credit enhancement does not fall 
within the rule's definition of a guarantee or demand feature and 
may be disregarded for purposes of the rule's diversification 
standards. See paragraphs (a)(8) (definition of ``demand feature'') 
and (a)(15) (definition of ``guarantee'') of rule 2a-7, as amended.
---------------------------------------------------------------------------

    c. Periodic Determinations Regarding Ten Percent Obligors. The 1996 
Amendments required a fund to adopt written procedures requiring 
periodic determinations of the number of ten percent obligors deemed to 
be issuers of all or a portion of an ABS. The Commission is amending 
this requirement so that periodic determinations are not required with

[[Page 64974]]

respect to any ABS that a fund's board of directors initially has 
determined will never have, or is unlikely to have, any ten percent 
obligors.<SUP>69</SUP> This determination may be based upon a 
structural analysis of the ABS or upon representations in the offering 
materials or governing documents of an ABS that it will never have ten 
percent obligors. Funds also must maintain a record of this 
determination.<SUP>70</SUP>
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    \69\ Paragraph (c)(9)(iv) of rule 2a-7, as amended. The board of 
directors may delegate this determination, and most other 
determinations required by the rule, to the fund's adviser or to the 
officers of the fund. The board, however, may not delegate certain 
specific determinations required under rule 2a-7. See paragraph (e) 
of rule 2a-7, as amended.
    \70\ Paragraph (c)(10)(v) of rule 2a-7, as amended.
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    d. Swap Arrangements. The Proposing Release noted that certain ABSs 
may consist of qualifying assets whose cash flow has been ``swapped'' 
to a financial institution (the ``swap counterparty'') that ultimately 
acts as the primary source of payment to funds holding the ABSs (i.e., 
a ``total return swap''). The Commission requested comment whether the 
swap counterparty in this instance should be treated as the issuer of 
the ABSs for diversification purposes and on the appropriate treatment 
of swaps and similar arrangements under the rule.
    Commenters suggested various approaches to the treatment of swaps 
under the rule.<SUP>71</SUP> All acknowledged, however, the difficulty 
of addressing swaps and similar arrangements by rule due to the 
constantly evolving nature of swap transactions and the wide variations 
in the types of swaps used to structure ABSs offerings. The Commission 
has determined not to amend the rule at this time to specifically 
address the treatment of swaps or similar arrangements. Swaps and 
similar arrangements that fall within the rule's definition of a 
guarantee or demand feature, however, should be treated as such for 
purposes of guarantee and demand feature diversification.<SUP>72</SUP> 
A fund's adviser, however, should seek to ensure that investments by 
the fund in securities subject to swap arrangements are consistent with 
rule 2a-7's overriding policy of limiting funds to investments that are 
consistent with maintaining a stable net asset value and do not expose 
the fund excessively to credit risks posed by swap counterparties.
---------------------------------------------------------------------------

    \71\ Six commenters addressed this issue and generally suggested 
that a swap counterparty acting as the primary source of payment to 
a fund be treated as an issuer and subject to the issuer 
diversification standards. Most of these commenters suggested that 
counterparties in swaps that support or guarantee the obligations of 
an ABS issuer or other party to pay (but are not the sole source of 
payment on the ABS) be treated as guarantees subject to the 
guarantee and demand feature diversification standards.
    \72\ See paragraphs (a)(8), (a)(15), (c)(4)(iii) and (c)(4)(iv) 
of rule 2a-7, as amended.
---------------------------------------------------------------------------

4. Other Amendments to Rule 2a-7
    a. Investments in Other Money Market Funds. The 1996 Amendments 
permitted a fund (``acquiring fund'') to treat an investment in another 
money market fund (``acquired fund'') as a first tier security, but 
limited investment in any single money market fund to no more than five 
percent of fund assets. The 1996 Amendments created an exception, 
however, for a fund investing substantially all of its assets in shares 
of another money market fund in reliance on section 12(d)(1)(E) of the 
1940 Act (e.g., a master-feeder arrangement).<SUP>73</SUP> The 1996 
Amendments deemed this type of a fund to be in compliance with rule 2a-
7's diversification standards if the acquiring fund's board of 
directors reasonably believed that the acquired fund is in compliance 
with rule 2a-7.
---------------------------------------------------------------------------

    \73\ 15 USC 80a-12(d)(1)(E).
---------------------------------------------------------------------------

    Several commenters pointed out that, as a result of Commission 
exemptive orders <SUP>74</SUP> and amendments to the 1940 Act's 
limitations on ``funds of funds'' arrangements,<SUP>75</SUP> some money 
market funds may now invest more than five percent but less than 
substantially all of their assets in shares of another money market 
fund. The Commission is amending the rule to expand the exception to 
cover all investments by a fund in the shares of another money market 
fund in excess of the otherwise applicable issuer diversification 
standards.<SUP>76</SUP>
---------------------------------------------------------------------------

    \74\ See, e.g., Daily Money Fund, et al., Investment Company Act 
Release Nos. 22285 (Oct. 16, 1996) (Order) and 22236 (Sept. 20, 
1996) (Notice).
    \75\ In 1996, the 1940 Act's restrictions on fund investments in 
other funds were relaxed by, among other things, adding new section 
12(d)(1)(G) [15 USC 80a-12(d)(1)(G)] that excepts ``affiliated'' 
funds of funds from the restrictions of section 12(d)(1)(A) under 
certain conditions. See The National Securities Markets Improvement 
Act of 1996, Pub. L. No. 104-290, 110 Stat. 3416 (1996).
    \76\ Paragraph (c)(4)(ii)(E) of rule 2a-7, as amended.
---------------------------------------------------------------------------

    Under the amended rule, shares of money market funds are considered 
to be first tier securities,<SUP>77</SUP> and are thus subject to the 
rule's issuer diversification standards with respect to first tier 
securities.<SUP>78</SUP> A fund may, however, within the limitations of 
section 12(d)(1) of the 1940 Act, invest in shares of another money 
market fund in excess of the rule's issuer diversification standards, 
but only if the acquiring fund's board of directors reasonably believes 
that the acquired fund is in compliance with rule 2a-7.<SUP>79</SUP>
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    \77\ Paragraph (a)(12) of rule 2a-7, as amended.
    \78\ See paragraph (c)(4)(i) of rule 2a-7, as amended.
    \79\ Paragraph (c)(4)(ii)(E) of rule 2a-7, as amended. A taxable 
or national fund could take advantage of the three day safe harbor 
of paragraph (c)(4)(i)(A) and a single state fund could use its 
``twenty-five percent basket'' under paragraph (c)(4)(i)(B) to 
invest up to twenty-five percent of fund assets in the securities of 
a single money market fund without the board making a ``reasonable 
belief'' finding, even though, in both cases, the investment would 
be in excess of five percent of fund assets. Under the rule, an 
acquiring fund that holds securities of a particular issuer 
(``Issuer A''), and invests in shares of an acquired fund that also 
holds securities of Issuer A, would not aggregate those positions to 
determine its compliance with the rule's diversification standards 
with respect to Issuer A.
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    b. Definition of Eligible Security--Certain Unrated Securities. 
Under the 1996 Amendments, an unrated security that was a long-term 
security when issued, but had a remaining maturity of less than 397 
calendar days when purchased by the fund, was an eligible security 
based on whether the security is comparable in quality to a rated 
security (i.e., one with a short-term rating), unless the unrated 
security had received a long-term rating from any NRSRO that was not 
within the three highest categories of long-term ratings. The 
Commission is adopting a proposed amendment to the rule permitting a 
fund to treat such a security as an eligible security if that security 
has a long-term rating from the ``requisite NRSROs'' <SUP>80</SUP> 
within the three highest rating categories.<SUP>81</SUP>
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    \80\ Paragraph (a)(21) of rule 2a-7, as amended (definition of 
``requisite NRSROs'').
    \81\ Paragraph (a)(10)(ii)(A) of rule 2a-7, as amended. For 
example, an unrated ``stub'' security may have long-term ratings 
from three NRSROs. One of these NRSROs may give the security a long-
term rating in the NRSRO's fourth highest category, which would have 
precluded the fund from purchasing the security before the adoption 
of these amendments. Under the revised rule, however, the fund may 
look to the other ratings and treat the security as an eligible 
security if the two other NRSROs have given the security long-term 
ratings within one of their three highest long-term rating 
categories. If any NRSRO has given the security (or the issuer of 
the security with respect to a class of debt obligations that is 
comparable in priority and security) a short-term rating, however, 
the short-term rating would override the long-term ratings and 
reference to long-term ratings would be unnecessary to determine 
whether the security was an eligible security. Long-term ratings may 
be relevant, however, to an evaluation of whether the issuer 
presents minimal credit risks under paragraph (c)(3)(i) of rule 2a-
7, as amended.
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    c. Additional Amendments. The Commission proposed additional 
amendments designed to further clarify and make technical corrections 
to the rule. Commenters supported the amendments, and the Commission is 
adopting them as follows:
    (i) Acquisition of Portfolio Securities. The Commission is adding 
the new defined term ``acquisition'' to make the rule more uniform in 
its application to

[[Page 64975]]

fund investments and to clarify that the failure of a fund to exercise 
a demand feature does not have similar consequences under the rule as a 
decision to ``rollover'' commercial paper.<SUP>82</SUP>
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    \82\ Paragraph (a)(1) of rule 2a-7, as amended.
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    (ii) Single State Funds. The Commission is amending the definition 
of a ``single state fund'' to include a fund seeking to ``maximize'' 
the amount of income exempt from income taxes of a particular 
state.<SUP>83</SUP>
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    \83\ Paragraph (a)(23) of rule 2a-7, as amended. The effect of 
the amendment would be to permit this type of a fund to take 
advantage of the twenty-five percent basket in determining 
compliance with the rule's diversification standards, even if it did 
not primarily distribute income exempt from state income taxes. See 
paragraph (c)(4)(i)(B) of rule 2a-7, as amended; see also Proposing 
Release, supra note 6, at nn.66-68 and accompanying text.
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    (iii) Standby Commitments. As proposed, the Commission has deleted 
the term ``standby commitment'' and all references to that term from 
the rule.<SUP>84</SUP>
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    \84\ See Proposing Release, supra note 6, at nn.69-71 and 
accompanying text. Under the amended rule, a standby commitment that 
meets the definition of a demand feature must be treated as such. 
See paragraph (a)(8) of rule 2a-7, as amended (definition of 
``demand feature''). A standby commitment that is not a demand 
feature is not subject to the rule's credit quality or 
diversification standards.
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    (iv) Downgrades, Defaults, and Other Events. The Commission is 
amending the rule to require a fund's board of directors to reassess 
whether an unrated or second tier security continues to present minimal 
credit risks only when the fund's adviser (or other person delegated 
portfolio management responsibilities) becomes aware that the security 
has been downgraded by any NRSRO below that NRSRO's two highest short-
term rating categories.<SUP>85</SUP>
---------------------------------------------------------------------------

    \85\ Paragraph (c)(6)(i)(A)(2) of rule 2a-7, as amended; see 
Proposing Release, supra note 6, at n.72 and accompanying text.
---------------------------------------------------------------------------

    (v) Recordkeeping Requirements. The Commission is adding rule text 
inadvertently omitted from the 1996 Amendments that requires the board 
of directors to document minimal credit risk determinations of 
portfolio securities.<SUP>86</SUP>
---------------------------------------------------------------------------

    \86\ Paragraph (c)(10)(iii) of rule 2a-7, as amended; see 
Proposing Release, supra note 6, at nn.74-75 and accompanying text.
---------------------------------------------------------------------------

    (vi) Holding Out. Using new rulemaking authority, the Commission is 
restating the rule's prohibition on a fund's use of names suggesting 
that it is a money market fund, unless it complies with rule 2a-
7.<SUP>87</SUP>
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    \87\ Paragraph (b) of rule 2a-7, as amended. The National 
Securities Markets Improvement Act of 1996 [Pub. L. 104-290, 110 
Stat. 3416 (1996)] amended Section 35(d) of the 1940 Act [15 USC 
80a-34(d)] to make it unlawful to adopt as a fund name or title, or 
as a title of fund securities, words that the Commission finds are 
materially deceptive or misleading, and to authorize the Commission 
to define names and titles deemed to be ``materially deceptive and 
misleading.''
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II. Amendments to the Advertising Rules Applicable to Money Market 
Funds

    The Commission is adopting amendments to the Commission's money 
market fund advertising rules and forms to clarify the formula used by 
money market funds to calculate yield and to reduce the potential for 
investors being misled or confused by the presentation of a money 
market fund's short-term total return.

A. Calculation of Yield

    The Commission proposed to amend its money market fund yield 
formula to clarify that only investment income may be included in the 
yield of a money market fund. Three commenters supported the amendment; 
one opposed it and urged the Commission to specifically permit 
inclusion of non-investment income. The Commission is concerned that 
inclusion of non-investment income will distort yield and diminish the 
utility of money market fund yield to investors. The Commission, 
therefore, has decided to adopt the proposed amendment to the money 
market fund yield formula.<SUP>88</SUP>
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    \88\ See Item 22 of Form N-1A [17 CFR 239.15A and 274.11A], Item 
25 of Form N-3 [17 CFR 239.17a and 274.11b], and Item 21 of Form N-4 
[17 CFR 239.17b and 274.11c], as amended.
---------------------------------------------------------------------------

B. Use of Total Return

    The Proposing Release noted that some money market fund 
advertisements have used short-term total return instead of yield and 
expressed concern that many investors may not understand the 
difference.<SUP>89</SUP> The Commission proposed to amend its rules to 
require that total return quotations in advertisements and sales 
literature cover a period of at least one year, and that such 
quotations be accompanied by a quotation of current yield, computed in 
accordance with Commission rules and set forth with equal prominence.
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    \89\ Proposing Release, supra note 6, at n.81 and accompanying 
text. As a result, investors may assume incorrectly that a fund 
quoting the higher total return figure is a better performing fund 
than other money market funds quoting yield. For example, during a 
period of declining interest rates, the fund's total return will be 
higher than its current yield because it will include periods of 
time during which the fund held higher yielding securities. In 
addition, investors may incorrectly assume that the higher ``total 
return'' is the yield they can expect to receive upon an investment 
in the fund.
---------------------------------------------------------------------------

    All commenters that addressed this proposal objected to the 
proposed requirement that total return quotations cover at least one 
year. They argued that the proposal would preclude total return 
quotations during a fund's first year and in other circumstances in 
which the purpose of the advertisement was other than to circumvent the 
Commission's yield formula. The Commission has decided not to require 
all money market fund total return quotations to cover a period of one 
year. Instead, the Commission is revising its rules to require that (i) 
quotations of total return be accompanied by quotations of current 
yield and that both quotations be placed next to each other and shown 
in the same size print, <SUP>90</SUP> and (ii) if there is a material 
difference between the quoted total return and the quoted yield, a 
statement that the yield quotation more closely reflects the current 
earnings of the fund than the total return quotation.<SUP>91</SUP>
---------------------------------------------------------------------------

    \90\ Quotations of total return and current yield in an 
advertisement delivered electronically must be presented together 
and in a manner that presents each quotation with identical 
prominence in light of the particular electronic medium used to 
transmit the advertisement.
    \91\ See paragraph (d)(2) of rule 482 under the 1933 Act, as 
amended [17 CFR 230.482(d)(2)]; paragraph (b)(1)(ii)(C) of rule 34b-
1 under the 1940 Act, as amended [17 CFR 270.34b-1(b)(1)(ii)(C)].
---------------------------------------------------------------------------

III. Effective Date/Compliance Date

A. Effective Date

    The rule amendments adopted in this Release will become effective 
February 10, 1998. The Office of Management and Budget has determined 
that the technical amendments to rule 2a-7 are ``major rules'' and the 
amendments to the Commission's money market fund advertising rules and 
forms are ``minor rules'' under Chapter 8 of the Administrative 
Procedure Act, <SUP>92</SUP> which was added by the Small Business 
Regulatory Enforcement Fairness Act of 1996 (``SBREFA'').<SUP>93</SUP> 
SBREFA requires all final agency rules to be submitted to Congress for 
review and requires generally that the effective date of a major rule 
be delayed for sixty days pending Congressional review. A major rule 
may become effective at the end of the sixty-day review period, unless 
Congress passes a joint resolution disapproving the rule.<SUP>94</SUP>
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    \92\ 5 USC 801.
    \93\ Pub. L. No. 104-121, Title II, 110 Stat. 857 (1996). Under 
SBREFA, a rule is ``major'' if it is likely to result in (i) an 
annual effect on the economy of $100 million or more, (ii) a major 
increase in costs or prices for consumers or individual industries, 
or (iii) significant adverse effects on competition, investment, or 
innovation. 5 USC 804(2).
    \94\ 5 USC 801(a)(3).
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B. Compliance Dates

    The Proposing Release requested comment whether the Commission 
should provide for a six-month

[[Page 64976]]

transition period for compliance.<SUP>95</SUP> Commenters supported a 
six-month period to give fund boards of directors sufficient time to 
review and approve fund procedures. Several commenters also suggested 
that the ``grandfathering'' of certain securities provided for by the 
release adopting the 1996 Amendments be extended, <SUP>96</SUP> whereas 
one commenter opposed such extension. The Commission has decided to 
delay the date for compliance with the amended rule for six months and 
to extend the ``grandfathering'' of fund investments in certain 
securities, as described below.
---------------------------------------------------------------------------

    \95\ See Proposing Release, supra note 6, at nn.84-85 and 
accompanying text.
    \96\ The 1996 Amendments ``grandfathered'' fund investments in 
certain securities issued on or before June 3, 1996.
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1. General Compliance Date
    All money market funds must be in compliance with rule 2a-7, as 
amended, (and with conforming amendments reflecting the revisions to 
rule 2a-7) by July 1, 1998, except with respect to ``grandfathered 
securities'' as provided below.<SUP>97</SUP> Funds must comply with the 
amendments to the advertising rules and forms applicable to money 
market funds by February 10, 1998.
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    \97\ Rule 2a-7 requires a fund to meet the rule's 
diversification standards with respect to a particular issuer on the 
date the fund acquires a security of that issuer. Paragraphs 
(c)(4)(i) and (ii) (with respect to issuer diversification) and 
(c)(4)(iii) and (iv) (with respect to diversification of demand 
features and guarantees) of rule 2a-7, as amended. A tax exempt fund 
holding a greater percentage of its total assets in the securities 
of an issuer than the applicable diversification standard permits as 
of July 1, 1998 may not purchase additional securities or ``roll 
over'' current holdings until the purchase or roll over of such 
securities will not cause the fund to exceed the applicable 
diversification standards immediately after the purchase or roll 
over. Funds are not required to exercise puts or otherwise dispose 
of portfolio holdings to meet the new diversification standards.
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2. ``Grandfathered'' Securities
    To minimize disruption to funds and markets as a result of the 
adoption of these amendments, the Commission is ``grandfathering'' 
certain securities first issued on or before February 10, 1998 that do 
not meet the following requirements of the amended rule:
    (i) The Rating Requirement for guarantees; <SUP>98</SUP>
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    \98\ Paragraph (a)(10)(iii)(A) of rule 2a-7, as amended.
---------------------------------------------------------------------------

    (ii) The Notification Requirement, which provides that, in order 
for a security subject to a guarantee or demand feature to be an 
eligible security, the fund must receive notice from the demand feature 
or guarantee provider (or another institution) if there is a 
substitution of the provider of the demand feature or guarantee; 
<SUP>99</SUP>
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    \99\ Paragraph (a)(10)(iii)(B) of rule 2a-7, as amended.
---------------------------------------------------------------------------

    (iii) The requirements for ABSs regarding maturity determinations 
and ratings; <SUP>100</SUP>
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    \100\ Paragraphs (a)(8)(ii) (definition of demand feature for 
ABSs) and (a)(10)(ii)(B) (rating requirement for ABSs) of rule 2a-7, 
as amended. Funds are required, however, to apply the issuer 
diversification standards for ABSs in accordance with Section 
I.B.3.b. of this Release, supra. See paragraph (c)(4)(ii)(D) of rule 
2a-7, as amended.
---------------------------------------------------------------------------

    (iv) The requirement that a demand feature and a guarantee include 
the ability to recover principal and any accrued interest; 
<SUP>101</SUP> and
---------------------------------------------------------------------------

    \101\ Paragraphs (a)(8) and (a)(15) of rule 2a-7, as amended.
---------------------------------------------------------------------------

    (v) The requirement that a security subject to a conditional demand 
feature is an eligible security only if the fund's board of directors 
makes certain determinations regarding the conditional demand feature's 
exercisability.<SUP>102</SUP>
---------------------------------------------------------------------------

    \102\ Paragraph (c)(3)(iv)(B) of rule 2a-7, as amended.
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    A fund may continue to hold these ``grandfathered'' securities or 
acquire these securities provided that they satisfy the other 
provisions of the rule, as amended, and are issued on or before 
February 10, 1998.

IV. Cost/Benefit Analysis and Effects on Competition, Efficiency 
and Capital Formation

A. Technical Amendments to Rule 2a-7

    The technical amendments to rule 2a-7 make refinements and 
corrections to the 1996 Amendments. They are intended to permit money 
market funds the maximum amount of flexibility in selecting their 
investments consistent with the objective of maintaining a stable net 
asset value. This additional flexibility will promote market efficiency 
by allowing funds to invest in a wider variety of instruments that 
present risks consistent with that objective. For example, the 
technical amendments expand the investment opportunities of funds, 
without increasing risks, by allowing funds to substitute the credit 
quality of guarantee providers for the issuers of securities subject to 
guarantees (instead of only those subject to unconditional demand 
features) for purposes of compliance with the rule's credit quality 
standards. By resolving interpretive issues, the technical amendments 
also address competitive inequities that might arise among funds if, 
for example, funds draw different conclusions as to the permissibility 
of a particular investment that may increase fund yield.
    As discussed above,<SUP>103</SUP> the 1996 Amendments tighten the 
risk-limiting conditions of rule 2a-7 applicable to tax exempt money 
market funds and clarify the rule's treatment of certain instruments, 
such as ABSs. The technical amendments potentially will benefit 
investors to the extent that rule 2a-7, as finally amended, operates to 
decrease the likelihood that a fund will not maintain a stable net 
asset value and provides investors greater opportunities to obtain 
higher yields without exposure to risks inconsistent with their 
investment expectations.
---------------------------------------------------------------------------

    \103\ See supra Section I.A. of this Release.
---------------------------------------------------------------------------

    The costs of the technical amendments to funds and fund advisers 
(and ultimately fund shareholders) are likely to be minimal, since the 
amendments do not impose additional procedural requirements or 
reporting burdens on funds. The Commission believes that the direct or 
indirect benefits derived from the technical amendments cannot be 
quantified because it is impossible to predict with certainty how funds 
will structure their portfolio holdings in response to these 
amendments.<SUP>104</SUP> In addition, any costs or benefits are likely 
to affect not only funds, but also a wide variety of market 
participants.<SUP>105</SUP>
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    \104\ For example, many money market funds currently do not 
invest in ABSs, or invest only in those ABSs that do not raise the 
diversification issues addressed in this Release. The Commission 
expects that more funds will invest in ABSs, although there is no 
empirical basis for predicting the size of that expected effect.
    \105\ Many of the complex money market fund instruments affected 
by the technical amendments are specifically designed to comply with 
rule 2a-7. The primary effect of the amendments will be to change 
how those instruments are structured, rather than to prohibit funds 
from investing in currently-available money market instruments. 
Thus, to the extent the amendments impose costs or provide benefits, 
these costs and benefits may be shared by funds, investors, issuers, 
and the investment banks or other entities that structure money 
market instruments.
---------------------------------------------------------------------------

    In the Proposing Release, the Commission requested specific comment 
on the costs and benefits associated with the proposals. No commenters 
provided specific estimates of any costs or benefits. One noted 
generally the increase in time and costs incurred to document 
compliance with rule 2a-7 since 1991, and suggested that procedural 
requirements focus less on periodic reviews of existing information and 
more on actions required by a board or fund managers in response to new 
information.<SUP>106</SUP> In response to these

[[Page 64977]]

concerns, the technical amendments create exceptions to the rule's 
periodic review requirements when those requirements are not necessary 
to prevent the fund from inadvertently holding ineligible 
securities.<SUP>107</SUP>
---------------------------------------------------------------------------

    \106\ The technical amendments do not require additional 
periodic reviews. The rule's procedural requirements, including 
periodic reviews of certain determinations, were adopted before the 
proposal of the technical amendments. The costs and benefits of 
these procedures were analyzed previously in connection with the 
adoption of rule 2a-7 in 1983, and in connection with amendments to 
rule 2a-7 in 1986, 1991 and 1996.
    \107\ For example, the amended rule does not require periodic 
determinations of the number of ten percent obligors of an ABS that 
the board determines will never have, or is unlikely to have, ten 
percent obligors. See paragraphs (c)(9)(iv) and (c)(10)(v) of rule 
2a-7, as amended.
---------------------------------------------------------------------------

    Section 2(c) of the 1940 Act provides that whenever the Commission 
is engaged in rulemaking and is required to consider whether an action 
is necessary or appropriate in the public interest, the Commission also 
must consider, in addition to the protection of investors, whether the 
action will promote efficiency, competition, and capital 
formation.<SUP>108</SUP> For the reasons stated in the cost/benefit 
analysis above, the Commission has concluded that the technical 
amendments will promote efficiency, competition and capital formation.
---------------------------------------------------------------------------

    \108\ 15 USC 80a-2(c).
---------------------------------------------------------------------------

B. Amendments to Advertising Rules Applicable to Money Market Funds

    The amendments to the Commission's advertising rules and forms 
applicable to money market funds are designed to clarify the formula 
used by money market funds to calculate yield and reduce the potential 
for investors being misled or confused by the presentation of a money 
market fund's short-term total return. They benefit funds and fund 
investors by clarifying the yield formula and codifying accepted 
practices under the current rules. The amendments are intended to 
preserve the consistency of advertised yield and to maintain the 
ability of investors to compare yields quoted by various funds.
    The Commission anticipates that the costs of these amendments to 
funds and investors are likely to be minimal. No commenters responded 
to the Commission's request for specific estimates of costs or benefits 
associated with the proposed rule amendments. One commenter stated that 
the proposal to clarify that only investment income may be included in 
a fund's yield would benefit neither funds nor investors, because it 
would discourage funds from identifying sources of safe, non-investment 
income, encourage funds to increase yield through riskier investments, 
and deprive investors of information regarding consistent sources of 
non-investment income.<SUP>109</SUP> The Commission believes, however, 
that the rule will benefit investors by ensuring that a money market 
fund's yield is consistently advertised and represents only income that 
reflects the performance of the fund's investment 
portfolio.<SUP>110</SUP>
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    \109\ According to this commenter, the inability to advertise 
non-investment income also would have an adverse effect on 
competition in the industry.
    \110\ The Commission believes that it is not relevant to 
consider the costs to funds identified by the commenter in 
connection with these amendments. The amendments are intended to 
clarify the existing money market fund yield formula, and as noted 
in the Proposing Release, the existing yield formula does not permit 
the inclusion of non-investment income in yield. See Proposing 
Release, supra note 6, at n.83 and accompanying text. In addition, 
the Commission believes that any such costs are in fact quite 
limited, since it is aware of only one fund that has sought to 
include non-investment income in its calculation of yield.
---------------------------------------------------------------------------

V. Paperwork Reduction Act

    As set forth in the Proposing Release, certain provisions of the 
amendments adopted in this Release contain ``collection of 
information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995 (``PRA'').<SUP>111</SUP> The collection of 
information requirements contained in these amendments were submitted 
to the Office of Management and Budget (``OMB'') for review in 
accordance with section 3507(d) of the PRA. The title for the 
collection of information is ``Rules Regulating Money Market Funds.'' 
The collection of information requirements are in accordance with 
section 3507 of the PRA. An agency may not conduct or sponsor, and a 
person is not required to respond to, a collection of information 
unless the agency displays a valid OMB control number. OMB approved the 
PRA submission with respect to these amendments and assigned OMB 
control numbers with respect to the rules amended by this 
Release.<SUP>112</SUP>
---------------------------------------------------------------------------

    \111\ 44 U.S.C 3501--3520.
    \112\ OMB control numbers are as follows: rule 2a-7 (3235-0268, 
expires Mar. 31, 2000); rule 34b-1 (3235-0346, expires Mar. 31, 
2000); rule 482 (3235-0074, expires Mar, 31, 2000); Form N-1A (3235-
0307, expires May 31, 2000); Form N-3 (3235-0316, expires Mar. 31, 
2000); and Form N-4 (3235-0318, expires Apr. 30, 2000).
---------------------------------------------------------------------------

    Responses to the collection of information requirements for the 
rules and forms amended by this Release are mandatory. The collection 
of information requirements under rule 2a-7 are designed to enable the 
Commission staff to ascertain a money market funds' compliance with the 
rule and ensure that funds have in place procedures for collecting 
information necessary to make the required determinations regarding 
portfolio securities. Most responses required by rule 2a-7 and 
requested by or submitted to the Commission will be kept confidential 
to the extent permitted by relevant statutory and regulatory 
provisions.<SUP>113</SUP> The collection of information required by 
rule 34b-1, rule 482, Form N-1A, Form N-3 and Form N-4, and which is 
disclosed in fund prospectuses, registration statements and 
advertisements, is public and is not kept confidential by the 
Commission.
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    \113\ If the board of directors takes action with respect to 
defaulted securities, events of insolvency or deviations in share 
price, however, funds must file an exhibit to Form N-SAR describing 
the action. This collection of information under rule 2a-7 is public 
and is not kept confidential by the Commission. See paragraph 
(c)(10)(vii) of rule 2a-7, as amended.
---------------------------------------------------------------------------

    The Supporting Statement to this Paperwork Reduction Act submission 
notes that, because the technical amendments to rule 2a-7 clarify 
existing reporting and recordkeeping obligations, it is estimated that 
they will have no effect on the annual reporting burden of money market 
funds. The amendments to the advertising rules and forms applicable to 
money market funds are estimated to impose no substantive additional 
paperwork burdens on funds. The Commission is aware of only one money 
market fund that has sought to include income other than investment 
income in its yield calculation, and very few money market funds that 
quote any type of total return in their advertisements. If total return 
is quoted, however, an insignificant additional burden is required only 
if the quoted yield differs materially from quoted total return, which 
the Commission believes occurs infrequently.

VI. Summary of Regulatory Flexibility Analysis

    A summary of the Initial Regulatory Flexibility Analysis (``IRFA'') 
regarding the proposed amendments, which was prepared in accordance 
with 5 U.S.C 603, was published in the Proposing Release. No comments 
were received on the IRFA. The Commission has prepared a Final 
Regulatory Flexibility Analysis (``FRFA'') in accordance with 5 U.S.C 
604 regarding the adoption of technical amendments to rule 2a-7 and the 
adoption of amendments to the Commission's advertising rules applicable 
to money market funds.
    The FRFA discusses the need for, and objectives of, the rule 
amendments. The FRFA explains that the technical amendments to rule 2a-
7 address many of the questions and issues raised by industry 
participants after the adoption of the 1996 Amendments. The objective 
of the technical amendments is to refine

[[Page 64978]]

and correct the 1996 Amendments, and thereby permit money market funds 
the maximum amount of flexibility in selecting their investments 
consistent with the objective of maintaining a stable net asset value. 
The FRFA explains that the amendments to the advertising rules 
applicable to money market funds clarify that only investment income 
may be included in the yield of a money market fund and reduce the 
potential for investors being misled or confused by the presentation of 
a money market fund's short-term total return.
    The FRFA estimates that out of the approximately 650 investment 
companies registered with the Commission that have one or more 
portfolios that are money market funds, a total of 130 would be 
considered small entities. The FRFA indicates that the technical 
amendments to rule 2a-7 and the amendments to the advertising rules and 
forms applicable to money market funds would effect small entities in 
the same manner as other funds subject to these rules.
    The FRFA explains that neither the technical amendments to rule 2a-
7 nor the amendments to the advertising rules applicable to money 
market funds impose any substantive additional reporting, recordkeeping 
or other compliance burdens. Finally, the FRFA states that in adopting 
the amendments the Commission considered (a) the establishment of 
differing compliance requirements that take into account the resources 
available to small entities; (b) simplification of the requirements for 
small entities; (c) the use of performance rather than design 
standards; and (d) an exemption from the rules for small entities. The 
FRFA states that the Commission concluded that different requirements 
for small entities with respect to either the technical amendments to 
rule 2a-7 or the amendments to the advertising rules applicable to 
money market funds are unnecessary and would be inconsistent with 
investor protection, and that the adopted amendments are not design 
standards.
    Cost/benefit information reflected in the ``Cost/Benefit Analysis'' 
section of this Release also is reflected in the FRFA. A copy of the 
FRFA may be obtained by contacting David P. Mathews, Senior Counsel, 
Mail Stop 10-2, Securities and Exchange Commission, 450 Fifth Street, 
N.W., Washington, D.C. 20549.

VII. Statutory Authority

    The Commission is amending rule 2a-7 and the advertising rules and 
forms applicable to money market funds under the exemptive and 
rulemaking authority set forth in sections 6(c) [15 USC 80a-6(c)], 8(b) 
[15 USC 80a-8(b)], 22(c) [15 USC 80a-22(c)], 34(b) [15 USC 80a-33(b)], 
35(d) [15 USC 80a-34(d)] and 38(a) [15 USC 80a-37(a)] of the Investment 
Company Act of 1940. The authority citations for the amendments to the 
rules and forms precede the text of the amendments.

VIII. Text of Rule and Form Amendments

List of Subjects in 17 CFR Parts 230, 239, 270 and 274

    Investment companies, Reporting and recordkeeping requirements, 
Securities.

    For the reasons set out in the preamble, the Commission is amending 
chapter II, title 17 of the Code of Federal Regulations as follows:

PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933

    1. The authority citation for Part 230 continues to read, in part, 
as follows:

    Authority: 15 U.S.C. 77b, 77f, 77g, 77h, 77j, 77s, 77sss, 78c, 
78d, 78l, 78m, 78n, 78o, 78w, 79ll(d), 79t, 80a-8, 80a-29, 80a-30, 
and 80a-37, unless otherwise noted.
* * * * *
    2. Section 230.482 is amended by revising paragraph (d) to read as 
follows:


Sec. 230.482  Advertising by an investment company as satisfying 
requirements of section 10.

* * * * *
    (d) In the case of a money market fund:
    (1) Any quotation of the money market fund's yield in an 
advertisement shall be based on the methods of computation prescribed 
in Form N-1A (Secs. 239.15A and 274.11A of this chapter), Form N-3 
(Secs. 239.17a and 274.11b of this chapter), or Form N-4 (Secs. 239.17b 
and 274.11c of this chapter) and may include:
    (i) A quotation of current yield that identifies the length of and 
the date of the last day in the base period used in computing that 
quotation; or
    (ii) A quotation of effective yield if it appears in the same 
advertisement as a quotation of current yield and each quotation 
relates to an identical base period and is presented with equal 
prominence.
    (2) Accompany any quotation of the money market fund's total return 
in an advertisement with a quotation of the money market fund's current 
yield under paragraph (d)(1)(i) of this section. Place the quotations 
of total return and current yield next to each other, in the same size 
print, and if there is a material difference between the quoted total 
return and the quoted current yield, include a statement that the yield 
quotation more closely reflects the current earnings of the money 
market fund than the total return quotation.
* * * * *

PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940

    3. The general authority citation for Part 270 is revised to read 
as follows:

    Authority: 15 U.S.C. 80a-1 et seq., 80a-34(b), 80a-37, 80a-39 
unless otherwise noted;
* * * * *
    4. Section 270.2a-7 is revised to read as follows:


Sec. 270.2a-7  Money market funds.

    (a) Definitions.
    (1) Acquisition (or Acquire) means any purchase or subsequent 
rollover (but does not include the failure to exercise a Demand 
Feature).
    (2) Amortized Cost Method of valuation means the method of 
calculating an investment company's net asset value whereby portfolio 
securities are valued at the fund's Acquisition cost as adjusted for 
amortization of premium or accretion of discount rather than at their 
value based on current market factors.
    (3) Asset Backed Security means a fixed income security (other than 
a Government security) issued by a Special Purpose Entity (as defined 
in this paragraph), substantially all of the assets which consist of 
Qualifying Assets (as defined in this paragraph). Special Purpose 
Entity means a trust, corporation, partnership or other entity 
organized for the sole purpose of issuing securities that entitle their 
holders to receive payments that depend primarily on the cash flow from 
Qualifying Assets, but does not include a registered investment 
company. Qualifying Assets means financial assets, either fixed or 
revolving, that by their terms convert into cash within a finite time 
period, plus any rights or other assets designed to assure the 
servicing or timely distribution of proceeds to security holders.
    (4) Business Day means any day, other than Saturday, Sunday, or any 
customary business holiday.
    (5) Collateralized Fully in the case of a repurchase agreement 
means that:
    (i) The value of the securities collateralizing the repurchase 
agreement (reduced by the transaction costs (including loss of 
interest) that the money market fund reasonably could

[[Page 64979]]

expect to incur if the seller defaults) is, and during the entire term 
of the repurchase agreement remains, at least equal to the Resale Price 
(as defined in paragraph (a)(5)(v) of this section) provided in the 
agreement;
    (ii) The money market fund or its custodian either has actual 
physical possession of the collateral or, in the case of a security 
registered on a book entry system, the book entry is maintained in the 
name of the money market fund or its custodian;
    (iii) The collateral consists entirely of cash items, Government 
Securities or other securities that at the time the repurchase 
agreement is entered into are rated in the highest rating category by 
the Requisite NRSROs; and
    (iv) Upon an Event of Insolvency with respect to the seller, the 
repurchase agreement would qualify under a provision of applicable 
insolvency law providing an exclusion from any automatic stay of 
creditors' rights against the seller.
    (v) Resale Price means the Acquisition price paid to the seller of 
the securities plus the accrued resale premium on such Acquisition 
price. The accrued resale premium shall be the amount specified in the 
repurchase agreement or the daily amortization of the difference 
between the Acquisition price and the resale price specified in the 
repurchase agreement.
    (6) Conditional Demand Feature means a Demand Feature that is not 
an Unconditional Demand Feature. A Conditional Demand Feature is not a 
Guarantee.
    (7) Conduit Security means a security issued by a Municipal Issuer 
(as defined in this paragraph) involving an arrangement or agreement 
entered into, directly or indirectly, with a person other than a 
Municipal Issuer, which arrangement or agreement provides for or 
secures repayment of the security. Municipal Issuer means a state or 
territory of the United States (including the District of Columbia), or 
any political subdivision or public instrumentality of a state or 
territory of the United States. A Conduit Security does not include a 
security that is:
    (i) Fully and unconditionally guaranteed by a Municipal Issuer; or
    (ii) Payable from the general revenues of the Municipal Issuer or 
other Municipal Issuers (other than those revenues derived from an 
agreement or arrangement with a person who is not a Municipal Issuer 
that provides for or secures repayment of the security issued by the 
Municipal Issuer); or
    (iii) Related to a project owned and operated by a Municipal 
Issuer; or
    (iv) Related to a facility leased to and under the control of an 
industrial or commercial enterprise that is part of a public project 
which, as a whole, is owned and under the control of a Municipal 
Issuer.
    (8) Demand Feature means:
    (i) A feature permitting the holder of a security to sell the 
security at an exercise price equal to the approximate amortized cost 
of the security plus accrued interest, if any, at the time of exercise. 
A Demand Feature must be exercisable either:
    (A) At any time on no more than 30 calendar days' notice; or
    (B) At specified intervals not exceeding 397 calendar days and upon 
no more than 30 calendar days' notice; or
    (ii) A feature permitting the holder of an Asset Backed Security 
unconditionally to receive principal and interest within 397 calendar 
days of making demand.
    (9) Demand Feature Issued By A Non-Controlled Person means a Demand 
Feature issued by:
    (i) A person that, directly or indirectly, does not control, and is 
not controlled by or under common control with the issuer of the 
security subject to the Demand Feature (control means ``control'' as 
defined in section 2(a)(9) of the Act (15 U.S.C. 80a-2(a)(9)); or
    (ii) A sponsor of a Special Purpose Entity with respect to an Asset 
Backed Security.
    (10) Eligible Security means:
    (i) A Rated Security with a remaining maturity of 397 calendar days 
or less that has received a rating from the Requisite NRSROs in one of 
the two highest short-term rating categories (within which there may be 
sub-categories or gradations indicating relative standing); or
    (ii) An Unrated Security that is of comparable quality to a 
security meeting the requirements for a Rated Security in paragraph 
(a)(10)(i) of this section, as determined by the money market fund's 
board of directors; Provided, however, that:
    (A) A security that at the time of issuance had a remaining 
maturity of more than 397 calendar days but that has a remaining 
maturity of 397 calendar days or less and that is an Unrated Security 
is not an Eligible Security if the security has received a long-term 
rating from any NRSRO that is not within the NRSRO's three highest 
long-term ratings categories (within which there may be sub-categories 
or gradations indicating relative standing), unless the security has 
received a long-term rating from the Requisite NRSROs in one of the 
three highest rating categories;
    (B) An Asset Backed Security (other than an Asset Backed Security 
substantially all of whose Qualifying Assets consist of obligations of 
one or more Municipal Issuers, as that term is defined in paragraph 
(a)(7) of this section) shall not be an Eligible Security unless it has 
received a rating from an NRSRO.
    (iii) In addition, in the case of a security that is subject to a 
Demand Feature or Guarantee:
    (A) The Guarantee has received a rating from an NRSRO or the 
Guarantee is issued by a guarantor that has received a rating from an 
NRSRO with respect to a class of debt obligations (or any debt 
obligation within that class) that is comparable in priority and 
security to the Guarantee, unless:
    (1) The Guarantee is issued by a person that, directly or 
indirectly, controls, is controlled by or is under common control with 
the issuer of the security subject to the Guarantee (other than a 
sponsor of a Special Purpose Entity with respect to an Asset Backed 
Security);
    (2) The security subject to the Guarantee is a repurchase agreement 
that is Collateralized Fully; or
    (3) The Guarantee is itself a Government Security; and
    (B) The issuer of the Demand Feature or Guarantee, or another 
institution, has undertaken promptly to notify the holder of the 
security in the event the Demand Feature or Guarantee is substituted 
with another Demand Feature or Guarantee (if such substitution is 
permissible under the terms of the Demand Feature or Guarantee).
    (11) Event of Insolvency means, with respect to a person:
    (i) An admission of insolvency, the application by the person for 
the appointment of a trustee, receiver, rehabilitator, or similar 
officer for all or substantially all of its assets, a general 
assignment for the benefit of creditors, the filing by the person of a 
voluntary petition in bankruptcy or application for reorganization or 
an arrangement with creditors; or
    (ii) The institution of similar proceedings by another person which 
proceedings are not contested by the person; or
    (iii) The institution of similar proceedings by a government agency 
responsible for regulating the activities of the person, whether or not 
contested by the person.
    (12) First Tier Security means any Eligible Security that:

[[Page 64980]]

    (i) Is a Rated Security that has received a short-term rating from 
the Requisite NRSROs in the highest short-term rating category for debt 
obligations (within which there may be sub-categories or gradations 
indicating relative standing); or
    (ii) Is an Unrated Security that is of comparable quality to a 
security meeting the requirements for a Rated Security in paragraph 
(a)(12)(i) of this section, as determined by the fund's board of 
directors; or
    (iii) Is a security issued by a registered investment company that 
is a money market fund; or
    (iv) Is a Government Security.
    (13) Floating Rate Security means a security the terms of which 
provide for the adjustment of its interest rate whenever a specified 
interest rate changes and that, at any time until the final maturity of 
the instrument or the period remaining until the principal amount can 
be recovered through demand, can reasonably be expected to have a 
market value that approximates its amortized cost.
    (14) Government Security means any ``Government security'' as 
defined in section 2(a)(16) of the Act (15 U.S.C. 80a-2(a)(16)).
    (15) Guarantee means an unconditional obligation of a person other 
than the issuer of the security to undertake to pay, upon presentment 
by the holder of the Guarantee (if required), the principal amount of 
the underlying security plus accrued interest when due or upon default, 
or, in the case of an Unconditional Demand Feature, an obligation that 
entitles the holder to receive upon exercise the approximate amortized 
cost of the underlying security or securities, plus accrued interest, 
if any. A Guarantee includes a letter of credit, financial guaranty 
(bond) insurance, and an Unconditional Demand Feature (other than an 
Unconditional Demand Feature provided by the issuer of the security).
    (16) Guarantee Issued By A Non-Controlled Person means a Guarantee 
issued by:
    (i) A person that, directly or indirectly, does not control, and is 
not controlled by or under common control with the issuer of the 
security subject to the Guarantee (control means ``control'' as defined 
in section 2(a)(9) of the Act (15 U.S.C. 80a-2(a)(9)); or
    (ii) A sponsor of a Special Purpose Entity with respect to an Asset 
Backed Security.
    (17) NRSRO means any nationally recognized statistical rating 
organization, as that term is used in paragraphs (c)(2)(vi)(E), (F) and 
(H) of Sec. 240.15c3-1 of this Chapter, that is not an ``affiliated 
person,'' as defined in section 2(a)(3)(C) of the Act (15 U.S.C. 80a-
2(a)(3)(C)), of the issuer of, or any insurer or provider of credit 
support for, the security.
    (18) Penny-Rounding Method of pricing means the method of computing 
an investment company's price per share for purposes of distribution, 
redemption and repurchase whereby the current net asset value per share 
is rounded to the nearest one percent.
    (19) Rated Security means a security that meets the requirements of 
paragraphs (a)(19)(i) or (ii) of this section, in each case subject to 
paragraph (a)(19)(iii) of this section:
    (i) The security has received a short-term rating from an NRSRO, or 
has been issued by an issuer that has received a short-term rating from 
an NRSRO with respect to a class of debt obligations (or any debt 
obligation within that class) that is comparable in priority and 
security with the security; or
    (ii) The security is subject to a Guarantee that has received a 
short-term rating from an NRSRO, or a Guarantee issued by a guarantor 
that has received a short-term rating from an NRSRO with respect to a 
class of debt obligations (or any debt obligation within that class) 
that is comparable in priority and security with the Guarantee; but
    (iii) A security is not a Rated Security if it is subject to an 
external credit support agreement (including an arrangement by which 
the security has become a Refunded Security) that was not in effect 
when the security was assigned its rating, unless the security has 
received a short-term rating reflecting the existence of the credit 
support agreement as provided in paragraph (a)(19)(i) of this section, 
or the credit support agreement with respect to the security has 
received a short-term rating as provided in paragraph (a)(19)(ii) of 
this section.
    (20) Refunded Security means a debt security the principal and 
interest payments of which are to be paid by Government Securities 
(``deposited securities'') that have been irrevocably placed in an 
escrow account pursuant to agreement between the issuer of the debt 
security and an escrow agent that is not an ``affiliated person,'' as 
defined in section 2(a)(3)(C) of the Act (15 U.S.C. 80a-2(a)(3)(C)), of 
the issuer of the debt security, and, in accordance with such escrow 
agreement, are pledged only to the payment of the debt security and, to 
the extent that excess proceeds are available after all payments of 
principal, interest, and applicable premiums on the Refunded 
Securities, the expenses of the escrow agent and, thereafter, to the 
issuer or another party; provided that:
    (i) The deposited securities shall not be redeemable prior to their 
final maturity;
    (ii) The escrow agreement shall prohibit the substitution of the 
deposited securities unless the substituted securities are Government 
Securities; and
    (iii) At the time the deposited securities are placed in the escrow 
account, or at the time a substitution of the deposited securities is 
made, an independent certified public accountant shall have certified 
to the escrow agent that the deposited securities will satisfy all 
scheduled payments of principal, interest and applicable premiums on 
the Refunded Securities; Provided, however, an independent public 
accountant need not have provided the certification described in this 
paragraph (a)(20)(iii) if the security, as a Refunded Security, has 
received a rating from an NRSRO in the highest category for debt 
obligations (within which there may be sub-categories or gradations 
including relative standing).
    (21) Requisite NRSROs means:
    (i) Any two NRSROs that have issued a rating with respect to a 
security or class of debt obligations of an issuer; or
    (ii) If only one NRSRO has issued a rating with respect to such 
security or class of debt obligations of an issuer at the time the fund 
acquires the security, that NRSRO.
    (22) Second Tier Security means any Eligible Security that is not a 
First Tier Security. Second Tier Conduit Security means any Conduit 
Security that is an Eligible Security that is not a First Tier 
Security.
    (23) Single State Fund means a Tax Exempt Fund that holds itself 
out as seeking to maximize the amount of its distributed income that is 
exempt from the income taxes or other taxes on investments of a 
particular state and, where applicable, subdivisions thereof.
    (24) Tax Exempt Fund means any money market fund that holds itself 
out as distributing income exempt from regular federal income tax.
    (25) Total Assets means, with respect to a money market fund using 
the Amortized Cost Method, the total amortized cost of its assets and, 
with respect to any other money market fund, the total market-based 
value of its assets.
    (26) Unconditional Demand Feature means a Demand Feature that by 
its terms would be readily exercisable in the event of a default in 
payment of principal or interest on the underlying security or 
securities.

[[Page 64981]]

    (27) United States Dollar-Denominated means, with reference to a 
security, that all principal and interest payments on such security are 
payable to security holders in United States dollars under all 
circumstances and that the interest rate of, the principal amount to be 
repaid, and the timing of payments related to such security do not vary 
or float with the value of a foreign currency, the rate of interest 
payable on foreign currency borrowings, or with any other interest rate 
or index expressed in a currency other than United States dollars.
    (28) Unrated Security means a security that is not a Rated 
Security.
    (29) Variable Rate Security means a security the terms of which 
provide for the adjustment of its interest rate on set dates (such as 
the last day of a month or calendar quarter) and that, upon each 
adjustment until the final maturity of the instrument or the period 
remaining until the principal amount can be recovered through demand, 
can reasonably be expected to have a market value that approximates its 
amortized cost.
    (b) Holding Out and Use of Names and Titles. (1) It shall be an 
untrue statement of material fact within the meaning of section 34(b) 
of the Act (15 U.S.C. 80a-33(b)) for a registered investment company, 
in any registration statement, application, report, account, record, or 
other document filed or transmitted pursuant to the Act, including any 
advertisement, pamphlet, circular, form letter, or other sales 
literature addressed to or intended for distribution to prospective 
investors that is required to be filed with the Commission by section 
24(b) of the Act (15 U.S.C. 80a-24(b)), to hold itself out to investors 
as a money market fund or the equivalent of a money market fund, unless 
such registered investment company meets the conditions of paragraphs 
(c)(2), (c)(3) and (c)(4) of this section.
    (2) It shall constitute the use of a materially deceptive or 
misleading name or title within the meaning of section 35(d) of the Act 
(15 U.S.C. 80a-34(d)) for a registered investment company to adopt the 
term ``money market'' as part of its name or title or the name or title 
of any redeemable securities of which it is the issuer, or to adopt a 
name that suggests that it is a money market fund or the equivalent of 
a money market fund, unless such registered investment company meets 
the conditions of paragraphs (c)(2), (c)(3), and (c)(4) of this 
section.
    (3) For purposes of this paragraph, a name that suggests that a 
registered investment company is a money market fund or the equivalent 
thereof shall include one that uses such terms as ``cash,'' ``liquid,'' 
``money,'' ``ready assets'' or similar terms.
    (c) Share Price Calculations. The current price per share, for 
purposes of distribution, redemption and repurchase, of any redeemable 
security issued by any registered investment company (``money market 
fund'' or ``fund''), notwithstanding the requirements of section 
2(a)(41) of the Act (15 U.S.C. 80a-2(a)(41)) and of Secs. 270.2a-4 and 
270.22c-1 thereunder, may be computed by use of the Amortized Cost 
Method or the Penny-Rounding Method; Provided, however, that:
    (1) Board Findings. The board of directors of the money market fund 
shall determine, in good faith, that it is in the best interests of the 
fund and its shareholders to maintain a stable net asset value per 
share or stable price per share, by virtue of either the Amortized Cost 
Method or the Penny-Rounding Method, and that the money market fund 
will continue to use such method only so long as the board of directors 
believes that it fairly reflects the market-based net asset value per 
share.
    (2) Portfolio Maturity. The money market fund shall maintain a 
dollar-weighted average portfolio maturity appropriate to its objective 
of maintaining a stable net asset value per share or price per share; 
Provided, however, that the money market fund will not:
    (i) Except as provided in paragraph (c)(2)(ii) of this section, 
Acquire any instrument with a remaining maturity of greater than 397 
calendar days; or
    (ii) In the case of a money market fund not using the Amortized 
Cost Method, Acquire a Government Security with a remaining maturity of 
greater than 762 calendar days; or
    (iii) Maintain a dollar-weighted average portfolio maturity that 
exceeds ninety days.
    (3) Portfolio Quality--(i) General. The money market fund shall 
limit its portfolio investments to those United States Dollar-
Denominated securities that the fund's board of directors determines 
present minimal credit risks (which determination must be based on 
factors pertaining to credit quality in addition to any rating assigned 
to such securities by an NRSRO) and that are at the time of Acquisition 
Eligible Securities.
    (ii) Second Tier Securities. Immediately after the Acquisition of 
any Second Tier Security:
    (A) Taxable Funds. A money market fund that is not a Tax Exempt 
Fund shall not have invested more than five percent of its Total Assets 
in securities that are Second Tier Securities; and
    (B) Tax Exempt Funds. A money market fund that is a Tax Exempt Fund 
shall not have invested more than five percent of its Total Assets in 
Conduit Securities that are Second Tier Conduit Securities.
    (iii) Securities Subject to Guarantees. A security that is subject 
to a Guarantee may be determined to be an Eligible Security or a First 
Tier Security based solely on whether the Guarantee is an Eligible 
Security or First Tier Security, as the case may be.
    (iv) Securities Subject to Conditional Demand Features. A security 
that is subject to a Conditional Demand Feature (``Underlying 
Security'') may be determined to be an Eligible Security or a First 
Tier Security only if:
    (A) The Conditional Demand Feature is an Eligible Security or First 
Tier Security, as the case may be;
    (B) At the time of the Acquisition of the Underlying Security, the 
money market fund's board of directors has determined that there is 
minimal risk that the circumstances that would result in the 
Conditional Demand Feature not being exercisable will occur; and
    (1) The conditions limiting exercise either can be monitored 
readily by the fund, or relate to the taxability, under federal, state 
or local law, of the interest payments on the security; or
    (2) The terms of the Conditional Demand Feature require that the 
fund will receive notice of the occurrence of the condition and the 
opportunity to exercise the Demand Feature in accordance with its 
terms; and
    (C) The Underlying Security or any Guarantee of such security (or 
the debt securities of the issuer of the Underlying Security or 
Guarantee that are comparable in priority and security with the 
Underlying Security or Guarantee) has received either a short-term 
rating or a long-term rating, as the case may be, from the Requisite 
NRSROs within the NRSROs' two highest short-term or long-term rating 
categories (within which there may be sub-categories or gradations 
indicating relative standing) or, if unrated, is determined to be of 
comparable quality by the money market fund's board of directors to a 
security that has received a rating from the Requisite NRSROs within 
the NRSROs' two highest short-term or long-term rating categories, as 
the case may be.
    (4) Portfolio Diversification--(i) Issuer Diversification. The 
money market fund shall be diversified with respect to issuers of 
securities Acquired by the fund as provided in paragraphs (c)(4)(i) and 
(c)(4)(ii) of this section, other than

[[Page 64982]]

with respect to Government Securities and securities subject to a 
Guarantee Issued By A Non-Controlled Person.
    (A) Taxable and National Funds. Immediately after the Acquisition 
of any security, a money market fund other than a Single State Fund 
shall not have invested more than five percent of its Total Assets in 
securities issued by the issuer of the security; Provided, however, 
that such a fund may invest up to twenty-five percent of its Total 
Assets in the First Tier Securities of a single issuer for a period of 
up to three Business Days after the Acquisition thereof; Provided, 
further, that the fund may not invest in the securities of more than 
one issuer in accordance with the foregoing proviso in this paragraph 
at any time.
    (B) Single State Funds. With respect to seventy-five percent of its 
Total Assets, immediately after the Acquisition of any security, a 
Single State Fund shall not have invested more than five percent of its 
Total Assets in securities issued by the issuer of the security; 
Provided, however, that a Single State Fund shall not invest more than 
five percent of its Total Assets in securities issued by the issuer of 
the security unless the securities are First Tier Securities.
    (C) Second Tier Securities--(1) Taxable Funds. Immediately after 
the Acquisition of any Second Tier Security, a money market fund that 
is not a Tax Exempt Fund shall not have invested more than the greater 
of one percent of its Total Assets or one million dollars in securities 
issued by that issuer that are Second Tier Securities.
    (2) Tax Exempt Funds. Immediately after the Acquisition of any 
Second Tier Conduit Security, a money market fund that is a Tax Exempt 
Fund shall not have invested more than the greater of one percent of 
its Total Assets or one million dollars in securities issued by that 
issuer that are Second Tier Conduit Securities.
    (ii) Issuer Diversification Calculations. For purposes of making 
calculations under paragraph (c)(4)(i) of this section:
    (A) Repurchase Agreements. The Acquisition of a repurchase 
agreement may be deemed to be an Acquisition of the underlying 
securities, provided the obligation of the seller to repurchase the 
securities from the money market fund is Collateralized Fully.
    (B) Refunded Securities. The Acquisition of a Refunded Security 
shall be deemed to be an Acquisition of the escrowed Government 
Securities.
    (C) Conduit Securities. A Conduit Security shall be deemed to be 
issued by the person (other than the Municipal Issuer) ultimately 
responsible for payments of interest and principal on the security.
    (D) Asset Backed Securities--(1) General. An Asset Backed Security 
Acquired by a fund (``Primary ABS'') shall be deemed to be issued by 
the Special Purpose Entity that issued the Asset Backed Security, 
Provided, however:
    (i) Holdings of Primary ABS. Any person whose obligations 
constitute ten percent or more of the principal amount of the 
Qualifying Assets of the Primary ABS (``Ten Percent Obligor'') shall be 
deemed to be an issuer of the portion of the Primary ABS such 
obligations represent; and
    (ii) Holdings of Secondary ABS. If a Ten Percent Obligor of a 
Primary ABS is itself a Special Purpose Entity issuing Asset Backed 
Securities (``Secondary ABS''), any Ten Percent Obligor of such 
Secondary ABS also shall be deemed to be an issuer of the portion of 
the Primary ABS that such Ten Percent Obligor represents.
    (2) Restricted Special Purpose Entities. A Ten Percent Obligor with 
respect to a Primary or Secondary ABS shall not be deemed to have 
issued any portion of the assets of a Primary ABS as provided in 
paragraph (c)(4)(ii)(D)(1) of this section if that Ten Percent Obligor 
is itself a Special Purpose Entity issuing Asset Backed Securities 
(``Restricted Special Purpose Entity''), and the securities that it 
issues (other than securities issued to a company that controls, or is 
controlled by or under common control with, the Restricted Special 
Purpose Entity and which is not itself a Special Purpose Entity issuing 
Asset Backed Securities) are held by only one other Special Purpose 
Entity.
    (3) Demand Features and Guarantees. In the case of a Ten Percent 
Obligor deemed to be an issuer, the fund shall satisfy the 
diversification requirements of paragraph (c)(4)(iii) of this section 
with respect to any Demand Feature or Guarantee to which the Ten 
Percent Obligor's obligations are subject.
    (E) Shares of Other Money Market Funds. A money market fund that 
Acquires shares issued by another money market fund in an amount that 
would otherwise be prohibited by paragraph (c)(4)(i) of this section 
shall nonetheless be deemed in compliance with this section if the 
board of directors of the Acquiring money market fund reasonably 
believes that the fund in which it has invested is in compliance with 
this section.
    (iii) Diversification Rules for Demand Features and Guarantees. The 
money market fund shall be diversified with respect to Demand Features 
and Guarantees Acquired by the fund as provided in paragraphs 
(c)(4)(iii) and (c)(4)(iv) of this section, other than with respect to 
a Demand Feature issued by the same institution that issued the 
underlying security, or with respect to a Guarantee or Demand Feature 
that is itself a Government Security.
    (A) General. Immediately after the Acquisition of any Demand 
Feature or Guarantee or security subject to a Demand Feature or 
Guarantee, a money market fund, with respect to seventy-five percent of 
its Total Assets, shall not have invested more than ten percent of its 
Total Assets in securities issued by or subject to Demand Features or 
Guarantees from the institution that issued the Demand Feature or 
Guarantee, subject to paragraphs (c)(4)(iii) (B) and (C) of this 
section.
    (B) Second Tier Demand Features or Guarantees. Immediately after 
the Acquisition of any Demand Feature or Guarantee (or a security after 
giving effect to the Demand Feature or Guarantee) that is a Second Tier 
Security, a money market fund shall not have invested more than five 
percent of its Total Assets in securities issued by or subject to 
Demand Features or Guarantees from the institution that issued the 
Demand Feature or Guarantee.
    (C) Demand Features or Guarantees Issued by Non-Controlled Persons. 
Immediately after the Acquisition of any security subject to a Demand 
Feature or Guarantee, a money market fund shall not have invested more 
than ten percent of its Total Assets in securities issued by, or 
subject to Demand Features or Guarantees from the institution that 
issued the Demand Feature or Guarantee, unless, with respect to any 
security subject to Demand Features or Guarantees from that institution 
(other than securities issued by such institution), the Demand Feature 
or Guarantee is a Demand Feature or Guarantee Issued By A Non-
Controlled Person.
    (iv) Demand Feature and Guarantee Diversification Calculations--(A) 
Fractional Demand Features or Guarantees. In the case of a security 
subject to a Demand Feature or Guarantee from an institution by which 
the institution guarantees a specified portion of the value of the 
security, the institution shall be deemed to guarantee the specified 
portion thereof.
    (B) Layered Demand Features or Guarantees. In the case of a 
security subject to Demand Features or Guarantees from multiple 
institutions that have not limited the extent of their obligations as 
described in paragraph (c)(4)(iv)(A) of this section, each

[[Page 64983]]

institution shall be deemed to have provided the Demand Feature or 
Guarantee with respect to the entire principal amount of the security.
    (v) Diversification Safe Harbor. A money market fund that satisfies 
the applicable diversification requirements of paragraphs (c)(4) and 
(c)(5) of this section shall be deemed to have satisfied the 
diversification requirements of section 5(b)(1) of the Act (15 U.S.C. 
80a-5(b)(1)) and the rules adopted thereunder.
    (5) Demand Features and Guarantees Not Relied Upon. If the fund's 
board of directors has determined that the fund is not relying on a 
Demand Feature or Guarantee to determine the quality (pursuant to 
paragraph (c)(3) of this section), or maturity (pursuant to paragraph 
(d) of this section), or liquidity of a portfolio security, and 
maintains a record of this determination (pursuant to paragraphs 
(c)(9)(ii) and (c)(10)(vi) of this section), then the fund may 
disregard such Demand Feature or Guarantee for all purposes of this 
section.
    (6) Downgrades, Defaults and Other Events--(i) Downgrades--(A) 
General. Upon the occurrence of either of the events specified in 
paragraphs (c)(6)(i)(A) (1) and (2) of this section with respect to a 
portfolio security, the board of directors of the money market fund 
shall reassess promptly whether such security continues to present 
minimal credit risks and shall cause the fund to take such action as 
the board of directors determines is in the best interests of the money 
market fund and its shareholders:
    (1) A portfolio security of a money market fund ceases to be a 
First Tier Security (either because it no longer has the highest rating 
from the Requisite NRSROs or, in the case of an Unrated Security, the 
board of directors of the money market fund determines that it is no 
longer of comparable quality to a First Tier Security); and
    (2) The money market fund's investment adviser (or any person to 
whom the fund's board of directors has delegated portfolio management 
responsibilities) becomes aware that any Unrated Security or Second 
Tier Security held by the money market fund has, since the security was 
Acquired by the fund, been given a rating by any NRSRO below the 
NRSRO's second highest short-term rating category.
    (B) Securities to Be Disposed Of. The reassessments required by 
paragraph (c)(6)(i)(A) of this section shall not be required if, in 
accordance with the procedures adopted by the board of directors, the 
security is disposed of (or matures) within five Business Days of the 
specified event and, in the case of events specified in paragraph 
(c)(6)(i)(A)(2) of this section, the board is subsequently notified of 
the adviser's actions.
    (C) Special Rule for Certain Securities Subject to Demand Features. 
 In the event that after giving effect to a rating downgrade, more than 
five percent of the fund's Total Assets are invested in securities 
issued by or subject to Demand Features from a single institution that 
are Second Tier Securities, the fund shall reduce its investment in 
securities issued by or subject to Demand Features from that 
institution to no more than five percent of its Total Assets by 
exercising the Demand Features at the next succeeding exercise date(s), 
absent a finding by the board of directors that disposal of the 
portfolio security would not be in the best interests of the money 
market fund.
    (ii) Defaults and Other Events. Upon the occurrence of any of the 
events specified in paragraphs (c)(6)(ii)(A) through (D) of this 
section with respect to a portfolio security, the money market fund 
shall dispose of such security as soon as practicable consistent with 
achieving an orderly disposition of the security, by sale, exercise of 
any Demand Feature or otherwise, absent a finding by the board of 
directors that disposal of the portfolio security would not be in the 
best interests of the money market fund (which determination may take 
into account, among other factors, market conditions that could affect 
the orderly disposition of the portfolio security):
    (A) The default with respect to a portfolio security (other than an 
immaterial default unrelated to the financial condition of the issuer);
    (B) A portfolio security ceases to be an Eligible Security;
    (C) A portfolio security has been determined to no longer present 
minimal credit risks; or
    (D) An Event of Insolvency occurs with respect to the issuer of a 
portfolio security or the provider of any Demand Feature or Guarantee.
    (iii) Notice to the Commission. In the event of a default with 
respect to one or more portfolio securities (other than an immaterial 
default unrelated to the financial condition of the issuer) or an Event 
of Insolvency with respect to the issuer of the security or any Demand 
Feature or Guarantee to which it is subject, where immediately before 
default the securities (or the securities subject to the Demand Feature 
or Guarantee) accounted for \1/2\ of 1 percent or more of a money 
market fund's Total Assets, the money market fund shall promptly notify 
the Commission of such fact and the actions the money market fund 
intends to take in response to such situation. Notification under this 
paragraph shall be made telephonically, or by means of a facsimile 
transmission or electronic mail, followed by letter sent by first class 
mail, directed to the attention of the Director of the Division of 
Investment Management.
    (iv) Defaults for Purposes of Paragraphs (c)(6) (ii) and (iii). For 
purposes of paragraphs (c)(6) (ii) and (iii) of this section, an 
instrument subject to a Demand Feature or Guarantee shall not be deemed 
to be in default (and an Event of Insolvency with respect to the 
security shall not be deemed to have occurred) if:
    (A) In the case of an instrument subject to a Demand Feature, the 
Demand Feature has been exercised and the fund has recovered either the 
principal amount or the amortized cost of the instrument, plus accrued 
interest; or
    (B) The provider of the Guarantee is continuing, without protest, 
to make payments as due on the instrument.
    (7) Required Procedures: Amortized Cost Method. In the case of a 
money market fund using the Amortized Cost Method:
    (i) General. In supervising the money market fund's operations and 
delegating special responsibilities involving portfolio management to 
the money market fund's investment adviser, the money market fund's 
board of directors, as a particular responsibility within the overall 
duty of care owed to its shareholders, shall establish written 
procedures reasonably designed, taking into account current market 
conditions and the money market fund's investment objectives, to 
stabilize the money market fund's net asset value per share, as 
computed for the purpose of distribution, redemption and repurchase, at 
a single value.
    (ii) Specific Procedures. Included within the procedures adopted by 
the board of directors shall be the following:
    (A) Shadow Pricing. Written procedures shall provide:
    (1) That the extent of deviation, if any, of the current net asset 
value per share calculated using available market quotations (or an 
appropriate substitute that reflects current market conditions) from 
the money market fund's amortized cost price per share, shall be 
calculated at such intervals as the board of directors determines 
appropriate and reasonable in light of current market conditions;
    (2) For the periodic review by the board of directors of the amount 
of the deviation as well as the methods used to calculate the 
deviation; and

[[Page 64984]]

    (3) For the maintenance of records of the determination of 
deviation and the board's review thereof.
    (B) Prompt Consideration of Deviation. In the event such deviation 
from the money market fund's amortized cost price per share exceeds \1/
2\ of 1 percent, the board of directors shall promptly consider what 
action, if any, should be initiated by the board of directors.
    (C) Material Dilution or Unfair Results. Where the board of 
directors believes the extent of any deviation from the money market 
fund's amortized cost price per share may result in material dilution 
or other unfair results to investors or existing shareholders, it shall 
cause the fund to take such action as it deems appropriate to eliminate 
or reduce to the extent reasonably practicable such dilution or unfair 
results.
    (8) Required Procedures: Penny-Rounding Method. In the case of a 
money market fund using the Penny-Rounding Method, in supervising the 
money market fund's operations and delegating special responsibilities 
involving portfolio management to the money market fund's investment 
adviser, the money market fund's board of directors undertakes, as a 
particular responsibility within the overall duty of care owed to its 
shareholders, to assure to the extent reasonably practicable, taking 
into account current market conditions affecting the money market 
fund's investment objectives, that the money market fund's price per 
share as computed for the purpose of distribution, redemption and 
repurchase, rounded to the nearest one percent, will not deviate from 
the single price established by the board of directors.
    (9) Specific Procedures: Amortized Cost and Penny-Rounding Methods. 
Included within the procedures adopted by the board of directors for 
money market funds using either the Amortized Cost or Penny-Rounding 
Methods shall be the following:
    (i) Securities for Which Maturity is Determined by Reference to 
Demand Features. In the case of a security for which maturity is 
determined by reference to a Demand Feature, written procedures shall 
require ongoing review of the security's continued minimal credit 
risks, and that review must be based on, among other things, financial 
data for the most recent fiscal year of the issuer of the Demand 
Feature and, in the case of a security subject to a Conditional Demand 
Feature, the issuer of the security whose financial condition must be 
monitored under paragraph (c)(3)(iv) of this section, whether such data 
is publicly available or provided under the terms of the security's 
governing documentation.
    (ii) Securities Subject to Demand Features or Guarantees. In the 
case of a security subject to one or more Demand Features or Guarantees 
that the fund's board of directors has determined that the fund is not 
relying on to determine the quality (pursuant to paragraph (c)(3) of 
this section), maturity (pursuant to paragraph (d) of this section) or 
liquidity of the security subject to the Demand Feature or Guarantee, 
written procedures shall require periodic evaluation of such 
determination.
    (iii) Adjustable Rate Securities Without Demand Features. In the 
case of a Variable Rate or Floating Rate Security that is not subject 
to a Demand Feature and for which maturity is determined pursuant to 
paragraphs (d)(1), (d)(2) or (d)(4) of this section, written procedures 
shall require periodic review of whether the interest rate formula, 
upon readjustment of its interest rate, can reasonably be expected to 
cause the security to have a market value that approximates its 
amortized cost value.
    (iv) Asset Backed Securities. In the case of an Asset Backed 
Security, written procedures shall require the fund to periodically 
determine the number of Ten Percent Obligors (as that term is used in 
paragraph (c)(4)(ii)(D) of this section) deemed to be the issuers of 
all or a portion of the Asset Backed Security for purposes of paragraph 
(c)(4)(ii)(D) of this section; Provided, however, written procedures 
need not require periodic determinations with respect to any Asset 
Backed Security that a fund's board of directors has determined, at the 
time of Acquisition, will not have, or is unlikely to have, Ten Percent 
Obligors that are deemed to be issuers of all or a portion of that 
Asset Backed Security for purposes of paragraph (c)(4)(ii)(D) of this 
section, and maintains a record of this determination.
    (10) Record Keeping and Reporting--(i) Written Procedures. For a 
period of not less than six years following the replacement of such 
procedures with new procedures (the first two years in an easily 
accessible place), a written copy of the procedures (and any 
modifications thereto) described in paragraphs (c)(6) through (c)(9) 
and (e) of this section shall be maintained and preserved.
    (ii) Board Considerations and Actions. For a period of not less 
than six years (the first two years in an easily accessible place) a 
written record shall be maintained and preserved of the board of 
directors' considerations and actions taken in connection with the 
discharge of its responsibilities, as set forth in this section, to be 
included in the minutes of the board of directors' meetings.
    (iii) Credit Risk Analysis. For a period of not less than three 
years from the date that the credit risks of a portfolio security were 
most recently reviewed, a written record of the determination that a 
portfolio security presents minimal credit risks and the NRSRO ratings 
(if any) used to determine the status of the security as an Eligible 
Security, First Tier Security or Second Tier Security shall be 
maintained and preserved in an easily accessible place.
    (iv) Determinations With Respect to Adjustable Rate Securities. For 
a period of not less than three years from the date when the 
determination was most recently made, a written record shall be 
preserved and maintained, in an easily accessible place, of the 
determination required by paragraph (c)(9)(iii) of this section (that a 
Variable Rate or Floating Rate Security that is not subject to a Demand 
Feature and for which maturity is determined pursuant to paragraphs 
(d)(1), (d)(2) or (d)(4) of this section can reasonably be expected, 
upon readjustment of its interest rate at all times during the life of 
the instrument, to have a market value that approximates its amortized 
cost).
    (v) Determinations with Respect to Asset Backed Securities. For a 
period of not less than three years from the date when the 
determination was most recently made, a written record shall be 
preserved and maintained, in an easily accessible place, of the 
determinations required by paragraph (c)(9)(iv) of this section (the 
number of Ten Percent Obligors (as that term is used in paragraph 
(c)(4)(ii)(D) of this section) deemed to be the issuers of all or a 
portion of the Asset Backed Security for purposes of paragraph 
(c)(4)(ii)(D) of this section). The written record shall include:
    (A) The identities of the Ten Percent Obligors (as that term is 
used in paragraph (c)(4)(ii)(D) of this section), the percentage of the 
Qualifying Assets constituted by the securities of each Ten Percent 
Obligor and the percentage of the fund's Total Assets that are invested 
in securities of each Ten Percent Obligor; and
    (B) Any determination that an Asset Backed Security will not have, 
or is unlikely to have, Ten Percent Obligors deemed to be issuers of 
all or a portion of that Asset Backed Security for purposes of 
paragraph (c)(4)(ii)(D) of this section.
    (vi) Evaluations with Respect to Securities Subject to Demand 
Features or Guarantees. For a period of not less

[[Page 64985]]

than three years from the date when the evaluation was most recently 
made, a written record shall be preserved and maintained, in an easily 
accessible place, of the evaluation required by paragraph (c)(9)(ii) 
(regarding securities subject to one or more Demand Features or 
Guarantees) of this section.
    (vii) Inspection of Records. The documents preserved pursuant to 
this paragraph (c)(10) shall be subject to inspection by the Commission 
in accordance with section 31(b) of the Act (15 U.S.C. 80a-30(b)) as if 
such documents were records required to be maintained pursuant to rules 
adopted under section 31(a) of the Act (15 U.S.C. 80a-30(a)). If any 
action was taken under paragraphs (c)(6)(ii) (with respect to defaulted 
securities and events of insolvency) or (c)(7)(ii) (with respect to a 
deviation from the fund's share price of more than 1/2 of 1 percent) of 
this section, the money market fund will file an exhibit to the Form N-
SAR (17 CFR 274.101) filed for the period in which the action was taken 
describing with specificity the nature and circumstances of such 
action. The money market fund will report in an exhibit to such Form 
any securities it holds on the final day of the reporting period that 
are not Eligible Securities.
    (d) Maturity of Portfolio Securities. For purposes of this section, 
the maturity of a portfolio security shall be deemed to be the period 
remaining (calculated from the trade date or such other date on which 
the fund's interest in the security is subject to market action) until 
the date on which, in accordance with the terms of the security, the 
principal amount must unconditionally be paid, or in the case of a 
security called for redemption, the date on which the redemption 
payment must be made, except as provided in paragraphs (d)(1) through 
(d)(8) of this section:
    (1) Adjustable Rate Government Securities. A Government Security 
that is a Variable Rate Security where the variable rate of interest is 
readjusted no less frequently than every 762 calendar days shall be 
deemed to have a maturity equal to the period remaining until the next 
readjustment of the interest rate. A Government Security that is a 
Floating Rate Security shall be deemed to have a remaining maturity of 
one day.
    (2) Short-Term Variable Rate Securities. A Variable Rate Security, 
the principal amount of which, in accordance with the terms of the 
security, must unconditionally be paid in 397 calendar days or less 
shall be deemed to have a maturity equal to the earlier of the period 
remaining until the next readjustment of the interest rate or the 
period remaining until the principal amount can be recovered through 
demand.
    (3) Long-Term Variable Rate Securities. A Variable Rate Security, 
the principal amount of which is scheduled to be paid in more than 397 
calendar days, that is subject to a Demand Feature, shall be deemed to 
have a maturity equal to the longer of the period remaining until the 
next readjustment of the interest rate or the period remaining until 
the principal amount can be recovered through demand.
    (4) Short-Term Floating Rate Securities. A Floating Rate Security, 
the principal amount of which, in accordance with the terms of the 
security, must unconditionally be paid in 397 calendar days or less 
shall be deemed to have a maturity of one day.
    (5) Long-Term Floating Rate Securities. A Floating Rate Security, 
the principal amount of which is scheduled to be paid in more than 397 
calendar days, that is subject to a Demand Feature, shall be deemed to 
have a maturity equal to the period remaining until the principal 
amount can be recovered through demand.
    (6) Repurchase Agreements. A repurchase agreement shall be deemed 
to have a maturity equal to the period remaining until the date on 
which the repurchase of the underlying securities is scheduled to 
occur, or, where the agreement is subject to demand, the notice period 
applicable to a demand for the repurchase of the securities.
    (7) Portfolio Lending Agreements. A portfolio lending agreement 
shall be treated as having a maturity equal to the period remaining 
until the date on which the loaned securities are scheduled to be 
returned, or where the agreement is subject to demand, the notice 
period applicable to a demand for the return of the loaned securities.
    (8) Money Market Fund Securities. An investment in a money market 
fund shall be treated as having a maturity equal to the period of time 
within which the Acquired money market fund is required to make payment 
upon redemption, unless the Acquired money market fund has agreed in 
writing to provide redemption proceeds to the investing money market 
fund within a shorter time period, in which case the maturity of such 
investment shall be deemed to be the shorter period.
    (e) Delegation. The money market fund's board of directors may 
delegate to the fund's investment adviser or officers the 
responsibility to make any determination required to be made by the 
board of directors under this section (other than the determinations 
required by paragraphs (c)(1) (board findings); (c)(6)(i)(C) (rule for 
certain securities subject to second tier Demand Features); (c)(6)(ii) 
(defaults and other events); (c)(7)(i) (general required procedures: 
Amortized Cost Method); (c)(7)(ii)(A) (shadow pricing), (B) (prompt 
consideration of deviation), and (C) (material dilution or unfair 
results); and (c)(8) (required procedures: Penny Rounding Method) of 
this section) provided:
    (1) Written Guidelines. The Board shall establish and periodically 
review written guidelines (including guidelines for determining whether 
securities present minimal credit risks as required in paragraph (c)(3) 
of this section) and procedures under which the delegate makes such 
determinations:
    (2) Oversight. The Board shall take any measures reasonably 
necessary (through periodic reviews of fund investments and the 
delegate's procedures in connection with investment decisions and 
prompt review of the adviser's actions in the event of the default of a 
security or Event of Insolvency with respect to the issuer of the 
security or any Guarantee to which it is subject that requires 
notification of the Commission under paragraph (c)(6)(iii) of this 
section) to assure that the guidelines and procedures are being 
followed.
    5. Section 270.2a41-1 is amended by revising the introductory text 
of paragraph (a) to read as follows:


Sec. 270.2a41-1  Valuation of standby commitments by registered 
investment companies.

    (a) A standby commitment means a right to sell a specified 
underlying security or securities within a specified period of time and 
at an exercise price equal to the amortized cost of the underlying 
security or securities plus accrued interest, if any, at the time of 
exercise, that may be sold, transferred or assigned only with the 
underlying security or securities. A standby commitment entitles the 
holder to receive same day settlement, and will be considered to be 
from the party to whom the investment company will look for payment of 
the exercise price. A standby commitment may be assigned a fair value 
of zero, Provided, That:
* * * * *
    6. Section 270.12d3-1 is amended by revising paragraph (d)(7)(v) to 
read as follows:


Sec. 270.12d3-1  Exemption of acquisitions of securities issued by 
persons engaged in securities related businesses.

* * * * *
    (d) * * *

[[Page 64986]]

    (7) * * *
    (v) Acquisition of Demand Features or Guarantees, as these terms 
are defined in Secs. 270.2a-7(a)(8) and 270.2a-7(a)(15) respectively, 
provided that, immediately after the acquisition of any Demand Feature 
or Guarantee, the company will not, with respect to 75 percent of the 
total value of its assets, have invested more than ten percent of the 
total value of its assets in securities underlying Demand Features or 
Guarantees from the same institution. For the purposes of this section, 
a Demand Feature or Guarantee will be considered to be from the party 
to whom the company will look for payment of the exercise price.
* * * * *
    7. Section 270.17a-9 is amended by revising the cite to ``paragraph 
(a)(9)'' in the introductory paragraph to read ``paragraph (a)(10)''.
    8. Section 270.31a-1 is amended by revising the last sentence of 
paragraph (b)(1) to read as follows:


Sec. 270.31a-1  Records to be maintained by registered investment 
companies, certain majority-owned subsidiaries thereof, and other 
persons having transactions with registered investment companies.

* * * * *
    (b) * * *
    (1) * * * In the case of a money market fund, also identify the 
provider of any Demand Feature or Guarantee (as defined in Sec. 270.2a-
7(a)(8) or Sec. 270.2a-7(a)(15) respectively) and give a brief 
description of the nature of the Demand Feature or Guarantee (e.g., 
unconditional demand feature, conditional demand feature, letter of 
credit, or bond insurance) and, in a subsidiary portfolio investment 
record, provide the complete legal name and accounting and other 
information (including sufficient information to calculate coupons, 
accruals, maturities, puts, and calls) necessary to identify, value, 
and account for each investment.
* * * * *
    9. Section 270.34b-1 is amended by revising paragraph (b) (the Note 
remains unchanged) to read as follows:


Sec. 270.34b-1  Sales literature deemed to be misleading.

* * * * *
    (b)(1) Except as provided in paragraph (b)(3) of this section:
    (i) In any sales literature that contains performance data for an 
investment company, include the disclosure required by paragraph (a)(6) 
of Sec. 230.482 of this chapter.
    (ii) In any sales literature for a money market fund:
    (A) Accompany any quotation of yield or similar quotation 
purporting to demonstrate the income earned or distributions made by 
the money market fund with a quotation of current yield specified by 
paragraph (d)(1)(i) of Sec. 230.482 of this chapter;
    (B) Accompany any quotation of tax equivalent yield or other 
similar quotation purporting to demonstrate the tax equivalent yield 
earned or distributions made by the money market fund with a quotation 
of current yield specified in paragraph (d)(1)(i) of Sec. 230.482 of 
this chapter; and
    (C) Accompany any quotation of the money market fund's total return 
with a quotation of the money market fund's current yield specified in 
paragraph (d)(1)(i) of Sec. 230.482 of this chapter. Place the 
quotations of total return and current yield next to each other, in the 
same size print, and if there is a material difference between the 
quoted total return and the quoted current yield, include a statement 
that the yield quotation more closely reflects the current earnings of 
the money market fund than the total return quotation.
    (iii) In any sales literature for an investment company other than 
a money market fund that contains performance data:
    (A) Include the total return information required by paragraph 
(e)(3) of Sec. 230.482 of this chapter;
    (B) Accompany any quotation of yield or similar quotation 
purporting to demonstrate the income earned or distributions made by 
the company with a quotation of current yield specified by paragraph 
(e)(1) of Sec. 230.482 of this chapter; and
    (C) Accompany any quotation of tax equivalent yield or other 
similar quotation purporting to demonstrate the tax equivalent yield 
earned or distributions made by the company with a quotation of tax 
equivalent yield specified in paragraph (e)(2) and current yield 
specified by paragraph (e)(1) of Sec. 230.482 of this chapter.
    (2) Any performance data included in sales literature under 
paragraphs (b)(1)(ii) or (iii) of this section must meet the 
currentness requirements of paragraph (f) of Sec. 230.482 of this 
chapter.
    (3) The requirements specified in paragraph (b)(1) of this section 
shall not apply to any quarterly, semi-annual, or annual report to 
shareholders under Section 30 of the Act (15 U.S.C. 80a-29), containing 
performance data for a period commencing no earlier than the first day 
of the period covered by the report; nor shall the requirements of 
paragraphs (e)(3)(ii) and (f) of Sec. 230.482 of this chapter apply to 
any such periodic report containing any other performance data.
* * * * *

PART 239--FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933

PART 274--FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY ACT OF 1940

    10. The authority citation for part 239 continues to read, in part, 
as follows:

    Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77sss, 78c, 
78l, 78m, 78n, 78o(d), 78u-5, 78w(a), 78ll(d), 79e, 79f, 79g, 79j, 
79l, 79m, 79n, 79q, 79t, 80a-8, 80a-29, 80a-30 and 80a-37, unless 
otherwise noted.
* * * * *
    11. The authority citation for part 274 continues to read as 
follows:

    Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 78c(b), 78l, 78m, 
78n, 78o(d), 80a-8, 80a-24, and 80a-29, unless otherwise noted.

    12. Part B, Item 22(a) of Form N-1A (referenced in Secs. 239.15A 
and 274.11A) is amended by:
    (a) Adding in paragraphs (i) and (ii) the phrase ``and income other 
than investment income'' after the phrase ``exclusive of capital 
changes'' in each paragraph.
    (b) Adding at the end of Instruction 2 the following: ``Exclude 
income other than investment income.''

    Note: Form N-1A does not and the amendments will not appear in 
the Code of Federal Regulations.

    13. Item 25(a) of Form N-3 (referenced in Secs. 239.17a and 
274.11b) is amended by:
    (a) Adding in paragraphs (i) and (ii) the phrase ``and income other 
than investment income'' after the phrase ``exclusive of capital 
changes'' in each paragraph.
    (b) Adding at the end of Instruction 3 the following: ``Exclude 
income other than investment income.''

    Note: Form N-3 does not and the amendments will not appear in 
the Code of Federal Regulations.

    14. Guide 38 to Form N-3 (Money Market Fund Investments in Other 
Money Market Funds) (referenced in Secs. 239.17a and 274.11b) is 
amended by revising the last sentence to read as follows:
    * * * Paragraph (c)(4)(ii)(E) of rule 2a-7 describes the 
obligations of a fund that invests its assets in another money market 
fund.

    Note: Guide 38 to Form N-3 does not and the amendments will not 
appear in the Code of Federal Regulations.

    15. Part B, Item 21(a) of Form N-4 (referenced in Secs. 239.17b and 
274.11c) is amended by:

[[Page 64987]]

    (a) Adding in paragraphs (i) and (ii) the phrase ``and income other 
than investment income'' after the phrase ``exclusive of capital 
changes'' in each paragraph.
    (b) Adding at the end of Instruction 3 the following: ``Exclude 
income other than investment income.''

    Note: Form N-4 does not and the amendments will not appear in 
the Code of Federal Regulations.

    By the Commission.

    Dated: December 2, 1997.
Margaret H. McFarland,
Deputy Secretary.

    Note: The following Appendix will not appear in the Code of 
Federal Regulations.

BILLING CODE 8010-01-P
      

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[FR Doc. 97-32026 Filed 12-8-97; 8:45 am]
BILLING CODE 8010-01-C