64968 Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Rules and Regulations

1Unless 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.

2Revisions 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.

3The 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.

4The 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’’).

5Revisions 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.

6Technical 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’’).

7See Investment Company Institute (pub. avail.

May 9, 1996).

8The 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.

9The new compliance date is discussed infra in

Section III.B. of this Release.

10The 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

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.

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’’).1 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].

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.2 These risk-limiting

conditions include requirements that a

fund limit itself to investing in high

quality securities 3 and that the fund’s

portfolio be diversified.4 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.5

On December 10, 1996, the

Commission issued a release proposing

technical amendments to rule 2a–7

(‘‘Proposing Release’’).6 The proposed

amendments would: (1) codify certain

interpretive views expressed by the

Division of Investment Management;7

(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.

The Commission received comments

on the proposed amendments from

seventeen commenters, including nine

mutual fund complexes.8 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.9

B. Discussion

1. Guarantees

a. Definition of ‘‘Guarantee’’. Rule 2a7 currently characterizes certain features

that enhance the credit or liquidity of

portfolio securities as ‘‘puts’’ and

‘‘unconditional puts.’’10 To clarify
Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Rules and Regulations 64969

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.

11See Proposing Release, supra note , at n.7 and

accompanying text.

12Under 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 2a7 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.

13See 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.

14Under 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.

15Tax 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].

17Proposing Release, supra note 6, at nn. 8–16

and accompanying text.

18See 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.

19Paragraph (c)(3)(iii) of rule 2a–7, as amended.

20Paragraph (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.

21Proposing Release, supra note 6, at nn. 17–24

and accompanying text.

22Paragraph (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.

23Paragraph (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.

24Paragraph (a)(10)(iii)(A)(2) of rule 2a–7, as

amended. The Commission has relaxed the Rating

Continued

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.11 Commenters

generally supported the proposed

amendments, which the Commission is

adopting substantially as proposed.12

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.13 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 (‘‘noncontrolled person’’).14 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.

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.15 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’’);16 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’’).

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.17

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.18

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.19 In addition,

securities subject to guarantees issued

by non-controlled persons are not

subject to the rule’s issuer

diversification standards.20

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.21

Commenters generally supported the

proposal, which the Commission is

adopting substantially as proposed.

Under rule 2a–7, as amended, all

guarantees must be rated by an

NRSRO,22 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,23 (ii) a

guarantee with respect to a repurchase

agreement (‘‘repo’’) that is collateralized

fully,24 (iii) a guarantee issued by the
64970 Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Rules and Regulations

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’’).

25Paragraph (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).

26Paragraph (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).

27A conditional demand feature is any demand

feature that is not an unconditional demand feature.

Paragraph (a)(6) of rule 2a–7, as amended.

28Paragraph (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 reevaluations 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.

29A ‘‘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 nongovernment 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’’).

31Paragraphs (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.

32Paragraphs (c)(4)(iii) and (c)(4)(iv) of rule 2a–

7, as amended.

33Proposing Release, supra note 6, at nn. 30–36

and accompanying text.

34The 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).

35Paragraph (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.

U.S. Government,25 or (iv) a guarantee

not relied upon for quality, maturity or

liquidity purposes.26 Conditional

demand features, which are not within

the definition of a ‘‘guarantee’’ under

the amended rule, are not subject to the

Rating Requirement.27

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.28

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.29 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.30 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 noncontrolled person.31 Securities subject to

guarantees from non-controlled persons

are subject only to the rule’s guarantee

and demand feature diversification

standards.32

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.33

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.34

The Commission is adopting the

proposed amendments, revised in part

to reflect the commenters’ suggestions.35

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
Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Rules and Regulations 64971

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 securitiesrelated 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.

37Paragraph (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).

38See, e.g., Standard & Poor’s Municipal Finance

Criteria, 176–77 (1996).

39Paragraph (a)(20)(iii) of rule 2a–7, as amended

(definition of ‘‘refunded security’’).

40Paragraph (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.

41A 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.’’

42Paragraph (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’’).

43A ‘‘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.

44For 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.’’

45Paragraph (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.

46Paragraph (a)(10)(ii)(B) of rule 2a–7, as

amended.

47Paragraph (c)(4)(ii)(D) of rule 2a–7, as amended.

48Paragraph (d) of rule 2a–7, as amended.

49A 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).

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.36

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.37 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.38 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.39

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.40

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.41 The Commission is

amending the demand feature and

guarantee diversification standards

accordingly.42

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.43

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 44

issued by a ‘‘special purpose entity’’

substantially all of the assets of which

consist of ‘‘qualifying assets.’’ 45 Rule

2a–7 provides separate credit quality,46

diversification 47 and maturity 48

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.49

a. Rating Requirement. In recognition

of the independent legal, structural and

credit analysis conducted by NRSROs

before assigning a rating to an ABS, the
64972 Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Rules and Regulations

50The 1996 Amendments excluded unrated ABSs

from the definition of an ‘‘eligible security.’’

51Proposing 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.

53Paragraph (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.

54Paragraph (c)(4)(ii)(D)(1)(i) of rule 2a–7, as

amended.

55Proposing 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).

56Paragraphs (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 ‘‘lookthrough’’ to secondary ABSs under the amended

rule.

57This 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.

58Paragraph (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.

59Paragraph (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.

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.

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.51 The

Commission was persuaded by the

assertions of industry participants that,

as applied to these ABSs, the rating

requirement was burdensome and

unnecessary.52 Commenters generally

supported the amendment, which the

Commission is adopting as proposed.53

b. Diversification Standards. i. LookThrough 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.54 The ‘‘lookthrough’’ 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.

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.55 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.

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 ‘‘lookthrough’’ 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.56

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.57 The Commission has decided

to further amend the rule to exclude

restricted special purpose entities from

treatment as ten percent obligors.58

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.59
Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Rules and Regulations 64973

60Proposing Release, supra note 6, at n.52 and

accompanying text.

61NRSROs, 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.

62Paragraph (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 twentyfive percent basket under the amended rule when

securities are subject to guarantees or demand

features from multiple providers.

64This 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.

65Release 21837, supra note 2, at n.73 and

accompanying text.

66Paragraphs (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.

67The 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.

68Paragraph (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 sellerprovided 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.

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.60 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.

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.61 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.

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’’).62 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.63 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.64

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.65

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.66

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,67 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.

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.68 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.

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
64974 Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Rules and Regulations

69Paragraph (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.

70Paragraph (c)(10)(v) of rule 2a–7, as amended.

71Six 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.

72See paragraphs (a)(8), (a)(15), (c)(4)(iii) and

(c)(4)(iv) of rule 2a–7, as amended.

73 15 USC 80a–12(d)(1)(E).

74See, 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).

76Paragraph (c)(4)(ii)(E) of rule 2a–7, as amended.

77Paragraph (a)(12) of rule 2a–7, as amended.

78See paragraph (c)(4)(i) of rule 2a–7, as

amended.

79Paragraph (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.

80Paragraph (a)(21) of rule 2a–7, as amended

(definition of ‘‘requisite NRSROs’’).

81Paragraph (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 longterm 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 shortterm 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.

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.69 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.70

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.71 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.72 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.

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).73

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.

Several commenters pointed out that,

as a result of Commission exemptive

orders 74 and amendments to the 1940

Act’s limitations on ‘‘funds of funds’’

arrangements,75 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.76

Under the amended rule, shares of

money market funds are considered to

be first tier securities,77 and are thus

subject to the rule’s issuer

diversification standards with respect to

first tier securities.78 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–7.79

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’’ 80 within the three highest

rating categories.81

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
Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Rules and Regulations 64975

82Paragraph (a)(1) of rule 2a–7, as amended.

83Paragraph (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.

84See 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.

85Paragraph (c)(6)(i)(A)(2) of rule 2a–7, as

amended; see Proposing Release, supra note 6, at

n.72 and accompanying text.

86Paragraph (c)(10)(iii) of rule 2a–7, as amended;

see Proposing Release, supra note 6, at nn.74–75

and accompanying text.

87Paragraph (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.’’

88See 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.

89Proposing 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.

90Quotations 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.

91See 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)].

92 5 USC 801.

93Pub. 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).

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.82

(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.83

(iii) Standby Commitments. As

proposed, the Commission has deleted

the term ‘‘standby commitment’’ and all

references to that term from the rule.84

(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.85

(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.86

(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–7.87

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 noninvestment income. The Commission is

concerned that inclusion of noninvestment 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.88

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.89

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.

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, 90 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.91

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, 92 which

was added by the Small Business

Regulatory Enforcement Fairness Act of

1996 (‘‘SBREFA’’).93 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.94

B. Compliance Dates

The Proposing Release requested

comment whether the Commission

should provide for a six-month
64976 Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Rules and Regulations

95See Proposing Release, supra note 6, at nn.84–

85 and accompanying text.

96The 1996 Amendments ‘‘grandfathered’’ fund

investments in certain securities issued on or before

June 3, 1996.

97Rule 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.

98Paragraph (a)(10)(iii)(A) of rule 2a–7, as

amended.

99Paragraph (a)(10)(iii)(B) of rule 2a–7, as

amended.

100Paragraphs (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.

101Paragraphs (a)(8) and (a)(15) of rule 2a–7, as

amended.

102Paragraph (c)(3)(iv)(B) of rule 2a–7, as

amended.

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

104For 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.

105Many 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 currentlyavailable 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.

106The 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

transition period for compliance.95

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, 96 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.

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.97 Funds must comply with the

amendments to the advertising rules

and forms applicable to money market

funds by February 10, 1998.

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; 98

(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; 99

(iii) The requirements for ABSs

regarding maturity determinations and

ratings; 100

(iv) The requirement that a demand

feature and a guarantee include the

ability to recover principal and any

accrued interest; 101 and

(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.102

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,103 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.

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.104 In addition, any costs

or benefits are likely to affect not only

funds, but also a wide variety of market

participants.105

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.106 In response to these
Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Rules and Regulations 64977

connection with the adoption of rule 2a–7 in 1983,

and in connection with amendments to rule 2a–7

in 1986, 1991 and 1996.

107For 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.

108 15 USC 80a–2(c).

109According to this commenter, the inability to

advertise non-investment income also would have

an adverse effect on competition in the industry.

110The 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.

111 44 U.S.C 3501—3520.

112OMB 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).

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.

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.107

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.108 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.

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, noninvestment income, encourage funds to

increase yield through riskier

investments, and deprive investors of

information regarding consistent

sources of non-investment income.109

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.110

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’’).111 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.112

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.113 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.

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
64978 Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Rules and Regulations

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:

§ 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

(§§ 239.15A and 274.11A of this

chapter), Form N–3 (§§ 239.17a and

274.11b of this chapter), or Form N–4

(§§ 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:

§ 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
Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Rules and Regulations 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 NonControlled 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 subcategories 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 longterm 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:
64980 Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Rules and Regulations

(i) Is a Rated Security that has

received a short-term rating from the

Requisite NRSROs in the highest shortterm rating category for debt obligations

(within which there may be subcategories 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 NonControlled 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

§ 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 shortterm 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 subcategories 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.
Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Rules and Regulations 64981

(27) United States DollarDenominated 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

§§ 270.2a–4 and 270.22c–1 thereunder,

may be computed by use of the

Amortized Cost Method or the PennyRounding 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 marketbased net asset value per share.

(2) Portfolio Maturity. The money

market fund shall maintain a dollarweighted 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
64982 Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Rules and Regulations

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 seventyfive 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
Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Rules and Regulations 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
64984 Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Rules and Regulations

(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: PennyRounding Method. In the case of a

money market fund using the PennyRounding 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
Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Rules and Regulations 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:

§ 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:

§ 270.12d3–1 Exemption of acquisitions of

securities issued by persons engaged in

securities related businesses.

* * * * *

(d) * * *
64986 Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Rules and Regulations

(7) * * *

(v) Acquisition of Demand Features or

Guarantees, as these terms are defined

in §§ 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:

§ 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 § 270.2a–7(a)(8) or § 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:

§ 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 § 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

§ 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

§ 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 § 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 § 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 § 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

§ 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 § 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 § 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 §§ 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 §§ 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

§§ 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 §§ 239.17b and 274.11c)

is amended by:
Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Rules and Regulations 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
64988 Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Rules and Regulations
Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Rules and Regulations 64989
64990 Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Rules and Regulations

[FR Doc. 97–32026 Filed 12–8–97; 8:45 am]

BILLING CODE 8010–01–C