SEC Zeroing In on ‘Prime’ Funds; Money Funds Viewed as Most Vulnerable to Flight by Anxious Investors Would Face Tighter Rules

Updated May 2, 2013, 7:01 p.m. ET

SEC Zeroing In on ‘Prime’ Funds

Money Funds Viewed as Most Vulnerable to Flight by Anxious Investors Would Face Tighter Rules

By ANDREW ACKERMAN

WASHINGTON—U.S. securities regulators, under pressure to address risks posed by the $2.6 trillion money-market-mutual fund industry, are considering a scaled-back approach that would tighten rules for about half of the sector that is seen as most vulnerable to investor runs, according to people familiar with staff discussions.The approach, one of several being contemplated at the Securities and Exchange Commission, would require only the riskiest funds to abandon their fixed $1 share price and allow shares to float in value like other mutual funds, these people said.

Such a move would be a win for the industry, which balked at last year’s effort to require money managers to float all of their funds’ share prices or have the funds post banklike capital. The SEC abandoned that approach after then-SEC Chairman Mary Schapiro was unable to secure enough votes.

The ability to resolve long-standing concerns about money funds is a crucial early test for SEC Chairman Mary Jo White, who is under pressure from U.S. and global regulators to fix structural issues that encourage investors to sell their shares quickly during times of stress.

Ms. White is expected to touch on the issue in her first public speech Friday before the Investment Company Institute, a mutual-fund trade group.

The SEC discussions could help pave the way for agreement among the agency’s five commissioners, since it would address the riskiness of money funds in a way that is more palatable to the industry and the commissioners who opposed last year’s plan.

The SEC staff is discussing requiring only funds deemed most at risk of investor stampedes to switch to a floating share price, on the grounds that it would train investors to realize their investments will fluctuate in value without causing them to bolt in times of stress.

The SEC may require only “prime” money funds, which invest in short-term corporate debt, to make the switch. Those funds, which comprise about 54% of the industry, according to Crane Data LLC, are seen as most vulnerable because they were the source of investor runs during the height of the 2008 financial crisis.

More than $300 billion, or 15% of prime-fund assets, fled the funds in one week after the collapse of Lehman Brothers Holdings Inc. in September 2008. Large corporations, securities lenders and other institutions raced to sell shares after the Reserve Primary Fund, one of the largest and oldest prime funds, “broke the buck,” as its share price fell below $1. The U.S. was forced to step in and backstop the funds.

One concern is whether identifying certain funds as more vulnerable to runs could create a self-fulfilling prophecy, with jittery investors fleeing at the first signs of market stress. But supporters argue that switching to a floating share price would make prime funds less susceptible because investors would know the current share price and wouldn’t race to sell in anticipation that it could fall below $1.

The idea has support from the 12 regional Federal Reserve presidents, who endorsed a floating share price earlier this year in a joint letter to the SEC, saying it reduces the advantage to investors who flee a fund just before it breaks the buck. The Fed presidents urged regulators to focus on prime funds, which they said pose the “greatest credit risk.”

Concerns about money funds have increased in recent years as regulators worry about a sudden rise in interest rates, which could depress the value of the funds’ asset holdings. An International Monetary Fund report outlined such a scenario last month, and the Financial Stability Oversight Council, for the third year in a row, cited money funds as a source of systemic risk.
The bulk of the largest money-fund providers have moved since January to voluntarily disclose the daily market values of their fund share prices, an attempt by the industry to pre-empt regulatory changes. The SEC currently discloses the funds’ mark-to-market values after a lag of 60 to 90 days.

The industry says a tailored approach is tolerable because they believe investors who might shun funds with a floating share price will keep their investments in the mutual-fund sector, shifting their cash to other funds that would be allowed to keep a stable share price. Mike McNamee, a spokesman for the ICI, said “if any measures are necessary, they should only apply to prime funds.”

Still, Fidelity Investments Inc., the largest U.S. money-fund firm by assets, doesn’t support a floating share price, saying there is no evidence that funds with variable share prices are at lower risk of significant shareholder redemptions during market turmoil.

The company prefers a narrower approach focused around prime funds held by corporations and other “institutional” investors, including “gates” or special “liquidity fees” that would stop or discourage redemptions in times of stress. A Republican SEC commissioner, Daniel Gallagher, has backed coupling a floating share price with gates.

“The data show that the only funds that experienced large sudden redemptions were institutional prime funds, and therefore regulators need to narrowly tailor any additional reform to those funds,” said Nancy Prior, Fidelity’s president of money markets.