FSOC It to 'Em: Money Fund Reforms Back
November 17, 2012
A jury last week found the father and son running the Reserve Primary fund not guilty of fraud but liable on one count of negligence. The verdict seemed another setback for the Securities and Exchange Commission, which in August shot down proposed money fund reforms from its own chairman, Mary Schapiro.
But make no mistake: Regulators are pressing ahead reforms to the funds, which present themselves as safe alternatives to bank accounts.
The effort is to address threats money funds can pose to the financial system, such as a run on their accounts that might require another federal bailout as happened in 2008 after the Reserve Primary fund famously broke the fundamental industry promise that a dollar invested would always be worth a buck.
Proposals put on the table by the two-year-old Financial Stability Oversight Council, chaired by Treasury Secretary Timothy Geithner, included:
* Floating the Net Asset Value. Funds would publish net asset values at end of each day that would fluctuate, based on the actual value of underlying assets. Meaning: The value of a share won't be a buck at all times. The proposal removes a special exemption that allows funds to utilize amortized cost accounting or penny rounding or both to maintain a stable net asset value;
* Stable NAV with Capital Buffer and Minimum Balance at Risk. Funds would set asset up to 1% of assets to absorb day-to-day fluctuations in the value of the funds' portfolio securities and allow the funds to maintain a stable NAV;
* Stable NAV with Greater Capital Buffer. Funds would establish buffer of 3% of assets to absorb losses or sudden runs. This could be combined with other measures, such as limits on redemptions in given periods, to increase the resiliency of money funds
In a statement, the FSOC said its proposed recommendations "are not mutually exclusive and could be implemented in combination to address the structural vulnerabilities that result in the susceptibility of (money market mutual funds) to runs."
"The Council also recognizes that regulated and unregulated or less-regulated cash management products may pose risks that are similar to those posed by MMFs and that further MMF reforms could increase demand for non-MMF cash management products," it said.
Opponents of the FSOC's proposals immediately surfaced. The Investment Company Institute, which also opposed the SEC's proposal to float the NAV, and the chairman of the ICI Money Market Working Group, William McNabb, responded with dismay.
"It's deeply disappointing that the Council has proceeded without giving due weight to the views of fund sponsors, investors, and the issuers who depend upon money market funds for vital financing," said McNabb. McNabb is also the chief executive of Vanguard Group, the largest operator of mutual funds.
ICI president and CEO Paul Schott Stevens said that: "Regrettably, today's action by the FSOC fails to advance the debate over how to make money market funds more resilient in the face of financial crisis. The Council apparently is proposing to send back to the SEC the very same concepts that a majority of the Commission's members declined to issue for public comment in August."
The process that the FSOC is following is "deeply flawed," Stevens said, because the SEC is the only agency that has the necessary expertise as the regulator of mutual funds. He said that the FSOC's proposals, if implemented, will increase risks to the financial system by concentrating assets in a few large institutions or driving assets into alternative products that are far less regulated and transparent than money market funds."
Bent, But Not Broken
The SEC's "expertise" in regulating money funds, in fact, took a hit last week when a panel of six women and one man in New York City found Bruce Bent II, president of the failed $62.5 billion Reserve Primary money-market fund, liable for one claim that he negligently violated a securities law regulating investment advisers. His father, formerly chief executive officer at Reserve, Bruce Bent, was cleared of all four claims against him, including that he "knowingly and recklessly violated" U.S. securities law, in promoting the fund.
The SEC sued the Bents, their investment advisory firm Reserve Management Co. and Resrv Partners in 2009, alleging they had defrauded customers by falsely claiming they would support the fund financially when it faced a run by investors in the wake of the 2008 Lehman Brothers Holdings bankruptcy.
The fund held $785 million in Lehman debt on Sept. 15, 2008, the day Lehman filed the biggest bankruptcy in history, causing the run on the fund and triggering its failure the following day when it "broke the buck" by failing to maintain a $1-a-share net asset value.
The SEC alleged the Bents lied on the morning after Lehman announced its bankruptcy, falsely telling investors, regulators and the fund's trustees that they would use money from their firm, Reserve Management Co., to support the $1 net asset value of fund shares.
The jury today found that RMCI and Reserve Partners "knowingly and recklessly" violated federal securities laws and that RMCI had violated a federal law regulating investment advisers. But the jury also found the elder Bent not guilty on all counts of fraud.
John Dellaportas, a lawyer for the Bents, said he's considering an appeal of the jury's negligence verdict against Bruce Bent II.
On the other side, Robert Khuzami, director of the SEC's Division of Enforcement, is claiming victory for the Commission. "Today's verdict of liability sends the message that fund executives cannot withhold from investors and trustees key information about their fund's vulnerability," he said, in a statement.
Spokespeople for the SEC, ICI, Treasury and Federated Investors declined to further comment on the case.