WASHINGTON - The Securities and Exchange Commission is likely to vote soon on a plan to tighten credit quality standards for tax-exempt money market funds that will differentiate between holdings in governmental and conduit bonds, SEC Chairman Arthur Levitt, Jr., told Congress yesterday.
Levitt made the announcement at an oversight hearing on the nation's $1.9 trillion mutual and money market fund industry that was conducted by the Senate Banking Committee's subcommittee on securities.
"The commission will soon consider further revisions to its money market fund rule to set forth appropriate diversification standards for funds investing in tax-exempt instruments," Levitt told the panel chaired by Sen. Christopher Dodd, D-Conn.
"The revisions will likely include credit quality standards for tax-exempt funds designed to address, among other things, the differences between instruments issued by a governmental entity, such as a city, and ~conduit' bonds in which the underlying obligor is a corporation or other non-governmental project," Levitt said.
"These revisions will be designed to provide investors in tax-exempt funds the same degree of safety of principal that the rule provides for taxable funds," he said.
Last year the SEC issued final rules that tightened its standards governing the quality and diversity of commercial paper and other securities held by money market funds. The revisions to the agency's Rule 2a-7 applied largely to taxable funds because the commission's staff said it needed more time to study the tax-exempt market.
Robert Plaze, assistant director for investment management at the SEC, said in a telephone interview yesterday that the staff probably will send a proposal to the commission for review by the end of the year.
The commission then would conduct an open meeting where it would vote on whether to propose the standard for public comment, which Levitt said will be "soon."
"One of the things we are going to look at is whether tax-exempts should be brought in [in] two groups and treated differently," Plaze said. "The question is whether governmental bonds should be treated differently than conduit municipals for purposes of diversity and quality.
"Let's say there are limits on what percentage of its portfolio [a fund] can hold in securities issued by a particular issuer. [You] could have one level of diversity for municipals directly issued by municipalities and another for conduits," Plaze said.
The SEC ruled in 1991 that a taxable money market fund can invest only up to 5% of its assets in "second-tier" commercial paper, such as debt rated A-2 or P-2 by nationally recognized rating agencies. And no more than 1% of the fund's assets or $1 million per issue, whichever is grea"ter, can be invested in second-tier debt of a single issuer.
The rule also limits a fund's holdings in "split paper," which is an issue rated differently by various agencies. A fund can buy split-rated paper that has received the highest rating from at least two rating agencies. A split-rated security that has received the highest rating by only one rating agency may be bought by a fund, but it must be included in the 5% basket of second-tier securities.
The SEC also said a fund can invest no more than 5% of its assets in securities of any one issuer and no more that 10% of its assets in securities backed by any one bank or other institution.
The Investment Company Institute recommended in an "informal" letter to the SEC in 1991 that so-called single state funds should not be held to the same diversity standards as funds that invest in the securities of more than one state. According to the diversity standards, no more than 5% of assets can be invested in any one issuer.
The reason is that there is a limited supply of tax-exempt securities in certain states, the group said.
Levitt did not address a controversial proposal being pushed by SEC Commissioner Richard Roberts that Rule 2a-7 be amended to restrict fund managers from holding the bonds of issuers that do not pledge in official statements to provide secondary market disclosure.
"It's in the mix," Plaze said, noting, however, that the investment management division has not made a final decision on whether to include the proposal in the rule it finally recommends before the end of the year to the commission.
"I will be surprised if it's not included in the proposal," Roberts said in a telephone interview late yesterday.
At yesterday's hearing, Levitt also released the results of a survey commissioned by the SEC Office of Economic Analysis that found that 66% of investors holding money market funds sold through banks think the funds are federally insured.
And 28% of the total number of people surveyed thought all mutual funds sold through banks were federally insured like savings accounts and certificates of deposit.
Levitt said he is concerned about the results and has briefed bank regulators about the problem. The issue is one of several issues the agency is tracking in the mutual fund area, he said.
"Mutual funds and other investment companies have become significant purchasers not only of equity securities but also of municipal securities," Levitt said. "The participation of these funds has resulted in significant savings for municipalities. One source estimated that municipalities saved $230 million in 1992 because they were able to place large amounts of their municipal securities with a small number of mutual fund purchasers."
