WASHINGTON - A rule proposed by the SEC in December aimed at tightening standards for tax-exempt money market funds would significantly weaken the ability of funds to purchase bonds without increasing investor protection, the Public Securities Association said.
The PSA statement came in a 16-page comment letter that the association sent last week to the Securities and Exchange Commission in response to a rule proposed by the agency Dec. 15 that is designed to heighten the diversity and quality of bonds held by tax-exempt funds. Comments on the SEC's proposed amendments to its money market Rule 2a-7 were due Friday.
The rule would require national funds to limit their invesments in the securities of any one issuer to 5% of total fund assets. In addition, such funds could invest no more than 5% of their assets in "second tier" conduit bonds - those that have the second-highest marks from a rating agency. And national funds could invest no more than 1% of their assets or $1 million, whichever is greater, in the second tier conduit bonds of a single issuer.
The SEC's current rule gives managers of tax-exempt funds more flexibility. It says that with 75% of fund assets, fund managers may invest up to 5% in the securities of any one issuer. The remaining 25% of fund assets, called the "basket," may be invested in any manner, the SEC says.
"The SEC's proposal would eliminate the basket for tax-exempt funds" even though the SEC itself points out in the rule that national funds typically are diversified and do not use the basket anyway, the PSA said. So if funds already are diversified, it is difficult to understand how "casting this diversification in bronze" will significantly increase protection for investors, the PSA said.
The association said the 25% basket rule is a useful device that allows fund to respond to temporary volume increases or shortages in the market.
In other comments, the PSA said it appreciates the fact that the SEC did not extend the 5% diversification test to single state funds, which could be driven out of existence by such a standard, the association said. But the SEC did propose that single state funds be allowed only to invest in first tier securities.
"PSA is concerned that investors do not differentiate between national funds and state funds and that they will be confused if there are substantially different rules for each group," the association said. It would be better to subject national funds and single state funds to the same limitations as long as certain conditions are met, the PSA said.
The PSA also said it had further problems with the SEC restricting single state funds to purchasing only first tier securities. "This would needlessly restrict single state funds and actually work to the disadvantage of the investor," it said.
The group said usually the supply of short-term tax-exempt notes that are eligible for investment by money market funds fluctuates widely during the course of the year. Most states operate on fiscal years that are either the same as the calendar year or run from July 1 to June 30.
Consequently, during June and July or December and January, the supply of short-term tax-exempt notes will likely be greater, while during the remaining months of the year the supply will be more even and possibly low, the PSA said.
"Because of this peculiar characteristic of the municipal short term market, single state funds need greater flexibility rather than less if they are to meet the needs of their investors," the PSA said.
The group said it would be better "to extend the second tier security tests to conduit securities held by single state funds or, if the commission determines more restrictions are required, extend the second tier security tests to all securities held by single state funds."
The PSA and other groups recommended that, once the SEC has reviewed all the comments filed with the agency on the proposed rule and presumably made changes in response to those comments, it re-propose Rule 2a-7 for another round of industry input.
The SEC approved tighter standards for taxable money market funds in 1991, but said it needed more time to study the unique problems of tax-exempts before making its proposals in December.
