Insurance Trend Update: SEC Approves Tighter Money Fund Rules -- Why Financial Institutions Insurers Should Care

June 7, 2013

On  Wednesday, June 5, 2013, the U.S. Securities and Exchange Commission unanimously approved tightened rules for prime institutional money-market funds. (See here for a copy of the SEC press release) The long-discussed new rules would have an impact on "prime" money-market funds, which are among the most attractive for institutional investors and were significantly impacted by the 2008 financial crisis.  The new rules would allow the net asset value ("NAV") share prices of prime funds to float - thereby abandoning the $1/share price currently attached to these funds.  Like other mutual funds, therefore,  the share price of prime funds would be allowed to fluctuate above and below $1.  Also under consideration is a rule that would allow funds to limit redemptions (i.e. "redemption gates") or charge a fee (i.e. "liquidity fees") to redeem shares in prime funds in times of crisis.  The SEC has proposed the rules as either alternatives or to be enacted in tandem.  The proposed rules also includes certain diversification and disclosure requirements, which apply under either or both proposals.

Unlike money-market funds, which invest more heavily in "safe" investments, (like government securities for instance), prime finds are considered to be a riskier investment because they also may invest in short-term corporate debt. 

Supporters of both proposals suggest that the principle behind them is that dramatic changes in prime money-market funds would not cause the extreme market panic -- like "runs" on the funds -- that arose in September 2008 when the Reserve Primary Fund "broke the buck" - i.e. its per share price dropped to less and $1:  "[The SEC] goal is to implement effective reform that decreases the susceptibility of money market funds to runs and prevents events like what occurred in 2008 from repeating themselves,” said Mary Jo White, Chair of the SEC.  Critics say that the proposed rules would not prevent a run on a fund in a time of crisis or could lead to arbitrage of a fund's shares where investors sense a correction coming and try to redeem before any blackout redemption period.

For insurers of mutual funds and investment advisers, the implications of the proposals are related to both liability and damages exposures.  For instance, allowing the NAV to fluctuate below $1 weakens a claim that the loss of NAV below $1 is a per se cause of action.  Increased diversification and disclosure requirements likewise act as a check on liability as well as an affirmative defense to claims.  In addition, redemptions gates can curtail damages to a fund, and liquidity fees could offset losses to a fund caused by redemptions.  

The proposed changes are not uncontroversial; observers believe that lobbying efforts will continue to alter the proposed changes.  Before the changes can be approved, the SEC will solicit comments over the next 90 days.  The industry is sure to respond.

For more information on this issue or Bowditch & Dewey's litigation practice as it relates to insurance issues, please contact Mary-Pat Cormier at mcormier@bowditch.com or 617-757-6527.