Recent events in the commercial paper market, beginning with Lehman Brothers Holdings, Inc.'s declaration of bankruptcy on September 15, 2008, have led some money market funds to "break the buck." These funds were unable to maintain a stable net asset value or share price (a "stable share price") of $1.00. As this was the first incidence of any significant money market funds paying redemption proceeds of less than $1.00 per share, many money market funds began experiencing a wave of redemptions. In turn, these redemptions led to further dislocations in the credit markets. In an effort to enhance market confidence and alleviate investors' concerns, the Treasury Department has established a temporary guarantee program for money market funds (the "Program") that provides coverage to certain shareholders of a publicly offered money market fund that is registered under the Investment Company Act of 1940 (the "1940 Act") and is regulated pursuant to Rule 2a-7 under the 1940 Act.1The Program only protects shareholders' accounts that were in existence on September 19, 2008 , as discussed below, and only if the fund applied to participate by October 8, 2008 .2
The Program guarantees a $1.00 share price for the number of shares owned by a shareholder in any participating money market fund as of the close of business on September 19, 2008 . The value attributed to an increase in the number of shares owned by a shareholder after the close of business on September 19, 2008 is not guaranteed. If the number of shares owned by a shareholder fluctuates over the period of the Program, the shareholder is covered for the lesser of the number of shares owned as of the close of business on September 19, 2008 or the number of shares owned as of the Guarantee Event, as defined below. This means that if an investor sells shares in a participating money market fund after September 19, 2008 and that fund's market value based net asset value per share falls below $0.995, the Program will compensate the investor only for the lesser number of shares owned.
The Program's guarantee will be triggered if a participating fund's market value based net asset value per share falls below $0.995, commonly referred to as "breaking the buck" (a "Guarantee Event"), unless promptly cured, provided that the fund liquidates promptly after the Guarantee Event. The coverage provided to any fund is subject to the overall amount of funds available under the Program.
The Program is funded through the Treasury Department's Exchange Stabilization Fund.3A fund must pay a fee to participate in the Program. Money market funds with a market value based net asset value per share greater than or equal to $0.9975 as of the close of business on September 19, 2008 must pay a nonrefundable up-front fee of 0.01 percent (1 basis point) based on the number of shares per class outstanding on that date. Money market funds with a market value based net asset value per share greater than or equal to $0.995 and below $0.9975 as of the close of business on September 19, 2008 must pay a nonrefundable up-front fee of 0.015 percent (1.5 basis points) based on the number of shares per class outstanding on that date. Money market funds with a market value based net asset value per share below $0.995 as of the close of business on September 19, 2008 were not eligible to participate in the Program.
The Program applied to participating funds on a fund-by-fund basis, and the performance of one fund in a fund complex would not affect the guarantee of a different participating fund in the same complex. A Guarantee Event would occur for the entire fund whenever the market value based net asset value of any class of a fund falls below $0.995 per share.
The form of guarantee agreement for participating money market funds, as further clarified by the Treasury Department, imposed a number of significant requirements, including the following:
• If a Guarantee Event occurs, the fund must be liquidated in an orderly manner. Specifically, after a Guarantee Event the fund must provide notice to the Treasury Department on the next business day, initiate liquidation of the fund within five business days, cease the declaration and payment of dividends, cease issuing new shares, suspend redemptions and complete liquidation of the fund within 30 days, unless the Treasury Department consents to a later date.
• Participating money market funds must represent that they are managed in a manner that is designed to reduce the likelihood that a Guarantee Event under the Program will occur.
• Participating money market funds must comply with Rule 2a-7 under the 1940 Act at all times. However, the Treasury Department does not intend to withhold payment if non-compliance with Rule 2a-7 amounts to a technical, procedural or clerical error that was not a contributing factor to a Guarantee Event.
• If a Guarantee Event occurs, the fund must promptly demand payment of all amounts due to the fund from any person that has agreed to make a capital contribution or other payment to the fund pursuant to an agreement to facilitate the maintenance of a stable share price (a "NAV Support Agreement"). Generally, this means that any other credit support should be used before the Treasury Department pays under the Program. In a common credit support arrangement, an affiliate of a fund would guarantee to make up the difference should the value of a portfolio security fall below a predetermined value.
• Participating money market funds must agree that they will not terminate any NAV Support Agreement unless (1) it is replaced with a new NAV Support Agreement approved by the Treasury Department, (2) the funds renew any such agreement subject to an extension and (3) the funds use their "best efforts" to obtain NAV Support Agreements as may be necessary and appropriate (taking into account the expenses that the fund would incur) to facilitate the maintenance of their $1.00 share price.
• Participating money market funds must assign to the Treasury Department all rights to claims, demands, lawsuits and judgments with respect to the fund's business, ownership or use or value of any asset, including, but not limited to, any rights against the fund's investment adviser for malfeasance, breach of contract, breach of fiduciary duty or any other claim, to the extent of any guarantee payment under the Program.
• Participating money market funds must consent to the appointment of any receiver, liquidation trustee or similar official designated by the Treasury Department or the Securities and Exchange Commission to administer and oversee the liquidation of the fund.
• The Treasury Department is not obligated to pay a guarantee to any money market fund participating in the Program if the Treasury Department, in its sole and absolute discretion, determines that any of the representations and warranties made by a fund or its investment adviser under the guarantee agreement and its related acknowledgements and extensions, or under any other notice delivered or any information provided under the guarantee agreement, was incorrect when made.
Additional clarification, including details on operational matters, has also been provided from the Investment Company Institute, the staff of the Securities and Exchange Commission and the Treasury Department (available on their respective websites).
Renewal Of The Program
While the Program was voluntary, many fund complexes (including large fund groups) have applied to participate. The Program and the guarantee will initially expire on December 18, 2008, but the Treasury Department may choose to extend the Program until September 18, 2009. The participation fees described above cover only the first three months of participation in the Program. If the Program is extended beyond its initial time frame, money market funds will have to renew their participation in the Program with each extension in order to maintain the guarantee. To be eligible to participate in the extension of the Program, a participating fund must have a net asset value per share of at least $0.995 on the extension date.
Money market funds are an important market for commercial paper. Substantial redemptions in money market funds have caused dislocations in the commercial paper market, causing many operating companies to have difficulty financing their daily operations. (The U.S. Federal Reserve has announced details of a program to purchase companies' top-rated commercial paper in hopes of normalizing the commercial paper market.) So long as these dislocations exist, the Treasury Department may need to extend the Program in order to prevent further large redemptions from money market fund investors. Other factors may also lead the Treasury Department to extend the Program, including the need to avoid large capital movements from money market funds to insured bank deposit accounts, and causing additional credit market dislocations.
1 The staff of the Securities and Exchange Commission has indicated that it is considering substantial amendments to Rule 2a-7, which specifically governs money market funds (including standards for credit quality, diversification and maturity of portfolio instruments).
2 The Program initially required that a fund have a policy of maintaining a stable share price of $1.00; however, on October 8, 2008, the Treasury Department extended the enrollment period for the Program to October 10, 2008 for funds that have a policy of maintaining a stable share price that is greater than $1.00, and had such a policy on September 19, 2008. The Program is substantially similar for such funds, but certain technical items, such as the definition of a Guarantee Event, are different to reflect the differences in the stable share price of such funds.
3 The Exchange Stabilization Fund was established by the Gold Reserve Act of 1934, as amended, and has approximately $50 billion in assets. The Act authorizes the Secretary of the Treasury, with the approval of the President, "to deal in gold, foreign exchange, and other instruments of credit and securities" consistent with the obligations of the U.S. government in the International Monetary Fund to promote international financial stability. The amount of any guarantee payment under the Program is dependent on the availability of funds in the Exchange Stabilization Fund.
Benjamin J. Haskin is a Partner in the Washington, DC office of Willkie Farr & Gallagher LLP where he practices in the Asset Management Group. Y. Rachel Kuo is an Associate in the Asset Management Group in Willkie's Washington office.