Commissioner Daniel M. Gallagher
Washington, D.C.
July 23, 2014
Thank you, Chair White. I would like to join my colleagues in thanking the staff again for all of the hard work that went into today’s adopting release. I would like to extend a special thank you to Norm Champ, David Grimm, Diane Blizzard, Sarah ten Siethoff, and Thoreau Bartmann in the Division of Investment Management, as well as Jennifer Marietta-Westberg, Vanessa Countryman, Jennifer Bethel and our former colleague Craig Lewis in the Division of Economic and Risk Analysis for their tremendous – and often thankless – efforts on a rulemaking process that has spanned several years and followed a circuitous and sometimes contentious path. It is because of the staff’s dedication and perseverance that we have arrived where we are today.
From the beginning, this rulemaking process has proven to be a difficult undertaking for the Commission and a stark reminder of the heavy weight that comes with sharing the stewardship of an agency that for eight decades has played a pivotal role in our nation’s capital markets. The process has illustrated that it is incumbent on us as Commissioners to set aside any preconceptions we may have and approach each issue dispassionately and with an open mind. It is our duty to strive to understand the substance of those issues as well as the potential impacts of any regulatory approaches we consider – and then to make the difficult decisions that often follow.
Despite an inauspicious start, this rulemaking process has demonstrated the Commission’s ability to make those difficult decisions, and I’m pleased that a majority of the Commission has joined together to successfully conclude our long and arduous path to implement commonsense, reasonable reforms to our rules governing money market mutual funds.
As for my own path to today’s rulemaking, I consistently have been a proponent of requiring money market mutual funds to adopt market-based pricing[1] – that is, a floating net asset value – but not at any cost, and only in the context of a reform package that effectively mitigates risks to investors without forcing money funds to masquerade as federally insured bank deposits. I was not able to support an earlier reform proposal that included a proposal for so-called “capital buffer” requirements. [2] That proposal made no economic sense, as proven by Craig Lewis,[3] and did not fit either the definition of regulatory capital or the structure of money market funds. The paltry so-called “buffer” would have offered only an illusion of protection to investors and the markets. And I would note that the infirmities of the unsuccessful SEC capital buffer proposal of 2012 also feature in pending international proposals, and foreign policymakers should be loath to follow that rabbit down the hole.
Make no mistake – money market mutual funds are not bank products. However, because of the unintended, but perhaps predictable, consequences flowing from the Commission’s adoption of Rule 2a-7 in 1983, today’s multi-trillion dollar money market fund industry is viewed by many market participants as providing the functional equivalent of federally insured bank products. And, of course, the 2008 Treasury money fund insurance program and related Federal Reserve commercial paper facilities did nothing to disabuse market participants of that perception. The status quo of implicit guarantees for money funds is unacceptable, just as it was for Fannie Mae and Freddie Mac in the decades leading up to the crisis. The difference though is that, today, the Commission is doing for money market funds what precious few policymakers were willing to do with the GSEs before the crisis: we are taking action to correct any misconceptions of federal backstops and bailouts for money funds. Addressing a three decade old error in a nuanced and tailored manner to reinstate market-based pricing should not be seen, as some have argued, as a heavy-handed act of government. This is especially true when the fix will positively impact investor behavior and eliminate the perception of taxpayer support.
Like other mutual funds, money market funds should be risk-taking ventures borne of the capital markets, where we want investors, whether retail or institutional, to take risks – informed risks that they freely choose in pursuit of a return on their investments. Today’s reforms squarely address and put investors on notice of this distinction, and I applaud the Commission and staff for resisting outside pressure to apply a bank regulatory paradigm to a product that is so integral to the functioning of the capital markets. Many forget, sometimes all too conveniently, that this agency came very close to imposing a capital buffer on money funds. This was a big-government, bank-regulator preferred proposal that would have crippled the industry. I take great pride in my successful efforts to kill that misguided proposal.
The Commission does not have oversight authority over banks or bank products, and we do not have access to the tools available to the prudential regulators who do. There should be no confusion about that, now or ever, and the agency learned no tougher lesson from the events of 2008. The Commission is an appropriated independent agency without a Treasury line of credit or a balance sheet. We cannot bail out any firm or product, and that is the proper order of things. Our oversight should be focused on market-based valuations and strict capital standards employing those valuations, and in the case of failure, we should be expert in the wind-down process. As I have said so many times recently, we should be the morticians, not the ER doctors.
The tailored floating NAV requirement we are adopting today directly addresses concerns that arose during the financial crisis. Most notably, as has been discussed, it eliminates the first-mover “put” advantage that favors sophisticated institutional investors at the expense of retail investors, leaving the latter holding the proverbial bag. Just as importantly, in my view, today’s floating NAV reforms clarify for investors the risks associated with investing in money market mutual funds while making it clear to the markets and to policymakers that these financial instruments are not bank products to be overseen by prudential regulators, but rather investment products properly regulated by the SEC.
However, as I have consistently stated, requiring money market funds to float their net asset values should help stem a run, but does not fully solve the problem of run risk.[4] Unlike in the banking sector, there is no federal insurance program, and no taxpayer dollars, to help stop runs. Accordingly, it is critical for fund boards to have discretionary tools at their disposal to limit or suspend redemptions temporarily in appropriate circumstances. The fees and gates allowed in today’s rule give fund boards a mechanism to stem the tidal wave of redemptions that can materialize in the midst of a market crisis – and that cannot be stopped by floating the NAV alone. And the gating component of today’s rule is actually just a codification of the status quo with mandated disclosure so investors can better understand the potential of a liquidity event. The current inscrutable hodgepodge of Rule 22E-3 and ad-hoc exemptive relief leaves many investors understandably confused about, or worse, completely oblivious to, the liquidity risks lurking in 2a-7 funds, and it is incumbent on the Commission to address this confusion and provide clarity to investors and the markets – which is exactly what today’s rulemaking does.
Neither reform on its own would have meaningfully achieved all of the objectives we set out to accomplish. But together, as demonstrated by DERA’s comprehensive analysis, today’s floating NAV and fees and gates reforms are a targeted and measured regulatory response and the best path forward for our regulatory oversight of money market mutual funds in the future.
All that said, I have consistently, loudly, and publicly stated that my vote for a floating NAV was contingent on the resolution of the tax and accounting-related issues arising from the move away from a constant NAV.[5] As we make abundantly clear in today’s release, the accounting issues have been completely addressed: money funds are cash equivalents. And, as Chair White noted, concurrently with today’s rulemaking, the Department of the Treasury and the IRS have issued a revenue procedure, that is, an official IRS statement of procedure that may be relied on by taxpayers under the Internal Revenue Code, and a proposed rulemaking that squarely addresses each of the principal concerns that were raised by commenters, and that may be relied upon by taxpayers beginning on the same date that today’s rule becomes effective.
First, Treasury and the IRS have issued a proposed rulemaking that allows taxpayers to use the simplified aggregate accounting method for funds subject to a floating NAV. Under this method, investors will not be required to track and report the cost or tax basis and redemption price of all shares they purchase and redeem. Rather, they will calculate their taxable gain or loss on an aggregate basis at the end of the tax year, based on information already provided in their year-end statements.
Second, Treasury and the IRS have issued a revenue procedure that exempts taxpayers invested in funds subject to a floating NAV from the “wash sale” rules, which prohibit taxpayers from recognizing a loss on the sale of a security if the investor buys a substantially identical security within 30 days – a common occurrence with short term cash management securities such as money market funds. This revenue procedure will become effective on the same day as our amendments, providing full and immediate relief to taxpayers who otherwise would have had to track the timing of individual purchases and redemptions for compliance with the wash sale rules.
These pronouncements from Treasury and the IRS provide the two critical forms of tax relief that commenters consistently cited as necessary in light of our proposed amendments, and my vote for today’s rule is predicated upon the granting of this relief.
I have also insisted that we provide a long compliance period to give the industry and investors the time needed to implement and understand the intricacies of today’s rule, and so I am pleased that there will be a two-year compliance period. Today’s amendments introduce substantial changes to the regulatory framework governing money market funds, and it is imperative that we afford money funds and their investors ample time to make business and investment decisions.
It is also critical that the SEC, as well as Treasury and the IRS, have sufficient time to identify whether any changes need to be made to address unforeseen and unanticipated impacts on registrants and taxpayers. To that end, I called for the creation of an internal working group here at the Commission, as alluded to by Norm Champ, Chair White, and Commissioner Aguilar, that will be dedicated to closely monitoring the application of the rule and responding to any issues that are identified or raised by registrants and taxpayers between now and the compliance date. I will be interacting with this group on a regular basis to ensure appropriate responses to the issues that are raised. Treasury and the IRS also have agreed to work with this newly-formed working group to the extent any further changes need to be made to ensure complete relief for taxpayers under the amended rules.
Given the level of chatter about this rulemaking in the EU, IOSCO, and the FSB, there will be international reactions to today’s rule amendments. It will be up to local authorities to determine whether reforms are needed in their markets, and I caution policymakers abroad to recognize that our reforms reflect the unique features of the U.S. money fund marketplace. In this era of increasingly brazen attempts at reckless, unprecedented “one world” financial regulation, it is crucial to acknowledge that one size does not fit all for money fund reform.
Finally, I note that today we also are reproposing a rule that would remove references to nationally recognized statistical rating organizations from our rules governing money market mutual funds. The congressional mandate to eliminate references to credit ratings from all of our rules is one of the few provisions of the Dodd-Frank Act that actually addresses a core financial crisis problem, and the one year deadline to do so was one of the only deadlines in Dodd-Frank that could have realistically been met had not numerous rulemakings of dubious relevance taken precedence. The process of implementing this mandate has taken far, far too long, and to put it plainly, is unacceptable. There should be no further delay on this rulemaking and I would hope and expect that we will be considering a final rule this year.
Despite the rocky road that we followed to get here, today’s rulemakings in many ways represent the best of the Commission and its staff. Before I conclude, I want to thank my friend and colleague, Luis Aguilar, for his wise counsel, unwavering principles, and collegiality throughout this process. None here can understand what we have been through, Luis, and it is especially satisfying to join you today in moving the agency from the tragedy of 2012 to a proper rulemaking today.
Once again, I would like to express my gratitude for the tireless efforts of the Commission staff and, like Luis, I have no questions.
[1] See, e.g., Joshua Gallu & Robert Schmidt, SEC’s Gallagher Calls for Floating Price for Money Funds, Bloomberg (Sept. 27, 2012), available at http://www.bloomberg.com/news/2012-09-27/sec-s-gallagher-calls-for-floating-price-for-money-market-funds.html (reporting Gallagher comment that “[r]equiring money funds to have a fluctuating share price… [is] an attractive option that I am likely to support”); see also Commissioner Daniel M. Gallagher, SEC Reform After Dodd-Frank and the Financial Crisis (Dec. 14, 2011), available athttp://www.sec.gov/news/speech/2011/spch121411dmg.htm.
[2] See, e.g., Commissioners Daniel M. Gallagher and Troy A. Paredes, Statement on the Regulation of Money Market Funds (Aug. 28, 2012),http://www.sec.gov/News/PublicStmt/Detail/PublicStmt/1365171491064 (“The truth is that we have carefully considered many alternatives, including the Chairman’s preferred alternatives of a “floating NAV” and a capital buffer coupled with a holdback restriction, and we are convinced that the Commission can do better.”); Gallu & Schmidt, supra n. 1 (“Gallagher said he couldn’t vote for Schapiro’s plan because its centerpiece was to make the funds hold extra capital. The cushion was too small to protect investors, Gallagher said, leading him to believe the money would be used as collateral in case the funds needed to borrow from the Federal Reserve. ‘I could not be complicit in a rulemaking that purported to eliminate bailouts but would actually do the opposite,’ Gallagher said.”).
[3] See Craig M. Lewis, The Economic Implications of Money Market Fund Capital Buffers (Nov. 2013), available at http://www.sec.gov/divisions/riskfin/workingpapers/rsfi-wp2014-01.pdf.
[4] See Statement of Commissioners Gallagher and Paredes, supra n. 2 (“As for the floating NAV proposal, even if there is no stable $1.00 NAV — i.e., even if, by definition, there is no ‘buck’ to break — investors will still have an incentive to flee from risk during a crisis period such as 2008, because investors who redeem sooner rather than later during a period of financial distress will get out at a higher valuation.”).
[5] See, e.g., Gallu & Schmidt, supra n. 1 (“Gallagher said his support of a floating share price was contingent on the SEC ‘fully understanding and addressing’ the tax and accounting issues that could arise.”).
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