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SECURITIES AND EXCHANGE COMMISSION

U.S. Immigration and Customs Enforcement

CFR Citation: 17 CFR Parts 270 and 275

RIN ID: RIN 3235-AK19

DOCUMENT ID: [Release Nos. IC-28327; IA-2751 File No. S7-19-08]

NOTICE: Part IV

DOCUMENT ACTION: Proposed rule.

SUBJECT CATEGORY: References to Ratings of Nationally Recognized Statistical Rating Organizations

DATES: Comments should be received on or before September 5, 2008.

DOCUMENT SUMMARY: This is one of three releases that the Securities and Exchange Commission (``Commission'') is publishing simultaneously relating to the use in its rules and forms of credit ratings issued by nationally recognized statistical rating organizations (``NRSROs''). In this release, the Commission proposes to amend five rules under the Investment Company Act of 1940 and the Investment Advisers Act of 1940 that rely on NRSRO ratings. The proposed amendments are designed to address concerns that the reference to NRSRO ratings in Commission rules may have contributed to an undue reliance on NRSRO ratings by market participants.

SUMMARY: Securities and Exchange Commission,

SUPPLEMENTAL INFORMATION

The Commission is proposing for public comment amendments to rules 2a7 [17 CFR 270.2a7], 3a7 [17 CFR 270.3a7], 5b3 [17 CFR 270.5b3], and 10f3 [17 CFR 270.10f3] under the Investment Company Act of 1940 (``Investment Company Act''),\1\ and amendments to rule 206(3)3T [17 CFR 275.206(3)3T] under the Investment Advisers Act of 1940 (``Investment Advisers Act'' or ``Advisers Act'').\2\
\1\ 15 U.S.C. 80a. Unless otherwise noted, all references to rules under the Investment Company Act will be to Title 17, Part 270 of the Code of Federal Regulations [17 CFR 270], and all references to statutory sections are to the Investment Company Act.
\2\ 15 U.S.C. 80b. Unless otherwise noted, all references to rules under the Investment Advisers Act will be to Title 17, Part 275 of the Code of Federal Regulations [17 CFR 275], and all references to statutory sections are to the Investment Advisers Act. Table of Contents
I. Introduction
II. Background
III. Discussion

A. Rule 2a7

1. Minimal Credit Risk Determination

2. Portfolio Liquidity

3. Monitoring Minimal Credit Risks

4. Commission Notice of Rule 17a9 Transactions

B. Rule 3a7

C. Rule 5b3

D. Rule 10f3

E. Rule 206(3)3T
IV. Request for Comment
V. Paperwork Reduction Act
VI. CostBenefit Analysis
VII. Consideration of Promotion of Efficiency, Competition and Capital Formation
VIII. Regulatory Flexibility Act Certification
IX. Initial Regulatory Flexibility Analysis
X. Statutory Authority
Text of Proposed Rule Amendments

I. Introduction

On June 16, 2008, in furtherance of the Credit Rating Agency Reform Act of 2006,\3\ the Commission published for notice and comment two rulemaking initiatives.\4\ The first proposes additional requirements for NRSROs \5\ that were directed at reducing conflicts of interest in the credit rating process, fostering competition and comparability among credit rating agencies, and increasing transparency of the credit rating process.\6\ The second is designed to improve investor understanding of the risk characteristics of structured finance products. Those proposals address concerns about the integrity of the credit rating procedures and methodologies of NRSROs in light of the role they played in determining the credit ratings for securities that were the subject of the recent turmoil in the credit markets. \3\ Public Law No. 109291, 120 Stat. 1327 (2006).
\4\ Proposed Rules for Nationally Recognized Statistical Rating Organizations, Securities Exchange Act Release No. 57967 (June 16, 2008) [73 FR 36212 (June 25, 2008)] (``NRSRO June 16, 2008 Proposing Release'').
\5\ As described in more detail below, an NRSRO is an
organization that issues ratings that assess the creditworthiness of an obligor itself or with regard to specific securities or money market instruments, has been in existence as a credit rating agency for at least three years, and meets certain other criteria. The term is defined in section 3(a)(62) of the Securities Exchange Act of 1934 (``Exchange Act''). A credit rating agency must apply with the Commission to register as an NRSRO, and currently there are ten registered NRSROs.

\6\ See Press Release No. 2008110 (June 11, 2008).

Today's proposals comprise the third of these three rulemaking initiatives relating to credit ratings by an NRSRO that the Commission is proposing. This release, together with two companion releases, sets forth the results of the Commission's review of the requirements in its rules and forms that rely on credit ratings by an NRSRO. The proposals also address recent recommendations issued by the President's Working Group on Financial Markets (``PWG''), the Financial Stability Forum (``FSF'') and the Technical Committee of the International Organization of Securities Commissions (``IOSCO'').\7\ Consistent
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with these recommendations, the Commission is considering whether the inclusion of requirements related to ratings in its rules and forms has, in effect, placed an ``official seal of approval'' on ratings that could adversely affect the quality of due diligence and investment analysis. The Commission believes that today's proposals could reduce undue reliance on credit ratings and result in improvements in the analysis that underlies investment decisions.
\7\ See President's Working Group on Financial Markets, Policy Statement on Financial Market Developments (March 2008), available at www.ustreas.gov (``PWG Statement''); The Report of the Financial Stability Forum on Enhancing Market and Institutional Resilience (April 2008), available at www.fsforum.org (``FSF Report''); Technical Committee of the International Organization of Securities Commissions, Consultation Report: The Role of Credit Rating Agencies in Structured Finance Markets (March 2008), p. 9, available at www.iosco.org. II. Background

The Commission first used the term ``NRSRO'' in our rules in 1975 in the net capital rule for brokerdealers, Rule 15c31 (``Net Capital Rule'') \8\ under the Securities Exchange Act of 1934 (the ``Exchange Act'') \9\ as an objective benchmark to prescribe capital charges for different types of debt securities. Since then, we have used the designation in a number of regulations under the federal securities laws. Although we originated the use of the term NRSRO for a narrow purpose in our own regulations, ratings by NRSROs today are used widely as benchmarks in federal and state legislation, rules issued by other financial regulators, in the United States and abroad, and private financial contracts.
\8\ 17 CFR 240.15c31.

\9\ 15 U.S.C. 78a.

Referring to NRSRO ratings in regulations was intended to provide a clear reference point to both regulators and market participants. Increasingly, we have seen clear disadvantages of using the term in many of our regulations. Foremost, there is a risk that investors interpret the use of the term in laws and regulations as an endorsement of the quality of the credit ratings issued by NRSROs, which may have encouraged investors to place undue reliance on the credit ratings issued by these entities. In addition, as demonstrated by recent events,\10\ there has been increasing concern about ratings and the ratings process. Further, by referencing ratings in the Commission's rules, market participants operating pursuant to these rules may be vulnerable to failures in the ratings process. In light of this, the Commission proposes to amend regulations under the Investment Company Act and the Investment Advisers Act that use the term NRSRO or refer to NRSRO ratings.\11\
\10\ See NRSRO June 16, 2008 Proposing Release, supra note 4, at Section I.C.
\11\ These regulations include rules 2a7, 3a7, 5b3 and 10f3 under the Investment Company Act and rule 206(3)3T under the Investment Advisers Act.

III. Discussion

The credit ratings issued by NRSROs are used in four of the Commission's rules under the Investment Company Actrules 2a7, 3a7, 5b3, and 10f3and one rule under the Investment Advisers Actrule 206(3)3T. These rules use the credit ratings issued by the NRSROs in different contexts, and for different purposes, to distinguish among various grades of debt and other rated securities. We propose to amend each rule to omit references to NRSRO ratings and, except with respect to one of the rules, substitute alternative provisions that are designed to appropriately achieve the same purpose as the ratings. Below we discuss these proposals in greater detail in the context of each rule we propose to amend.

A. Rule 2a7

Rule 2a7 under the Investment Company Act governs the operation of money market funds. Unlike other investment companies (``funds''), money market funds seek to maintain a stable share price, typically at $1.00 per share. To do so, most money market funds use the amortized cost method of valuation (``amortized cost method'') or the penny rounding method of pricing (``pennyrounding method'') permitted by rule 2a7.\12\ The Investment Company Act and applicable rules generally require funds to calculate current net asset value per share by valuing their portfolio instruments at market value or, if market quotations are not readily available, at fair value as determined in good faith by the board of directors.\13\ These valuation requirements are designed to prevent unfair share pricing from diluting or otherwise adversely affecting the interests of investors.\14\
\12\ Under the amortized cost method, portfolio instruments are valued by reference to their acquisition cost as adjusted for amortization of premium or accretion of discount. See rule 2a 7(a)(2). Share price is determined under the pennyrounding method by valuing securities at market value, fair value or amortized cost and rounding the per share net asset value to the nearest cent on a share value of a dollar, as opposed to the nearest one tenth of one cent. See rule 2a7 (a)(18).
\13\ See section 2(a)(41) of the Investment Company Act (defining value) and rules 2a4 (defining current net asset value) and 2a7(c) thereunder (money market fund share price calculations). \14\ If shares are sold or redeemed based on a net asset value which turns out to have been either understated or overstated to the amount at which portfolio instruments could have been sold, then the interests of either existing shareholders or new investors will have been diluted. See Investment Trusts and Investment Companies: Hearings on S. 3580 Before a Subcomm. of the Sen. Comm. on Banking and Currency, 76th Cong., 3d Sess. 136138, 288 (1940).

Rule 2a7 exempts money market funds from these provisions but contains maturity, quality, and diversification conditions designed to minimize the deviation between a money market fund's stabilized share price and the market value of its portfolio.\15\ Among these conditions, rule 2a7 limits a money market fund's portfolio investments to securities that have received credit ratings from the ``Requisite NRSROs'' in one of the two highest shortterm rating categories or comparable unrated securities (i.e., ``Eligible Securities'').\16\ Rule 2a7 further restricts money market funds to securities that the fund's board of directors (which typically rely on the fund's adviser \17\) determines present minimal credit risks, and specifically requires that determination ``be based on factors pertaining to credit quality in addition to any ratings assigned to such securities by an NRSRO.'' \18\
\15\ Rule 2a7 contains conditions that apply to each investment a money market fund proposes to make, as well as conditions that apply to a money market fund's entire portfolio.
\16\ The term ``Eligible Security'' is defined in rule 2a 7(a)(10). ``Requisite NRSROs'' is defined in rule 2a7(a)(21). \17\ See rule 2a7(e).
\18\ Rule 2a7(c)(3)(i). Thus, under the current rule, where the security is rated, having the requisite NRSRO rating is a necessary but not sufficient condition for investing in the security and cannot be the sole factor considered in determining whether a security presents minimal credit risks. See Revisions to Rules Regulating Money Market Funds, Investment Company Act Release No. 18005 (Feb. 20, 1991) [56 FR 8113 (Feb. 27, 1991)], at text preceding n.18.

We propose to eliminate references to ratings by amending rule 2a7 in four principal ways.\19\ In combination, these proposed amendments are designed to offer similar protections to the current rule's reliance on NRSRO ratings.\20\
\19\ The proposed amendments would also make conforming amendments to rule 2a7's record keeping and reporting requirements. See proposed rule 2a7(c)(11).
\20\ In 2003, the Commission published a concept release in which we sought comment on the use of NRSRO ratings in our rules. See Rating Agencies and the Use of Credit Ratings Under the Federal Securities Laws, Investment Company Act Release No. 26066 (June 4, 2003) [68 FR 35258 (June 12, 2003)]. Comments on the concept release are available at: http://www.sec.gov/rules/concept/s71203.shtml. As discussed above, recent events have highlighted the need to revisit our reliance on NRSRO ratings in the context of these developments. See also the extensive discussion of market developments in the NRSRO June 16, 2008 Proposing Release, supra note 4.

1. Minimal Credit Risk Determination

Under the proposed amendments, we would rely on money market fund boards of directors to determine that each portfolio instrument presents minimal credit risks,\21\ and whether the
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security is a ``First Tier Security'' or a ``Second Tier Security'' for purposes of the rule.\22\ We believe that money market fund boards of directors would still be able to use quality determinations prepared by outside sources, including NRSRO ratings that they conclude are credible, in making credit risk determinations. We expect that the boards of directors (or their delegates) would understand the basis for the rating and make an independent judgment of credit risks. \21\ See proposed rule 2a7(a)(10).
\22\ Rule 2a7(c)(4) addresses portfolio diversification requirements for money market funds, including diversification requirements relating to First and Second Tier Securities.

Under the proposed amendments, a security would be an Eligible Security if the board of directors determines that it presents minimal credit risks, which determination must be based on factors pertaining to credit quality and the issuer's ability to meet its shortterm financial obligations.\23\ A security would be a First Tier Security if the fund's board had determined that the issuer has the ``highest capacity to meet its shortterm financial obligations.'' \24\ A security would be a Second Tier Security if it is an Eligible Security but is not a First Tier Security.\25\ We have designed these proposed definitions to retain a degree of risk limitations similar to what is in the current rule.
\23\ Proposed rule 2a7(a)(10).
\24\ Proposed rule 2a7(a)(12).
\25\ See rule 2a7(a)(22). The specific language of this provision would not change, but the definitions of ``Eligible Security'' and ``First Tier Security'' would change under the proposal. Consistent with the current rule, under proposed rule 2a 7, a money market fund that is not a tax exempt fund generally must limit its investments in Second Tier Securities to no more than five percent of fund assets, with investment in the Second Tier Securities of any one issuer being limited to the greater of one percent of fund assets or one million dollars. Proposed rule 2a 7(c)(3)(ii)(A) and (c)(4)(i)(C)(1). Tax exempt money market funds are subject to different limitations on investments in Second Tier Conduit Securities. Rule 2a7(c)(3)(ii)(B) and (c)(4)(i)(C)(2).

We request comment on the proposed amendments. What are the advantages and disadvantages of eliminating the requirement to use NRSRO ratings from rule 2a7? Would eliminating the rating requirements from rule 2a7 affect the amount or nature of risks money market funds would be willing or able to take? What are the advantages and disadvantages of relying on minimum credit risk determinations? What are the advantages and disadvantages of having fund directors and investment advisers exclusively make credit quality determinations? Are we correct that the current rule's reliance on credit ratings discourages fund directors and investment advisers from performing independent credit risk assessments? What other alternatives could we adopt to encourage more independent credit risk analysis and meet the regulatory objectives of rule 2a7's requirement of NRSRO ratings? Are the distinctions our proposed amendments would draw between First Tier and Second Tier Securities workable? Is there a better way to describe the characteristics of a First Tier Security without reference to ratings? Are we correct in our expectation that the proposed standards would not impose additional burdens on boards or investment advisers, or require new recordkeeping requirements?

2. Portfolio Liquidity

Under the proposed amendments, a money market fund must hold securities that are sufficiently liquid to meet reasonably foreseeable redemptions in light of the fund's obligations under section 22(e) of the Investment Company Act and any commitments the fund has made to its shareholders.\26\ In addition, the proposed amendments would expressly limit a money market fund's investment in illiquid securities to not more than 10 percent of its total assets.\27\ The proposed amendments would define a Liquid Security as a security that can be sold or disposed of in the ordinary course of business within seven days at approximately the value ascribed to it by the money market fund.\28\ These proposed provisions should be familiar to managers of money market funds. Past releases proposing, adopting and amending rule 2a7 repeatedly emphasized the special duty of the board of directors of a money market fund to monitor purchases of illiquid instruments.\29\ Money market funds often have a greater and perhaps less predictable volume of redemptions than other openend investment companies. Further, the portfolio management of a money market fund may be impaired if a fund were forced to meet redemption requests by selling marketable securities that it would otherwise wish to retain in order to avoid attempting to dispose of illiquid portfolio instruments.\30\ In light of these potential problems, the proposal would prohibit money market funds from acquiring illiquid securities representing more than 10 percent of their total assets.\31\ In the event that changes in the money market fund's portfolio or other external events cause the fund's investments in illiquid instruments to exceed 10 percent of the fund's assets, the money market fund would have to take steps to bring the aggregate amount of illiquid securities back within the proposed limitations as soon as reasonably practicable. However, consistent with the current rule, this requirement generally would not force the money market fund to liquidate any portfolio security where the fund would suffer a loss on the sale of that instrument.\32\
\26\ See proposed rule 2a7(c)(5). Section 22(e) of the Investment Company Act prohibits registered investment companies from suspending the right of redemption or postponing the date of payment upon redemption of any redeemable security for more than seven days except for certain periods specified in the provision. While the Investment Company Act requires only that an investment company make payment of the proceeds of redemption within seven days, most money market funds promise investors that they will receive proceeds much sooner, often on the same day that the request for redemption is received by the fund.
\27\ The proposed standard codifies the current standard regarding portfolio liquidity. See Revisions to Rules Regulating Money Market Funds, Investment Company Act Release No. 21837 (Mar. 21, 1996) [61 FR 13956 (Mar. 28, 1996)] (``Rule 2a7 1996 Amending Release''), at text accompanying n.108 (``The limit on money fund holdings of illiquid securities is ten percent of fund assets.''); Acquisition and Valuation of Certain Portfolio Instruments by Registered Investment Companies, Investment Company Act Release No. 14983 (Mar. 12, 1986) [51 FR 9773 (Mar. 21, 1986)] (``1986 Valuation Release''). Although credit ratings do not directly incorporate liquidity risks, they have been used as a proxy for liquidity because a security may lose liquidity if its credit rating falls. \28\ See proposed rule 2a7(a)(17). See also 1986 Valuation Release, supra note 27 at text following n.21.
\29\ See, e.g., Valuation of Debt Instruments and Computation of Current Price per Share by Certain OpenEnd Investment Companies (Money Market Funds), Investment Company Act Release No. 12206 (Feb. 1, 1982) [47 FR 5428 (Feb. 5, 1982)] (proposing rule 2a7); Valuation of Debt Instruments and Computation of Current Price Per Share by Certain OpenEnd Investment Companies (Money Market Funds), Investment Company Act Release No. 13380 (July 11, 1983) [48 FR 32555 (July 18, 1983)] (``Rule 2a7 Adopting Release''); 1986 Valuation Release, supra note 27.
\30\ Rule 2a7 Adopting Release, supra note 29, at text preceding, accompanying and following nn.3739.
\31\ Proposed rule 2a7(c)(5). Money market funds must limit their investments in illiquid assets to not more than 10 percent of their net assets. See rule 2a7 1996 Amending Release, supra note 27, at n.108 and accompanying text. An investment company's portfolio security is illiquid if it cannot be disposed of in the ordinary course of business within seven days at approximately the value ascribed to it by the investment company. See id. at n.107 and accompanying text.
\32\ See Rule 2a7 Adopting Release, supra note 29, at n.38.

We request comment on the proposed amendments. Should we include in rule 2a7 an express requirement that money market funds limit their exposure to illiquid securities? Do the proposed requirements provide money market funds sufficient flexibility to retain securities that may be illiquid if the disposal of those securities would not be in the best interests of the fund? Are there alternative or additional provisions that we should consider to address the way in which money market
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funds should evaluate liquidity risk and determine whether to dispose of securities that present an increasing liquidity risk?

3. Monitoring Minimal Credit Risks

The proposed amendments would also amend rule 2a7's downgrade and default provisions. We propose that in the event the money market fund's investment adviser becomes aware of any information about a portfolio security or an issuer of a portfolio security that suggests that the security may not continue to present minimal credit risks, the money market fund's board of directors would have to reassess promptly whether the portfolio security continues to present minimal credit risks.\33\ This proposed requirement would replace the provisions in the current rule that generally require a money market fund board to promptly reassess whether a security that has been downgraded by an NRSRO continues to present minimal credit risks, and take such action as the board determines is in the best interests of the fund and its shareholders.\34\ We do not believe that the proposed amendments would require investment advisers to subscribe to every rating service publication in order to comply with this proposal. However, we would expect an investment adviser to exercise reasonable diligence in keeping abreast of new information about a portfolio security that is reported in the national financial press or in publications to which the investment adviser subscribes.
\33\ Proposed rule 2a7(c)(7) (``In the event the money market fund's investment adviser (or any person to whom the fund's board of directors has delegated portfolio management responsibilities) becomes aware of any information about a portfolio security or an issuer of a portfolio security that may suggest that the security may not continue to present minimal credit risks, the board of directors shall reassess promptly whether such security continues to present minimal credit risks and shall cause the fund to take such action as the board of directors determines is in the best interests of the money market fund and its shareholders.'').
\34\ Rule 2a7(c)(6)(i)(A). This current assessment is not required, however, if the downgraded security is disposed of or matures within five business days of the specified event and in the case of events specified in rule 2a7(c)(6)(i)(A)(2), the board is subsequently notified of the adviser's actions. Rule 2a

7(c)(6)(i)(B).

We request comment on the proposed amendments. Would the requirement that the board of directors reassess the credit risk of a security when investment advisers become aware of information that may suggest the security no longer presents minimal credit risks provide adequate investor protections? Would investment advisers be able to stay abreast of new information about their portfolio securities? 4. Commission Notice of Rule 17a9 Transactions

Finally, the proposed amendments would require that money market funds provide the Commission with prompt notice when an affiliate of the money market fund (or its promoter or principal underwriter) purchases from the fund a security that is no longer an Eligible Security, pursuant to rule 17a9 under the Investment Company Act.\35\ We believe that the current notice provisions, which are triggered when a security held by a fund defaults, provide us with incomplete information about money market funds holding distressed securities, particularly those that have engaged in an affiliated transaction with an affiliated person. The additional notice, which we believe would impose little burden on money market funds or their managers, would enhance our oversight of money market funds especially during times of economic stress.
\35\ Proposed rule 2a7(c)(7)(iii)(B) (requiring notice to the Commission of any ``purchase of a security from the fund by an affiliated person or promoter of or principal underwriter for the fund or an affiliated person of such a person in reliance on rule 17a9''). See rule 17a9 (exempting from section 17(a) of the Act the purchase of a security ``that is no longer an Eligible Security (as defined in [rule 2a7(a)(10)]) under certain conditions).'' Notification under this proposed provision would also be amended to require electronic mail, instead of the other means currently listed in rule 2a7(c)(6)(iii). We believe this change is appropriate in light of recent changes in telecommunications technology, and because most of the notices of default that we have received in the past year have been transmitted electronically.

We request comment on the proposed amendments.

B. Rule 3a7

Rule 3a7 under the Investment Company Act excludes structured finance vehicles from the Act's definition of ``investment company'' subject to certain conditions.\36\ In a typical financing, a sponsor transfers a pool of assets (such as residential mortgages) to a limited purpose entity, which in turn issues fixed income securities that are rated investment grade or higher by at least one NRSRO. Payment on the securities depends primarily on the cash flows generated by the pooled assets. As a result, these are often referred to as ``assetbacked'' securities.
\36\ Structured financings meet the definition of investment company under section 3(a) of the Act because they issue securities and invest in, own, hold, or trade securities. Almost none of the structured financings, however, are able to operate under the Act's requirements. See Exclusion from the Definition of Investment Company for Structured Financings, Investment Company Act Release No. 19105 (Nov. 19, 1992) [57 FR 56248 (Nov. 27, 1992)] (``Rule 3a7 Adopting Release'').

Rule 3a7 contains a number of conditions that differentiate investment companies from structured financings. The conditions include the requirement that structured financings offered to the general public are rated by at least one NRSRO in one of the four highest ratings categories.\37\ The rule contains an exception under which assetbacked securities sold to accredited investors \38\ and qualified institutional buyers \39\ may be unrated, or may be rated less than investment grade, if the issuer and its underwriters use reasonable care to ensure that all excepted sales are to such persons.\40\ We concluded that these persons are in a position to evaluate the structured financing vehicle and to take steps to protect themselves from the types of abusive practices against which the Investment Company Act was designed to protect.\41\
\37\ Rule 3a7(a)(2).
\38\ The exception permits the sale of asset backed fixedincome securities to ``accredited investors'' as defined in paragraphs (1), (2), (3) and (7) of rule 501(a) under the Securities Act [17 CFR 230.501(a)], and includes any entity in which all of the equity owners come within such paragraphs. Rule 3a7(a)(2)(i).
\39\ The exception permits the sale of any asset backed securities to ``qualified institutional buyers'' as defined in rule 144A under the Securities Act [17 CFR 230.144A] and certain other persons involved in the organization or operation of the issuer or an affiliate, as defined in rule 405 under the Securities Act [17 CFR 230.405]. Rule 3a7(a)(2)(ii).
\40\ Rule 3a7(a)(2).
\41\ See Exclusion from the Definition of Investment Company for Certain Structured Financings, Investment Company Act Release No. 18736 (May 29, 1992) [57 FR 23980 (June 5, 1992)] (proposing rule 3a7).

We understand that today most assetbacked securities are issued by special purpose vehicles that do not rely on rule 3a7 to exclude them from the application of the Investment Company Act. Instead, they rely on section 3(c)(7), which was added to the Act in 1996, after the Commission adopted rule 3a7, and provides an exception from the Act for companies whose securities are limited to any issuer, the outstanding securities of which are owned exclusively by persons who are qualified purchasers, and that is not making and does not at that time propose to make a public offering of such securities. Moreover, assetbacked securities issued by financing vehicles that rely on rule 3a7, even when highly rated, generally are not marketed to retail investors.\42\ Accordingly, we propose to eliminate the rule's reliance on ratings by amending the rule to
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eliminate the exclusion for structured financings offered to the general public.
\42\ See Credit & Finance Risk Analysis Asset Backed Securities and Structural Finance, at http://www.credfinrisk.com/ assetsecure.html.

In addition, we are proposing to amend the part of the rule that addresses substitution of eligible assets to remove the reference to ratings downgrades. The rule permits the issuer to acquire additional eligible assets or dispose of assets only if, among other conditions, the acquisition or disposition of the assets does not result in a downgrading in the rating of the issuer's outstanding fixedincome securities.\43\ We propose to require instead that the issuer have procedures to ensure that the acquisition or disposition does not adversely affect the full and timely payment of the outstanding fixed income securities.\44\
\43\ Rule 3a7(a)(3)(ii).

\44\ Proposed rule 3a7(a)(3)(ii).

Finally, we propose to amend the portion of the rule that deals with the safekeeping of assets.\45\ Among other requirements, the rule provides that cash flows from the asset pool periodically be deposited in a segregated account, consistent with the rating of the outstanding fixed income securities.\46\ This provision was intended to ensure that the segregated account in which the cash flows are deposited and the length of time that the servicer holds the cash flows before depositing them in the segregated account would pose a minimal risk of loss to the fixed income security holders. We propose to change this provision to require that the cash flows be deposited in a segregated account consistent with the full and timely payment of the outstanding fixed income securities.\47\ The proposed amendment is designed to minimize the risk of loss of cash flows pending payment to the fixed income securities holders.
\45\ Rule 3a7(a)(4).
\46\ Rule 3a7(a)(4)(iii).
\47\ Proposed rule 3a7(a)(4)(iii). The proposed amendment would require the issuer to take ``actions necessary for the cash flows derived from eligible assets for the benefit of the holders of fixedincome securities to be deposited periodically in a segregated account that is maintained or controlled by the trustee consistent with the full and timely payment of the outstanding fixed income securities.''

We request comment on our proposed amendments to rule 3a7. What are the advantages and disadvantages of eliminating the NRSRO rating requirement from the rule? Is our understanding that structured financings are generally not marketed to retail investors correct? If not, should we retain an exclusion for structured finance offerings to the general public? If so, what standards should we impose that could distinguish structured finance vehicles from investment companies for those investors? For example, should we permit offerings to the general public if a sponsor or trustee conducts an independent statistical analysis of the anticipated cash flows? Are we correct in our assumption that dropping the rating requirement from the rule will not blur the current distinction between structured finance vehicles and investment companies? If not, should the rule incorporate alternatives to the rule's rating requirement that would clarify the distinction? For example, should the rule contain specific requirements regarding abuses that the Act is designed to address, such as selfdealing and overreaching by the issuer? Does our proposal regarding the deposit of cash flows into a segregated account provide sufficient protection against the possibility of loss while the servicer is handling cash flows pending payment to the fixed income security holders? Would an alternative standard provide better protection?

C. Rule 5b3

Rule 5b3 under the Investment Company Act permits a fund, subject to certain conditions, to treat a repurchase agreement as an acquisition of the securities collateralizing the repurchase agreement in determining whether the fund is in compliance with two provisions of the Act that may affect a fund's ability to invest in repurchase agreements.\48\ Section 12(d)(3) of the Investment Company Act generally prohibits a fund from acquiring an interest in a broker, dealer, or underwriter. Because a repurchase agreement may be considered to be the acquisition of an interest in the counterparty, section 12(d)(3) may limit a fund's ability to enter into repurchase agreements with many of the firms that act as repurchase agreement counterparties. Section 5(b)(1) of the Act limits the amount that a fund that holds itself out as being a diversified investment company may invest in the securities of any one issuer (other than the U.S. Government). This provision may limit the number and principal amounts of repurchase agreements a diversified fund may enter into with any one counterparty.
\48\ In a typical investment company repurchase agreement, a fund enters into a contract with a broker, dealer, or bank (the ``counterparty'' to the transaction) for the purchase of securities. The counterparty agrees to repurchase the securities at a specified future date, or on demand, for a price that is sufficient to return to the fund its original purchase price, plus an additional amount representing the return on the fund's investment. Repurchase agreements provide funds with a convenient means to invest excess cash on a secured basis, generally for short periods of time. Economically, a repurchase agreement functions as a loan from the fund to the counterparty, in which the securities purchased by the fund serve as collateral for the loan and are placed in the possession or under the control of the fund's custodian during the term of the agreement. See Treatment of Repurchase Agreements and Refunded Securities as an Acquisition of the Underlying Securities, Investment Company Act Release No. 25058 (July 5, 2001) [66 FR 36156 (July 11, 2001)] (``Rule 5b3 Adopting Release'').

Rule 5b3 allows funds to treat the acquisition of a repurchase agreement as an acquisition of securities collateralizing the repurchase agreement for purposes of sections 5(b)(1) and 12(d)(3) of the Act if the obligation of the seller to repurchase the securities from the fund is ``collateralized fully.'' \49\ A repurchase agreement is collateralized fully if, among other things, the collateral for the repurchase agreement consists entirely of (i) cash items, (ii) government securities, (iii) securities that at the time the repurchase agreement is entered into are rated in the highest rating category by the ``Requisite NRSROs'' or (iv) unrated securities that are of a comparable quality to securities that are rated in the highest rating category by the Requisite NRSROs, as determined by the fund's board of directors or its delegate.\50\
\49\ Rule 5b3(a). The term ``Collateralized Fully'' is defined in rule 5b3(c)(1). An investment company investing in a repurchase agreement primarily looks to the value and liquidity of the securities collateralizing the repurchase agreement rather than the credit quality of the counterparty for satisfaction of the repurchase agreement.
\50\ Rule 5b3(c)(1)(iv). The term ``Requisite NRSROs'' means any two NRSROs that have issued a rating with respect to a security or class of debt obligations of an issuer or, if only one NRSRO has issued a rating with respect to such security or class of debt obligations of an issuer at the time the investment company acquires the security, that NRSRO. Rule 5b3(c)(6). The term ``unrated securities'' means securities that have not received a rating from the Requisite NRSROs. Rule 5b3(c)(8).

In proposing rule 5b3, the Commission explained that the highest rating category requirement in the definition of collateralized fully was designed to ensure that the market value of the collateral would remain fairly stable and that the fund could more readily liquidate the collateral quickly in the event of a default.\51\
\51\ See Treatment of Repurchase Agreements and Refunded Securities as an Acquisition of the Underlying Securities, Investment Company Act Release No. 24050 (Sept. 23, 1999) [64 FR 52476 (Sept. 29, 1999)] (``Rule 5b3 Proposing Release''), at n.43 and accompanying text.

We propose to eliminate the requirement that collateral other than cash or government securities be rated by an NRSRO. As an alternative, we propose to require that if the collateral is not cash or government securities, the fund's board of directors (or its delegate) [[Page 40129]]
determines that the collateral securities present minimum credit risks and are highly liquid. Specifically, the proposal would require collateral other than cash or government securities to consist of securities that the fund's board of directors (or its delegate) determines at the time the repurchase agreement is entered into (i) are sufficiently liquid that they can be sold at or near their carrying value within a reasonably short period of time, (ii) are subject to no greater than minimal credit risk, and (iii) are issued by a person that has the highest capacity to meet its financial obligations.\52\ Although the rule would no longer require the collateral to be rated by an NRSRO, we anticipate that evaluating credit risk and liquidity of the collateral could incorporate ratings, reports, analyses, and other assessments issued by NRSROs and other persons.\53\
\52\ Proposed rule 5b3(c)(1)(iv)(C). Under the proposal, the board would make credit quality determinations for all non
government collateral securities, rather than just unrated securities. As in the current rule, the proposed rule would permit the board to delegate this credit quality and liquidity
determination.
\53\ A fund that acquires repurchase agreements would have to adopt and implement a written policy reasonably designed to comply with this requirement under rule 38a1 under the Investment Company Act. See rule 38a1(a) (requiring registered funds to adopt and implement written policies and procedures reasonably designed to prevent the fund's violation of federal securities laws).

NRSRO ratings are also used in a provision of rule 5b3 that permits a fund to deem the acquisition of a ``refunded security'' as the acquisition of the escrowed government securities for purposes of section 5(b)(1)'s diversification requirements.\54\ Under this provision, a debt security must satisfy certain conditions to be considered a refunded security under the rule. One of these conditions is that an independent certified public accountant must have certified to the escrow agent that the escrowed securities will satisfy all scheduled payments of principal, interest, and applicable premiums on the refunded securities.\55\ This condition is not required, however, if the refunded security has received a debt rating in the highest rating category from an NRSRO.\56\
\54\ Rule 5b3(b). Under the rule, a refunded security means a debt security the principal and interest payments of which are to be paid by U.S. government securities that have been irrevocably placed in an escrow account and are pledged only to the payment of the debt security. Rule 5b3(c)(4).
\55\ Rule 5b3(c)(4)(iii).

\56\ Id.

We are proposing to eliminate the exception to the certification requirement for securities that have received the highest rating from an NRSRO. Rule 5b3 requires the certification by an independent certified public accountant (together with the other conditions) to ensure that the bankruptcy of the issuer of the prerefunded securities would not affect payments on the securities from the escrow account.\57\ The Commission included this exception because in rating refunded securities, NRSROs typically require that an independent third party make the same determination.\58\
\57\ See Rule 5b3 Adopting Release, supra note 48, at text accompanying n.25 (explaining that the conditions required in the definition of refunded security correspond to those in the definition of the term in rule 2a7); Rule 2a7 1986 Amending Release, supra note 31, at section II.D.2.
\58\ See Technical Revisions to the Rules and Forms Regulating Money Market Funds, Investment Company Act Release No. 22921 (Dec. 2, 1997) [62 FR 64968 (Dec. 9, 1997)], at section I.B.2.c.

We request comment on the proposed amendments. How would the proposed elimination of the rating requirement from the definition of ``collateralized fully'' affect funds? Would the proposed board determinations sufficiently address our concerns that collateral securities be of high quality in order to limit a fund's exposure to counterparties' credit risks? If not, are there additional or alternative standards that would better address our concerns? How would the proposal to eliminate the exception for rated securities from the condition that refunded securities obtain a certification from an independent auditor affect funds? We expect that with respect to rated refunded securities, funds may be able to satisfy the certification requirement by determining that an NRSRO required an independent certified public accountant to make the same determination.\59\ Would funds incur any costs in determining that a refunded security has received an accountant certification rather than relying on an NRSRO rating? Is there an alternative standard that would provide an equivalent evaluation? For example, should we permit the board to rely on another independent third party to provide the certification? \59\ See, e.g., Standard & Poor's, Public Finance Criteria: Defeasance: Legal Defeasance Criteria, Cash Flow Verification (Sept. 8, 2006).

D. Rule 10f3

Section 10(f) of the Investment Company Act prohibits a registered investment company from purchasing any security for which an affiliated underwriter is acting as a principal underwriter \60\ during the existence of an underwriting or selling syndicate for that security.\61\ The prohibition was intended to address Congress's concern that underwriters were ``dumping'' otherwise unmarketable securities on affiliated funds, either by forcing the fund to purchase unmarketable securities from the underwriting affiliate itself, or by forcing or encouraging the fund to purchase the securities from another member of the syndicate.\62\ Congress also expressed concern regarding the amount of underwriting fees earned by the sponsors and affiliated persons who placed the securities with the fund.\63\
\60\ The term ``principal underwriter'' means (in relevant part) an underwriter who, in connection with a primary distribution for securities: (i) Is in privity of contract with the issuer or an affiliated person of the issuer; (ii) acting alone or in concert with one or more other persons, initiates or directs the formation of an underwriting syndicate; or (iii) is allowed a rate of gross commission, spread, or other profit greater than the rate allowed another underwriter participating in the distribution. 15 U.S.C. 80a2a(a)(29).
\61\ Section 10(f) prohibits a fund from purchasing a security during the existence of an underwriting or selling syndicate if a principal underwriter of the security is an officer, director, member of an advisory board, investment adviser, or employee of the fund or is a person of which any such officer, director, member of an advisory board, investment adviser, or employee is an affiliated person. An affiliated person of a fund includes, among others: (i) Any person directly or indirectly owning, controlling, or holding with power to vote, five percent or more of the outstanding voting securities of the fund; (ii) any person five percent or more of whose outstanding voting securities are directly or indirectly owned, controlled, or held with power to vote by the fund; and (iii) any person directly or indirectly controlling, controlled by, or under common control with such other person. 15 U.S.C. 80a
2(a)(3)(A), (B) and (C).
\62\ See Report of the SEC, Investment Trusts and Investment Companies, H.R. Doc. No. 279, 76th Cong., 2d Sess., pt. 3, at 2581, 2589 (1939). The sales were also used to alleviate certain of an affiliated underwriter's financial difficulties. For example, an underwriter could benefit by rapidly turning over its securities inventory to produce working capital and to reduce the related expenses of carrying the inventory.
\63\ See Hearings on S.3580 Before a Subcommittee of the Commission on Banking and Currency, 76th Cong., 3d Sess. 209, 21223 (1940).

The Commission adopted rule 10f3 in 1958 to permit a fund that is affiliated with members of an underwriting syndicate to purchase securities from the syndicate if certain conditions are met.\64 \We amended rule 10f3 in 1979 to add municipal securities to the class of securities that funds could purchase under the rule.\65\ The rule defines
[[Page 40130]]
municipal securities that may be purchased during an underwriting in reliance on the rule (``eligible municipal securities'') to include securities that have an investment grade rating from at least one NRSRO or, if the issuer or the entity supplying the revenues or other payments from which the issue is to be paid has been in continuous operation for less than three years (i.e., a less seasoned security), one of the three highest ratings from an NRSRO.\66\ The Commission explained that the rationale behind the rating requirement was to prevent the purchase of less seasoned securities and reduce the risk of unloading unmarketable securities on the fund.\67\
\64\ Adoption of Rule N10F3 Permitting Acquisition of
Securities of Underwriting Syndicate Pursuant to Section 10(f) of the Investment Company Act of 1940, Release No. 2797 (Dec. 2, 1958) [23 FR 9548 (Dec. 10, 1958)]. The rule codified the conditions of orders that the Commission had granted prior to 1958 exempting certain funds from section 10(f) to permit them to purchase specific securities.
\65\ Exemption of Acquisition of Securities During the Existence of Underwriting Syndicate, Investment Company Act Release No. 10736 (June 14, 1979) [44 FR 36152 (June 20, 1979)] (``Rule 10f3 1979 Adopting Release''). Rule 10f3(c)(1)(iii).
\66\ Rule 10f3(a)(3).
\67\ Exemption of Acquisition of Securities During the Existence of Underwriting Syndicate, Investment Company Act Release No. 10592 (Feb. 13, 1979) [44 FR 10580 (Feb. 21, 1979)] (``1979 10f3 Amendments Proposing Release'').

We propose to eliminate the references to ratings in rule 10f3, and amend the rule's definition of ``eligible municipal security'' to mean securities that are sufficiently liquid that they can be sold at or near their carrying value within a reasonably short period of time. In addition, the securities would have to be either: (i) Subject to no greater than moderate credit risk; or (ii) if they are less seasoned securities, subject to a minimal or low amount of credit risk.\68\ \68\ Proposed rule 10f3(a)(3). The proposed rule would define ``eligible municipal securities'' to mean ``'municipal securities'' as defined in section 3(a)(29) of the Securities Exchange Act of 1934, that have sufficient liquidity such that they can be sold at or near their carrying value within a reasonably short period of time and either (i) are subject to no greater than moderate credit risk or (ii) if the issuer of the municipal securities, or the entity supplying the revenues or other payments from which the issue is to be paid, has been in continuous operation for less than three years, including the operation of any predecessors, the securities are subject to a minimal or low amount of credit risk.''

Unlike our proposals to amend other rules, we are not proposing to add a requirement that the board of directors make the determination regarding credit risk and liquidity. Rule 10f3 already requires a fund's directors, including a majority of disinterested directors, to approve procedures regarding purchases made in reliance on the rule and to determine each quarter that all purchases were made in compliance with the procedures.\69\ Accordingly, the board, including a majority of disinterested directors, already is required to review purchases of municipal securities made in reliance on the rule, and would continue to do so under our proposal. In addition, pursuant to its oversight role, the board would be required to approve procedures for ensuring that municipal securities meet the proposed conditions for credit quality and liquidity. Although the rule would no longer require municipal securities to be rated by an NRSRO, fund boards of directors would still be able to incorporate quality determinations prepared by outside sources, including ratings, reports, analyses, and other assessments issued by NRSROs and other persons, in their approval of procedures and in their review of transactions under the rule. \69\ Rule 10f3(c)(10). The Commission added the requirement that disinterested directors adopt procedures made in reliance on the rule and periodically review the fund's compliance with these procedures in 1979. See Rule 10f3 1979 Adopting Release, supra note 65. At the time, we stressed that in determining specific procedures to be included in the guidelines for transactions in reliance on the rule, the board should be aware generally of the nature of any affiliation that the investment company (or any of its officers, directors, employees or adviser) may have with underwriters and any role the affiliate person would play in mounting the underwriting of a particular issue. See 1979 10f3 Amendments Proposing Release, supra note 67, at text preceding n.23. Our proposal would not affect this existing requirement with respect to the purchase of municipal securities.

We request comment on the proposed amendment to rule 10f3. What would be the effect of eliminating the rating requirement in the definition of ``eligible municipal securities''? Is the proposed standard that municipal securities purchased in reliance on rule 10f3 present no more than moderate credit risks and are highly liquid sufficient to limit the possibility underwriters may sell unmarketable securities to the fund? Is there an alternative that would better address our regulatory concerns?

E. Rule 206(3)3T

Rule 206(3)3T under the Investment Advisers Act of 1940 establishes a temporary alternative means for investment advisers who are registered with the Commission as brokerdealers to meet the requirements of section 206(3) of the Advisers Act when they act in a principal capacity in transactions with certain of their advisory clients.\70\ That section makes it unlawful for any investment adviser, directly or indirectly ``acting as principal for his own account, knowingly to sell any security to or purchase any security from a client * * *, without disclosing to such client in writing before the completion of such transaction the capacity in which he is acting and obtaining the consent of the client to such transaction.'' \71\ Rule 206(3)3T contains several conditions that are designed to prevent overreaching by advisers by requiring an adviser to disclose to its client the conflicts of interest involved in principal transactions, inform the client of the circumstances in which the adviser may effect a trade on a principal basis, and provide the client with meaningful opportunities to refuse to consent to a particular transaction or revoke the prospective general consent to these transactions.\72\ \70\ Rule 206(3)3T [17 CFR 275.206(3)3T]. See also Temporary Rule Regarding Principal Trades with Certain Advisory Clients, Investment Advisers Act Release No. 2653 (Sept. 24, 2007) [72 FR 55022 (Sept. 28, 2007)] (``Principal Trade Rule Release''). \71\ 15 U.S.C. 80b6(3).
\72\ See Principal Trade Rule Release, supra note 70, at text accompanying n.28.

An adviser generally may not rely on the rule for principal trades of securities if the investment adviser or a person who controls, is controlled by, or is under common control with the adviser (``control person'') is the issuer or is an underwriter of the security.\73\ As we stated when we adopted the rule, the incentives associated with underwriting securities may bias the advice being provided or lead the adviser to exert undue influence on its client's decision to invest in the offering or the terms of that investment.\74\ The rule contains an exception to this ``underwritten securities'' exclusion for trades in which the adviser or a control person is an underwriter of non convertible investmentgrade debt securities.\75\ We provided this exception because nonconvertible investment grade debt securities may be less risky and therefore less likely to be ``dumped'' on clients.\76\ The rule defines an ``investment grade debt security'' as a nonconvertible debt security that, at the time of sale, is rated in one of the four highest rating categories of at least two NRSROs.\77\ \73\ Rule 206(3)3T(a)(2).
\74\ Principal Trade Rule Release, supra note 70, at n.35 and accompanying and following text.
\75\ Id. at text accompanying n.36. There is no exception if the adviser or a control person is the issuer of the securities. \76\ Id. at text following n.36. We also noted in the Principal Trade Rule Release that it may be easier for clients to identify whether the price they are being quoted for a nonconvertible investment grade debt security is fair given the relative
comparability, and the significant size, of the nonconvertible investment grade debt markets. Id.

\77\ Rule 206(3)3T(c).

We propose to amend rule 206(3)3(T), to eliminate an adviser's ability to rely exclusively on NRSRO ratings to determine whether a security is investment grade for purposes of the rule. Instead, the adviser would have to make its own assessment taking into account specified criteria, including that the security: (i) Has no greater than
[[Page 40131]]
moderate credit risk; and (ii) is sufficiently liquid that it can be sold at or near its carrying value within a reasonably short period of time.\78\
\78\ Proposed rule 206(3)3T(c). Although the proposed amendment would no longer require a security underwritten by an adviser or its control person to be rated by NRSROs to be eligible under the rule, investment advisers could refer to ratings, reports, analyses, and other assessments issued by NRSROs and other persons, for the purpose of evaluating credit risk and liquidity.

Finally, as we stated when we adopted rule 206(3)3T, an adviser subject to rule 206(4)7 of the Advisers Act must adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act (and the rules thereunder) by the adviser or any of its supervised persons.\79\ An adviser seeking to rely on rule 206(3)3T, therefore, would have to adopt and implement policies and procedures that address the adviser's methodology for determining whether a security is investment grade quality. \79\ Principal Trade Rule Release, supra note 70, at nn.5658 and accompanying text. In that connection, an adviser seeking to rely on rule 206(3)3T, as proposed to be amended, would need to adopt and implement policies and procedures reasonably designed to ensure that the adviser's methodology for determining investment grade quality is consistent with the adviser's legal obligations.

We request comment on our proposed revised definition of ``investment grade debt security.'' Is it appropriate for us to allow advisers seeking to rely upon the rule to determine whether a security is investment grade based on the criteria in the rule? Is there another definition of ``investment grade'' elsewhere in the federal securities laws that we should incorporate by reference into the rule? Are there alternative methods to ensure that advisers seeking to rely on the exception to the underwriting exclusion do so only with respect to investment grade debt? Are there alternative or additional factors we should require an adviser to consider in making its determination? In addition, we expect that advisers, in order to establish their eligibility to rely on the rule, would document their determination that a security is investment grade quality, as well as the process for making such a determination. Are we correct? Should we make such documentation an explicit requirement of the rule, or amend rule 2042 under the Advisers Act \80\ (the books and records rule) to require such documentation?
\80\ 17 CFR 275.2042.

IV. Request for Comment

We request comment on the rule amendments proposed in this release. We also request suggestions for additional changes to existing rules, and comments on other matters that might have an effect on the proposals contained in this release. Commenters are requested to provide empirical data to support their views.

V. Paperwork Reduction Act

Certain provisions of the proposed amendments to rules 2a7, 3a7, 5b3, and 10f3 under the Investment Company Act, and rule 206(3)(3)T under the Investment Advisers Act, contain ``collection of information'' requirements within the meaning of the Paperwork Reduction Act of 1995 (``PRA'').\81\ The Commission is submitting this proposal to the Office of Management and Budget (``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. The titles for the collections of information are: ``Rule 2a7 under the Investment Company Act of 1940, Money market funds'' (OMB Control No. 32350268); ``Rule 10f3 under the Investment Company Act of 1940, Exemption for the Acquisition of Securities During the Existence of an Underwriting and Selling Syndicate'' (OMB Control No. 32350226); and ``Temporary rule for principal trades with certain advisory clients, rule 206(3) 3T'' (OMB Control No. 32350630). There are currently no approved collections for rules 3a7 and 5b3, and the proposed amendments would not create any new collections. We adopted the rules pursuant to the Investment Company Act and the Investment Advisers Act.

\81\ 44 U.S.C. 35013520.

Our proposed amendments are designed to address the risk that the reference to and required use of NRSRO ratings in our rules:

Is interpreted by investors as an endorsement of the quality of the credit ratings issued by NRSROs; and

Encourages investors to place undue reliance on NRSRO ratings.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a currently valid control number.

A. Rule 2a7

Rule 2a7 under the Investment Company Act exempts money market funds from the Act's valuation requirements, permitting money market funds to maintain stable share pricing, subject to certain risk limiting conditions. We propose to amend rule 2a7 in four principal ways to: (i) Rely on money market fund boards of directors (who usually rely on the funds' advisers) to determine that each portfolio instrument presents minimal credit risks, and whether the security is a ``First Tier Security'' or a ``Second Tier Security;'' (ii) add a portfolio liquidity requirement to the rule that would require that money market funds hold securities that are sufficiently liquid to meet reasonably foreseeable shareholder redemptions, and expressly limit their investment in illiquid securities to not more than 10% of their total assets; (iii) in the event the money market fund's investment adviser becomes aware of any new information about a portfolio security (or an issuer of a portfolio security) that may suggest that the security may not continue to present minimal credit risks, the proposal would amend rule 2a7's downgrade and default provisions to require a money market fund's board of directors to reassess promptly whether the portfolio security continues to present minimal credit risks; and (iv) require a money market fund to notify the Commission of the purchase of a money market fund's portfolio security by an affiliated person in reliance on rule 17a9 under the Investment Company Act.\82\ The proposed amendments also would make conforming amendments to rule 2a 7's record keeping and reporting requirements.\83\
\82\ See rule 17a9.

\83\ See proposed rule 2a7(c)(11).

The proposed amendments to rule 2a7 would impose a new reporting obligation on money market funds. The proposed reporting requirement to notify the Commission of the purchase of a money market fund's portfolio securities by an affiliated person in reliance on rule 17a9 under the Investment Company Act is designed to assist Commission staff in overseeing money market funds' affiliated transactions that are otherwise prohibited. If adopted, the new collection of information would be mandatory for money market funds. Information submitted to the Commission related to a rule 17a9 transaction would be accorded confidential treatment to the extent permitted by law.\84\

\84\ See, e.g., 17 CFR 200.83.

Commission staff estimates that there are 808 money market funds, all of whom are subject to rule 2a7.\85\ Of these money market funds, Commission staff estimates that an average of 10 funds per year would be required to provide notice to the Commission of a rule 17a9 transaction, with the total
[[Page 40132]]
annual responses per fund, on average, requiring .5 hours of an attorney's time at a cost of $147.50.\86\ Given these estimates, we estimate that the total annual burden of the proposed amendments to rule 2a7 for all money market funds would be approximately 5 hours and $1,475.\87\
\85\ These include registered money market funds and series of registered money market funds. See Investment Company Institute, Trends in Mutual Fund Investing April 2008, May 29, 2008. Available at http://www.ici.org/stats/latest/trends_04_08.html. \86\ Based on information provided by money market fund representatives, Commission staff estimates the cost would equal 0.5 hours of an attorney's time at $295 per hour (0.5 hours x $295 per hour = $147.50). The estimated

FOR FURTHER INFORMATION CONTACT Penelope Saltzman, Acting Assistant Director, or Vincent Meehan, Senior Counsel, (202) 5516792, Office of Regulatory Policy, or Smeeta Ramarathnam, Senior Counsel, (202) 551 6792, Office of Special Projects, Division of Investment Management, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 205495041.