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INVESTMENT COMPANIES_In Letter to SEC, Former OCC Head Says Floating NAV for Money Market Funds Could Increase Both Systemic Risk and Federal Tax Burden

By Jim Hamilton, J.D., LL.M.

In a letter to the SEC, former Comptroller of the Currency John D. Hawke, Jr. cautioned that requiring money market funds to utilize a floating NAV would accelerate the flow of assets to "Too Big to Fail" banks, further concentrating risk in that sector. The former federal official, now with the Arnold & Porter firm, noted that, even bank regulators have acknowledged that a broad shift of institutional cash to the banking system could lead to a large increase in uninsured, "hot money," deposits, which would increase systemic risk. Similarly, and importantly, he noted that requiring a floating NAV would force current users of money market funds to less regulated and less transparent products, which alternatives may be more susceptible to market risk. More broadly, he said that a review of the record developed by the SEC over the past three and a half years reveals no evidence of any benefits that would be derived from requiring money market funds to use a floating NAV.

Mr. Hawke, who also served as Treasury under Secretary for Domestic Finance, said that requiring a floating NAV would impose significant accounting and tax burdens on users of money market funds and destroy their utility. The stable NAV currently allows a money market fund to distribute all returns to shareholders as income, which greatly reduces tax and accounting burdens for both retail and institutional investors. Importantly, the stable NAV also relieves investors of having to consider the timing of purchases and sales of shares of money market funds, as they must with variable NAV funds, to ensure compliance with the IRS wash sale rule, which prohibits investors from recognizing a loss on the sale of a security if they purchase a replacement security within the next 30 days. Instead, the loss is added to the basis of the replacement security. The holding period for the sold stock is also added to the holding period of the replacement stock. Money market fund transactions currently do not implicate the rule due to the funds' stable NAV.

The former OCC head also pointed out that, if money market funds were forced to adopt a floating NAV, investors would need to track the amount and timing of all purchases and sales, capital gains and losses, and share cost basis to ensure compliance with the rule. Investors already face these burdens in connection with investments in long-term mutual funds, but most investors do not trade in and out of long-term mutual funds with the same frequency as many do with money market funds. Moreover, as the ICI explained, often the investments in long-term mutual funds are made within tax-advantaged accounts, such as 401(k) plans, where such issues do not arise. Thus, if money market funds had a floating NAV, and all share sales become tax-reportable events, the result would be to magnify greatly the tax and recordkeeping burdens of investors who use such funds for daily cash management purposes, all for the purpose of tracking fluctuations amounting to fractions of a cent.

In his view, eliminating the stable NAV for money market funds is unnecessary to address any investor misperceptions about the nature of such funds. Surveys and comment letters show that investors know and understand that money market funds are investments that are not FDIC insured and that may lose value. In addition, he posited that a floating NAV would not reflect a measurably more accurate valuation of fund shares than the amortized cost accounting method currently being used. For prime money market funds, he added, many portfolio instruments are fair valued and, while rigorous and objective pricing criteria is utilized to approximate market value, the suggestion that a floating NAV would reflect a true mark-to-market value is a myth.

Requiring a floating NAV would do nothing to advance the regulatory goal of reducing eliminating runs on money market funds since no data supports this proposition and, indeed, data from the recent financial crisis show just the opposite. Similarly, requiring a floating NAV for the sake of showing minute variations in value that cancel out over time would eliminate money market funds as a viable cash management tool for many users by destroying their principal liquidity function. A wide range of money market fund users have filed comment letters with the Commission making this point.

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