This post continues my discussion of the IM Guidance Update released on January 6, 2016, in which the SEC staff urges boards to consider the following factors in meeting the staff’s expectations of boards, vis-à-vis Rule 12b-1 and Rule 38a-1, in overseeing the use of fund assets to cover what the staff has dubbed “Sub-Accounting Fees” for recordkeeping, sub-transfer agent, and other purely administrative services (“Sub-Accounting Services”) that intermediaries provide to shareholders:

Since the SEC’s mutual fund distribution sweep examination began in 2013, the industry has become increasingly focused on the various types of payments made to intermediaries selling fund shares and providing services to shareholders.  Fund assets may, of course, be used to compensate intermediaries for marketing and other distribution-related costs, including “shelf space” on sales platforms, only under a board-approved Rule 12b-1 plan.  Outside of a 12b-1 plan, Fund assets may be used to cover what the SEC has dubbed “Sub-Accounting Fees” for recordkeeping, sub-transfer agent, and other purely administrative services (“Sub-Accounting Services”) that intermediaries provide to shareholders.

Many have found Question 28 of the SEC staff’s 2014 Money Market Fund Reform Frequently Asked Questions frustrating. The question is whether a money market fund’s board of directors can determine to impose a liquidity fee or temporarily suspend redemptions (“gate” the fund) but delay the implementation. The delay would allow the fund to notify its shareholders and their intermediaries. Delay would also provide time to “close the gate” or start charging the fee.

Currently, managers and directors of money market funds are wrestling with the question of how to make certain that every intermediary selling their funds can implement a liquidity fee. Intermediaries, in turn, are worried about implementing different fees for different funds that may change continuously.

This series of posts asks a different question: How would intermediaries adapt to receiving redemptions proceeds net of any liquidity fee?

Part One of this series of posts explained how intermediaries could avoid calculating, collecting and remitting liquidity fees to money market funds by (1) having the transfer agent (“TA”) calculate and retain the fees from the redemption proceeds paid to the intermediary and (2) prorating the proceeds received from the TA among the intermediary’s clients based on the dollar or share amount of each client’s redemption. This method should address an intermediary’s concern that it might need to impose multiple and constantly changing liquidity fees for various money market funds during a financial crisis. The only question is how to handle contemporaneous purchases by the intermediary’s clients, which ordinarily would be netted against the other clients’ redemptions.

Why Would Anyone Buy Shares Subject to a Liquidity Fee?

Before addressing this question, we should consider how unlikely it would be for anyone to purchase shares subject to a liquidity fee.

I continue to hear about intermediaries fretting over whether and how to redesign their trading systems to accommodate the possibility of money market fund liquidity fees. This series of blogs will explain why this should be a problem only for the funds’ transfer agents (“TAs”). An intermediary should never need to collect and remit a liquidity fee.

Background

Reforms adopted by the SEC in July 2014 permit the board of directors of a money market fund (including a majority of the independent directors, the “Board”) to:

  • suspend redemptions for a period of not more than 10 business days (known as “gating”), or
  • impose a fee of not more than 2% on all redemptions (a “liquidity fee”).