Money Market Funds and Implications For ERISA Fiduciaries By: Paul Holloway
New Securities and Exchange Commission (“SEC”) regulations designed to prevent runs on money market funds during times of economic stress will take effect October 14, 2016.  Although October of 2016 may seem like a long way away, plan fiduciaries should begin thinking about how the rule will affect their plans, in order to leave themselves adequate time to review options and take appropriate action.

Money market funds are open-ended mutual funds that invest primarily in short-term debt securities such as treasury bills, corporate debt securities, and municipal securities.  Money market funds also must meet certain quality, diversity, maturity, and liquidity standards.  As a result, such funds have historically been considered appropriate for investors seeking liquid, low-risk holdings.  Indeed, since they seek to maintain a stable net asset value (“NAV”) of $1.00 per share, money market funds are among the lowest-volatility investment options.  Under the new rules, certain types of money market funds will no longer have the same stability and liquidity profile as in years past.  Accordingly, a thorough review of such funds should be undertaken by plan fiduciaries in order to ensure that the appropriate vehicle is used going forward.

By way of background, during the 2008 financial crisis, some money market funds experienced losses and raised investor concerns regarding their security and liquidity.  In the wake of this crisis, the SEC began to review the need for more oversight of money market funds, and ultimately issued final regulations in 2014.  These regulations are intended to strengthen money market funds’ ability to manage redemption activity during times of economic stress.   

The final regulations classify funds into three separate categories: government, retail, or institutional prime money market funds.  Government money market funds are money market funds that invest at least 99.5 percent (up from the current minimum of 80 percent) of their assets in cash, government securities, or repurchase agreements that are collateralized by cash or government securities.  Retail money market funds are money market funds that have policies and procedures reasonably designed to limit all beneficial owners of the fund to “natural persons.”  Defined benefit plans would not qualify, but individual retirement accounts and participant-directed retirement plans (such as most 401(k) plans) qualify as “natural persons” for this purpose.  Institutional prime funds, a newly defined fund type under the final regulations, are money market funds that do not meet the definition of either a government or retail fund. 

Both government and retail funds will have the option of imposing a floating NAV for sales and redemptions, but institutional prime funds will be required to maintain a floating NAV.  The floating NAV means that the share value can drop below $1.00 and is intended to dissuade an influx of redemption activity.  Furthermore, if any money market fund’s level of weekly liquid assets falls below 30 percent of its total assets, the fund’s board would be permitted to impose a liquidity fee of up to 2 percent on redemptions and/or impose a redemption gate in order to temporarily freeze redemptions.  Retail and institutional prime funds must impose a 1-2 percent liquidity fee if weekly assets fall below 10 percent, unless the fund’s board determines that imposing a liquidity fee is not in the best interests of the fund.

Action Items for Plan Fiduciaries

The new rules will not become effective until October 14, 2016 but plan fiduciaries should begin to think about a process and timeline for reviewing the anticipated impact of the new regulations on any current money market holdings and the extent to which changes in their plans’ investments may be warranted.   Like any fiduciary decision, the decision to invest in a money market fund must be made in the best interests of the plan participants and based on the plan’s particular circumstances.  A money market fund may be highly suitable for some plans, and a poor option for others.

For example, government money market funds may be an attractive option to plans seeking stable, liquid, and straightforward investment options, but such funds generally have the lowest yield of any money market fund type.  Furthermore, the new rules permit a government money market fund to use a floating NAV and/or impose liquidity gates under specified circumstances, meaning that fiduciaries will need to check on funds’ policies in this regard when deciding whether the low return is justified by the fund’s liquidity and risk profile. 

Some plans may consider switching from money market to stable value funds, particularly once the new regulations take effect, but stable value funds present their own list of issues for consideration.  For example, many stable value funds require a lengthy notice period before a plan fiduciary can initiate a full liquidation of the plan’s investment and the rate of return may not be as responsive to rising interest rates as that of a money market fund.  

In addition to determining whether a money market fund is a good fit for the plan’s investment needs, fiduciaries of participant directed plans should make sure that the plan’s communication materials adequately explain any potential liquidity restrictions.

The new rules mean that early in 2106 2016 plan fiduciaries should begin working with their investment advisors in order to determine the most appropriate vehicle for their plan. 

Paul W. Holloway

Paul Holloway is a Partner and the Chair of the Employee Benefits Department at Harter Secrest & Emery LLP. His experience includes:

• Designing employee benefit programs, including 403(b), 457, 401(k), 125, pension, ESOP, profit sharing, defined benefit, employee stock ownership, and welfare benefit...

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