Money market funds (MMFs) have, since the 2008 financial crisis, been deemed part of the nefarious shadow banking industry and targeted for regulatory reform. In my paper, The Broken Buck Stops Here: Embracing Sponsor Support in Money Market Fund Reform, I critically evaluate the logic behind current reform proposals, demonstrating that none of the proposals is likely to be effective in addressing the primary source of MMF stability—redemption demands in times of economic resources that impose pressure on MMF liquidity. In addition, inherent limitations in the mechanisms for calculating the fair value of MMF assets present a practical limitation on the utility of a floating NAV. I then offer an unprecedented alternative approach—mandatory sponsor support. My proposal would require MMF sponsors to commit to supporting their funds as a condition of offering a fund with a fixed $1 NAV.
Posts Tagged ‘Mutual funds’
Index fund sponsors today oversee about 18% of all mutual fund and ETF assets (or $2.3 trillion), but their ability to govern is hampered by a pressing need to keep expense ratios low (ICI, 2013). Thus traditional governance channels, such as evaluating and guiding project selection by managers (intervention), are foreclosed to them. Neither can these fund sponsors strategically trade in response to private information, because they must hold the index. Nonetheless, index fund sponsors would still like to govern their portfolio companies, because high index returns mean more inflows into their funds and fees. In my paper, Shareholder Governance through Disclosure, which was recently made publicly available on SSRN, I conjecture that index fund sponsors govern by asking management of firms to disclose more about their activities. These disclosures can facilitate the monitoring activities of all stakeholders and increase firm value, thus benefiting the index fund sponsor. For example, more disclosure enhances other blockholders’ monitoring activities and makes stock prices more informative about management’s actions. In addition, eliciting such disclosures about current projects undertaken by management does not require the index fund sponsor to invest in and acquire specific skills about how to run the business. This feature of disclosure makes it particularly attractive to index fund sponsors, who compete by keeping their expenses low.
As a practicing securities lawyer for more than thirty years, I have in the past advised boards of directors, including mutual fund boards, and I am well acquainted with the important work that you do. I also understand the essential role that independent directors play in ensuring good corporate governance. As fiduciaries, you play a critical role in setting the appropriate tone at the top and overseeing the funds’ business. Thus, I commend the Mutual Fund Directors Forum’s efforts in providing a platform for independent mutual fund directors to share ideas and best practices. Improving fund governance is vital to investor protection and maintaining the integrity of our financial markets.
The 2010 Dodd-Frank Act mandated over 200 new rules, bringing renewed attention to the use of cost-benefit analysis (CBA) in financial regulation. CBA proponents and industry advocates have criticized the independent financial regulatory agencies for failing to base the new rules on CBA, and many have sought to mandate judicial review of quantified CBA (examples of “white papers” advocating CBA of financial regulation can be found here and here). An increasing number of judicial challenges to financial regulations have been brought in the D.C. Circuit under existing law, many successful, and bills have been introduced in Congress to mandate CBA of financial regulation.
Mutual funds’ support for corporate political disclosure reached a new high in 2013, according to a ten-year analysis by the Center for Political Accountability. Forty large US mutual fund families voted in favor of corporate political spending disclosure an unprecedented 39% of the time, on average.
CPA’s review of mutual fund votes looks at how 40 of the largest U.S. fund families voted on 276 shareholder requests for disclosure of corporate political contributions at U.S. companies over proxy seasons from 2004 to 2013 (covering shareholder meetings from 1 July 2003 to 30 June 2013). Together, these fund families manage around $3.3 trillion in U.S. securities, according to Morningstar® fund data, and control a large portion of the shareholder vote in US securities.
The increase in institutional ownership of corporate stock has led to questions about the role of financial intermediaries in the corporate governance process. This post focuses on the issues associated with the so-called “separation of ownership from ownership,” arising from the growth of three types of institutional investors, pensions, mutual funds, and hedge funds.
To a great extent, individuals no longer buy and hold shares directly in a corporation. Instead, they invest, or become invested, in any variety of institutions, and those institutions, whether directly or through the services of one or more investment advisers, then invest in the shares of America’s corporations. This lengthening of the investment chain, or “intermediation” between individual investor and the corporation, translates into additional agency costs for the individual investor and the system, as control over investment decisions becomes increasingly distanced from those who bear the economic benefits and risks of owners as principals. The rapid growth in intermediated investments has led to concerns about the consequences of intermediation and the role of institutional investors and other financial intermediaries in the corporate governance process. These concerns are particularly relevant against a background of increasing demands for shareholder engagement and involvement in the governance of America’s corporations.
The SEC settled claims against a registered investment adviser (the “Adviser”), its affiliated broker-dealer (the “Broker-Dealer”), and the founder, owner, and president of each (the “CEO”) that related to (1) investments in Class A shares of underlying funds made by funds managed by the Adviser (the “Funds”) and (2) commissions paid by the Funds to the Broker-Dealer for trades in exchange-traded funds (“ETFs”). Without admitting or denying its findings, the Respondents agreed to the settlement order (the “Order”), available here, which this post summarizes.
It is a privilege to appear before a group that is so important to the strength and integrity of the fund industry. Independent directors have significant responsibilities, and it requires tremendous effort and time on your part to do your job well. I applaud your efforts to learn from the professionals who are participating in this conference. The insights of the panels you heard yesterday and this morning, and those you will hear after lunch will provide valuable information.
The importance of mutual funds in the lives of American investors is clear. Mutual funds hold close to $14 trillion of the hard earned savings of over 53 million American households. The majority of Americans access the markets through mutual funds. They invest in funds, and hope their investments will grow, for many reasons—to make a down payment on a house, to save for a college education, and ultimately to pay for a retirement.
On June 5, 2013, the SEC voted unanimously to propose alternatives for amending rules that govern money market mutual funds under the Investment Company Act of 1940. Two alternative reforms to rule 2a-7 under the Investment Company Act of 1940 could be adopted separately or combined into a single reform package:
- Alternative One: Floating Net Asset Value (“NAV”): The proposal would require all institutional prime money market funds to sell and redeem shares based on the current market value of the fund’s portfolio securities, rounded to the fourth decimal place, rather than at a $1.00 stable share price. Retail and government money market funds would be exempt from the floating net asset value requirement and would be allowed to continue using the penny-rounding method of pricing to maintain a stable share price but would not be allowed to use the amortized cost method to value securities.
- Alternative Two: Liquidity Fees and Redemption Gates: Money market funds, other than government money market funds, would be required to impose a 2% liquidity fee if the fund’s level of weekly liquid assets fell below 15% of its total assets, unless the fund’s board of directors (a “Board”) determined that it was not in the best interest of the fund or that a lesser liquidity fee was in the best interests of the fund. After a fund has fallen below the 15% weekly liquid assets threshold, the Board would also be able to temporarily suspend redemptions in the fund for no more than 30 days in any 90-day period.
This paper suggests that the essence of these funds and their regulation lies not just in the nature of their investments, as is widely supposed, but also—and more importantly—in the nature of their organization.
Specifically, every enterprise that we commonly think of as an investment fund adopts a pattern of organization that I am calling the “separation of investments and management.” These enterprises place their securities, currency and other investment assets and liabilities into one entity (a “fund”) with one set of owners, and their managers, workers, office space and other operational assets and liabilities into a different entity (a “management company” or “adviser”) with a different set of owners. Investment enterprises also radically limit fund investors’ control. A typical hedge fund, for example, cannot fire and replace its management company or its employees—not even by unanimous vote of the fund’s board and equity holders.
I explain this pattern of organization and explore its costs and benefits. I argue, paradoxically, that the separation of investments and management benefits fund investors by limiting their control over managers and their exposure to managers’ profits and liabilities.