SEC Division of Investment Management staff letter: CBA Money Fund, et al.

9 JUN 1994 lEBll
Our Ref. No 93-834-CC

RESPONSE OF THE OFFICE OF CHIEF COUNSEL CBA Money Fund, et . a 1 DIVISION OF INVESTMENT MANAGEMENT File No. 811-3703

By letter dated December 21, 1993, you request our assurance

that we would not recommend enforcement action to the Commission

under Rule 22c-l under the Investment Company Act of 1940 (the

"1940 Act") if, as described in your letter, the money market

mutual funds advised by Merrill Lynch Asset Management ("MLA")

and its subsidiary, Fund Asset Management, Inc. (collectively,

the "Funds"), implement certain automatic redemption procedures.

You state that, at 4:00 p.m. each business day, each Fund

declares a dividend in shares and calculates the net asset value

(1. e. , "dividend/price"). Accordingly, a redeeming shareholder who places a redemption request prior to 4:00 p.m. retains the

last dividend paid on that date ("order date"). You state that

currently a shareholder who places a redemption request receives

redemption proceeds on the next business day following the order

date. You further state that currently a Fund shareholder with a

securities account ~it~ Merrill Lynch, Pierce, Fenner & Smith

Incorporated ("MLPF&S") who places a redemption order and

requests same-day settlement receives the redemption proceeds

that day. ~I In those instances, MLPF&S or an affiliate, to

accommodate its customers, will advance funds on behalf of the

customer on the order date but will not receive the proceeds from

the redemption of the customer's Fund shares until the business

day following the order date. ii You further state that, under the proposed automatic redemption procedures, if a. shareholder requests same-day settlement, his Fund shares would be

transferred to MLPF&S on the basis of the prior business day's

share price, which would exclude the dividend declared on the

order date. MLPF&S would then redeem the shares at the order

date's 4:00 p.m. price for its own account so that MLPF&S would

receive the dividend declared immediately prior to the 4: 00 p.m.

pricing. The redeeming shareholder would receive the dividends only through the business day preceding the order. date. You represent that these procedures would partially

compensate MLPF&S for its foregone cost of funds in connection

wi th same-day settlement transactions. You also represent that

~i You state that a shareholder may require same-day funds to

purchase Treasury bi 1 Is and certa in other U. S. Government

securities, or to enter into other types of transactions

that typically require same-day settlement.

~/ You state that, because MLPF&S does not receive Fund

redemption proceeds until the next business day in

connection with same-day settlement transactions, it loses

the overnight interest on the funds advanced on behalf of

customers on the order date.

the proposed procedures would apply only to same-day settlement

transactions involving money market funds, and that a Fund's use

of the proposed procedures would be suspended during any period

in which the net asset value of the Fund is not maintained at a

constant $1.00 per share or in the event of a negative dividend.

You further represent that the redemption policy would be noted

prominently on the shareholder's monthly account statement and

would be disclosed in the Funds' prospectuses. d/ Finally, you

represent that, if a Fund's yield exceeds the cost of funds to

MLPF&S, the proposed redemption procedures would be suspended for

that Fund until MLA and the Funds were satisfied that MLPF&S

would receive no additional benefits beyond recouping the costs

of advancing these funds.

Rule 22c-1 prohibits an open-end fund, the fund's principal

underwr iter, and any dealer from selling or redeeming the fund's

securities except at a price based on the next computed net asset

value. The Commission adopted Rule 22c-1 to: (i) eliminate

dilution of existing shareholders' interests that might arise

through the sale of shares at a price below their net asset

value, or the redemption or repurchase of shares at a price above

their net asset vaiue¡ and (ii) eliminate speculative trading

practices. ~/ You state that because the Funds are designed to

maintain a constant net asset value per share, and because the

procedures would be suspended if the Funds' net asset value per

share deviated from $1.00, the proposed redemption procedures do

not present the potential for the backward pricing abuses that Rule 22c-l was intended to address. We would not recommend enforcement action to the Commission

under Rule 22c-1 if the Funds implement the automatic redemption

procedures as described in your letter. You should note that

different facts or representations may require a different

conclusion. Further, this response expresses the Division's

posi tion on enforcement action only and does not express any legal conclusion~ on the issues presented.

r Janice M. BiShOpB /
. Attorney ij~
1~ r:iii1¿( 111 ~~%'. ii Telephone conversation between Laurin Blumenthal Kleiman and Janice M. Bishop on February 1, i 994. ~i Investment Company Act ReI. No. 5519 (Oct. 16, 1968).

555 CALIFORNIA STREET
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SHIROYAMA .JT MORI 8UILDING, 15TH FLOOR BLACKWELL HOUSE 3-1, TORANOMON 4-CHOME, MINATO-KU GUILDHALL YARD TOKYO lOS, .JAPAN LONDON EC2V 5AB TELEPHONE: 03-5472-5360 TELEPHONE: 071-606-1888 FACSIMILE: 03-5472-5058 FACSIMILE: 071-796-1807

(DUPLICATE)
December 21, 1993

BY FEDERAL EXPRESS ACT L-lelf-Ljo

SECTION
Off ice of Chief Counsel

Di vision of Investme~t Management RULE ~d. (-I

Securities and Exchange Commission PUBLIC ' 450 Fifth street, N.W. AVAILABILIT 61/ n 9' r Washington, D.C. 20549 Re: Proposed Automatic Redemption Procedures

for Money Market Funds Advised by Merrill Lynch

Asset Management or Fund Asset Management, Inc.

In Connection With Same-Day Settlement Transactions

Ladies and Gentlemen:

This letter is submitted on behalf of several of the money

market mutual funds advised by Merrill Lynch Asset Management!

and its subsidiary, Fund Asset Management, Inc. (each a "Fund"

and, collectively, the "Funds,,).2 On behalf of the Funds, we

The name under which Merrill Lynch Asset Management is

incorporated in Delaware is Merrill Lynch Investment

Management, Inc. Merrill Lynch Asset Management and Fund

Asset Management, Inc. are together referred to herein as

"MLA. "
The Funds are CBA Money Fund, CMA Government Securities

Fund, CMA Money Fund, CMA Tax-Exempt Fund, CMA Treasury Fund

and the ten series of CMA Multi-State Municipal Series Trust

(collectively, the "CMA/CBA Funds"), Merrill Lynch Ready

Assets Trust ("Ready Assets Trust"), Merrill Lynch

Retirdment Reserves Money Fund of Merrill Lynch Retirement

series Trust ("Retirement Reserves Money Fund"), Merrill

(continued. . . )
2

hereby request that the staff of the Division of Investment

Management (the "Division") of the Securities and Exchange

Commission (the "Commission") advise us that it would not

recommend enforcement action for violation of Rule 22c-1 ("Rule

22C-1") under the Investment Company Act of 1940, as amended (the

"Investment Company Act") if the Funds implement the proposed

automatic redemption procedures described below. 3 I.

Current Automatic Redemption Procedures

Current procedures for all automatic redemptions. Each Fund

is a no-load money market fund registered under the Investment

Company Act as an open-end management investment company. 4 The

Funds' current automatic redemption procedures are applicable to

shareholders who maintain securities accounts with Merrill Lynch,

Pierce, Fenner & smith Incorporated ("MLPF&S,,).5 Under these

procedures, each Fund may redeem a suff icient number of its

shares automatically to satisfy amounts due MLPF&S or an

affiliate as a result' of (a) account fees and expenses due and/or

2 ( . . . continued)
Lynch U.S. Treasury Money Fund, Merrill Lynch U.S.A.

Government Reserves and Summit Cash Reserves Fund of

Financial Institutions Series Trust ( "Summi t Cash Reserves

Fund") . It is requested that the relief sought in this

letter extend both to the Funds currently advised by MLA

and to any new Funds advised by MLA in the future.

3 The proposed procedures originally were discussed by telephone and by letters dated April 27, 1990 and October 31, 1990 from Thomas R. Smith, Jr. of this firm to David L. Wills of the Division staff. These procedures were further discussed by Robert Harris of MLA by telephone with Thomas S. Harman and Dorothy M. Donohue of the Division staff and

by letter to Ms. Donohue dated October 6, 1992. Based on

those communications, Ms. Donohue recommended that this

formal no-action request be made.

4 Most of the Funds finance the distribution of their shares

under the terms of a distribution plan pursuant to Rule

12b-1 under the Investment Company Act (a "Rule 12b-1

plan"). Neither the Summit Cash Reserves Fund nor the

Retirement Reserves Money Fund have adopted a Rule 12b-1

plan.
5 Such accounts generally do not include margin accounts with MLPF&S, except. in the case of the CMA/CBA Funds. 2

6
(b) purchases of securities or other transactions in the shareholder's securities account.

For all of the Funds except the cMA/CBA Funds, these

procedures are conducted on an "opt-out" basis; i.e., unless the

shareholder notifies MLPF&S in advance that he or she does not

want his or her Fund shares to be subject to the automatic

redemption procedures, such shareholder's account will be scanned

for debits (a "sweep") each business day prior to 4:00 p.m. New

York time, the time at which such Funds are priced. In the case

of the CMA/CBA Funds, the sweep is an integral feature of the CMA

or CBA programs and takes place on each business day prior to

those Funds' 12:00 p.m. pricing. In either case, if a debit

exists, a sufficient number of Fund shares are redeemed as of the

related Fund's pricing6 and the redemption proceeds are received

the next business day to satisfy the amount due in the

shareholder's account.

II.

Same-Day Settlement Transactions

Automatic redemption procedures are utilized to accommodate

shareholders' needs for liquid funds to purchase securities or

execute other transactions. The required settlement periods for

these transactions range from same-day (in which immediately

available funds must be delivered on the order date -- the time

the order is placed or the transaction entered into) to five or

more business days thereafter. Currently, automatic redemptions

are effected on the business day preceding the date the

shareholder is obligated to make such payment, and MLPF&S or its

affiliate receives the redemption proceeds on the business day

following the redemption date. Under the current procedures,

shareholders receive all dividends declared and reinvested through the date of redemption. Therefore, for transactions requiring funds one business day or more after the order is

placed, the redemption order can be placed on the business day

prior to the date funds are needed, and MLPF&S will receive the

customer's redemption proceeds on the proper day.

At each Fund's pricing time each day, the Fund first

declares the daily dividend in shares and then determines

the net asset value (i.e., "dividends/price"). Accordingly,

the redeeming shareholder retains the last dividend paid on

such date. certain other money market funds that are not

part of the MLA complex price first and then declare the

dividend (Le., "price/dividend"), in which event the

redeeming shareholder does not receive the daily dividend

paid on the redemption date.

3

Transactions that require execution on a same-day settlement

basis, such as the purchase of Treasury bills, 7 however, cannot

be processed in this manner, because Fund redemption proceeds

cannot be made available on a same-day basis. In this event,

MLPF&S, to accommodate its customers, advances funds on behalf of

the customers on the order date but does not receive the proceeds

from the redemption of the customer's Fund shares until the

business day following the order date. Transactions entered into

by Fund shareholders that require same-day settlement for which

MLPF&S advances funds against the receipt of Fund redemption

proceeds are herein referred to as "same-day settlement

transactions. "
Because MLPF&S does not receive Fund redemption proceeds

until the next business day in connection with same-day

settlement transactions, it loses the overnight interest on the

funds advanced on behalf of customers on the order date. 8 Based

on its cost of funds, MLPF&S estimates that losses due to sarne￾day settlement transactions aggregated over $7.0 million in 1990,

over $5.4 million in l991 and over $3.4 million in 1992.9

7 In addition to the purchase of Treasury bills and certain other U.S. Government securities, other types of transactions that typically require same-day settlement include (a) transmission of federal funds by wire; (b) certain securities purchases involving, ~, options,

precious metals, money market securities, customer

repurchase agreements and customer agreements pursuant to

which cash is advanced collateralized by the customer's own

securities; (c) checks issued by MLPF&S branch offices drawn

on local banks in immediately available funds; and (d) transfer of funds from one customer account to another to

cover debit balances.

8 Conversely, the shareholder receives a double return on his or her investment in the Fund for that day, since he or she receives both the benefit of immediately available cost-free funds and the dividend on the shares to be redeemed. 9 The decline in the amount of Merrill Lynch's losses in connection with same-day settlement transactions is not attributable to a decline in the number of transactions but is instead a result of the decline in interest rates over the past three years. 4

III.

Proposed Additional Automatic Redemption Procedures

Proposed procedures. MLPF&S has informed MLA that it

intends to continue its practice of advancing funds in connection

wi th same-day settlement transactions if it can defray, in part,

the overnight cost of funds presently incurred in connection with

such transactions. In this regard, the Funds seek to implement

the additional automatic redemption procedures described below.

Under the proposed automatic redemption procedures, Fund

shares would be transferred to MLPF&S prior to the declaration of

the daily dividend and the subsequent 4:00 p.m. pricing on the

10 day the order for a same-day settlement transaction is placed.

MLPF&S would then redeem the shares at such 4: 00 p.m. pricing for

its own account so that MLPF&S would receive the daily dividend

declared immediately prior to such 4:00 p.m. pricing.

These procedures would partially compensate MLPF&S for the

fact that the redemption proceeds would not be received by MLPF&S

until the day after the shareholder is obligated to make payment.

The proposed automatic redemption procedures would be conducted

on the same "opt-out" basis that applies to the current automatic

redemption procedures.
Restrictions on proposed procedures. The proposed automatic

redemption procedures would apply only to same-day settlement

transactions. Moreover, a Fund's use of the proposed procedures

would be suspended during any period in which the net asset value

of the Fund is not maintained at a constant $1.00 per share.

Shareholder statement disclosure. To ensure that each

shareholder understands that there is a cost associated with

same-day settlement transactions, each such transaction would be

noted prominently on the shareholder's monthly account statement.

Each same-day settlement transaction appearing on the statement would be followed by a symbol. On the reverse side of the statement, that symbol will be included in the section explaining

symbols and abbreviations followed by the following explanation:

Transaction you requested required same-day

payment -- MLPF&S retained last day's

dividend to offset cost of advancing payment

on your behalf.
10 The shares will be transferred prior to the daily dividend declaration to avoid any adverse Federal tax consequences to the Fund shareholder on account of the di "ridend. 5

MLPF&S cost of funds versus Fund dividend amount. As previously stated herein and discussed with the Division staff, the proposed procedures will only partially compensate MLPF&S for

its forgone cost of funds in connection with same-day settlement

transactions. Based on an historical comparison of the Funds'

yields and MLPF&S's cost of funds, both MLPF&S and the Funds are

confident that the aggregate amount represented by dividends

recovered by MLPF&S under the proposed procedures will not exceed

the aggregate amount expended in borrowing money to cover same-

day settlement transactions. For example, set forth in the table

below for the last three years is MLPF&S's cost of funds as

compared to the yields on MLA's two largest Funds:

Year
Ended I
Average 3D-day Fund Yield I
MLPF&S Cost of Funds
December
31, CMA Money
Fund
Ready Assets
Trust
Short-Term
Borrowing
Blended Cost From
All Sources II
1990 7.72% 7.76% 8.51% 9.26%
1991 5.87% 5.85% 6.36% 7.06%
1992 3.37% 1 3.31% 3.95% 4.67%
On an ongoing basis, MLPF&S will provide MLA with an average weekly cost of funds to ensure that MLPF&S does not profit from the proposed automatic redemption procedures by obtaining more in dividends than it costs to advance same-day settlement transaction funds. In the unlikely event that a Fund's yield exceeded the cost of funds to MLPF&S, the proposed

redemption procedures would be suspended until MLA and the Funds

were satisfied that MLPF&S would receive no additional benefits

beyond the recouping of its cost of funds due to the use of the

proposed automatic redemption procedures.

iv.
Leqal Analysis

Rule 22c-1 provides, in pertinent part, that:

No registered investment company issuing any redeemable

security ... and no principal underwriter of, or dealer

in, any such security shall sell, redeem, or repurchase

any such security except at a price based on the

In general, funds advanced in connection with same-day

settlement transactions are acquired through both short-term

and longer-term borrowings.

6
11

current net asset value of such security which is next

computed after receipt of a tender of such security for

redemption ....

Rule 22c-l was adopted to institute "forward pricing" to

eliminate or reduce so far as reasonably practicable perceived

abuses in connection with the sale, redemption or repurchase of mutual fund shares at prices based on "backward pricing" (i. e. , prices based on the last determined net asset value). Investment

Company Act Release No. 5519 (October 16, 1968) (adopting

release) (the "Release"). The Commission sought to eliminate the

practice of selling, redeeming or repurchasing shares for a

certain period of time at a previously determined net asset

value. According to the Release, such practice enabled investors

to take unfair advantage of increases in share value by

purchasing shares at prices lower than current net asset value,

thus diluting the value of the fund's outstanding shares. The

ability to trade fund shares at prices other than current net

asset value also invited speculative trading practices by

enabling investors to purchase large blocks of shares whose value

had increased above the selling price and then redeem them at the

higher price after the next valuation. The Release stated that

such speculative trading practices could seriously interfere with

fund management to the extent that" (i) management may hesitate

to invest what it believes to be speculators' money and (ii)

management may have to effect untimely liquidations when

speculators redeem their securities." Id.

It is submitted that the proposed automatic redemption

procedures do not present the potential for the backward pricing

abuses that Rule 22c-1 was intended to address. Money market

funds invest in high quality, short-term money market

instruments, declare daily dividends and maintain a stable $1.00

net asset value per share. In this context, the types of

fluctuations in net asset value that present opportunities for

speculation do not exist. Furthermore, the declaration of a

"negative dividend" by a Fund (Le., automatic redemption of

shares to cover daily losses) is extremely rare and, in the

unlikely event of a negative dividend, the proposed automatic

redemption procedures would be suspended. Therefore, the

proposed procedures create no risk of dilution. The fact that

the automatic procedures will be used only to satisfy a same-day

settlement obligation is a further disincentive to speculation.

The Commission staff has in several instances recognized the

practical necessity for a liberal interpretation of the technical

requirements of Rule 22c-l in the money market fund context and

has allowed money market funds to price on a technically backward

basis (i.e., prior to the daily declaration of the dividend).

Certain institutional money market funds, such as TernpFund, issne

7

two classes of shares, one of which prices prior to the dividend

declaration (i.e., backward pricing) and the other of which

prices subsequent to dividend declaration (i.e., forward

pricing) . (Moreover, due to systems requirements, the Commission

staff has allowed the Funds to make a technical deviation from

the requirements of Rule 22c-l by allowing purchase orders placed

through MLPF&S to be made effective on the business day following

the day the order is placed, in which case the customer receives the next day's price.) In addition, the Commission staff has in the past officially

taken an equitable approach to Rule 22c-l in other contexts,

granting no-action relief in unique circumstances in which the

staff has determined that noncompliance with the Rule is justified on grounds of practicality. See,~, Baldwin Life Insurance Co.. et ale (pub. avail. February 3,1989); Templeton

Global Fund. Inc. (pub. avail. September 7, 1982); Scudder Tax

Free Money Fund. et ale (pub. avail. July 16, 1982); Scudder.

Stevens & Clark (pub. avail. February 18, 1976).

As a practical ~atter, unless MLPF&S continues to incur

substantial losses in connection with its customers' same-day

settlement transactions, a customer would be unable to enter into

such transactions using Fund redemption proceeds and would

instead be forced either to produce cash in large amounts when

placing his or her order or (ii) to wait and have the order

effected on the following business day. MLPF&S is willing,

however, to continue to advance funds on behalf of its customers

if it can reduce its consequent losses by using the proposed

automatic redemption procedures with no adverse consequences to a

Fund or its shareholders. MLPF&S therefore believes that the

Funds and their shareholders would be best served by allowing the

automatic redemption procedures to be effected as proposed, and

that the proposed procedures are appropriate in the context of

Rule 22c-l and the relevant interpretations discussed above.

V.
Conclusion
In light of the foregoing, we believe that the proposed

automatic redemption procedures for same-day settlement

transactions are fair and equitable under the circumstances,

provide a benefit to
Fund shareholders with no negative effect on

any Fund or its shareholders and are appropriate and permissible

under the Investment Company Act. Accordingly, we hereby request

that the staff of the Division of Investment Management advise us

that it would not recommend that the Commission take any

enforcement action for violation of Rule 22c-l if the Funds

8

implement the proposed automatic redemption procedures as descr ibed herein. If you have any questions regarding this matter, please call

the undersigned at (212) 839-5525.

Sincerely,
Laurin Blumenthal Kleiman

i!
CC: Robert Harris, Esq.
9