SEC Division of Investment Management staff letter: Investment Company Institute

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON. D.C. 20549 'SION OF

"':IT MANAGEMENT
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MS. Amy B.R. Lancellotta
: Sect10n . Associate Counsel

Investment Company Institute
:Sule ól i1- 7 1600 M Street
;Public Washington, D.C. 20036
'Avallablllty ¿'-/~-93 re: Applicability of Rule 2a-7 to Certain Capped Floating and Variable Rate Instruents Dear Ms. Lancellotta:

This letter is in response to your request that the Division

of Investment Management clarify its position with respect to the

ability of money market funds to acquire certain capped floating

and variable rate government securities in compliance with Rule

2a-7 under the Investment Company Act of 1940. .

Paragraph (c) (~) (i) of Rule 2a-7, with limited exceptions, prohibits money market funds from holding portfolio' securities having maturities greater than 397 days. Paragraph (d) (1) per,its funds to measure the maturity of a security issued or

guaranteed by the United States government (or agency thereof) paying a variable rate of interest by reference to the period

remaining until the next interest rate adjustment. Paragraphs

(d) (3) and (4) provide similar relief for variable rate' and

floating rate instruents subj ect to demand features, but require

their maturity dates to be measured by reference to the later of

their interest rate readjustment dates or final maturity. In addition, . the terms of these instruents must provide for the readjustment of interest,rates so that, upon readjustment, it can

reasonably be expected that the security will have a market value

of par. See paragraphs (a) (7) (defining "floating rate instruent") and (a) (21) (defining "variable rate instruent"). Although paragraph (d) (1) does not explicitly provide that the instruents covered by that paragraph must have a market value that approximates their par value upon their interest rate

readjustment, such a requirement is implicit in the rule.

Morgan, Keegan & Co., Inc. (pub. avail. July 24,1992), n.7.

As the Division has stated, interest rate caps on floating

or variable rate instruents are inconsistent with the

requirement that they can reasonably be expected to return to par

upon readjustment. Id. Once the cap is reached (and, more

likely, once short-term interest rates approach the cap) it can

reasonably be expected that the instruents will trade below par.

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  Nonetheless, in~he current interest rate environment the

Division does not object if money market funds purchase variable

or floating rate instruents issued by the United States

government or agencies thereof the interest rates of which are

capped at a rate in excess of 20% to comply with certain state

usury laws. This exception does not relieve money market funds

from the overall duty of care to manage the fund in such a manner

as to stabilize the fund's net asset value. This obligation will

require money market funds to pay close attention to the market

value of capped instruents to assure that their market value

does not deviate significantly from their amortized cost and

affect the ability of the fund to maintain its stable share price. This position does not limit the ability of money market

funds to invest in capped floating anõ variable rate instruments

with final maturities of less than 397 days, because investment

in such instruents does not require reliance on paragraph (d) to

shorten their maturities. For purpose of determining the average

weighted maturity, the remaining maturity of these securities

must be determined by 'reference to their final maturity ~~ther

than their interest rate readjustment date. However, consistent

with the position taken above, funds may determine the maturity

of variable or floating rate instruents issued by the United

States government or agencies thereof the interest rates of which

are capped at a rate ,in excess of 20% to comply with Certain

state usury laws based on their interest rate readjustment date ~

Finally, this position does not affect the ability of money

market funds to invest in capped floating or variable rate demand

,notes or other instruents the maturity of which is determined by reference to a demand feature under paragraph (d) (3) or (4) of Rule 2a-'7. See John Nuveen & Co. (Sept: 4,1990). If short-'

term interest rates rise so that the market value of the

instruent is below par as a result of the cap, a money market

fund may exercise the demand feature and may receive the

amortized value of the instruent.

Sincerely,
/Wl?/A~
Robert E. Plaze

Assistant Director