[Federal Register Volume 76, Number 46 (Wednesday, March 9, 2011)]
[Proposed Rules]
[Pages 12896-12916]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-5184]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 239, 270, and 274

[Release Nos. 33-9193; IC-29592; File No. S7-07-11]
RIN 3235-AL02


References to Credit Ratings in Certain Investment Company Act 
Rules and Forms

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: This is one of several releases that the Securities and 
Exchange Commission (``Commission'') will be considering relating to 
the use of credit ratings in our rules and forms. In this release, we 
are proposing a new rule as well as rule and form amendments under the 
Securities Act of 1933 and the Investment Company Act of 1940 to 
implement provisions of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (``Dodd-Frank Act''). The Commission is proposing 
amendments to two rules and four forms under the Investment Company Act 
and the Securities Act that contain references to credit ratings. The 
proposed amendments would give effect to provisions of the Dodd-Frank 
Act that call for the amendment of Commission regulations that contain 
credit rating references. In addition, the Commission is proposing a 
new rule under the Investment Company Act to establish a standard of 
credit-worthiness in place of a statutory reference to credit ratings 
in that Act that the Dodd-Frank Act removes.

DATES: Comments should be received on or before April 25, 2011.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number S7-07-11 on the subject line; or
     Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number S7-07-11. This file number 
should be included on the subject line if e-mail is used. To help us 
process and review your comments more efficiently, please use only one 
method. The Commission will post all comments on the Commission's Web 
site (http://www.sec.gov/rules/proposed.shtml). Comments are also 
available for Web site viewing and printing in the Commission's Public 
Reference Room, 100 F Street, NE., Washington, DC 20549, on official 
business days between the hours of 10 a.m. and 3 p.m. All comments 
received will be posted without change; we do not edit personal 
identifying information from submissions. You should submit only 
information that you wish to make publicly available.

FOR FURTHER INFORMATION CONTACT: With respect to the proposed rule, 
rule amendments or Form N-MFP, Anu Dubey, Attorney, or Penelope 
Saltzman, Assistant Director (202) 551-6792, Office of Regulatory 
Policy, or with respect to Forms N-1A, N-2 and N-3, Jane H. Kim, 
Attorney, or Mark T. Uyeda, Assistant Director, (202) 551-6784, Office 
of Disclosure Regulation, Division of Investment Management, Securities 
and Exchange Commission, 100 F Street, NE., Washington, DC 20549-8549.

SUPPLEMENTARY INFORMATION: The Commission is proposing for public 
comment amendments to rules 2a-7 [17 CFR 270.2a-7] and 5b-3 [17 CFR 
270.5b-3] and new rule 6a-5 [17 CFR 270.6a-5] under the Investment 
Company Act of 1940 (``Investment Company Act'').\1\ The Commission is 
also proposing for comment amendments to Forms N-1A [17 CFR 239.15A and 
17 CFR 274.11A], N-2 [17 CFR 239.14 and 17 CFR 274.11a-1] and N-3 [17 
CFR 239.17a and 17 CFR 274.11b] under the Investment Company Act and 
the Securities Act of 1933 (``Securities Act'')\2\ and Form N-MFP [17 
CFR 274.201] under the Investment Company Act.
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    \1\ 15 U.S.C. 80a-1. Unless otherwise noted, all references to 
statutory sections are to the Investment Company Act, and all 
references to rules under the Investment Company Act are to Title 
17, Part 270 of the Code of Federal Regulations [17 CFR 270].
    \2\ 15 U.S.C. 77a.
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Table of Contents

I. Background
II. Discussion
    A. Rule 2a-7
    1. Eligible Securities
    2. Securities With a Conditional Demand Feature
    3. Monitoring Minimal Credit Risks
    4. Stress Testing
    B. Form N-MFP
    C. Rule 5b-3
    D. Proposed Rule 6a-5
    E. Forms N-1A, N-2 and N-3
III. Request for Comment
IV. Paperwork Reduction Act
V. Cost-Benefit Analysis
VI. Consideration of Promotion of Efficiency, Competition and 
Capital Formation
VII. Regulatory Flexibility Act Certification
VIII. Initial Regulatory Flexibility Analysis
Statutory Authority
Text of Proposed Rule and Form Amendments

I. Background

    The Dodd-Frank Act was enacted on July 21, 2010.\3\ Section 939A of 
the Act requires the Commission to review its regulations for any 
references to or requirements regarding credit ratings that require the 
use of an assessment of the credit-worthiness of a security or money 
market instrument, remove these references or requirements and 
substitute in those regulations other standards of credit-worthiness in 
place of the credit ratings that we determine to be appropriate.\4\ 
Section 939 of the Dodd-Frank Act removes a reference to credit ratings 
from section 6(a)(5) of the Investment Company Act and replaces it with 
a reference to ``such standards of credit-worthiness as the Commission 
shall adopt.''\5\
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    \3\ Public Law 111-203, 124 Stat. 1376 (2010).
    \4\ Section 939A(a)-(b) of the Dodd-Frank Act.
    \5\ Section 939(c) of the Dodd-Frank Act (amending section 
6(a)(5)(A)(iv)(I) of the Investment Company Act). The Dodd-Frank Act 
also requires the Commission to adopt a number of rules concerning 
the integrity and transparency of the credit rating process and the 
accountability of credit rating agencies. See sections 931 to 939H 
of the Dodd-Frank Act.
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    In 2008, we undertook a review similar to that required under 
section 939A for references to credit ratings in our rules. As a result 
of that review, we proposed to eliminate references to ratings issued 
by nationally recognized statistical rating organizations (``NRSROs'') 
in four rules under the Investment Company Act.\6\ Specifically,

[[Page 12897]]

we proposed to remove references to credit ratings in rules 2a-7, 3a-7, 
5b-3 and 10f-3 under the Investment Company Act. In 2009, we adopted 
certain of the proposed amendments to rules 5b-3 and 10f-3 and reopened 
the comment period for the other proposed amendments to rules 3a-7 and 
5b-3.\7\ In 2010, when we adopted amendments to rule 2a-7 (which 
governs the operation of money market funds), we retained the use of 
credit ratings in rule 2a-7 as an initial threshold requirement for 
whether a money market fund may invest in the security, but eliminated 
a requirement that all asset-backed securities in which a money market 
fund invests have received a rating.\8\
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    \6\ See References to Ratings of Nationally Recognized 
Statistical Rating Organizations, Investment Company Act Release No. 
28327 (July 1, 2008) [73 FR 40124 (July 11, 2008)] (``2008 Ratings 
Removal Proposing Release''). The Commission also proposed to 
eliminate references to credit ratings in rules under the Securities 
Act and the Securities Exchange Act of 1934 (15 U.S.C. 78a) 
(``Exchange Act''). See Security Ratings, Securities Act Release No. 
8940 (July 1, 2008) [73 FR 40106 (July 11, 2008)]; References to 
Ratings of Nationally Recognized Statistical Rating Organizations, 
Securities Exchange Act Release No. 58070 (July 1, 2008) [73 FR 
40088 (July 11, 2008)]. Prior to this initiative, in 2003, the 
Commission published a concept release in which we sought comment on 
the use of NRSRO ratings in our rules. See Rating Agencies and the 
Use of Credit Ratings under the Federal Securities Laws, Investment 
Company Act Release No. 26066 (June 4, 2003) [68 FR 35258 (June 12, 
2003)].
    \7\ See References to Ratings of Nationally Recognized 
Statistical Rating Organizations, Investment Company Act Release No. 
28939 (Oct. 5, 2009) [74 FR 52358 (Oct. 9, 2009)] (``2009 Ratings 
Removal Adopting Release'') (adopting amendments to rule 5b-3, with 
respect to the treatment of refunded securities, and rule 10f-3); 
References to Ratings of Nationally Recognized Statistical Rating 
Organizations, Investment Company Act Release No. 28940 (Oct. 5, 
2009) [74 FR 52374 (Oct. 9, 2009)] at Section IV (reopening the 
comment period for the proposed amendments to rules 3a-7 and 5b-3, 
with respect only to repurchase agreements). We also sought comment 
on removing references to credit ratings in rule 2a-7 in our 2009 
proposal for certain reforms for money market funds. See Money 
Market Fund Reform Proposing Release, infra note 8. We received over 
70 comments in response to the 2008 proposed amendments. Most 
commenters opposed the proposals. These comment letters are 
available on the Commission's Internet Web site (http://www.sec.gov/comments/s7-19-08/s71908.shtml; http://www.sec.gov/comments/s7-17-08/s71708.shtml). In light of today's proposal to amend rule 5b-3, 
we are withdrawing the 2008 proposed amendments to rule 5b-3 from 
further consideration.
    \8\ See Money Market Fund Reform, Investment Company Act Release 
No. 29132 (Feb. 23, 2010) [75 FR 10060 (Mar. 4, 2010)] (``Money 
Market Fund Reform Adopting Release''). See also Money Market Fund 
Reform, Investment Company Act Release No. 28807 (June 30, 2009) [74 
FR 32688 (July 8, 2009)] (``Money Market Fund Reform Proposing 
Release''). Most commenters that responded to our request for 
additional comment on the 2008 proposed amendments to rule 2a-7 in 
the Money Market Fund Reform Proposing Release opposed that 
approach.
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    As directed by section 939A of the Dodd-Frank Act, we have reviewed 
our regulations for any references to or requirements regarding credit 
ratings in regulations that require the use of an assessment of the 
credit-worthiness of a security or money market instrument. In light of 
our review, and as further directed by the Dodd-Frank Act, we are 
proposing in this release to amend two rules and four forms under the 
Investment Company Act and the Securities Act.\9\ In addition, in order 
to implement section 939(c) of the Dodd-Frank Act, we are proposing a 
new rule to establish a standard of credit-worthiness for purposes of 
section 6(a)(5) of the Investment Company Act.
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    \9\ We have already proposed to remove references to credit 
ratings in certain rules and forms under the Securities Act and the 
Exchange Act. See Security Ratings, Securities Act Release No. 9186 
(Feb. 9, 2011) [76 FR 8946 (Feb. 16, 2011)].
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II. Discussion

    Three rules--rules 2a-7, 3a-7 and 5b-3 and four forms--Forms N-1A, 
N-2, N-3 and N-MFP under the Investment Company Act currently contain 
references to credit ratings issued by NRSROs.\10\ We propose to remove 
the references to credit ratings in rules 2a-7 and 5b-3 and replace 
them with alternative standards of credit-worthiness that are designed 
to appropriately achieve the same purposes as the ratings requirements. 
In addition to the amendments to rules 2a-7 and 5b-3, we are proposing 
a new rule--rule 6a-5 under the Investment Company Act--to establish a 
credit-worthiness standard to replace the credit rating reference in 
section 6(a)(5) of that Act that the Dodd-Frank Act eliminates.\11\ 
Finally, we propose to eliminate required disclosures of credit ratings 
in Form N-MFP and remove from Forms N-1A, N-2 and N-3 the requirement 
that NRSRO credit ratings be used when portraying credit quality in 
shareholder reports. We discuss our proposed amendments and new rule in 
greater detail below.
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    \10\ Rule 2a-7 defines the term NRSRO to have the same meaning 
as in section 3(a)(62) of the Exchange Act [15 U.S.C. 78c(a)(62)]. 
Rule 5b-3 defines NRSRO with reference to Exchange Act rule 15c3-
1(c)(2)(vi)(E), (F), and (H) [17 CFR 240.15c3-1(c)(2)(vi)(E), (F), 
(H)].
    \11\ We intend to propose amendments to rule 3a-7 in a separate 
release.
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A. Rule 2a-7

    Rule 2a-7 under the Investment Company Act governs the operation of 
money market funds. Unlike other investment companies (``funds''), 
money market funds seek to maintain a stable share price, typically at 
$1.00 per share. To do so, most money market funds use the amortized 
cost method of valuation (``amortized cost method'') and the penny-
rounding method of pricing (``penny-rounding method'') permitted by 
rule 2a-7.\12\ The Investment Company Act and applicable rules 
generally require funds to calculate current net asset value per share 
by valuing their portfolio instruments at market value or, if market 
quotations are not readily available, at fair value as determined in 
good faith by the board of directors.\13\ These valuation requirements 
are designed to prevent unfair share pricing from diluting or otherwise 
adversely affecting the interests of investors.\14\
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    \12\ Under the amortized cost method, portfolio instruments are 
valued by reference to their acquisition cost as adjusted for 
amortization of premium or accretion of discount. See rule 2a-
7(a)(2). Share price is determined under the penny-rounding method 
by valuing securities at market value, fair value or amortized cost 
and rounding the per share net asset value to the nearest cent on a 
share value of a dollar, as opposed to the nearest one tenth of one 
cent as otherwise would be required. See Valuation of Debt 
Instruments and Computation of Current Price Per Share by Certain 
Open-End Investment Companies (Money Market Funds), Investment 
Company Act Release No. 13380 (July 11, 1983) [48 FR 32555 (July 18, 
1983)] (``1983 Money Market Fund Adopting Release'') at n.6 
(``Release 9786 sets the amount of less than \1/10\ of one cent on a 
share value of one dollar as the benchmark for materiality.''); 
Valuation of Debt Instruments by Money Market Funds and Certain 
Other Open-End Investment Companies, Investment Company Act Release 
No. 9786 (May 31, 1977) [42 FR 28999 (June 7, 1977)] at text 
accompanying n.11; rule 2a-7(a)(20) (defining penny-rounding 
method).
    \13\ See section 2(a)(41) of the Investment Company Act 
(defining value) and rules 2a-4 (defining current net asset value) 
and 22c-1 (generally requiring open-end funds to sell and redeem 
their shares at a price based on the funds' current net asset value 
as next computed after receipt of a redemption, purchase or sale 
order).
    \14\ If shares are sold or redeemed based on a net asset value 
that turns out to have been either understated or overstated 
compared to the amount at which portfolio instruments could have 
been sold, then the interests of either existing shareholders or new 
investors will have been diluted. See Investment Trusts and 
Investment Companies: Hearings on S. 3580 Before a Subcomm. of the 
Sen. Comm. on Banking and Currency, 76th Cong., 3d Sess. 136-138, 
288-289 (1940).
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    Rule 2a-7 exempts money market funds from these provisions but 
contains conditions designed to minimize the amount of risk a money 
market fund may assume and thus reduce the deviation between a money 
market fund's stabilized share price and the market value of its 
portfolio.\15\ Among these conditions, rule 2a-7 limits a money market 
fund's portfolio investments to securities that have received credit 
ratings from the ``requisite NRSROs'' in one of the two highest short-
term rating categories or comparable unrated securities (i.e., 
``eligible securities'').\16\ A requisite NRSRO must be one of the 
NRSROs that a money market fund's board of directors has designated 
(``designated NRSRO'') for use, and determines at least annually issues 
credit ratings that

[[Page 12898]]

are sufficiently reliable for the fund to use, in determining the 
eligibility of portfolio securities.\17\ Rule 2a-7 further restricts 
money market funds to securities that the fund's board of directors (or 
its delegate\18\) determines present minimal credit risks, and 
specifically requires that determination ``be based on factors 
pertaining to credit quality in addition to any ratings assigned to 
such securities by an NRSRO.''\19\
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    \15\ Rule 2a-7 contains conditions that apply to each investment 
a money market fund proposes to make, as well as conditions that 
apply to a money market fund's entire portfolio.
    \16\ The term ``eligible security'' is currently defined in rule 
2a-7(a)(12).
    \17\ See rule 2a-7(a)(11) (defining ``designated NRSRO''); 2a-
7(a)(23) (defining ``requisite NRSRO'').
    \18\ See rule 2a-7(e).
    \19\ Rule 2a-7(c)(3)(i). Thus, under the current rule, where the 
security is rated, having the requisite NRSRO rating is a necessary 
but not sufficient condition for investing in the security and 
cannot be the sole factor considered in determining whether a 
security presents minimal credit risks. See Revisions to Rules 
Regulating Money Market Funds, Investment Company Act Release No. 
18005 (Feb. 20, 1991) [56 FR 8113 (Feb. 27, 1991)] (``1991 Money 
Market Fund Adopting Release'') at text preceding n.18.
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    We are proposing to remove references to credit ratings in rule 2a-
7, which would affect five elements of the rule: Determination of 
whether a security is an eligible security; determination of whether a 
security is a first tier security; credit quality standards for 
securities with a conditional demand feature; requirements for 
monitoring securities for ratings downgrades and other credit events; 
and stress testing.\20\ The proposed amendments to rule 2a-7, which are 
similar to those we proposed in 2008, are designed to offer protections 
comparable to those provided by the NRSRO ratings.\21\
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    \20\ The proposed rule also would make conforming amendments to 
rule 2a-7's recordkeeping and reporting requirements. See proposed 
rule 2a-7(c)(11)(iii).
    \21\ We previously adopted certain of the amendments that we 
proposed in 2008 as part of the 2010 money market fund reforms. See 
Money Market Fund Reform Adopting Release, supra note 8, at Sections 
II.C.2, II.G.2. Specifically, we expressly limited money market 
funds' investments in illiquid securities. See rule 2a-7(c)(5)(i). 
We also required money market funds to notify the Commission 
promptly when an affiliate has purchased certain securities, 
including a security that is no longer an eligible security, from 
the fund in reliance on rule 17a-9, which permits certain affiliated 
persons to purchase certain portfolio securities from a money market 
fund under certain conditions. See rule 2a-7(c)(7)(iii)(B). See also 
2008 Ratings Removal Proposing Release, supra note 6, at Sections 
III.A.2, III.A.4.
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1. Eligible Securities
    Under the proposed amendments, a money market fund would continue 
to be limited to investing in securities that money market fund boards 
of directors (or their delegates) determine present minimal credit 
risks,\22\ and each of which is either a ``first tier security'' or a 
``second tier security'' under the rule.\23\ Fund boards of directors 
(which typically rely on the fund's adviser) would still be able to 
consider quality determinations prepared by outside sources, including 
NRSRO ratings, that fund advisers conclude are credible and reliable, 
in making credit risk determinations. We would expect the fund advisers 
to understand the method for determining the rating and make an 
independent judgment of credit risks, and to consider an outside 
source's record with respect to evaluating the types of securities in 
which the fund invests.
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    \22\ See proposed rule 2a-7(a)(11).
    \23\ The proposal would not change current rule 2a-7 limitations 
on money market fund investments in second tier securities, under 
which a money market fund cannot acquire second tier securities with 
remaining maturities greater than 45 days, generally must limit its 
investments in second tier securities to no more than three percent 
of fund assets, and limit investments in the second tier securities 
of any one issuer to one half of one percent of fund assets. Rule 
2a-7(c)(3)(ii); 2a-7(c)(4)(i)(C).
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    We propose to eliminate the requirement that an eligible security 
be rated by an NRSRO or be of comparable quality while maintaining the 
two-step analysis currently required by rule 2a-7. Under the proposed 
amendments, a security would be a first tier security (regardless of 
the ratings it has received from any credit rating agency) if the 
fund's board (or its delegate) determines that the issuer (or in the 
case of a security subject to a guarantee, the guarantor) \24\ has the 
``highest capacity to meet its short-term financial obligations.'' \25\ 
A security would be a second tier security if it is an eligible 
security but is not a first tier security.\26\ In addition, a security 
would be an eligible security only if the board of directors (or its 
delegate) determines that it presents minimal credit risks, which 
determination must be based on factors pertaining to credit quality and 
the issuer's ability to meet its short-term financial obligations.\27\
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    \24\ See rule 2a-7(c)(3)(iii) (allowing the credit quality of a 
guarantee to substitute for the credit quality of the security 
subject to the guarantee); 2a-7(a)(17) (defining ``guarantee'' to 
mean ``an unconditional obligation of a person other than the issuer 
of the security to undertake to pay, upon presentment by the holder 
of the guarantee (if required), the principal amount of the 
underlying security plus accrued interest when due or upon default, 
or, in the case of an unconditional demand feature, an obligation 
that entitles the holder to receive upon exercise the approximate 
amortized cost of the underlying security or securities, plus 
accrued interest, if any.'').
    \25\ Proposed rule 2a-7(a)(13). As under the current rule, 
government securities and securities issued by a money market fund 
also would be first tier securities. Proposed rule 2a-7(a)(13); see 
rule 2a-7(a)(14).
     Our proposed amendments would eliminate the defined terms 
``designated NRSRO,'' ``rated security,'' ``requisite NRSRO,'' and 
``unrated security'' from the rule. As a result, under the proposal, 
fund boards would no longer be required to designate NRSROs and 
funds would not have to disclose designated NRSROs in their 
statements of additional information (``SAI''). See rule 2a-7(a)(11) 
(defining ``designated NRSRO'' as one of at least four NRSROs that, 
among other things, the fund's board has designated as an NRSRO 
whose credit ratings will be used by the fund to determine the 
eligibility of portfolio securities, the board determines at least 
annually issues credit ratings sufficiently reliable for such use, 
and the fund discloses in its SAI is a designated NRSRO, including 
any limitations on the fund's use of the designation). We note that 
after enactment of the Dodd-Frank Act, money market funds received 
Commission staff assurances that the staff would not recommend 
enforcement action if a money market fund board did not designate 
NRSROs and did not make related disclosures in its SAI before the 
Commission had completed its review of rule 2a-7 required by the 
Dodd-Frank Act and made any modifications to the rule. See 
Investment Company Institute, SEC No-Action Letter (Aug. 19, 2010).
    \26\ See proposed rule 2a-7(a)(21). The specific language of 
this provision would not change (compare current rule 2a-7(a)(24)), 
but the definitions of ``eligible security'' and ``first tier 
security'' would change under the proposal.
    \27\ Proposed rule 2a-7(a)(11). Currently, the requirement that 
the fund board (or its delegate) determine that a security presents 
minimal credit risks is contained in paragraph (c)(3)(i) of the 
rule. In connection with the amendments discussed above, we propose 
to restructure the rule to incorporate the minimal credit risk 
determination into the definition of ``eligible security,'' 
currently in paragraph (a)(12) of the rule, but which would be 
renumbered as paragraph (a)(11).
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    We have designed these amendments to retain a degree of risk 
limitation on money market funds similar to the current rule. The 
proposed amendments would continue to require that funds invest at 
least 97 percent of their total assets in the highest quality short-
term debt securities.\28\ Money market fund holdings of these first 
tier securities would have to satisfy a standard similar to the credit 
quality standards that have been articulated by the credit ratings 
agencies.\29\ An issuer of a first tier

[[Page 12899]]

security that would satisfy our proposed standard should have an 
exceptionally strong ability to repay its short-term debt obligations 
and the lowest expectation of default.\30\ The credit risk associated 
with a second tier security, which would continue to be limited to 
three percent of total fund assets,\31\ would differ from that 
associated with first tier securities only to a small degree. Thus, the 
issuer of a second tier security that would satisfy our proposed 
standard should have a very strong ability to repay its short-term debt 
obligations, and a very low vulnerability to default.\32\ Finally, we 
propose to eliminate the requirement that guarantors or guarantees of 
securities held by a money market fund be rated by an NRSRO.\33\
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    \28\ See proposed rule 2a-7(a)(13) (defining first tier 
security); rule 2a-7(c)(3)(ii) (prohibiting money market funds from 
acquiring second tier securities if, as a result of the acquisition, 
second tier securities would comprise more than three percent of the 
fund's total assets).
    \29\ See, e.g., Standard & Poor's Ratings Definitions, Short-
Term Issue Credit Ratings, http://www.standardandpoors.com/ratings/articles/en/us/?assetID=1245219848760 (``S&P Ratings Definitions'') 
(a short-term obligation rated ``A-1'' is rated in the highest 
category, and the obligor's capacity to meet its financial 
commitment on the obligation is strong; obligations within the 
category designated with a plus sign (+) indicates that the 
obligor's capacity to meet its financial commitment on these 
obligations is extremely strong); Moody's Investors Service Rating 
Symbols and Definitions, http://v3.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004 (``Moody's Ratings 
Definitions'') at 5-6 (issuers rated Prime-1 ``have a superior 
ability to repay short-term debt obligations.''); FitchRatings, 
International Issuer and Credit Rating Scales, http://www.fitchratings.com/creditdesk/public/ratings_definitions/index.cfm?rd_file=ltr (``Fitch Ratings Definitions'') (stating that 
a rating of F1 is the highest short-term rating, indicating the 
``strongest intrinsic capacity for timely payment of financial 
commitments; may have an added `+' to denote any exceptionally 
strong credit feature.'').
    \30\ We note that all money market fund portfolio securities 
also must be eligible securities (i.e., present minimal credit risks 
under the proposed amendments). See proposed rule 2a-7(a)(13). Thus, 
even if the issuer had the highest capacity to meet its short-term 
financial obligations, a security, such as a subordinated short-term 
security secured by assets that are not of high credit quality, 
likely would not present minimal credit risks to a money market 
fund's portfolio and therefore likely would not be an eligible 
security.
    \31\ Rule 2a-7(c)(3)(ii).
    \32\ Nothing in the proposed rule would prohibit a money market 
fund from relying on policies and procedures it has adopted to 
comply with the current rule as long as the board (or its delegate) 
concluded that the ratings specified in the policies and procedures 
establish similar standards to those proposed, and are credible and 
reliable for that use. A fund also would be able to revise its 
policies and procedures to change or eliminate the use of specific 
NRSRO ratings or to incorporate other third party evaluations of 
credit quality.
    \33\ See rule 2a-7(a)(12)(iii)(A). We also propose to move the 
provision that conditions the eligibility of a demand feature or 
guarantee of the issuer, or another institution, on an undertaking 
promptly to notify the fund in the event of a substitution of a 
demand feature or guarantee, which is currently in paragraph 
(a)(12)(iii)(B), to paragraphs (c)(3)(iii) (permitting money market 
funds to substitute the credit quality of a guarantee for the credit 
quality of the security subject to the guarantee in determining 
whether a security is an eligible or first tier security) and 
(c)(3)(iv)(D) (conditions under which a security subject to a 
conditional demand feature may be determined to be an eligible 
security or first tier security).
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    Our proposal would eliminate the objective standard provided by 
credit ratings in the definitions of eligible security and first tier 
security and instead require a subjective determination of both 
eligible securities and first tier securities. We request comment on 
this proposed approach.
     Would our proposed approach achieve the goal of retaining 
a degree of risk limitation on money market funds similar to the 
current rule?
     Are there alternatives to our proposed approach that would 
provide a more robust or objective evaluation of credit quality?
     Is there a better way to describe the characteristics of a 
first tier security?
     Should we instead simply limit money market funds to 
investing in securities solely based on a minimal credit risk 
determination, i.e., establish a single test for determining whether a 
fund could invest in a security?
     Would such an approach allow money market funds to invest 
a large portion of their portfolios in what are currently second tier 
securities?
2. Securities With a Conditional Demand Feature
    Under rule 2a-7, a security subject to a conditional demand feature 
\34\ may be determined to be an eligible security or a first tier 
security if, among other conditions, (i) the conditional demand feature 
is an eligible security or a first tier security, and (ii) the 
underlying security (or its guarantee) has received either a short-term 
rating or a long-term rating, as the case may be, within the highest 
two categories from the requisite NRSROs or is a comparable unrated 
security.\35\ We propose to remove the credit rating requirement from 
this provision of the rule and amend the provision to require that the 
fund's board (or its delegate) determine that the underlying security 
be of high quality and subject to very low credit risk.\36\ The 
proposed standard is designed to retain a similar degree of risk 
limitation to that in the current rule. An issuer that is determined to 
have a very strong capacity to meet its financial commitments, a very 
low risk of default, and a capacity for payment of its financial 
commitments that is not significantly vulnerable to reasonably 
foreseeable events would satisfy the proposed definition.\37\ In making 
the credit quality determinations required under the proposed 
amendment, a fund board (or its delegate) would continue to be able to 
consider analyses provided by third parties, including ratings provided 
by ratings agencies, that it concludes are credible and reliable for 
such purposes.\38\
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    \34\ A conditional demand feature is a demand feature that a 
fund may be precluded from exercising because of the occurrence of a 
condition. See rule 2a-7(a)(6) (defining ``conditional demand 
feature'' as a demand feature that is not an unconditional demand 
feature); 2a-7(a)(28) (defining ``unconditional demand feature'' as 
a demand feature that by its terms would be readily exercisable in 
the event of a default in payment of principal or interest on the 
underlying security). For purposes of rule 2a-7, a demand feature 
allows the security holder to receive, upon exercise, the 
approximate amortized cost of the security, plus accrued interest, 
if any. In addition, a demand feature must be exercisable either: 
(i) At any time on no more than 30 calendar days' notice; or (ii) at 
specified intervals not exceeding 397 calendar days and upon no more 
than 30 calendar days' notice. Rule 2a-7(a)(9)(i). If an asset-
backed security is subject to a demand feature, the feature must 
permit the security holder unconditionally to receive principal and 
interest within 397 calendar days of making demand. Rule 2a-
7(a)(9)(ii).
    \35\ Rule 2a-7(c)(3)(iv).
    \36\ Proposed rule 2a-7(c)(3)(iv)(C). The rule references both 
short-term and long-term ratings because most money market fund 
portfolio securities with demand features are long-term securities 
(that would not meet the portfolio maturity requirements of rule 2a-
7 without the demand feature). Under current rule 2a-7, a money 
market fund must limit its investments in securities subject to a 
demand feature or guarantee of the same issuer that are second tier 
securities to 2.5% of the fund's total assets. Rule 2a-7(c)(4)(iii). 
If, as a result of a downgrade, a fund exceeds this limitation on 
such securities, the fund must reduce its investment in the 
securities to no more than 2.5% of total assets by exercising the 
demand feature at the next succeeding exercise date(s). Rule 2a-
7(c)(7)(i)(C). In a conforming change, we propose to amend this 
provision to require the fund to reduce its investment in securities 
subject to a demand feature or guarantee of a single issuer that are 
second tier securities, if, as a result of a portfolio security that 
ceases to be a first tier security, the fund exceeds the 2.5% 
investment limit on such securities. Proposed rule 2a-7(c)(7)(i)(B).
    \37\ These credit quality characteristics are similar to credit 
quality standards that have been articulated by credit rating 
agencies. See, e.g., S&P Ratings Definitions, supra note 29 
(describing the capacity of an issuer of long-term obligations rated 
``AA'' as ``very strong''); Moody's Ratings Definitions, supra note 
29 (describing Aa-rated long-term obligations as ``judged to be of 
high quality and are subject to very low credit risk.''); Fitch 
Ratings Definitions, supra note 29 (describing AA-rated long-term 
obligations as denoting expectations of very low default risk and 
indicating that the issuer's capacity for payment of financial 
commitments is very strong and ``not significantly vulnerable to 
foreseeable events'').
    \38\ The proposed amendment would not prohibit a money market 
fund from relying on policies and procedures it has adopted to 
comply with the current rule regarding the credit quality of 
securities with conditional demand features as long as the board (or 
its delegate) concluded that the ratings specified in the policies 
and procedures establish similar standards to those proposed, and 
that the agencies providing ratings used in the policies and 
procedures are credible and reliable for that use. A fund also could 
revise its policies and procedures to change or eliminate the 
consideration of specific NRSRO ratings or to incorporate other 
third party evaluations of credit quality.
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    We request comment on the proposed credit quality standard for 
securities with a conditional demand feature.
     Does our proposed standard retain the same or similar 
degree of risk limitation as that under the current rule?
     Are there alternative standards that would provide a more 
robust or objective evaluation of credit quality?
3. Monitoring Minimal Credit Risks
    Rule 2a-7 currently requires a money market fund board (or its 
delegate) promptly to reassess whether a security that has been 
downgraded by an NRSRO continues to present minimal credit risks, and 
take such action as it

[[Page 12900]]

determines is in the best interests of the fund and its 
shareholders.\39\ We propose to amend the rule to require that, in the 
event the money market fund's adviser (or any person to whom the board 
has delegated portfolio management responsibilities) becomes aware of 
any credible information about a portfolio security or an issuer of a 
portfolio security that suggests that the security is no longer a first 
tier security or a second tier security, as the case may be, the board 
or its delegate would have to reassess promptly whether the portfolio 
security continues to present minimal credit risks.\40\ To satisfy the 
proposed standard, an investment adviser would be required to exercise 
reasonable diligence in keeping abreast of new information about a 
portfolio security that the adviser believes to be credible. We 
understand that most money market fund advisers currently exercise a 
similar degree of diligence in monitoring their portfolios in order to 
meet the rule 2a-7 requirement that portfolio investments be limited to 
securities that the board determines present minimal credit risks.
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    \39\ Rule 2a-7(c)(7)(i)(A). This current reassessment is not 
required, however, if the downgraded security is disposed of or 
matures within five business days of the specified event and in the 
case of events specified in rule 2a-7(c)(7)(i)(A)(2), the board is 
subsequently notified of the adviser's actions. Rule 2a-
7(c)(7)(i)(B).
    \40\ Proposed rule 2a-7(c)(7)(i)(A). As under the current rule, 
the proposal would not require reassessment in certain 
circumstances. See supra note 39. Our proposed standard differs 
slightly from our proposal in 2008, which would have required the 
board's reassessment if the money market fund's investment adviser 
became aware of any information about a portfolio security or an 
issuer of a portfolio security that suggested that the security 
might not have continued to present minimal credit risks. See 2008 
Ratings Removal Proposing Release, supra note 6, at Section III.A.3. 
We believe that requiring the relevant information to relate to 
whether the portfolio security may no longer be first or second tier 
(as compared with the standard proposed in 2008) is more similar to 
the current standard. In addition, as noted by several commenters on 
the standard proposed in 2008, without limiting the information to 
be monitored in any way, the standard could be interpreted to 
require monitoring of all information regarding portfolio 
securities, including unreliable sources or unsubstantiated market 
rumors. See, e.g., Comment Letter of CFA Institute Centre for 
Financial Market Integrity (Mar. 26, 2009); Comment Letter of 
Charles Schwab & Co., Inc. (Sept. 5, 2008); Comment Letter of 
Federated Investors, Inc. (Sept. 5, 2008).
---------------------------------------------------------------------------

    We request comment on the proposed amendments for monitoring 
minimal credit risks.
     Would our proposed approach to describing when 
reassessment of whether a portfolio security presents minimal credit 
risks is required achieve the objective of retaining a degree of risk 
limitation on money market funds similar to the current rule?
     Is there an alternative or more objective standard for 
determining when the board must reassess the credit risk of a security 
that would provide adequate investor protections?
     Are we correct in our understanding of current monitoring 
practices?
4. Stress Testing
    Rule 2a-7 currently requires money market funds to adopt written 
procedures for stress testing their portfolios. Specifically they must 
test the fund's ability to maintain a stable net asset value per share 
based on certain hypothetical events, including a downgrade of 
portfolio securities.\41\ We propose to replace this reference to 
ratings downgrades with a hypothetical event that is designed to have a 
similar impact on a money market fund's portfolio. Our proposal would 
require that money market funds stress test for an adverse change in 
the ability of a portfolio security issuer to meet its short-term 
financial obligations.\42\ Under the proposed rule, funds could 
continue to test their portfolios by treating a downgrade as a credit 
event that might adversely affect the value or liquidity of the 
portfolio security (and affect the fund's ability to maintain a stable 
net asset value per share).
---------------------------------------------------------------------------

    \41\ Rule 2a-7(c)(10)(v)(A).
    \42\ Proposed rule 2a-7(c)(10)(v)(A).
---------------------------------------------------------------------------

    We request comment on our proposed amendment to the stress testing 
requirements.
     Does the standard we propose adequately address the same 
concerns that arise when a security is downgraded?
     Is the proposed standard too broad?
     Would the proposed standard provide adequate guidance to 
funds?
     Is there a narrower standard that we should specify?

B. Form N-MFP

    As part of the money market fund reforms we adopted in 2010, money 
market funds must provide to the Commission a monthly electronic filing 
of portfolio holdings information on Form N-MFP.\43\ The information 
money market funds must disclose with respect to each portfolio 
security (and any guarantee, demand feature or other enhancement 
associated with the portfolio security) includes the name of each 
designated NRSRO for the portfolio security and the rating assigned to 
the security.\44\ We propose to eliminate the items requiring 
disclosure of ratings information from the form. We also propose to 
amend Item 33 of Form N-MFP to remove the reference to a rating in this 
item so that funds would only disclose whether a portfolio security is 
first or second tier or no longer an eligible security.\45\
---------------------------------------------------------------------------

    \43\ See rule 30b1-7. See also Money Market Fund Reform Adopting 
Release, supra note 8, at n.301 and accompanying and preceding text.
    \44\ See Items 34 (requiring disclosure of each designated NRSRO 
for a portfolio security and the credit rating given by the 
designated NRSRO for each portfolio security); 37b-c (requiring 
disclosure of each designated NRSRO and the credit rating given by 
the designated NRSRO for each portfolio security demand feature); 
38b-c (requiring disclosure of each designated NRSRO and the credit 
rating given by the designated NRSRO for each portfolio security 
guarantee); 39c-d (requiring disclosure of each designated NRSRO and 
the credit rating given by the designated NRSRO for each portfolio 
security enhancement) of Form N-MFP.
    \45\ See Item 33 of Form N-MFP (requiring money market funds to 
disclose whether a security is a ``rated'' first or second tier 
security, an unrated security, or no longer an eligible security).
---------------------------------------------------------------------------

    We request comment on the proposed form amendments.

C. Rule 5b-3

    Rule 5b-3 under the Investment Company Act permits a fund, subject 
to certain conditions, to treat a repurchase agreement as an 
acquisition of the securities collateralizing the repurchase agreement 
in determining whether the fund is in compliance with two provisions of 
the Investment Company Act that may affect a fund's ability to invest 
in repurchase agreements. In a typical investment company repurchase 
agreement, a fund enters into a contract with a broker, dealer or bank 
(the ``counterparty'' to the transaction) for the purchase of 
securities. The counterparty agrees to repurchase the securities at a 
specified future date, or on demand, for a price that is sufficient to 
return to the fund its original purchase price, plus an additional 
amount representing the return on the fund's investment.\46\
---------------------------------------------------------------------------

    \46\ Repurchase agreements provide funds with a convenient means 
to invest excess cash on a secured basis, generally for short 
periods of time. Economically, a repurchase agreement functions as a 
loan from the fund to the counterparty, in which the securities 
purchased by the fund serve as collateral for the loan and are 
placed in the possession or under the control of the fund's 
custodian during the term of the agreement. See Treatment of 
Repurchase Agreements and Refunded Securities as an Acquisition of 
the Underlying Securities, Investment Company Act Release No. 25058 
(July 5, 2001) [66 FR 36156 (July 11, 2001)] (``Rule 5b-3 Adopting 
Release''). Various issues arose during the market events of 2007 to 
2009 that affected the market for repurchase agreements. In 
response, a task force of participants in the market for tri-party 
repurchase agreements was formed and issued a report setting forth 
its findings and recommendations for improvements. See Report of 
Task Force on Tri-Party Repo Infrastructure, (May 17, 2010) at 
http://www.ny.frb.org/prc/report_100517.pdf.
---------------------------------------------------------------------------

    Section 12(d)(3) of the Investment Company Act generally prohibits 
a fund from acquiring an interest in a broker, dealer, or underwriter. 
Because a repurchase agreement may be considered to be the acquisition 
of an

[[Page 12901]]

interest in the counterparty, section 12(d)(3) may limit a fund's 
ability to enter into repurchase agreements with many of the firms that 
act as repurchase agreement counterparties. Section 5(b)(1) of the 
Investment Company Act limits the amount that a fund that holds itself 
out as being a diversified investment company may invest in the 
securities of any one issuer (other than the U.S. Government). This 
provision may limit the number and principal amounts of repurchase 
agreements a diversified fund may enter into with any one counterparty.
    Rule 5b-3 allows funds to treat the acquisition of a repurchase 
agreement as an acquisition of securities collateralizing the 
repurchase agreement for purposes of sections 5(b)(1) and 12(d)(3) of 
the Investment Company Act if the obligation of the seller to 
repurchase the securities from the fund is ``collateralized fully.'' 
\47\ A repurchase agreement is collateralized fully if, among other 
things, the collateral for the repurchase agreement consists entirely 
of (i) cash items, (ii) government securities, (iii) securities that at 
the time the repurchase agreement is entered into are rated in the 
highest rating category by the ``requisite NRSROs'' \48\ or (iv) 
unrated securities that are of a comparable quality to securities that 
are rated in the highest rating category by the requisite NRSROs, as 
determined by the fund's board of directors or its delegate.\49\ In 
proposing rule 5b-3, the Commission explained that the highest rating 
category requirement in the definition of collateralized fully was 
designed to help ensure that the market value of the collateral would 
remain stable and that the fund could more readily liquidate the 
collateral quickly in the event of a default.\50\
---------------------------------------------------------------------------

    \47\ Rule 5b-3(a). The term ``collateralized fully'' is defined 
in rule 5b-3(c)(1). In general, a fund investing in a repurchase 
agreement looks to the value and liquidity of the securities 
collateralizing the repurchase agreement rather than the credit 
quality of the counterparty for satisfaction of the repurchase 
agreement. See Rule 5b-3 Adopting Release, supra note 46, at Section 
II.A.3. But see rule 2a-7(c)(4)(ii)(A) (requiring money market funds 
to evaluate the counterparty's credit-worthiness).
    \48\ The term ``requisite NRSROs'' means any two NRSROs that 
have issued a rating with respect to a security or class of debt 
obligations of an issuer or, if only one NRSRO has issued a rating 
with respect to such security or class of debt obligations of an 
issuer at the time the investment company acquires the security, 
that NRSRO. Rule 5b-3(c)(6).
    \49\ Rule 5b-3(c)(1)(iv). The term ``unrated securities'' means 
securities that have not received a rating from the requisite 
NRSROs. Rule 5b-3(c)(8). We note, however, that as a result of our 
recent money market fund reforms, money market funds seeking similar 
treatment with respect to the diversification requirements under 
rule 2a-7 are subject to stricter limitations. In order to qualify 
for such special treatment, a repurchase agreement is collateralized 
fully only if the collateral for the repurchase agreement consists 
entirely of cash or government securities. Rule 2a-7(a)(5). See 
Money Market Fund Reform Adopting Release, supra note 8, at Section 
II.D.
    \50\ See Treatment of Repurchase Agreements and Refunded 
Securities as an Acquisition of the Underlying Securities, 
Investment Company Act Release No. 24050 (Sept. 23, 1999) [64 FR 
52476 (Sept. 29, 1999)] (``Rule 5b-3 Proposing Release'') at n.43 
and accompanying text (noting that the high quality requirement is 
designed to limit a fund's exposure to the ability of the 
counterparty to maintain sufficient collateral, and that securities 
of lower quality may be subject to greater price fluctuation).
---------------------------------------------------------------------------

    We propose to eliminate the requirement that collateral other than 
cash or government securities be rated in the highest category by the 
requisite NRSROs or be of comparable quality. In place of this 
requirement, we propose to require that collateral other than cash or 
government securities consist of securities that the fund's board of 
directors (or its delegate) determines at the time the repurchase 
agreement is entered into are: (i) Issued by an issuer that has the 
highest capacity to meet its financial obligations; and (ii) 
sufficiently liquid that they can be sold at approximately their 
carrying value in the ordinary course of business within seven calendar 
days.\51\ For purposes of rule 5b-3, an issuer would be defined to 
include an issuer of an unconditional guarantee of the security.\52\ 
Thus, a collateral security with an unconditional guarantee, the issuer 
of which meets the proposed credit quality test, would satisfy that 
element of the proposed standard.
---------------------------------------------------------------------------

    \51\ Proposed rule 5b-3(c)(1)(iv)(C). Under the proposal, the 
board would make credit quality determinations for all collateral 
securities that are not government securities, rather than just 
unrated securities. As in the current rule, the proposed rule would 
permit the board to delegate the credit quality and liquidity 
determination. The proposed amendment to rule 5b-3 would not affect 
a money market fund that seeks special treatment under the 
diversification provisions of rule 2a-7 because in order to obtain 
such treatment, a money market fund is limited to investing in 
repurchase agreements collateralized by cash items or government 
securities. See supra note 49. We are proposing to amend rule 2a-
7(a)(5), which defines ``collateralized fully,'' to conform the 
references in that provision to the proposed amendments to rule 5b-
3.
     The first element of this proposed standard reflects the same 
standard as that proposed for the definition of first tier security 
under rule 2a-7. See proposed rule 2a-7(a)(13).
    \52\ Proposed rule 5b-3(c)(4) (defining ``issuer'' to mean ``the 
issuer of a collateral security or the issuer of an unconditional 
obligation of a person other than the issuer of the collateral 
security to undertake to pay, upon presentment by the holder of the 
obligation (if required), the principal amount of the underlying 
collateral security plus accrued interest when due or upon 
default.'').
---------------------------------------------------------------------------

    We have designed the proposed amendments to retain a degree of 
credit quality similar to that under the current rule. An issuer of 
collateral securities that the board (or its delegate) determined has 
an exceptionally strong capacity to repay its short or long-term debt 
obligations, as appropriate, the lowest expectation of default, and a 
capacity for repayment of its financial commitments that is the least 
susceptible to adverse effects of changes in circumstances would 
satisfy the proposed standard.\53\
---------------------------------------------------------------------------

    \53\ See supra text accompanying note 30.
---------------------------------------------------------------------------

    Our proposal also would require that at the time the repurchase 
agreement is entered into, collateral could be sold at approximately 
its carrying value in the ordinary course of business within seven 
calendar days.\54\ We expect that securities that trade in a secondary 
market at the time of the acquisition of the repurchase agreement would 
satisfy this liquidity standard. We also understand that most 
securities that are currently used to collateralize repurchase 
agreements \55\ generally trade in a secondary market.
---------------------------------------------------------------------------

    \54\ The proposed liquidity standard is the same as that we use 
for rule 2a-7. See, e.g., rule 2a-7(a)(19) (defining illiquid 
security to mean a security that cannot be sold or disposed of in 
the ordinary course of business within seven calendar days at 
approximately the value ascribed to it by the fund).
    \55\ See Tri-Party Repo Infrastructure, Reform Task Force, Tri-
Party Repo Margin Data, Summary Statistics for the U.S. Tri-Party 
Repo Market (as of Jan. 11, 2011), http://www.newyorkfed.org/tripartyrepo/margin_data.html (describing 98.7% of tri-party 
repurchase agreement collateral as composed of asset-backed 
securities, agency collateralized mortgage backed obligations 
(``CMOs''), agency debentures and strips, agency mortgage-backed 
securities, private label CMOs, corporate debt, equity securities, 
money market instruments and U.S. Treasury securities).
---------------------------------------------------------------------------

    We have designed the proposed amendments to be clear enough to 
permit a fund board or fund investment adviser to make a determination 
regarding credit quality and liquidity that would achieve the same 
objectives that the credit rating requirement was designed to achieve, 
i.e., to limit collateral securities to those that are likely to retain 
a fairly stable market value and that, under ordinary circumstances, 
the fund would be able to liquidate quickly in the event of a 
counterparty default.\56\ We believe that fund advisers have experience 
with or knowledge of the evaluation of securities and would be 
qualified to make the credit and liquidity

[[Page 12902]]

determinations proposed under the rule.\57\
---------------------------------------------------------------------------

    \56\ See supra note 50. A fund that acquires repurchase 
agreements would, under rule 38a-1, have to adopt and implement a 
written policy reasonably designed to comply with the conditions of 
rule 5b-3, including any credit quality and liquidity requirements 
we might adopt under the rule. See rule 38a-1(a) (requiring 
registered funds to adopt and implement written policies and 
procedures reasonably designed to prevent the fund's violation of 
Federal securities laws).
    \57\ We note that under the current rule, if collateral 
securities are unrated, fund boards of directors (or their 
delegates) must determine that the securities are of comparable 
quality to securities rated in the highest category by an NRSRO. 
Rule 5b-3(c)(iv)(D).
---------------------------------------------------------------------------

    Under the proposal, the board could delegate day-to-day 
determinations regarding the quality and liquidity of collateral if it 
chooses, provided that the board retained sufficient oversight. In 
addition, although the rule would no longer require the collateral to 
be rated by an NRSRO, fund boards (or their delegates) would still be 
able to consider analysis provided by outside sources, including credit 
agency ratings, that they conclude are credible and reliable, for 
purposes of making these credit quality evaluations.\58\
---------------------------------------------------------------------------

    \58\ We understand that credit quality standards for securities 
collateralizing repurchase agreements are typically contained in the 
agreements between funds and counterparties. We expect that those 
standards include a rating (for rated collateral securities) and any 
additional criteria a fund manager considers necessary to ensure 
that the credit quality of collateral securities meets the fund's 
requirements, or for unrated securities, a comparable credit quality 
standard. The proposed amendment would not prohibit fund boards (or 
their delegates) from relying on the credit quality standards in 
current repurchase agreements and policies and procedures adopted to 
comply with the current rule regarding the credit quality of 
collateral securities as long as they conclude that the ratings 
specified in the repurchase agreements and policies and procedures 
establish similar standards to those proposed, and that the agencies 
providing the ratings used in the policies and procedures are 
credible and reliable for that use. A fund could also revise its 
repurchase agreements and policies and procedures to change or 
eliminate the consideration of specific NRSRO ratings or to 
incorporate other third party evaluations of credit quality.
---------------------------------------------------------------------------

    We request comment on our proposed amendment to rule 5b-3.
     Would the proposed determinations sufficiently address our 
concerns that collateral securities be of high quality in order to 
limit a fund's exposure to counterparties' credit risks? If not, are 
there additional or alternative standards that do not use credit 
ratings that would better address our concerns?
     Should a fund board (or its delegate) be permitted to 
consider assessments issued by third parties, as we anticipate? What, 
if any, criteria or standards should be imposed on the use of such 
assessments? Would the use of third party assessments help fund boards 
(or their delegates) arrive at consistent determinations regarding the 
credit quality of collateral under the rule?
     We propose to allow the credit quality of an issuer of an 
unconditional guarantee to substitute for the credit quality of the 
issuer of a collateral security subject to the guarantee.\59\ This is 
designed to preserve a fund's ability to use the same types of 
collateral securities as it currently uses to satisfy the conditions of 
rule 5b-3. Should we instead limit collateral to securities that alone 
satisfy the proposed credit quality standard regardless of whether the 
security is subject to an unconditional guarantee?
---------------------------------------------------------------------------

    \59\ See proposed rule 5b-3(c)(1)(iv)(C)(4).
---------------------------------------------------------------------------

     Would the proposed standard adequately address our concern 
that a fund be able to readily liquidate collateral securities in the 
event of a counterparty default?
     As noted above, we expect that, in general, securities 
that trade in secondary markets and most securities that are used as 
collateral for repurchase agreements would meet the proposed liquidity 
requirement. Are there securities typically used for collateral that 
would not meet the proposed liquidity standard?
     We have noted before that high quality securities 
generally are more liquid than lower quality securities.\60\ Would the 
proposed credit quality requirement alone be sufficient to address 
concerns regarding liquidity of the collateral?
---------------------------------------------------------------------------

    \60\ See Rule 5b-3 Proposing Release, supra note 50, at n.43.
---------------------------------------------------------------------------

     We acknowledge that securities that may be liquid at the 
time of acquisition of the repurchase agreement may be less liquid when 
the counterparty defaults.\61\ Would a different standard of liquidity 
provide any greater protection? For example, if we required that 
collateral could be sold at carrying value almost immediately, would it 
be more likely to remain liquid if many holders of the security are 
trying to sell at the same time? Would such a standard limit collateral 
securities to U.S. Treasury securities as a practical matter?
---------------------------------------------------------------------------

    \61\ We have noted before the difficulties of liquidating 
collateral in the case of a default by a large counterparty when 
many investors in repurchase agreements seek to liquidate similar 
collateral at the same time. See Money Market Fund Reform Proposing 
Release, supra note 8, at n.229 and accompanying and preceding text.
---------------------------------------------------------------------------

     In light of the potential for decreased liquidity of 
collateral securities at the time of a counterparty default, should we 
limit the exemption to repurchase agreements that are collateralized 
only by cash or government securities?
     Would we better achieve the goals of rule 5b-3 if the rule 
provided that a fund could no longer rely on rule 5b-3 if, at any point 
after the time a fund enters into a repurchase agreement, the 
collateral no longer met the proposed liquidity standard?

D. Proposed Rule 6a-5

    Business and industrial development companies (``BIDCOs'') are 
companies that operate under state statute that provide direct 
investment and loan financing, as well as managerial assistance, to 
state and local enterprises.\62\ Because they invest in securities, 
BIDCOs frequently meet the definition of ``investment company'' under 
the Investment Company Act.\63\ In 1996, the Investment Company Act was 
amended to add section 6(a)(5) to exempt these companies from most 
provisions of the Act subject to certain conditions.\64\ The statutory 
exemption was premised on states having a strong interest in overseeing 
the structure and operations of these companies, thus rendering 
regulation under the Investment Company Act largely duplicative and 
unnecessary.\65\
---------------------------------------------------------------------------

    \62\ See S. Rep. No. 103-166, at 11 (1993) (``1993 Senate 
Report'').
    \63\ For purposes of the Investment Company Act, an ``investment 
company'' means any issuer that (A) is or holds itself out as being 
engaged primarily, or proposes to engage primarily, in the business 
of investing, reinvesting, or trading in securities; (B) is engaged 
or proposes to engage in the business of issuing face-amount 
certificates of the installment type, or has been engaged in such 
business and has any such certificate outstanding; or (C) is engaged 
or proposes to engage in the business of investing, reinvesting, 
owning, holding, or trading in securities, and owns or proposes to 
acquire investment securities having a value exceeding 40 per centum 
of the value of such issuer's total assets (exclusive of government 
securities and cash items) on an unconsolidated basis. 15 U.S.C. 
80a-3(a)(1).
    \64\ 15 U.S.C. 80a-6(a)(5); Pub. L. 104-290 Sec.  501, 110 Stat. 
3416, 3444 (1996). Section 6(a)(5)(B) provides that section 9 and, 
to the extent necessary to enforce section 9, sections 38 through 
51, apply to a BIDCO as though the company were a registered 
investment company. Among other conditions to reliance on the 
exemption in section 6(a)(5), a BIDCO may not issue redeemable 
securities.
    \65\ See 1993 Senate Report, supra note 62, at 19 (further 
stating that states are well positioned to monitor these companies 
and address the needs of resident investors). Prior to the addition 
of section 6(a)(5), the Commission had granted orders to exempt 
BIDCOs from regulation under the Act. See, e.g., The Idaho Company, 
Investment Company Release Nos. 18926 (Sept. 3, 1992) (notice) and 
18985 (Sept. 30, 1992) (order).
---------------------------------------------------------------------------

    BIDCOs that seek to rely on the exemption in section 6(a)(5) are 
limited with respect to the types of securities issued by investment 
companies and companies exempt from the definition of investment 
company under section 3(c)(1) or 3(c)(7) of the Act (``private funds'') 
that they may purchase. Specifically, section 6(a)(5)(A)(iv) limits 
these BIDCOs from purchasing securities issued by investment companies 
and private funds other than debt securities that are rated investment 
grade by at least one NRSRO and securities issued by registered open-
end investment companies that invest at

[[Page 12903]]

least 65 percent of their assets in investment grade securities or 
securities that the fund determines are comparable in quality.\66\ This 
provision was intended to provide limited flexibility to invest capital 
not immediately needed for the company's long-term commitments.\67\ 
Although the legislative history of the provision does not specifically 
explain why Congress restricted BIDCOs to acquiring ``investment 
grade'' debt of investment companies and private funds, it may have 
been designed to limit BIDCOs to investing in debt securities of 
sufficiently high credit quality that they are likely to maintain a 
fairly stable market value and that could be liquidated easily, as 
appropriate, for the BIDCO to support its investment and financing 
activities.
---------------------------------------------------------------------------

    \66\ 15 U.S.C. 80a-6(a)(5)(A), as in effect prior to July 21, 
2012 (exempting any company that is not engaged in the business of 
issuing redeemable securities, the operations of which are subject 
to regulation by the State in which the company is organized under a 
statute governing entities that provide financial or managerial 
assistance to enterprises doing business, or proposing to do 
business in that state if, among other things, the company does not 
purchase any security issued by an investment company or by any 
company that would be an investment company except for the 
exclusions from the definition of the term ``investment company'' 
under sections 3(c)(1) or 3(c)(7), other than (I) any debt security 
that is rated investment grade by not less than 1 nationally 
recognized statistical rating organization; or (II) any security 
issued by a registered open-end fund that is required by its 
investment policies to invest not less than 65% of its total assets 
in securities described in subclause (I) or securities that are 
determined by such registered open-end fund to be comparable in 
quality to securities described in subclause (I)).
    \67\ See 1993 Senate Report, supra note 62, at 20.
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    As described above, section 939(c) of the Dodd-Frank Act eliminates 
the credit rating reference in section 6(a)(5)(A)(iv) of the Investment 
Company Act. Instead of limiting BIDCOs to purchasing debt securities 
issued by investment companies and private funds that are rated 
``investment grade,'' the amendment requires such debt securities to 
meet ``such standards of credit-worthiness as the Commission shall 
adopt.''
    We are proposing new rule 6a-5 to establish this standard of 
credit-worthiness. Proposed rule 6a-5 would deem a BIDCO to have met 
the requirements for credit-worthiness of certain debt securities under 
section 6(a)(5)(A)(iv)(I) if the board of directors or members of the 
company (or its delegate) determines that the debt security is (i) 
subject to no greater than moderate credit risk and (ii) sufficiently 
liquid that the security can be sold at or near its carrying value 
within a reasonably short period of time.\68\ The proposed standard is 
designed to limit BIDCOs to purchasing debt securities issued by 
investment companies or private funds of sufficiently high credit 
quality that they are likely to maintain a fairly stable market value 
and may be liquidated easily, as appropriate, for the BIDCO to support 
its investment and financing activities. The board of directors or 
members of a BIDCO (or its delegate) would have to make the 
determination at the time of acquisition.\69\ As a result of the 
proposed rule, section 6(a)(5) of the Act would also limit a BIDCO's 
investments in registered open-end funds to those funds that invest at 
least 65 percent of their assets in debt securities that meet our 
proposed standard.\70\
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    \68\ Proposed rule 6a-5. The standard for credit-worthiness that 
we are proposing in rule 6a-5 is similar to the standard that we 
adopted in rule 10f-3 under the Investment Company Act. See 2009 
Ratings Removal Adopting Release, supra note 7, at Section II.B.2; 
rule 10f-3(a)(3). This credit quality standard differs from those we 
propose for rules 2a-7 and 5b-3 because it reflects the different 
standard of credit quality associated with the ratings referenced in 
rule 10f-3 and section 6(a)(5)(A)(iv)(I) of the Act before the 
amendment of each provision. Compare supra notes 16, 48, and 
accompanying text with supra note 66 and accompanying text and rule 
10f-3(a)(3), as in effect before November 12, 2009 (conditioning an 
exemption to permit an investment company that is affiliated with 
members of an underwriting syndicate to purchase securities from the 
syndicate if certain conditions are met, including if the securities 
are municipal securities, that have received an investment grade 
rating, or if the securities are less seasoned, one of the three 
highest ratings, from an NRSRO).
    \69\ Proposed rule 6a-5. From our review of the state statutes 
under which BIDCOs are formed and operate, we understand that BIDCOs 
must be organized as corporations with boards of directors or 
limited liability companies that are managed by members or managers. 
See, e.g., Mich. comp. Laws Sec.  301 (2010) (stating that a company 
other than a Michigan corporation or a limited liability company 
cannot apply for a license to be a BIDCO); Mont. Code Ann. Sec.  102 
(2010) (defining a BIDCO as a corporation that is licensed under the 
act to provide financial and management assistance to businesses); 
Alaska Stat. Sec.  20 (2010) (stating that a license to operate a 
BIDCO will be issued to a corporation if certain conditions are 
met); Tenn. Code Ann. Sec.  208 (2010) (stating that a person other 
than a Tennessee corporation cannot apply for a license to be a 
BIDCO).
    \70\ Section 6(a)(5)(A)(iv)(II) (permitting a BIDCO to purchase 
any security issued by a registered open-end fund that is required 
by its investment policies to invest not less than 65% of its total 
assets in securities described in subclause (I) (i.e., securities 
that meet the standards of credit-worthiness that the Commission 
adopts) or securities that are determined by such registered open-
end fund to be comparable in quality to securities described in 
subclause (I)).
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    Moderate credit risk would denote current low expectations of 
default risk, with an adequate capacity for payment of principal and 
interest.\71\ Debt securities (or their issuers) subject to a moderate 
level of credit risk would demonstrate at least average credit-
worthiness relative to other similar debt issues (or issuers of similar 
debt).\72\ In making these determinations, a BIDCO's board of 
directors, members or managers would be able to consider credit quality 
reports prepared by outside sources, including NRSRO ratings, that they 
conclude are credible and reliable for this purpose.
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    \71\ See 2009 Ratings Removal Adopting Release, supra note 7, at 
n.86.
    \72\ Id.
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    We request comment on proposed rule 6a-5.
     Does the standard we have proposed provide BIDCOs with 
flexibility to invest in certain debt securities that are likely to 
retain their value and that a BIDCO could sell quickly if necessary to 
support its investment and financing activities? If not, are there 
additional or alternative standards that do not use credit ratings that 
would be more appropriate to the statutory intent of section 6(a)(5)?
     Is our understanding that BIDCOs are organized as 
corporations with a board of directors or limited liability companies 
with members or managers correct? Are there BIDCOs that are formed as 
partnerships or other structures?
     Do BIDCO directors or members have sufficient experience 
with or knowledge of evaluating securities to allow them to make the 
determinations called for by proposed rule 6a-5 or to oversee decisions 
made by a delegate?

E. Forms N-1A, N-2 and N-3

    We are proposing to amend Forms N-1A, N-2 and N-3 to remove the 
required use of credit ratings assigned by an NRSRO. Forms N-1A, N-2 
and N-3, among other things, contain the requirements for shareholder 
reports of mutual funds, closed-end funds, and certain insurance 
company separate accounts that offer variable annuities.\73\
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    \73\ Form N-1A is used by open-end management investment 
companies, commonly known as mutual funds. Form N-2 is used by 
closed-end management investment companies. Form N-3 is used by 
separate accounts, organized as management investment companies, 
that offer variable annuity contracts.
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    Currently, Forms N-1A, N-2 and N-3 each require shareholder reports 
to include a table, chart, or graph depicting portfolio holdings by 
reasonably identifiable categories (e.g., type of security, industry 
sector, geographic region, credit quality or maturity).\74\ The forms 
require the categories to be selected in a manner reasonably designed 
to depict clearly the types of investments made by the fund, given its 
investment objectives. If credit quality is

[[Page 12904]]

used to present portfolio holdings, the forms require that credit 
quality be depicted using the credit ratings assigned by a single 
NRSRO.
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    \74\ Item 27(d)(2) of Form N-1A; Instruction 6(a) to Item 24 of 
Form N-2; Instruction 6(i) to Item 28(a) of Form N-3.
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    We are proposing to amend Forms N-1A, N-2 and N-3 to eliminate the 
required use of NRSRO credit ratings by funds that choose to use credit 
quality categorizations in the required table, chart or graph of 
portfolio holdings. If a fund chooses to use NRSRO credit ratings to 
depict credit quality of portfolio holdings, the proposal, like the 
current forms, generally would require the fund to use the credit 
ratings of a single NRSRO. This requirement is intended to eliminate 
the possibility that a fund could choose to use NRSRO credit ratings 
and then select the most favorable ratings among credit ratings 
assigned by multiple NRSROs. The proposal would clarify that, if credit 
ratings of the NRSRO selected by a fund are not available for certain 
holdings, the fund must briefly discuss the methodology for determining 
credit quality for those holdings, including, if applicable, the use of 
credit ratings assigned by another NRSRO.\75\ Funds typically provide 
this discussion in their shareholder reports today.\76\
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    \75\ Proposed Item 27(d)(2) of Form N-1A; proposed Instruction 
6(a) to Item 24 of Form N-2; proposed Instruction 6(i) to Item 28(a) 
of Form N-3. In these items, we are also proposing to define NRSRO 
by reference to the Exchange Act definition, rather than by 
reference to Exchange Act rule 15c3-1 as is currently the case, and 
to replace the use of the term ``rating'' with ``credit rating'' as 
defined under the Exchange Act. See sections 3(a)(60) [15 U.S.C. 
78c(a)(60)] and 3(a)(62) [15 U.S.C. 78c(a)(62)] of the Exchange Act, 
which define ``credit rating'' and ``nationally recognized 
statistical rating organization,'' respectively.
    \76\ This statement is based on a staff review of a sample of 
fund shareholder reports filed with the Commission.
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    We request comment on the proposal to eliminate the required use of 
NRSRO credit ratings by funds that choose to use credit quality 
categorizations in shareholder reports.
     Are there better methods than the proposal by which funds 
could portray credit quality for purposes of the required table, chart 
or graph that presents portfolio holdings?
     Does the proposal adequately address situations where a 
fund would choose to portray credit quality using NRSRO ratings and 
there is no single NRSRO that has rated all of the fund's portfolio 
holdings?

III. Request for Comment

    We request comment on the rule and form amendments and new rule 
proposed in this release. We also request suggestions for additional 
changes to existing rules, and comments on other matters that might 
have an effect on the proposals contained in this release. Commenters 
are requested to provide empirical data to support their views.

IV. Paperwork Reduction Act

    Certain provisions of our proposal contain ``collections of 
information'' within the meaning of the Paperwork Reduction Act of 1995 
(``PRA'').\77\ The titles for the existing collections of information 
are: (1) ``Rule 2a-7 under the Investment Company Act of 1940, Money 
market funds''; (2) ``Rule 30e-1 under the Investment Company Act of 
1940, Reports to Stockholders of Management Companies'';\78\ (3) ``Rule 
38a-1 under the Investment Company Act of 1940, Compliance procedures 
and practices of registered investment companies''; and (4) ``Form N-
MFP under the Investment Company Act of 1940, Portfolio Holdings of 
Money Market Funds.'' We adopted the rules and form pursuant to the 
Investment Company Act. The Commission is submitting these collections 
of information to the Office of Management and Budget (``OMB'') for 
review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11.
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    \77\ 44 U.S.C. 3501-3520.
    \78\ The proposed amendments to Forms N-1A, N-2 and N-3 relate 
solely to the contents of fund shareholder reports. The PRA burden 
associated with fund shareholder reports is included in the burden 
associated with the collection of information for rule 30e-1 under 
the Investment Company Act rather than Forms N-1A, N-2 and N-3.
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    There is currently no approved collection of information for rule 
5b-3 and the proposed amendments would not create any new collections 
under that rule. The proposed amendments to rule 5b-3 would, however, 
affect the collection of information burden for rule 38a-1. Proposed 
rule 6a-5 also would not create any new collections of information.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a 
currently valid control number. The approved collection of information 
associated with rule 2a-7 displays control number 3235-0268. The 
approved collection of information associated with rule 30e-1 displays 
control number 3235-0025. The approved collection of information 
associated with rule 38a-1, which would be revised by the proposed 
amendments to rule 5b-3, displays control number 3235-0586. The 
approved collection of information associated with Form N-MFP displays 
control number 3235-0657.

A. Money Market Funds

1. Rule 2a-7
    As discussed above, we are proposing to remove references to credit 
ratings in rule 2a-7, which would affect five elements of the rule. 
First, we propose to eliminate the requirement that an eligible 
security be rated by an NRSRO or be of comparable quality, while 
maintaining the two-step analysis currently required by rule 2a-7. A 
security would be an eligible security only if the board of directors 
(or its delegate) determines that it presents minimal credit risks, 
which determination must be based on factors pertaining to credit 
quality and the issuer's ability to meet its short-term financial 
obligations.\79\ Second, we propose to define first tier security as a 
security whose issuer the fund's board (or its delegate) determines has 
the ``highest capacity to meet its short-term financial obligations.'' 
\80\ Third, we propose to require that with respect to a security (or 
its guarantee) subject to a conditional demand feature, in addition to 
other conditions, the underlying security (or its guarantee) must 
itself be of high quality and subject to very low credit risk as 
determined by the fund's board (or its delegate).\81\ Fourth, we 
propose to eliminate the use of credit ratings in the rule's downgrade 
and default provisions. The proposed amendment would require that in 
the event the money market fund's investment adviser (or any person to 
whom the fund's board of directors has delegated portfolio management 
responsibilities) becomes aware of any credible information about a 
portfolio security or an issuer of a portfolio security that suggests 
that the security is no longer a first tier security or a second tier 
security, as the case may be, the money market fund's board of 
directors would have to reassess promptly whether the portfolio 
security continues to present minimal credit risks.\82\ Finally, we 
propose to eliminate the reference to portfolio securities' downgrades 
in the stress testing provisions. Under the proposal, a money market 
fund's stress testing procedures would be required to include as a 
hypothetical event, ``an adverse change in the ability of the issuer of 
a portfolio security to meet its

[[Page 12905]]

short-term financial obligations.'' \83\ The respondents to these 
collections of information are money market funds. A fund must comply 
with the requirements of rule 2a-7, including the collections of 
information, in order to obtain the exemptive relief provided under the 
rule and to operate as a money market fund.
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    \79\ Proposed rule 2a-7(a)(11). See supra Section II.A.1.
    \80\ Proposed rule 2a-7(a)(13). See supra Section II.A.1.
    \81\ Proposed rule 2a-7(c)(3)(iv)(C). See supra Section II.A.2.
    \82\ Proposed rule 2a-7(c)(7)(i)(A). See supra Section II.A.3.
    \83\ Proposed rule 2a-7(c)(10)(v)(A). See supra Section II.A.4. 
As a result of eliminating the term ``designated NRSRO,'' the 
proposal would eliminate the requirement that boards of directors 
designate NRSROs and disclose such designated NRSROs in their SAIs. 
See supra note 25. We believe that the deletion of the disclosure 
requirement would not affect the collection of information 
requirements in the SAI, however, and therefore would not change 
current paperwork burden estimates. When we adopted the requirement 
to disclose designated NRSROs in the SAI, we stated that we 
anticipated that making this disclosure would not result in 
additional hourly burdens or printing costs beyond those currently 
approved in the existing collection of information for Form N-1A. 
See Money Market Fund Reform Adopting Release, supra note 8, at 106. 
The proposed amendments also would make conforming amendments to 
rule 2a-7's recordkeeping and reporting requirements. See proposed 
rule 2a-7(c)(11)(iii). These conforming changes would not result in 
changes in the estimated hourly burden associated with the 
recordkeeping and reporting requirements.
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    We do not anticipate that the proposed amendments would 
significantly change collection of information requirements under rule 
2a-7 because we believe funds would likely rely on their current 
policies and procedures to comply with the proposed amendments. Under 
current rule 2a-7, money market fund boards, or their delegates, are 
required to perform a minimal credit risk evaluation with respect to 
each of the fund's portfolio securities. Funds also must adopt policies 
and procedures regarding those determinations.\84\ Eligible securities 
and first tier securities currently are defined with reference to 
credit ratings, and securities subject to a conditional demand feature 
must meet a minimum credit rating threshold or if unrated, be of 
comparable quality. With respect to monitoring for downgrades and 
defaults, Commission staff understands that money market funds 
generally monitor for information regarding credit events that may 
affect the portfolio in addition to those specified in the rule. In 
addition, a fund could treat a downgrade as a credit event that might 
adversely affect a portfolio security. Finally, staff also understands 
that money market funds stress test for credit events other than 
downgrades that might affect the fund's portfolio. As we have noted 
above, with respect to each of the amendments we propose today, money 
market funds could continue to consider evaluations of outside sources, 
including credit ratings, in making credit quality determinations, 
monitoring and stress testing. Moreover, we anticipate that funds would 
likely continue to rely on their current policies and procedures with 
respect to credit quality determinations, monitoring for credit events 
and stress testing because that is likely to be less costly than 
revising policies. Accordingly, we do not expect the proposed 
amendments would significantly change current collection of information 
burden estimates for rule 2a-7.\85\ Nevertheless, money market funds 
may make technical changes to their policies and procedures in response 
to the proposed amendments, if adopted. Staff estimates that it would 
take, on average, 1.5 hours of a senior business analyst's time to make 
any technical changes for an individual money market fund, for an 
estimated one-time burden of 978 hours for all money market funds at a 
total cost of $226,896.\86\ Amortized over three years, we estimate 
that the total annual burden would be 326 hours at a cost of $75,632.
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    \84\ See rules 2a-7(c)(3); 2a-7(c)(11)(ii); 2a-7(e); 38a-1.
    \85\ The current approved annual burden for rule 2a-7 under the 
PRA is 395,779 hours. The estimated number of respondents is 652 
money market funds as of December 31, 2010. The estimated number of 
money market funds is based on the Investment Company Institute, 
Trends in Mutual Fund Investing, December 2010 (Jan. 27, 2011), 
http://www.ici.org/research/stats/trends/trends_12_10.
    \86\These estimates are based on the following calculation: (652 
money market funds x 1.5 hours = 978 hours); (978 hours x $232 per 
hour = $226,896). The staff estimates that the internal cost of a 
senior business analyst is $232 per hour. This estimate, as well as 
other internal time cost estimates made in this analysis, is derived 
from SIFMA's Management and Professional Earnings in the Securities 
Industry 2010, modified by Commission staff to account for an 1800-
hour work week and multiplied by 5.35 to account for bonuses, firm 
size, employee benefits and overhead.
---------------------------------------------------------------------------

     We request comment on these assumptions. If commenters 
believe these assumptions are not accurate, we request they provide 
specific data that would allow us to make more accurate estimates.
2. Form N-MFP
    Rule 30b1-7 requires money market funds to file electronically a 
monthly report on Form N-MFP within five business days after the end of 
each month. The information required by the form must be data-tagged in 
XML format and filed through EDGAR. Preparing Form N-MFP is a 
collection of information under the PRA.\87\ The respondents to the 
requirement to prepare Form N-MFP are investment companies that are 
regulated as money market funds under rule 2a-7. Compliance with the 
requirement to prepare Form N-MFP is mandatory for any fund that holds 
itself out as a money market fund in reliance on rule 2a-7. Responses 
to the disclosure requirement of Form N-MFP are not kept confidential.
---------------------------------------------------------------------------

    \87\ For purposes of the PRA analysis, the current burden 
associated with the requirements of rule 30b1-7 is included in the 
collection of information requirements of Form N-MFP. The current 
approved annual burden for Form N-MFP under the PRA is 94,189 hours.
---------------------------------------------------------------------------

    As discussed previously, the proposed amendments would eliminate 
the items requiring disclosure for each portfolio security (and any 
guarantee, demand feature or enhancement associated with the portfolio 
security) of the designated NRSROs for the security and the rating 
assigned to the security in Items 34, 37, 38 and 39 of the Form. The 
proposed amendments would also eliminate the requirement in Item 33 
that a money market fund disclose whether a security is a rated 
security or an unrated security.
    The staff estimates that, as of December 31, 2010, there are 
approximately 652 money market funds that are required to file Form N-
MFP.\88\ The staff estimates that our proposed amendments would reduce 
the time it takes money market funds to complete Form N-MFP by 0.5 
hours. Because Form N-MFP is completed 12 times a year, the staff 
estimates that each respondent would save approximately 6 hours 
annually (at an internal cost of $301 per hour).\89\ The staff 
therefore estimates that our proposed amendments to Form N-MFP would 
result in total incremental time savings of approximately 3912 hours 
(and $1,177,512) annually.\90\
---------------------------------------------------------------------------

    \88\ See supra note 85.
    \89\ The staff estimates that the internal cost of a senior 
database administrator is $301 per hour.
    \90\ These estimates are based on the following calculation: 
(652 x 6 hours = 3912 hours); (3912 hours x $301 per hour = 
$1,177,512). We understand that some money market funds may 
outsource all or a portion of their responsibilities regarding Form 
N-MFP to a filing agent, software consultant, or other third-party 
service provider. We believe that a fund would engage third-party 
service providers at an external cost similar to or less than the 
estimated internal costs so the amount of the savings would be 
comparable.
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     We request comment on these estimates. If commenters 
believe these estimates are not accurate, we request they provide 
specific data that would allow us to make more accurate estimates.

B. Rule 5b-3

    Rule 5b-3 under the Investment Company Act allows funds to treat 
the acquisition of a repurchase agreement as an acquisition of 
securities collateralizing the repurchase agreement for purposes of 
sections 5(b)(1) and

[[Page 12906]]

12(d)(3) of the Act under certain conditions. We propose to amend rule 
5b-3 to require that the securities collateralizing a repurchase 
agreement consist of securities that the fund's board of directors, or 
its delegate, determines are issued (or have unconditional guarantees 
that are issued) by an issuer that has the highest capacity to meet its 
financial obligations and are highly liquid.\91\ To that end, the 
fund's board of directors, pursuant to rule 38a-1 under the Act, would 
have to develop procedures to ensure that at the time the repurchase 
agreement is entered into, the securities meet the requirements for 
collateral outlined in the proposed amendments to the rule.\92\ As 
discussed above, these procedures are designed to limit collateral 
securities to those that are likely to retain a stable market value and 
that, in ordinary circumstances, the fund would be able to liquidate 
quickly in the event of a default. This collection of information would 
be mandatory for funds that rely on rule 5b-3. Records of information 
made in connection with this requirement would be required to be 
maintained for inspection by Commission staff, but the collection would 
not otherwise be submitted to the Commission. The information, when 
provided to the Commission in connection with staff examinations or 
investigations, would be kept confidential to the extent permitted by 
law.
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    \91\ Proposed rule 5b-3(c)(1)(iv)(C). See supra Section II.C.
    \92\ Under rule 38a-1, funds must have written policies and 
procedures reasonably designed to prevent violation of the Federal 
securities laws. Rule 38a-1(a)(1). Funds thus would have policies 
and procedures for complying with rule 5b-3, which would include 
policies and procedures relating to credit quality determinations of 
unrated collateral securities, if appropriate.
---------------------------------------------------------------------------

    We do not anticipate that the proposed amendments would 
significantly change collection of information burdens under rule 38a-1 
because we believe funds would likely rely on their current policies 
and procedures to determine the credit quality of collateral securities 
to comply with rule 5b-3, as we propose to amend it. We understand that 
credit quality standards for securities collateralizing repurchase 
agreements are contained in the repurchase agreements between funds and 
counterparties. We expect that those standards currently include a 
rating and any additional criteria a fund manager considers necessary 
to ensure that the credit quality of the collateral securities meets 
the fund's requirements, or, for unrated securities, a comparable 
credit quality standard. Counterparties provide collateral securities 
to conform to these standards and funds confirm that the securities are 
conforming. As we have noted above, funds could continue to consider 
evaluations of outside sources, including credit ratings, that the 
board determines are credible and reliable in making their credit 
quality determinations under the proposed rule. We expect that funds 
would likely continue to rely on their current policies and procedures 
(i.e., using credit quality standards that include ratings currently 
set forth in their repurchase agreements with counterparties). Thus, we 
do not expect that the proposed amendments would significantly change 
the current collection of information burden estimates for rule 38a-
1.\93\ Nevertheless, funds may review their repurchase agreements and 
policies and procedures that address rule 5b-3 compliance and make 
technical changes to those documents in response to the proposed 
amendments, if adopted. Staff estimates that it will take, on average, 
1.5 hours of a senior business analyst's time to perform this review 
and make any technical changes for an individual fund portfolio, for an 
estimated burden of 12,690 hours for all fund portfolios (other than 
money market fund portfolios) \94\ at a total cost of $2,944,080.\95\ 
Amortized over three years, we estimate that the total burden would be 
4230 hours at a cost of $981,360. We anticipate that the fund's board 
would review the fund manager's recommendation, but that the cost of 
this review would be incorporated in the fund's overall annual board 
costs and would not result in any particular additional cost.
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    \93\ The current approved annual burden for rule 38a-1 under the 
PRA is 254,703 hours.
    \94\ For purposes of this PRA analysis, we assume that all funds 
enter into repurchase agreements and rely on rule 5b-3. We have not 
included money market funds in our estimates, however, because they 
are subject to different requirements under rule 2a-7, as noted 
above. See supra note 49. The staff's estimate of the number of fund 
portfolios is based on staff examination of industry data as of 
December 31, 2010.
    \95\ These estimates are based on the following calculation: 
(8,460 fund portfolios x 1.5 hours = 12,690 hours); (12,690 hours 
$232 per hour = $2,944,080). The staff estimates that the internal 
cost for time spent by a senior business analyst is $232 per hour.
---------------------------------------------------------------------------

     We request comment on these estimates. If commenters 
believe these estimates are not accurate, we request they provide 
specific data that would allow us to make more accurate estimates.
     Is our expectation that funds would continue to consider 
ratings in their credit quality standards to evaluate rated collateral 
securities for repurchase agreements correct? If funds choose not to 
continue this consideration of ratings, we request comment on how long 
it would take a fund to confirm that collateral securities satisfy the 
credit quality standards in a repurchase agreement under our proposed 
standard.

C. Rule 30e-1

    The proposed amendments to Forms N-1A, N-2 and N-3 eliminate the 
required use of NRSRO credit ratings by funds that choose to use credit 
quality categorizations in the required table, chart, or graph of 
portfolio holdings. If a fund chooses to use NRSRO credit ratings to 
depict credit quality of portfolio holdings, the proposed amendments, 
like the current forms, generally would require the fund to use the 
credit ratings of a single NRSRO. The proposed amendments would clarify 
that, if credit ratings of the NRSRO selected by a fund are not 
available for certain holdings, the fund must briefly discuss the 
methodology for determining credit quality for those holdings, 
including, if applicable, the use of credit ratings assigned by another 
NRSRO.
    The Commission believes that the proposed amendments to Forms N-1A, 
N-2 and N-3 would not affect the current PRA burden under rule 30e-1, 
because funds would remain obligated to provide a table, chart, or 
graph of portfolio holdings by reasonably identifiable categories. The 
proposed amendments only eliminate the required use of NRSRO credit 
ratings by funds that choose to use credit quality categorizations. The 
Commission further believes that the proposed clarification for cases 
when credit ratings of the NRSRO selected by a fund are not available 
for certain holdings would not impose any additional PRA burden because 
funds typically provide this disclosure in their shareholder reports 
today.\96\
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    \96\ This assessment is based on a staff review of a sample of 
fund shareholder reports filed with the Commission.
---------------------------------------------------------------------------

     We request comment on this analysis. If commenters believe 
this analysis is not accurate, we request that they provide specific 
data that would allow us to make a more accurate analysis.

D. Request for Comments

    We request comment on whether the estimates provided in this PRA 
analysis are accurate. Pursuant to 44 U.S.C. 3506(c)(2)(B), the 
Commission solicits comments in order to: (i) Evaluate whether the 
proposed collections of information are necessary for the proper

[[Page 12907]]

performance of the functions of the Commission, including whether the 
information will have practical utility; (ii) evaluate the accuracy of 
the Commission's estimate of the burden of the proposed collections of 
information; (iii) determine whether there are ways to enhance the 
quality, utility, and clarity of the information to be collected; and 
(iv) minimize the burden of the collections of information on those who 
are to respond, including through the use of automated collection 
techniques or other forms of information technology.
    Persons wishing to submit comments on the collection of information 
requirements of the proposed amendments should direct them to the 
Office of Management and Budget, Attention Desk Officer for the 
Securities and Exchange Commission, Office of Information and 
Regulatory Affairs, Room 10102, New Executive Office Building, 
Washington DC 20503, and should send a copy to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090, with reference to File No. S7-7-11. OMB is 
required to make a decision concerning the collections of information 
between 30 and 60 days after publication of this Release; therefore a 
comment to OMB is best assured of having its full effect if OMB 
receives it within 30 days after publication of this Release. Requests 
for materials submitted to OMB by the Commission with regard to these 
collections of information should be in writing, refer to File No. S7-
7-11, and be submitted to the Securities and Exchange Commission, 
Office of Investor Education and Advocacy, 100 F Street, NE., 
Washington, DC 20549-0213.

V. Cost-Benefit Analysis

    The Commission is sensitive to the costs and benefits imposed by 
its rules. We have identified certain costs and benefits of the 
proposed rule and form amendments and proposed rule, and we request 
comment on all aspects of this cost-benefit analysis, including 
identification and assessment of any costs and benefits not discussed 
in this analysis. We seek comment and data on the value of the benefits 
identified. We also welcome comments on the accuracy of the cost 
estimates in each section of this analysis, and request that commenters 
provide data that may be relevant to these cost estimates. In addition, 
we seek estimates and views regarding these costs and benefits for 
particular funds, including funds that are small entities, as well as 
any other costs or benefits that may result from the adoption of the 
proposed rule and rule and form amendments. Where possible, we request 
commenters provide empirical data to support any positions advanced.
    As discussed above, to implement provisions of the Dodd-Frank Act, 
we propose to (i) remove the references to credit ratings in rules 2a-7 
and 5b-3 and replace them with alternative standards of credit-
worthiness that are designed to appropriately achieve the same purposes 
as the ratings, (ii) eliminate references to credit ratings in Form N-
MFP, and (iii) remove from Forms N-1A, N-2 and N-3 the requirement that 
NRSRO credit ratings be used when portraying credit quality in 
shareholder reports. We are also proposing rule 6a-5 to replace a 
statutory reference to credit ratings that the Dodd-Frank Act removes 
from the Investment Company Act and for which the Dodd-Frank Act 
anticipates the Commission will adopt a replacement standard. Thus, the 
benefits and costs associated with the replacement of credit rating 
references with alternative standards of credit-worthiness are 
attributable to the Dodd-Frank Act. The Commission has discretion, 
however, in adopting the alternative standards of credit-worthiness, 
and we undertake below to discuss the costs and benefits of the rule 
and form amendments and new rule that we are proposing.

A. Money Market Funds

1. Rule 2a-7
    As discussed above, we are proposing to remove references to credit 
ratings in rule 2a-7, which would affect five elements of the rule. 
First, we propose to eliminate the requirement that an eligible 
security be rated by an NRSRO or be of comparable quality, while 
maintaining the two-step analysis currently required by rule 2a-7. A 
security would be an eligible security only if the board of directors 
(or its delegate) determines that it presents minimal credit risks, 
which determination must be based on factors pertaining to credit 
quality and the issuer's ability to meet its short-term financial 
obligations.\97\ Second, we propose to define first tier security as a 
security whose issuer the fund's board (or its delegate) determines has 
the ``highest capacity to meet its short-term financial obligations.'' 
\98\ Third, we propose to require that with respect to a security (or 
its guarantee) subject to a conditional demand feature, in addition to 
other conditions, the underlying security (or its guarantee) must 
itself be of high quality and subject to very low credit risk as 
determined by the fund's board (or its delegate).\99\ Fourth, we 
propose to remove the reference to credit ratings in the rule's 
downgrade and default provisions. The proposed amendment would require 
that, in the event the money market fund's investment adviser (or any 
person to whom the fund's board of directors has delegated portfolio 
management responsibilities) becomes aware of any credible information 
about a portfolio security or an issuer of a portfolio security that 
suggests that the security is no longer a first tier security or a 
second tier security, as the case may be, the money market fund's board 
of directors would have to reassess promptly whether the portfolio 
security continues to present minimal credit risks.\100\ Finally, we 
propose to eliminate the reference to portfolio securities' downgrades 
in the stress testing provisions. Under the proposal, a money market 
fund's stress testing procedures would be required to include as a 
hypothetical event, ``an adverse change in the ability of the issuer of 
a portfolio security to meet its short-term financial obligations.'' 
\101\
---------------------------------------------------------------------------

    \97\ Proposed rule 2a-7(a)(11). See supra Section II.A.1.
    \98\ Proposed rule 2a-7(a)(13). See supra Section II.A.1.
    \99\ Proposed rule 2a-7(c)(3)(iv)(C). See supra Section II.A.2.
    \100\ Proposed rule 2a-7(c)(7)(i)(A). See supra Section II.A.3.
    \101\ Proposed rule 2a-7(c)(10)(v)(A). See supra Section II.A.4. 
As noted above, see supra note 20, the proposed amendments would 
make conforming changes to rule 2a-7's recordkeeping and reporting 
requirements. We do not believe that these amendments would affect 
costs.
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a. Benefits
    We believe that the proposed amendments to rule 2a-7 may provide 
certain benefits to money market funds. As discussed above, in 
connection with the PRA analysis, money market funds have adopted 
policies and procedures that with respect to portfolio securities 
(including securities subject to a conditional demand feature) address 
credit quality, minimal credit risk determinations, monitoring for 
downgrades and defaults and stress testing. Under the proposed rules, 
money market funds could revise their policies and procedures with 
respect to each of these requirements to change or eliminate the 
consideration of credit ratings or consider other sources of credit 
quality evaluations as funds determine would be appropriate. 
Nevertheless, because the proposed amendments are designed to retain 
the same degree of credit risk limitation and similar standards for 
monitoring credit

[[Page 12908]]

events and stress testing as under current rule 2a-7, the proposed 
amendments would not prohibit a money market fund from using its 
current policies and procedures to comply with the proposed amendments. 
In particular, as discussed above, fund boards (or their delegates) 
could still consider credit quality evaluations prepared by outside 
sources, including NRSRO ratings, that they conclude are credible and 
reliable for purposes of making credit quality determinations with 
respect to portfolio securities (including securities subject to a 
conditional demand feature), monitoring minimal credit risks of the 
portfolio and stress testing. We expect that each money market fund 
would undertake its own analysis of the costs or benefits of revising 
policies and procedures and would only change them to the extent the 
fund believed the benefits justified the costs of doing so.
    Although some money market funds may eliminate the specific use of 
ratings in their credit risk determinations, we anticipate that many of 
those funds are likely to consider some outside analyses in evaluating 
the credit quality of, and minimal credit risks presented by, portfolio 
securities (including securities subject to a conditional demand 
feature). Fund boards' (or their delegates') consideration of external 
analyses by third party sources determined to be credible and reliable 
to the extent the fund board (or its delegate) considers appropriate 
may contribute to the accuracy of funds' determinations and thus help 
money market funds arrive at consistent credit risk determinations.
b. Costs
    We recognize that there may be minor costs associated with the 
proposed amendments to rule 2a-7. Money market funds may incur some 
costs internally or to consult outside legal counsel to evaluate any 
need to change their policies and procedures relating to determinations 
of credit quality, monitoring for credit events and stress testing if 
the proposed amendments were adopted. We do not believe, however, that 
these costs are attributable to the proposed rule and form amendments 
because the requirement in the Dodd-Frank Act that we replace the use 
of credit ratings in rules with alternative standards of credit-
worthiness would result in similar costs of evaluating compliance with 
a new credit quality standard.
    As discussed above, because the proposed amendments are designed to 
retain the same degree of credit risk limitation and similar standards 
for monitoring credit events and stress testing as under current rule 
2a-7, a money market fund also could use its current policies and 
procedures to comply with the proposed amendments. In particular, as 
discussed above, a fund could still incorporate credit quality 
evaluations prepared by outside sources, including NRSRO ratings, that 
the fund's board or adviser concludes are credible and reliable for 
purposes of making credit quality determinations with respect to 
portfolio securities (including securities subject to a conditional 
demand feature), monitoring minimal credit risks of the portfolio, and 
stress testing. We expect that each money market fund would undertake 
its own analysis of the costs or benefits of revising policies and 
procedures and would only change its policies to the extent the fund 
believed the benefits justified the costs of doing so. Nevertheless, 
money market funds may make technical changes to their policies and 
procedures in response to the proposed amendments, if adopted. We 
estimate that money market funds would incur a one-time aggregate cost 
of $226,896 to make any technical changes.\102\
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    \102\ See supra note 86 and accompanying text.
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    In addition to the costs that funds may incur, the removal of 
credit ratings pursuant to the Dodd-Frank Act may result in increased 
risks to money market funds and their shareholders. As discussed above, 
rule 2a-7 limits money market funds to investing in securities that, 
among other things, have received a rating in one of the highest two 
short-term rating categories from the requisite NRSROs or are unrated 
securities of comparable quality.\103\ The rule further limits money 
market funds' investments in second tier securities to no more than 
three percent of the fund's portfolio.\104\ The minimum credit rating 
requirement in the current rule provides the Commission with an 
objective standard to use in examining and enforcing money market fund 
compliance with rule 2a-7's credit quality conditions, including the 
limitation on investments in second tier securities. As discussed 
above, the proposed rule would eliminate the requirement that eligible 
securities meet minimum rating requirements, while maintaining the two-
step analysis provided in the current rule and the limitation on 
investments in second tier securities.\105\ Although we anticipate that 
funds would continue to manage risk in the same manner as under the 
current rule, under the proposed subjective standard, a money market 
fund board (or its delegate) could disregard a second tier rating in 
order to invest a larger portion of the fund's portfolio in lower 
quality securities that it classifies as first tier securities. In 
addition, it could be difficult for the Commission to challenge the 
determination of a money market fund board (or its delegate) in those 
circumstances.\106\
---------------------------------------------------------------------------

    \103\ See rule 2a-7(a)(12)(i)-(ii); supra notes 15-17 and 
accompanying text.
    \104\ Rule 2a-7(c)(3)(ii).
    \105\ See supra note 23, notes 24-25 and accompanying and 
preceding text.
    \106\ The increased risks to money market funds associated with 
investments in short-term securities rated second tier are discussed 
in detail in the Money Market Fund Reform Adopting Release, supra 
note 8, at Section II.A.1. and Money Market Fund Reform Proposing 
Release, supra note 8, at Section II.A.1.
---------------------------------------------------------------------------

2. Form N-MFP
    We propose to amend Form N-MFP to eliminate the items requiring 
disclosure for each portfolio security (and any guarantee, demand 
feature or enhancement associated with the portfolio security) of the 
designated NRSROs for the security and the rating assigned to the 
security. We also propose to eliminate the requirement that a money 
market fund disclose whether a security is a rated security or an 
unrated security.
a. Benefits
    The proposed amendments to Form N-MFP would conform the disclosure 
in Form N-MFP to the proposed amendments to rule 2a-7. The proposed 
amendments to Form N-MFP should reduce costs for money market funds by 
eliminating from the form certain disclosure items relating to 
designated NRSROs and ratings, which would no longer be elements of 
rule 2a-7. For purposes of the PRA analysis, we estimate that money 
market funds would realize, in the aggregate, a cost savings of 
$1,177,512 in completing Form N-MFP as a result of the proposed 
amendments.\107\
---------------------------------------------------------------------------

    \107\ See supra note 90 and accompanying text. As noted above, 
however, money market funds have not had to make these disclosures 
so actual savings may be less.
---------------------------------------------------------------------------

b. Costs
    We do not believe there would be any costs associated with the 
proposed amendments to Form N-MFP.

B. Rule 5b-3

    We propose to amend rule 5b-3 to allow a fund to treat the 
acquisition of a repurchase agreement as an acquisition of securities 
collateralizing the repurchase agreement for purposes of sections 
5(b)(1) and 12(d)(3) of the Investment Company Act if the

[[Page 12909]]

collateral other than cash or government securities consists of 
securities that the fund's board of directors, or its delegate, 
determines at the time the repurchase agreement is entered into are: 
(i) Issued by an issuer that has the highest capacity to meet its 
financial obligations; and (ii) sufficiently liquid that they can be 
sold at approximately their carrying value in the ordinary course of 
business within seven days.
1. Benefits
    We believe that the proposed amendments to rule 5b-3 may yield 
certain benefits. First, our proposed standard is designed to achieve 
the same purpose as the credit rating reference in the existing rule. 
i.e., limit collateral securities to those that are likely to retain a 
stable market value and that, under ordinary circumstances, the fund 
would be able to liquidate quickly in the event of a counterparty 
default. Second, we believe that the proposed standards would not 
result in significant changes in fund evaluations of the quality of 
collateral securities. A fund's board of directors or its delegate is 
already required under the rule to assess the credit quality of unrated 
securities.\108\ As noted above, funds typically establish standards 
for the credit quality of collateral securities (that include credit 
ratings and additional credit quality criteria required by the fund) in 
repurchase agreements with counterparties.\109\ In addition, although 
the rule would no longer require the collateral to be rated by an 
NRSRO, the evaluation of credit risk could incorporate ratings, 
reports, analyses and other assessments issued by third parties, 
including NRSRO ratings, that the board concludes are credible and 
reliable for purposes of making the evaluation. We expect that the 
ability to consider outside assessments would help minimize any burdens 
on the fund's board or its delegate under the proposed amendments. In 
addition, the use of external analyses by third party sources that fund 
boards (or their delegates) believe are credible and reliable to the 
extent the fund board (or its delegate) considers appropriate may 
contribute to the accuracy of funds' determinations and thus help funds 
arrive at consistent minimal credit risk determinations.
---------------------------------------------------------------------------

    \108\ Rule 5b-3(c)(1)(iv)(D).
    \109\ See supra text preceding note 93.
---------------------------------------------------------------------------

2. Costs
    The proposed credit quality standard for rule 5b-3 may impose costs 
on funds that rely on the rule. A fund's board of directors, or its 
delegate, pursuant to rule 38a-1 of the Act, would be required to 
develop written policies or procedures to ensure that at the time the 
repurchase agreement is entered into, the collateral meets the 
requirements outlined in the proposed amendments.\110\ Consistent with 
the requirements of rule 38a-1 under the Act, we expect that boards of 
funds relying on rule 5b-3 have established procedures regarding 
compliance with the rule. We recognize that these funds may incur minor 
costs associated with the proposed amendments to rule 5b-3 including 
some internal costs or costs of consulting outside legal counsel to 
determine whether they must change their policies and procedures for 
evaluating collateral securities if the proposed amendments are 
adopted. We do not believe, however, that those costs are attributable 
to the proposed amendments because the requirement in the Dodd-Frank 
Act that we replace the use of credit ratings in rules with alternative 
standards of credit-worthiness would result in similar costs of 
evaluating compliance with a new standard of credit quality.
---------------------------------------------------------------------------

    \110\ Rule 38a-1(a).
---------------------------------------------------------------------------

    As noted above, funds typically set forth credit quality standards 
for securities collateralizing a repurchase agreement in the agreement 
with the counterparty. We expect that those standards include a rating 
and any additional criteria a fund manager considers necessary to 
ensure that the credit quality of the collateral meets the fund's 
requirements. As we have noted above, fund boards (or their delegates) 
could continue to consider evaluations of outside sources, including 
credit rating agencies, in making their credit quality determinations 
under rule 5b-3, as we propose to amend it. We anticipate that funds 
would likely continue to rely on the credit quality standards in their 
current repurchase agreements and their existing policies and 
procedures that address compliance with rule 5b-3 if the proposed 
amendments were adopted. We expect that each fund would undertake its 
own analysis of the costs or benefits of revising repurchase agreements 
and policies and procedures that address compliance with rule 5b-3 and 
would only change these documents to the extent the fund believed the 
benefits justified the costs of doing so. Nevertheless, funds may 
consider whether to amend their repurchase agreements and policies and 
procedures that address compliance with rule 5b-3, including making 
technical changes to these documents in response to the proposed 
amendments, if adopted. As noted above, we estimate that funds would 
incur a one-time aggregate cost of $2,944,080 to make any of these 
changes.\111\
---------------------------------------------------------------------------

    \111\ See supra note 95 and accompanying text.
---------------------------------------------------------------------------

     We request comment on these cost estimates. Do commenters 
foresee additional or alternative costs if the proposed amendments to 
rule 5b-3 are adopted? Have we accurately estimated costs of amending 
repurchase agreements and policies and procedures for the evaluation of 
the credit quality and liquidity of collateral securities?

C. Proposed Rule 6a-5

    We are proposing new rule 6a-5, which would establish a credit-
worthiness standard under section 6(a)(5)(A)(iv)(I) of the Investment 
Company Act. BIDCOs that seek to rely on the exemption in section 
6(a)(5) of the Act would be limited to investing in debt securities 
issued by investment companies and private funds if, at the time of 
purchase, the board of directors or members of the BIDCO (or their 
delegate) determines that the debt security is (i) subject to no 
greater than moderate credit risk and (ii) sufficiently liquid that the 
security can be sold at or near its carrying value within a reasonably 
short period of time.
1. Benefits
    We anticipate that proposed rule 6a-5 would result in certain 
benefits. Our proposed standard is intended to achieve the same purpose 
as the credit rating it would replace. In particular, the proposed 
standard is designed to limit BIDCOs to purchasing debt securities 
issued by investment companies or private funds of sufficiently high 
credit quality that they are likely to maintain a fairly stable market 
value and may be liquidated easily, as appropriate, for the BIDCO to 
support its investment and financing activities.
    Furthermore, to comply with the proposed standard, we do not 
believe that BIDCOs would be required to change any policies and 
procedures they may have with respect to the evaluation of these debt 
securities. As noted above, under proposed rule 6a-5, in evaluating 
whether debt securities issued by investment companies and private 
funds present moderate credit risk, boards of directors and members of 
BIDCOs (or their delegates) would be able to consider credit quality 
determinations prepared by outside sources, including NRSRO ratings, 
that they conclude are credible and reliable for purposes of making 
these determinations. We expect that the

[[Page 12910]]

ability to consider outside assessments in making these determinations 
would help minimize the burden on BIDCOs and contribute to a BIDCO's 
ability to make consistent credit quality determinations.
2. Costs
    We recognize that BIDCOs may incur some costs if we adopted 
proposed rule 6a-5. These may be internal costs or costs to consult 
outside legal counsel to evaluate whether changes to any policies and 
procedures the BIDCOs may have currently for acquiring debt securities 
issued by investment companies or private funds may be appropriate in 
light of the proposed rule. We do not believe, however, that these 
costs are attributable to the proposed rule because the Dodd-Frank 
Act's replacement of the credit rating standard in the Investment 
Company Act with a standard to be adopted by the Commission would 
result in similar costs of evaluating compliance with a new credit 
quality standard.
    We expect that, although not required by the Investment Company 
Act, as a matter of good business practice, directors or members of 
most BIDCOs that do not currently have them may prepare policies and 
procedures to make the credit quality and liquidity determinations 
required by the proposed rule. Commission staff estimates that the 
costs of preparing the procedures for making determinations of credit 
quality and liquidity under the rule would be borne upfront. Once 
generated, reviewed and implemented by directors or members of BIDCOs 
(or their delegates), directors and members (or their delegates) would 
be able to follow them for purposes of making future determinations 
under the rule. Our staff has estimated that each BIDCO would incur, on 
average, an initial one-time cost of $928 to prepare policies and 
procedures and an average of $928 in annual costs for making credit 
determinations with respect to the acquisition of debt securities.\112\
---------------------------------------------------------------------------

    \112\ We estimate that each BIDCO would incur on average a one-
time burden of 4 hours for a senior business analyst (under board or 
member delegation) to develop policies and procedures for evaluating 
credit and liquidity risk (4 hours x $232 per hour = $928). 
Commission staff believes that additional costs incurred by boards 
or members for review of procedures would be incorporated into 
BIDCOs' overall board or member costs and would not add any 
particular costs. In addition, Commission staff estimates that a 
BIDCO board or member is likely to delegate the credit risk 
determinations, and that such determinations would take on average 1 
hour of a senior business analyst's time (at $232 per hour) to 
evaluate the credit quality for each of an average of 4 investment 
company or private fund debt securities that a BIDCO would purchase 
each year (4 hours x $232 per hour) for a total cost of $928 per 
year.
---------------------------------------------------------------------------

    We anticipate that many BIDCOs that invest cash in these types of 
debt securities would continue to consider credit quality 
determinations prepared by outside sources, including NRSRO ratings, 
that they conclude are credible and reliable for purposes of making 
these determinations. Nevertheless, we recognize that some BIDCO boards 
or members may choose to hire consultants to assist in developing 
procedures and to make or oversee the proposed determinations.\113\ 
Staff estimates that the cost to hire such consultants would be, on 
average, $8,000 for each BIDCO.\114\
---------------------------------------------------------------------------

    \113\ We do not expect that money market funds would incur 
similar development assistance costs with respect to the proposed 
amendments to rule 2a-7 because rule 2a-7 currently requires these 
funds to perform credit quality determinations with respect to 
portfolio securities. Similarly, we expect that funds that rely on 
rule 5b-3 currently incorporate credit quality standards for 
collateral securities in addition to ratings in their repurchase 
agreements.
    \114\ Staff estimates that a BIDCO would need up to 16 hours of 
consulting advice to assist in developing procedures and to make or 
oversee the proposed determinations. Staff estimates that this 
advice would cost a BIDCO $500 per hour based on an understanding of 
the rates typically charged by outside consulting firms.
---------------------------------------------------------------------------

     We request comment on these cost estimates. Are the costs 
estimates accurate regarding the proposed procedures for making credit 
quality determinations? Do commenters foresee additional or alternative 
costs if proposed rule 6a-5 were adopted?

D. Forms N-1A, N-2 and N-3

    The proposed amendments to Forms N-1A, N-2 and N-3 would eliminate 
the required use of NRSRO credit ratings by funds that choose to use 
credit quality categorizations in the required table, chart, or graph 
of portfolio holdings. If a fund chooses to use NRSRO credit ratings to 
depict credit quality of portfolio holdings, the proposed amendments, 
like the current forms, generally would require the fund to use the 
credit ratings of a single NRSRO. The proposed amendments would clarify 
that, if credit ratings of the NRSRO selected by a fund are not 
available for certain holdings, the fund must briefly discuss the 
methodology for determining credit quality for those holdings, 
including, if applicable, the use of credit ratings assigned by another 
NRSRO.
1. Benefits
    Under the proposed amendments, funds will have greater flexibility 
to depict credit quality in the most meaningful manner, which may lead 
to better information for investors. This largely results from the 
congressionally mandated removal of the required use of credit ratings 
under section 939A of the Dodd-Frank Act.
2. Costs
    The Commission believes that because the proposed amendments only 
eliminate the required use of NRSRO credit ratings by funds that choose 
to use credit quality categorizations, any cost imposed on funds would 
not be material. Funds might incur costs to the extent that they choose 
to develop new methodologies for depicting credit quality. If a fund 
chooses to use NRSRO credit ratings to depict credit quality of 
portfolio holdings, the proposed amendments would clarify that, if 
credit ratings of the NRSRO selected by a fund are not available for 
certain holdings, the fund must briefly discuss the methodology for 
determining credit quality for those holdings. The Commission believes 
that the proposed clarification would not impose any additional cost 
because funds typically provide this disclosure in their shareholder 
reports today.\115\
---------------------------------------------------------------------------

    \115\ This assessment is based on a staff review of a sample of 
fund shareholder reports filed with the Commission.
---------------------------------------------------------------------------

E. Request for Comment

    The Commission requests comments on all aspects of the cost-benefit 
analysis, including the accuracy of the potential costs and benefits 
identified and assessed in this Release, as well as any other costs or 
benefits that may result from the proposals. We encourage commenters to 
identify, discuss, analyze, and supply relevant data regarding these or 
additional costs and benefits. For purposes of the Small Business 
Regulatory Enforcement Fairness Act of 1996,\116\ the Commission also 
requests information regarding the potential annual effect of the 
proposals on the U.S. economy. Commenters are requested to provide 
empirical data to support their views.
---------------------------------------------------------------------------

    \116\ Public Law 104-121, Title II, 110 Stat. 857 (1996) 
(codified in various sections of 5 U.S.C., 15 U.S.C. and as a note 
to 5 U.S.C. 601).
---------------------------------------------------------------------------

VI. Consideration of Promotion of Efficiency, Competition and Capital 
Formation

    Section 2(c) of the Investment Company Act and section 2(b) of the 
Securities Act each requires the Commission, when engaging in 
rulemaking under the respective Act that requires it to consider or 
determine whether an action is consistent with or necessary or 
appropriate in the public interest, to consider, in addition to the 
protection of investors, whether the

[[Page 12911]]

action will promote efficiency, competition, and capital 
formation.\117\
---------------------------------------------------------------------------

    \117\ 15 U.S.C. 80a-2(c); 15 U.S.C. 77b(b).
---------------------------------------------------------------------------

    Our proposed amendments to rules 2a-7 and 5b-3 and Forms N-MFP, N-
1A, N-2 and N-3 implement provisions of the Dodd-Frank Act that call 
for the Commission to remove credit rating references in its 
regulations and to substitute other appropriate standards of credit-
worthiness in place of the credit ratings. Thus, effects on efficiency, 
competition, and capital formation that arise from the removal of 
credit ratings are attributable to the congressionally mandated removal 
of the required use of credit ratings under section 939A of the Dodd-
Frank Act. The Commission has discretion, however, to adopt rule and 
rule amendments that set forth the alternative standards of credit-
worthiness, and we undertake below to discuss the effects on 
efficiency, competition and capital formation of the specific standards 
that we are proposing.
    We do not believe that the proposed amendments to rules 2a-7 and 
5b-3 and Forms N-MFP, N-1A, N-2 and N-3 would significantly affect 
competition or have an adverse effect on efficiency or capital 
formation.
    Rule 2a-7. With respect to rule 2a-7, as we have discussed above, 
money market funds have procedures for making credit quality and credit 
risk determinations under current rule 2a-7. In addition, we have 
designed the proposed standard to retain a degree of risk limitation 
similar to that reflected by the credit ratings in the current rule. 
Because we do not anticipate that the proposed amendments are likely to 
change the types of investments that are made by money market funds, we 
do not believe that the proposed amendments would have a significant 
effect on competition or capital formation. As we have noted above, we 
believe that money market funds could change their policies and 
procedures to reflect changes in the proposed amendments or continue to 
rely on their current policies and procedures to comply with the 
proposed amendments. We expect that money market funds are likely to 
make changes only if the benefits of such changes would justify the 
costs, which would not be likely to have an adverse effect on 
efficiency.
    Form N-MFP. The proposed amendments would conform the disclosures 
in Form N-MFP to the proposed amendments to rule 2a-7. We do not 
believe that our proposal to remove certain disclosures from the form 
would change the types of securities money market funds invest in and, 
therefore, would have no effect on competition or capital formation. To 
the extent that the proposed amendments reduce the time funds spend 
making the disclosures required in Form N-MFP, the proposed amendments 
may slightly increase efficiency.
    Rule 5b-3. The proposed standard for determining the credit quality 
of collateral securities in rule 5b-3 is designed to achieve the same 
purpose as the credit rating reference in the existing rule, i.e., to 
limit collateral securities to those that are likely to retain a stable 
market value and that, under ordinary circumstances, the fund could 
liquidate quickly in the event of a counterparty default. Because we do 
not anticipate that the proposed amendments would change the types of 
collateral securities that funds relying on 5b-3 would use, we do not 
believe that the proposed amendments would have a significant effect on 
competition or capital formation. Furthermore, funds typically 
establish credit quality standards for collateral securities that 
include credit ratings in repurchase agreements they enter into with 
counterparties. Funds could change their policies and procedures to 
reflect changes in the proposed amendments, but the rule would not 
prohibit funds from relying on the standards in current repurchase 
agreements and policies and procedures that address compliance with 
rule 5b-3. We anticipate that the consideration of outside sources in 
making credit quality determinations with respect to collateral 
securities may help funds arrive at consistent credit quality 
determinations. For these reasons, we do not believe that the proposed 
amendments to rule 5b-3 would have a significant effect on efficiency.
    Forms N-1A, N-2 and N-3. The proposed amendments to Forms N-1A, N-2 
and N-3 would eliminate the required use of NRSRO ratings by funds that 
choose to use credit quality categorizations in the required table, 
chart, or graph of portfolio holdings. If a fund chooses to use NRSRO 
credit ratings to depict credit quality of portfolio holdings, the 
proposed amendments would clarify that, if credit ratings of the NRSRO 
selected by a fund are not available for certain holdings, the fund 
must briefly discuss the methodology for determining credit quality for 
those holdings, including, if applicable, the use of credit ratings 
assigned by another NRSRO. We do not believe that the proposed 
clarification would affect efficiency, competition or capital formation 
because funds typically provide this disclosure in their shareholder 
reports today.\118\ The effect, if any, on efficiency, competition and 
capital formation that would arise from the proposed amendments to 
Forms N-1A, N-2 and N-3 results from the congressionally mandated 
removal of the required use of credit ratings under section 939A of the 
Dodd-Frank Act.
---------------------------------------------------------------------------

    \118\ This assessment is based on a staff review of fund 
shareholder reports filed with the Commission.
---------------------------------------------------------------------------

    Request for comment. We request comment whether the proposed rule 
and rule and form amendments would, if adopted, promote efficiency, 
competition, and capital formation. Commenters are requested to provide 
empirical data to support their views.

VII. Regulatory Flexibility Act Certification

    Pursuant to section 5(b) of the Regulatory Flexibility Act,\119\ 
the Commission hereby certifies that the proposed amendments to rule 
2a-7 and Form N-MFP under the Investment Company Act would not, if 
adopted, have a significant economic impact on a substantial number of 
small entities. For purposes of the RFA, an investment company is a 
small entity if it, together with other investment companies in the 
same group of related investment companies, has net assets of $50 
million or less as of the end of its most recent fiscal year.\120\ 
Based on information in filings submitted to the Commission, we believe 
that there are no money market funds that are small entities. For this 
reason, the Commission believes that the amendments to rule 2a-7 and 
Form N-MFP under the Investment Company Act would not, if adopted, have 
a significant economic impact on a substantial number of small 
entities.
---------------------------------------------------------------------------

    \119\ 5 U.S.C. 605(b).
    \120\ 17 CFR 270.0-10(a).
---------------------------------------------------------------------------

    The Commission requests written comments regarding this 
certification. The Commission requests that commenters describe the 
nature of any impact on small businesses and provide empirical data to 
support the extent of the impact.

VIII. Initial Regulatory Flexibility Analysis

    The Commission has prepared the following Initial Regulatory 
Flexibility Analysis (``IRFA'') in accordance with section 3(a) of the 
Regulatory Flexibility Act.\121\ It relates to the Commission's 
proposed amendments to rule 5b-3 under the Investment Company Act and 
Forms N-1A, N-2 and N-3 under the Investment Company Act and Securities

[[Page 12912]]

Act and proposed rule 6a-5 under the Investment Company Act.
---------------------------------------------------------------------------

    \121\ 5 U.S.C. 603(a).
---------------------------------------------------------------------------

A. Objectives and Legal Basis

    As described more fully in Sections I and II of this Release, to 
implement section 939A of the Dodd-Frank Act, the Commission is 
proposing to amend (i) rule 5b-3 to eliminate references to the credit 
rating and replace it with an alternative standard of credit-worthiness 
that is designed to appropriately achieve the same purpose as the use 
of the credit rating and (ii) Forms N-1A, N-2 and N-3 to eliminate the 
required use of NRSRO credit ratings by funds that choose to use credit 
quality categorizations in the required table, chart, or graph of 
portfolio holdings in their shareholder reports. The Commission is also 
proposing new rule 6a-5 to set forth a standard of credit-worthiness 
for purposes of section 6(a)(5)(A)(iv) of the Act, as anticipated by 
the Dodd Frank Act, which eliminates the investment grade standard from 
section 6(a)(5) of the Investment Company Act.
    The Commission is proposing amendments to rule 5b-3 pursuant to our 
authority set forth in sections 6(c) and 38(a) of the Investment 
Company Act [15 U.S.C. 80a-6(c), 80a-37(a)] and section 939A of the 
Dodd-Frank Act. The Commission is proposing rule 6a-5 pursuant to our 
authority set forth in section 38(a) of the Investment Company Act [15 
U.S.C. 80a-37(a)] and section 939 of the Dodd-Frank Act, codified at 
section 6(a)(5)(A)(iv)(I) of the Investment Company Act [15 U.S.C. 80a-
6(a)(5)(A)(iv)(I)]. The Commission is proposing amendments to Forms N-
1A, N-2 and N-3 pursuant to the authority set forth in sections 5, 6, 
7, 10 and 19(a) of the Securities Act and sections 8, 24(a), 30 and 38 
of the Investment Company Act.

B. Small Entities Subject to the Rule

    The proposed amendments to rule 5b-3 and proposed rule 6a-5 under 
the Investment Company Act would affect funds and BIDCOs, respectively, 
including entities that are considered to be a small business or small 
organization (collectively, ``small entity'') for purposes of the 
Regulatory Flexibility Act.
    Investment Companies. For purposes of the Regulatory Flexibility 
Act, an investment company is a small entity if it, together with other 
investment companies in the same group of related investment companies, 
has net assets of $50 million or less as of the end of its most recent 
fiscal year.\122\ Based on a review of filings submitted to the 
Commission, we estimate that 181 investment companies may be considered 
small entities and that all of these investment companies may 
potentially rely on rule 5b-3.\123\ We estimate that approximately 150 
investment companies that meet the definition of small entity would be 
subject to the proposed amendments to Forms N-1A, N-2 and N-3.
---------------------------------------------------------------------------

    \122\ 17 CFR 270.0-10(a).
    \123\ The 181 investment companies that meet the definition of 
small entity include business development companies, which are 
subject to sections 5 and 12 of the Investment Company Act. 15 
U.S.C. 80a-58; 15 U.S.C. 80a-59.
---------------------------------------------------------------------------

    BIDCOs. Under the standards adopted by the Small Business 
Administration, small entities in the financial investment industry 
include entities with $7 million or less in annual receipts.\124\ We do 
not have any data and are not aware of any databases that compile 
information regarding how many BIDCOs would be small entities under 
this definition. We request comment on how many BIDCOs are small 
entities under this definition.
---------------------------------------------------------------------------

    \124\ 13 CFR 121.201.
---------------------------------------------------------------------------

C. Reporting, Recordkeeping, and Other Compliance Requirements

    Rule 5b-3. We propose to amend rule 5b-3 to allow a fund to treat 
the acquisition of a repurchase agreement as an acquisition of 
securities collateralizing the repurchase agreement for purposes of 
sections 5(b)(1) and 12(d)(3) of the Act if the collateral other than 
cash or government securities consists of securities that the fund's 
board of directors (or its delegate) determines at the time the 
repurchase agreement is entered into are: (i) Issued by an issuer that 
has the highest capacity to meet its financial obligations; and (ii) 
sufficiently liquid that they can be sold at approximately their 
carrying value in the ordinary course of business within seven days. A 
fund that acquires repurchase agreements and intends the acquisition to 
be treated as an acquisition of the collateral securities must adopt 
and implement written policies and procedures reasonably designed to 
comply with the conditions of rule 5b-3, including any credit quality 
or liquidity requirements that we adopt.\125\
---------------------------------------------------------------------------

    \125\ 17 CFR 270.38a-1(a).
---------------------------------------------------------------------------

    We have estimated the costs of these amendments previously in the 
cost-benefit analysis in Section V above.\126\
---------------------------------------------------------------------------

    \126\ See supra Section V.B.2.
---------------------------------------------------------------------------

    Proposed rule 6a-5. Proposed rule 6a-5 would impose no reporting, 
recordkeeping or other compliance requirements.
    Forms N-1A, N-2 and N-3. The proposed amendments to Forms N-1A, N-2 
and N-3 would apply to open-end management investment companies, 
closed-end management investment companies and separate accounts 
organized as management investment companies that offer variable 
annuity contracts, including those that are small entities. We are 
proposing to amend the forms to eliminate the required use of NRSRO 
credit ratings by funds that choose to use credit quality 
categorizations in the required table, chart, or graph of portfolio 
holdings in their shareholder reports. If a fund chooses to use NRSRO 
credit ratings to depict credit quality of portfolio holdings, the 
proposed amendments, like the current forms, generally would require 
the fund to use the credit ratings of a single NRSRO. The proposed 
amendments would clarify that, if credit ratings of the NRSRO selected 
by a fund are not available for certain holdings, the fund must briefly 
discuss the methodology for determining credit quality for those 
holdings, including, if applicable, the use of credit ratings assigned 
by another NRSRO. For purposes of the cost-benefit analysis, we have 
estimated that any cost imposed on funds would not be material.

D. Duplicating, Overlapping, or Conflicting Federal Rules

    Rule 31a-1 under the Act requires the retention of ledger accounts 
for each portfolio security and each person through which a portfolio 
transaction is effected, including certain records of collateral for 
monies borrowed and loaned.\127\ Although some of the procedures under 
the proposed amendments to rule 5b-3 may overlap with information in 
the ledgers, we believe any overlap would be minimal and the rule 5b-3 
procedures would contain additional information specifically related to 
the concerns underlying these rules. The Commission believes that there 
are no other rules that duplicate, overlap, or conflict with the 
proposed amendments to Forms N-1A, N-2 and N-3 and proposed new rule 
6a-5.
---------------------------------------------------------------------------

    \127\ See rule 31a-1(b)(2)(i)(d).
---------------------------------------------------------------------------

E. Significant Alternatives

    The Regulatory Flexibility Act directs us to consider significant 
alternatives that would accomplish our stated objectives, while 
minimizing any significant adverse impact on small issuers. In 
connection with the proposed rule and rule and form amendments, the 
Commission considered the following alternatives: (i)

[[Page 12913]]

Establishing different compliance standards or timetables that take 
into account the resources available to small entities; (ii) 
clarifying, consolidating, or simplifying compliance and reporting 
requirements under the rule for small entities; (iii) use of 
performance rather than design standards; and (iv) exempting small 
entities from all or part of the requirements.
    The Commission believes that, at the present time, special 
compliance or reporting requirements for small entities, or an 
exemption from coverage for small entities, would not be appropriate or 
consistent with investor protection. The proposed rule and amendments 
to rules and forms are intended to implement sections 939 and 939A of 
the Dodd-Frank Act. We believe that, with respect to rule 5b-3, 
different credit quality standards, special compliance requirements or 
timetables for small entities, or an exemption from coverage for small 
entities, may create a risk that those entities could acquire 
repurchase agreements with collateral that is less likely to retain its 
market value or liquidity in the event of a counterparty default. 
Similarly, with respect to proposed rule 6a-5, we believe that special 
compliance requirements or timetables for small entities, or an 
exemption from coverage for small entities, may create a risk that 
those BIDCOs could acquire debt securities that are not of sufficiently 
high credit quality that they would be likely to maintain a fairly 
stable market value or be liquidated easily, as we believe may have 
been intended for the BIDCO to support its long-term commitments. 
Further consolidation or simplification of the proposals for funds that 
are small entities would be inconsistent with the Commission's goals of 
fostering investor protection.
    The proposed form amendments, if adopted, would apply to all 
investment companies that use Forms N-1A, N-2 and N-3 to register under 
the Investment Company Act and to offer their securities under the 
Securities Act. If the Commission excluded small entities from the 
proposed form amendments, small entities would be required to use NRSRO 
credit ratings if they choose to depict credit quality, while other 
entities would not be subject to that requirement. We believe this 
outcome is inconsistent with section 939A of the Dodd-Frank Act. We 
believe that special compliance or reporting requirements, or an 
exemption, for small entities would not be appropriate because the 
proposed requirement--that if a fund chooses to use NRSRO credit 
ratings to depict credit quality of portfolio holdings, generally it 
must use the ratings of a single NRSRO--is intended to eliminate the 
possibility that a fund of any size could choose to use NRSRO credit 
ratings and then select the most favorable ratings among credit ratings 
assigned by multiple NRSROs.
    We have endeavored through the proposed form amendments to minimize 
regulatory burden on investment companies, including small entities, 
while meeting our regulatory objectives. We have endeavored to clarify, 
consolidate, and simplify the requirements applicable to investment 
companies, including those that are small entities. Finally, the 
proposal would use performance rather than design standards for 
determining the credit quality of specific securities.
    For these reasons, we have not proposed alternatives to the 
proposed rule and rule and form amendments.

F. Request for Comments

    We encourage the submission of comments with respect to any aspect 
of the IRFA. In particular, the Commission seeks comment on the number 
of small entities that would be subject to the proposed rule and rule 
and form amendments and whether the effect of the proposed rule on 
small entities subject to it would be economically significant. 
Commenters are asked to describe the nature of any impact and provide 
empirical data supporting its extent. These comments will be considered 
in connection with any adoption of the proposed rule and rule and form 
amendments, and reflected in a Final Regulatory Flexibility Analysis.
    Comments should be submitted in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090. Comments may also be submitted 
electronically to the following e-mail address: [email protected]. 
All comment letters should refer to File No. S7-7-11, and this file 
number should be included on the subject line if e-mail is used.\128\ 
Comment letters will be available for website viewing and printing in 
the Commission's Public Reference Room, 100 F Street, NE., Washington, 
DC 20549-1520, on official business days between the hours of 10 a.m. 
and 3 p.m. Electronically submitted comment letters also will be posted 
on the Commission's Internet Web site (http://www.sec.gov).
---------------------------------------------------------------------------

    \128\ Comments on the IRFA will be placed in the same public 
file that contains comments on the proposed rule and rule and form 
amendments.
---------------------------------------------------------------------------

Statutory Authority

    The Commission is proposing amendments to rules 2a-7 and 5b-3 under 
the authority set forth in sections 6(c) and 38(a) of the Investment 
Company Act [15 U.S.C. 80a-6(c), 80a-37(a)] and section 939A of the 
Dodd-Frank Act. The Commission is proposing new rule 6a-5 under the 
authority set forth in section 38(a) of the Investment Company Act [15 
U.S.C. 80a-37(a)] and section 939 of the Dodd-Frank Act, to be codified 
at section 6(a)(5)(A)(iv)(I) of the Investment Company Act [15 U.S.C. 
80a-6(a)(5)(A)(iv)(I)]. The Commission is proposing amendments to Form 
N-1A, Form N-2 and Form N-3 under the authority set forth in sections 
5, 6, 7, 10 and 19(a) of the Securities Act [15 U.S.C. 77e, 77f, 77g, 
77j, and 77s(a)] and sections 8, 24(a), 30 and 38 of the Investment 
Company Act [15 U.S.C. 80a-8, 80a-24(a), 80a-29 and 80a-37]. The 
Commission is proposing amendments to Form N-MFP under the authority 
set forth in sections 8(b), 30(b), 31(a) and 38(a) of the Investment 
Company Act [15 U.S.C. 80a-8(b), 80a-29(b), 80a-30(a) and 80a-37(a)] 
and section 939A of the Dodd-Frank Act.

List of Subjects

17 CFR Part 239

    Reporting and recordkeeping requirements, Securities.

17 CFR Parts 270 and 274

    Investment companies, Reporting and recordkeeping requirements, 
Securities.

Text of Proposed Rule and Form Amendments

    For reasons set out in the preamble, Title 17, Chapter II of the 
Code of Federal Regulations is proposed to be amended as follows:

PART 239--FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933

    1. The authority citation for Part 239 continues to read in part as 
follow:

    Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77z-3, 
77sss, 78c, 78l, 78m, 78n, 78o(d), 78u-5, 78w(a), 78ll, 78mm, 80a-
2(a), 80a-3, 80a-8, 80a-9, 80a-10, 80a-13, 80a-24, 80a-26, 80a-29, 
80a-30, and 80a-37, unless otherwise noted.
* * * * *

PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940

    2. The authority citation for part 270 is revised to read in part 
as follows:


[[Page 12914]]


    Authority:  15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, and 80a-
39, unless otherwise noted.
* * * * *
    Section 270.6a-5 is also issued under 15 U.S.C. 80a-
6(a)(5)(A)(iv)(I).
* * * * *
    3. Section 270.2a-7 is amended by:
    a. In paragraph (a)(5), removing the words ``and (D)'';
    b. Removing paragraph (a)(11);
    c. Redesignating paragraphs (a)(12) through (a)(20) as (a)(11) 
through (a)(19);
    d. Revising newly designated paragraph (a)(11);
    e. Revising newly designated paragraph (a)(13);
    f. Removing paragraph (a)(21);
    g. Redesignating paragraph (a)(22) as paragraph (a)(20);
    h. Removing paragraph (a)(23);
    i. Redesignating paragraphs (a)(24) through (a)(29) as paragraphs 
(a)(21) through (a)(26);
    j. Removing paragraph (a)(30);
    k. Redesignating paragraphs (a)(31) and (a)(32) as paragraphs 
(a)(27) and (a)(28);
    l. Revising paragraphs (c)(3)(i), (c)(3)(iii), and (c)(3)(iv)(C);
    m. Adding paragraph (c)(3)(iv)(D);
    n. In paragraph (c)(7):
    i. Revising the paragraph heading;
    ii. Revising paragraph (c)(7)(i);
    iii. In the introductory text of paragraph (c)(7)(ii), removing the 
phrase ``paragraphs (c)(7)(ii)(A) through (D)'' and adding in its place 
``paragraphs (c)(7)(ii)(A) through (C)'';
    iv. Adding ``or'' at the end of paragraph (c)(7)(ii)(B);
    v. Removing paragraph (c)(7)(ii)(C) and redesignating paragraph 
(c)(7)(ii)(D) as paragraph (c)(7)(ii)(C);
    o. Revising paragraph (c)(10)(v)(A);
    p. Revising paragraph (c)(11)(iii);
    q. In paragraph (e):
    i. Removing the words ``(a)(11)(i) (designation of NRSROs);'' from 
the introductory text of paragraph (e); and
    ii. Revising paragraph (e)(1).
    These additions and revisions read as follows:


Sec.  270.2a-7  Money market funds.

    (a) * * *
    (11) Eligible Security means a security with a remaining maturity 
of 397 calendar days or less that the fund's board of directors 
determines presents minimal credit risks (which determination must be 
based on factors pertaining to credit quality and the issuer's ability 
to meet its short-term financial obligations).
* * * * *
    (13) First Tier Security means any Eligible Security:
    (i) The issuer of which the fund's board of directors has 
determined has the highest capacity to meet its short-term financial 
obligations;
    (ii) That is a security issued by a registered investment company 
that is a money market fund; or
    (iii) That is a Government Security.
* * * * *
    (c) * * *
    (3) * * *
    (i) General. The money market fund shall limit its portfolio 
investments to those United States Dollar-Denominated securities that 
are at the time of Acquisition Eligible Securities.
* * * * *
    (iii) Securities Subject to Guarantees. A security that is subject 
to a Guarantee may be determined to be an Eligible Security or a First 
Tier Security based solely on whether the Guarantee is an Eligible 
Security or First Tier Security, as the case may be, provided however, 
that the issuer of the Guarantee, or another institution, has 
undertaken to promptly notify the holder of the security in the event 
the Guarantee is substituted with another Guarantee (if such 
substitution is permissible under the terms of the Guarantee).
    (iv) * * *
    (C) The fund's board of directors determines that the Underlying 
Security or any Guarantee of such security is of high quality and 
subject to very low credit risk; and
    (D) The issuer of the Conditional Demand Feature, or another 
institution, has undertaken to promptly notify the holder of the 
security in the event the Conditional Demand Feature is substituted 
with another Conditional Demand Feature (if such substitution is 
permissible under the terms of the Conditional Demand Feature).
* * * * *
    (7) Monitoring, Defaults and Other Events.
    (i)(A) Monitoring. In the event the money market fund's investment 
adviser (or any person to whom the fund's board of directors has 
delegated portfolio management responsibilities) becomes aware of any 
credible information about a portfolio security or an issuer of a 
portfolio security that may suggest that the security is no longer a 
First Tier Security or a Second Tier Security, as the case may be, the 
board of directors shall reassess promptly whether such security 
continues to present minimal credit risks and shall cause the fund to 
take such action as the board of directors determines is in the best 
interests of the money market fund and its shareholders. This 
reassessment shall not be required if the fund disposes of the security 
(or it matures) within five Business Days after the date the money 
market fund's adviser (or any person to whom the fund's board of 
directors has delegated portfolio management responsibilities) becomes 
aware of the relevant information, and the board is subsequently 
notified of the adviser's actions.
    (B) Special Rule for Certain Securities Subject to Demand Features. 
If, as a result of a portfolio security that ceases to be a First Tier 
Security, more than 2.5 percent of the fund's Total Assets are invested 
in securities issued by or subject to Demand Features from a single 
institution that are Second Tier Securities, the fund shall reduce its 
investment in securities issued by or subject to Demand Features from 
that institution to no more than 2.5 percent of its Total Assets by 
exercising the Demand Features at the next succeeding exercise date(s), 
absent a finding by the board of directors that disposal of the 
portfolio security would not be in the best interests of the money 
market fund.
* * * * *
    (10) * * *
    (v) * * *
    (A) The periodic testing, at such intervals as the board of 
directors determines appropriate and reasonable in light of current 
market conditions, of the money market fund's ability to maintain a 
stable net asset value per share based upon specified hypothetical 
events that include, but are not limited to, a change in short-term 
interest rates, an increase in shareholder redemptions, an adverse 
change in the ability of the issuer of a portfolio security to meet its 
short-term financial obligations or a default on portfolio securities, 
and the widening or narrowing of spreads between yields on an 
appropriate benchmark the fund has selected for overnight interest 
rates and commercial paper and other types of securities held by the 
fund.
* * * * *
    (11) * * *
    (iii) Credit Risk Analysis. For a period of not less than three 
years from the date that the credit risks of a portfolio security were 
most recently reviewed, a written record of the determination that a 
portfolio security presents minimal credit risks used to determine the 
status of the security as an Eligible Security shall be maintained and 
preserved in an easily accessible place.
* * * * *
    (e) * * *
    (1) Written Guidelines. The Board shall establish and periodically 
review written guidelines (including guidelines for determining whether 
securities present minimal credit risks as required in paragraph (c)(3) 
of this section (by

[[Page 12915]]

reference to paragraph (a)(11)) and procedures under which the delegate 
makes such determinations.
* * * * *
    4. Section 270.5b-3 is amended by:
    a. Adding ``or'' at the end of paragraph (c)(1)(iv)(B);
    b. Revising paragraph (c)(1)(iv)(C);
    c. Removing paragraph (c)(1)(iv)(D);
    d. Removing paragraphs (c)(5), (c)(6), and (c)(8);
    e. Redesignating paragraph (c)(4) as (c)(5);
    f. Adding new paragraph (c)(4); and
    g. Redesignating paragraph (c)(7) as paragraph (c)(6).
    The revisions read as follows:


Sec.  270.5b-3  Acquisition of repurchase agreement or refunded 
security treated as acquisition of underlying securities.

* * * * *
    (c) * * *
    (1) * * *
    (iv) * * *
    (C) Securities that the investment company's board of directors, or 
its delegate, determines at the time the repurchase agreement is 
entered into:
    (1) Each issuer of which has the highest capacity to meet its 
financial obligations; and
    (2) Are sufficiently liquid that they can be sold at approximately 
their carrying value in the ordinary course of business within seven 
calendar days; and
* * * * *
    (4) Issuer, as used in paragraph (c)(1)(iv)(C) of this section, 
means the issuer of a collateral security or the issuer of an 
unconditional obligation of a person other than the issuer of the 
collateral security to undertake to pay, upon presentment by the holder 
of the obligation (if required), the principal amount of the underlying 
collateral security plus accrued interest when due or upon default.
* * * * *
    5. Section 270.6a-5 is added to read as follows:


Sec.  270.6a-5  Purchase of certain debt securities by companies 
relying on section 6(a)(5) of the Act.

    For purposes of reliance on the exemption for certain companies 
under section 6(a)(5)(A) of the Act (15 U.S.C. 80a-6(a)(5)(A)), a 
company shall be deemed to have met the requirement for credit-
worthiness of certain debt securities under section 6(a)(5)(A)(iv)(I) 
of the Investment Company Act (15 U.S.C. 80a-6(a)(5)(A)(iv)(I)) if, at 
the time of purchase, the board of directors (or its delegate) 
determines or members of the company (or their delegate) determine that 
the debt security is:
    (a) Subject to no greater than moderate credit risk; and
    (b) Sufficiently liquid that it can be sold at or near its carrying 
value within a reasonably short period of time.

PART 239--FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933

PART 274--FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY ACT OF 1940

    6. The authority citation for part 274 continues to read in part as 
follows:

    Authority:  15 U.S.C. 77f, 77g, 77h, 77j, 77s, 78c(b), 78l, 78m, 
78n, 78o(d), 80a-8, 80a-24, 80a-26, and 80a-29, unless otherwise 
noted.
* * * * *
    7. Form N-1A (referenced in Sec. Sec.  239.15A and 274.11A) is 
amended by revising Item 27(d)(2) to read as follows:

    Note: The text of Form N-1A does not, and these amendments will 
not, appear in the Code of Federal Regulations.

Form N-1A

* * * * *

Item 27. Financial Statements

* * * * *
    (d) Annual and Semi-Annual Reports. * * *
    (2) Graphical Representation of Holdings. One or more tables, 
charts, or graphs depicting the portfolio holdings of the Fund by 
reasonably identifiable categories (e.g., type of security, industry 
sector, geographic region, credit quality, or maturity) showing the 
percentage of net asset value or total investments attributable to 
each. The categories and the basis of presentation (e.g., net asset 
value or total investments) should be selected, and the presentation 
should be formatted, in a manner reasonably designed to depict clearly 
the types of investments made by the Fund, given its investment 
objectives. If the Fund uses the credit ratings, as defined in section 
3(a)(60) of the Securities Exchange Act [15 U.S.C. 78(c)(a)(60)], 
assigned by a nationally recognized statistical rating organization 
(``NRSRO''), as defined in section 3(a)(62) of the Securities Exchange 
Act [15 U.S.C. 78(c)(a)(62)], to categorize the credit quality of 
portfolio holdings, it should use the credit ratings of only one NRSRO 
except in the case of portfolio holdings that are not rated by that 
NRSRO. If credit ratings of that NRSRO are not available for certain 
holdings, the Fund must briefly discuss the methodology for determining 
credit quality for such holdings, including, if applicable, the use of 
credit ratings assigned by another NRSRO.
* * * * *
    8. Form N-2 (referenced in Sec. Sec.  239.14 and 274.11a-1) is 
amended by revising Instruction 6(a) to Item 24 to read as follows:

    Note: The text of Form N-2 does not, and these amendments will 
not, appear in the Code of Federal Regulations.

Form N-2

* * * * *

Item 24. Financial Statements

* * * * *
Instructions:
* * * * *
    6. * * *
    a. One or more tables, charts, or graphs depicting the portfolio 
holdings of the Registrant by reasonably identifiable categories (e.g., 
type of security, industry sector, geographic region, credit quality, 
or maturity) showing the percentage of net asset value or total 
investments attributable to each. The categories and the basis of 
presentation (e.g., net asset value or total investments) should be 
selected, and the presentation should be formatted, in a manner 
reasonably designed to depict clearly the types of investments made by 
the Registrant, given its investment objectives. If the Registrant uses 
the credit ratings, as defined in Section 3(a)(60) of the Exchange Act 
[15 U.S.C. 78(c)(a)(60)], assigned by a nationally recognized 
statistical rating organization (``NRSRO''), as defined in Section 
3(a)(62) of the Exchange Act [15 U.S.C. 78(c)(a)(62)], to categorize 
the credit quality of portfolio holdings, it should use the credit 
ratings of only one NRSRO except in the case of portfolio holdings that 
are not rated by that NRSRO. If credit ratings of that NRSRO are not 
available for certain holdings, the Registrant must briefly discuss the 
methodology for determining credit quality for such holdings, 
including, if applicable, the use of credit ratings assigned by another 
NRSRO.
* * * * *
    9. Form N-3 (referenced in Sec. Sec.  239.17a and 274.11b) is 
amended by revising Instruction 6(i) to Item 28(a) to read as follows:

    Note:  The text of Form N-3 does not, and these amendments will 
not, appear in the Code of Federal Regulations.

Form N-3

* * * * *

Item 28. Financial Statements

    (a) * * *

[[Page 12916]]

Instructions:
* * * * *
    6. * * *
    (i) One or more tables, charts, or graphs depicting the portfolio 
holdings of the Registrant by reasonably identifiable categories (e.g., 
type of security, industry sector, geographic region, credit quality, 
or maturity) showing the percentage of net asset value or total 
investments attributable to each. If the Registrant has sub-accounts, 
provide the information separately for each sub-account. The categories 
and the basis of presentation (e.g., net asset value or total 
investments) should be selected, and the presentation should be 
formatted, in a manner reasonably designed to depict clearly the types 
of investments made by the Registrant, given its investment objectives. 
If the Registrant uses the credit ratings, as defined in Section 
3(a)(60) [15 U.S.C. 78c(a)(60)] of the Exchange Act, assigned by a 
nationally recognized statistical rating organization (``NRSRO''), as 
defined in Section 3(a)(62) of the Exchange Act [15 U.S.C. 78c(a)(62)], 
to categorize the credit quality of portfolio holdings, it should use 
the credit ratings of only one NRSRO except in the case of portfolio 
holdings that are not rated by that NRSRO. If credit ratings of that 
NRSRO are not available for certain holdings, the Registrant must 
briefly discuss the methodology for determining credit quality for such 
holdings, including, if applicable, the use of credit ratings assigned 
by another NRSRO.
* * * * *

PART 274--FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY ACT OF 1940

    10. Form N-MFP (referenced in Sec.  274.201) is amended by:
    a. Revising Item 33;
    b. Removing Item 34;
    c. Revising Item 37.b;
    d. Removing Item 37.c;
    e. Removing Items 38.b and 38.c;
    f. Removing Items 39.c and 39.d;
    g. Redesignating Items 35 through 46 as Items 34 through 45; and
    h. In redesignated Item 38, replacing ``Items 37 and 38'' with 
``Items 36 and 37''.
    The revisions read as follows:

    Note: The text of Form N-MFP does not, and this amendment will 
not, appear in the Code of Federal Regulations.

Form N-MFP

* * * * *

Item 33

    Indicate whether the security is a First Tier Security, a Second 
Tier Security or no longer an Eligible Security.
* * * * *

Item 37

* * * * *
    b. The period remaining until the principal amount of the security 
may be recovered through the Demand Feature.

    Dated: March 3, 2011.

    By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2011-5184 Filed 3-8-11; 8:45 am]
BILLING CODE 8011-01-P