CURRENT DEVELOPMENTS FOR MUTUAL FUND AUDIT COMMITTEES QUARTERLY SUMMARY

www.pwc.com/us/assetmanagement March 31, 2012 Current Developments for Mutual Fund Audit Committees Quarterly summary Table of contents PwC articles & observations for the three months ended March 31, 2012 More money market fund reform? 1 CFTC adopts new rules requiring advisors to investment companies 3 and private funds to register Regulatory developments 9 Tax developments Senate Permanent Subcommittee on Investigations hearing on 15 mutual fund investments in commodities Summary of developments for the six 17 months ended March 31, 2012 Publications of interest to mutual fund 20 directors issued during the three years ended March 31, 2012 PwC PwC articles & observations for the three months ended March 31, 2012 More money market fund reform? Money market funds, prior to 2008, were rarely the topic of news headlines. However, since the market turmoil of September 2008, during which one fund infamously “broke the buck,” money market reform has been at the forefront of the SEC’s agenda and there has rarely been a day without some sort of news story about money funds. In 2010, the SEC implemented several changes to Rule 2a-7 (the rule under the Investment Company Act of 1940 that governs money market funds). The rule changes were designed to provide, among other things, greater liquidity and transparency into money market funds. However, at that time the SEC made it clear that those changes were only an initial step and that further reform to money market fund regulation, including potentially more significant changes, would be proposed. At the direction of SEC Chairman Mary Schapiro, currently, the SEC is considering two alternatives: 1) A floating NAV 2) Requiring a capital “buffer” to provide support to address losses in a money market fund. This would be combined with a 30-day hold on a specified percentage of amounts redeemed from a shareholder’s account (possibly 3% to 5%), which would be charged with any losses in excess of the buffer, to mitigate the incentive for investors to flee the fund at the first sign of trouble, thereby setting off a “run.” PwC The industry has been outspoken in its reaction to these options. The entire premise of a money market fund is, of course, its stable NAV. Money market funds are widely used as overnight investment vehicles for both retail investors and, increasingly, large institutions, with SEC estimates that over two-thirds of all money market fund shares are now held by institutional investors. They are popularly used for overnight investing often because of the fact that investors know they will receive back exactly what they put in, with interest. Changing to a floating NAV, some argue, would create disincentives to investment in money funds; for example, if every withdrawal from a money fund led to recognition of small capital gains and losses, the tax consequences (and paperwork) alone would be so onerous that many investors may instead put their money in a much simpler alternative – namely, bank deposits. Others have noted that adding to bank deposits is itself a further concentration of risk within the banking industry, and thus substituting money fund investments with bank deposits may actually be counterproductive to the goal of reducing overall systemic risk. On the other hand, a different concern is that, if stable NAVs no longer existed, there would be no particular difference between investing in money market funds and short-duration bond funds (which pay higher yields), potentially leading some investors to take on more, rather than less, risk. There is also concern that institutions would look for other stable-value alternatives (often unregistered and potentially offshore), thereby reducing transparency and increasing the risk of systemic events occurring without regulatory knowledge. 1 In fact, some institutional investors might even be prevented under investment guidelines (or, for some governmental investors, statutes) from investing in any short-term vehicle where full redemption access is restricted. Further, redemption restrictions would impose potentially immense logistical challenges, such as changes to transfer agency systems and, particularly, how restrictions could be applied (or even monitored) in omnibus accounts at intermediaries. However, although this may indeed be a fall-out effect of money market reform, alternative investments may also have the option to restrict redemptions. Indeed, there are concerns that intermediaries would simply remove money market funds as investment options altogether in favor of bank deposits, simply to avoid having to deal with these restrictions. One prominent manager of money market funds has, in fact, publicly stated that, should the SEC ultimately adopt such proposals, it would take legal action against the Commission, arguing that it had not undertaken suficient analysis of the rules’ potential impact. Many in the industry argue that the reforms put in place in 2010 have suficiently mitigated the risks in money market funds that existed leading up to the financial crisis. Specifically, it has been stated that the fact that money funds withstood the market volatility during the summer of 2011 (including unwinding exposure to European banks) with no funds breaking the buck proves PwC that further reform is not necessary. However, proponents of additional reform note that, had that exposure deteriorated as quickly as did the exposure to tainted financial institutions in 2008, a replay of that turmoil could have occurred. Further, as the SEC has noted recently, there were numerous instances before 2008 where investment advisors bailed out money market funds, and in the 2007–2008 period over 100 funds — nearly 20% of the industry — in 18 complexes required support from their advisors or afiliates. Overall, the intent of the SEC to protect investors and better ensure stability in money market funds is applauded and understood. The SEC is adamant that the industry must be prepared for a future crisis arising from a currently unpredictable source, requiring the exploration of further changes to money market funds. However, based on the reactions to the SEC’s comments to date, it is evident that there are widespread concerns that if the SEC ultimately implements these changes, the result might be large-scale redemptions from money market funds and a fundamental reordering of the mutual fund industry. The SEC acknowledged that there likely will be costs of implementing any proposed changes, but, in recent discussions, has implored the industry to come together and communicate on this topic. The SEC expects to issue new rule proposals some time in the second quarter of 2012. 2 CFTC adopts new rules requiring advisors to investment companies and private funds to register Also adopts new reporting requirements and proposes new “harmonization” rules On February 9, 2012, the Commodity Futures Trading Commission (CFTC) adopted amendments to its rules to require private fund managers and SEC-registered investment companies that hold more than 5% of their portfolio holdings in commodity interests (futures, commodity options, and swaps) to become registered with the CFTC, unless they meet new criteria for exemption.1 Registration will have a significant impact as imposes new CFTC-driven obligations, including new disclosures to customers and new regulatory reporting requirements. The CFTC also proposed “harmonization” rules intended to ease the burden of complying with both the Securities and Exchange Commission (SEC) and CFTC requirements.2 The CFTC is asking for public comment on these rules. The CFTC also adopted new reporting requirements for commodity pool operators (CPOs) on Form CPO-PQR. This article describes the CFTC’s new registration rules, proposed harmonization rules, and new information reporting requirements. In Sum The final rules, which became effective April 24, 2012: • Reinstate a trading threshold and marketing restriction for mutual funds and other SEC-registered investment companies — thus requiring CFTC registration for many mutual fund advisers • Establish new annual, and in some cases quarterly, reporting requirements for CPOs and commodity trading advisors (CTAs) on new Forms CPO-PRQ and CTA-PR • Require that CPOs and CTAs provide specific risk disclosures in connection with swap transactions New requirements for SEC-registered investment companies Historically, SEC-registered investment companies were not required to register with the CFTC, irrespective of the amount of their portfolio holdings in commodity interests. Until the CFTC adopted these new rules, the CFTC maintained an exclusion from the definition of a CPO for investment companies that were registered with the SEC under the Investment Company Act (Rule 4.5). In adopting the new rules, the CFTC stated that it had observed SEC-registered investment companies offering interests in “de facto commodity pools” (funds consisting primarily or solely of commodity interests) while not being registered with the CFTC as a CPO.3 1 77 Fed. Reg. 11252 (Feb. 24, 2012) (“Final Rule Release”), available at http://www.gpo.gov/fdsys/pkg/FR-2012-02-24/pdf/2012-3390.pdf 2 77 Fed. Reg. 11345 (Feb. 24, 2012), available at http://www.gpo.gov/fdsys/pkg/FR-2012-02-24/pdf/2012-3388.pdf 3 The CEA, as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) defines commodity pool as “any investment trust, syndicate, or similar form of enterprise operated for the purpose of trading in commodity interests, including any . . . commodity for future delivery, security futures product, or swap.” PwC 3 ... - tailieumienphi.vn