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No-Action Letter under:
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| Response of the Office Of Chief Counsel Division of Investment Management | Our Ref. No. 2002281328 Merrill Lynch Investment Managers File No. 801-11583 |
By letter dated May 8, 2002, you request our assurance that we would not recommend that the Commission take any enforcement action under Sections 34(b) or 35(d) of the Investment Company Act (the "1940 Act") or Rule 22c-1 thereunder against funds that hold themselves out as money market funds in reliance on Rule 2a-7 under the 1940 Act ("Money Market Funds") if they purchase certain preferred stock, as described in your letter.1
Your request relates to whether Money Market Funds may purchase two types of preferred stock: Auction Market Preferred Stock ("AMPS") and/or Remarketed Preferred Stock ("RP") (together, the "Preferred Stock"), each of which is subject to what you term a "Demand Feature," which is defined in Rule 2a-7(a)(8). As described in your letter, certain closed-end management investment companies issue the Preferred Stock (each, an "Issuer"). We set forth the major features of the Preferred Stock and the putative Demand Feature below.
AMPS is a form of equity security that has priority over common stock in, among other things, the payment of dividends. You state that AMPS is issued at its liquidation preference, or stated price, which is equal to the price that a purchaser or seller will pay or receive in a successful auction (or remarketing, in the case of the RP), as described in your letter. You state that an Issuer must pay the liquidation preference, plus any accumulated but unpaid dividends, to redeem the AMPS or to retire the AMPS in liquidation.
You further state that the AMPS accumulates dividends at a rate that is periodically reset for a specified period, the "Dividend Period," pursuant to a "Dutch Auction" that generally will be held every seven days. The AMPS thus generally will have a seven-day Dividend Period. An auction will be held on the first business day preceding the first day of a new Dividend Period (the "Auction Date"). The first day of the new Dividend Period is the dividend payment date ("Dividend Payment Date") for the preceding Dividend Period, as well as the settlement date ("Settlement Date") for any AMPS shares that were purchased and sold at auction the preceding business day.2 You also state that the AMPS shares generally will be callable, in whole or in part, at the option of the Issuer on any Dividend Payment Date at their liquidation preference plus any accumulated but unpaid dividends.
As further described in your letter, an auction will be deemed to have "failed" if a sufficient number of clearing bids are not made. In such an event, Money Market Funds (and other holders of the stock) might not be able to sell all of their AMPS shares through the auction mechanism. They would, however, receive notice of the failed auction and be able to sell their unsold shares to a guarantor that is unaffiliated with the Issuer (a "Counterparty"), as set forth in part C, below.3
You state that the terms of the RP are substantially similar to those of the AMPS. You state that the primary difference between the RP and the AMPS is the dividend- determination mechanism. Unlike the AMPS, the RP does not have its dividend rates determined by auction. Instead, an Issuer enters into a remarketing agreement with one or more remarketing agents ("Remarketing Agents"). These agents have sole discretion to set dividend rates, subject to the terms of the remarketing agreement. The dividend rate of RP shares generally will be reset every seven days, meaning that a remarketing of RP shares that are sold to Money Market Funds generally will take place every seven days. Hence, the RP, like the AMPS, generally will have a seven-day Dividend Period.
If the remarketing process fails for any of the reasons set forth in your letter, the RP's dividend rate for the subsequent Dividend Period (also known as a "Remarketing Period," in the case of the RP) would revert to a preset rate in the same fashion as that of the AMPS. As with the AMPS, holders of RP shares would receive notification of the failure and be able to exercise the Preferred Stock's Demand Feature, as set forth below.
You state that, pursuant to agreements between the Issuers and the Counterparties, holders of the Preferred Stock will have a right to sell their Preferred Stock to a Counterparty for its liquidation preference plus any accumulated dividends, whether or not earned or declared (the "PS Demand Feature").4 The PS Demand Feature will be exercisable upon: (i) a failed auction or remarketing; (ii) a failure by an Issuer to make a scheduled payment of dividends or redemption proceeds of the Preferred Stock; or (iii) a failure by an Issuer to make scheduled payments of the required liquidation amounts, in each case at the liquidation preference plus accumulated dividends, whether or not earned or declared. In the event of a failed auction or remarketing, a Money Market Fund holding the Preferred Stock would be notified of the failure on the day that it occurs and have a right to exercise the PS Demand Feature for three business days, beginning with and including the Dividend Payment Date/Settlement Date. In the event that an Issuer fails to make a scheduled dividend, redemption or liquidation amount payment, a Money Market Fund would receive similar notice and have a right to exercise the PS Demand Feature at any time before the Issuer makes the missing payment.
You represent that, before entering into an agreement with an Issuer to provide the PS Demand Feature, a Counterparty will have received a short-term rating in one of the two highest short-term rating categories by a Nationally Recognized Statistical Rating Organization ("NRSRO") with respect to a class of debt obligations that is comparable in priority and security to the PS Demand Feature.5 The PS Demand Feature will be in effect for a period of approximately 364 days from its effective date and is subject to renewal at the end of that period. Either the Counterparty or the Issuer may elect not to renew the PS Demand Feature or to terminate the PS Demand Feature before the end of the 364-day period, subject to the notice requirements set forth in your letter. You state that Money Market Funds always will have an opportunity to sell their Preferred Stock to the Counterparty pursuant to the PS Demand Feature, if necessary, on at least the two last auctions or remarketings prior to the expiration of the PS Demand Feature.
Money Market Funds generally may invest in securities that satisfy, among other things, certain maturity and quality conditions of Rule 2a-7. You argue that the Preferred Stock in conjunction with the PS Demand Feature is the functional equivalent of securities that satisfy the Rule's maturity and quality conditions.6 We address these conditions in the order in which you discuss them.7
Rule 2a-7(c)(2) provides that a Money Market Fund generally may not acquire "any instrument with a remaining maturity of greater than 397 days" or maintain "a dollar-weighted average portfolio maturity that exceeds 90 days."8 You acknowledge that the Preferred Stock, by itself, would not meet the Rule's maturity conditions because it has no stated maturity. You argue, however, that the Preferred Stock, in combination with the PS Demand Feature, should be treated as a "Long-Term Variable Rate Security," which is described by Paragraph (d)(3) of the Rule as a "Variable Rate Security," the "principal amount of which is scheduled to be paid back in more than 397 days." You further argue that the Preferred Stock-PS Demand Feature combination should be viewed as a Long-Term Variable Rate Security that is subject to a Demand Feature. Treated as such, you argue, the Preferred Stock, in combination with the PS Demand Feature, would have a maturity of generally no more than seven days, which would satisfy Paragraph (c)(2) of the Rule.9 We discuss this argument below.
Paragraph (a)(29) of the Rule defines a "Variable Rate Security" as a security
the terms of which provide for the adjustment of its interest rate on set dates (such as the last day of a month or calendar quarter) and that, upon each adjustment until the final maturity of the instrument or the period remaining until the principal amount can be recovered through demand, can reasonably be expected to have a market value that approximates its amortized cost.
You argue that the Preferred Stock satisfies the condition in the Rule that a Variable Rate Security must provide for the adjustment of its interest rate on set dates because the terms of the Preferred Stock provide for the adjustment of the stock's dividend rate on "preset dates pursuant to either the auction or remarketing process." You acknowledge, however, that the Preferred Stock, as an equity security, does not appear to fall within the literal definition of a "Variable Rate Security" because: (i) distributions paid on the Preferred Stock are dividends, not interest payments; and (ii) the Preferred Stock has no "final maturity" or principal amount. You argue that, for purposes of the Rule, there is no meaningful distinction between a dividend rate and an interest rate, each of which restates periodically pursuant to market mechanisms, or between the "principal amount" of a variable-rate debt security and the liquidation preference of a variable-rate Preferred Stock.
You further argue that the Preferred Stock should be treated as a Variable Rate Security even though its principal amount can be recovered through demand under only limited and indefinite circumstances. The principal amount of a debt security with a demand feature can be "recovered through demand" from the issuer at final maturity,10 or when the demand feature can be exercised and the holder is unconditionally entitled to payment of the principal amount by either the issuer or a third party. You acknowledge that there is no definite time at which a Money Market Fund would be entitled to recover the liquidation preference (or principal amount) through demand because the Preferred Stock has no final maturity and because exercise of the PS Demand Feature is contingent upon the occurrence of certain events. You contend, however, that the Preferred Stock's liquidation preference can be recovered through demand or through sale by means of an auction or remarketing. In your view, it is unimportant that the PS Demand Feature cannot be exercised until a Money Market Fund first attempts to sell the Preferred Stock in an auction or remarketing (or upon certain other events). You represent that, upon each adjustment of the dividend rate or until the liquidation preference can be recovered through demand pursuant to the PS Demand Feature, the Preferred Stock can reasonably be expected to have a market value that approximates its amortized cost.11
You assert that the Preferred Stock should be treated as a "Variable Rate Security," the "principal amount of which is scheduled to be paid back in more than 397 days," i.e., as a Long-Term Variable Rate Security. You argue that it does not matter whether the Preferred Stock should be treated as having a principal amount that is scheduled to be paid back in 398 days or as having a principal amount that is never scheduled to be paid back because, either way, the security would not be an eligible investment under the Rule unless the security were subject to a Demand Feature. As discussed below, you contend that the Preferred Stock should be treated as a security that is subject to a Demand Feature.
You argue that the Preferred Stock should be viewed as a "Long-Term Variable Rate Security" that is subject to a Demand Feature. In relevant part, Paragraph (a)(8) of the Rule defines a Demand Feature as:
A feature permitting the holder of a security to sell the security at an exercise price equal to the approximate amortized cost of the security plus accrued interest, if any, at the time of exercise.12
Under Paragraph (a)(8), a Demand Feature also must be exercisable: (i) at any time on no more than 30 calendar days' notice; or (ii) at specified intervals not exceeding 397 days and upon no more than 30 calendar days' notice (the "Exercise Requirements").13 You acknowledge that the PS Demand Feature satisfies neither Exercise Requirement because the PS Demand Feature cannot be exercised "at any time" upon no more than 30 calendar days' notice or at specified intervals; rather, it may be exercised only upon the occurrence of certain events, i.e., (i) a failed auction or remarketing, (ii) an Issuer's failure to make a scheduled payment of dividends or redemption proceeds, or (iii) an Issuer's failure to make scheduled payments of required liquidation amounts.
You nevertheless assert that the PS Demand Feature, in conjunction with the terms of the Preferred Stock auction or remarketing process, effectively provides Money Market Funds with maturity protection that is equivalent to that provided by a Demand Feature that complies with all of the conditions of Paragraph (a)(8) of the Rule.14 As with a Demand Feature, you argue, the Preferred Stock-PS Demand Feature combination would provide Money Market Funds with the ability to sell the Preferred Stock to a Counterparty at the security's amortized cost, at specified intervals not exceeding 397 calendar days and upon no more than 30 calendar days' notice. You specifically state that the terms of the Preferred Stock and PS Demand Feature, taken together, would allow a Money Market Fund to sell the stock at its liquidation preference plus any accumulated but unpaid dividends, at specified intervals of generally no more than seven days and upon no more than one business day's notice.15
Paragraph (c)(3) of Rule 2a-7 provides, among other things, that a Money Market Fund shall limit its portfolio investments to dollar-denominated securities that the fund's board determines present minimal credit risks and that are, at the time of acquisition, "Eligible Securit[ies]," as defined in Paragraph (a)(10) of the Rule. You argue that the Preferred Stock, in combination with the PS Demand Feature, should be treated as an Eligible Security because the PS Demand Feature: (i) acts as a "Guarantee"; and (ii) is itself an Eligible Security.
In pertinent part, Paragraph (a)(10) of the Rule generally defines an "Eligible Security" as a "Rated Security" with a remaining maturity of 397 calendar days or less that has received a rating from "the Requisite NRSROs in one of the two highest short-
term rating categories . . . ."16 Paragraph (a)(19)(ii) of the Rule, in turn, generally defines a "Rated Security" as:
[A] security [that] is subject to a Guarantee that has received a short-term rating from an NRSRO, or a Guarantee issued by a guarantor that has received a short-term rating from an NRSRO with respect to a class of debt obligations . . . that is comparable in priority and security with the Guarantee . . . .
Paragraph (a)(15) of the Rule defines a "Guarantee" to include an "Unconditional Demand Feature" that is not provided by the issuer of the underlying security. Paragraph (a)(26) of the Rule, in turn, defines an "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 securities.
You argue that the PS Demand Feature should be treated as a Guarantee under paragraph (a)(15) of the Rule because it would function as an Unconditional Demand Feature that is not provided by the issuer of the underlying security.17 You note that the term "readily exercisable" is not defined in the Rule. You believe, however, that the PS Demand Feature should be treated as "readily exercisable in the event of a default in payment of principal or interest" because: (i) its holder will receive same-day notification of an event that permits its exercise; and (ii) it may be exercised during the three business days immediately following each Auction or Remarketing Date (beginning with and including the Settlement Date) in the event of a failed auction or remarketing, and, in the event of a failure to make a dividend, redemption or liquidation payment, from the date such payment was scheduled until the time such payment is made.18
Under Paragraph (c)(3)(iii) of the Rule, a security that is subject to a Guarantee may be determined to be an Eligible Security based solely on whether the Guarantee is itself an Eligible Security.19 You contend that the PS Demand Feature should be treated as an "Eligible Security" as defined in Paragraph (a)(10) because it is exercisable (as necessary) in 397 days or less and will have been issued by a Counterparty that has received the requisite rating with respect to debt obligations of the same priority and security as the PS Demand Feature.20
Based on the facts and representations set forth in your letter, we would not recommend that the Commission take any enforcement action under Sections 34(b) or 35(d) of the 1940 Act or Rule 22c-1 thereunder against Money Market Funds if they purchase the Preferred Stock, as described in your letter, provided that such Money Market Funds otherwise comply with the conditions of Rule 2a-7.21 Other than with respect to the position stated in footnote 17 above, this response expresses our views on enforcement action only and does not express any legal or interpretive conclusion on the issues presented. You should note that any different facts or representations may require a different conclusion.
Martin Kimel
Senior Counsel
1 Money Market Funds that fail to meet certain conditions of Rule 2a-7 (the "Rule") may violate Sections 34(b) and 35(d) of the 1940 Act. See Rule 2a-7(b)(1) and (2). Section 34(b), in pertinent part, makes it unlawful for any person to make any untrue statement of material fact in a registration statement or other document filed pursuant to the 1940 Act. Section 35(d) makes it unlawful for any registered investment company to adopt a name that the Commission finds materially deceptive or misleading, and authorizes the Commission to adopt rules to define such names as are materially deceptive or misleading. Money Market Funds that do not satisfy all of the conditions of the Rule also may violate Rule 22c-1 under the 1940 Act if they use the amortized cost method, as defined under Rule 2a-7(a)(2), to value their portfolio securities. See Paragraph (c) of the Rule (share price calculations).
2 You state that if a normal Settlement Date were to fall on a non-business day, the Settlement Date would be moved to the next business day. In such a case, the Dividend Period would be slightly longer or shorter than seven days but soon would revert to a seven-day period.
3 In the event of a failed auction, the dividend rate for the subsequent Dividend Period would revert to a prearranged maximum rate. You state, however, that no Money Market Fund would be forced to hold the Preferred Stock at this maximum rate because a Money Market Fund would be able to exercise the PS Demand Feature (defined below) and sell its shares to a Counterparty before the maximum rate came into effect.
4 The PS Demand Feature will not be transferable or assignable independent of the underlying Preferred Stock, and will accompany each transfer of the Preferred Stock. You state that the issuance of the PS Demand Feature by Counterparties will comply with all of the applicable provisions of the Securities Act of 1933. We express no opinion or conclusion regarding the issuance of a PS Demand Feature in reliance on any exemption from registration under the federal securities laws.
5 In addition, the Preferred Stock underlying the PS Demand Feature will be rated in the highest preferred stock category (generally, AAA) by at least one NRSRO. "NRSRO" is defined in Paragraph (a)(17) of the Rule.
6 You note that the Rule speaks of eligible investments for Money Market Funds in terms that are typically used in relation to debt securities. See, e.g., Rule 2a-7(a)(29) (defining "Variable Rate Security" in terms of "interest rate" and "principal amount"); Rule 2a-7(c)(2) (limiting portfolio "maturity"); and Rule 2a-7(c)(3) (restricting portfolio quality in terms of "credit risk"). You believe, however, that the Preferred Stock-PS Demand Feature combination can provide maturity and quality protections equivalent to those of a variable-rate debt security that is subject to a Demand Feature.
7 You do not ask for our views, and we express none, with respect to the liquidity of the Preferred Stock.
8 Under Paragraph (d) of Rule 2a-7, the maturity of a portfolio security is generally the period remaining until the date on which, in accordance with the terms of the instrument, the principal amount must be paid unconditionally.
9 Paragraph (d)(3) of the Rule provides that the maturity of a Long-Term Variable Rate Security that is subject to a Demand Feature is deemed to be the longer of the period remaining until the next readjustment of the interest rate (here, dividend rate) or the period until the principal amount can be recovered through demand.
10 See Goldman Sachs & Co. (pub. avail. Aug. 14, 1998) at nn. 13 and 14 & accompanying text. The principal amount of a debt security without a demand feature can be recovered through demand at the final maturity of the instrument. See id.
11 Telephone conversation between Martin Kimel of the staff and Elizabeth Keeley of Sidley Austin Brown & Wood, LLP on May 9, 2002.
12 Paragraph (a)(8)(i) of the Rule.
13 Id. Paragraphs (a)(8)(i)(A) and (B).
14 As an example of the Preferred Stock's relative safety, you note that even if a failed auction or remarketing resulted in the stock's dividend rate reverting to its maximum rate -- in which case the stock's market value might fall below its par equivalent, i.e., below its liquidation preference or stated value -- a Money Market Fund could still avoid a loss by exercising the PS Demand Feature and putting the stock to a Counterparty for its amortized cost plus any accrued dividends before the maximum rate came into effect.
15 In the event of a failed auction or remarketing, a Money Market Fund could not exercise the PS Demand Feature until the next business day, which would be the Settlement Date.
16 "Requisite NRSRO" means, in relevant part, any two NRSROs that have issued a rating with respect to a security or class of debt obligations of an issuer, or one NRSRO if it is the only NRSRO that has issued a rating with respect to such security or class of debt obligations of an issuer at the time the fund acquires the security. Paragraph (a)(21) of the Rule.
17 As previously stated, Counterparties will be unaffiliated with the issuers of the stock that they guarantee.
18 We agree that the PS Demand Feature is "readily exercisable" for purposes of Paragraph (a)(26) of the Rule.
19 See also Investment Company Institute (pub. avail. Nov. 2, 1992) (unrated long-term bond subject to an Unconditional Demand Feature would be considered a "first tier security" when the provider of the demand feature has short-term debt outstanding that is first tier).
20 See Paragraph (a)(19)(i) (definition of "Rated Security"). In essence, you also argue that the Preferred Stock in conjunction with the PS Demand Feature should be treated as a security that is subject to a Guarantee Issued By A Non-Controlled Person, as defined in Rule 2a-7(a)(16). As such, you essentially contend that it would be subject to the Demand Feature-diversification requirements of Paragraph (c)(4)(iii) of the Rule, but not to the issuer-diversification requirements of Paragraph (c)(4)(i).
21 We particularly note that a Money Market Fund may treat the Preferred Stock as a Variable Rate Security only if, upon each dividend-rate adjustment, the Money Market Fund can reasonably expect the Preferred Stock to have a market value that approximates its amortized cost. See Paragraph (a)(29) of the Rule (definition of Variable Rate Security); Investment Company Release No. 21837 (March 21, 1996) at n.160; Goldman Sachs & Co. (pub. avail. Aug. 14, 1998).
Investment Company Act of 1940
Rule 2a-7
May 8, 2002
Office of Chief Counsel
Division of Investment Management
Securities and Exchange Commission
450 Fifth Street, N.W.
Judiciary Plaza
Washington, D.C. 20549
Re: Merrill Lynch Investment Managers, L.P.
Ladies and Gentlemen:
On behalf of Merrill Lynch Investment Managers, L.P. and its affiliates ("MLIM"),1 and certain closed-end investment companies for which MLIM serves or may in the future serve as investment adviser (the "Funds"), we hereby request that the staff of the Division of Investment Management (the "Staff") advise us that it will not recommend that the Securities and Exchange Commission (the "Commission") take any enforcement action under Sections 34(b) or 35(d) of the Investment Company Act of 1940 (the "1940 Act") or Rule 22c-1 thereunder against funds that hold themselves out as money market funds in reliance on Rule 2a-7 under the 1940 Act if they purchase certain preferred stock, as described more fully below.
The Funds include both diversified and non-diversified closed-end management investment companies that invest in tax-exempt securities issued by one or more states, territories or possessions of the United States and their various political subdivisions, agencies or instrumentalities. In general, the Funds seek to provide stockholders with current income exempt from Federal and, in some cases, state income taxes. As a result, the Funds' portfolios are typically comprised primarily of long-term tax-exempt obligations with credit and other characteristics suited to each Fund's particular investment objective and policies.
The Funds periodically issue Auction Market Preferred Stock® ("AMPS"), Remarketed PreferredSM Stock ("RP") or similar preferred stock (together, the "Preferred Stock") (as described below), which results in leveraging of the common stock of the Funds. The Preferred Stock pays dividends that are adjusted over relatively short periods. The Preferred Stock is rated by one or more nationally recognized statistical rating organizations ("NRSROs") (generally AAA) and typically contains terms requiring the Fund's portfolio to meet prescribed quality standards while the Preferred Stock is outstanding. The proceeds of the Preferred Stock offerings are invested in longer-term tax-exempt obligations. Since under normal market conditions obligations with longer maturities produce higher yields than the dividend rates on the Preferred Stock, the spread between the short-term rates paid by a Fund on Preferred Stock and the longer-term rates received by the Fund on its investments will generally result in a higher yield for common stockholders.
Preferred Stock like that described below is one of the few cost-effective means of leverage available to closed-end investment companies that invest primarily in tax-exempt securities. Because any debt issued by the Funds would be taxable, and tax-exempt obligations such as those held by the Funds generally yield less than similar taxable debt obligations, the Funds cannot earn a spread by issuing debt. Preferred Stock offers a solution to this problem because it allows a fund to pass through tax-exempt interest received on its portfolio holdings. Unfortunately, the largest potential purchasers of short-term tax-exempt instruments, tax-exempt money market funds, cannot currently invest in Preferred Stock. Consequently, market demand for the Preferred Stock issued by the Funds has been lower than it might otherwise be, resulting in higher dividend rates on the Preferred Stock and, consequently, decreased returns to Fund common stockholders. If the Staff takes a no-action position with respect to the purchase of Preferred Stock by money market funds, a new category of high quality investments will become available to such funds, which could increase the demand for the Preferred Stock and, as a result, benefit the Funds' common stockholders by lowering their cost of capital.2 In that regard, we believe that instruments such as the Preferred Stock are among the highest quality investments paying tax-exempt money market rates.
The AMPS are a form of equity security that have priority over common stock in the payment of dividends and liquidation preference in the case of an issuer's dissolution.3 AMPS are issued at their liquidation preference and accumulate dividends at a rate that is periodically reset pursuant to an auction (sometimes referred to as a "Dutch auction"). The auctions are typically held every seven days (each, a "Dividend Period"). The timing of these auctions may vary and in some instances the issuer may elect, subject to certain limitations, to change the Dividend Period (i.e., declare a "Special Dividend Period"). However, no Fund relying upon the Staff's response to this request will have or elect any Dividend Period other than seven days.4 In addition, such AMPS generally are redeemable, in whole or in part, at the option of the issuer on any dividend payment date. The auction is held on the first business day preceding the first day of a new Dividend Period (the "Auction Date"), which such first day is also the dividend payment date for the preceding Dividend Period and the settlement date for AMPS purchased and sold in an auction (each, a "Settlement Date").5 All AMPS are sold in successful auctions at their liquidation preference. The auction process establishes the dividend rate for the subsequent Dividend Period, not the underlying value of the AMPS.
Auctions are usually conducted by the trust department of a major commercial bank (the "Auction Agent") pursuant to an agreement with the issuer (the "Auction Agent Agreement"). On or prior to the Auction Date, existing and prospective holders of the Fund's AMPS submit either hold orders, bids or sell orders to a broker-dealer who, as agent, forwards them to the Auction Agent prior to a submission deadline (usually between 9:30 a.m. and 1:00 p.m., Eastern standard time, on the Auction Date). The Auction Agent assembles all the orders and determines if sufficient clearing bids have been made. Sufficient clearing bids exist if the number of outstanding AMPS that are subject to submitted bids by prospective holders equals or exceeds the number of shares that are subject to submitted sell orders. If this is the case, the Auction Agent determines the lowest rate at which the number of bids submitted by prospective holders equals the shares available to be purchased at the liquidation preference (i.e., all those shares not subject to hold orders). If sufficient clearing bids have not been made the auction is deemed to have "failed" and the applicable dividend rate for the subsequent Dividend Period is a prearranged maximum rate.6 In this situation the current holders of the Funds' AMPS may not be able to sell their shares through the auction mechanism. However, under the instant proposal, holders of the Fund's AMPS would be given notice of any failed auction and would be able to put their shares to a counterparty unaffiliated with the issuer for the liquidation preference plus any accumulated dividends, whether or not earned or declared.7
The terms of the RP are substantially similar to those of the AMPS described above. RP is issued at its liquidation preference, is evidenced in book-entry form, has a prearranged maximum dividend rate in the case of failed remarketings and generally is redeemable. In addition, the dividend period and special dividend provisions for RP are generally the same as those for AMPS. The primary difference between the two types of securities is the dividend determination mechanism. In the case of RP, there is no auction process. Instead, the issuer enters into a Remarketing Agreement with one or more Remarketing Agents at whose sole discretion subsequent dividend rates are set, subject to the terms of the Remarketing Agreement.
The remarketing process takes place over two business days. The first day is the "Tender Date." Typically, by noon on this day the Remarketing Agent notifies holders of the Funds' RP of the preliminary indications of the dividend rate expected on the RP based on discussions with existing holders and potential buyers. These indications are nonbinding and the actual rates may be higher or lower depending on market conditions. However, based on these indications each holder must notify the Remarketing Agent of its desire to tender shares at the liquidation preference or to hold its shares. The holder's decision at this point is binding. If the holder does nothing, it is considered an election to retain the present shares.
The next business day is the dividend reset date (referred to herein as the "Remarketing Date"). On this day the Remarketing Agent must determine the lowest possible rate for the applicable dividend period which will enable it to remarket at the liquidation preference all the shares tendered for sale. The Remarketing Agent generally has 27 hours to complete this process successfully. The remarketing effort will be deemed to have failed if such a rate cannot be determined, the rate exceeds a fixed maximum, all the shares cannot be remarketed, there is no Remarketing Agent or the Remarketing Agent is not required to conduct a remarketing pursuant to the Remarketing Agreement. Under these circumstances, the dividend rate will revert to a prearranged maximum rate in the same fashion as AMPS. Similarly, the unconditional demand feature, described below, would allow holders to put their RP shares to an unaffiliated counterparty in the event that a remarketing failed. The first business date after the Remarketing Date is the dividend payment date for the previous remarketing period and the settlement date for RP purchased and sold in the remarketing (each, a "Settlement Date"). As was the case with regard to AMPS, discussed above, no Fund relying upon the Staff's response to this request will have or elect any Remarketing Period other than seven days.8
Pursuant to an agreement between the Funds and an unaffiliated counterparty (the "Counterparty"), holders of the Preferred Stock will have an unconditional right to sell their shares to the Counterparty for the shares' liquidation preference plus any accumulated dividends, whether or not earned or declared (the "Demand Feature").9 The Demand Feature will not be transferable or assignable independent of the underlying Preferred Stock, but will accompany each transfer of the Preferred Stock. It will be exercisable upon (i) a failed auction in the case of AMPS or a failed remarketing in the case of RP, (ii) a failure to hold a scheduled auction or remarketing, (iii) a failure by a Fund to make a scheduled payment of dividends or redemption proceeds, or (iv) a failure to make scheduled payments of the required liquidation amounts, in each case at the liquidation preference plus accumulated but unpaid dividends, whether or not earned or declared. If any holder of the Preferred Stock wishing to sell the Preferred Stock cannot do so on a scheduled Settlement Date for a scheduled auction or remarketing, whether or not such auction or remarketing process actually takes place, at the liquidation preference plus accumulated but unpaid dividends, whether or not earned or declared, then the Counterparty will buy the Preferred Stock at a price equal to such liquidation preference plus accumulated but unpaid dividends, whether or not earned or declared.10 In addition, if any holder of the Preferred Stock fails to receive a scheduled dividend or redemption payment or fails to receive a scheduled payment of the required liquidation amount, the Counterparty will also buy the Preferred Stock at a price equal to such liquidation preference plus accumulated but unpaid dividends, whether or not earned or declared.
The Fund will notify the Auction Agent, which in turn will notify each broker-dealer immediately in the event of any of the four occurrences that trigger exercise of the Demand Feature, as described above. On that same day, the broker-dealers will notify each beneficial owner, including any money market fund, of its right to exercise the Demand Feature for a period of three business days (in the event of a failed auction or remarketing) or for a period up to the date that a missed dividend or redemption payment or payment of the liquidation amount is made, in each case beginning with and including the Settlement Date (which is also the scheduled dividend payment date) or the scheduled date of the failed redemption payment or of the failed liquidation amount payment.
Prior to entering into the Demand Feature, the Counterparty will have received a short-term rating with respect to a class of debt obligations comparable in priority and security to the Demand Feature in one of the two highest short-term rating categories by a NRSRO. In addition, the Preferred Stock underlying the Demand Feature will be rated in the highest preferred stock category by at least one NRSRO. In the event that any holders of the Preferred Stock wish to tender their shares to the Counterparty pursuant to the terms of the Demand Feature and the Counterparty fails to honor such a request in a timely manner, the holder of the Preferred Stock, including any money market fund, will be able to seek enforcement of the Demand Feature directly against the Counterparty.
The Demand Feature will be in effect for a period of approximately 364 days from the effective date of the Demand Feature and subject to renewal at the end of that period. Either the Counterparty or the Fund may elect not to renew the Demand Feature, subject to notice provisions consistent with the following. In the event that the Demand Feature will not be renewed, notice will be given to the Auction Agent at least two auctions or remarketings prior to the expiration of the Demand Feature, which such expiration date shall also be the last Settlement Date with respect to an auction or remarketing on which the Demand Feature may be exercised. The Auction Agent will notify each broker-dealer of the impending expiration of the Demand Feature no less than two auctions or remarketings prior to the last Settlement Date upon which the Demand Feature may be exercised. Each broker-dealer will then give at least two auctions or remarketings advance notice of the decision not to renew to each beneficial owner, including any money market funds holding the Preferred Stock.
In addition, it is also possible that either the Fund or the Counterparty may terminate the Demand Feature for any reason upon appropriate notice to the other party sufficiently in advance so that similar notice may be received by investors within at least two auctions or remarketings prior to the last Settlement Date upon which the Demand Feature may be exercised. The notice of termination will allow sufficient time for the investors, including money market funds, to sell the Preferred Stock in an auction or remarketing or exercise the Demand Feature before it terminates.
Holders of the Preferred Stock will always have the opportunity to sell their shares to the Counterparty, if necessary, pursuant to the Demand Feature on at least two occasions subsequent to the receipt of notice of either a decision not to renew the Demand Feature or the termination of the Demand Feature. In any case, the Demand Feature may be exercised upon no more than 30 days' notice and is readily exercisable in the event of a failure to pay a scheduled dividend, redemption or liquidation amount payment.
Rule 2a-7 under the 1940 Act generally requires that any investment company holding itself out as a money market fund (a "Money Market Fund") comply with certain requirements. Among other things, a Money Market Fund must satisfy maturity and quality requirements with respect to the securities in which it invests. It is our belief that the Preferred Stock described above, in combination with the Demand Feature, satisfies these requirements.
Rule 2a-7(c)(2) prohibits a Money Market Fund from purchasing "any instrument with a remaining maturity of greater than 397 calendar days," or from maintaining "a dollar-weighted average portfolio maturity that exceeds 90 days." Under paragraph (d) of Rule 2a-7 the maturity of a portfolio security is generally deemed to be the period remaining until the date noted on the face of the instrument as the date on which principal must unconditionally be paid. Because Preferred Stock has no stated maturity, Preferred Stock would not normally be an eligible investment for money market funds.
We believe, however, that the Preferred Stock described above in combination with the Demand Feature should be viewed as a variable rate security subject to a demand feature and as such, should be considered to have a maturity equal to the time from the day after the Settlement Date for an auction or remarketing to the next Settlement Date for an auction or remarketing (i.e., seven days).11 A "Long-Term Variable Rate Security" (i.e., a variable rate security the principal amount of which is not scheduled to be paid within 397 days) subject to a "demand feature" is deemed to have a maturity equal to the longer of the period remaining until the next readjustment of the interest rate or the period remaining until the principal amount can be recovered through demand.12 Paragraph (a)(29) of Rule 2a-7 defines a "variable rate security" as a security the terms of which provide for the adjustment of its interest rate on set dates . . . and that, upon each adjustment until the final maturity of the instrument or the period remaining until the principal amount can be recovered through demand, can reasonably be expected to have a market value that approximates its amortized cost.
A "demand feature," as defined in paragraph (a)(8) of Rule 2a-7, permits a security holder to sell a security "at an exercise price equal to the approximate amortized cost of the security plus accrued interest, if any, at the time of the exercise." A demand feature must be exercisable either: (a) at any time on no more than 30 calendar days' notice; or (b) at specified intervals not exceeding 397 calendar days and upon no more than 30 calendar days' notice.
As discussed above, the underlying Preferred Stock provides for the adjustment of the yield on preset dates pursuant either to the remarketing process or an auction.13 During the course of the Dividend Period (i.e., the period remaining until the principal amount (liquidation preference14) can be recovered through an auction or remarketing or through demand pursuant to the Demand Feature) shares of the Preferred Stock are reasonably expected to have a market value that approximates their amortized cost.15
The Demand Feature gives holders of the Preferred Stock the right to put their shares to the Counterparty in the event of a failed auction or remarketing, a failure to hold a scheduled auction or remarketing, or a failure to pay dividends or make a redemption or liquidation payment at a price equal to the security's amortized cost.16 We acknowledge that the Demand Feature, when viewed in isolation, does not technically meet the definition of demand feature in that is it exercisable neither "at any time" nor "at specified intervals." Viewed in conjunction with the terms of the Preferred Stock auction or remarketing process, however, the Demand Feature effectively provides Money Market Funds with maturity protection that is equivalent to that provided by a demand feature that complies with all of the conditions of paragraph (a)(8) of Rule 2a-7. As with a demand feature, the Preferred Stock/Demand Feature combination will provide Money Market Funds with the ability to sell the Preferred Stock to a counterparty at the security's amortized cost, at specified intervals not exceeding 397 calendar days and upon no more than 30 calendar days' notice. Specifically, the terms of the Preferred Stock and Demand Feature, taken together, will allow a Money Market Fund to sell the stock at its liquidation preference plus any accumulated but unpaid dividends, at specified intervals of generally no more than seven days and upon no more than one business day's notice. Furthermore, since the Demand Feature is typically exercisable, when necessary, at regular intervals that will not exceed 397 calendar days and does not require more than 30 days' notice on the part of shareholders, the Demand Feature should be viewed in this context as a "demand feature" as that term is defined in Rule 2a-7(a)(8).
As a variable rate security subject to a demand feature exercisable in the event of a failed auction or remarketing or the failure to hold a scheduled auction or remarketing, on each Settlement Date and the next two business days thereafter (or in the event of a failure to make a dividend, redemption or liquidation payment, from the date such payment was scheduled until such payment is made), the maturity of the Preferred Stock pursuant to Rule 2a-7(d) should equal the length of the Dividend Period (i.e., seven days).17 Since the Dividend Period is both the period between readjustments of the securities' yield and the period until the principal amount (i.e., liquidation preference) of the securities can be recovered through demand (or through sale in a successful auction or remarketing), it is the proper measure of the Preferred Stock's maturity. Given that the applicable Dividend Period generally will be no longer than seven days,18 Money Market Funds should be able to purchase such securities without violating the maturity requirements of 2a-7(c)(2).
Rule 2a-7(c)(3) requires, among other things, that a Money Market Fund limit its portfolio investments to United States dollar-denominated securities that the fund's board of directors determines present minimal credit risks and that are at the time of acquisition "Eligible Securities." A security that is subject to a guarantee may be determined to be an Eligible Security based solely upon whether the guarantee is an Eligible Security. To be an Eligible Security an instrument must have a remaining maturity of 397 calendar days or less and have received a short-term rating (or been issued by an issuer that has received a short-term rating with respect to any class of debt obligations, or any debt obligation within that class, that is comparable in priority and security with that security) by a NRSRO in one of the two highest short-term rating categories.
Under paragraph (a)(15) of Rule 2a-7 a "guarantee" is defined as,
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 or securities, 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.
As indicated above, the definition of guarantee specifically includes "unconditional demand features," which are defined in paragraph (a)(26) of Rule 2a-7 as demand features that by their terms would be readily exercisable in the event of a default in payment of principal or interest on the underlying security or securities.
It is our view that the Demand Feature functions in effect as a guarantee generally and, in particular, as an "unconditional demand feature" as that term is defined in paragraph (a)(26) of Rule 2a-7. Since (i) holders of the Preferred Stock will receive same-day notification of an event that permits exercise of the Demand Feature, and (ii) rights under the Demand Feature may be exercised on the three business days after each Auction or Remarketing Date in the event of a failed auction or remarketing or a failure to hold a scheduled auction or remarketing, and on any day beginning with the Settlement Date in the event of a failure to make a dividend payment, or on the scheduled payment date in the event of a failed redemption or liquidation payment, up until such payment is made, we believe this instrument should be considered "readily exercisable."19 Additionally, as previously discussed, the Counterparty is unconditionally obligated to purchase the Preferred Stock from a holder upon exercise of the Demand Feature.
Assuming the Demand Feature is a guarantee, the Preferred Stock will be considered to have met the quality requirements of Rule 2a-7(c)(3) without the consideration of any rating that attaches to the Preferred Stock itself.20 Since the Demand Feature will be exercisable (as necessary) within 397 days and will have been issued by a Counterparty that has received a rating in one of the two highest short-term rating categories by a NRSRO with respect to debt obligations of the same priority and security as the Demand Feature, the Preferred Stock will, pursuant to Rule 2a-7(c)(3)(iii), meet the quality requirements of Rule 2a-7. Similarly, assuming the Demand Feature is a guarantee, it will be considered a "Guarantee Issued by a Non-Controlled Person," as defined in Rule 2a-7,21 and as such a Money Market Fund would be permitted to look to the Counterparty, in lieu of the issuer, for purposes of meeting the diversification requirements of Rule 2a-7.22
As far as we are aware, the Staff has not previously considered the purchase of preferred stock subject to an unconditional demand feature or other guarantee by Money Market Funds. However, the Staff has considered the use of conditional demand features to meet the maturity requirements of Rule 2a-7 in the context of preferred stock securities.
The Staff addressed preferred stock securities in Donaldson, Lufkin & Jenrette Securities Corporation (available Sept. 23, 1994) ("Donaldson Lufkin"). In this letter the Staff refused to take a no-action position in connection with the purchase by Money Market Funds of certificates of a trust whose sole assets were securities similar to AMPS and whose payments were tied to the dividends on the AMPS. The certificates were subject to a demand feature in that they could be tendered to an unaffiliated bank at periodic intervals at a price equal to the stated amount of the certificate plus accumulated distributions. That demand feature was conditional, however, since upon the occurrence of certain specified events the demand feature was withdrawn and outstanding certificate holders had no recourse but to absorb any associated decline in the value of the certificates.
The Staff's refusal to take a no-action position in Donaldson Lufkin appears to involve the requestor's failure to comply with the quality requirements of Rule 2a-7(c)(3)(iii). That paragraph of the rule requires, among other things, that securities having a remaining maturity of more than 397 days that are also subject to conditional demand features receive a long-term rating by a NRSRO within the NRSRO's two highest long-term rating categories or be of comparable quality. (In addition, the rule requires that the conditional demand feature itself receive a NRSRO rating in one of the two highest short-term ratings categories.) In Donaldson Lufkin the Staff was asked to consider the ability of Money Market Funds to purchase certificates that were rated by a NRSRO in the highest preferred stock category. Based on the concern that preferred stock ratings, unlike debt ratings, do not rate an issuer's willingness and capacity to repay principal, the Staff concluded that the quality requirements of Rule 2a-7(c)(3)(iii) with respect to securities subject to conditional demand features had not been met. In essence, while the issuer of the demand feature had the necessary rating, the underlying certificates did not.
In contrast to the situation in Donaldson Lufkin, the Preferred Stock referred to in this letter is subject to a guarantee consisting of the Demand Feature. As a result, the quality requirements of Rule 2a-7(c)(3) may be satisfied solely by reference to the short-term debt rating of the issuer of the Demand Feature and it is unnecessary to consider the ratings of the Preferred Stock for Rule 2a-7 purposes. Thus, the Staff's objections to the product in Donaldson Lufkin are not applicable here. As discussed above, we submit that the Demand Feature will comply with all the ratings requirements of this provision.
Based on the forgoing, we respectfully request that the Staff advise us that it will not recommend any enforcement action in the event Money Market Funds purchase Preferred Stock issued by the Funds and subject to the conditions set forth in this letter, provided such Money Market Funds otherwise comply with the provisions of Rule 2a-7.
If you have any further questions concerning this matter please feel free to contact Frank P. Bruno at (212) 906-2539, Brian M. Kaplowitz at (212) 906-2126 or Elizabeth Keeley at (212) 906-2799, extension 23298. If the Staff is unable to concur with the conclusions set forth herein, we would appreciate the opportunity to discuss these matters with the Staff prior to the issuance of its response.
Very truly yours,
/s/ Sidley Austin Brown & Wood LLP
1 The principal U.S. registered investment advisers affiliated with MLIM are currently Fund Asset Management, L.P. and Mercury Asset Management International, Limited.
2 An additional benefit might be derived by "single state" money market funds, which concentrate their investments in debt securities issued by a single state (or issuers located within that state). Pursuant to paragraph (c)(4)(i)(B) of Rule 2a-7, single state funds are limited, as to 75 percent of their total assets, to investing no more than five percent of their total assets in securities of a single issuer. With the remaining "25 percent basket," such Funds may commit greater than five percent of their total assets to a single issuer, but only if such securities are "first tier." A first tier security is defined in paragraph (a)(12) of Rule 2a-7 as one that has received the highest short-term rating from the requisite nationally recognized statistical rating organizations, or has been determined to be of comparable credit quality. As noted by the Commission in Investment Company Act Release No. 21837 (March 21, 1996), diversification can be difficult to achieve in certain states with a limited number of quality issuers. The availability of another high-quality short-term tax-exempt instrument, such as the Preferred Stock, will make it easier for funds in such states to meet the diversification requirements of Rule 2a-7.
3 AMPS, as equity, are subordinate to the debt of an issuer.
4 Generally, Special Dividend Periods could otherwise be for periods evenly divisible by seven and not greater than five years.
5 In cases where a normal Settlement Date falls on a day that is not a business day, the Dividend Period will be slightly longer or shorter than seven days, but will eventually revert back to a seven day pattern. If the normal Settlement Date falls on a day that is not a business day, the Settlement Date shall be the next succeeding business day. After that, the next succeeding Settlement Date will occur on the next following normal Settlement Date. For example, if a Thursday that would normally be a Settlement Date is not a business day, then such Settlement Date would be the succeeding Friday, resulting in an eight day Dividend Period. After that Friday, the next succeeding Settlement Date would revert to the following Thursday, so that the Dividend Period would be six days in that instance. Succeeding Settlement Dates and Dividend Periods will revert back to a seven day pattern.
6 This maximum rate typically varies depending on the credit ratings assigned to the AMPS by an NRSRO and whether any portion of the distribution on such securities will be taxable, but is generally equal to 110% of the taxable commercial paper rate. Bids in excess of the maximum rate will not be accepted. Thus, the auction process will never result in a dividend rate in excess of the maximum. However, we have been informed by MLIM that to its knowledge, no auction for investment company AMPS has ever set the Preferred Stock rate at the maximum rate. Moreover, as a result of the unconditional nature of the Demand Feature, as defined fully below, we submit that the Commission's concerns with respect to interest rate caps are not implicated by the existence of a maximum rate. See e.g., Investment Company Act Release No. 19959 (Dec. 17, 1993); Investment Company Institute (available June 16, 1993); Morgan Keegan & Company, Inc. (available July 24, 1992). Since any holder of the Preferred Stock will have notice of the dividend rate for the next Dividend Period during the three business days in which the Demand Feature (as defined herein) can be exercised, such holders can choose to sell their stock to the counterparty, as discussed below, when the maximum (i.e., "cap") rate comes into effect. Thus, even in the unlikely event that an auction resulted in the Preferred Stock rate being set at the maximum rate, no holder of the Preferred Stock will ever be forced to hold the stock at the maximum rate.
7 Because purchases and sales of AMPS and changes in the Dividend Period are effected through the book-entry method, notice would be provided by the Auction Agent to the broker-dealers pursuant to the requirements of the Auction Agent Agreement. The broker-dealers would then be obligated to give notice to each beneficial owner, including money market funds, pursuant to the terms of a broker-dealer agreement.
8 See supra notes 4 and 5 and accompanying text.
9 A separate Demand Feature will be negotiated with respect to the Preferred Stock of each Fund. In each case, the Counterparty will receive a fee from the Fund for providing the Demand Feature. In addition, to the extent that the Demand Feature is created pursuant to an agreement with an institution whose securities are not exempt from the registration requirements of the Securities Act of 1933, all applicable provisions of that Act will be complied with.
10 A Fund is not obligated to repurchase the Preferred Stock from the Counterparty after the Demand Feature has been exercised.
11 As discussed previously, the maturity of the Preferred Stock in combination with the Demand Feature temporarily may be slightly longer or shorter than seven days where the normal Settlement Date is not a business day, but will revert back to the seven day schedule. See supra note 5.
12 Although we acknowledge that the Preferred Stock has no stated maturity date, it is of no consequence whether the Preferred Stock is treated as having a principal amount that is scheduled to be paid back in 398 days or as having a principal amount that is never scheduled to be paid back, because in either case the Preferred Stock would not meet the maturity requirements of Rule 2a-7, and therefore would not be an eligible security under Rule 2a-7, unless the Preferred Stock were subject to a demand feature.
13 Although we acknowledge that the Preferred Stock is not a debt security and distributions paid on the Preferred Stock are not referred to as "interest," we believe there should be no distinction for Rule 2a-7 purposes between a dividend rate that resets periodically pursuant to market mechanisms and an interest rate that is periodically readjusted pursuant to the very same mechanisms. Regardless of whether the yield on the instrument is an interest payment or a dividend, it is set to reflect the value of the expected cash flows discounted at a rate that reflects the various risks associated with the instrument. In addition, dividends on the Preferred Stock will accumulate regardless of whether they are declared on a particular date.
14 Once again, we acknowledge that Preferred Stock is not a debt security and has no stated principal amount. We believe, however, there should be no distinction for Rule 2a-7 purposes between liquidation preference and principal amount since, as with the principal amount of an auction rate or remarketed debt security, the liquidation preference of the Preferred Stock is the amount that a purchaser/seller expects to pay/receive in an auction or remarketing and is the amount (plus any accumulated but unpaid dividends) that the issuer must pay to redeem the Preferred Stock or retire the Preferred Stock in a liquidation.
15 On each Settlement Date, the market value and amortized cost of the Preferred Stock will be the liquidation preference of the Preferred Stock, just as the market value and amortized cost of an auction rate or remarketed debt security on the equivalent settlement date is the principal amount of the debt security, since in both cases this is the price at which the Preferred Stock or debt security is purchased and sold in a successful auction or remarketing. On the Settlement Date of a successful auction or remarketing, a purchaser buys Preferred Stock with no accumulated but unpaid dividends since dividends also will be paid to the previous holder on the Settlement Date. Between Settlement Dates, the market value and amortized cost should be the liquidation preference plus accumulated but unpaid dividends, just as with an auction rate or remarketed debt security the market value and amortized cost between settlement dates should be the principal amount plus accrued but unpaid interest. In both the case of the Preferred Stock and an auction rate or remarketed debt security there is no amortization of premium or accretion of discount.
16 On the Settlement Date of an auction or remarketing (which is also a Dividend Payment Date), or on some other date on which a liquidation payment was scheduled, the holder of the security is entitled to receive from the Counterparty the liquidation preference plus accumulated but unpaid dividends, which equals the security's amortized cost on that date.
17 We acknowledge that there is no definite time at which a Money Market Fund will be entitled to recover the liquidation preference (or principal amount) through demand because the Preferred Stock has no final maturity and because exercise of the Demand Feature is contingent on the occurrence of one of the events discussed above. Because the Preferred Stock's liquidation preference can be recovered through demand or through sale by means of an auction or remarketing, however, it is unimportant that the Demand Feature cannot be exercised until a Money Market Fund first attempts to sell the Preferred Stock in an auction or remarketing (or upon certain other events). As a practical matter, a Money Market Fund holding preferred stock would still be able to recover the liquidation preference of the Preferred Stock (plus accrued but unpaid dividends) as it would through a demand feature that would be exercised at any time or at set times within 397 days, subject to notice.
18 As discussed previously, the maturity of the Preferred Stock in combination with the Demand Feature temporarily may be slightly longer or shorter than seven days where the normal Settlement Date is not a business day, but will revert back to the seven day schedule. See supra note 5.
19 We note that the term "readily exercisable" is not defined in Rule 2a-7.
20 Paragraph (c)(3)(iii) of Rule 2a-7 provides that a security that is subject to a guarantee may be considered an eligible security or first tier security based solely on whether the guarantee is an eligible security or first tier security. See also Investment Company Institute (available Nov. 2, 1992) (an unrated long-term bond subject to an unconditional demand feature would be considered first tier where the provider of the demand feature has a short-term debt rating outstanding that is first tier).
21 Paragraph (a)(16) defines "Guarantee Issued by a Non-Controlled Person" (in relevant part) as a guarantee issued by a "person that directly or indirectly, does not control [as defined in Section 2(a)(9) of the 1940 Act], and is not controlled by or under common control with the issuer of the security subject to the Guarantee."
22 Paragraph (c)(4)(iii)(A) of Rule 2a-7 generally limits Money Market Funds, as to 75 percent of their total assets, to investing no more than 10 percent of their total assets in securities issued by or subject to demand features or guarantees issued by non-controlled persons from the same institution. See also paragraph (c)(4)(iii)(C) of Rule 2a-7 (excluding demand features or guarantees issued by non-controlled persons from more restrictive diversification requirements).
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