In a move to protect investors, the Securities and Exchange Commission yesterday voted to tighten investment and disclosure standards for money-market mutual funds.
The new standards were designed to make money funds less risky, although the funds already were among the safest investment products. In addition, companies that sell money-market funds will be required to tell investors that the funds are not federally insured.
However, some experts said investors could see their money-fund yields decline as a result of restrictions on investing in higher-yielding, but riskier, securities.
A money-market fund is a type of mutual fund that invests in short-term bank notes, commercial paper and U.S. Treasury securities. There are about 700 such funds, with more than $530 billion in assets in more than 20 million shareholder accounts.
Though money funds are relatively safe, investors could lose money if companies or banks default on their loans. The SEC's decision to issue new standards stems, in part, from recent defaults on commercial paper, a form of short-term debt issued by banks, corporations and others.
"The commission will do everything it can to ensure the safety of money-market funds," SEC Chairman Richard C. Breeden said in a statement. "That includes not only rule-making but also an active inspection and enforcement program. Indeed, the commission's policy is to inspect every money-market fund at least once a year."
The new rules, which take effect in 90 days, will:
* Prohibit the funds from investing more than 5 percent of their assets in the securities of any one issuer, except for U.S. government securities, which are federally insured. The current limit is 25 percent.
* Limit money-fund investments to securities that are given at least one of the two highest possible ratings by at least two agencies assigning a risk factor to that security. If only one agency rates the security, that agency must give it one of the two top ratings.
If the securities have only the second-highest risk rating, they could account for no more than 5 percent of a taxable money-fund's assets. Money funds currently may invest all of their assets in those second-tier securities.
* Prohibit money funds from investing more than 1 percent of assets in lower-grade security of any one issuer.
* Require that in most cases, funds buy securities with remaining maturities of less than 30 months; the shorter terms make them less risky.
The new rules also require that money-fund portfolios have an average maturity of no more than 90 days; the current requirement is 120 days.
To reduce confusion, the cover page of a money-fund prospectus would be required to state that the fund is not insured or guaranteed by the U.S. government and that there is no guarantee that fund shares will maintain a constant value.
The tougher standards gained widespread support in the mutual-fund industry, despite the possibility of slightly lower yields. Fund managers said people who buy the funds expect safety first.
"Raising the quality standards for commercial paper held by money-market mutual funds is entirely appropriate and welcome," said David Silver, president of the Investment Company Institute, a Washington trade group. "While these funds have an outstanding safety record under present SEC rules, more stringent standards should further reduce risk to money-market mutual fund shareholders."
Funds that will be hurt most by the new standards are those that buy lower-quality securities to boost yields, said Martha Wittbrodt, editor of IBC/Donoghue's Money Fund Report.