Alert June 09, 2009

SEC Staff Grants No-Action Relief to Allow Money Market Funds to Hold Window Variable Rate Demand Notes

The staff of the SEC’s Division of Investment Management (the “Staff”) published a no-action letter regarding the treatment of window variable rate demand notes (“WVRDNs”) under Rule 2a-7 under the Investment Company Act of 1940, the SEC rule that applies to registered open‑end investment companies that operate as money market funds.  According to the no‑action request letter, a WVRDN typically is issued in series and each series has a long-term stated maturity (generally 30 years), with each series having an interest rate that generally is calculated as the sum of a floating base rate plus a spread   The interest rate is reset weekly (and thus, is a variable rate for Rule 2a-7 purposes).  The spread may be increased from time to time with the agreement of the issuer.  As represented in the no-action request letter, each WVRDN issuer must have at least an A-rating and the highest short-term rating.  The no-action request letter claims that WVRDNs are expected to be used principally by municipalities wanting to access the variable rate market.

WVRDN’s Dual Put Feature.  As described in the no-action request letter, the key feature of a WVRDN is the “dual put” feature, which is intended to replace the traditional bond insurer support or credit or external bank support.  Under the dual put feature, a holder has the right at any time to tender his note for purchase, giving the remarketing agent 30 days to find a buyer (the “remarketing window”).  If the remarketing agent finds a buyer at the current spread, or at a higher spread acceptable to the issuer, the holder delivers his note and the sale is completed.  (If the interest rate is based on a greater spread agreed to by the issuer, all WVRDNs of that series will receive the higher rate.)  If the remarketing agent cannot find a buyer at the current spread, or at a greater spread acceptable to the issuer, the remarketing window closes at the end of the 30-day period.  The closing of the remarketing window triggers an unconditional mandatory tender to the issuer of all WVRDNs, not just those notes voluntarily tendered to start the remarketing window, and the issuer generally has up to one year (397 days from the date of the original voluntary tender) to purchase all WVRDNs (the “funding window”).  If the issuer fails to purchase all WVRDNs before the close of the funding window, the issuer is in default under the note.

WVRDNs as Long‑Term Variable Rate Securities.  In the no-action request letter, the issuer characterized the WVRDN for Rule 2a-7 purposes as a “Long-Term Variable Rate Security,” that is, a variable rate security, the principal amount of which is scheduled to be paid in more than 397 calendar days, which is subject to a demand feature.  (The primary purpose of the demand feature is to shorten a security’s maturity to comply with Rule 2a-7’s requirement that any security acquired by a money market fund must have a remaining maturity of 397 days or less.)  Under Rule 2a-7(d)(3), a long-term variable rate security has a maturity that is the longer of (a) the period until the next interest reset date and (b) the period remaining until the principal amount may be recovered on demand.

Dual Put as Demand Feature.  In the no-action request letter, the issuer asked the Staff whether it may treat the dual put feature as a demand feature for purposes of Rule 2a-7, and in response, the Staff said that it would not object.  Under Rule 2a-7(a)(8)(i), a demand feature, among other things, “must be exercisable on no more than 30 calendar days’ notice” or “at specified intervals not exceeding 397 days.”  With respect to WVRDNs, the no-action request letter stated that the dual put feature is consistent with Rule 2a-7(a)(8)(i), but noted that a question could be raised about the lack of any requirement that a WVRDN’s holder be paid by the conclusion of the 30-day remarketing window, even though the holder should be paid no later than the close of the funding window.  The request letter argued that the 30-day notice requirement in Rule 2a-7 was intended primarily to address issues of fund portfolio liquidity and not the length of the notice period.  The no‑action request letter also noted the potential question as to whether the dual put feature qualifies as a demand feature by virtue of being exercisable at specified intervals and simply noted that the Staff had demonstrated some flexibility on this issue in response to other requests for no-action relief in this area.  The Staff did not give any explanation for its no-action position or indicate whether it agreed or disagreed with the  justifications in the request for relief.