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Most 401(k) plans today offer a low risk investment option designed to maintain a constant net asset value. This option is usually a money market or stable value fund.
Recently, the Securities Exchange Commission (SEC) made changes to the rules that govern money market mutual funds (MMFs). These changes are intended to increase MMF transparency as well as give investors additional protection during periods of extraordinary market stress, when redemptions in some MMFs can increase significantly. These changes are effective October 14, 2016.
The SEC changes affect 401(k) plans. If you are a 401(k) fiduciary, you should be evaluating any plan MMF today so it can be replaced (if necessary) prior to the deadline.
Background
In the days following the 2008 Lehman Brothers bankruptcy, the Reserve Primary Fund, a $62 billion MMF, lowered its share price below $1 (“breaking the buck”) due to its holding in Lehman Brother debt. The SEC believed these events triggered a heavy sell-off of MMFs that invested in commercial paper and a breakdown in the commercial paper market in general, resulting in a cash squeeze for many businesses that affected the wider economy.
As a result of these events, the SEC decided new rules were necessary to reduce the risk of investor “runs” on MMFs in times of financial stress.
Summary of new rules:
- MMFs are broken into 3 classifications: government, retail, and institutional.
- Government funds – must be at least 99.5% invested in short-term U.S. government securities.
- All other MMFs are considered “prime.” In addition to short-term U.S. government securities, Prime MMFs can invest in high-quality commercial paper, certificates of deposit and bankers' acceptances.
- Retail funds – must restrict investors to “natural persons.” 401k plans that permit participants to direct the investment of their account qualify for retail funds, while plans that do not permit participant investment direction do not.
- Institutional funds – must use a “floating” Net Asset Value (NAV), or price per share, based on the market value of its underlying investments. Government and retail MMFs may continue to use a $1 NAV.
- Government funds – must be at least 99.5% invested in short-term U.S. government securities.
- All MMFs, except government funds, are subject to redemption fees and gates if their weekly liquid assets (securities that convert to cash within a week) dip below certain thresholds:
- If a fund's weekly liquid assets fall below 30% of its total assets, its board may impose a liquidity fee of up to 2% on redemptions.
- Additionally, the board may suspend redemptions (impose a gate) for up to 10 business days in a 90-day period.
- If weekly liquid assets fall below 10% of total assets, nongovernment funds must impose a 1% liquidity fee, unless its board determines it would not be in the fund's best interest.
- If a fund's weekly liquid assets fall below 30% of its total assets, its board may impose a liquidity fee of up to 2% on redemptions.
| Government | Prime (Retail) | Prime (Institutional) | |
| NAV | Stable ($1) | Stable ($1) | Floating |
| Eligibility | All investors | Natural persons only | All investors |
| Fees and Gates | No | Yes | Yes |
Decision time for 401(k) fiduciaries
While 401(k) plans are not required to comply with the SEC’s new MMF rules until October 14, 2016, 401(k) fiduciaries should be evaluating any plan MMF today so it can be replaced (if necessary) prior to the deadline.
Fiduciary considerations:
- Institutional MMFs can no longer be considered a cash equivalent due to their floating NAV.
- Prime MMF redemption fees and gates present a new risk for 401k participants and fiduciaries—the possibility that sales can’t be made without some delay or reduction in value.
- This risk is not unprecedented - stable value funds are generally subject to even stricter redemption rules.
- Prime MMFs will be managed to avoid fees and gates.
- Prime MMFs generally offer higher yields when compared to government MMFs.
Ultimately, the best MMF choice for a particular 401(k) plan is a risk/reward decision for fiduciaries. Very risk averse fiduciaries are the most likely to choose a government MMF, while fiduciaries that see little potential for fees and gates are likely to choose a prime MMF to achieve higher yields. Like any fiduciary decision, either choice should be justified.
