FSOC And Money Market Fund Reform: A Path To Nowhere

In a letter (the "Geithner Letter"), to the members of the Financial Stability Oversight Counsel ("FSOC"), Treasury Secretary Geithner started the next round of debate over subjecting money market funds to further regulatory reforms. In the aftermath of SEC Chairman Schapiro's announcement that "a majority of the Commission ... will not support a staff proposal to reform the structure of money market funds", Secretary Geithner asked FSOC "to consider taking a series of additional steps to address this challenge." He characterized these steps as a "path forward to protect investors and the economy." This client alert discusses each of the steps the Geithner Letter urged FSOC to take, and why these steps will probably not lead to the structural reform of money market funds.

What Is FSOC?

FSOC was created by the Financial Stability Act of 2010, which is Title I of the Dodd-Frank Wall Street Reform and Consumer Protection Action (the "DFA"). The voting members of FSOC are the Treasury Secretary (who serves as Chairman of the Council), the Chairmen of the Federal Reserve, the Securities and Exchange Commission (the "SEC"), the Commodity Futures Trading Commission ("CFTC"), the Federal Deposit Insurance Corporation and the National Credit Union Administration Board, the directors of the Bureau of Consumer Financial Protection and the Federal Housing Finance Agency, the Comptroller of the Currency and an independent insurance expert appointed by the president. FSOC also has five nonvoting members.

The purposes of FSOC are:

to identify risks to the financial stability of the United States that could arise from the material financial distress or failure, or ongoing activities, of large, interconnected bank holding companies or nonbank financial companies, or that could arise outside the financial services marketplace; to promote market discipline, by eliminating expectations on the part of shareholders, creditors, and counterparties of such companies that the Government will shield them from losses in the event of failure; and to respond to emerging threats to the stability of the United States financial system. (DFA § 112(a)(1))

Although the Dodd-Frank Act only requires FSOC to meet quarterly, it has averaged a meeting every one or two months since its initial meeting October 1, 2010. The Geithner Letter proposes that FSOC take action on money market fund reforms at its next meeting in November.

Secretary Geithner's Path Forward

Secretary Geithner seeks to have FSOC exercise, for the first time, its authority under section 120 of the DFA to:

provide for more stringent regulation of a financial activity by issuing recommendations to the primary financial regulatory agencies to apply new or heightened standards and safeguards, ..., for a financial activity or practice conducted by bank holding companies or nonbank financial companies under their respective jurisdictions, if [FSOC] determines that the conduct, scope, nature, size, scale, concentration, or interconnectedness of such activity or practice could create or increase the risk of significant liquidity, credit, or other problems spreading among bank holding companies and nonbank financial companies, financial markets of the United States, or low-income, minority, or underserved communities. [Added emphasis]

Nonbank financial companies include any company predominantly engaged in financial activities. (DFA § 102(a)(4)) The DFA incorporates by reference the "financial activities" specified in section 4(k) of the Bank Holding Company Act, which expressly includes selling interests in pools of assets (§ 4(k)(4)(D)) and advising an investment company (§ 4(k)(4)(C)). Thus, money market funds and their managers are arguably "nonbank financial companies" for purposes of the DFA.

Before making a recommendation, FSOC must consult with the primary financial regulatory agency (the SEC in the case of money market funds and their managers), and must solicit public comment on the proposed recommendation. When making a recommendation, FSOC must "take costs to long-term economic growth into account." (DFA § 120(b)) Once this process is completed, the primary agency is not required to adopt FSOC's recommendation. The agency may "explain in writing to [FSOC], not later than 90 days after the date on which [FSOC] issues the recommendation, why the agency has determined not to follow the recommendation ...." (DFA § 120(c)(2)) FSOC must report to Congress on any recommendations and the implementation or failure to implement the recommendation. (DFA § 120(d))

Where Does Section 120 Lead?

Secretary...