Situation:
A client called worried about the Sept. 16 decline in value of her money market fund below $1.
She is concerned if her investments are federally insured. She has asked if the federal government has taken any actions to assist with the money market funds.
Solution:
An Internal Revenue Service notice, which became effective Sept, 22, provides guidance on the use of the Exchange Stabilization Fund.
On Sept. 29, the Department of the Treasury created the Temporary Guaranteed Program for Money Market Funds in response to the credit market instability.
The program will make funds available, on a temporary basis, under prescribed terms and conditions to money market funds that are regulated under the Investment Company Act of 1940 to enable money market funds to maintain stable $1-per-share net asset values under Internal Revenue Code Section 103. The program is available to money market funds that are subject to federal income tax and money market funds that are tax-exempt.
Under Notice 2008-81, the Treasury Department will guarantee the share price of any publicly offered eligible money market fund that applies for and pays a fee to participate in the program.
A money market mutual fund invests in short-term fixed-income securities and matures in one year or less. Money market funds are pooled investments that allow investors to participate in a diversified portfolio managed by professionals to meet certain goals stated in the fund’s prospectus. There are two types of money market funds, taxable and tax-free.
Money market funds seek to preserve the value of the investment at a constant $1 per share, but it is possible to lose money. They are not Federal Deposit Insurance Corp.-insured yet tend to have a higher yield return than certificates of deposit which are FDIC-insured.
Maintenance of the $1.00 NAV for money market funds is important to investors, and if the value falls below $1 per share, it undermines investor confidence.
The program will provide coverage to shareholders for amounts they held in participating money market funds as of the close of business Sept. 19. The guarantee will be triggered if a participating fund’s NAV falls below $0.995.
The program will exist for an initial three-month term, after which time the secretary of the Treasury will review the need and terms for extending the program.
After the initial three months, the secretary has the option to extend the program up to the close of business Sept. 18, 2009.
Money market funds must proactively choose to participate in the program. For funds whose NAV as of Sept. 19 is equal to or greater than $0.9975, the upfront fee will be 0.01% based on the number of shares outstanding on that date.
Funds whose NAV as of Sept. 19 is greater than or equal to $0.995 and below $0.9975 will be required to pay an upfront fee of 0.015% based on the number of shares outstanding on that date. Funds with an NAV below $0.995 as of the close of business Sept. 19 may not participate in the program. Participation in the program will not be treated as a federal guarantee that jeopardizes the tax-exempt status of payments by tax-exempt money market funds.
In response to the client, her money market funds are not federally insured and the value may go below $1 per share. However, under the Temporary Guaranteed Program for Money Market Funds, if her money market funds proactively choose to participate in the program, she will be guaranteed $1 per share at liquidation on any investment she held in the money market fund at the close of business Sept. 19.
Any money that was deposited after that date is not guaranteed under the program. Participation in the program by the money market will not change the tax treatment of the money market fund. That is, if it was tax-exempt, it will retain that status.
The Gold Reserve Act of 1934 authorizes the secretary of the Treasury, with the approval of the president, to deal in gold, foreign exchange and other instruments of credit and securities consistent with the obligations of the U.S. government in the International Monetary Fund to promote international financial stability. The act established the Exchange Stabilization Fund.
Tax INsight is prepared by experts who are active members of the American Institute of Certified Public Accountants. Tax INsight appears on the web and in IN Daily every Tuesday. Comments are welcome at
IN_Editor@InvestmentNews.com.
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