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Response to Questions Posed by Commissioners Aguilar, Paredes, and Gallagher*

This paper primarily addresses the relationship between a fund’s board and adviser and their respective roles in addressing risk issues impacting the fund. Some of the discussion may also apply to the fund’s relationship with other service providers, such as the fund’s administrator, principal underwriter, transfer agent, accountant, and custodian. Those providers also manage the risks associated with the services they provide to the funds. For instance, the transfer agent may manage the risks associated with maintaining shareholder records. This paper does not attempt to address the different service provider relationships a fund may have, but rather, focuses on the. | Response to Questions Posed by Commissioners Aguilar Paredes and Gallagher Division of Risk Strategy and Financial Innovation U.S. Securities and Exchange Commission November 30 2012 This report is by the staff of Division of Risk Strategy and Financial Innovation. The Commission has expressed no view regarding the analysis findings or conclusions contained herein. Executive Summary This report addresses the questions posed by Commissioners Aguilar Paredes and Gallagher in their September 17 2012 memo to Chairman Schapiro and Director Lewis. The Commissioners specific questions can be grouped into three categories. The first category addresses the causes of investor redemptions of prime money market fund shares and purchases of Treasury money market fund shares during the 2008 financial crisis. Many potential explanations exist for the money market fund flows during this period. Since the explanations are not mutually exclusive it is not possible to attribute shareholders redemptions and purchases to any single explanation. This report provides evidence in support of each of the different explanations such as flights to quality liquidity transparency and performance. The failure of Lehman Brothers and the breaking of the buck by The Reserve Primary Fund occurred contemporaneously with fund flows perhaps triggering them. Investors however did not appear to react to the earlier financial distress of Bear Stearns or the government s support of Fannie Mae and Freddie Mac. The Commissioners asked whether money market funds that break the buck outside a period of financial distress would cause a systemic problem. RSFI documents that a number of funds received or requested sponsor support during non-crisis times an indication that defaults and rating downgrades have led to significant valuation losses for individual funds. With the exception of The Reserve Primary Fund however these funds distress did not trigger industrywide redemptions. This finding suggests that .