Rule 2a-7 is a crucial piece of regulation from the U.S. Securities and Exchange Commission (SEC) that governs money market funds (MMFs). Think of it as the strict rulebook that allows these funds to behave like high-yield savings accounts. Its primary purpose is to enable MMFs to maintain a stable net asset value (NAV) of $1.00 per share, making them appear as safe and simple as cash. To achieve this, the rule imposes tight restrictions on the investments a money market fund can hold, focusing on credit quality, diversification, and liquidity. It was established under the Investment Company Act of 1940 to provide a framework for these cash-like investment vehicles, ensuring they remain low-risk havens for investors' short-term cash. However, as history has shown, this stability is a carefully constructed convention, not an ironclad guarantee.
At its heart, Rule 2a-7 is all about risk management. It provides a special exemption that allows money market funds to use amortized cost accounting. This method lets the fund value its securities at their purchase price plus any accrued interest, rather than their fluctuating market value. This is what makes the stable $1.00 share price possible. Without this rule, a money market fund's NAV would bounce around daily, just like any other mutual fund. In exchange for this privilege, the rule acts like a strict chaperone for fund managers, forcing them to operate within a very tight “safety box.” The goal is to minimize the risk of the fund's NAV falling below $1.00—an event famously known as “breaking the buck.”
The rule sets forth several non-negotiable conditions to keep the funds on a short leash. The main pillars of this regulation include:
For a value investor, cash is not just idle money; it's a strategic asset waiting to be deployed when opportunities arise. Understanding the safety of where you park that cash is paramount.
The ultimate test for Rule 2a-7 came during the 2008 financial crisis. The Reserve Primary Fund, a large money market fund, held debt from the investment bank Lehman Brothers. When Lehman went bankrupt, the fund was forced to write off that debt, and its NAV fell to $0.97 per share. It “broke the buck.” This event shattered the illusion that money market funds were perfectly safe and triggered a panic. Investors rushed to pull over $300 billion from prime MMFs, forcing the U.S. Treasury to step in with a temporary guarantee to halt the run. For value investors, this was a stark lesson: an investment that looks and feels like cash is not the same as cash in an FDIC-insured bank account. Always understand the underlying assets.
In response to the 2008 crisis, the SEC enacted significant reforms to Rule 2a-7. The most important change was the introduction of a floating NAV for certain types of MMFs.
This distinction is critical. If you are an individual investor, the retail money market fund in your brokerage account likely still operates under the old model, but the underlying risks, though small, remain.