SEC Rule 2a-7

SEC Rule 2a-7 is the key set of regulations from the U.S. Securities and Exchange Commission (SEC) that governs money market funds. Think of it as the official safety and construction code for the financial world’s most popular parking garage for cash. Its primary mission is to ensure these funds remain low-risk, highly liquid, and stable, making them a reliable alternative to a traditional savings account for individual and institutional investors. The rule achieves this by imposing strict limits on what money market funds can invest in, how much risk they can take, and how quickly they must be able to return money to investors. For decades, the rule helped funds maintain a stable $1.00 Net Asset Value (NAV) per share, a feature that made them feel as safe as cash. While recent changes have modified this for some fund types, the core principle of Rule 2a-7 remains the same: protecting investors’ principal.

At its heart, Rule 2a-7 is designed to prevent a money market fund from “breaking the buck.” This is the industry slang for a fund’s share price falling below the stable $1.00 NAV. When you put a dollar into a savings account, you expect to get a dollar back (plus some interest). Investors have long viewed money market funds in the same light. A fund breaking the buck can shatter this confidence, as it did during the 2008 Financial Crisis when the Reserve Primary Fund’s NAV fell to $0.97 due to its holdings in Lehman Brothers' debt, triggering widespread panic. Rule 2a-7 acts as a powerful guardian by forcing fund managers to prioritize safety and liquidity over chasing higher yields. It lays down a non-negotiable set of conservative investment practices, ensuring the fund is robust enough to handle severe market stress and large-scale withdrawals.

To keep money market funds on the straight and narrow, Rule 2a-7 enforces several critical requirements.

A fund cannot simply buy any debt it wants. It is restricted to high-quality, short-term investments from issuers with a strong financial standing. This means the bulk of the portfolio must consist of securities that are determined to present minimal credit risk. Fund managers often rely on ratings from major credit rating agencies to meet this standard. Typical investments include:

• U.S. Treasury bills and other government securities.
• High-quality commercial paper (short-term IOUs) from vetted corporations.
• Debt from government-sponsored enterprises.

To avoid putting all its eggs in one basket, a fund must be diversified. The rule states that, with the exception of U.S. government securities, a fund cannot invest more than 5% of its assets in any single issuer. This diversification minimizes the impact if one company unexpectedly defaults on its debt.

To limit sensitivity to interest rate fluctuations, the rule dictates that the fund’s portfolio must have a very short average maturity. It uses two key metrics:

• Weighted Average Maturity (WAM): This must be 60 days or less. It measures the average time it takes for the securities in the portfolio to be repaid, weighted by their size.
• Weighted Average Life (WAL): This must be 120 days or less. It’s a similar measure but accounts for features that could extend a security’s final repayment date.

A money market fund must be able to meet redemption requests from investors at a moment's notice. The rule mandates that funds hold a minimum percentage of their assets in cash or securities that can be converted to cash very quickly.

• At least 10% of assets must be convertible to cash within one business day (daily liquid assets).
• At least 30% of assets must be convertible to cash within five business days (weekly liquid assets).

The crisis of 2008 proved that the old rules weren't foolproof. In response, the SEC strengthened Rule 2a-7 significantly to build a stronger safety net.

The most important change distinguished between different types of money market funds.

• Institutional Prime and Municipal Funds: These funds, used mainly by corporations and large entities, are now required to have a floating NAV. Their share price fluctuates daily based on the market value of their underlying assets, just like a typical bond fund.
• Retail Funds: Funds designed for individual investors like us can still seek to maintain a stable $1.00 NAV, offering that cash-like stability we’ve come to expect.
• Government Funds: Funds that invest at least 99.5% of their assets in government securities, cash, or repurchase agreements collateralized by government securities can also maintain a stable $1.00 NAV.

To prevent a “run” on a fund, the new rules gave fund boards emergency tools. If a fund's weekly liquid assets fall below the 30% threshold, the board has the option to implement:

• Liquidity Fees: A temporary fee (up to 2%) on withdrawals.
• Redemption Gates: A temporary suspension of withdrawals for up to 10 business days.

These “emergency brakes” are designed to give the fund manager time to sell assets in an orderly way, rather than in a fire sale, protecting the value for all remaining shareholders.

For a value investing practitioner, a money market fund isn't a tool for generating wealth; it's a critical instrument for preserving it. This aligns perfectly with Benjamin Graham's immortal advice: “Rule No. 1: Never lose money. Rule No. 2: Never forget Rule No. 1.” Your greatest strategic advantage as an investor is often the “dry powder”—the cash held in reserve—that allows you to act decisively when Mr. Market offers up a bargain. Rule 2a-7 provides the regulatory foundation that makes money market funds a suitable home for that dry powder. It is the rulebook that underpins the margin of safety for the cash portion of your portfolio. Understanding how it works—including its strengths and the post-2008 emergency measures—allows you to be confident that your cash is in a well-regulated, stable, and liquid vehicle, ready to be deployed when true opportunity knocks.