March 18th, 2023

Proposed by Virginia Resident, Yashaswi Sunkara

Mutual Fund Stability and Security Act of 2023

PURPOSE:

To address the vulnerabilities of mutual funds to runs and the risks they pose during financial crises, and to establish a comprehensive regulatory framework to prevent another financial collapse like the one experienced during the Great Recession.

SECTION 1: SHORT TITLE

This act shall be known as the Mutual Fund Stability and Security Act of 2023.

SECTION 2: FINDINGS AND PURPOSES

(a) Findings: Congress finds that:

(1) The financial crisis of 2008 exposed vulnerabilities in the regulation of mutual funds, which played a significant role in the collapse of financial markets and the resulting economic recession. These funds are a significant funding source for corporations and the economy, but their regulation is a large hole in the regulatory framework.

(2) Mutual funds are susceptible to runs, which can amplify market stress and exacerbate systemic risks.

(3) The regulation of mutual funds is a critical component of maintaining the stability and integrity of financial markets.

(4) Recent research has identified additional risks associated with mutual funds, including liquidity and pricing risks.

(5) The existing regulatory framework for mutual funds is inadequate to address these risks, and further reform is necessary to prevent future financial crises.

(6) The Dodd-Frank Act, EESA, and the Basel Accords have been successful in preventing similar crises and should serve as a guide to this legislation.

(b) Purposes: The purposes of this Act are:

(1) To enhance the regulation of mutual funds to reduce systemic risk and promote financial stability.

(2) To establish robust risk management standards for mutual funds to mitigate the risks they pose to investors and the broader financial system.

(3) To strengthen the supervision and oversight of mutual funds by multiple departments and agencies of the US Government.

(4) To promote international cooperation in the regulation of mutual funds.

SECTION 3: DEFINITIONS

For the purposes of this Act:

(1) "Mutual fund" means an investment company registered under the Investment Company Act of 1940, including open-end and closed-end funds.

(2) "Systemically important mutual fund" means a mutual fund that the Financial Stability Oversight Council (FSOC) determines could pose a threat to US financial stability if it experiences financial distress or defaults.

(3) "SEC" means the Securities and Exchange Commission.

(4) "FRB" means the Board of Governors of the Federal Reserve System.

(5) "Department" means the Department of the Treasury.

(5) “Secretary” means the Secretary of the Treasury.

(6) Other terms used in this Act shall have the same meanings as under the Investment Company Act of 1940 and the Dodd-Frank Wall Street Reform and Consumer Protection Act.

SECTION 4: REGISTRATION AND DISCLOSURE REQUIREMENTS

(a) Registration Requirements

(1) All mutual funds shall be required to register with the SEC, provide the SEC with a description of their investment strategies, and meet other registration requirements as determined by the SEC.

(2) The SEC shall have the authority to require additional reporting requirements for these Systemically Important Mutual Funds.

(3) The FSOC shall have the authority to designate certain mutual funds as Systemically Important Mutual Funds based on their potential impact on financial stability.

(i) Designation: The FSOC shall have the power to designate mutual funds as “Systemically Important Mutual Funds” based on factors such as complexity, interconnectedness, and other relevant characteristics.

(ii) Enhanced Supervision: Systemically important mutual funds shall be subject to enhanced supervision by the SEC, including additional capital and liquidity requirements, and heightened scrutiny of their investment activities.

(iii) Early Warning: The SEC shall establish an early warning system to monitor the risks posed by systemically important mutual funds and take corrective action as outlined in Section 5.

(b) Disclosure Requirements

(1) All mutual funds shall be required to disclose their investment strategies, asset composition, liabilities, and other relevant information to the SEC and to public and private investors in a clear and concise manner. The SEC shall prescribe regulations governing such disclosures.

(2) Mutual funds must provide liquidity disclosures, including daily and weekly liquid asset levels.

(3) The SEC shall establish stress tests for all mutual funds and conduct periodic assessments of their systemic risk.

(4) Mutual funds must disclose any conflicts of interest related to their investment strategies.

SECTION 6: LIQUIDITY REQUIREMENTS

(a) The SEC shall establish new liquidity requirements for mutual funds that invest in illiquid assets, such as corporate bonds or loans. These new requirements shall apply to all mutual funds with net assets greater than $1 billion or if they are classified as a “High-Risk Fund” and shall be based on the following principles:

(1) Mutual funds must maintain a minimum percentage of 10% of their total assets in cash or other highly liquid holdings.

(2) Mutual funds shall be required to limit the percentage of their portfolio invested in illiquid assets, such as corporate bonds or loans, to no more than 5% of their total assets.

(3) The SEC may adjust the liquidity requirements based on market conditions or other factors as deemed necessary.

(b) The SEC shall define what constitutes a "corporate bond fund" for the purposes of this Act, including the minimum percentage of the fund's portfolio that must be invested in corporate bonds.

(c) A “High-Risk Fund” shall be a secondary classification made by the SEC that involved funds such as Corporate Bond Funds, Prime Funds, High-Yield Bond Funds, Short-term Bond Funds, and Ultra-short bond funds. An update in classification will be made to:

(i) A “Corporate Bond Fund” shall be defined as a mutual fund that invests primarily in corporate bonds issued by companies. If a fund holds a minimum of 50% of its holdings in this way, it shall be considered a “corporate bond fund.”

(ii) A “Prime Fund” shall be defined as a mutual fund that invests in loans or other short-term debt instruments issued by banks or other financial institutions. This title applies to funds if at least 50% of their funds are held in this way. 

(d) Both Corporate Bond Funds and Prime Funds and all other High-Risk Funds as classified by the SEC shall be subject to higher liquidity requirements or withdrawal limits of 10% more. 

SECTION 7: WITHDRAWAL LIMITS

(a) The SEC shall have the authority to impose limits on the number of withdrawals that investors can make from mutual funds during times of market stress.

(b) The withdrawal limits shall apply to all mutual funds with net assets greater than $1 billion and shall be based on the following principles:

(1) Mutual funds shall be required to limit investor redemptions to no more than 20% of the fund's net assets per day.

(2) Mutual funds shall be required to impose redemption fees of up to 5% on investors who redeem shares during times of market stress.

(3) The SEC may adjust the withdrawal limits based on market conditions or other factors as deemed necessary.

(4) The stated withdrawal limits shall be triggered by the following events:

(1) A decline in the value of the mutual fund's assets by 15% or more in a single day.

(2) A decline in the value of the mutual fund's assets by 30% or more in a period of five consecutive business days.

SECTION 8: RISK MANAGEMENT

(a) Mutual funds shall establish clear risk management procedures to monitor risks to their financial positions.

(b) Mutual funds shall have contingency plans to address potential runs on the fund, which include liquidity risk management plans and stress testing scenarios to assess their resilience to market shocks.

(c) Mutual funds shall establish and maintain lines of credit or other arrangements to provide liquidity in times of stress.

SECTION 9: INTERNATIONAL COOPERATION

(a) The FRB shall coordinate with foreign regulators to ensure consistent, effective regulation of mutual funds with cross-border activities. The FRB shall also participate in discussions to promote cooperation and information-sharing on mutual fund regulation.

(b) The Secretary shall work with international organizations to develop international standards for regulating mutual funds and promote them to be put into place for international stability.

SECTION 10: ENFORCEMENT AUTHORITY

(a) The SEC shall have the authority to take enforcement actions against mutual funds for violations of this act, including fines and penalties.

(b) The SEC shall have the authority to suspend or revoke the registration of mutual funds of severe violations.

(c) The SEC shall have the authority to refer criminal violations of this act to the Department of Justice.

(d) The SEC shall coordinate with other regulators, including the FSOC and FRB, to ensure consistent and effective regulation of mutual funds.

SECTION 11: LIABILITY

Agencies and groups, including the SEC, FSOC, and FRB, will not be held liable for any losses or damages arising from any action or inaction taken under this act.

SECTION 12: FUNDING

(a) The SEC is authorized to fund such sums as necessary to carry out this act.

(b) The fees collected by the SEC under this act shall be deposited in the Investor Protection Fund and used to carry out the purposes of this act if required.

SECTION 13: SEVERABILITY

If any provision or application of this act is held to be unconstitutional, the rest of this act, or the application of such provision to other circumstances, shall not be affected thereby.

SECTION 14: EFFECTIVE DATE

This act shall take effect 3 months after its enactment.

SECTION 15: REPORT TO CONGRESS

Within three years of the enactment of this act, the SEC shall submit a report to Congress that includes an assessment of the effectiveness of this act in reducing the systemic risk posed by mutual funds, and any recommendations for further improvements. These adjustments shall be made in accordance with this act.

Bill Status - In Progress

Explanation/Summary:

This legislation addresses the vulnerabilities of mutual funds to runs and the risks they pose during financial crises. The Mutual Fund Stability and Security Act of 2023 establishes a comprehensive regulatory framework to prevent another financial collapse like the one experienced during the Great Recession.

The legislation requires all mutual funds to register with the SEC and provide periodic reporting of their assets, liabilities, and investment strategies. It also establishes stress tests and periodic assessments of systemic risk. Systemically Important Mutual Funds are subject to enhanced supervision by the SEC, including additional capital and liquidity requirements.

The Act also requires mutual funds to have risk management procedures to identify, assess, and monitor risks to their financial stability and investors. Mutual funds must have contingency plans to address potential runs on the fund, including liquidity risk management plans and stress testing scenarios.

The legislation also promotes international cooperation in the regulation of mutual funds. The FRB shall coordinate with foreign regulators to ensure consistent and effective regulation of mutual funds with cross-border activities. The FRB shall also participate in international forums to promote cooperation and information-sharing on mutual fund regulation.

The SEC has the authority to take enforcement actions against mutual funds for violations of this act, including fines and penalties, and suspension or revocation of registration of severe violations. The SEC shall also have the authority to refer criminal violations of this act to the Department of Justice.

Finally, the legislation provides for funding for the SEC to carry out the act's purposes and includes a severability clause and a limitation on liability for the SEC, FSOC, and FRB.