The Securities and Exchange Commission is proposing a new rule that would formally permit mutual fund companies to invest in repurchase agreements (repo's) and pre-refunded bonds (pre-re's). Since the early 1980's, the SEC has not taken an official position but has informally viewed repo's and pre-re's as collateralized investments. It has done this by responding with so-called no-action letters to requests from fund companies to invest in repos and pre-re's.

The Investment Company Act of 1940 prohibits fund companies from issuing or accepting loans.

The SEC is now proposing formally treating repo's and pre-refunded bonds in mutual fund portfolios as collateralized investments. The SEC is making the proposal in response to a number of recent requests from fund companies to hold repo's and pre-re's. The commission decided to establish a policy rather than continue to respond individually to every request, said an SEC spokesperson.

The SEC will accept public comments on its proposal through Nov. 23. A spokesperson for the SEC declined to comment further on the proposed rule and referred all inquiries to the repo/pre-re notice the SEC has posted at its website in the proposed rules section.

Mutual fund companies use repo's to invest excess cash at competitive rates on a secured, short-term basis - in some cases, overnight. Such transactions are called repurchase agreements because the fund finds a broker, dealer or bank which agrees to repurchase the repo securities from the fund at a specified future date for the original purchase price plus an additional amount.

Pre-refunded bonds refer to elaborate financings on the part of municipal bond issuers. In such pre-re sales, the bond issuer floats a second bond to guarantee it will be able to pay off the first bond at its first call date. Money received from the sale of the second bond is conservatively invested, usually in U.S. Treasuries whose maturity date coincides with the first call date.

The SEC would like to enact a rule that would permit funds to value the securities in repo's and pre-re's as repayment collateral, so that such transactions could be treated as investments rather than as loans, the SEC says in its web notice.

In addition, by viewing the securities as collateral in a repurchase agreement, the SEC would have no reason to view repo transactions as fund companies acquiring interest in a broker, dealer or underwriter, which also is prohibited by the 40 Act, the SEC said.

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