High-Yield Bond Funds Said to Face SEC Scrutiny on Liquidity

(Bloomberg) — U.S. market regulators ordered high-yield credit managers to turn over information showing why their bonds could be sold as quickly as they say following the collapse of a Third Avenue Management LLC fund.

Securities and Exchange Commission examiners sent letters last month to funds that invest in similar securities to the Third Avenue Focused Credit Fund, which had the bulk of its assets in distressed debt and bank loans, according to a person familiar with the matter. The $788.5 million fundblocked client withdrawals to avoid dumping bonds at fire-sale prices.The regulator appeared to be trying to gauge whether other funds could face the same fate as Third Avenues fund, said the person, who asked not be named because examination letters are private.

The SEC sought answers to a long list of questions including whether the value of holdings ever conflicted with estimates provided by external parties such as pricing services, according to the person. They also asked funds how they judge the liquidity of holdings and whether they had ever changed their methodologies. It wasnt clear how many managers received the letters, which sought some of the information within 24 hours and the rest of the data within a week, according to the person.

The targeted effort by SEC examiners, who seek to ensure compliance with the agencys rules, follows other recent moves by the agency to ensure funds can meet their duty to return cash to investors within seven days. The regulator disclosed earlier this week that it wouldscrutinize how mutual funds, exchange- traded funds and hedge funds value their least liquid holdings and manage the risk they cant be sold when managers need the cash.

The SEC in September proposed new rules that would require funds to maintain a minimum cushion of cash or cash-like investments that can be sold within three days, and asked funds to classify how many days it would take to sell each asset they own.

Its not surprising they would have started a sweep after the Third Avenue fund given the commissions overall concern about managing a fixed-income portfolio in a rising interest- rate environment, said Kenneth J. Berman, a partner at Debevoise & Plimpton and formerly the associate director of the SECs division of investment management. This concern plays into that rule proposal as well.

The SEC letters were first reported by BoardIQ, a service of the Financial Times.