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Fidelity fought Washington over money market funds — and won


WASHINGTON — Abigail P. Johnson, the billionaire president and CEO of Fidelity Investments, epitomizes the quiet, old-money side of the Boston mutual fund world. With her understated, publicity-shy manner, messy Washington politics would not seem to be her thing.

But when she arrived at the soaring glass lobby of the Securities and Exchange Commission, Johnson was showing another facet of the Fidelity image: its political power, which flows from the forceful personality of her father, Fidelity chairman Edward “Ned’’ C. Johnson 3d, and the financial might of her vast enterprise.

Her trip to meet with the SEC chief in June 2012 was part of an epic and unusually harsh lobbying battle waged by Fidelity and a handful of allies in the mutual fund industry. Their mission: stop the Obama administration’s move in the aftermath of the financial crisis to rein in a huge and highly profitable part of their business, money market funds.

The saga, unresolved until this year, played out in the shadow of higher-profile debates roiling Washington over extreme risks taken by high-flying Wall Street investment banks. Critics say intense opposition by typically staid mutual fund executives, who manage trillions of dollars in assets, offers an equally instructive example of the financial industry’s Washington potency — and its bluntly self-interested priorities.


The SEC faced withering criticism as it tried to fortify money market funds — which emerged as a surprising threat to the economy at the height of the crisis — against future investor runs and potentially calamitous failures.

“The lobbying pressure was relentless,’’ said Sheila Bair, the former chairwoman of the Federal Deposit Insurance Corporation and now head of the Systemic Risk Council, a nonprofit watchdog group in Washington. “It is a good example of how the narrow interest of the industry prevails in this debate.”

The story also offers a window into the public policy agenda of one of Boston’s richest corporate sectors.


Among mutual funds, Fidelity had the most to lose.

Ned Johnson made Fidelity an early pioneer in money market funds, which are low-risk investments that offer small gains but are supposed to provide a stable and convenient place to park cash. He invented the concept of check-writing for the funds in the 1970s, helping them become hugely popular with mom-and-pop investors across America.

Today Fidelity manages by far the largest amount of assets in money market funds in the world, with $410 billion. By charging just a tiny fraction of that massive sum in fees, it reaps about $650 million in annual revenue.

But the seeming bedrock of the money market business cracked wide open at the peak of the 2008 financial crisis, when a New York-based fund failed and triggered a much broader and nearly catastrophic investor stampede. The SEC, sifting through the fallout, over time devised an array of proposed rules that provoked outrage in mutual fund boardrooms.

A Fidelity executive accused the SEC of hatching a plan that “will ultimately destroy the money market industry.’’ Observers called it the most fractious regulatory battle in the history of mutual funds.

Fidelity mobilized, alone retaining enough new Washington lobbyists to field a baseball team with a few left over for the dugout. It significantly boosted the amount of political money it contributed to federal candidates. It sent its executives to Washington for dozens of meetings.


Washington’s most vociferous financial industry watchdogs, Fidelity’s home-state lawmakers Barney Frank and Elizabeth Warren, meanwhile, stayed conspicuously out of the fray.

Representative Frank said he was caught off guard by the effectiveness of the opposition to the SEC plan. Warren, a powerful critic of financial sector excesses, was embroiled in a bitter and close Senate race in 2012 against incumbent Republican Scott Brown, a big favorite of Fidelity and its allies who poured millions into his campaign. Picking a fight with a potent home-state corporation that employs more than 5,000 people in Massachusetts was not part of her campaign agenda.

With no cavalry in Congress to back up the SEC, Fidelity and the mutual fund industry found Washington to be favorable territory as it dug millions out of its pockets to influence the system. But a big impediment to victory remained — the vivid memory of the financial cataclysm and the sense, among regulators, that something simply had to be done.

Breaking the buck

It may seem paradoxical that a bare-knuckled Washington regulatory fight would be waged over money market funds, which, by their design, are intended to be dull — convenient, reliable, and anything but risky. And from a consumers’ vantage point, that’s what they seemed to be.

Until suddenly in 2008 they emerged as neither dull, nor low-risk.

A New York fund called Reserve Primary Fund that invested heavily in Lehman Brothers short-term debt “broke the buck’’ when Lehman went bankrupt in September 2008, meaning it was unable to return $1 for each $1 an investor placed on deposit.


That fund’s failure and inability to meet the $1 share price guarantee — a defining feature of money market funds — triggered an immediate global run on the funds by panicked investors. That, in turn, jeopardized a vital system of short-term credit that is relied upon by banks and corporations around the world to keep the economy operating. The economy teetered.

The danger to the machinery of global credit was so dire that an official at the Federal Reserve Bank of New York, on secret tape recordings recently revealed by ProPublica, confessed that when he learned Reserve Primary Fund broke the buck, he excused himself to a nearby bathroom and vomited.

As investors sucked $310 billion out of money market funds in just one week, the Department of Treasury and the Federal Reserve scrambled to stem the contagion. They set up temporary government guarantees and taxpayer-backed loans that soothed investors, stopped the runs, and helped pull the economy back from the brink. With $150 billion in Fed loans over 10 days, American taxpayers had bailed out the nation’s money market funds.

Looking for a fix

With the immediate crisis averted, attention quickly turned to fixing the system. To the SEC, that meant imposing new limits on the fund managers. The new SEC chairwoman, Mary Schapiro, wanted to move fast to make sure taxpayers would not be asked again to bail out investors in money funds.

“The reality is we had a significant fund break the buck and start a run. It’s not hypothetical,’’ Schapiro, who is now a private consultant, said in an interview. “It’s not a matter of regulators sitting in their offices trying to think up what could be a doomsday scenario and trying to plan for it. We know what happened.’’


On the other side, Fidelity was joined by a handful of mutual fund companies that also managed large money market funds: Vanguard Group Inc., BlackRock Inc., and Federated Investors Inc.

Those heavy-hitters and their trade group, the Investment Company Institute, worked with the SEC in 2009 and 2010 to draft an initial set of rules. The most significant was a new liquidity requirement requiring 30 percent of a fund’s investments to be convertible to cash in one week.

But the mutual fund leaders dug in their heels in late 2011 once it became clear Schapiro and her SEC team weren’t through, that they had even tougher measures in mind.

They hotly opposed the SEC’s plan to strip away the fixed $1 share price that is a hallmark of the funds. The SEC wanted to replace it with a more accurate “floating’’ share price representing the actual value of a fund’s investments. The theory is that change would remove unrealistic expectations about the stability of the funds.

The companies also hated the SEC’s idea of imposing stiffer capital reserve requirements.

Industry executives said both proposals would eliminate the simplicity and sense of security of the funds that make them a prized investment tool.

“Ultimately the industry made a decision: instead of working with the SEC, there was war declared,’’ said one person with direct knowledge of the battle who insisted on anonymity to give an insider’s view of events.

Fidelity said it felt obligated to take a hard stand for a investment vehicle relied upon by millions of investors.

“It was an important issue to Fidelity because it was an important issue to our customers,’’ said Nancy D. Prior, the company’s president of fixed-income investments.

Two months before Abigail Johnson went to Washington to meet Schapiro in 2012, the US Chamber of Commerce undertook an only-in-Washington sort of opinion-shaping initiative. It bought out all of the available advertising space at the Metro’s Union Station stop, which is near the Capitol but more importantly right next door to the SEC headquarters. The targets of this ad blitz? Agency staffers commuting to work.

The message on the posters, including one affixed to the floor, said that money market funds are vital to corporations and American cities, so “Why risk changing them now?’’ SEC regulators literally had to walk across a huge question mark, driving home the political goal: sowing doubt.

Johnson heads to D.C.

Abigail Johnson, who declined a request for an interview, is a deeply private person not known for outspoken public advocacy. She has waded into politics behind the scenes. She is generous with campaign contributions, personally doling out $94,400 to federal candidates since 2009, 85 percent of it to Republicans.

She met with Obama administration officials, including Cass Sunstein, then in charge of regulatory affairs for the administration (and now back at his job as a professor at Harvard Law School), during a visit to the White House in 2011, according to White House visitor logs. That trip, which came as the debate over money market funds was becoming more adversarial, was not accompanied by any fanfare or public announcement.

Neither side would disclose details of what transpired behind closed doors when Johnson visited Schapiro at the SEC. Fidelity’s president of fixed income, Prior, said money market overhaul was not the only subject discussed. She pointed out that such meetings are not unusual in Washington.

Fidelity was already on the record with dire warnings. Eliminating the fixed $1 share price, “imposing onerous capital requirements or adding burdensome redemption restrictions will ultimately destroy the money-market industry,’’ Scott C. Goebel, Fidelity’s senior vice president and general counsel, wrote to the SEC several weeks earlier.

While the warning struck some as exaggerated, the importance of the businesses to Fidelity is hard to understate.

From an office complex in Merrimack, N.H., Fidelity now manages a 16.4 percent share of the $2.5 trillion invested in US money market funds. Getting revenue from managing that money is the most obvious benefit, but using money market funds to retain customers is another important feature. It works like glue, keeping that cash within the Fidelity family.

Johnson’s visit to the SEC was one of 36 meetings between Fidelity executives and SEC officials between January 2011 and March 2013 — all specifically on this issue, according to a Globe review of public records.

Fidelity’s spending on Washington lobbyists more than doubled, from $1.6 million in 2008 to as much as $3.7 million in 2010 and 2013. Taken in context of the goal — protecting a $650 million a year revenue stream — the potential was for, in effect, a 17,000 percent return, beyond the dreams of even a fund management hall-of-famer like Fidelity’s Peter Lynch.

Fidelity also reshuffled its lineup of outside lobbyists. Not only did it retain eight former Capitol Hill staffers, it added former White House and financial regulators to the mix.

Among the high-wattage players was Charles Brain, a former director of legislative affairs to President Bill Clinton; Heather McHugh, a former aide to Democratic New York Senator Charles Schumer, a key member of the Senate Banking Committee; and Justin Daly, a former senior counsel at the SEC.

An important GOP lobbyist in the lineup was Marc S. Lampkin, who has close ties to House Speaker John Boehner.

Another pivotal insider Fidelity hired was James Segel, who had been Frank’s special counsel at the House Financial Services Committee and a longtime political confidant who helped draft the Dodd-Frank financial regulation overhaul law.

It was Segel’s second trip through Washington’s revolving door. He registered as a lobbyist for the Investment Company Institute from 1999 to 2006, earning more than $200,000, before he went to work for Frank in the House. Then, a year after Segel left Frank’s Capitol office in 2011, he returned to lobbying for the Investment Company Institute and also added Fidelity as a client. Fidelity paid him $96,000 during parts of 2013 and 2014, according to Segel’s disclosure filings. Segel did not return calls for comment.

Segel did not speak with Frank about money market fund regulations once he went back to work for the investment industry, the former congressman said.

Frank, who lost his chairman’s gavel when Republicans took control of the House in 2010 and left office in January 2013, said he stayed out of the debate over money market funds in 2012 because he thought Schapiro was on track to win SEC passage of her plan.

“I never got into the weeds on the specifics of the money market fund. I was in the minority, and I didn’t have any problem with what [the SEC] was doing,’’ Frank said.

Assuming Schapiro had the votes proved to be a mistake.

By August 2012, it had became clear Schapiro was on the losing end of the fight. A week before observers expected her to press ahead with the proposal, she pulled back. Three of the five commission members were opposed, she announced.

In a dramatic statement, she cited a “false sense of security’’ in money market funds exposed by the 2008 crisis.

“The issue is too important to investors, to our economy, and to taxpayers to put our head in the sand and wish it away,’’ she said.

The swing vote against Schapiro’s initiative was Luis A. Aguilar, a Democratic commissioner who once worked as a lawyer in the mutual fund industry.

In an echo of the big question marks on the advertisements in the Metro’s Union Station, Aguilar said moving forward without more study could pose “serious and damaging consequences.’’

He had too many doubts.

More wrangling

Fidelity’s lobbying fight was not over. The collapse of Schapiro’s initiative opened up another round of intense wrangling. Frustrated Obama administration officials including Treasury Secretary Timothy Geithner, sitting as members of the newly created Financial Stability Oversight Council (a board mandated by the Dodd-Frank law), released their own set of tough recommendations, which prodded the SEC to go back to the drawing board.

Last year, the agency came out with a new proposal. Gone were capital requirements, but the idea of “floating’’ share prices remained.

New objections then came from both Massachusetts senators, Democrats Edward Markey and Warren. In a joint conference call, their staffers telephoned SEC staff in February 2014 to suggest the “floating’’ price rules needed to be scaled back. They did not specifically side with industry; they cited complaints by state and local governments in Massachusetts about possible market disruptions for short-term credit. Opposition letters were written to the SEC by Governor Deval Patrick and Treasurer Steven Grossman, as well as the mayor of Quincy and the Massachusetts Municipal Association. It was part of a flood of such complaints from across the country.

Warren’s position appeared to represent a shift in tone. As chairwoman of a federal bailout oversight panel five years earlier (three years before her Senate campaign in Massachusetts), she denounced the “implicit guarantee’’ of future taxpayer-funded bailouts in money markets.

“It distorts the market and changes risk-taking behavior, and that can’t be right,’’ Warren said in a 2009 interview with Bloomberg News.

Her latest statements were more nuanced. Calling the SEC rules an “important first step,’’ in a statement to the Globe, Warren said the agency must “balance the risks that money market funds can pose to the economy against the need to maintain money market funds as an important investment alternative.’’

Warren spokeswoman Lacey Rose said the contrasting tone does not indicate any change, and that the senator’s “position is exactly the same as it was in 2009.’’

‘A qualified victory’

Five years of trench warfare lurched to a close this year, in July, when the SEC issued final rules.

It was billed as a compromise, but reformers said industry got the best of the deal.

The “floating’’ share price will be required, but only for funds that serve large institutional investors — the category that experienced the biggest runs in 2008. The fixed $1 share price will remain in place for funds open to small-time, retail investors and for funds that invest in government and municipal debt.

For Fidelity and others, it represented “a qualified victory,’’ said Marcus Stanley, policy director for Americans for Financial Reform, a nonprofit advocacy group that sought tougher action. “They fought off a bunch of things that were much more problematic for them.’’

At the time of passage, Mary Jo White, the former federal prosecutor and SEC chairwoman who replaced Schapiro, hailed the new rules as a “strong reform package’’ that will reduce the risk of runs. Fidelity’s head of fixed-income, Nancy Prior, said the SEC struck “a reasonable balance.’’

“Money funds are far more resilient than they were in 2008,’’ said Brian Reid, chief economist for the Investment Company Institute, the industry trade group, of the final outcome.

Not everyone is so sure.

Measuring investor psychology is an inexact science, but many observers and regulators say the threat of destabilizing investor stampedes remains — and may, in some new respects, be worse.

The rules will allow money market managers to slam down a “gate’’ in times of distress to temporarily block investors from cashing out their shares. Mutual fund executives supported that concept.

“It will stop the run at the first fund, but if you are sitting at any of the other funds, you are going to want to get out before the gates are imposed,’’ said Eric Rosengren, president of the Federal Reserve Bank of Boston.

Harvard Business School professor David Scharfstein, an influential figure in the debate, said the result of the new rules overall is underlying risks have not changed that much:

“There’s still an incentive to get out,’’ he said, “before there’s a fire sale.’’

Christopher Rowland can be reached at crowland@ globe.com. Follow him on Twitter @GlobeRowland.

Correction: The Reserve Primary Fund was misidentified in an earlier version of this article.