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Calling back those money-market 'clone' funds

Send back the "clones." Those creations of the mutual fund industry, meant to provide a way for people to invest in money-market funds after the Federal Reserve Board put reserve requirements on them in March, are about to be taken over by their "parent" funds and disappear.

A ruling this week by the Securities and exchange Commission (SEC) would allow the original funds to make an offer to the clone-fund shareholders to buy out their shares. In addition, the commission announced its support for a temporary suspension of the rule prohibiting an investment company from selling the assets of one of its funds to another in its group. This would allow the clone funds to sell their investments -- money-markets securities -- to the parent funds.

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When they have completed this process, the mutual fund managers will breathe a collective sigh of relief now that an extra layer of regulation has been removed from their indusv try, which they say is already heavily regulated.

As part of President Carter's March 14 anti-inflation package, the Federal Reserve told the money funds they must put 15 percent of all new deposits on reserve with the Fed. The deposits earned no interest.

To protect the investments of people who were in the funds before March 14, the companies brought out the new funds, said to be exactly like the old ones -- thus the "clone" nickname -- except that their deposits were subject to the 15 percent reserve rule.

In all, 34 clones were set up. By the end of last week, according to Donoghue's Money Fund Report, they had combined assets of over $3.6 billion, compared with nearly $74.5 billion for the first-generation funds.

The 15 percent reserve requirements was lifted July 3, leaving many investment companies with two money-market funds. Since the newer, smaller funds would not have the earning power of their larger parent funds, the SEC has been looking for a way to let the funds merger.

The 3 1/2-month set-aside requirement was "a great object lesson in the cost of regulation," said Arnold D. Scott, senior vice-president and general counsel for Massachusetts Financial Services Inc. "It was a waste of time and money," he added, pointing to the continued rapid growth of the money funds -- in spite of the reserve requirement, and in spite of rapidly declining interest rates that have seen the yields of some funds cut almost in half.

Shortly after the restrictions were announced, the funds' assets added up to investors found that, even with 15 percent of their money earning no interest, they would still do better in the money funds than in a savings account. This was shown in the fact that most of the funds' recent growth came in the parent funds.

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The cost of opening and operating the clones came to approximately $4.5 million, said Stave Paggioli, counsel for the Investment Company Institute, the mutual fund trade group. In addition, the reserve requirement meant the fund investors lost some $43 million in interest, he noted.

The clone funds cannot actually disappear until Aug. 11, which is the day the Fed will return the money it has held in reserve. Thus clone fund managers are hoping their investors will not try to redeem all their shares before then, "or we may not have their money," Mr. Scott said. Until then, "we'll be keeping our fingers crossed."

Surprisingly, there are some in the savings banking industry who are not sorry to see the end of the restrictions. "The reserve requirement was part of a whole package of credit controls," noted James Butera, general counsel for the National Association of Mutual Savings Banks. "And we're not sorry to see those removed."

But Mr. Butera still thinks the money funds have an unfair advantage that encourages depositors to favor them over savings institutions. "They should operate under the same restrictions we face. And that includes keeping money on reserve with the Fed."

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