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UPDATE 2-Fed's Tarullo warns on passing the buck on money-fund reforms

* SEC action is 'first-best' option; FSOC is 'second-best'

* Fed official still hopes SEC will adopt money market rules

(Adds FSOC's options on money funds)

By Jonathan Spicer

PHILADELPHIA, Oct 10 (Reuters) - It would be best if theSecurities and Exchange Commission finally moved forward withmoney market reforms instead of leaving the job to the new U.S.financial risk council, a top Federal Reserve official said onW edn esday.

Fed Governor Daniel Tarullo said it was unfortunate that theSEC, the primary regulator of the $2.6 trillion industry, has sofar failed to advance new rules for the market, which since thefinancial crisis has been viewed as posing a systemic risk.

On Aug. 22, SEC Chairman Mary Schapiro said the regulatorwould not formally put forward its money market reform proposalssince three of five commissioners opposed them. That left thenext move to the Financial Stability Oversight Council, or FSOC.

"Each of the options open to the FSOC and the rest of itsconstituent agencies is decidedly a second-best alternative ascompared to a change in SEC rules to remove the fixed net assetvalue exception, to require a capital buffer that would staunchor buffer runs, or measures of similar effect," Tarullo said atthe University of Pennsylvania Law School.

Any FSOC reforms would be worse for the funds themselves, heargued, because the tools available to the council "do not fitthe problem precisely and thus will not regulate at the leastcost to the funds while still mitigating financial risk."

The industry says money market funds are a safe investmentwith attractive returns, while critics worry that they arevulnerable to runs and create a false sense of security forinvestors who do not realize they are not backed by federalinsurance.

Schapiro has argued that a series of reforms the SEC adoptedin 2010 do not go far enough to prevent runs on funds like theone experienced in 2008 when the Reserve Primary Fund "broke thebuck," meaning its net asset value fell below $1 a share.

On Sept. 27, U.S. Treasury Secretary Timothy Geithner calledon the FSOC to formally ask the SEC to move forward with newrules. He also said the council should consider exercising otherpowers to regulate the money market fund industry more tightly.

The next day, Daniel Gallagher, a Republican SECcommissioner who had previously helped block the fund reforms,told Reuters he hopes the agency will consider a fresh packageof reforms.

In a nod to those comments, Tarullo said: "My hope, ofcourse, is that recent indications that other SEC commissionersare now willing to move forward with reforms will lead to theSEC adopting first-best measures in the near-term."

As the Fed's point person on financial regulation, Tarullosits in on FSOC meetings, though Fed Chairman Ben Bernanke isthe central bank's official representative on the council.

The FSOC's options include imposing restrictions on banks'and other firms' "ability to sponsor, borrow from, invest in, orprovide credit to" money market funds that do not havestructural protections, Tarullo said.

The council could also designate money funds as"systemically important" and thus subject to capital andliquidity rules included in the Dodd-Frank financial reform law,he said.

For non-banks in general, the FSOC is "actively considering"possible systemically important designees, Tarullo added.

(Reporting by Jonathan Spicer; Editing by Diane Craft and DanGrebler)

((jonathan.spicer@thomsonreuters.com)(+1 646 223 6253)(ReutersMessaging: jonathan.spicer.reuters.com@reuters.net))

Keywords: USA FED/TARULLO