Law firm urges US risk council to tread carefully on money funds

* Dechert says FSOC could violate rulemaking procedures

* Firm partner calls for transparency, fair process

* FSOC is preparing to issue recommendations on money funds

* Geithner wants FSOC to step in after SEC failed to act

WASHINGTON, Nov 1 (Reuters) - A prominent law firm is raising concerns about the new U.S. financial risk council's approach to tackling money market fund reform, saying the council could expose itself to legal challenges if it does not watch its step.

In a letter to the U.S. Treasury Department, Dechert partner Thomas Vartanian laid out his concerns with the recommendations that Treasury Secretary Timothy Geithner presented to the new Financial Stability Oversight Council for the $2.6 trillion fund industry earlier this fall.

Dechert wrote the 12-page letter on behalf of clients who would potentially be impacted by new reforms. It did not name the clients.

Among Geithner's chief recommendations is for the FSOC, a council of regulators created by the 2010 Dodd-Frank law, to put pressure on the U.S. Securities and Exchange Commission to adopt new money market fund rules after SEC Chairman Mary Schapiro could not muster enough votes from her fellow commissioners.

Such a move would entail the FSOC's formally presenting the SEC with a list of recommendations and forcing the agency to respond in writing if it is unwilling to adopt them.

But Vartanian warns that such action could violate federal policymaking rules, leading the FSOC to act ``arbitrarily, capriciously and contrary to law.''

That is the same type of legal argument that has been used successfully in the past by trade groups seeking to kill SEC rules on mutual fund director independence and ``proxy access.''

Whether a similar argument could ever work in a potential future legal fight against the FSOC, however, remains unclear. The nascent regulatory body's authority is still untested.

``A failure by the FSOC and its members to adhere to appropriate legal, administrative and substantive standards of decision-making could expose the recommendation process to numerous potential challenges,'' said Vartanian.

The FSOC is one of the newest regulatory bodies to come out of the Dodd-Frank law. Chaired by the Treasury secretary, its membership consists of the heads of the top banking and market regulators, including Schapiro.

Since last year, Schapiro has been urging the SEC to adopt reforms that she says will protect investors from runs on money market funds like the one seen in the financial crisis, when the Reserve Primary Fund ``broke the buck.''

Schapiro had circulated a draft proposal on reforms that included requiring the funds to build up capital buffers and impose limits on redemptions.

The proposal also included a plan to move away from funds' policy of maintaining a stable $1 per share net asset value.

But three of the SEC's commissioners - Democrat Luis Aguilar and Republicans Troy Paredes and Dan Gallagher - said they could not support her specific proposals.

They, along with many large players in the fund industry and corporate treasurers, have all expressed skepticism about the need to adopt additional money market reforms beyond the ones enacted in 2010.

After the SEC failed to back Schapiro's proposal, Geithner drafted a letter to regulators in late September urging the FSOC to step in. Geithner said he hoped to have the FSOC consider a draft proposal in November and put it out for comment.

Vartanian said he was concerned that Geithner is asking the FSOC to ``rush'' and feared there are no internal procedures in place for the nascent regulatory body to follow so that the process is fair and open.

Geithner's proposed course of action ``raises significant legal and regulatory issues of first impression for the FSOC regarding how it will, and must, conduct its business in a manner consistent with the law,'' said Vartanian.

``There are no clear rules of engagement to guarantee transparency, fairness and accountability in this unprecedented action that the Secretary requests the FSOC to take.''