24 Dec 2008
Dec. 24 (Bloomberg) -- Bruce Bent, inventor of the money- market mutual fund, and his New York-based company may be charged by federal regulators with violating securities laws in the collapse of its $63 billion Reserve Primary Fund.Reserve Management Co. was told last week by the enforcement division of the U.S. Securities and Exchange Commission that it will recommend suing the company and Bent, its chairman, Reserve said yesterday in a statement. The closely held firm also expects the agency to file complaints against Bent's sons, Bruce Bent II and Arthur Bent III.
Reserve Primary's value fell below the $1-a-share price paid by investors on Sept. 16 because of losses from debt issued by bankrupt Lehman Brothers Holdings Inc., making it the first money-market fund in 14 years to break the buck. The fund's demise sparked a run on money-market accounts and at least 19 lawsuits over how it was managed and how the losses should be divided among investors.
"The scrutiny to date has likely centered on valuation issues related to the Lehman paper and communications with shareholders," Peter Crane, president of Crane Data LLC, a research firm in Westborough, Massachusetts, said in an interview.
The Bents and the company "expect to defend vigorously against the allegations," Reserve said in the statement.
Kevin Callahan, an SEC spokesman in Washington, and Reserve spokeswoman Ming Lee Hatch declined to comment. SEC staff have been investigating the fund since it broke the buck.
Losses Loom
Some shareholders may lose as much as 3 percent of their investment. The company has so far returned about 78 percent of the $51.8 billion that was left in the fund on Sept. 16.
In the three weeks after Reserve Primary broke the buck, institutional investors yanked about $347 billion from money funds that can buy corporate debt. The run robbed companies of a crucial source of short-term funding, prompting the U.S. Treasury to roll out a temporary program insuring money-market fund holdings.
Bent is credited with having invented the money-market mutual fund in 1970, creating a safe and liquid place for retail investors to park cash. That year he opened Reserve Primary and his company with partner Henry B. R. Brown, who died in August. He was also known for lecturing fellow money-fund managers for taking on excessive risk.
In a November 2007 interview with Bloomberg News, he criticized those funds that suffered losses on debt linked to subprime mortgages.
"When you get involved in this contest to make 3 basis points more here or 2 basis points more there, that's insane," he said. "It's not what I designed the money fund to do."
More Bucks Broken
In addition to Reserve Primary, the company managed an offshore money fund, International Liquidity, and an enhanced cash fund, High Yield, that dropped below $1 a share because of Lehman holdings. The funds, which are in liquidation, weren't regulated by the SEC. Client redemptions also forced the company to shut down another 15 money-market funds. Investors in those funds won't suffer losses.
Under a Wells notice, the SEC's staff attorneys inform investigation targets that they plan to recommend legal action in a case. Defendants are given a chance to respond in writing before the SEC's commissioners vote on any sanctions. In 90 percent of the cases, the agency will proceed with the lawsuit, said George Newhouse, a defense lawyer with Brown White & Newhouse in Los Angeles.
Lehman Legacy
The Reserve fund's trouble began when Lehman filed for bankruptcy early on Sept. 15. Reserve Primary held $785 million in Lehman-issued debt, about 1.5 percent of assets. That same morning, the fund's trustees partially wrote down the debt by 20 percent. The partial writedown wasn't disclosed until Nov. 26, when the company also announced it had miscalculated the fund's net asset value for several hours on Sept. 16.
The miscalculation caused some investors who are now facing losses to believe initially that they were entitled to get back all their principal investment.
The lawsuits pending against the fund and Reserve Management allege separately that the company selectively disclosed information about its losses causing some clients to flee the fund before it broke the buck, improperly valued the Lehman holdings on Sept. 15 and violated its prospectus by buying risky assets.
According to Kirk Dillman with law firm Hennigan Bennett & Dorman in Los Angeles, the SEC may focus on the fund's failure to writedown its Lehman holdings until the end of the trading day on Sept. 16, more than a day after Lehman filed for bankruptcy.
Sharing the Pain
Shareholders have also sued over how the Lehman losses should be divided. Shareholders who asked to withdraw before the fund broke the buck say they are entitled to all their money, while others claim that all account holders should share in the losses.
The fund is being liquidated as securities mature or can be sold without loss. Money returned has so far been distributed to shareholders on a pro-rata basis. Reserve Management has said it won't distribute any disputed money and will hold back enough money to cover its expenses, including legal costs for the fund, the company and its managers.
