Inside the panic at Reserve Management

The evening of Sept. 15 was the worst of Bruce Bent II's career.

Panicked investors, who woke up that Monday morning to news of New York-based Lehman Brothers Holdings Corp.'s filing for bankruptcy protection, had yanked billions of dollars out of the money market fund that he ran with his father, money market fund inventor Bruce Bent Sr. The business to which the Bent family had dedicated their lives, New York-based Reserve Management Co. Inc., faced disaster if the run on the Reserve Primary Fund continued.

As the younger Mr. Bent, Re-serve's president, sifted through his e-mails, he reviewed a statement drafted by his marketing staff to calm investors. The final line proclaimed that Reserve was “confident in the underlying credit strength and quality” of its holdings, which included hundreds of millions in debt from Lehman and other free-falling institutions, including Merrill Lynch & Co. Inc. and Washington Mutual Inc.

“Drop the last line and then go with it,” the younger Mr. Bent said.

Unfortunately, this editing job represented one of the few times that he or his father, chairman of Reserve, were honest with shareholders in the three terrible days that their firm spiraled downward, according to regulators.

The Securities and Exchange Commission this month charged the Bents and Reserve with fraud, alleging that they failed to provide key information to customers, board members and credit ratings agencies after Lehman collapsed. Reserve and the Bents said that they would support the $1-a-share asset value of their fund, when in fact there was no such intention, the SEC contends.

The SEC also charges that Reserve misled directors and credit raters by significantly understating how many investors were yanking money out after the Lehman bankruptcy hit.

BREAKING THE BUCK

The day after the younger Mr. Bent approved his marketing staff's statement, disaster struck. Reserve, whose pioneering money market fund in 1970 spawned a $3.8 trillion industry, “broke the buck.”

In other words, the net asset value of the flagship $62 billion Primary Fund fell below the sacrosanct $1 a share because the fund held $785 million in Lehman debt that was suddenly worthless. It was only the second time in history that a money market fund had broken the buck, and it unleashed such panic in the stodgy world of cash investments that the federal government had to intervene by week's end to guarantee money fund holdings.

Court documents, including copies of e-mails and board minutes, show that the younger Mr. Bent saw trouble brewing even before Lehman filed for bankruptcy. Late Sunday night, Sept. 14, he ordered senior staff members to work on a customer memo “that assumes Lehman liquidates” and warned that Reserve could see up to $1.5 billion of client redemptions the next day.

It turned out much worse than that.

“$5.2 billion already?” a stunned Reserve executive wrote in an e-mail that Monday at 8:37 a.m. ET.

Meanwhile, Mr. Bent and his father, who was in Italy on vacation, were working behind the scenes.

Some 45 minutes earlier, unbeknownst to their board, the SEC alleges, they had contacted the Federal Reserve Bank of New York for assistance. The Fed declined to help.

By midmorning, redemptions were accelerating — they reached $40 billion over two days — and Reserve couldn't meet the demand because its bank, State Street Corp. of Boston, stopped wiring funds shortly after 10 a.m. ET.

This was the moment. With his father far away, Mr. Bent had to show that he had matters in hand.

Was he up to it?

Known in the industry as “Bruce Two,” his long hair and beard hinted at his youthful past as a drum-playing philosophy major.

“He was very quiet, very mellow, very introspective,” said Peter Crane, president of money market tracker Crane Data LLC in Westboro, Mass.

But Mr. Bent, 42, had greatly expanded his father's business. Assets under management grew from about $4 billion in the mid-1990s, when he was handed day-to-day control of operations, to $18 billion in 2002, and swelled to $125 billion last year.

Reserve shifted from courting individuals to attracting big corporate accounts such as Time Warner Inc. of New York. Its biggest client last year, with $5.4 billion in the Primary Fund, was China Investment Corp. of Beijing.

At 1:19 p.m. ET on Sept. 15, the younger Mr. Bent e-mailed senior staff members, saying that the firm would financially support the Primary Fund “to whatever degree is required” so it wouldn't break the buck. He added that Reserve was awaiting SEC approval, though the commission contends that it never heard from Reserve on the matter and alleges that the Bents had no intention of producing the hundreds of millions of dollars necessary to support the ailing fund.

NO CASH LIFELINE, ACQUIRER

The next day, Mr. Bent in New York and his father in Italy fruitlessly searched for a cash lifeline or an acquirer. Later that afternoon, Reserve announced that the buck had in fact been broken.

It was a stunning fall for a firm that had long touted its funds as the ultimate in safety.

The trouble seems to be rooted in 2007, when the senior Mr. Bent, who oversaw investment decisions, began buying short-term debt from brokerage houses such as Lehman and Merrill. Those moves boosted yields and attracted customers for a while.

In a statement this month, Re-serve said that it “intends to defend itself vigorously,” and the elder Mr. Bent said that he is “confident that we acted in the best interest of our shareholders.” The Primary Fund is being liquidated. Massachusetts regulators have also filed fraud charges, and nearly 30 shareholders have sued.

Perhaps in anticipation of the costly legal battle ahead — not to mention a seriously diminished income — the younger Mr. Bent has put his 10-room penthouse apartment in Manhattan up for sale. The asking price is $14.5 million.

Aaron Elstein and Megan Johnston are reporters at sister publication Crain's New York Business.