Reserve founder charged with defrauding investors when Primary Fund broke the buck

The Securities and Exchange Commission filed fraud charges today against the father and son team who ran Reserve Management Co., the money-market fund company that rocked the financial world last September when it “broke the buck” on its flagship fund.

The SEC charges represent the latest in a series of heavy blows to Reserve, a Manhattan-based firm that pioneered money-market funds in the early 1970s and invested some $125 billion of clients’ money in low-yielding, ultra-safe assets, such as certificates of deposit or short-term government and corporate debt. Founder and Chairman Bruce Bent, 71, liked to say the point of money-market funds was “to provide safety of principal, liquidity and a reasonable rate of return all the while boring investors into a sound sleep.”

Mr. Bent’s decades of work came undone last September, when his firm revealed that the net asset value of its $62 billion Primary Fund had fallen below the sacrosanct $1 a share, the result of $785 million of investments in Lehman Brothers turning worthless after that investment banker for bankruptcy. In other words, Reserve’s Primary Fund “broke the buck”—only the second time such a thing had ever happened to a money-market fund.

As Mr. Bent and his son, Reserve President Bruce Bent II, grasped the depth of disaster they faced, the SEC says they failed to provide key material information to customers, board members and ratings agencies after Lehman collapsed. Reserve and the Bents misrepresented that they would provide the support necessary to protect the $1-per-share asset value of their fund when in fact there was no such intention, the SEC contends. The SEC also charges that Reserve officials significantly understated how many investors were racing to yank their money out after the Lehman bankruptcy hit.

“The fund’s managers turned a blind eye to investors and the reality of the situation at hand,” SEC Chairman Mary Schapiro said in a statement.

“Since we created the money fund in 1970 we have operated and grown our business by putting our shareholders’ interests first, Bruce Bent, chairman of Reserve Management, said in an e-mail.
The Lehman Brothers Bankruptcy filing created an unforeseeable and out- of- control condition for many parties and the results were serious. Our management worked extremely hard throughout the chaotic and fast-moving events of September 15 -16 and we remain confident that we acted in the best interest of our shareholders. We are hopeful that this matter can be resolved quickly.”

Reserve froze withdrawals after breaking the buck and the fund is now being liquidated. It has set aside $3.5 billion of client money to cover legal expenses anticipated due to suits brought by angry investors.

Reserve began to drift into riskier investments, such as short-term debt issued by Lehman and Merrill Lynch, in 2007, the SEC says. Those investments generated higher returns, helping Reserve attract more customers—and boost its management fees. Unlike other money-market outfits owned by larger institutions, Reserve lacked the resources to shore up its fund when large numbers of investors demanded their money back at once.

The SEC charges are similar to allegations made in January by Massachusetts regulators. According to court documents in the Massachusetts case, Reserve officials sought a federal bailout hours before they disclosed on Sept. 16 that the Primary fund had broken the buck. Mr. Bent II phoned Timothy Geithner, then president of the Federal Reserve Bank of New York, to beg for urgent assistance. The New York Fed declined.

Related Topics: Lehman Brothers, Securities and Exchange Commission