MANHATTAN (CN) – The SEC charged the Reserve Primary Fund and the father-and-son team who run it with fraud. The SEC says that for two days after Lehman Bros. filed bankruptcy, the defendants participated in a “systematic campaign to deceive the investing public into believing that the Primary Fund – their flagship money market fund – was safe and secure despite its substantial Lehman holdings.”
Defendants in the federal lawsuit are the Reserve Primary Fund, Reserve Management Company, Resrv Partners, the companies’ Chairman Bruce Bent Sr., 71, and Vice Chairman Bruce Bent II, 42.
Prosecutors claim that the money market fund, which “historically provided shareholders with a $1.00 per share NAV,” [net asset value] has been considered “a safe and stable option for the preservation of capital” and “an attractive regulated alternative to bank deposits.” The conservative assets the company purchased gave the Fund the “highest possible ratings from Moody’s and Standard & Poor’s,” the SEC says.
But in 2007 and 2008, prosecutors say, the Fund started making “riskier” investments in Lehman, Merrill Lynch, and Washington Mutual, ignoring warnings that an “unforeseen credit event” could endanger its ratings.
The company knew that the $785 million it held in Lehman debt securities could reduce its share value, but the Primary Fund’s adviser persuaded the many shareholders who “besieged” them to redeem their shares that their investments were safe and protected, the SEC says.
The company’s false assurances included claims that the company was liquid, that it was honoring redemptions in a timely manner, that it expected relief from the Commission to be granted within hours and that it intended to protect the $1 standard with the company and the Bents’ capital, if necessary, according to the complaint.
But the SEC says the company told Moody’s rating service that redemptions had stopped, though billions of dollars in shareholder redemptions remained unfunded.
Contrary to the company’s press releases, the SEC says that the Primary Fund never submitted any documents to it and did not have credit support in place.
“Defendants’ campaign of misinformation came to an end at 4:00 p.m. EST on September 16, 2008,” the complaint states, “when RMCI disclosed that the Primary Fund had broken the buck, i.e., its shares had declined in value below $0.995, the lowest point at which they could permissibly be rounded to $1.00.”
The SEC says that since the scheme unraveled, “approximately 29 lawsuits have been filed by investors in the Primary Fund against Defendants and the Fund. The vast majority of these actions have been consolidated for pre-trial purposes … The resolution of those suits may lead to conflicting judicial determinations and inconsistent treatment of shareholders, as well as an inexorable and piecemeal drain on the Fund’s assets.”
Prosecutors say the Primary Fund is planning to withhold $3.5 billion from shareholders until the lawsuits are resolved, at which point they will be distributed according to the judgments.
“To address this scenario,” says the SEC, “the Commission seeks to compel the distribution of the remaining Fund assets on a pro rata basis.”
The SEC seeks disgorgement and penalties.