Reserve fund's woes undercut mantra of safety, liquidity

ByABC News
November 11, 2008, 12:01 AM

— -- Appearing on public television's Nightly Business Report on Aug. 19, Bruce Bent, one of the inventors of money market mutual funds during the 1970s, repeated his familiar criticism of managers who chased higher returns at the potential risk of investor safety.

"It's supposed to be a mantra. Every morning, every night, a money fund provider should be safety of principal, liquidity, a reasonable rate of return and a sound night's sleep. And they forgot the mantra," said Bent, founder of The Reserve, one of the largest money market firms.

But less than one month later, Reserve's flagship Primary Fund notified startled investors it could not pay them all they were owed because the fund held Lehman Bros.' debt with a face value of $785 million. The securities, written down to zero after Lehman sought bankruptcy court protection on Sept. 15, were tied in part to soured subprime mortgages.

Now Bent's words are boomeranging against him in investor lawsuits that accuse him and his funds of failing to practice the financial gospel he had long publicly advocated. The allegations have made Bent, 71, a focus of corner-office controversy in this year's economic crisis.

"There was a wave of schadenfreude that rollicked across the fund industry when it was announced that it was his fund that had a problem," says Mercer Bullard, founder and president of Fund Democracy, a mutual fund shareholder advocacy group. They enjoyed his predicament because, Bullard adds, "He has been preaching about the irresponsible ways of other money market funds for years, and, in fact, it turns out that it was his that he wasn't really paying attention to."

Bent isn't commenting, says spokeswoman Ming Lee Hatch; some of his statements are posted on the firm's website.

But Reserve investors are clamoring. Up to 2 million Primary Fund shareholders could lose part of their money as a result of the redemption tsunami that hit the fund after the Lehman bankruptcy, says attorney Harvey Wolkoff of Ropes & Gray, the law firm for investment adviser Ameriprise Financial Services in a federal lawsuit against Reserve.

One day after the bankruptcy filing, the Primary Fund and two offshore funds "broke the buck," or disclosed they couldn't repay investors the full $1-per-share price. That had happened only once before in the 38-year history of money market mutual funds. Alarmed that the development would spook an investor stampede out of money market funds, the Treasury Department quickly announced a temporary insurance plan for the industry.

But for the Primary Fund and several smaller Reserve siblings, the damage had been done. In a proverbial run on the bank, the $64 billion Primary Fund was hit with an estimated $41 billion in redemption requests on Sept. 15. By Oct. 8, net assets in Reserve's Interstate Tax-Exempt Fund dropped from $1.78 billion to $154.6 million, the company said in a Securities and Exchange Commission filing.