Managers of buck-breaking money market fund accused of fraud

BOSTON -- Massachusetts' top securities regulator on Tuesday accused managers of a fallen money-market fund of lying about its safety in an ultimately futile bid to prevent investors from pulling out cash before they suffered almost unprecedented losses in a normally safe type of investment.

Secretary of State William Galvin's administrative complaint against Reserve Management Co. comes three weeks after the company that pioneered money-market funds said it expected federal securities regulators to bring a separate civil case against it. That case has not yet been filed.

Galvin's complaint alleges Reserve sales workers were directed by managers to reassure investors that they could not lose money, even though Reserve's Primary Fund had made an investment in unsecured debt of Lehman Brothers.

That investment totaled about 1% of the Primary Fund holdings that stood at more than $64 billion three days before Lehman's Sept. 15 bankruptcy filing.

The same day, the bankruptcy prompted Reserve Management's board to write down the value of the $785 million in Lehman debt, the complaint alleges.

But on that day and the next, Reserve was telling investors that the Lehman holdings were being valued on par, the complaint says.

Written and oral statements to investors "contained outright falsities which the principals of Reserve Management knew at the time were not true," the complaint says. It seeks restitution on behalf of 566 Massachusetts businesses and residents who had invested about $2.1 billion in the Primary Fund, according to the complaint. It also seeks an unspecified administrative fine.

Reserve Management spokeswoman Ming Lee Hatch declined to comment, saying the New York-based company had not yet seen the complaint.

Reserve's purchase of commercial paper from Lehman — a type of short-term corporate debt that company co-founder Bruce Bent once said was risky for conservative money-market funds — triggered a rush of redemption orders by institutional clients. Those orders gutted the fund's value as fund managers were forced to sell assets amid sharply declining markets.

The night of Sept. 16, Reserve said the Primary Fund had "broken the buck" when the value of its assets fell to 97 cents per investor dollar put in — below the dollar-for-dollar level needed to fully repay clients. The episode was the first such investor exposure to money-market losses since 1994, and created fears about the safety of the more than $3 trillion in assets held in money-market funds.

The government ultimately stepped in with a temporary program to guarantee money funds, but the Primary Fund — the first money fund, established in 1970 — didn't qualify and is in the process of liquidating.

Reserve Management faces several lawsuits from investors in Primary and other Reserve funds, many of which also are liquidating. In addition, Colorado's securities commissioner last week announced a complaint that accuses the fund of violating his state's anti-fraud provisions.

Primary Fund clients have expressed shock that they were exposed to losses in an investment they had regarded as practically as safe and liquid as cash. While there's no final tally of how close they will get to receiving 97 cents on the dollar, their losses aren't expected to be as steep as those from other recent instances of alleged fraud, including accused Ponzi mastermind Bernard Madoff.

On Oct. 30, Reserve began returning an initial $26 billion to Primary Fund investors whose funds had been frozen more than a month. That was roughly half the fund's total account balance at the time — after redemptions were processed at full value from institutional clients who placed more than $8 billion in orders Sept. 16 as the fund was breaking the buck. Another distribution of $14 billion began Dec. 3.

The final tally depends on whether Reserve can sell the fund's remaining assets at full value, and the extent to which expenses to defend Reserve against litigation will drain what's left for investors.

Last week, the company said a reserve from which it will return investor cash had accrued fund management and other expenses of nearly $7.6 million as of Dec. 16 — not including legal fees and other items that it couldn't estimate. That compared with $10 billion in "remaining assets at amortized cost."

Galvin's complaint alleges Reserve Management favored institutional investors over smaller clients by giving bigger customers priority for processing redemption orders, despite statements to the contrary that it was using a first-come, first-served policy.

In one instance, clients were allegedly told of an agreement under which Reserve Management could take steps to prop up the fund financially. The company told clients that the agreement was awaiting approval by the Securities and Exchange Commission, Galvin said. Instead, the SEC had merely asked Reserve what type of "support agreement" was planned, and Reserve had agreed to let the SEC know, Galvin alleges.

On Dec. 23, Reserve Management said the SEC's enforcement unit had told the company that staff planned to recommend that the SEC allege securities law violations by Reserve and three executives. Reserve said it intended to defend itself and the executives vigorously.

SEC spokesman John Heine declined to comment Tuesday on the status of any pending case against Reserve.