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Reserve Fund’s Fraud Started After Call With SEC, Galvin Says
By Christopher Condon and Cary O’Reilly
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(January 15, 2009 - Thursday) - http://www.bloomberg.com/apps/news?pid=20601103&sid=ae7shx7gv22A&refer=news
Jan. 15 (Bloomberg) -- In about four minutes, Bruce Bent II stepped from trying to bail out the flagship money-market fund of Reserve Management Co. to committing fraud, according to a complaint filed by Massachusetts regulators.
Around 1:15 p.m. on Sept. 15, Bent, president of New York- based Reserve Management, talked with the U.S. Securities and Exchange Commission about propping up the Reserve Primary Fund. The $62.6 billion fund was close to collapse because of investments in debt issued by Lehman Brothers Holdings Inc., which hours earlier had filed for bankruptcy.
At 1:19 p.m., when that conversation ended, Bent sent an e- mail to Reserve executives that said SEC approval for a bailout was imminent, the state said in the filing. No such plan was in place. Still, the message spread, with salespeople using it to persuade investors not to abandon the fund, the complaint said.
The next day, Reserve Primary became only the second money fund to break the buck, or fall below the $1-a-share price paid by investors, triggering an industrywide run that helped freeze global credit markets.
“It was like a body blow,” John Drahzal, global head of sales for Reserve Management, told Massachusetts investigators. “We told people we were going to protect” the value of their shares, he said.
Bent showed “a brazen disregard for the truth in an attempt to keep investors from fleeing the Primary Fund,” Massachusetts Secretary of the Commonwealth William F. Galvin said in the Jan. 13 filing.
In-depth Look
The civil suit by Galvin, 48, provides the most detailed public account of the events leading up to the fund’s demise. The company said on Dec. 23 that the SEC may take action against Bent, his father and company founder Bruce R. Bent, and brother Arthur Bent III for violating securities laws.
Galvin in the complaint calls for Bent II and the company to provide restitution to all Massachusetts investors and to pay administrative fines to be determined later. He also recommends that Reserve Partners, the company’s brokerage arm, be censured.
Ming Hatch, a spokeswoman for Reserve Management, declined to comment, as did Kevin Callahan, an SEC spokesman in Washington.
Galvin said in the filing that company records, along with testimony that Bent II and other Reserve employees gave to Massachusetts investigators, show that as Reserve Primary unraveled, he directed his staff to reassure investors with the false claim that the company had agreed to rescue the fund.
September Events
Bent, 42, is the only individual accused in the complaint, which also names the family-owned company. His 71-year-old father and Arthur Bent, 40, are listed only with “other involved and related parties.”
The elder Bent is credited with inventing the retail money- market fund in 1970 when he opened Reserve Primary. He was in Italy with his wife celebrating their 40th wedding anniversary in September when the crisis started.
That was early on Sept. 15, when Lehman sought bankruptcy protection. According to the complaint, Bent II told the trustees of Reserve Primary about 1 p.m. New York time that Reserve Management was prepared to protect shareholders against losses on the $785 million of Lehman debt.
Access to Capital
Bent assured the board that the company had access to sufficient capital to provide the necessary support, Galvin said in the filing. The trustees authorized him to contact the SEC for approval.
Bent called the SEC about 1:15 p.m. and raised the topic of a capital-support agreement, according to the suit. Such an arrangement represents a pledge by a fund’s owner or sponsor, to cover investment losses that would cut into investors’ principal.
The call ended with the SEC staff asking Bent for details of the planned agreement, according to the complaint. Bent agreed to “think about it and get back to the SEC.”
He never did, the filing said. Instead, he sent the 1:19 p.m. e-mail to Drahzal; Eric Lansky, head of marketing; general counsel Catherine Crowley; his father and his brother, Reserve Management’s chief operating officer. The e-mail made it appear that the SEC was prepared to sign off on a bailout that would keep the fund’s net asset value at $1, the complaint said.
Money-market funds regulated by the SEC strive never to fall below a $1 NAV, preserving investors’ principal while paying interest. Fund investments are restricted to highly rated securities maturing in 13 months or less. Money funds, which oversee $3.85 trillion, promote their safety and yields that are usually slightly higher yields than bank accounts and Treasury debt.
Waiting for Approval
“We (Reserve Management Company Inc.) intend to protect the NAV on the Primary Fund to whatever degree is required,” Bent wrote in the e-mail, which was included in the filing. “We have spoken with the SEC and are waiting for their final approval, which we expect to have in a few hours.”
Drahzal and other sales staff testified that they took this to mean that a capital-support agreement was in place and spread that message to shareholders in the fund.
No agreement was submitted to the SEC, Bent told Massachusetts investigators on Jan. 9. The company never lined up money to back up his promise to the trustees, he said.
Given market conditions, by the evening of Sept. 15, “we concluded that putting the credit-support agreement in place was not something that would be effective or within our wherewithal,” Bent testified, according to the complaint.
That conclusion wasn’t passed on to sales staff and his previous message kept going out to clients that night and throughout the next day, the complaint said.
Breaking the Buck
Drahzal said he learned there was no agreement only when the board announced at 4 p.m. on Sept. 16 that the fund had broken the buck, according to the filing.
Galvin also accused Bent of misleading shareholders over the value of Reserve Primary’s Lehman holdings. At 10:15 a.m. on Sept. 15, hours after the investment bank had declared bankruptcy, the fund’s board had written the Lehman debt down to 80 cents on the dollar, Galvin said in the suit.
Reserve salespeople told shareholders throughout the day and evening that the fund continued to value the Lehman debt at par. A newsletter sent to shareholders about 8 p.m. on Sept. 15 said, “Based on the current valuations of these holdings, we believe that the holdings will mature at par value.”
The Lehman holdings were written down to zero effective at 4 p.m. on Sept. 16.
To contact the reporters on this story: Christopher Condon in Boston at ccondon4@bloomberg.net; Cary O’Reilly in Washington at caryoreilly@bloomberg.net.
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