Galvin Charges Reserve, Bent With Fraud

Massachusetts Secretary of the Commonwealth William Francis Galvin filed an administrative proceeding Tuesday against Reserve Funds and its founder Bruce Bent, accusing them of lying to investors about the dire straights of their investments in Lehman Brothers.

Galvin said the firm “made numerous false and misleading statements to dissuade investors from redeeming their shares of the Primary Fund in the days and hours before it ‘broke the buck’ and subsequently became unable to meet investor redemptions.”

The lawsuit seeks accounting records for the fund for Sept. 15 and Sept. 16 and restitution to all Massachusetts investors, along with a fine to be determined.

Following the bankruptcy of Lehman on Sept. 14, investors flooded Reserve, which held 1.2% of the firm’s assets in the Primary Fund, with redemption requests on the following two days. Rather than honestly admit to investors that the Primary Fund, exposed to a $785 million loss, was in danger of breaking the buck, Reserve falsely told them that it would support the fund’s NAV. Further, the fund company allegedly told investors that the reason why redemptions were not being immediately made was because of an operational problem at custodial bank State Street Corp.

Galvin’s office says it has obtained an internal memo that Bent personally sent to the firm’s global head of sales and other executives on Sept. 15 laying out steps to protect the fund’s NAV 100% through a Securities and Exchange Commission-approved capital support agreement. However, in point of fact, according to the complaint, the firm never submitted such a request to the SEC.

Bent, in a deposition to Massachusetts, said the firm decided to delay the request due to the ongoing illiquidity in the markets, yet failed to let the sales team, and therefore, Primary Fund’s clients, know until 4:15 p.m. Sept. 16, through a press release stating the fund had broken the buck.

In addition, the fund company struggled on Sept. 15 and Sept. 16 over how to value its Lehman holdings, according to the complaint. Although on Sept. 15, it was already apparent that the value of its Lehman paper may have fallen to as little as 45 cents on the dollar, or 80 cents at the most, the fund supplied salespeople with materials stating it would support its Lehman holdings at par value.

Further, rather than honor redemptions on a first-come, first-served basis, Reserve prioritized certain larger clients’ redemptions over others, according to the lawsuit.