Week in Review

Reserve Shuts Down Funds, Delays Primary Payout

With just $6 billion in assets left, of what once totaled $83 billion, Reserve Management is liquidating its 18 remaining funds. Given its longtime vow to guarantee investors safety, and its spectacular failure to do that with the Sept. 16 implosion of its flagship Primary Fund, industry watchers say the company's demise is not surprising, and also warranted.

"The first rule of investing is to allow investors to redeem," said Peter Crane, principal of Crane Data. "If you don't do that, investors will do it for you." Connie Bugbee, managing editor of iMoneyNet, pointed to Reserve founder Bruce Bent's mantra of offering investors "safety" and "boredom." As to why the fund changed its prospectus a year ago to invest in commercial paper and began loading up on Lehman Brothers and other commercial debt-reaching 49% of assets and a big reason the fund's 4% return was at the top of the money fund charts-Bugbee believes Bent might have been overshadowed by his two sons and chief investment officer.

But that is no excuse for the fund to have changed course so radically, Bugbee said. "If your name is at the top, that is where the buck stops. Whether Bruce Bent was CEO in effect or in name only, he bears responsibility," she said.

Reserve is in discussions with the Securities and Exchange Commission to pay redemptions over a period exceeding seven days, but could not say when distributions to investors will be made, or how much, and did not want to sell assets at fire-sale prices, according to a statement. The market for short-term securities remains illiquid, with the exception of short-term U.S. Treasuries.

Just ahead of this news, Reserve Management applied for the Treasury Department's Temporary Money Market Fund Guarantee Program on behalf of all of its 21 funds. If Treasury approves Reserve's application for the guarantee, investors should be able to receive their money back in full; otherwise, their money will remain frozen until the capital markets return to normal trading.

Meanwhile, Reserve said that due to difficulties in determining investor shares held in its flagship Primary Fund on Sept. 15, it would have to postpone its planned $20 billion distribution of redemptions on Oct. 13. "The process of determining accurately the number of shares each investor held in the Primary Fund has proven to be extremely complex and could not be completed in the originally anticipated timeframe," Reserve said in a statement on its website. Of particular difficulty is determining what redemptions investors received in the Primary Fund via checks, debit cards or automatic clearinghouse (ACH) transactions, and fund purchases through dividend reinvestments. Thus, the firm's auditor, KPMG, is trying to pinpoint investors' account balances.

Peter Lynch Swept Up in Fines Against Mortgage Co.

New Hampshire regulators have fined a now-defunct mortgage company, First Call Mortgage, in which Peter Lynch of Fidelity Investments fame had a 13% stake. As such, Lynch faces an $85,000 fine, and First Call, $767,500. In addition, the regulator is seeking a fine from another Fidelity portfolio manager, George Vanderheiden, who held a 25% stake in the company.

Regulators say the firm overstated borrowers' incomes, sold reverse mortgages improperly and didn't safeguard confidential information.

Lynch and Vanderheiden issued a joint statement calling their holdings in First Call "passive" and emphasizing they were not involved in the management of the company. Separately, Fidelity told The Wall Street Journal that while the two executives still offer consulting to the firm, their investments are apart from management of the fund company.

Nine From Fidelity Settle SEC Charges for Gifts

Nine former and current traders with Fidelity Investments have reached preliminary settlements with the Securities and Exchange Commission for allegedly receiving more than $1.6 million worth of lavish gifts from brokerages seeking business from Fidelity between 2002 and 2004.

One Fidelity trader has yet to reach an agreement with the SEC. Three traders have already settled with the Commission, including Peter Lynch, who was accused of receiving $16,000 of free tickets.

The people named in the suit are: Timothy J. Burnieika, Robert L. Burns, Scott E. DeSano, David K. Donovan, Edward S. Driscoll, Jeffrey D. Harris, Christopher J. Horan, Steven P. Pascucci and Kirk C. Smith.

Morningstar Hedge Fund Index Takes 7.87% Beating

The Morningstar 1000 Hedge Fund Index declined 7.87% in September, its largest one-month decline since its inception in January 2003. In the third quarter, the index declined 13.17%.

In addition, the Morningstar Global Equity Hedge Fund Index gave up 11.22% in September, and the Morningstar Europe Equity Hedge Fund Index tumbled by 9.62%. The best-performing hedge fund category in September was one that focused on fixed income, currencies and commodities; thus, the Morningstar Global Trend Hedge Fund Index declined by only 1.26% in September.

"In September, the financial world as we know it turned upside down," said Morningstar Analyst Nadia Van Dalen. "We saw a shakeout in the hedge fund industry all around the globe. Hedge funds experienced poor borrowing, hedging and trading conditions, while liquidity dried up and volatility skyrocketed."

Morningstar also noted that the temporary ban on short selling and an increase in the price of credit default swaps adversely affected hedge funds.

Top Hedge Fund Managers Load Up on Cash

More than ever, hedge funds are loading up on unusually high amounts of cash, a clear sign that the smart money is bearish on the market through the rest of the year, The Wall Street Journal reports.

Both Steven Cohen, who runs the $14 billion SAC Capital Advisors, and Israel Englander, who runs the $14 billion Millennium Partners, have put a whopping 50% of their holdings into cash, cash equivalents, money market funds and other short-term instruments. Though the amount is not known, the $35 billion Paulson & Co. now has a substantial amount of its holdings in cash, as well.

"There is a lot of uncertainty out there, and some people may be saying from a timing point of view they are more comfortable on the sidelines," said Goldman Sachs Analyst David Kostin.

Justice Department Probes Lehman Brothers Collapse

The U.S. Justice Department has subpoenaed several large firms and agencies as part of an investigation to determine whether Lehman Brothers misled investors before its Sept. 15 bankruptcy filing.

Those subpoenaed include Lehman, its auditor Ernst & Young, American International Group, Barclays, BlackRock, C.V. Starr & Co. the New Jersey Division of Investments and Putnam Investments.

At the heart of the case is determining whether Lehman failed to disclose its rapidly eroding finances. Federal Prosecutors acknowledge that it could be difficult to build a fraud case around those disclosures. "For a criminal case, they would need to show that at the time of this offering, Lehman knew some bad facts that it didn't tell everybody," former Prosecutor Christopher Clark told the Stamford Advocate. "That will probably be fairly difficult to show. The fact that Lehman was in some financial distress was known to everyone in the world."

Prosecutors will undoubtedly review financial disclosures, conference call conversations and which shares and assets were sold or repositioned, said former federal Prosecutor Andrew Hruska.

"The primary theme is: Was Lehman telling investors one thing and doing another," he said.

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