From the February 2009 issue of Investment Advisor • Subscribe!

February 1, 2009

State Sues Reserve Funds for Fraud

The Massachusetts Securities Division on January 13 charged Reserve Management Company with making numerous false and misleading statements to investors in attempts to dissuade them from redeeming shares in the company's Primary Fund, which "broke the buck" a day after Lehman Brothers filed for bankruptcy.

According to the complaint, Reserve's Primary Fund held Lehman commercial paper and floating-rate notes, which comprised 1.2% of the Primary Fund's holdings as of September 15, 2008, or about $785 million. That same morning, anxious investors flooded Reserve Management with inquiries about the potential impact of its Lehman holdings on the NAV of the Primary Fund. To calm investors, sales personnel of Reserve Management, at the direction of senior management, made statements and distributed materials that "contained outright falsities which the principals of Reserve Management knew at the time were not true," the complaint states.

The suit further states that Reserve falsely told investors that Reserve Management would support the NAV of the Primary Fund "to whatever degree is required" and that Reserve Management was entering into a capital support agreement to prop up the NAV of the Primary Fund and that the paperwork for the capital support agreement had been submitted to the SEC and was awaiting final sign-off. Reserve also falsely stated that Reserve Management (and the trustees of the Primary Fund) were still valuing the Lehman paper held in the Primary Fund at par, even after they had decided to value it at below par, the complaint states. Finally, Reserve Management stated that the reason the redemptions were not occurring was due to an operations issue at State Street (Reserve Management's custodial bank), not because of any liquidity issues with respect to Reserve itself, the complaint says.

The complaint was filed against Reserve Management Company, Reserve Funds Trust, Reserve Partners, Inc., and Bruce Bent II, son of the Reserve's founder and chairman, Bruce R. Bent.

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