Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

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Tuesday, May 5, 2009

SEC Charges The Reserve Primary Fund with Fraud

On May 5, 2009, the SEC filed a civil action in the United States District Court for the Southern District of New York charging the entities and individuals who operate The Reserve Primary Fund, including the Reserve Management Company, Inc. (RMCI), its Chairman, Bruce Bent Sr., its Vice Chairman and President, Bruce Bent II, and Resrv Partners, Inc., with fraud for failing to provide key material facts to investors and trustees about the fund's vulnerability as Lehman Brothers Holdings, Inc. sought bankruptcy protection. The Reserve Primary Fund "broke the buck" on Sept. 16, 2008, when its net asset value fell below $1.00 per share. In bringing the enforcement action, the SEC also seeks to expedite the distribution of the fund's remaining assets to investors.

According to the complaint, defendants failed to provide key material information to the Primary Fund's investors, board of trustees, and ratings agencies after Lehman Brothers filed for bankruptcy protection on September 15. The fund, which held $785 million in Lehman-issued securities, became illiquid on that day when the fund was unable to meet investor requests for redemptions. According to the SEC's complaint, the defendants misrepresented that RMCI would provide the credit support necessary to protect the $1 net asset value of the Primary Fund when, in fact, RMCI had no such intention.

The SEC also alleges that RMCI significantly understated the volume of redemption requests received by the fund and failed to provide the trustees with accurate information concerning the value of Lehman securities. Because of these misrepresentations and omissions, the fund was unable to strike a meaningful hourly net asset value as required by the fund's prospectus.

The complaint alleges that RMCI, Resrv Partners and Bruce Bent II violated Section 17(a) of the Securities Act of 1933 (Securities Act) and Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) and Rule 10b-5 thereunder and that RMCI directly violated and Bruce Bent Sr. and Bruce Bent II directly violated and aided and abetted violations of Sections 206(1), (2) and (4) of the Investment Advisers Act and Rule 206(4)-8 thereunder. The complaint further alleges violations by Bruce Bent Sr. and Bruce Bent II of Section 10(b) and Rule 10b-5 thereunder as aiders and abettors and control persons.

The complaint names the Reserve Primary Fund as a relief defendant and seeks an order pursuant to Section 25(c) of the Investment Company Act and Section 21(d)(5) of the Exchange Act compelling a pro rata distribution of remaining fund assets which would release a significant amount of money that is currently being withheld from investors pending the outcome of numerous lawsuits against the fund, the trustees and other officers and directors of the Reserve entities.

The SEC's complaint seeks a final judgment permanently enjoining the defendants from future violations of the federal securities laws and ordering them to pay civil penalties and disgorgement of ill-gotten gains plus prejudgment interest.

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