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SEC Sues Money Market Fund Over Losses Connected to Lehman Collapse

By Zachary A. Goldfarb
Washington Post Staff Writer
Wednesday, May 6, 2009

The Securities and Exchange Commission yesterday filed civil fraud charges against a large money market fund and two of its executives, alleging that the Reserve Primary Fund misled investors about potential losses connected to the bankruptcy of Lehman Brothers.

Last September, Lehman's collapse caused the $62 billion Reserve Primary Fund, which loaned money to the investment bank, to "break the buck," meaning that the value of assets fell below the level needed to repay investors for each dollar put into the fund.

The development triggered widespread fear that the $4 trillion money-market-fund business, which individuals and companies usually treat as safe places to put their money, could see damaging runs. It prompted the creation of a $50 billion Treasury Department program to safeguard money market fund assets, as well as massive Federal Reserve programs to assist the market.

The SEC complaint, filed in a U.S. District Court in New York, alleges that the New York-based Reserve Management Co., its chairman Bruce Bent Sr. and its vice chairman Bruce Bent II understated the volume of redemption requests and failed to provide trustees with accurate information about the value of Lehman securities as Lehman Brothers filed for bankruptcy.

After Lehman's bankruptcy, "defendants engaged in a systematic campaign to deceive the investing public into believing that the Primary Fund -- their flagship money market fund -- was safe and secure," the SEC charged.

"The company . . . intends to defend itself vigorously," Reserve said in a statement yesterday.

The Reserve Primary Fund case is the most prominent financial fraud action directly arising from last fall's financial chaos. "We're taking the lead in this matter because we want to get money back into the pockets of the investors as quickly as possible," SEC Chairman Mary Schapiro said in a statement.

Reserve Management Co., which helped pioneer money-market mutual funds in the 1970s, froze the assets of the fund after it "broke the buck." Several lawsuits have been filed to reclaim frozen assets, and as part of its suit the SEC is seeking to consolidate claims to return money to investors.

The SEC is seeking a range of penalties, including civil fines and restitution, against Reserve and its operators.

Credit Default Swaps

Also yesterday, the SEC filed the first case arising from more than a dozen investigations the agency is conducting into the use of exotic financial instruments known as credit default swaps.

The SEC charged Renato Negrin, a former portfolio manager at the hedge fund Millennium Partners, and Jon-Paul Rorech, a salesman at Deutsche Bank, with insider trading in credit default swaps. Credit default swaps work like insurance contracts, covering an investor in case of a bond default.

The agency says Rorech learned information from his bank about a change to a proposed bond offering by the Dutch publishing and holding company VNU that would increase the value of credit default swaps that insure VNU debt. The SEC says that Rorech tipped Negrin off and that Negrin was able to make a $1.2 million profit.

The SEC investigated the complaint through its New York-based Hedge Fund Working Group, which ratcheted up probes in recent months and filed 20 cases this year, more than all of last year.

Credit default swaps "may still be obscure to the average individual investor, but there is nothing obscure about fraudulently trading with an unfair advantage," said James Clarkson, acting director of the SEC's New York office.

An attorney for Negrin said he was confident his client would be exonerated. "Negrin did not trade on inside information," said the attorney, Larry Iason.

"The SEC's case has no merit," said Richard Strassberg, an attorney for Rorech. "Mr. Rorech did not commit insider trading or any other violation of the securities laws. Mr. Rorech intends vigorously to defend his position and expects to be completely vindicated in this matter."

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