The opinion of the court was delivered by: Paul G. Gardephe, U.S.D.J.
The Securities and Exchange Commission filed this action on May 5, 2009. Pursuant to the Complaint's Eighth Claim for Relief, which names Relief Defendant The Reserve Primary Fund ("Primary Fund"), the Commission seeks an order that inter alia (1) provides for a pro rata distribution of the remaining assets of the Primary Fund; and (2) enjoins all claims against (a) Primary Fund assets, including shareholder claims against the Primary Fund, and (b) any of the Defendants or their officers, directors, trustees, representatives, agents or employees to the extent that such claims are subject to indemnification by the Primary Fund. The Commission also requests that the Court appoint a monitor to oversee the distribution of Primary Fund assets and to review any claims by the Primary Fund's adviser and distributor for management fees and expenses, and any claims by Primary Fund indemnitees for indemnification expenses, among other duties.
On June 8, 2009, this Court ordered the Commission and the Primary Fund to provide notice of this proceeding and the Commission's application to all record owners of shares of the Primary Fund, and directed all claimants against the assets of the Primary Fund, the Defendants, or any of their respective officers, directors, trustees, representatives, agents or employees to file any objections to the entry of the relief sought by the Commission by July 22, 2009. (Dkt. No.11, June 8, 2009 Order)
The Primary Fund and its Board of Trustees -- including the Independent Trustees -- support the Commission's application. (Relief Def. Aug. 21 Br. 9-10; Independent Trustees Aug. 21 Br. 1) While the Defendants do not concede the truth of all of the Commission's factual allegations, they also support the SEC's application.*fn1 (Def. Aug. 21 Br. 2) Similarly, investors holding shares representing over 75% of the Primary Fund's remaining assets have filed submissions supporting the SEC's application or have not objected to it. See Relief Def. Aug. 21 Br. 4-5.
Based on the hearings held in this matter and on the written submissions of the parties and of claimants against the Fund, and for the reasons set forth below, this Court will issue an Order with this Memorandum Opinion providing for, inter alia, the pro rata distribution of the remaining assets of the Primary Fund and enjoining all claims against (1) Primary Fund assets, including shareholder claims against the Primary Fund; and (2) any of the Defendants and any of the Defendants' officers, directors, trustees, representatives, agents or employees to the extent that such claims are subject to indemnification by the Primary Fund. As discussed below, the Court will refer to a monitor or aUnited States Magistrate Judge the responsibility of overseeing the distribution of Primary Fund assets and reviewing claims by the Primary Fund's adviser and distributor for management fees and expenses, and claims by Primary Fund indemnitees for indemnification expenses.
This action arises from the unprecedented collapse of the Reserve Primary Fund,*fn2 a money market fund that, as of September 14, 2008, held debt securities issued by Lehman Bros. Holdings, Inc. ("Lehman") with a face value of $785 million, amid total assets under management of $62.5 billion.*fn3 (Osnato Decl. Ex. 3)*fn4
On Sunday, September 14, 2008, Lehman announced that it would file for bankruptcy protection the following day. In response to this announcement, on Monday morning, September 15, 2008, the Primary Fund faced a tidal wave of redemption requests. By 8:40 a.m., redemption requests totaled more than $5 billion. (Osnato Decl. Ex. 6)*fn5 At 10:10 a.m., State Street Bank and Trust Company, the Primary Fund's custodial bank, stopped funding redemption requests and suspended the Fund's overdraft privileges. (Osnato Decl. at 7) Although redemptions were no longer being paid out, requests continued to pour in. By 10:30 a.m., redemption requests had doubled, totaling more than $10 billion. (Osnato Decl. Ex. 6)*fn6 By 1:00 p.m., redemption requests had grown to approximately $16.5 billion. (Osnato Decl. Ex. 3)*fn7
The run on the Primary Fund continued throughout the day and into Tuesday, September 16. By 3:45 Tuesday afternoon, redemption requests totaled a staggering $40 billion (Osnato Decl. Ex. 15),*fn8 or roughly two-thirds of the total assets under Fund management. The run on the Primary Fund coincided with a period of enormous turmoil in the credit markets that resulted in a near freeze of trading.*fn9
At the first meeting of the Primary Fund's Trustees -- conducted at 8:00 a.m. on September 15 -- the Trustees tasked Reserve Management Company, Inc. ("RMCI"), the Fund's investment advisor, to "review market events and pricing activity" in an effort to reach a valuation for the Primary Fund's Lehman holdings. (Osnato Decl. Ex. 3; Ex. 7 at 15)*fn10 When the Trustees met next at 9:30 a.m., Defendant Bent Sr.*fn11 advised the Board that the Lehman holdings should be valued at par. There is evidence in the record, however, that Lehman debt was trading well below par at that time.*fn12 See Osnato Decl. Ex. 26.*fn13 At the 9:30 a.m. meeting, the Trustees ultimately settled on a valuation of 80% of par (Osnato Decl. Ex. 27),*fn14 a determination that preserved the Primary Fund's $1.00 net asset value ("NAV"). As one Trustee stated at the time, however, choosing that valuation was akin to "throwing a dart on the wall." Id. at 14:11-15:37.
The Trustees met once more on September 15, at 1:00 p.m. (Osnato Decl. Ex. 3)*fn15 Although the record is not entirely clear, there is substantial evidence that the Trustees were told that redemption requests at that time totaled $8 billion. The correct figure was $16.5 billion.*fn16 See Osnato Decl. Ex. 8, Ex. 9 at 62-65.*fn17 The minutes indicate that the Trustees were not told that State Street had stopped funding redemptions and had suspended the Fund's overdraft privileges, both of which had occurred some three hours earlier. See Osnato Decl. Ex. 3; Ex. 9 at 68-70.*fn18
The Trustees did not alter their valuation of the Lehman debt at the 1:00 p.m. meeting, although evidence in the record indicates that trading prices were between 29 and 36 cents on the dollar for Lehman debt throughout September 15. See Powell Decl. Exs. B-E.*fn19
The minutes of the 1:00 p.m. meeting indicate that the Trustees discussed the possibility of the Primary Fund entering into a credit support agreement with RMCI aimed at preserving the $1.00 NAV. (Osnato Decl. Ex. 3)*fn20 The minutes further reflect that, under questioning by the Trustees, RMCI represented that sufficient capital would be made available to support the Primary Fund and preserve the $1.00 NAV. Id.
During the afternoon of September 15, RMCI issued a press release addressing the effect of Lehman's bankruptcy on the Primary Fund. (Osnato Decl. Ex. 16)*fn21 The release states that RMCI "intends to enter into support agreements with the Primary Fund to support the value of Lehman credit held in the Fund," and that these "support agreements ensure the integrity of a $1.00 NAV." Id. The release further states that RMCI has "discussed with the SEC that our intent is to mitigate any decline in value of the Lehman debt so that it will not result in a decrease to the NAV of the Fund," and that RMCI would submit "appropriate documentation to the SEC today, September 15, 2008," to put those support agreements in place. Id. RMCI did not enter into such support agreements, however, and by the following morning the Bents had concluded that "RMCI could not support the Primary Fund's NAV." (Osnato Decl. Ex. 7 at 18)*fn22
The full Board of Trustees next met at 10:00 a.m. on September 16. At that meeting, Defendant Bent II informed the Board that RMCI would not be able to provide the level of credit support necessary to preserve the $1.00 NAV. Bent II further reported that redemption requests through 9:00 a.m. on Tuesday totaled $24.6 billion. (Osnato Decl. Ex. 15)
At 10:30 a.m., immediately following the meeting of the full board, the Independent Trustees convened an Executive Session by telephone. (Osnato Decl. Ex. 11)*fn23 The Independent Trustees discussed "how shocked they were by the information relayed to them by Reserve Management during the morning's earlier call," including the amount of the redemption requests on September 15 and RMCI's announcement that it could not support the $1.00 NAV. Id.
The Independent Trustees then engaged in "extensive discussion as to how to value the Lehman commercial paper held by the Primary Fund." (Osnato Decl. Ex. 11 at 1)*fn24 In response to RMCI's representation that there had been "indications of interest" in the Primary Fund's Lehman paper, "[t]he Trustees determined that in light of the fact that there were no actual trades or bids in the markets, these indications of interest were more a reflection of a bankruptcy type valuation than an estimate of value that could be realized on a current sale."
(Osnato Decl. Ex. 11 at 1-2)*fn25 The Independent Trustees resolved to focus on "the value that could be realized on an immediate sale of the entire Lehman position" in light of "the huge amounts of redemptions and the likelihood that more will follow." (Osnato Decl. Ex. 11 at 2)*fn26
At the close of this meeting, the Independent Trustees determined that RMCI should be directed to "immediately seek firm bids on the entire Lehman position" and, if RMCI "was unable to obtain such firm bids, then it should value the Lehman paper at zero." (Osnato Decl. Ex. 11 at 2)*fn27 Efforts to find a buyer for the Lehman paper were unsuccessful. See Osnato Decl. Ex. 9 at 91-93.*fn28 Accordingly, the full Board of Trustees reduced its valuation of the Lehman debt to zero as of 4:00 p.m. on September 16, 2008, which caused the Primary Fund's NAV to drop to $0.97 per share. (Osnato Decl. Ex. 14)*fn29 The Primary Fund announced that all redemption requests received prior to 3:00 p.m. would be redeemed at a NAV of $1.00 per share. Id. Redemption requests received after 3:00 p.m. would be redeemed at a NAV that attributed a zero value to the Lehman holdings, yielding a NAV of $0.97 per share. See id. The Primary Fund had thus "broken the buck," becoming the first retail money market fund ever to do so.*fn30
The Primary Fund also announced a "seven day redemption delay" on September 16, in place "until further notice."*fn31 (Osnato Decl. Ex. 14)*fn32 On September 22, 2008, the Commission entered an order suspending redemptions based on RMCI's representation on behalf of the Primary Fund that it would "create a plan for the orderly liquidation" of the Fund.*fn33
On November 26, 2008, RMCI issued a press release stating that the Primary Fund had "broken the buck" not as of 4:00 p.m. on September 16, 2008 -- as previously announced -- but instead had dropped below a $1.00 NAV as of 11:00 a.m. on September 16. (Osnato Decl. Ex. 13)*fn34 The November 26 press release disclosed "an administrative error in computing the Fund's NAV." Id. In computing the hourly NAV*fn35 on September 15, 2008, RMCI's Fund Accounting Group valued the Lehman holdings at 80% of par, as directed by the Board of Trustees. Id. On September 16, however, the Fund Accounting Group "inadvertently left out" the write-down of the Lehman paper in calculating the NAV, causing the NAV to be overstated. Id. Had the Lehman paper been valued at 80% of par throughout the morning of September 16 as the Trustees had instructed, the Primary Fund's NAV would have fallen to $0.99 per share at 11:00 a.m. and remained at $0.99 per share until the Trustees reduced their valuation of the Lehman holdings to zero that afternoon. See id.
The drop in the NAV of the Primary Fund, and the suspension of redemptions, led to the filing of numerous class and individual actions, most of which have been consolidated for pre-trial purposes before this Court. See In Re: The Reserve Fund Securities and Derivative Litigation, 09 MD 2011. In light of this litigation, the Board announced on February 26, 2009, that it had created a special reserve of $3.5 billion to satisfy "(a) anticipated costs and expenses of the Fund, including legal and accounting fees; (b) pending and threatened claims against the Fund, its officers and Trustees; and (c) claims, including but not limited to claims for indemnification that could be made against Fund assets." (Osnato Decl. Ex. 1)*fn36
During the past year, the Primary Fund has, under Commissionsupervision,*fn37 distributed $47.1 billion in Fund assets. An estimated $3.5 billion remains to be distributed.*fn38
To date, Primary Fund assets have been paid out on a pro rata basis to those shareholders who were not fully paid for shares they beneficially owned on or after September 15, 2008. The Commission and the Independent Trustees estimate that if all remaining Primary Fund assets are distributed on a pro rata basis to all shareholders, investors will recover approximately 99 cents per share.*fn39 (Sept. 23, 2009 Oral Arg. Tr. 18, 28)
The Commission filed this action on May 5, 2009, and on June 8, 2009, this Court ordered the Commission and the Primary Fund to provide notice of this proceeding to all record owners of shares of the Primary Fund and directed all claimants against the assets of the Primary Fund, the Defendants, or any of their respective officers, directors, trustees, representatives, agents or employees, to file any objections to the entry of the relief sought by the Commission by July 22, 2009. (Dkt. No. 11, June 8, 2009 Order)
The Court's June 8, 2009 Order required that the Commission and the Primary Fund provide notice to potentially interested parties in a variety of ways, including: (1) posting copies of the order and the Commission's application on the Commission's web site, www.sec.gov; (2) serving copies of the order and the Commission's application by overnight courier on the Defendants and all parties in the actions consolidated for pre-trial proceedings pursuant to 28 U.S.C. § 1407 in the multi-district litigation captioned In Re: The Reserve Fund Securities and Derivative Litigation, 09 MD 2011; (3) posting copies of the order and the Commission's application on the Primary Fund's website, www.ther.com, and requiring that both the Commission and the Primary Fund issue press releases announcing the entry of the order and directing investors to the SEC's website and the Reserve's website for additional information; and (4) requiring that the Primary Fund mail copies of the order and the Commission's application to all individuals and entities who were record owners of shares of the Primary Fund as of September 15-18, 2008. (Id.)
II. INVESTOR COMMENTS CONCERNING THE SEC'S APPLICATION
In response to this Court's June 8, 2009 Order, more than 75 investors submitted comments concerning the Commission's requested relief. These investors hold shares representing approximately 47% of the assets remaining in the Fund. (Relief Def. Aug. 21 Br. 5)
A. Support for the SEC's Application
Although the Court's June 8 Order required only those objecting to the SEC's requested relief to make submissions by July 22, 2009, many of the filings received by the Court expressed support for the Commission's application. See, e.g., BP Corp. North America July 24 Ltr. 1; Dyer Group July 27 Br. 1; Visa U.S.A. July 27 Br. 3. Investors holding shares representing over 75% of the Primary Fund's remaining assets have filed submissions supporting the Commission's application or have not objected to it. See Relief Def. Aug. 21 Br. 4-5. Support for the SEC's application is also strong among that group of investors who unsuccessfully sought to redeem their shares on September 15 and 16. By the Primary Fund's estimate, investors holding $28 billion in Primary Fund shares unsuccessfully sought to redeem their shares between the morning of September 15, 2008 and 3:00 p.m. on September 16. Of that $28 billion, investors who held approximately $13 billion in Primary Fund shares on September 15 have filed submissions supporting the SEC's application. (Relief Def. Aug. 21 Br. 4) Holders of an additional $8.5 billion in Primary Fund shares that were not successfully redeemed have not objected to the SEC's requested relief. Id. Accordingly, within the group of unsuccessful redeemers -- by share count -- investors who support the SEC's application or who have not objected to it outnumber objectors by a 3 to 1 margin. Id.
B. Objections to the SEC's Application
All of the investors who object to the SEC's application submitted unsuccessful redemption requests prior to 3:00 p.m. on September 16. Many of the objectors argue that the Primary Fund has a contractual duty under the Fund prospectus to fulfill redemption requests at the NAV next determined after the redemption request, and that because the Board determined that the NAV was $1.00, they are entitled to redeem at that NAV.*fn40 See, e.g., CellCo Partnership Br. 4; E*Trade Entities Br. 9-11; Verisign, Inc. Br. 5-8. Several of the objectors likewise argue that Rule 22c-1(a) of the Investment Company Act requires that redemption requests be filled at the next calculated NAV, which as to all objectors was $1.00.*fn41 See, e.g., Bank of America Securities Br. 2; Colorado Surplus Asset Fund Trust Br. 3.
In arguing that this Court should give effect to the $1.00 NAVs struck on September 15 and 16, 2008, certain objectors contend that these NAVs were calculated in good faith and according to generally accepted accounting principles. See, e.g., Mount Vernon Securities et al. Br. 7-9 (citing 17 C.F.R. § 270.2(a)-7(c)). These objectors note that the Trustees were consulting regularly with the Fund's auditor and legal counsel on September 15 and 16 and that on the morning of September 16 -- after the Trustees understood how far the value of the Lehman paper had fallen -- they allowed RMCI to seek additional liquidity before changing their valuation of the Lehman debt. See Verisign Br. 7-8.
Other objectors argue that even if the NAVs struck on September 15 and 16 are unreliable, the Primary Fund's assets could and should be distributed based on a more accurate NAV calculated now, with the benefit of hindsight, rather than through a pro rata distribution as proposed by the Commission. See Deutsche Bank Securities Br. 11-12; Russell Investment Co. Br. 13-14. These investors point to the "widespread holdings of Lehman debt securities" as an indication that this Court could now retroactively calculate -- presumably on an hourly basis -- what the NAVs should have been on September 15 and 16. Id.
Some objectors contend that the Primary Fund's acceptance of their requests to redeem changed their legal status from shareholders to creditors. See E*Trade Entities Br. 11; Russell Investment Co. Br. 11. Citing principles of bankruptcy law, these objectors claim that their alleged creditor status dictates that they must be paid in the order they redeemed and before "equity holders" -- i.e., those who failed to submit redemption requests.
Finally, many of the objectors oppose the SEC's request for an All Writs Act injunction, see, e.g., E*Trade Entities Br. 6-8; J.M. Huber Corp. Br. 5-6; Wal Mart Br. 2, particularly in connection with state law claims filed in state court, see id., arguing that cases supporting the issuance of such an injunction under the All Writs Act, 28 U.S.C. ...