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In re Reserve Fund Securities and Derivative Litigation

February 24, 2010


The opinion of the court was delivered by: Paul G. Gardephe, U.S.D.J.:



No. 09 MD. 2011 (PGG)

This action arises from the unprecedented collapse of the Reserve Primary Fund, 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. After Lehman announced on September 14 that it would file a bankruptcy petition, a run on the Fund ensued. Over the next two days, the Fund received redemption requests totaling approximately $40 billion. On September 16, 2008, the Fund announced that it had "broken the buck" -- i.e., its per-share net asset value ("NAV") had fallen below $0.995 -- and officially suspended redemptions to investors.

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 before this Court. See In re the Reserve Fund Securities and Derivative Litigation, 09 MD 2011.

The Securities and Exchange Commission filed this action on May 5, 2009, against Defendants Reserve Management Company, Inc. ("RMCI"), Resrv Partners, Inc., Bruce Bent Sr., and Bruce Bent II (collectively, "Defendants"). The Complaint also names the Reserve Primary Fund as Relief Defendant.*fn1

Defendants move to dismiss the complaint pursuant to Fed. R. Civ. P. 12(b)(6). For the reasons set forth below, Defendants' motion to dismiss is DENIED.


RMCI, which operates under the name "The Reserve," is a privately held corporation which provides "investment advisory services to five registered, open-end, investment companies set up as trusts, offering a total of 22 open-end investment portfolios," collectively known as the Reserve Funds. (Compl. ¶ 19) Resrv Partners serves as distributor for all of the Reserve Funds. (Compl. ¶ 20) The Reserve Primary Fund -- a money market fund -- is the "flagship" of the Reserve Funds. (Compl. ¶¶ 3, 31)

Bruce Bent Sr. is the Chairman of RMCI and Chairman, President, Treasurer and Trustee of the Primary Fund. (Compl. ¶ 21) Bruce Bent II, his son, is Vice Chairman and President of RMCI and the Co-Chief Executive Officer, Senior Vice President and Assistant Treasurer of the Primary Fund. (Compl. ¶¶ 22, 27)

Founded in 1971, the Primary Fund has historically invested in conservative assets selected for safety and liquidity. (Compl. ¶ 34) In 2007 and 2008, however, the Fund allegedly began to invest in higher risk commercial paper issued by financial institutions, including Lehman, for the purpose of generating a higher return. (Compl. ¶ 35)

On Monday, September 15, 2008, Lehman filed its bankruptcy petition. (Compl. ¶¶ 3, 51) Because of the Primary Fund's holdings in Lehman securities, the Fund was immediately "besieged by shareholders seeking to redeem their shares." (Compl. ¶ 3) At 10:10 a.m. on September 15, State Street Bank and Trust Company, the Primary Fund's custodial bank -- having processed $10 billion in redemptions -- stopped funding redemption requests and suspended the Fund's overdraft privileges. (Compl. ¶ 61) On September 16, 2008, RMCI issued a press release announcing that the Fund had reduced its valuation of its Lehman holdings 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. (Compl. ¶ 121) The Primary Fund had thus "broken the buck," a "catastrophic development for a money market fund and its shareholders."*fn2 See Compl. ¶ 37. On September 29, 2008, RMCI "disclosed that the Primary Fund's Board of Trustees had voted to liquidate the Fund and distribute its assets to shareholders." (Compl. ¶ 123)

The Commission alleges that while the Fund was collapsing on September 15 and 16, 2008, the Defendants "engaged in a systematic campaign to deceive the investing public into believing that the Primary Fund . . . was safe and secure despite its substantial Lehman holdings." (Compl. ¶ 1) Defendants are alleged to have "violated the antifraud provisions of the federal securities laws" by engaging in a "campaign of misinformation" designed to "persuade investors to refrain from redeeming shares, and to induce new purchases of shares" in the Primary Fund. (Compl. ¶¶ 4-6)

The Primary Fund's Board of Trustees began meeting to address the effects of the Lehman bankruptcy on the Fund at 9:30 a.m. on September 15, 2008. At that meeting, Defendants Bent Sr. and Bent II, along with RMCI's chief investment officer ("CIO"), reported that there was "no valid market for Lehman paper," but that bids were in the range of 45 to 80 cents on the dollar. (Compl. ¶ 57) These statements were made despite "market data available to RMCI on the morning of September 15, which was shared with the Bents but not the Board," suggesting that "Lehman debt would not trade any higher than between $0.30 and $0.40" on the dollar. Id. The Complaint alleges that Bent Sr. also recommended that the Board value the Lehman holdings at par, despite conceding "that he would not authorize RMCI to purchase the Lehman debt at par value." (Compl. ¶ 58) The Trustees ultimately settled on a valuation of 80% of par. Id.

The Board met again at 1:00 p.m. on September 15. The Complaint alleges that RMCI and the Bents made several additional misstatements and omissions to the Board at this meeting including: (1) failing to inform the Board that State Street had suspended the Fund's overdraft privileges such that redemptions were no longer being paid; (2) understating the level of redemptions facing the Primary Fund; (3) failing to disclose that the Yield Plus and International Liquidity Funds, two other Reserve Funds holding Lehman debt, had broken the buck on the morning of September 15; and (4) failing to disclose that RMCI and Bent II had taken steps to avoid disclosure of the fact that the Yield Plus and International Liquidity Funds had broken the buck. (Compl. ¶¶ 62, 75)

At the 1:00 p.m. meeting, the Defendants introduced the idea of RMCI entering into a credit agreement to support the Fund's $1.00 NAV. The Complaint states that "persistent questions posed by the rating agencies and shareholders," as well as actions taken by another money market fund to protect its $1.00 NAV, "exerted immense pressure on RMCI and the Bents to publicly reassure shareholders that RMCI would in fact protect the $1.00 NAV of the Primary Fund." (Compl. ¶ 70) When the Board of Trustees convened at 1:00 p.m. on September 15, Bent II is alleged to have "informed the Trustees that RMCI intended to implement a credit support agreement to protect the $1.00 NAV of the Primary Fund" and to "seek immediate relief from the Commission to implement the credit support agreement." (Compl. ¶ 71) The Complaint indicates that outside counsel for the Independent Trustees asked whether RMCI had the financial resources to enter into such a support agreement. (Compl. ¶ 72) Bent Sr. is alleged to have reassured the Independent Trustees that RMCI would be able to provide sufficient capital. Id.

The Complaint alleges that at the 1:00 p.m. Board meeting, and throughout the day on September 15, Defendants failed to inform the Board not just of several crucial developments, but also of their "exceedingly grim assessment of the situation." (Compl. ¶ 101) For example, the Complaint alleges that by mid-afternoon "senior RMCI personnel, including the chief financial officer and CIO, had acknowledged that State Street's suspension of overdraft privileges (which occurred at approximately 10:10 a.m.) was the 'kiss of death' for the Primary Fund, and that the Fund was 'screwed' unless 'something magical happens.'" Id. Nevertheless, the Board was not informed that State Street had suspended the Fund's overdraft privileges until the morning of September 16. (Compl. ¶ 116)

Shortly after the 1:00 p.m. Board meeting, Bent II sent an e-mail to RMCI's Director of Sales and Marketing, with cc's to RMCI's General Counsel, COO, and Bent Sr. (Compl. ¶ 77) The e-mail stated that RMCI "intend[s] to protect the NAV on the Primary Fund to whatever degree is required. We have spoken with the SEC and are waiting [for] their final approval which we expect to have in a few hours. You may communicate this to clients on an as needed basis . . . [] if you want something on the website I need to see language for approval first, thanks." Id. The Complaint alleges that this e-mail was "materially misleading" in that RMCI and the Bents did not intend to protect the Primary Fund's NAV "to whatever degree [was] required" and "had not yet arrived at any decision concerning whether and to what extent [they] would support the Fund. . . ." (Compl. ¶¶ 78-79) Moreover, RMCI had not submitted a written request to the Commission seeking approval for a credit support agreement, and no such request was ever submitted. (Compl. ¶ 80)

Bent II also placed calls to rating agencies Moody's and Standard & Poor's and assured them that RMCI would be entering into a credit support agreement to preserve the $1.00 NAV of the Primary Fund. (Compl. ¶ 81)

As a result of Bent II's e-mail, the sales team -- which included Resrv Partners sales personnel -- told Primary Fund shareholders about RMCI's planned credit support agreement. (Compl. ¶ 84) The Complaint alleges that some members of the sales team indicated that RMCI and the Bents would "definitively" "step in and support" the Reserve Funds and would take "whatever steps that are needed to support the NAV of the funds." Id. One salesperson is alleged to have told an investor that "we have a backstop and are going to ensure that the fund does not break a buck." Id. The Complaint also alleges that these representations concerning a credit support agreement were designed to encourage prospective investors to purchase shares in the Primary Fund. (Compl. ¶ 85)

Bent II's e-mail is also alleged to have led RMCI marketing personnel to issue a shareholder communication entitled "The Reserve Insights." This communication, which was reviewed before distribution by Bent II, Bent Sr., and RMCI's sales and marketing teams among others (Compl. ¶¶ 89-91), is alleged to contain the following false statements: (1) that RMCI intended to enter into a credit support agreement to support the Primary Fund's $1.00 NAV; (2) that RMCI was submitting appropriate documentation to the Commission to ensure the implementation of the credit support agreement; (3) that the support agreement would "ensure the integrity of the $1.00 NAV"; and (4) that the Lehman holdings would not have a "material impact" on the Fund or a "negative impact[]" on the Fund's NAV because the holdings would "mature at par value." (Compl. ¶ 92)

"The Reserve Insights" release was sent to numerous Primary Fund investors, as well as to Standard & Poor's and Moody's. (Compl. ¶¶ 93-96) The communication was later posted on RMCI's website and, on September 16, was e-mailed to Crane Data, a web site covering developments in the money market industry. (Compl. ¶ 113) E-mails written by RMCI's Director of Sales, as well as by RMCI's CIO, indicate that this communication slowed the rate of redemptions from the Primary Fund and delayed adverse action by the rating agencies. (Compl. ¶¶ 86-87, 96-97, 110)

The Complaint alleges that despite Defendants' assurances that a credit support agreement would be put in place, the Bents "never asked to review or execute" the draft documentation, nor did they submit any such documentation to the Commission for approval. (Compl. ¶¶ 98-99)

In addition to disseminating allegedly misleading information about a credit support agreement, the Complaint alleges that Defendants misled investors and rating agencies as to the true state of affairs at the Fund throughout the day on September 15. The Complaint claims that RMCI and Resrv Partners sales personnel "falsely assured investors via telephone communications and email that the Primary Fund was not experiencing any liquidity problems and that any delay in transmitting money was caused by operational or technical delays at State Street," despite knowing that State Street had suspended the Fund's overdraft privileges, resulting in redemptions not being paid. (Compl. ¶ 102)

The Complaint also alleges that RMCI falsely informed Moody's during the afternoon of September 15 "that redemptions appeared to have 'stopped'" and that RMCI had been able to generate sufficient liquidity to fund outstanding redemption requests by selling assets. (Compl. ΒΆ 103) This message was reiterated by Bent ...

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