Inside the panic at Reserve Fund

The evening of Sept. 15, 2008, was the worst of Bruce Bent II’s career. Panicked investors, who woke up that Monday morning to news of Lehman Brothers’ bankruptcy, had yanked billions of dollars out of the money-market fund Mr. Bent ran with his father, money-market fund inventor Bruce Bent Sr. The business the Bent family had dedicated their lives to, Reserve Management Co., faced disaster if the run on their fund continued.

As the younger Mr. Bent, Reserve’s president, sifted through his e-mails, he reviewed a statement drafted by his marketing staff to calm investors. The final line proclaimed that Reserve was “confident in the underlying credit strength and quality” of its holdings, which included hundreds of millions in debt from Lehman and other free-falling institutions, including Washington Mutual and Merrill Lynch.

“Drop the last line,” he directed, “and then go with it.”

Unfortunately, this editing job represented one of the few times Mr. Bent or his father, the chairman of Reserve, were honest with shareholders in the three terrible days their firm spiraled downward, according to regulators.

The Securities and Exchange Commission last week charged the Bents and Reserve with fraud, alleging that they failed to provide key information to customers, board members and credit-rating agencies after Lehman collapsed. Reserve and the Bents said they would support the $1-per-share asset value of their fund when in fact there was no such intention, the SEC contends. The agency also charges that Reserve misled directors and credit raters by significantly understating how many investors were yanking money after the Lehman bankruptcy hit.

The day after Mr. Bent approved his marketing staff’s statement, disaster struck: Reserve, whose pioneering money-market fund in 1970 spawned a $3.8 trillion industry, “broke the buck.” In other words, the net asset value of its flagship $62 billion Primary Fund fell below the sacrosanct $1 a share because the fund held $785 million in Lehman debt that was suddenly worthless. It was only the second time in history a money-market fund broke the buck — and it unleashed such panic in the stodgy world of cash investments that the federal government had to intervene by week’s end to guarantee money-fund holdings.

Court documents, including copies of e-mails and board minutes, show that Mr. Bent saw trouble brewing even before Lehman filed for bankruptcy. Late Sunday night, Sept. 14, he ordered senior staffers to work on a customer memo “that assumes Lehman liquidates” and warned that Reserve could see up to $1.5 billion of client redemptions the next day.

It turned out much worse than that. “5.2 billion already?” a stunned Reserve executive wrote in an e-mail on Monday at 8:37 a.m. Meanwhile, Mr. Bent and his father, who was in Italy on vacation, were working behind the scenes. Some 45 minutes earlier, unbeknownst to their board, the SEC alleges, they had contacted the Federal Reserve Bank of New York for assistance. The Fed declined.

By midmorning, redemptions were accelerating — they reached $40 billion over two days — and Reserve couldn’t meet the demand because its bank, State Street Corp., stopped wiri ng funds shortly after 10 a.m.

This was the moment. With his father far away, Mr. Bent had to show he had matters in hand. Was he up to it? Known in the industry as Bruce Two, his long hair and a beard hinted at his youthful past as a drum-playing philosophy major. “He was very quiet, very mellow, very introspective,” says Peter Crane, president of money-market tracker Crane Data.

But the 42-year-old had greatly expanded his father’s business. Assets under management grew from about $4 billion in the mid-1990s, when he was handed day-to-day control of operations, to $18 billion in 2002, and swelled to $125 billion last year. Reserve shifted from courting individuals to attracting big corporate accounts like Time Warner Inc. Its biggest client last year, with $5.4 billion in the Primary Fund, was China Investment Corp.

At 1:19 p.m. on Sept. 15, Mr. Bent e-mailed senior staffers, saying the firm would financially support the Primary Fund “to whatever degree is required” so it wouldn’t break the buck. He added that Reserve was awaiting SEC approval, although the SEC contends it never heard from Reserve on the matter and alleges the Bents had no intention of producing the hundreds of millions of dollars necessary to support the ailing fund.

The next day, Sept. 16, Mr. Bent in New York and his father in Italy fruitlessly searched for a cash lifeline or an acquirer. Later that afternoon, Reserve announced that the buck had in fact been broken.

It was a stunning fall for a firm that had proudly marketed its funds as the ultimate in safety and security. The trouble seems to be rooted in 2007, when the senior Mr. Bent, who oversaw investment decisions, began buying short-term debt from brokerage houses like Lehman and Merrill Lynch. Those moves boosted yields and attracted more customers for a while.

In a statement last week, Reserve said it “intends to defend itself vigorously” and the elder Mr. Bent said he is “confident that we acted in the best interest of our shareholders.” The Reserve Primary Fund is being liquidated. Massachusetts regulators have also filed fraud charges, and nearly 30 shareholders have sued.

Aaron Elstein is a reporter at Crain's New York Business, a sister publication of Pensions & Investments