November 14, 2012
Some Observations on SEC v. Reserve Primary Fund, Et Al
Posted by David Zaring

Reserve Primary is the mutal fund that broke the buck during the financial crisis, and the SEC sued it and the Bent family that ran it for fraud and negligence in 2009.  Would this case be the one that showed that the financial crisis is being policed?

No, the consensus seems to be, given that the jury failed to find that either of the Bents had committed fraud.  Once again, the agency found itself in the difficult position of indicting the kind of things that worked against Ken Lay and Jeffrey Skilling (but there was also Andy Fastow's extremely dodgy featherbedding there), but doesn't always work in tough times: prosecuting executives for trying to calm the passengers as the ship was going down.

That didn't work with the jury, though they did find one Bent to be negligent, and got the company (as opposed to its managers) for fraud.  Some observations:

  • As we have observed, thousands of individuals went to jail after the S&L crisis, which makes the zero individuals going to jail in the wake of this much bigger crisis mystifying.  But maybe we should start crediting the surmises of prosecutors that cases against individuals are hard to win.  The question would be: what changed?  Just the locus of the crimes - Wall Street now, Main Street then?
  • “Today’s verdict of liability sends the message that fund executives cannot withhold from investors and trustees key information about their fund’s vulnerability,” [SEC Enforcement Director Robert Khuzami] said. “This case, along with our actions against more than 100 other entities and individuals, demonstrates our continuing commitment to pursuing cases arising out of the financial crisis."  I'd be very interested in knowing what this "100 defendants" group includes.  Can't be the hedge fund investigations (which are being handled by DOJ and the SDNY anyway).  Shouldn't be the usual affinity scams about stimulus money, or whatever.  So that seems like a pretty large group of relatively anonymous targets.
  • It could be that the better conclusion is that the SEC was making a mountain out of a molehill here.  As we observed upon reading the complaint:
the allegations look like the usual nondisclosure of bad news type stuff (usual to someone who doesn't track securities fraud very closely, anyway), with the remedy being a pro rata distribution of the Fund's remaining assets.

The key, though, appears to be that the Fund didn't reveal how exposed it was to Lehman Brothers (the defendants are there "for failing to provide key material facts to investors and trustees about the fund's vulnerability as Lehman Brothers Holdings, Inc. sought bankruptcy protection," as the SEC puts it).  Since Reserve Primary did tell everyone this three days after Lehman folded, the allegation appears to be that the three day delay was fraudulent.  Yikes!

One interesting question is whether this is sorta a case broken by journalists, given that the SEC has been talking about hiring them - the WSJ did a takedown of Reserve Primary, alleging that the putatively staid fund began chasing alpha with more exotic investments, in December.  It didn't emphasize the Lehman exposure angle, but maybe there isn't too much gap between that story and this complaint.

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