SEC Looks to Put Buck Back Together in Money Market Case

Reserve Primary Fund investors could get back 99 cents on the dollar.

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After a year of payments and legal wrangling, the broken buck is one step closer to repair. Under a Securities and Exchange Commission plan and a timeline articulated by a federal judge, the Reserve Primary Fund's shareholders could recover by the end of the year all but a penny on each dollar they had invested. But even as the process reaches a partial conclusion, some investors are digging in for another battle.

[See Money Market Insurance Program Set To Expire.]

Last Wednesday, U.S. District Judge Paul Gardephe said that he would like to see the Reserve Primary Fund liquidate virtually all of its holdings by December 23. His remarks came during a hearing on the SEC's plan to compensate investors who had money in the fund, which last September sparked an industrywide panic after it "broke the buck," meaning that its value dipped below $1 per share. After Lehman Brothers collapsed, the $62 billion Reserve Primary Fund's shares fell to 97 cents, shattering the common notion that money market funds—which invest in short-term, low-risk holdings like certificates of deposit and government bonds—couldn't lose money.

If the SEC has its way, each investor will get back 99 cents on the dollar, meaning the losses will be contained to a penny per share. Peter Crane, the president and CEO of the money market tracking firm Crane Data, labeled this prospect a victory for the industry, which suffered from severe investor uncertainty last year and was ultimately stabilized only by a last-minute government insurance program. "I think that the biggest issue is that the losses will be in the range of 1 cent," Crane says. "It's a shockingly small loss any way you slice. All this [drama] is over a penny."

After officially announcing it had broken the buck, the fund put a freeze on redemptions and has since been returning money to investors via pro-rata distributions. To date, there have been four payouts totaling $46.1 billion; a fifth distribution, which will be worth $1 billion, is scheduled for early October. Since the fund holds $785 million in currently worthless Lehman Brothers securities and investors pulled out $10.7 billion in shares before the freeze took hold, it will have $3.5 billion left after the next payout.

This remaining money forms a reserve for various expenses, most of them legal—the fund has been hit with a number of lawsuits in the last year. But the SEC's plan allows the fund to liquidate that $3.5 billion reserve down to $75 million. That's because if the judge signs off on the proposal, most lawsuits against the fund will be barred. There will be an exception for charges of fraud, but even in those cases, any winnings would have to go back into the fund to be distributed to all investors.

The long-term goal of the SEC's proposal is complete liquidation of the fund, but if Gardephe's accelerated timeline holds, investors should have somewhere near 99 cents on the dollar by the close of the year. Still, that assumes that the fund can unload its Lehman holdings for 17 percent of their par value; if not, investors will receive up to a quarter of a cent less per share.

Meanwhile, a separate issue is whether investors will be able to employ "clawbacks" suits against their fellow shareholders. Such suits would seek to retrieve assets from investors who redeemed $10.7 billion in holdings at full value just hours before the fund froze redemptions. It remains unclear whether Gardephe will decide the clawback issue directly or hear recommendations first from a monitor who will be appointed to oversee the fund's liquidation.

Already, though, the potential clawbacks—which, if permitted, could force the early redeemers to distribute some of their earnings to other shareholders who weren't able to pull out—have proven controversial.

In particular, the Massachusetts Securities Division, which is part of Secretary of the Commonwealth William Francis Galvin's office, sent a strongly worded letter to Gardephe. According to the letter, as of the day before the fund broke the buck, 2009 Massachusetts investors held a combined total of $2.158 billion worth of its shares. According to the Securities Division, those investors who were able to receive redemptions should not be punished via clawbacks. "To create a resolution to these claims against the fund, where only investors suffer the harm, is so far from equitable that it should shock the conscience," according to a copy of the letter provided to U.S. News by Galvin's office.