Bruce Bent, inventor of the money-market mutual fund, and his New York company may be charged by United States federal regulators with violating securities laws in the collapse of its US$63 billion ($109.6 billion) Reserve Primary Fund.
Reserve Management has revealed that it was told last week by the enforcement division of the US Securities and Exchange Commission (SEC) it would recommend suing the company and Bent, its chairman.
The closely held firm also expects the agency to file complaints against Bent's sons, Bruce Bent II and Arthur Bent III.
Reserve Primary's value fell below the US$1-a-share price paid by investors on September 16 because of losses from debt issued by bankrupt Lehman Brothers Holdings, making it the first money-market fund in 14 years to break the buck.
The fund's demise sparked a run on money-market accounts and at least 19 lawsuits over how it was managed and how the losses should be divided among investors.
"The scrutiny to date has likely centred on valuation issues related to the Lehman paper and communications with shareholders," said Peter Crane, president of Crane Data, a research firm in Westborough, Massachusetts. The Bents and the company "expect to defend vigorously against the allegations", Reserve said.
Kevin Callahan, an SEC spokesman in Washington, and Reserve spokeswoman Ming Lee Hatch declined to comment.
SEC staff have been investigating the fund since it broke the buck.
Some shareholders may lose as much as 3 per cent of their investment. The company has so far returned about 78 per cent of the US$51.8 billion that was left in the fund on September 16.
In the three weeks after Reserve Primary broke the buck, institutional investors yanked about US$347 billion from money funds that can buy corporate debt.
The run robbed companies of a crucial source of short-term funding, prompting the US Treasury to roll out a temporary programme insuring money-market fund holdings.
Bent is credited with having invented the money-market mutual fund in 1970, creating a safe and liquid place for retail investors to park cash.
That year he opened Reserve Primary and his company with partner Henry B.R. Brown, who died in August. He was also known for lecturing fellow money-fund managers for taking on excessive risk.
In an interview with Bloomberg News in November last year, he criticised those funds that suffered losses on debt linked to sub-prime mortgages.
"When you get involved in this contest to make three basis points more here or two basis points more there, that's insane," he said. "It's not what I designed the money fund to do."
In addition to Reserve Primary, the company managed an offshore money fund, International Liquidity, and an enhanced cash fund, High Yield, that dropped below US$1 a share because of Lehman holdings. The funds, which are in liquidation, were not regulated by the SEC.
Client redemptions also forced the company to shut down a further 15 money-market funds. Investors in those funds will not suffer losses.
Under a Wells notice, the SEC's staff lawyers inform investigation targets that they plan to recommend legal action in a case.
Defendants are given a chance to respond in writing before the SEC's commissioners vote on any sanctions.
In 90 per cent of the cases, the agency would proceed with the lawsuit, said George Newhouse, a defence lawyer with Brown White & Newhouse in Los Angeles.
The Reserve fund's trouble began when Lehman filed for bankruptcy early on September 15. Reserve Primary held US$785 million in Lehman-issued debt, about 1.5 per cent of assets.
That same morning, the fund's trustees partially wrote down the debt by 20 per cent. The partial writedown was not disclosed until November 26, when the company also announced it had miscalculated the fund's net asset value for several hours on September 16.
The miscalculation caused some investors who are now facing losses to believe initially that they were entitled to get back all their principal investment.
The lawsuits pending against the fund and Reserve Management allege separately that the company selectively disclosed information about its losses, causing some clients to flee the fund before it broke the buck, improperly valued the Lehman holdings on September 15 and violated its prospectus by buying risky assets.
Kirk Dillman, with law firm Hennigan Bennett & Dorman in Los Angeles, said the SEC might focus on the fund's failure to write down its Lehman holdings until the end of the trading day on September 16, more than a day after Lehman filed for bankruptcy.
Shareholders have also sued over how the Lehman losses should be divided. Those who asked to withdraw before the fund broke the buck say they are entitled to all their money, while others claim all account holders should share in the losses.
The fund is being liquidated as securities mature or can be sold without loss. Money returned has so far been distributed to shareholders on a pro-rata basis.
Reserve Management has said it will not distribute any disputed money and will hold back enough money to cover its expenses, including legal costs for the fund, the company and its managers.