The Reserve Primary Fund has presented its deeply frustrated shareholders with a stark choice.
If they are patient, they might ultimately get back 98.5 cents for each dollar they had in the money market fund, which in September became only the second such fund to ever “break the buck,” or report a share price below a dollar.
But if they continue to wage legal battles against the fund and its managers, the company will use investors’ own money to defend itself against their accusations of mismanagement and deception.
So this money fund once seen as risk-free has presented investors with a painful dilemma: if they fight for more than 98.5 cents, they risk getting far less, because more of their money will be used to pay the fund’s legal expenses. Those terms, described in a “plan of liquidation” posted on the Reserve Fund’s Web site late Wednesday, are part of the contract that fund trustees negotiated with the money manager that has been running the fund since its inception more than 30 years ago.
Even so, the choice struck some legal experts as brazen.
“This is a very smart thing they have done,” said Tamar Frankel, a law professor at Boston University who has written extensively on mutual fund legal issues. “It pours not only ice water but ice on any claims” by shareholders, she added.
But if the fund’s manager or trustees are to blame for the fund’s current troubles, Ms. Frankel said, she is very skeptical that they will be allowed to tap shareholder money for the legal bills.
The fund’s shareholders can avoid paying those legal bills only if the trustees or the fund adviser have committed willful malfeasance, acted in bad faith, displayed gross negligence or shown a reckless disregard for their duties.
But it is not clear how anyone could prove they engaged in such behavior without some sort of litigation — the very act that could reduce the return of 98.5 cents that shareholders will get if there are no new legal expenses.
“This is a complicated and unprecedented situation,” a spokesman for the trustees said. “The trustees are acting in good faith to treat all shareholders fairly and equitably.”
The offer is the latest jolt for investors in the once-formidable Primary Fund, whose founders invented the money fund concept more than 30 years ago. The fund was the largest of more than a dozen money funds operated by the Reserve Management Company.
The fund began to fray on Sept. 15, the morning Lehman Brothers filed for bankruptcy protection, when the fund was hit by a wave of redemption orders. By the next day, it had broken the buck.
The run was a shock to Primary Fund investors because the fund held only a small amount of Lehman Brothers notes — $785 million, out of $64 billion in assets. And it was a shock to the entire money fund industry, prompting federal regulators to quickly introduce an insurance program for money funds, in a bid to restore investor confidence.
The next day, the fund froze all Primary Fund redemptions and announced plans to liquidate the Primary Fund; within days, it had frozen all its money funds, even those that had not broken the buck, and began trying to liquidate assets in today’s weak credit markets.
The latest plan shows that the fund trustees still have not decided how to handle a fundamental dispute between shareholders who redeemed before the fund broke the buck and those who redeemed afterward. It says only that it “will attempt to resolve the question,” and said it hoped to announce in three weeks how big its legal contingency fund will be.
One of the most potentially damaging claims facing the fund is pending in federal court in Minneapolis, where Ameriprise Financial, hundreds of thousands of whose customers were caught in the fund, is accusing the fund managers of tipping some investors in advance that the fund was in danger of breaking the buck.
“The Reserve’s plan is ingenious,” said Harvey J. Wolkoff, a lawyer with Ropes & Gray in Boston who is handling that case for Ameriprise . “Their plan is that their own investors reimburse them for their wrongdoing.”
Along with the liquidation plan, the fund also announced on Wednesday that it was making a second distribution of cash to shareholders who had been unable to withdraw their money since the fund broke the buck.
The latest distribution of $14.4 billion, added to $25 billion in October, brings the shareholders’ recovery so far to about 80 cents on the dollar.
There is about $10.8 billion in assets left in the fund, about half of which matures between July and October of next year. Unless the credit markets strengthen enough to allow those notes to be sold at par before maturity, the final payments to shareholders could come more than a year after their money was first frozen.