Federal Judge Implements SEC's Pro Rata Distribution Plan in Connection with Money Market Fund That Collapsed in Lehman Chaos

A federal judge has approved the SEC’s pro-rata distribution plan providing an equal payout to all shareholders of a liquidating money market fund who have not had their redemption requests fulfilled, regardless of when they submitted those redemption requests. The court determined that distributing the fund’s limited assets on the basis of unreliable NAV calculations would not be equitable. While acknowledging that pro rata distribution is not necessarily a plan that everyone would like, the court said it was the most equitable means of distributing the remaining assets of the fund in light of the unprecedented circumstances surrounding its collapse. The court found authority under Section 21(d)(5) of the Exchange Act to grant any equitable relief that may be appropriate or necessary for the benefit of investors. SEC v. Reserve Management Company, Inc., 09 Civ. 4346 (PGG), 11-25-09.

The fund collapsed and became the first money market fund open to the general public ever to “break the buck’’ as part of the extraordinary and unique circumstances surrounding the implosion of Lehman Bros. Holdings, Inc. The fund faced a tidal wave of redemption requests as a result of Lehman’s bankruptcy filing. The run on the fund coincided with a period of enormous turmoil in the credit markets that resulted in a near freeze of trading. Sitting in equity, the court crafted a remedy providing appropriate and necessary equitable relief. With regard to distribution plans in securities cases, noted the court, the Second Circuit has stated that the Commission’s judgment is entitled to deference, in light of its experience and expertise in determining how to distribute funds.

Fund investors deciding whether or not to redeem following the collapse of Lehman were unable to make informed decisions or operate on an equal playing field in light of the chaotic circumstances and the actions of fund managers and salespeople. Even for those investors who sought to redeem part or all of their investments, said the court, the order in which they redeemed is far from clear. For example, a number of claimants contended that they redeemed at an earlier time than that reflected fund records

The Commission pointed out that any attempt to unravel the factual tangle presented by the fund’s interactions with investors on September 15 and 16, 2008, would necessarily involve the complex task of recalculating and reassessing the hourly NAV figures struck on those days. In the court’s view, such an undertaking would require a difficult, time-consuming, fact-intensive and expensive inquiry in light of the discrepancies in redemption records and the fact that the NAV is based not just on the value of the fund’s assets but on the number of shares remaining in the fund at any given time. And at the end of that exercise, the issues concerning why certain investors chose not to redeem would remain. Courts confronting similar circumstances have opted for a pro rata distribution as the fairest and most equitable approach.

Rejecting claims of contractual right to redemption at a NAV of $1.00 per share, or the fund’s statutory obligation to pay redemptions at the stated NAV, the court advised claimants to remember that the court is sitting in equity and is charged with crafting an equitable remedy that takes account of the competing claims of all unpaid investors. Finally, the court rejected the argument of some investors that the fund’s acceptance of their requests to redeem changed their legal status from shareholders to creditors, dictating that they must be paid in the order they redeemed and before those who have not redeemed, who they claim are equity holders. Given that the fund is in liquidation, reasoned the court, all of its current shareholders are “creditors” seeking the return of their investments.

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