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Week In Review

Galvin Charges Reserve, Bent With Fraud

Massachusetts Secretary of the Commonwealth William Francis Galvin filed an administrative proceeding against Reserve Funds and its founder Bruce Bent, accusing them of lying to investors about the dire straights of their investments in Lehman Brothers.

Galvin said the firm "made numerous false and misleading statements to dissuade investors from redeeming their shares of the Primary Fund in the days and hours before it 'broke the buck' and subsequently became unable to meet investor redemptions."

The lawsuit seeks accounting records for the fund for Sept. 15 and Sept. 16 and restitution to all Massachusetts investors, along with a fine to be determined.

Following the bankruptcy of Lehman on Sept. 14, investors flooded Reserve, which held 1.2% of the firm's assets in the Primary Fund, with redemption requests on the following two days. Rather than honestly admit to investors that the Primary Fund, exposed to a $785 million loss, was in danger of breaking the buck, Reserve falsely told them that it would support the fund's net asset value. Further, the fund company allegedly told investors that the reason why redemptions were not being immediately made was because of an operational problem at custodial bank State Street Corp.

Galvin's office said it has obtained an internal memo that Bent personally sent to the firm's global head of sales and other executives on Sept. 15 laying out steps to protect the fund's NAV 100% through a Securities and Exchange Commission-approved capital support agreement. However, in point of fact, the firm never submitted such a request to the SEC, according to the complaint.

Bent, in a deposition to Massachusetts, said the firm decided to delay the request due to the ongoing illiquidity in the markets, yet failed to let the sales team, and Primary Fund's clients, know until 4:15 p.m. Sept. 16, through a press release stating the fund had broken the buck.

In addition, the fund company struggled on Sept. 15 and Sept. 16 over how to value its Lehman holdings, according to the complaint. Although Reserve estimated that the value of its Lehman paper may have fallen to as little as 45 cents on the dollar, or 80 cents at the most, the fund supplied salespeople with materials stating it would support its Lehman holdings at par value.

Further, rather than honor redemptions on a first-come, first-served basis, Reserve prioritized certain larger clients' redemptions over others, according to the lawsuit.

Mutual Fund Firms Slash 3Q Advertising Budgets

A number of large fund companies slashed their advertising budgets by as much as 50% in the third quarter, according to data from Nielsen Monitor-Plus and FRC.

T. Rowe Price went from spending $9.12 million on advertising in the second quarter to only $4.58 million, or 50% less, in the third quarter. Other big cuts came at State Street Corp., which spent $2.62 million on advertising in the second quarter, but a mere $359,000, or fully 86% less, in the third quarter. Bank of America's budget declined 52% from $1.87 million in the second quarter to $891,862 in the third quarter. And, finally, Janus's budget declined 53% from $1.12 million to $529,078.

The biggest spender in the third quarter was Franklin Resources, at $9.5 million, down only slightly from $10.1 million in the previous quarter. The only two major companies to increase their advertising, albeit slightly, were Massachusetts Mutual Life Insurance, which spent $2.99 million in the third quarter, up from $2.43 million in the second quarter, and Vanguard, which spent $3.81 million, up from $1.64 million.

"Advertising is always the first cut because it's a bloodless cut," David Swanson, managing principal at consultancy SwanDog Strategic Marketing told Fund Action. Given the economic crisis, firms are likely to continue cutting their advertising spending throughout 2009, he predicted.

According to a survey Swanson's firm conducted, two-thirds of firms plan to trim those cuts at between 10% and 20%, but only a third foresee them topping 20%.

Financial M&As Expected To Be Brisk in Year Ahead

Large asset management mergers and acquisitions deals will likely occur this year, according to a report from Jefferies Putnam Lovell, as firms take advantage of distressed sales and divestitures.

Last year, there were 217 financial M&As. By volume, 2008 was the second most-active year on record, following 242 deals in 2007. By value, $1.99 trillion in assets under management exchanged, 2008 was also the second biggest year, tied with $1.99 trillion in 2007. The biggest year in terms of assets occurred in 2006, when $2.65 trillion in assets under management were bought or sold.

However, in terms of the value of the deals, companies spent only $16.1 billion on transactions in 2008, down a whopping 68% from $52.1 billion worth of deals in 2007. Last year, only three deals exceeded $1 billion in purchase price, compared with 15 $1 billion-plus M&As in 2007.

In the second half of last year, two-thirds of the value of the deals were of distressed divestitures, a record total. Private equity firms represented only 10% of the value of the deals in 2008.