Lehman sideshow underscores regulatory gaps

June 20, 2012

By Reynolds Holding
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

A case that’s a mere sideshow to the Lehman Brothers spectacle underscores serious regulatory gaps. Unable to bag Dick Fuld & Co, the U.S. Securities and Exchange Commission has spent three years suing a money market fund for its exposure to the collapsed bank. But while Lehman wreaked havoc on markets, the Reserve Primary Fund made investors essentially whole. The folly is a reminder of the watchdog’s flaws.

Reserve Primary was only the second money market fund to break the buck, falling below the touchstone $1 a share after getting caught with $785 million of Lehman paper when the bank failed and sparking a broader run. Investors pulled $140 billion from the $3.5 trillion industry in a single day, and the U.S. government was forced to guarantee all funds.

It remains unclear, however, what Reserve Primary did wrong. The SEC alleges that fund founders delayed disclosing the true value of its Lehman holdings and the rate of investor redemptions while falsely promising financial support. The founders, on the other hand, claim they shared information as quickly as possible amid confusing, fast-moving events.

Either way, investors suffered little harm. They got out with more than 99 percent of their money after the fund closed in 2008. Yet the SEC is forcing a costly trial, seeking penalties and any ill-gotten gains.

Meanwhile, the regulator has been flummoxed by Lehman itself. A mere five days before declaring bankruptcy, the bank assured Reserve Primary and other investors of its health. Yet it was papering over serious problems with dodgy accounting that temporarily shifted assets off the balance sheet. Though a court investigator concluded senior Lehman executives could be liable for fraud, they haven’t been charged.

Such cases are tough to win, requiring proof of intentional or reckless wrongdoing. Despite the investigator’s findings, evidence against the likes of Fuld may be thin. And though negligence claims are easier to prove, they’re also harder when the company involved is gone.

The SEC nevertheless sends a confusing and annoying message by doggedly pursuing the Reserve Fund while letting Lehman off the hook. The case is not only a distraction for the agency and a poor use of its resources but a clear marker that the real villains of the crisis have all but gone unpunished.

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