The legal battle over a failed money market fund for community banks is escalating, with investors asking a federal judge to bar the fund's manager from using what's left of their money to pay legal bills.
The plaintiffs -- about 32 community banks from across the country -- accuse the fund's managers, called Community Assets Management Inc., of inappropriately using the remaining $1.4 million in the fund to defend the firm against lawsuits by its former investors.
The investors believe that using their own money to hire legal help to be used against them in court constitutes further harm to the shareholders.
"Plaintiffs submit that it is improper and unjust to permit the company . . . to use plaintiffs' money to defend themselves against the very breaches of duty and securities law violations which caused plaintiff's losses," the complaint states.
The restraining order request came just days after the investors filed suit against Community Management Assets, charging them with fraud, insider trading, breach of fiduciary duty, and other securities laws violations.
The fund failed primarily because more than 40% of its portfolio was tied up in "structured notes," or derivatives, investments that became illiquid when interest rates started to rise earlier this year.
The initial lawsuit, which was filed on Oct. 21 in the U.S. district court in Los Angeles, claims that Community Assets had not disclosed that it had invested in such risky securities.
"It came as a total surprise to me that the money was invested in these kinds of notes," said Ronald Story, chairman and chief executive officer of Ionia County National Bank of Ionia, Mich. Ionia National was an investor in the fund but is not suing because its losses were minimal.
"We were totally shocked," he added. "I'm not saying we won't continue to invest in such funds, but we will be much more careful with where our money is invested."
The fund, called U.S. Government Money Market Fund and part of the. Community Bankers Mutual Fund Inc., first made headlines at the end of September when the fund managers announced it had "broken the buck," or dropped below the $1 share value. This marked the first time in recent memory that a money market fund had fallen below this level.
Of the 94 community banks that had invested in the fund, which represents nearly all the investors, 32 are suing the fund managers and its subadvisers. Those 32 held about 77% of the fund's stock.
In one of the more damning sections of the complaint filed against Community Assets, the investors claim that the fund and its president, John Backlund, were aware of the fund's derivatives problems as early as April but said nothing.
A statement by one of the investors, C. James Crowell, executive vice president of the Bank of San Bernandino, Calif., asserts that Mr. Backlund knew of the troubles "but did not disclose that information since, as he put it, then no one would have continued to invest in the fund."
The lawyers for the investors, Fried, Bird & Crumpacker in Los Angeles, believe the total loss of the fund is in the $3 million range.
The largest loss incurred by a single bank was about $400,000, the law firm said.
The law firm would not identify the largest losers from the fund's failure, but according to the fund's July 15 prospectus, the shareholders with the most stock were Cerritos Valley Bank of Norwalk, Calif., with 10.78% of the outstanding shares, Founders National Bank of Los Angeles with 5.95%, and Bar Harbor Banking and Trust of Bar Harbor, Maine, with 5.62%.
Cerritos Valley and Founders National have assets in the $85 million to $97 million range; Bar Harbor Banking has $267 million of assets.
In the month since the fund fell below $1 a share, the Denver-based Community Assets allegedly earmarked $676,000 of its remaining assets to pay for its lawyers, a Denver firm called James & Keller, and indicated that up to $915,000 of the investors money could be allocated to legal expenses.
To prevent further use of the remaining fund assets, the restraining order requests that the money be placed in an account with the court or frozen in an escrow account, pending resolution of the initial lawsuit.
Calls to Community Assets Management's president, John Backlund, and to the fund's law firm, James & Keller, were not returned.
The Securities and Exchange Commission is investigating the matter. As is its policy, the SEC would not comment on the status of the case. Picture of Fund's Collapse U.S. Government Money Market Fund failed in September,leaving 94 community banks in the lurch.Size of fund at time of collapse: $82 millionNumber of community banks filing suit: 32Percentage of fund's value in derivatives: 40%Percentage of fund's value in derivatives: $1.48 million (approximately)Largest single loss by investor: $400,000 (approximately)