Investors in a failed community bank money market fund won a partial victory last week when the investment managers agreed to distribute most of what remains in the fund -- about $1 million -- to investors.

Those investors -- 94 community banks across the country -- will receive a distribution of 1.1 cents a share. The payout will compensate the banks for part of the initial 6-cent-pershare, or $3 million, loss they suffered.

"From our standpoint it was a really good result," said David Schachter, a lawyer with Los Angeles-based Fried, Bird & Crumpacker, which represents 32 investors. "Now it's just a matter of pursuing the lawsuit to obtain the rest of the remuneration that is due them [the investors]."

The fund managers, called Community Assets Management Inc., previously had retained the money in part to defend themselves against anticipated lawsuits by the investors. Of the 94 community banks that had invested in the fund, 32 sued the firm about a month ago, charging it with fraud, insider trading, breach of fiduciary duty, and other securities violations.

The suit came shortly after Community Assets dissolved the fund in late September. About 40% of the fund's portfolio was in derivatives, the primary cause of its failure. The securities, which were mainly government backed, were tied to interest rates, and when rates rose earlier this year the investments became virtually illiquid.

The largest single loss by an investor was about $400,000.

The plaintiffs followed the suit several days later with a court challenge to bar the firm from using what was left in the fund to pay legal bills. Community Assets, located in Denver, had set aside 1.8 cents a share -- about $1.48 million -- for its legal reserve.

Mr. Schachter said one of the next steps is to amend the original complaint filed against Community Assets Management to add new parties to the list of defendants. One of those could be KPMG Peat Marwick, the accounting firm that audited the fund last winter.

"I don't know if Peat Marwick will be named or not," Mr. Schachter said. "Their last audit was as of Feb. 28, 1993. If there is no mention at all of the problems with the structured notes, then that factor alone is troublesome to us."

Carroll Wallace, the auditor in Peat Marwick's Denver office who handled the fund's audit, would not comment on the case.

A partner in Peat Marwick's New York office, speaking of mutual fund audits in general, said it is the auditor's duty to point out investments that violate the terms set out in a fund's prospectus.

While assessing the safety and soundness of an investment can often be a subjective process, an auditor still must determine the loss potential of investments and alert the board of directors if there is a problem, the partner said.

According to the fund's July 15, 1994, prospectus, the fund's objective was "to earn the highest possible yield consistent with liquidity and preservation of capital." It also sought to "provide national banks with an appropriate source of portfolio liquidity through mutual fund investment."

That statement puts the fund managers in conflict with the Securities and Exchange Commission, which ruled earlier this year that derivative investments are too risky for mutual funds.

James Koury, president and chief executive of Cerritos Valley Bank in Norwalk, Calif., one of the largest shareholders in the collapsed fund, said the plaintiffs were pleased with last week's decision but also realize that there are no funds left to make up the remaining amount that was lost.

"We're at ground zero as far as the next phase goes," Mr. Koury said. "We're still huddling to reassess any additional recoveries."

Mr. Koury's bank expects to receive about $45,000 from the distribution.

For some of the plaintiffs, the distribution was enough to make them drop out of the lawsuit. Colorado's First National Bank of Durango, for example, will receive $17,000 in the latest payout and believes involvement in any further litigation would not be worthwhile.

"These two payments were like finding money in the streets," said John A. Marvel, president and chief executive of First National. "We're just pleased to get something back. We made the business decision that any more legal expenses just aren't prudent. I imagine most of the other investors will stay in the hunt, though."

Mr. Marvel's bank, which has about $130 million of assets, lost about $60,000 from the fund's failure.

Community Asset Management's Rocky Aftermath

Sept. 26

Community bank investors learn that the fund has "broken the buck" and likely will be dissolved

Oct. 12

Investors request that remaining amount in the fund be returned to them or placed in escrow account

Oct. 21

Thirty-two of the investors file suit against the fund and other parties

Nov. 23

Fund managers agree to pay back $1 million of the $1.48 million left in the fund to the investors

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