Nov. 14 (Bloomberg) -- Two months after seizing up, Reserve Primary Fund hasn't disclosed how it will divvy up as much as $785 million in losses among investors. Its decision will test rules for pricing money-market funds, outrage one of two groups of investors and almost certainly be challenged in court.

About 40 hours after Lehman Brothers Holdings Inc. filed for bankruptcy on Sept. 16, Reserve Primary became only the second money-market mutual fund to drop below $1 a share, known as breaking the buck. Now, lawyers are making public arguments and lobbying the U.S. Securities and Exchange Commission over how the losses should be parceled out.

On one side are shareholders who asked to pull $29 billion from the fund on Sept. 15 and Sept. 16, before it broke the buck. They want to be paid in full, leaving remaining investors with losses of about 3 cents on the dollar. Those left behind, who had $22 billion in the fund, say both camps should share the pain. That would trim their loss to 1.5 cents. It would also require the fund to restate the net asset value, or NAV, published on Sept. 16, something no money-market fund has done.

``At stake here isn't just 97 cents versus 98.5,'' said Matthew Herrington, a litigator for Washington law firm Steptoe & Johnson LLP, whose clients had more than $1 billion in the fund. ``It's the sanctity of the NAV system. As an investor, can you trust the posted NAV?''

Reserve Primary, the oldest U.S. money-market mutual fund, became the first since 1994 to break the buck after writing down to zero its holdings of Lehman-issued debt. Once the fourth- largest U.S. investment bank, New York-based Lehman declared bankruptcy in the early hours of Sept. 15.

Sharing Loss

Robert Skinner, a litigator at Boston law firm Ropes & Gray LLP, said the NAV should be restated, making the larger group share the losses because Reserve Primary moved too slowly to mark down its Lehman debt.

``In addition, the fund was experiencing such severe redemptions that it was inconceivable these could be paid out at $1 without imposing unfair harm on the remaining shareholders,'' Skinner said.

Skinner represents Minneapolis-based Ameriprise Financial Inc., whose clients have $3.2 billion in Primary Reserve. The company didn't try to pull out its clients' money until after Sept. 16.

In a separate issue, Ameriprise sued Reserve Primary in U.S. District Court in Minneapolis on Sept. 19 over claims the fund secretly warned some institutional investors about the fund's risks related to Lehman early on Sept. 15. The tips allowed those clients to withdraw money before the fund froze payouts, according to the complaint.

New York's Univision Communications Inc., the Spanish- language media company, has joined the suit. Lawyers for New York-based Reserve Management Co., which runs the fund, have denied the allegations.

Going to Court

No lawsuits have yet been filed over the final distribution of cash. Reserve Primary's governing board hasn't said which resolution it favors.

Whichever path the fund goes, the decision probably will be challenged in court, said Peter Crane, president of Crane Data LLC, a money-fund research firm in Westborough, Massachusetts.

``This has lawsuit written all over it,'' Crane said.

Ming Lee Hatch, a spokeswoman for Reserve Management, said the company has submitted a plan to the SEC for the fund's remaining assets. She declined further comment. The fund began distributing $26 billion of the $51 billion it had left on Oct. 31, sending a proportionately equal amount to all shareholders.

SEC spokesman John Heine declined to comment on whether the staff of the SEC has taken a position on the issue.

SEC Leadership

``This is an issue that the SEC should be showing leadership on, because it has implications way beyond the Reserve fund,'' Herrington said.

Investors use money-market funds, which are offered by banks, asset managers like Vanguard Group Inc. and securities firms such as Charles Schwab Corp., as a safe place to park cash. Companies typically draw on money funds to meet payroll. The funds can be quickly tapped and earn interest.

Reserve Primary held $62.5 billion in assets the morning Lehman declared bankruptcy. By mid-day, investors had pulled out about $11.5 billion before the fund stopped distributing cash.

For the rest of the day and until 3 p.m. on Sept. 16, the fund accepted redemption requests and continued publishing a $1 NAV every hour. It didn't release the money to investors.

China Fund

The investors included China's $200 billion sovereign wealth fund, which had as much as $5.4 billion in Reserve Primary. Under the 1940 Investment Company Act, those investors are entitled to their full redemption, according to Herrington.

The share value dropped to 97 cents at 4 p.m. on Sept. 16 after the fund's board wrote down Lehman debt and formally suspended redemptions.

In calculating this last NAV, the fund followed the Investment Company Act and counted the $29 billion in unpaid redemption requests as if the cash was already out the door. That effectively concentrated the Lehman losses among investors holding the fund's remaining $22 billion.

``They shouldn't have promised redemptions at $1,'' Skinner said. ``They should have stopped, taken a breath and figured out what was the real value of the Lehman holdings.''

To contact the reporter on this story: Christopher Condon in Boston at ccondon4@bloomberg.net

Last Updated: November 14, 2008 00:01 EST