$600 Million Set Aside by State Street May Be Tip of Mortgage Litigation Iceburg

State Street Corp. announced it established a pre-tax reserve of $618 million billion “to address legal exposure and other costs associated with the under-performance of fixed-income strategies managed by the company’s investment management arm,” blaming exposure to subprime mortgages. The company referenced “customer concerns as to whether the execution of the strategies was consistent with the customers’ investment intent” without identifying any specific litigation.

However, the New York Times published an article stating that State Street created the reserve “after five clients sued it, claiming they had lost tens of millions of dollars in State Street funds they were told would be invested in risk-free debt like Treasuries.” The article added that State Street’s reserve “highlight the legal challenges that lie ahead for financial firms.”

The first of the five lawsuits referenced by the Times article was filed October 1, 2007, by Prudential Retirement Insurance and Annuity Co. The action “seeks, among other relief, restitution of certain losses attributable to certain investment funds” sold by State Street’s investment management arm, and alleges State Street “failed to exercise prudent investment management,” in violation of the Employee Retirement Income Security Act of 1974 (ERISA).

The complaint says the defendants “radically altered” the investment strategies of two bond funds, the Intermediate Bond Fund and the Government Credit Bond Fund and “took undisclosed, highly leveraged positions in mortgage-related financial derivatives” and thereby “exposed” the funds to “an inappropriate level of risk” that during the summer of 2007 “produced catastrophic results.” The complaint further alleges that as these events unfolded the defendants provided “untimely, incomplete and misleading information” causing losses of “roughly $80 million” to assets held by about 165 retirement plans for which Prudential is responsible, affecting approximately 28,000 plan participants.

This and three other lawsuits against State Street which reportedly lead to the mortgage litigation reserve allege ERISA violations were involved. One of these suits was filed October 17 by Unisystems and the trustee of the Unisystems Employees’ Profit Sharing Plan. Another was brought on October 24 by the Composite Pension Trust of Nashua Corporation. The third was brought on October 31 by the plan administrator and the trustee of the Employees’ Savings and Profit Sharing Plan of the Andover Companies.

A fifth lawsuit (not specifically identified by the New York Times article) alleging only state law claims, and not Federal ERISA violations, was filed on November 5 in a Harris County, Texas, District Court by Memorial Hermann Healthcare System. On December 3, the defendants removed the Memorial Hermann case to Federal Court in the Southern District of Texas. The petition alleges that the State Street defendants breached an “Agreement of Trust” to serve as trustee of nearly $91 million in the plaintiff’s assets, claiming these assets were invested in the State Street Limited Duration Bond Fund which lost 37 percent of its value during three weeks in August 2007.

The State Street lawsuits are reported to be indicative of legal problems to be faced by various financial institutions over the “mortgage meltdown” which began last year, including not only originators and market-makers in mortgage instruments, but also those who purchased such investments for others and perhaps companies who issued strong ratings concerning those investments.

The law firm of Shepherd Smith and Edwards is dedicated to assisting investors who have sustained losses as a result of improper handling of their retirement or other assets. Please contact Shepherd Smith and Edwards to arrange a free confidential consultation with one of our attorneys to discuss whether you may have a viable claim to recover your losses.