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SEC charges State Street for misleading investors about sub-prime mortgage investments

Feb 05, 2010

The Securities and Exchange Commission (SEC) has charged Boston-based State Street Bank and Trust Company with misleading its investors about their exposure to sub-prime investments while selectively disclosing more complete information to specific investors. State Street has agreed to settle the SEC's charges by paying more than $300 million that will be distributed to investors who lost money during the sub-prime market meltdown in 2007. This payment is in addition to nearly $350 million that State Street previously agreed to pay to investors in State Street funds to settle private claims. "State Street led investors to believe that their investments were more diversified than a typical money market portfolio, when instead they were invested almost entirely in sub-prime investments that ultimately caused hundreds of millions of dollars in losses," said Robert Khuzami, director of the SEC's Division of Enforcement. "Investigating potential securities law violations arising out of the credit crisis remains a high priority for the SEC Enforcement Division." The enforcement action is the result of joint efforts by the SEC with the Massachusetts Securities Division and the Massachusetts Attorney General's office, which both announced related charges against State Street. David P. Bergers, director of the SEC's Boston regional office, said, "State Street informed certain investors and left others in the dark about their sub-prime mortgage exposure. This global settlement will ensure that harmed investors are compensated." According to the SEC's complaint filed in federal court in Boston and a related administrative order issued by the Commission, State Street established its Limited Duration Bond Fund in 2002 and marketed it as an "enhanced cash" investment strategy that was an alternative to a money market fund for certain types of investors. By 2007, however, the fund was almost entirely invested in sub-prime residential mortgage-backed securities (MBS) and derivatives that magnified its exposure to subprime securities. But State Street continued to describe the fund to prospective and current investors as having better sector diversification than a typical money market fund, and failed to disclose the extent of the fund's concentration in subprime investments. According to the SEC's complaint and order, State Street sent investors a series of misleading communications beginning in July 2007 concerning the effect of the turmoil in the subprime market on the Limited Duration Bond Fund and other State Street funds that invested in it. At the same time, however, State Street provided particular investors with more complete information about the fund's subprime concentration and other problems with the fund. These other investors included clients of State Street's internal advisory groups, which provided advisory services to some investors in this fund and related funds. The SEC alleges that, based on this more complete information, State Street's internal advisory groups subsequently decided to recommend that all of their clients including the pension plan of State Street's publicly-traded parent company (State Street Corporation) redeem their investments from the fund and the related funds. The SEC alleges that State Street sold the fund's most liquid holdings and used the cash it received from these sales to meet the redemption demands of better informed investors, leaving the fund and its remaining investors with largely illiquid holdings. Under the terms of the settlement, State Street agreed to pay a $50 million penalty, more than $8.3 million in disgorgement and prejudgment interest, and more than $255 million in additional payments to compensate investors. Combined with nearly $350 million that State Street has already paid or agreed to pay some investors through settlements of private lawsuits, the total compensation to harmed State Street investors is approximately $663 million. State Street also was ordered to cease and desist from any further violations of certain securities laws. The SEC's enforcement action took into account the company's remediation and its cooperation, including: ►Replacement of key senior personnel and portfolio managers. ►Conducting a review of its procedures and revised its risk controls. ►Entering into private settlements with harmed investors. ►Recent agreement — pursuant to a limited privilege waiver — to provide information it was not otherwise obligated to provide to enable the SEC to assess the potential liability of individuals with respect to certain investor communications. The SEC's investigation is ongoing. The Commission appreciates the assistance of the offices of Secretary of the Commonwealth of Massachusetts William F. Galvin and Massachusetts Attorney General Martha Coakley. For more information, visit
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