Mass. enters into largest securities recovery settlement to date‏

Nick Rees Feb. 4, 2010, 3:19pm

Martha Coakley (D)

BOSTON (Legal Newsline) - Massachusetts Attorney General Martha Coakley has entered into a settlement with State Street Bank & Trust Company to resolve allegations that it misled fund investors about the riskiness of investments.

The settlement also resolved allegations that State Street failed to disclose material information to investors that was necessary when choosing to remain invested in certain certain collective trust funds that were managed by its fixed income portfolio management team.

"State Street gave preferential treatment to some investors over others, leaving many investors — including dozens of Massachusetts charities and retirement funds - completely unaware of key facts about the funds," Coakley said. "With this settlement, we are providing compensation to investors, applying a statutory penalty to State Street, and making sure that State Street reworks its internal practices to prevent these types of problems in the future."

Under terms of the settlement, the largest securities recovery to date for Coakley's office, approximately 50 Massachusetts residents and 270 investors total, including charities, non-profit companies, religious institutions and retirement funds will receive approximately $310 million.

State Street is also required to make a $78 million payment to investors as part of the settlement if it fails to resolve claims currently pending in a separate class action case in federal court in New York over certain ERISA investment claims.

A $10 million penalty will also be paid by State Street under terms of the settlement. The company also has agreed to undergo a procedures review by an Independent Compliance Consultant and has agreed to change internal practices in accordance with the ICC's recommendations to avoid similar problems in the future.

The settlement, which is still subject to approval by the Suffolk Superior Court, follows a lengthy investigation that saw Coakley's office partner with the Boston regional office of the federal Securities and Exchange Commission and the Securities Division of the Massachusetts Secretary of State's Office.

The investigation revealed that, during the 2007 subprime market crash, State Street's investment management arm failed to disclose material information to investors that would necessary for investors to decide if they should remain invested.

As a result, investors in approximately 40 funds were affected, including those in State Street's Limited Duration Bond Fund, Bond Market Common Trust Fund, Bond Market Non-Lending Fund, Intermediate Bond Common Trust Fund and Short Term Bond Common Trust Fund.

Investors in the bond funds were allegedly told they were a "moderate" active risk, or for those seeking attractive returns, a "controlling risk" or "preserving capital." State Street, in an attempt to keep these returns high, invested heavily in sub-prime related investments, including derivatives tied to the subprime market.

Investors were then sent letters from State Street that allegedly failed to disclose material information about the bond funds. A July 26, 2007 letter failed to disclose the full extent of the funds' subprime exposure or that the funds' losses were almost exclusively attributable to subprime holdings. The letter also did not disclose that a major State Street advisory group had already decided to recommend to their advisory clients that they liquidate their fund holdings.

State Street had also decided to sell most liquid holdings of the Limited Duration Bond Fund, which was not disclosed in the July 26, 2007 letter. Funds from that liquidation would be used to meet the redemption demands of internal advisory group clients and others leaving the fund, causing remaining investors to hold largely illiquid holdings. This also allegedly forced the remaining investors to maintain their holdings in a volatile market environment.

Additional letters sent from State Street in succeeding months allegedly failed to disclose information about the advisory group liquidations. An August 14, 2007 letter noted that State Street's investment management arm believed that "many judicious investors" would continue to hold their positions in the subprime market and failed to disclose that the internal advisory groups recommended that their clients abandon the funds. State Street's own retirement fund, by this time, had liquidated its holdings.

Investors who stayed in the funds following the letters were left with significant losses as the funds became more and more illiquid as the subprime market continued to erode.

Coakley's action in this case was brought under the state Consumer Protection Act and the State False Claims Act. The Secretary of the Commonwealth is also entering into a settlement with State Street to resolve state administrative claims.

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