State Street sued over bond fund losses

BOSTON --Institutional money manager State Street Corp. now faces three lawsuits over its management of bond funds that were touted for their conservative investment strategies, yet posted losses over the summer because of risky holdings tied to the subprime mortgage industry.

Managers of public employee funds in at least two states that suffered losses are following the litigation closely but have yet to file their own complaints.

The latest lawsuit was filed last week in federal court in Boston by Nashua Corp., a Nashua, N.H.-based maker of paper and imaging products, against State Street's investment arm, State Street Global Advisors.

State Street also was named in similar lawsuits filed earlier in October by Prudential Retirement Insurance and Annuity Co., a manager of retirement plans, and by New York-based publisher UniSystems Inc.

Nashua lost $5.6 million by investing company pension funds in State Street's Bond Market Fund, due to the fund's "overexposure in mortgage-related securities," according to the lawsuit.

Nashua's complaint seeks class-action certification, which could allow other companies that invested in certain State Street funds to join the case.

"As a result of State Street's misconduct, hundreds of millions, if not billions, of dollars have likely been lost through retirement and pension plans that invested in the bond funds," the lawsuit says.

Arlene Roberts, a spokeswoman for Boston-based State Street, said the company was "disappointed that a small number of our active fixed-income clients" have sued.

"We pride ourselves on our commitment to clients, and we believe that we managed these strategies consistent with stated investment objectives. The events in the fixed-income markets over the summer were unprecedented. We intend to defend ourselves against these complaints," she said.

Nashua's lawsuit seeks unspecified damages and alleges violations of the Employee Retirement Income Security Act, the federal law governing retirement plans in private industry.

"State Street held out the bond funds to be actively managed funds with little investment risk and returns comparable to their respective benchmark indices," the lawsuit says.

But State Street "significantly deviated from its investment strategy," the lawsuit says.

For example, as of the end of July, the Bond Market Fund "had invested more than 27 percent of the portfolio in asset-backed securities comprised of home equity loans" in the mortgage industry's subprime segment, the lawsuit says.

In late August, Nashua received a letter from State Street advising it of a more than 12 percent loss in the fund that month, in a period when an index the fund was supposed to track posted a 1 percent gain, the lawsuit says.

Idaho and Alaska are among the states with state employee funds that were invested in so-called "enhanced index" bond funds offered by State Street -- funds buffeted by the recent turmoil in investments tied to subprime mortgages geared toward customers with spotty credit.

Alan Winkle, executive director of the Public Employees Retirement System of Idaho, said Wednesday that his agency was reviewing the matter "to find out what happened."

Idaho has not pursued litigation over $3 million to $4 million in losses in a state Unused Sick Leave Benefits Fund that had invested in State Street's Government/Credit Bond fund, Winkle said.

Michael Barnhill, an attorney in Alaska's Department of Law, said his state is conducting a review after 1,300 state employees suffered losses totaling $6.1 million from their elective investments in a State Street Bond fund offered through a state supplemental annuities savings plan. Barnhill declined to comment on whether Alaska might sue State Street over the loss.

State Street says the problematic funds amounted to a small fraction of the $244 billion in fixed-income funds it manages. About $36 billion of that total is actively managed -- as opposed to passive funds that track indexes. The proportion exposed to subprime mortgages amounted to $7.8 billion as of June 30, and just $2.6 billion as of Sept. 30, Roberts said.