State Street Subprime Damages May Reach 12 Times Reserve Amount

Discussion in 'Wall St. News' started by THE-BEAKER, May 8, 2008.

  1. By Carlyn Kolker

    May 8 (Bloomberg) -- State Street Corp., the largest money

    manager for institutions, may have to pay more than 12 times the

    $625 million it set aside for damages from lawsuits over losses

    from subprime-mortgage investments made for pension funds.

    Prudential Financial Inc., the second-largest U.S. life

    insurer, is suing the Boston-based company on behalf of more

    than 200 retirement plans, alleging that State Street

    inappropriately invested their money in risky securities. Three

    other companies filed similar actions.

    Neither side has disclosed potential losses, though State

    Street has reported that the value of assets ``adversely

    affected'' by the collapse in subprime mortgages fell 56 percent

    to $6.1 billion at the end of 2007 from $13.9 billion on June

    30. That $7.8 billion decline represents the money manager's

    maximum legal exposure, according to Marcia Wagner, 45, a

    partner at Boston-based Wagner Law Group, which specializes in

    retirement fund and employee-benefit law.

    The cumulative loss in value serves as a ``ceiling'' in

    these cases, and the $625 million reserve State Street put aside

    in December is the company's ``floor,'' or minimum liability,

    Wagner said.

    The reserve is a ``lowball,'' Wagner said. ``We are talking

    very large in terms of damages,'' though they're unlikely to

    reach as high as the ceiling.

    ``To the extent plans were misled into purchasing something

    they were not authorized to purchase, they may have a fiduciary

    obligation to sue,'' said Wagner, who isn't representing the

    investment manager or plaintiffs. ``It's sue or be sued.''



    `Bad Investments'



    ``They allowed bad investments, so they should be

    attempting to make the plans whole,'' Wagner said. ``State

    Street is quite exposed, especially if one of its affiliates

    rendered advice or marketed the funds to be something they were

    not.''

    State Street will probably have to pay a minimum of

    $1 billion, according to William Fredericks, 46, attorney for

    plaintiff Unisystems Inc., a closely held New York publisher.

    ``Based on public disclosures to date, damages should

    certainly be in the 10 figures,'' said the lawyer from Bernstein

    Litowitz Berger & Grossmann in New York.

    State Street's reserve is ``currently adequate to satisfy

    our legal exposure,'' spokeswoman Arlene Roberts said. A sum of

    $1 billion would represent 80 percent of the company's 2007 net

    income.

    Three corporate retirement and welfare funds have asked the

    U.S. District Court in Manhattan to consider granting class-

    action status, which allows others with similar claims to join a

    case.



    Companies That Sued



    The companies are Nashua Corp., a maker of print-imaging

    products in Nashua, New Hampshire; Merrimack Mutual Fire

    Insurance Co., based in Andover, Massachusetts; and Unisystems.

    That possibility raises the financial stakes for State

    Street, according to Adam Savett, a vice president at

    RiskMetrics Group Inc., a New York firm that studies corporate

    risks, including legal issues.

    ``When you have a class action, and it's composed of

    hundreds or thousands of people, that starts to mean eye-opening

    amounts of damages,'' Savett said.

    To achieve class-action status, the funds need to show that

    their cases have common facts, said John Coffee, a securities

    law professor at Columbia University in New York.

    ``The common issue will be, did they all get the same

    advice?'' Coffee said. Even without class-action status, the

    pension plans may still sue separately because the size of the

    claims justifies the cost of individual cases, Coffee said.



    Under Erisa



    State Street is being sued under the federal Employee

    Retirement Income Security Act, or Erisa. Plaintiffs claim State

    Street breached its fiduciary duty by investing pensioners'

    money in high-risk securities instead of the conservative funds

    promised.

    That kind of accusation is easier to prove than fraud, a

    claim non-pension plaintiffs would have to make, said Patrick

    DiCarlo, a lawyer at Atlanta-based Alston & Bird, which isn't

    involved in the case.

    ``In your classic securities-fraud context, you have to

    prove a fraudulent intent,'' DiCarlo said. ``Here, all you have

    to prove is that the investment is imprudent.''

    Success against State Street might lead to similar

    litigation against other companies, DiCarlo said. Suits against

    investment advisers including Regions Financial Corp.'s Morgan

    Keegan unit are being studied, according to Derek Loeser of the

    Seattle law firm Keller Rohrback, which represents the

    plaintiffs seeking class-action status.



    Morgan Keegan Response



    ``With there not being any litigation in place, we don't

    have anything to comment on,'' Morgan Keegan spokeswoman Kathy

    Ridley said.

    ``You will absolutely see something like this State Street

    litigation against another company,'' said RiskMetrics' Savett,

    who tracks securities and Erisa cases related to the subprime

    lending crisis. He said he knows of none so far.

    Loeser said he expects State Street to become a target of

    more suits, particularly from public-sector pension funds.

    The company was also sued over pension-fund losses by the

    Houston police officers' pension system, the Memorial Hermann

    Healthcare System in Houston and the Welborn Baptist Foundation

    in Evansville, Indiana. Those cases don't include Erisa claims.

    Litigation makes investors uneasy about the shares,

    analysts said.

    ``It's certainly a dark cloud,'' said Gerard Cassidy of RBC

    Capital Markets in Portland, Maine. ``It's another reason why

    investors have to be cautious on this stock.'' He rates State

    Street sector perform, equivalent to a ``hold'' recommendation.



    Analyst Recommendations



    Nine analysts label the company ``buy,'' and 10 recommend

    holding it, according to Bloomberg data. State Street yesterday

    fell $1.92, or 2.5 percent, to $74 in New York Stock Exchange

    composite trading.

    The company is up 5.8 percent for the past 12 months,

    versus a 7.8 percent decline in the Standard & Poor's 500 Index

    and a 30 percent drop in the S&P 500 Financials Index.

    The cases are combined in In re State Street Bank and Trust

    Co. Erisa Litigation, 1:07-cv-08488, U.S. District Court,

    Southern District of New York (Manhattan).



    *T

    Related news:

    State Street financial analysis: STT US <Equity> FA 16 BN <GO>

    Company subprime stories:

    STT US <Equity> TCNI SUBPRIME BN <GO>

    Litigation stories: STT US <Equity> TCNI LAWSUITS BN <GO>

    State Street's earnings: STT US <Equity> TCNI ERN <GO>

    *T



    --Editors: Charles Carter, Pat Wechsler



    To contact the reporter on this story:

    Carlyn Kolker in New York

    at +1-212-617-4056 or ckolker@bloomberg.net.



    To contact the editors responsible for this story:

    Patrick Oster at +1-212-617-4088 or poster@bloomberg.net;

    Larry Edelman at +1-617-210-4621 or ledelman3@bloomberg.net.