State Street made the announcement after five clients sued it, claiming they had lost tens of millions of dollars in State Street funds that they were told would be largely invested in risk-free debt like Treasuries. One fund lost 28 percent of its value during the credit troubles in the summer after placing big bets on mortgage-related securities, according to the lawsuits.
The move by State Street highlights the legal challenges that lie ahead for financial firms that were involved in the origination, packaging and sale of complex mortgage securities.
Last month, a town in Australia sued a unit of Lehman Brothers for selling it collateralized debt obligations that lost 84 percent of their value, a charge refuted by the firm. In Norway, Terra Securities filed for bankruptcy protection in November after regulators revoked its license for selling risky American securities to a cluster of towns near the Arctic Circle.
“This is the first wave of these securities fraud suits,” said Gregory J. Hindy, a securities lawyer and partner at McCarter & English in Newark. “There could be many, many more.”
A study published by the Stanford Law School and Cornerstone Research on Thursday found that the number of securities lawsuits filed in 2007 increased 43 percent from the year before. The study attributed the increase to the subprime crisis. The total number of lawsuits, 166, still remain at historic lows.
State Street, which is based in Boston, said it had set aside the reserves because it wanted to put the issue behind it and because of a “desire to fully respond to customer concerns.” The company said William H. Hunt had resigned as chief executive of State Street Global Advisors, its investment management unit. He will be succeeded on an interim basis by James S. Phalen, who is currently an executive vice president.
The company will take a $279 million after-tax charge to account for the reserve. State Street also said it had closed some funds, dismissed a few lower-level employees and changed some investments policies.
“However, I want to be clear here,” Ronald E. Logue, chairman and chief executive, said in a conference call with analysts. “We will continue to defend ourselves against inappropriate claims, including those that seek recovery of investment losses arising solely from changes in market condition.”
Shares of State Street surged after the announcement, closing up $6.49, or 8.2 percent, to $85.37, a record close for the company.
Investors were pleased by the stronger-than-expected fourth-quarter profit, a large new contract and the fact that the company was moving to address the lawsuits. Dick Bove, a financial services analyst at Punk Ziegel & Company who has been bearish on other financial stocks, upgraded State Street stock to a buy, citing the company’s strong results.
At least four of the lawsuits against State Street stem from mortgage investments the company made for pension fund clients. The suits assert that the company breached its fiduciary duty under a pension law by investing in securities that did not fit the risk tolerance of its clients. It was unclear who brought the fifth suit.
In one case, Prudential Retirement Insurance and Annuity Company asserts that its clients — 165 retirement plans covering 28,000 people — lost $80 million by investing with State Street.
The lawsuit asserts that State Street last year used borrowed money to invest in subprime mortgages and related derivative contracts in a fund that was supposed to invest only in Treasuries and corporate bonds. When Prudential sought information about the investments, the suit alleges, its representatives received evasive and incomplete answers.
One executive at State Street told Prudential employees that its strategy had changed and it “forgot there was a lot more risk in the strategy,” according to the suit.
Others seeking damages include pension funds at a manufacturing firm in New Hampshire, Nashua Corporation; a publishing firm, Unisystems; and an insurance company, Andover Companies.
State Street executives declined to discuss the allegations.
The company has not yet responded to the complaints in court, but it is seeking to have the Nashua case dismissed.
The pension funds are suing under the Employment Retirement Income Security Act, or Erisa, a law passed in 1974 to protect employees’ pension benefits. The law requires managers to act “solely in the interest” of the plan’s participants and beneficiaries.
Proving that a manager breached a fiduciary duty to pensioners is generally easier than proving securities fraud, said Mr. Hindy, the securities lawyer. In a recent decision, the Supreme Court made it even more difficult to win such cases by requiring that plaintiffs demonstrate “cogent and compelling” evidence that the defendants intended to defraud investors.
“The plaintiffs’ bar is very clever,” Mr. Hindy said. “They are looking at Erisa as a way to get out of fraud pleading requirements.”
Mr. Hindy said defendants in subprime securities lawsuits would most likely argue that investors made money from the investments for a time and knew or should have known that there was a risk they could lose money. They will also assert that the bonds in question were highly rated by credit ratings agencies.
Gerald H. Silk, a lawyer who is representing two of the plaintiffs, Andover and Unisystems, said State Street had so far not offered to settle the suits.taken of nytimes.com