State Street’s Ex-Staff Sued by SEC – Analyst Blog

On Thursday, two former executives of State Street Corp. (STT) were accused by the Securities and Exchange Commission (SEC) of misleading investors about a risky mortgage fund. The SEC stated that Mr. John Flannery (a former member of State Street’s executive management group) and Mr. James Hopkins (the former head of the company’s product engineering for North America) marketed the company’s Limited Duration Bond Fund as an alternative to a money market fund with little risk to the principal.

 

In its complaint, the SEC commented that the State Street fund, which once had $1.4 billion of assets, had lost nearly 37% of its value by the third week of August 2007, after being almost totally tied up in subprime mortgage backed securities and derivatives.

 

According to the SEC, even while Flannery and Hopkins had been selling the funds without informing the clients of the inherent risks, the other investment advisors of State Street had been disclosing the subprime problems. This allowed those clients to exit the fund even as the others were left with an illiquid asset in their portfolio.

 

The SEC seeks a ban on these two employees, which will prevent them from joining any other investment company. It also plans on an indefinite civil penalty.

 

Reacting to the charges, State Street said that the company has already resolved the matter with its clients. In February 2010, the company agreed to pay over $300 million to about 270 investors to settle allegations by federal and state regulators over misleading investors about its investments in subprime mortgages at the beginning of the credit crisis. The company had also agreed to pay a $10 million fine to both the Massachusetts Attorney General’s office and the Secretary of State’s office.

 

State Street is not the only company to be accused of fraud related to subprime mortgage investments. In July 2010, Goldman Sachs Group Inc. (GS) agreed to pay nearly $550 million to settle a similar civil fraud suit linked with subprime mortgage investments.

 

In July 2010, Citigroup Inc. (C) agreed to pay $75 million in an effort to settle charges brought by the SEC over subprime exposures disclosure by the company. In addition to allegations against the company, the charges also individually targeted two Citi executives for preparing and approving deceptive statements.

 

The recent financial crisis precipitated by the meltdown of the subprime market has resulted in an intense scrutiny by the SEC into the subprime exposure of Wall Street companies and any related misdeeds. Going ahead, we expect the SEC to retain its surveillance.

 

Such civil fraud allegations and legal suits could jolt State Street’s operating capacity in an industry that is largely based on goodwill and trust. However, we expect the company’s acquisition of Intesa Sanpaolo’s Securities Services and Mourant International Finance Administration to reinforce its core asset servicing business, supporting the top line.

 

State Street currently retains a short term Zacks #4 Rank (‘Sell’), implying a slight likelihood of downward pressure on the shares over the near term. However, considering the fundamentals, we maintain our long term Neutral recommendation the shares.