SEC Enforcement today charged two employees at Boston-based State Street Bank and Trust Company with misleading investors about their exposure to subprime investments.  In a related case earlier this year, State Street agreed to repay fund investors more than $300 million to settle SEC charges.

John Flannery and James Hopkins are alleged to have marketed State Street's Limited Duration Bond Fund as an "enhanced cash" investment strategy that was an alternative to a money market fund for certain types of investors.  By 2007, however, the fund was almost entirely invested in subprime residential mortgage-backed securities and derivatives.  The fund, nonetheless continued to be described as less risky than a typical money market fund and the extent of its concentration in subprime investments was not disclosed to investors.

    Misleading Communications to Investors.   The SEC claims the individuals played an instrumental role in drafting a series of misleading communications to investors, beginning in July 2007.  Flannery was a CIO (chief investment officer) who's no longer with State Street;  Hopkins was a product engineer at the time, and currently is State Street's head of product engineering for North America. 

The SEC said the misleading communications to investors related to the effect of the turmoil in the subprime market on the Limited Duration Bond Fund (established in 2002) and other State Street funds that invested in it.  State Street provided certain investors with more complete information about the fund's subprime concentration and other problems with the fund.  These better-notified investors included clients of State Street's internal advisory groups, which provided advisory services to some of the investors in the fund and the related funds.

SEC Enforcement further alleges that State Street's internal advisory groups, one of which reported directly to Flannery, subsequently decided to recommend that all their clients redeem from the fund and the related funds - that included the pension plan of State Street's publicly-traded parent company.  At the direction of Flannery and State Street's Investment Committee, State Street sold the fund's most liquid holdings and used the cash it received from these sales to meet the redemption demands of better informed investors.  This left the fund and its remaining investors with largely illiquid holdings. 

In addition to paying more than $300 million to investors who lost money during the subprime market meltdown in 2007, State Street paid nearly $350 million to investors to settle private lawsuits.   [SEC PR 10-177, 9/30]