A growing number of institutional investors lost patience with securities-lending losses and frozen enhanced cash collateral pools and turned to the courts for relief.
The litigation is piling up: To date more than 20 securities-lending-related suits have been filed against seven custodians or securities-lending agents including the industry's three major custodians — Bank of New York Mellon Corp., Northern Trust Corp. and State Street Bank and Trust Corp.
Ongoing suits over losses incurred in 2008 in cash collateral pools stemming from the bankruptcy of Lehman Brothers Holdings Inc. or from failed individual investments like Sigma Finance Inc., a structured investment vehicle sponsored by Sigma Finance Corp. have been filed by the Imperial County Employees' Retirement System, City of Birmingham (Mich..) Employees' Retirement System. Manhattan & Bronx Surface Transit Operating Authority Pension Plan, AFTRA Retirement Fund, and Automobile Mechanics' Local No. 701 Pension Fund. Some suits seek class-action status or have been combined.
Other investors that have ongoing suits against their custodians over frozen enhanced cash collateral pools that back securities-lending programs include the Missouri Public School Retirement System and the retirement plans of FedEx Corp., Lockheed Martin Corp. and BP Corp. North America Inc.
The most recent legal action is a joint suit filed Jan. 29 in U.S. District Court in Chicago by the $9.2 billion Chicago Public School Teachers' Pension and Retirement Fund and the $363 million City of Atlanta Firefighters' Pension Plan.
The suit accuses Northern Trust Investments NA and Northern Trust Corp., Chicago, of “breaches of contract and fiduciary duty” in managing assets related to securities lending, according to the suit.
Rather than invest securities-lending collateral pools “in conservative, highly liquid, ultra-short-term investment funds,” Northern Trust, “in flagrant violation of its duties, instead locked those funds into risky, long-term investments — including hundreds of millions of dollars of unregistered, illiquid securities that plummeted in value,” the 43-page complaint said.
“For example, as of July 31, 2007, almost 70% of the securities held in (the short-term extendable portfolio) were not due to mature for over a year-and-half, and over 20% of the securities in STEP were not due for at least 10 years,” the suit alleges.
According to court documents, more than 15% of the assets of the STEP fund as of July 31, 2007, were invested in unregistered securities, “which, by definition, can only be sold under certain narrow circumstances and for which there is no ready market.” Those unregistered securities included two structured investment vehicles, Sigma Finance and (its corporate sibling) Theta Finance Corp., which the court filing said were not permitted by the guidelines of the STEP fund.
Avi Josefson, Chicago-based senior counsel, Bernstein Litowitz Berger & Grossmann LLP, New York, which is representing the pension funds in the suit, said in an interview that Northern Trust imposed withdrawal limitations in September 2008 and alleged the pools sustained further losses after doing so.
“While the loss sustained by Northern Trust is small compared to the $9.2 billion value of our portfolio, CTPF trustees, with the assistance of legal counsel, determined that litigation was in the best interest of our pensioners and members,” according to a Chicago fund statement.
The suit seeks unspecified award of damages and lifting of withdrawal limitations. In addition, it seeks an order that plaintiffs in the class are not liable for realized and unrealized losses incurred in the collateral pools, according to the suit.
Northern Trust said in a statement responding to the lawsuit, said: “We believe the litigation is seeking to assign blame for extraordinary, global economic events of 2007 to early 2009 ... In 1995, the (teachers) fund selected a custom investment option which gave it complete discretion over investment guidelines and level of potential risk and reward. Northern Trust complied with the fund's investment guidelines in reinvesting cash collateral for its securities lending program ... Northern Trust will vigorously defend itself against this litigation.” — Christine Williamson and Barry B. Burr