Roughly a month ago, the $500 million Middlesex pension fund, third largest system in Massachusetts, announced its intention to file suit against Mellon for breach of contract and negligent misrepresentation, among other claims (see  Mellon Unit Faces $40 Million Suit ).   Today Adler Pollock & Sheehan, lawyers for the Middlesex Retirement System, announced the filing of the suit.   They also said the fund fired Mellon at the end of June and hired State Street as the fund’s new custodian.   Mellon had provided custodian services to Middlesex since 1995.

Price “Check”

Middlesex claims that Mellon failed to accurately verify pricing data from a Bay State firm that had been investing pension money in foreign currency options.   The now-closed Cambridge Financial Management Inc. (CFM) had been providing statements to Middlesex through Mellon, valuing its investments at $1.6 million, the board said. However, after the death of fund manager James T. Kneafsey, founder and principal of CFM, the Middlesex system said it “learned for the first time that CFM was the only account where Mellon took market values for traded securities from a fund manager.”

In a press release, the attorneys for Middlesex state that CFM was managing a foreign currency overlay program that, “given Middlesex’s significant international investments, was a recognized method of reducing risk to protect against currency fluctuations.”   The attorneys say that by June 2002, Mellon’s reports showed that CFM had nearly doubled the initial investment of $4 million, and that “given the positive returns as documented in Mellon’s reports,” there was no apparent reason to question CFM’s performance or activities.

Value “Statement”

In a statement issued late Thursday, Pittsburgh-based Mellon said it ” categorically denies” the allegations and said it will “vigorously defend itself.”   Mellon also said, “Under its agreement with Middlesex, Mellon’s role was to take the values reported by Cambridge and report them to Middlesex.”

Mellon went on to say Middlesex hasn’t sued Cambridge, “who, as Middlesex’s investment manager, had full responsibility for entering into these foreign-currency options contracts, and who provided false pricing information to Mellon and Middlesex,” according to Reuters.

For its part, Middlesex continues to point to portions of Mellon’s responses to the fund’s requests for proposal (RFP), which contained language extolling the virtues of the custodian’s accounting systems and methodologies (see  Mellon Unit Faces $40 Million Suit ) – while Mellon’s position appears to be predicated on a more limited reading of its scope as custodian.

Counter-Party Claim

There was at least one new allegation from the Middlesex attorneys – that “in the ensuing investigation, Middlesex learned that Mellon handled more than half of CFM’s trades,” going on to claim that, as the counter-party, Mellon Brokerage profited from investments made by CFM on which Middlesex lost money.

“Since we made the discovery, we have taken prompt and appropriate actions to protect and preserve the fund’s assets and minimize and recoup actual or potential losses,” James Fahey, Jr., chairman of the Middlesex Retirement System’s board, said in a statement.   “Despite our aggressive efforts to get at the truth since Mr. Kneafsey’s death, much about how Cambridge Financial Management sustained such heavy losses remains unclear,” he added.

The lawsuit also names Boston Safe Deposit and Trust Co., The Boston Co., and Russell/Mellon Analytical Services as corporate defendants.