A news release said the agency alleges that John P. Flannery and James D. Hopkins 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.
However, according to the SEC, by 2007 the fund was almost entirely invested in subprime residential mortgage-backed securities and derivatives, but continued to be described as less risky than a typical money market fund. The extent of its concentration in subprime investments was not disclosed to investors.
Flannery was a chief investment officer at State Street, while Hopkins was a product engineer who the SEC said is currently State Street’s head of product engineering for North America. The Wall Street Journal reported Hopkins had also left the company.
The SEC alleged both men “played an instrumental role in drafting a series of misleading communications to investors.”
According to the SEC's order, 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, the SEC charged.
The regulator further alleged that State Street's internal advisory groups, one of which reported directly to Flannery, decided to recommend all their clients redeem from the fund and the related funds. The pension plan of State Street's parent company, State Street Corporation, was one of those clients.
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, the SEC said. This left the fund and its remaining investors with largely illiquid holdings.
In the settlement with the firm announced jointly by the SEC and the offices of Massachusetts Secretary of State William F. Galvin and Massachusetts Attorney General Martha Coakley earlier this year, State Street agreed to pay more than $300 million to investors who lost money during the subprime market meltdown in 2007 (see State Street Settles Subprime Mortgage Charges with State, Feds).
State Street distributed those funds to investors in February and March and has also paid nearly $350 million to investors to settle private lawsuits.
More information about the latest SEC case is at http://sec.gov/litigation/admin/2010/33-9147.pdf.