2nd UPDATE:SEC Settles With State Street On Subprime Mortgage Charges

State Street Corp. (STT) on Thursday agreed to pay more than $300 million to settle civil charges by the U.S. Securities and Exchange Commission alleging the bank misled investors about its exposure to subprime mortgages.

In a civil complaint filed in a Boston federal court and a related administrative order, the SEC said the bank selectively disclosed information about its subprime mortgage investments to specific investors. The settlement money will go to investors who lost money during the subprime market meltdown. The settlement is in addition to nearly $350 million the bank previously agreed to pay to settle private claims, the agency said.

The settlement came about following a joint investigation between the SEC and state regulators in Massachusetts, including the state's Attorney General and Secretary of State offices.

"Investors in State Street's funds included charities, pension funds and employee retirement plans. All of them relied on State Street to tell them the truth during a time of great economic turmoil," said David Bergers, the director of the SEC's Boston office. "Instead, State Street misled them, telling only certain investors that their money was nearly 100% invested in subprime securities. Those investors were able to get out of the fund, leaving the others with largely illiquid holdings."

State Street spokeswoman Arlene Roberts said the company believes that the settlement is "in the best interest of both our clients and our business."

Roberts said $313 million of the settlement will go toward establishing a FAIR Fund to compensate investors. About $50 million of that will cover a civil penalty and roughly $8 million will go toward disgorgement. In addition, Roberts said the company will also pay $10 million each to the Massachusetts Attorney General's office and the Secretary of State office.

The SEC alleged in its complaint that the bank established a "Limited Duration Bond Fund" in 2002 and marketed the fund as an "enhanced cash" investment strategy and an alternative to a money market fund, which is typically a very safe investment.

By 2007, however, the SEC said the fund was almost entirely invested in residential subprime mortgage-backed securities and derivatives.

Despite its heavy exposure to those toxic products, the SEC says State Street continued to describe the fund as having better sector diversification than regular money market funds and did not disclose the extent of its exposure to subprime investments.

In July 2007, the SEC said State Street sent investors misleading communications about the problems in the subprime market and its effect on the fund. But some investors received more complete information than others, including clients of State Street's internal advisory groups, the SEC said. Based on the information they received, those internal groups recommended that clients should redeem their investments.

Among the clients that received such advice included the pension fund for State Street Bank's publicly-traded parent company State Street Corporation, the SEC added.

State Street then sold the fund's most liquid holdings and used the cash to meet redemption demands of "better informed investors," the SEC said.

The SEC said in its talks with the bank over the allegations, it took into account the bank's efforts to remedy the situation.

Those actions included the replacement of key senior personnel, entering into private settlements with investors and agreeing to conduct a review of its procedures. In addition, the SEC said the bank agreed to provide private information it was not obligated to give the SEC to help the agency assess liability issues.

Massachusetts Attorney General Martha Coakley said in a release Thursday that about 270 investors, 50 of whom are in Massachusetts including charities and religious groups, will be compensated from the settlement.

"With this settlement, we are providing compensation to investors, applying a statutory penalty to State Street, and making sure that State Street reworks its internal practices to prevent these types of problems in the future," Coakley said.

The settlement size is the largest in Massachusetts for all subprime-related cases so far, and for that reason Coakley called it a "landmark decision."

Coakley declined to say if she has other subprime mortgage cases in the works at the moment, but she said her office will "continue our work" in looking at subprime-related issues.

"We have an extensive history here," she said.

SEC Enforcement Division Director Robert Khuzami, meanwhile, said Thursday that investigating potential securities violations arising out of the credit crisis "remains a high priority" for the agency.

-By Sarah N. Lynch, Dow Jones Newswires; 202-862-6634; sarah.lynch@dowjones.com.

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