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According to the U.S. Securities and Exchange Commission (“SEC”), Massachusetts-based State Street Bank and Trust Company (“State Street”) misled investors about the extent of subprime mortgage-backed securities in funds managed by State Street.  Conservative investors who thought they were investing in money market equivalent funds wound up owning funds full of extremely risky subprime mortgages.  According to the SEC, investors lost more than $300 million through investment in those funds.  Specifically:

State Street established the Limited Duration Bond Fund (“the Fund”) in 2002 and marketed it 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 that magnified its exposure to subprime securities.  The SEC alleged that State Street continued to describe the Fund to prospective and current investors as having better sector diversification than a typical money market fund, while failing to disclose the extent of the Fund’s concentration in subprime investments. 

The SEC’s complaint also alleges that State Street gave accurate information about just how risky the Fund was to certain of its clients, allowing them to avoid the big losses suffered by most State Street investors.  State Street has already paid back more than $300 million to aggrieved investors.  The $300 million plus that State Street will pay in connection with the SEC’s charges will also go to investors.

Charles Schwab, which has been accused of an almost identical fraud in its Yield Plus funds, has yet to do the right thing. Here’s hoping that the SEC is hot on Schwab’s trail.