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On Monday, the U.S. District Judge in Manhattan rejected The Bank of New York Mellon Corporation’s (BK - Analyst Report) bid to dismiss a lawsuit filed by the irate securities lending clients. These clients accused BNY Mellon of being reckless in investing their money in the Lehman Brothers Holdings, Inc.

The plaintiffs, led by two Detroit public pensions funds – General Retirement System of the City of Detroit and the Police & Fire Retirement System of the City of Detroit – had indicted BNY Mellon of taking no action to shield the $1.9 billion investments made in the floating-rate notes of Lehman brothers in spite of the clear signals regarding Lehman’s instability in 2008.

Soon, Lehman filed for bankruptcy and it resulted in severe losses amounting to nearly $1 billion for the plaintiffs. As a result, the plaintiffs dragged BNY Mellon to court over their negligent behavior.

The District Judge has dismissed three out of four claims against BNY Mellon while retaining the claim regarding the breach of contract.  This particular claim was retained since the judge was not clear whether the securities lending agreements were good enough to protect plaintiffs’ interest or were lacking due diligence. Further, the judge stated that the claim could be carried forward as the plaintiffs have suffered losses worth $36 million simply because of BNY Mellon’s inattentiveness.

The claims dismissed include breach of fiduciary duty and acting in bad faith. The claim pertaining to fiduciary duty was dismissed as the defendants had faltered in meeting the three-year deadline to file the lawsuit by waiting till September 12, 2011. Further, the district judge opined that the bankruptcy was not the immediate cause of the damages suffered by the defendants.

Other Institution Haunted by Lehman

The Lehman disaster seems to have a never-ending effect on the institutions, which were associated with the company when it filed for bankruptcy in 2008. Earlier in April 2012, it was JPMorgan Chase & Co. (JPM - Analyst Report), which faced the wrath of the U.S. Commodity Futures Trading Commission (CFTC) for allegedly over-extending credit to Lehman for almost two years (November 2006-September 2008) resulting in misuse of customers’ money. Consequently, JPMorgan will pay a fine of $20 million to the CFTC.

Our Take

The dismissal of most of the claims relating to the case allows BNY Mellon to breathe a sigh of relief. However, the pending claim, if proven, would result in penalties and dent the image of the company. Further, the company is facing a deluge of lawsuits associated to its foreign exchange transactions.

Although some of these claims have been dismissed, BNY Mellon remains under tremendous pressure due to the rising expenses. These lawsuits would further increase its costs. In addition, these litigations will force the clients to reconsider their business ties with the company.

BNY Mellon currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. Considering the fundamentals, we also maintain a long-term Neutral recommendation on the stock.

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