State Street Corporation (STT - Analyst Report) has been penalized by Massachusetts state regulators for its alleged role in marketing and selling risky collateralized debt obligation (CDO) without disclosing proper information to its clients. The company has been asked to pay a total of about $5 million ($3.54 million as fees and profits earned on the deal and $1.45 million as penalty).
In 2006, as an investment manager for a CDO, known as Carina CDO Ltd., State Street was helped by Magnetar Capital LLC, a hedge fund in selecting the assets that were included in the CDO. In addition to this, the company was approached by Deutsche Bank AG’s (DB - Analyst Report) Deutsche Bank Securities unit to market and sale the CDO.
However, Magnetar had placed a bet that some of the assets that were included in the CDO would fail and State Street failed to inform the investors who bought the CDO about this predicted mess. Thus, the investors failed to make an informed investment decision as they were unaware of the conflict of interest between Magnetar and other Carina investors.
State Street allegedly harmed the investors by leaving them with a loss of nearly $450 million when Carina failed. However, at this moment, State Street is neither admitting nor denying the findings of the Massachusetts regulators or the conclusions regarding information contained in the offering documents for the CDO.
Massachusetts state regulators have been trying to find out how the banks structured and sold a large number of debt products, prior to the financial crisis in 2008. Last month, Massachusetts regulators stated that they were investigating whether Bank of America Corporation (BAC - Analyst Report) had knowingly inflated the value of assets in two loan portfolios that were sold to the investors in the form of collateralized loan obligations. These loan portfolios led to nearly $150 million of losses to the investors.
We believe that by penalizing State Street, Massachusetts regulators have shown that financial institutions are liable for fines if they do not disclose correct information to the investors. Moreover, the inquiries and fines will lead to proper disclosures of the loan values and other debts by the banks and other financial institutions, which they sell to the investors.
Currently, State Street retains a Zacks #3 Rank, which translates into a short-term ‘Hold’ rating.