LOS ANGELES (CN) - California claims Northern Trust Corp. played "heads we win, tails you lose" with state pension funds, then forced the L.A. City Employees' Retirement System to cover its $95 million in losses on mortgage-backed securities.
In its Superior Court complaint, the People of the State of California claims that after Northern Trust gambled and lost its money on high-risk investments, it demanded that the Los Angeles Employees' Retirement System (LACERS) pay, "under protest," the millions that Northern Trust had lost, though the money manager had marketed its securities lending program as safe.
"These representations were false and made in knowing or reckless disregard for the truth. Northern Trust failed to disclose to LACERS that Northern Trust selected highly risky investments that Northern Trust knew were unsuitable for LACERS and in violation of the representations which Northern Trust made to LACERS," the complaint states.
In October 2011, Northern Trust disclosed $95 million in losses, involving financial institutions that invested heavily in mortgage-backed securities, including Washington Mutual Bank, CIT Group and Lehman Brothers, the complaint states.
"Northern Trust demanded payment from LACERS for these losses to be made prior to July 8, 2011. LACERS made the payment on July 7, 2011 in the sum of $95,662,812.92, under protest.
"These losses were caused by Northern Trust's mismanagement of its securities lending program for LACERS. Under that program, Northern Trust acted as custodian, investment advisor, fiduciary, and trustee of certain funds belonging to LACERS. Northern Trust warranted that it would invest these funds in such a way as to produce 'almost risk free returns' with 'minimized risk.' Instead, Northern Trust produced substantial losses by investing the assets of LACERS in unsuitable, high-risk investments without the ability to monitor the performance of those investments," the complaint states.
In its 72-page complaint, the state claims that Northern Trust took a share of profits from its high-risk investments, but did not share in the losses, adopting a lending strategy of "heads we win, tails you lose."
"Northern Trust placed its interests in making a profit ahead of the interests of LACERS in preserving capital because Northern Trust had, from its point of view, nothing to lose and everything to gain by making risky investments," the complaint states.
California claims that Northern Trust invested in high-risk, illiquid securities and that "the risk and illiquidity of these investments increased over time."
As early as 2004, Northern Trust knew of the risks of investing with mortgage originating companies such as Washington Mutual, CIT Group and Lehman Bros., but took a punt on them anyway, the state says.
"Long before Northern Trust's securities lending program incurred the first losses, which were tied to the collapse of the housing bubble and the subprime mortgage market, Northern Trust knew that U.S. housing prices were highly inflated, that the inflation in the housing market was unsustainable, and that the bursting of the housing bubble would have severe consequences for investors," the complaint states.
It adds: "Northern Trust kept LACERS in the dark about the investments it made until mounting and staggering losses compelled Northern Trust to provide rudimentary reporting of its activities."
California seeks civil penalties and treble damages for false claims that Northern Trust allegedly submitted to get more than $95 million from LACERS under the securities lending program, and civil penalties and restitution for unlawful and unfair business practices.
The state is represented by Carmen Trutanich with the Los Angeles City Attorney's Office.
Named as defendants are Northern Trust Corp., Northern Trust Co., and Pension Consulting Alliance Inc.