Botched financial planning is the accusation facing Northern Trust Company, which has been sued by the Chicago Teachers’ Pension Fund over claims that the investment company breached its fiduciary duty and made unsuitable investments in risky, long-term securities that ultimately plummeted in value. 

The lawsuit - which seeks class-action status - was filed by Public School Teachers’ Pension and Retirement Fund of Chicago and the city of Atlanta Firefighters’ Pension Plan. It also names Northern Trust Investments N.A. 

As reported Feb. 2 by Pensions & Investments, the lawsuit stems from a Northern Trust securities lending program.  Specifically, the 43-page complaint states that instead of investing the Chicago and Atlanta funds in conservative, highly liquid, ultra short-term investment funds, “Northern Trust, in flagrant violation of its duties, locked the funds into risky, long-term investments - including hundreds of millions of dollars of unregistered, illiquid securities that plummeted in value.” 

On July 31, 2007, almost 70% of the securities held in the Short-Term Extendable Portfolio (STEP) were not due to mature for more than a year-and-a-half, and more than 20% of the securities in STEP were not due for at least 10 years,” the suit alleges. 

“The STEP portfolio included hundreds of millions of dollars in exotic, unregistered securities issued by structured investment vehicles, or SIVs - entities that were recently identified in hearings before the congressional Financial Crisis Inquiry Commission as one of the causes of the financial crisis that served no good or productive purpose in the financial system - and millions more in securities backed by risky residential mortgages and other consumer loans.” 

As of July 31, 2007, more than 15% of the securities in STEP were invested in unregistered securities - securities which, by definition, can only be sold under certain narrow circumstances and for which there is no ready market, the suit said. 

Those unregistered securities included two structured investment vehicles, Sigma Finance and Theta Finance Corp. Both were created and managed by the United Kingdom-based investment management company, Gordian Knot.  According to the lawsuit, the notes issued by SIVs are exotic, high-risk investments that were outside the enumerated classes of securities permitted to be held in STEP. 

The lawsuit further contends that because SIVs in general - and Sigma and Theta in particular - lacked an established track record, they were entirely inappropriate investments for a conservative fund such as STEP. 

The complaint also cites what could be some telling information by Northern Trust’s chief economist, Paul Kasriel. In 2006, according to the complaint, Kasriel said the following: “The U.S. housing market was in a ‘recession’ and that the housing market would ‘pull the economy down’ in 2007.” 

Northern Trust, however, ignored the warnings of its own chief economist and kept the collateral pools invested in securities, the lawsuit states. And those securities had significant exposure to mortgage-backed securities, SIVs and financial institutions that (Mr.) Kasriel warned were overly exposed to mortgage-backed investments. 

Northern Trust has denied the allegations.

The fate of the Columbia Strategic Cash Portfolio Fund was sealed on Dec. 10, 2007, when losses on investments in mortgage and certain asset-backed securities combined with a $20 billion withdrawal from a single institutional investor forced Bank of America to shutter one of the largest U.S. short-term funds catering to institutional investors.

The Columbia Strategic Cash Portfolio Fund is run by Columbia Management, a unit of Bank of America. Described as an enhanced cash fund and a suitable substitute for money market accounts, the Columbia Strategic Cash Portfolio Fund went from $40 billion in assets to about $12 billion in a matter of months.

The reasons behind the forced liquidation of the Columbia Strategic Cash Portfolio can be traced to its exposure to risky asset-backed securities and structured investment vehicles (SIVs) tied to real-estate mortgages. Some of the SIVs associated with the fund were later downgraded by credit-ratings agencies, creating more losses for the fund.

Unlike traditional money-market funds, the Strategic Cash fund didn’t provide investors with a guarantee to maintain a $1-per-share net asset value.

At the time the Columbia Strategic Cash Portfolio was shuttered, only a few investors found themselves able to liquidate their positions. Other investors were given a pro rata share of the fund’s underlying securities in lieu of cash. And still other shareholders were told they could cash out at the fund’s current share price at a loss.

The liquidity problems associated with enhanced cash funds like the Columbia Strategic Cash Portfolio are reminiscent of those found in auction rate securities, investments once deemed as a safe haven for individual and institutional investors to park their cash. When the market for auction rate securities collapsed in February 2008, however, investors quickly discovered that their investments were far from cash-like.

And that’s exactly what many investors in the Columbia Strategic Cash Portfolio Fund have discovered. Case in point: Costco Wholesale Corporation. As reported May 16, 2008, by the Puget Sound Business Journal, Costco unsuccessfully tried to pull out of several enhanced cash funds in 2008, with $371 million that remained frozen in the Columbia fund and two similar funds. In turn, Costco was forced to report a $2.8 million write-down on investments in those funds because of the decline in their value, according to the company’s 2008 10-K filing with the Securities and Exchange Commission (SEC).

Other companies affected by the Columbia fund include Getty Images. As of March 31, 2008, Getty had $20.4 million invested in the Columbia Strategic Cash Portfolio Fund. According to the Puget Sound story, Getty reported a $400,000 loss because of the decline in the value of the fund.

Another company, SonoSite, Inc., had $8.2 million tied up in the Columbia fund as of March 31. Ultimately, the medical devices company reported $300,000 in losses from that investment.