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In Re State Street Bank and Trust Co. Fixed Income Funds Investment Litigation v. State Street Bank and Trust and Order Company

March 28, 2011

IN RE STATE STREET BANK AND TRUST CO. FIXED INCOME FUNDS INVESTMENT LITIGATION
PRUDENTIAL RETIREMENT INSURANCE AND ANNUITY CO., PLAINTIFF,
v.
STATE STREET BANK AND TRUST AND ORDER COMPANY, ET AL., DEFENDANTS.



The opinion of the court was delivered by: Richard J. Holwell, District Judge:

MEMORANDUM OPINION

Plaintiff Prudential Retirement Insurance and Annuity Co. ("PRIAC"), brought this action pursuant to sections 409(a) and 502(a)(2) and (3) of the Employee Retirement Income Security Act of 1974 ("ERISA")*fn1 against defendants State Street Bank and Trust Company ("State Street") and State Street Global Advisors, Inc. ("SSgA, Inc.") on October 1, 2007.*fn2

PRIAC commenced this suit as an ERISA fiduciary on behalf of nearly 200 retirement plans (the "Plans") that invested, through PRIAC, in two collective bank trusts managed by State Street- the Government Credit Bond Fund ("GCBF") and the Intermediate Bond Fund ("IBF") (collectively, the "Bond Funds"). In a previous opinion, the Court rejected State Street's challenge to the Plans' standing (and thereby PRIAC's) to bring this suit; denied State Street's motion for partial summary judgment, which argued that certain loans PRIAC made to the Plans would offset any damages awarded in this action; and dismissed PRIAC's claims for restitution, disgorgement, and permanent injunctive relief. See generally In re State Street Bank and Trust Co. ERISA Litig., 579 F. Supp. 2d 512 (S.D.N.Y. 2008). State Street filed its answer on October 27, 2008, bringing common-law counterclaims for contribution or indemnification and for defamation, and another counterclaim under the Massachusetts Unfair Trade Practices Act, Mass. Gen. Laws. ch. 93A, §§ 2, 11. Now before the Court are (1) State Street's motion for summary judgment based on a failure to mitigate damages and on the doctrine of superseding cause; (2) PRIAC's motion for partial summary judgment on State Street's contribution and indemnity, defamation, and Massachusetts Chapter 93A counterclaims; (3) State Street's cross-motion for partial summary judgment on its contribution counterclaim; and (4) State Street's motion to strike portions of the expert rebuttal report of Dennis E. Logue. The issue at the core of PRIAC's single cause of action-whether State Street breached a fiduciary duty under ERISA-is not addressed by the summary judgment motions. For the reasons that follow, State Street's motion and cross-motion for summary judgment are DENIED; PRIAC's motion for partial summary judgment is GRANTED as to the Massachusetts Chapter 93A counterclaim and DENIED as to the contribution and defamation counterclaims; and State Street's motion to strike sections of the expert report of Dennis E. Logue is DENIED.

BACKGROUND

I.The Parties

Plaintiff was established in 2004 when Prudential Financial, Inc. ("Prudential") acquired CIGNA Retirement & Investment Services ("CRIS") and renamed it PRIAC. (Pl.'s Rule 56.1 Stmt. ¶ 1; Def.'s Rule 56.1 Stmt. in Support of Motion for Summary Judgment ("Def.'s SJ Rule 56.1 Stmt") ¶ 6.) PRIAC provides investment options to defined benefit and defined contribution retirement plans; it provides these options to over 7,000 organizations and three million participants and beneficiaries. (Pl.'s Rule 56.1 Stmt. ¶¶ 1-3.) Plaintiff commenced this suit on behalf of the Plans, who invested in the Bond Funds through ERISA separate accounts (the "Separate Accounts") that PRIAC maintained. (Pl.'s Rule 56.1 Stmt. ¶ 4.) PRIAC's role with respect to the transactions at issue in this litigation was to serve as an intermediary between State Street and the Plans. (Def.'s SJ Rule 56.1 Stmt. ¶ 9.)

Defendant State Street, as trustee, established the IBF and the GCBF as unregistered collective trust funds. (Def.'s SJ Rule 56.1 Stmt. ¶ 5.) State Street's investment arm, State Street Global Advisors ("SSgA"),*fn3 a large institutional asset manager, managed the Bond Funds at issue in this case. (Pl.'s Rule 56.1 Stmt.¶¶ 7-9; Def.'s SJ Rule 56.1 Stmt ¶ 3.) The Fixed Income Group within SSgA played a central role in the investment management of the Bond Funds. (See PA 602 Wands.) *fn4 State Street is a recognized name among institutional asset managers and is regulated by state authorities, the Securities and Exchange Commission ("SEC"), and the Department of Labor. (Pl.'s Rule 56.1 Stmt. ¶¶ 12, 14, 15.)

II.The Bond Funds in PRIAC's "Manager of Managers" Program

The relationship between the parties reaches back to 1996, when CRIS offered the Bond Funds to its retirement plan clients. (Def.'s SJ Rule 56.1 Stmt. ¶ 5.) After Prudential acquired CRIS, PRIAC continued to offer the Bond Funds as part of its "Manager of Managers" ("MOM") program.*fn5 (Def.'s SJ Rule 56.1 Stmt. ¶ 6.) The MOM program was "specifically designed to help [defined contribution and defined benefit] plan sponsors manage their responsibilities in selecting and monitoring investments." (Palmer Decl. Ex. 5 at 1.) MOM had two major components: the Multi-Manager Matrix and the Prudential Due Diligence Advisor Program (the "DDA Program"). (Id. at 5.)

A.Institutional Sub-Advised and Alliance Funds in the Multi-Manager MatriX

The first component of the MOM program, the "Multi-Manager Matrix," classified funds so that plan sponsors could choose from "a comprehensive array of asset classes and fund offerings covering the full spectrum of risk and return objectives," which included hundreds of funds in various asset classes. (Palmer Decl. Ex. 5 at 6; Pl.'s Rule 56.1 Stmt. ¶ 32.) Each asset class contained two "primary types" of fund offerings: Institutional Sub-Advised and Alliance. (Palmer Decl. Ex. 5 at 6.) PRIAC took a more passive role with the latter category than it did with the former. With Institutional Sub-Advised Funds, PRIAC agreed on an investment strategy with the fund's investment manager and monitored the funds for the degree to which the manager adhered to the stated process and objective. (Pl.'s Rule 56.1 Stmt. ¶ 55.) PRIAC also had the authority to replace the investment manager of an Institutional Sub-Advised Fund. (Id. ¶ 56.)

With Alliance Funds, however, PRIAC advised clients that it could not "control the investment process in any way and cannot ensure style consistency." (Palmer Decl. Ex. 5 at 6.) PRIAC acknowledged that it was an ERISA fiduciary "for the selection, monitoring, and, if necessary, the deselection of the investment manager" for the Institutional Sub-Advised Funds, but only one for "selection and monitoring" for the Alliance Funds. (Id.) Although generally deselection was at the plan sponsor's discretion, "in extenuating circumstances," PRIAC could terminate an Alliance Fund "as a measure of last resort." (See id. at 6, 20.) PRIAC negotiated the investment strategy of an Institutional Sub-Advised Fund, but "the outside manager . . . controlled the investment process" of an Alliance Fund; that is, PRIAC had no input as to an outside manager's investment management, risk assessments, and investment decisions for an Alliance Fund. (Palms ¶ 11, PA 3;*fn6 see also Pl.'s Rule 56.1 Stmt. ¶ 10.) Furthermore, although PRIAC selected the funds comprising the menu of Alliance Funds from which plan sponsors and participants could choose, the plan sponsors and participants directed the investments of their plans within that menu. (See PA 2220.)

The separate accounts invested solely in the Bond Funds were Alliance Funds, in which PRIAC had the authority to discontinue investments only in extenuating circumstances as a measure of last resort. (Pl.'s Rule 56.1 Stmt. ¶ 37; see also Palmer Decl. Ex. 5 at 6.) PRIAC also had two "Balanced Funds," the Balanced Turner Fund and the Balanced Wellington Fund. (Pl.'s Rule 56.1 Stmt.¶ 57.) These funds were Institutional Sub-Advised Funds, with 40% of the fund invested in the IBF, and the remainder managed by Turner or Wellington. (Id. ¶ 58.) For these funds, PRIAC had the authority to discontinue investments in the IBF, even without extenuating circumstances. (See id. ¶ 56.)

B.The DDA Program

The second component of the MOM program, the DDA Program, was "the cornerstone of [PRIAC's] investment offerings, . . . [and] employ[ed] a disciplined process . . . for identifying, evaluating and selecting leading investment managers across asset classes." (Palmer Decl. Ex. 5 at 5.) PRIAC monitored the Bond Funds through the DDA Program, which purported to provide reporting and rigorous and objective analysis on funds. (See Pl.'s Rule 56.1 Stmt. ¶ 33, 44; Def.'s SJ Rule 56.1 Stmt. ¶ 12.) The MOM Program monitored funds "on an ongoing basis with the understanding that performance goals may not be met quarter to quarter, but are to be achieved over the longer term," (Palmer Decl. Ex. 5 at 13.), and the DDA Program used a "DDA Score," a composite score of a fund's past performance that weighted the longer term periods more heavily than shorter term periods, to monitor funds. (Palms ¶ 15, PA 4-5.)

The DDA Program also produced quarterly "DDA Reports" for each fund PRIAC offered, which were made available to clients. (Palms ¶ 14, PA 4.) The DDA Reports contained an explanation of the DDA Program, a summary of activity for each fund on the platform, a market review, fund performance and peer group rankings, and a page of data specific to each fund, such as the ten largest bond holdings of the fund, the fund's net asset value, and commentary on the fund's performance for each quarter. (Pl.'s Rule 56.1 Stmt. ¶ 54; Palms ¶¶ 14, 17, PA 4-5.) For each Alliance Fund, PRIAC defined a "peer group" for that fund using certain criteria. (Pl.'s Rule 56.1 Stmt. ¶ 51.) PRIAC then calculated the DDA Score for the Alliance Fund and for each peer fund, ranked the Alliance Fund among its peer funds, and included that peer ranking in the DDA Report. (Id. ¶ 52.) The DDA Reports contained data and commentary for 100 to 250 funds, and each report was 200 to 300 pages long. (Id. ¶ 62.)

In addition to information provided through the DDA Program, PRIAC provided "Fund Fact Sheets" to the Plans quarterly. These documents provided information about a fund's objectives, guidelines, and certain fund characteristics. (Palms ¶ 22, PA 6.) The Plans could also access daily performance and other information about the Bond Funds on PRIAC's Plan Sponsor and Plan Participant websites.*fn7 (Id. ¶ 24, PA 7.)

C.PRIAC's Use of Information Provided by State Street

PRIAC had a policy of not providing the names of its clients to anyone, including State Street. (Def.'s SJ Rule 56.1 Stmt ¶ 17.) State Street asked PRIAC for a list of investors in the Bond Funds in September 2007, but PRIAC refused. (Id.) For the Plans, then, PRIAC served as the primary conduit of information about the Bond Funds, although the Plans could access other publicly available information, such as the sector weights of benchmarks against which Funds were measured. (See Pl.'s Rule 56.1 Stmt. ¶ 65.) State Street provided to PRIAC monthly account summaries that reported on the performance of the Bond Funds and their benchmarks as well as quarterly qualitative and quantitative data reports that included additional information, such as the ten largest bond holdings of the fund, average coupon, average maturity, and a quarterly fund commentary. (Frascona ¶¶ 16, 18, PA 18-19.) PRIAC, in turn, would use this information in composing its DDA Reports and Fund Fact Sheets. (Id. ¶ 18.) PRIAC did not relay the information verbatim, but instead used its judgment to convey to its clients the information it deemed appropriate, which did not always include all the information State Street conveyed to it. (See Palms ¶¶ 14, 15, 17, 18, 22, PA 4-6.) State Street's monthly reports, for example, compared the sector allocations of the Bond Funds with those of their benchmarks, whereas the DDA Reports did not. (PA 825; Def.'s SJ Rule 56.1 Stmt. ¶ 29.) Instead, the DDA reports displayed a three-year average asset weighting for the funds' benchmarks. (Def.'s SJ Rule 56.1 Stmt. ¶ 29.)

D.The Watch List

PRIAC could alert its clients about the performance of an Alliance Fund via a quarterly "Watch List." Placement on the Watch List was a means of informing Plan Sponsors that PRIAC had concerns about the fund's performance or its investment manager. (Pl.'s Rule 56.1 Stmt. ¶ 43.) PRIAC compiled the Watch List after the end of each calendar quarter. (Id.) Typically, PRIAC's Investment Products team would identify Alliance Funds with which they had concerns at the end of each quarter, and submit this list to PRIAC's Separate Account Committee, who would decide ultimately whether to place the fund on the Watch List. (Palms ¶ 25, PA 7.)

III.The Bond Funds

A.Benchmarks

As mentioned above, the Plans, through PRIAC, invested in two particular funds at issue in this litigation, the GCBF and the IBF. Each of the Bond Funds used a Lehman Brothers Index as a benchmark by which the fund's performance could be measured; the GCBF used the Lehman Brothers Government Credit Bond Index, and the IBF used the Lehman Brothers Intermediate Government Credit Bond Index. (Pl.'s Rule 56.1 Stmt. ¶ 18.) The investment objective of the Bond Funds was to match or exceed the performance of the index by which they were measured. (See, e.g., PA 1432 ("The Investment Objective of the Fund shall be to match or exceed the return of the Lehman Brothers Intermediate Government Credit Bond Index . . . .").)

B."Enhanced Index" v. "Active" Funds

There is some dispute about how State Street categorized the Bond Funds. PRIAC asserts that State Street used three categories for their funds: "Passive" funds would closely track a benchmark index, "Active" funds sought more aggressive returns, and "Enhanced Index" funds would modestly outperform a benchmark index while mirroring its risk profile. (Pl.'s Rule 56.1 Stmt. ¶ 16.) Indeed, several State Street presentations depict "Enhanced Index" as a category between "Active" and "Passive." (E.g., PA 1908, 1943; PA 2119.) State Street, however, disputes that the "Enhanced Index" characterization had any consistent meaning, and emphasizes that the term has no accepted industry-wide meaning. (See Maher Decl. Ex. 8 at 238:9-238:23, Ex. 68 at 31:24-32:8; Def's SJ Rule 56.1 Stmt. ¶ 23.)*fn8 State Street maintains, therefore, that the Bond Funds are "Active" funds. It is undisputed that "enhanced index," to the extent the term is meaningful, would imply at least some "active management qualities." (Def.'s SJ Rule 56.1 Stmt. ¶ 24.)

Descriptions of the Bond Funds within a single document lend support for both interpretations of their categorization. One State Street presentation, for example, describes the "investment philosophy" of the Bond Funds as a "risk-controlled process [that] ensures consistent, steady performance," implying that the Bond Funds lie between Active and Passive, but elsewhere describes the Bond Funds' "active core bond strategy." (Compare PA 2050 with PA 2092-94.) The confusion exists elsewhere. An e-mail from Robert Frascona, Vice President of Investment Product Management for PRIAC, acknowledges that "SSgA characterizes the [GCBF] and [IBF] strategies as actively managed," but also says that "they truly fall between passive management . . . and active management." (Maher Decl. Ex. 72 at 334233.) A State Street employee described the fee paid to State Street for the Bond Funds as "recogniz[ing] the role of enhanced funds between active and passive strategies." (PA 1651.)

Regardless of whether State Street intended to distinguish the Bond Funds from Active Funds by describing them as "Enhanced Index" on some occasions, PRIAC described the Bond Funds as "enhanced index" funds in certain materials that it sent to its clients in early 2005. (See PA 1057-58, 1061.) PRIAC also stated that the Bond Funds "combine[] the usually predictable strength of passive management with the repeatable aspects of active management to seek to provide a stable pattern of incremental returns" in its Fund Fact Sheets. (Pl.'s Rule 56.1 Stmt. ¶ 26.) The Fact Fund Sheets also described State Street's management style as "enhanced" from 1996 through 2007. (Id. ¶ 25.) State Street reviewed Fact Fund Sheets containing the language described above on March 30, 2005 and August 1, 2007 and generally found them to be accurate, though it did not specifically comment on the relevant language. (PA 1057, 1355.) Until July 2005, PRIAC had sent Fund Fact Sheets to State Street for its review and approval each quarter, but PRIAC stopped this practice in mid-2005 to speed up the production and delivery to clients of the Fund Fact Sheets. (Pl.'s Rule 56.1 Stmt. ¶¶ 84, 85.)

C.Targeted Excess Returns and Predicted Tracking Error

Related to the categorization of "Active" or "Enhanced Index" are the Bond Funds' targeted excess returns and predicted tracking error as compared to their benchmarks. Both of these characteristics are measured in "basis points." Each basis point represents a 0.01% deviation from the benchmark. The points for targeted excess returns represent the margin by which the Bond Funds strove to outperform their benchmark; the predicted tracking error measured the anticipated deviation from the benchmark.

In 2003, in a presentation to PRIAC's predecessor, State Street stated that the Bond Funds' targeted excess return was 30 to 40 basis points (0.3-0.4%), and its target predicted tracking error was 40 to 50 basis points. (PA 2050.) CIGNA informed State Street that the Bond Funds were available for selection if Plan Sponsors chose the "particular style offered by the strategies-low tracking error fixed income." (PA 2027.) In February 2005, State Street informed PRIAC that the Bond Funds' excess returns target was 40 to 60 basis points and that their targeted predicted tracking error was 50 to 75 basis points. (Pl.'s Rule 56.1 Stmt. ¶ 24; Maher Decl. Ex. 8 at 564:9-565:9.)

In early 2006, State Street increased the excess returns target for the Bond Funds to 70 to 80 basis points. (Pl.'s Rule 56.1 Stmt. ¶ 96.) State Street never specifically disclosed this to PRIAC. (Compare PA 1574 with Frascona ¶ 9, PA 17; see also PA 2145 ("Our fee structure may very well suggest that our strategy is 'only' enhanced . . . .").) State Street informed PRIAC that there had been no changes in its investment strategy for the Bond Funds in September 2005 and August 2007-a statement that State Street contends is true because its view is that the Bond Funds were "Active" all along. (Pl.'s Rule 56.1 Stmt. ¶ 28.)

IV.Investment Strategy for the Bond Funds from 2005 to 2007

A.Active Management

The overall investment philosophy of State Street's Fixed Income Group provides a backdrop to the increase in the excess return targets for the Bond Funds from 2005 to 2007. At the end of 2005, State Street's chief executive officer set for the Fixed Income Group a goal of tripling the group's revenues and assets under management within three years. (Pl.'s Rule 56.1 Stmt. ¶ 91.) Typically State Street set its fees at 20-25% of a fund's excess return target, so the fee for an active fund would be higher than that for a passive fund. (PA 498 Kelly.) Although State Street had primarily been known as a passive fund manager in the past, State Street's executive group wanted the fixed income team's active fixed-income capabilities to be more widely known in 2006. (PA 466-69 Greff; PA 490-91 Hunt; PA 606-07 Wands.) In that year, State Street had eight "global strategy initiatives," known as the G-8, the third of which was "Leveraging Fixed Income." (PA 2153.) As part of implementing these initiatives, the Fixed Income Group decided to "take more active risk" in its bond investments and to "[g]enerate higher returns for clients in existing products." (Pl.'s Rule 56.1 Stmt. ¶ 95.) By early 2006, State Street had increased the return targets for the Bond Funds to 70 to 80 basis points above their respective benchmarks, a target consistent with an active fund. (Id. ¶ 96; PA 544-46 Pickett.)

B.The Limited Duration Bond Fund

State Street also invested the Bond Funds in the Limited Duration Bond Fund ("LDBF"), a "portable alpha" fund State Street managed and in which other State Street-managed funds invested. (See Pl.'s Rule 56.1 Stmt. ¶¶ 101, 102, 107.) Portable alpha refers to a strategy in which a number of funds invest in one "alpha-seeking" fund; alpha refers to the excess return on an investment over its benchmark. (Id. ¶¶ 102, 103.) In 2006 and 2007, the LDBF invested in home equity asset-backed securities ("ABS"), and by early 2007, virtually all of the LDBF's assets were invested in subprime mortgage-related securities.*fn9 (Id. ¶¶ 104, 105.)

C.Leverage

Between 2005 and 2007, State Street increased its use of leverage in the IBF and the GCBF. "Leverage" involves the use of financial instruments or debt to increase exposure to an investment beyond the cash invested. (Pl.'s Rule 56.1 Stmt.¶ 72.) Specifically, State Street increased the leverage in the IBF from 1.28 in September 2005 to 4.56 at the end of July 2007, and in the GCBF from 1.35 in September 2005 to 6.1 at the end of July 2007. (Id. ¶ 117.)

V.Disclosures Regarding the Bond Funds Between 2005 and 2007

A.The "Passive" Name Change for the IBF

On September 19, 2005, State Street advised PRIAC that it had made changes to certain funds to create operational efficiencies, including minor name changes. (Pl.'s Rule 56.1 Stmt. ¶ 78.) Sonya Hughes, State Street's "relationship manager" for PRIAC at the time, sent PRIAC an e-mail that mistakenly indicated that the name of the IBF had changed to the "Passive Intermediate Bond Index Securities Lending Series Fund." (Def.'s SJ Rule 56.1 Stmt. ¶ 18.) A fund declaration also included "passive" and "index" in the IBF's name. (Pl.'s Rule 56.1 Stmt. ¶ 79.) PRIAC requested a conference call to speak with State Street generally about the September 19, 2005 changes to the funds, though not specifically one to discuss the name change. (Id. ¶ 80.) After that call, Hughes sent a document to PRIAC confirming that the name of the IBF had been changed to include the words "passive" and "index." (See id. ¶ 81; PA 669.) The document also indicated that the investment objectives of the funds listed, including the IBF, had not changed. (PA 669.) Following this, PRIAC used the new name for the IBF in its communications with the Plans from October 2005 to July 2007, and its materials referred to the IBF as the Passive Intermediate Bond Index Fund during that time. (Id. ¶ 82.)

During this time, PRIAC employees responsible for monitoring the IBF believed that the IBF, despite its name, was an enhanced index fund. (Def.'s SJ Rule 56.1 Stmt. ¶ 19.) As noted, an enhanced index fund, to the extent the term has meaning, is not the same as a passive or index fund because of certain active management qualities. (Def.'s SJ Rule 56.1 Stmt. ¶ 24.) PRIAC continued, however, to use the new name for the IBF after State Street had advised PRIAC twice regarding the name change.

In late June 2007, PRIAC asked State Street about the accuracy of the IBF's name. (Pl.'s Rule 56.1 Stmt. ¶ 86.) Specifically, Matthew Dingee, a PRIAC investment analyst responsible for monitoring the IBF, forwarded Sonya Hughes's September 2005 e-mail regarding the name change to Mark Flinn, the new relationship manager for PRIAC at State Street, and stated that PRIAC was "confused as to why the fund's performance matches what SSgA considers to be the Active Intermediate Bond Fund (i.e., in the Q1 SSgA Investment commentary . . . )." (Palmer Ex. 21 at 529728.) On July 12, 2007, Flinn e-mailed Robert Frascona of PRIAC to confirm that State Street had mistakenly provided PRIAC with an incorrect name for the IBF and attached a document indicating the correct name for the IBF and that the IBF was an actively managed fund. (Pl.'s Rule 56.1 Stmt. ¶ 87; Def.'s SJ Rule 56.1 Stmt. ¶ 46.) State Street reiterated these points on a July 18, 2007 conference call with CIGNA, PRIAC, and State Street. (Def.'s SJ Rule 56.1 Stmt. ¶ 47.)

On July 27, 2007, Frascona internally forwarded to Dingee an IBF fact sheet that Dingee was to ask State Street to review for accuracy. (Def.'s SJ Rule 56.1 Stmt. ¶ 48.) Dingee did so, forwarding that fact sheet to Flinn at State Street on July 30, 2007. (Id. ¶ 49; Pl.'s Rule 56.1 Stmt. ¶ 88.) Because PRIAC had stopped regularly sending fact sheets to investment managers for quarterly review in mid-2005, this was the first time State Street had reviewed the IBF fact sheet since that time. (See Pl.'s Rule 56.1 Stmt. ¶¶ 84, 85.) On August 1, 2007, State Street responded that the name of the IBF was inaccurate on the Fund Fact Sheet. (Id. ¶ 89.) That same day, Frascona e-mailed co-workers at PRIAC to inform them that because they had "recently" been advised by State Street that they were using an incorrect name for the IBF, they were "immediately" changing the name of the fund. (Def.'s SJ Rule 56.1 Stmt. ¶ 52.) PRIAC updated its websites that day and began the process of correcting in-production reports to reflect the IBF's corrected name. (Pl.'s Rule 56.1 Stmt.¶ 90.) PRIAC ultimately notified its clients (other than CIGNA, who was already aware) of the name change by a method other than its website on August 20, 2007. (Maher Decl. Ex. 51, at Answer to Interrogatory No. 8.)

B. Leverage Disclosure

In the fourth quarter 2004 report for the GCBF, State Street showed sector allocations totaling 116%; the 2004 report for the IBF showed sector allocations totaling 100%. (Pl.'s Rule 56.1 Stmt. ¶ 73.) When PRIAC asked State Street why the total for the GCBF was over 100%, State Street explained that 116% included the GCBF's leverage component which might hold "a future or a swap." (Id.) PRIAC was therefore aware that the funds could use, and at least in GCBF's case, had previously used, moderate leverage to achieve returns above those of their benchmarks. (Id. ¶ 77.) In early 2005, State Street made an internal decision to "normalize" sector weights in its reports so that the weights would total 100%, even if the amount of invested assets exceeded the amount invested in a fund because of leverage. (Id. ¶ 75.) Subsequent reports did not disclose negative cash or sector exposures of more than 100%. (See PA 1047; PA 1082; PA 2161-63.) State Street's monthly and quarterly reports to PRIAC after this decision therefore did not show leverage in the Bond Funds. (Pl.'s Rule 56.1 Stmt ¶ 118.)

On July 12, 2007, PRIAC received from State Street a spreadsheet showing portfolio holdings of the IBF and a breakdown of the components of the IBF's ABS exposure. (Pl.'s Rule 56.1 Stmt. ¶ 136.) The spreadsheet listed the over 2,600 individual holdings of the IBF, associating each one with an alphanumeric identifier, a notional amount, and a description such as "US TREASURY BONDS," "CSX CORP," or "IRSwap USD 4.0 L1BOR 2Y." (See PA 689-776.) Although it was possible to divine the amount of leverage (namely, 4 to 1) in the IBF from this spreadsheet and other available information, PRIAC employees who received it at the time either did not conduct a detailed enough review to reveal that leverage or could not understand it. (See PA 516 Kinney; Dingee ¶ 6, PA 24; Palmer Decl. Ex. 18 ("Molinaro Dep.") at 105:21-107:6.)

C.Other Disclosures

i.Performance of the Bond Funds Compared with Their Benchmarks

State Street sent monthly reports to PRIAC that reported the Bond Funds' investment in various sectors by percentages as well as supplemental quantitative and qualitative information that reported other characteristics of the Bond Funds, such as their ten largest bond holdings, average coupon, average maturity, and a quarterly fund commentary. (Pl.'s Rule 56.1 Stmt. ¶¶ 69-70.) The reports showed that the performance of the Bond Funds, at times, varied from their benchmarks. In December 2006, for example, the IBF outperformed its benchmark by 69 basis points for the month, and by 27 basis points over a five year period; the GCBF outperformed its benchmark by 8 basis points that month, and by 23 points over a five year period. (Palmer Decl. Ex. 31 at 8182.) Performance in individual months would vary. In June 2006, both Bond Funds underperformed, the GCBF by 3 basis points, and the IBF by 2 basis points. (PA 2706.) And by March 31, 2007, the long-term performance of the Bond Funds showed less of a variance from their benchmarks than they did in December 2006. At that point, the IBF outperformed its benchmark by 10 basis points over a five-year period and just 6 points over a ten-year period; the GCBF outperformed its benchmark by 6 basis points over a five-year period and actually underperformed relative to its benchmark by 6 basis points over a ten-year period. (PA 1078; PA 1073.)

ii.Investment Strategy

State Street never specifically disclosed to PRIAC that the Bond Funds' target was 70 to 80 basis points above their benchmarks. (Compare PA 1574 with Frascona ¶ 9, PA 17; see also PA 2145 ("Our fee structure may very well suggest that our strategy is 'only' enhanced . . . .").) In February 2005, State Street did disclose that "[t]he strategy's goal is to generate excess returns of 40-60 bps [basis points], while targeted predicted tracking error is 50-75 bps. More recently we have generated less excess return than our goal, but we have also had a lower predicted tracking error. . . . We have started to increase both the tracking error and hopefully the excess returns." (PA 987.) In its commentaries for the fourth quarter of 2006 and the first quarter of 2007 on the Bond Funds, State Street also used the word "active" in the name of each fund, as opposed to its use of the word "passive" in the IBF's name in 2005. (Maher Decl. Ex. 27 at 7411; Ex. 28 at 274915; see also Pl.'s Rule 56.1 Stmt. ¶ 79.) Also, State Street's commentary for the first quarter of 2006 on the GCBF mentioned that "[o]verweight positions to the long triple B securitized debt sector" made a "[c]ontribution to excess return in our strategy" and that the GCBF would "maintain our existing triple B home equity exposure," although it did not explain those statements beyond that. (Palmer Decl. Ex. 40 at 6247.) PRIAC reviewed this commentary and used portions of it in its DDA Reports. (Def.'s SJ Rule 56.1 Stmt. ¶ 27.)

PRIAC knew in 2006 and 2007 that State Street's investment strategy for the Bond Funds involved making some investments in sectors in which their benchmarks did not invest to generate returns above those of the benchmarks. (Pl.'s Rule 56.1 Stmt. ¶ 109.) PRIAC also knew during that time that some of the Bond Funds' ABS holdings were backed by the home equity market. (Id. ¶ 114.) State Street's monthly reports did not detail the specific types of ABS exposure or break down by type the Bond Funds' ABS investments, although some quarterly commentaries alluded to subprime exposure, as discussed above. (Frascona ¶ 17, PA 19.) State Street did not inform PRIAC of the Bond Fund's investments in the LDBF until July 2007. (Pl.'s Rule 56.1 Stmt. ¶ 108.)

iii.Sector Composition

The reports also indicated that the Bond Funds invested in certain sectors, including asset-backed securities, that their benchmarks did not. (Def.'s SJ Rule 56.1 Stmt. ¶ 25.) The reported ABS holdings of the Bond Funds fluctuated during 2006 and 2007, as shown in the graphs below:

(PA 2595; PA 2617; PA 2639; PA 2668; PA 2690; PA 2712; PA 2742; PA 2764; PA 2785; PA 2817; PA 2839; PA 2861; PA 2892; Palmer Decl. Ex. 35 at 527898; Palmer Decl. Ex. 36 at 534579; PA 2914.)

(PA 2597; PA 2619; PA 2641; PA 2670; PA 2692; PA 2714; PA 2744; PA 2766; PA 2787; PA 2819; PA 2841; PA 2863; PA 2894; Palmer Decl. Ex. 35 at 527900; Palmer Decl. Ex. 36 at 534581; PA 2916.) Over this period, the State Street reports also indicated that the Bond Funds' ...


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