Earlier this month, a subsidiary of Prudential Financial sued State Street Corp., alleging that $80 million in losses incurred by its clients resulted from State Street investing in high-risk subprime mortgage-backed securities without informing Prudential.

“The suit is probably the first under the federal Employee Retirement Income Security Act alleging breach of fiduciary duty relating to the subprime mortgage collapse,” said Frederick Brodie, a partner in the New York office of Pillsbury Winthrop Shaw Pittman and leader of the firm's ERISA litigation team.

“Under ERISA, Prudential and State Street are both fiduciaries because both have discretion or control over the plan assets,” Brodie said. “However…Prudential is trying to shift the fiduciary liability to State Street.”

“Despite its monitoring of State Street, Prudential alleges the firm didn't tell it the assets had been invested differently from what State Street had promise,” Brodie explained. “The suit is unusual because Prudential charges [that] State Street's practices are deceptive, imprudent and incompetent. It is not typical for financial institutions to get into that kind of bare-knuckled fight in litigation.”

According to Brodie, “Under ERISA, when an entity is investing plan assets, it should have a prudent procedure in place for selecting the investments in which the assets are being placed. The entity then needs to reasonably monitor the performance of the investment managers with whom those assets are placed.”

But, Brodie says, “The duty to monitor hasn't been clearly defined by the U.S. courts or by regulators…[and] without specific legal guidance, fiduciaries have to act reasonably and prudently. In this case, Prudential alleges that despite any monitoring, it was unable to prevent the losses because State Street misled it.”