Prudential sues State Street units for fund losses

NEW YORK (Reuters) - U.S. insurer Prudential Financial Inc (PRU.N) said its retirement unit had filed suit against units of State Street Corp (STT.N) seeking restitution for funds sold by State Street that suffered heavy losses.

The insurer said in a filing with the U.S. Securities and Exchange Commission that results for the latest quarter would include a pretax charge of about $80 million to reflect payments to clients who suffered losses from the funds.

State Street responded by saying it was "disappointed" with Prudential's action and would "vigorously defend ourselves."

The suit, filed in U.S. District Court for the Southern District of New York, claims State Street Global Advisors and affiliate State Street Bank and Trust Co engaged in "deceptive, imprudent and incompetent" investing in their Intermediate Bond Fund and Government Credit Bond Fund.

Without notifying Prudential or its retirement plan participants, State Street made "undisclosed, highly-leveraged investments in mortgage-related financial instruments," Prudential charged in its suit.

State Street's inappropriate investments produced "catastrophic results" in the summer of 2007, and the two bond funds fell short of their benchmarks by about 28 percent and 14 percent respectively, the suit charges.

State Street spokeswoman Arlene Roberts said in a statement that the funds Prudential's clients were invested in were "actively managed, which entails market risk."

"The recent market conditions and lack of liquidity were unprecedented," Roberts said. "An unfortunate result ... is that some funds lost value."

In its suit, Prudential said State Street had invested in a "relatively new" synthetic index whose returns were linked to 20 subprime U.S. mortgage pools. There have been a surge of defaults in recent months on subprime mortgages, or loans to home buyers with lower credit scores.

(Reporting by Ed Leefeldt and Muralikumar Anantharaman in Boston)