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WASHINGTON, July 25 (Reuters) - U.S. government lawyers asked federal regulators on Friday to overturn a judge's ruling dismissing their case against two former State Street Corp executives accused of misleading investors in a fund exposed to subprime mortgages.
In oral arguments, the Securities and Exchange Commission's enforcement division told SEC commissioners it had convincing evidence the two men misled investors.
"The federal securities laws do not permit individuals to lie about what is in a portfolio," SEC enforcement attorney Kathleen Shields said. "When they choose to speak about it, they have to make accurate representations."
In October 2011, SEC Chief Administrative Law Judge Brenda Murray dismissed fraud claims against State Street's former chief investment officer, John Flannery, and the bank's former product engineer, James Hopkins, saying she felt they exhibited "candor" and that the division's case lacked evidence.
The decision was a blow for the SEC, which has fought to defend its record of targeting some bank officials for alleged wrongdoing during the 2007-2009 financial crisis.
The appeal also comes amid increasing scrutiny of the agency's track record in trials.
Although the SEC has had some big wins, it has also suffered from a string of recent losses, primarily in insider-trading cases.
In the case against Flannery and Hopkins, the SEC alleges each had a key role in marketing the bank's Limited Duration Bond fund, which was supposed to serve as an alternative to a money market fund, generally considered a safe investment.
The SEC, however, said the fund in 2007 was almost entirely invested in subprime mortgage-backed securities. Such assets, made up of loans to those with poor credit and other high-risk borrowers, are often blamed for triggering the financial crisis.
Flannery and Hopkins were involved in drafting letters and other communications to investors that failed to disclose the full picture of the fund's subprime concentration.
Lawyers for the two men on Friday disputed those accusations and urged the SEC to uphold Murray's 2011 decision.
"Jim Hopkins ... did nothing wrong. He was a good man. He has been living with this cloud over his head for many years," said John Sylvia, an attorney for Hopkins.
"The division had a full and fair opportunity to make their case and didn't because there was no case."
The SEC's commissioners did not give any hints on how they may rule in the matter.
In several instances, SEC Chair Mary Jo White and Democratic Commissioner Kara Stein asked an attorney for Flannery questions about his client's role in drafting some of the letters and whether their contents were deceptive.
"Even if Mr. Flannery did not make the statements in the ... letters or preside over them ... why did he not commit a deceptive act by participating in the drafting" of letters that may have "omitted material facts?" White asked.
The SEC's five commissioners must now issue a ruling in the case. If the losing party disagrees with the decision, it can still be appealed to a federal appeals court. (Reporting by Sarah N. Lynch; Editing by Paul Simao)